Many health systems are not currently considering inpatient capital projects because it is incredibly difficult to generate an appropriate profit margin with the current market pressures around reimbursement, rising expenses, and construction cost escalation. Expenses are even more challenging after COVID-19: national total expenses are up 18% YTD 2023 versus YTD 2020.
But if a health system’s need for additional bed capacity is significant enough or aged facilities create a cost or competitive imperative, we illustrate the layers of due diligence we undertake to generate a positive ROI (Return on Investment) on the investment.
Instead of starting with an inpatient bed target in mind, we start with the desired return on investment. At the end of the day, the financial pro-forma of a project will either enable it to be approved and move forward or become another “nice idea.” So why leave it at the end of your planning process to become a frustrating exercise of value engineering?
Here we will break down the components of achieving a positive ROI on an inpatient project:
- Increase the right type of revenue.
- Reduce fixed costs.
- Reduce variable costs.
- Right-size the project based on margin, not volume. (We realize this is a provocative statement.)
1. Focusing on the Right Type of Incoming Revenue
- Market Demand. Is the project located in a rapidly growing market? Most markets are experiencing stagnant to declining population growth. An estimated 87.7% of U.S. Counties experienced population growth of less than 1,000 people between 2021 and 2022. In our fee-for-service environment, there are still incentives to drive volume for certain specialties and within certain payer classes. A market analysis is a good starting point to identify untapped market demand and its potential to support your inpatient project.
- Reimbursement. Academic medical centers (AMCs) are typically well-positioned for inpatient expansion given their higher case mix index (CMI) and downstream revenue. For instance, Stanford Hospital’s average revenue per bed is almost 800% higher than the national average, at just over $49.5M average annual revenue per bed (AHD) compared to the national average annual revenue per bed of $6.2M. With this kind of revenue stream, it is easier to absorb sizeable increases in construction costs.
But even if you are not an academic medical center, leveraging your payer mix and contract negotiations based on performance and quality of care can incrementally increase your reimbursement and start to boost your margin for existing volumes.
- Referrals. Rising expenses aside, a major reason several inpatient projects never hit their ROI target is that original volume projections did not come to fruition. We recommend taking a conservative approach when projecting future volume by overlaying market utilization trends and embedding only volume growth that has a commitment from referring providers and current recruitment initiatives.
- Case Mix / Acuity Level. If a system has multiple hospitals across its market, there is an opportunity to shift services to maximize each campus’s case mix index (CMI) and associated reimbursement. We call this lever “geographic level loading” and it can help support replacement beds or desired referral patterns for expected ROI. But be careful not to “rob Peter to pay Paul." Otherwise, everyone loses.
- Payer Negotiations. While these do not occur frequently, there are opportunities during renewal periods to negotiate higher rates based on volume and outcomes. Data is crucial to building a persuasive case for higher reimbursement. We recommend this regardless of associated capital deployment as it is good balance sheet and liquidity management, but it is becoming increasingly harder to do in today’s payer environment, especially for inpatients.
- Revenue per Square Foot. One metric we scrutinize when planning for strategic success is revenue per square foot targets. Profitable retail businesses use this metric to size their footprints appropriately. For instance, Starbucks generates $781 in revenue per square foot, and this is why different stores are larger or smaller in different markets. If you follow the mantra of margin before volume, you will start to manage your overall service portfolio and capital more efficiently while still proving core mission-driven services. Hence Sister Irene Kraus’ motto, “no margin, no mission.”
2. Fixed Costs
The premise of this category is that if a proposed inpatient project cannot be profitable by moving the needle on the revenue, then it must become profitable by reducing costs. For instance, for each new case we add, the fixed cost per case is reduced. Fixed costs can include buildings, equipment, IT, housekeeping, and medical records, among other things.
- Reduce fixed costs by increasing facility utilization. Capacity challenges may drive the need for new inpatient beds at one hospital, but before you build, look for existing underutilized beds across the system. Consolidate low-volume locations to have fewer but more highly utilized inpatient service offerings, by emphasizing different specialties at distinct locations rather than trying to offer everything at every location. For instance, shift services so that different campuses have different focus areas, such as ortho, cardiac, and oncology. We use market data and capacity analyses to help quantify the amount of space that can support a fiscally viable utilization percentage.
The days of planning around 65-75% utilization are gone. If it does not consistently hit 80% or above, it most likely will not cover both indirect and direct expenses. Too many of our capital projects only focus on direct expenses plus capital and assume the indirect are handled by corporate or in another category outside the proforma. Our motto: “fill it or kill it!” Facility variability and specialization can also erode utilization so when you are planning new facilities or evaluating existing ones, look for opportunities to create a flexible standard.
3. Variable Costs
While it can be challenging to manage variable costs like supplies, medicine, and overtime, there are opportunities for cost savings centered around efficient operations and contracting. From an inpatient operations perspective, dated infrastructure and design can lead to inferior operations because of extended travel distances, insufficient staffing ratios, and physical workarounds.
- Length of Stay. Is the justification for a new inpatient project that an existing inpatient platform does not have the capacity? Perhaps the underlying problem is that ALOS (Average Length of Stay) is going up. Here, a quick review of ALOS trends often reveals that the unit has treated more patients with a shorter length of stay in the past, cycling them through more quickly so that a larger volume can be treated. In these instances, we recommend operational improvements to reduce capacity needs, such as addressing the root causes of slow discharges. Perhaps the true need is for a skilled nursing facility so that inpatients have somewhere to be discharged, and that is a much more affordable solution than building additional inpatient beds.
- Staff Utilization. We recommend designing inpatient units in even multiples of the system’s preferred nursing ratio. So, if the system has a ratio of 1:6, then a unit with 30, 36, or 42 beds utilizes staff more efficiently than a unit with 32, 37, or 40 beds. Additionally, larger nursing units have been found to be more efficient to operate from a staffing perspective.
4. Make the Project Smaller
If a project has the potential to be profitable, we challenge the team to create the most rightsized construction solution possible in the following ways:
- "Shrink to grow." Leveraging the same market analysis used to identify growth opportunities, systems can also evaluate if there are over-bedded services across the market and opportunities to shed low-volume, non-profitable service lines. This strategy allows hospitals to avoid the “jack of all trades, master of none” conundrum and focus on its core inpatient services. Once a system goes through this exercise, it may find existing capacity within the system to leverage to reduce the size of its new inpatient build.
- I2 Versus Business Occupancy. Greenfield I-2 construction costs in most parts of the U.S. are currently in the range of $700-800 per square foot, whereas business occupancy construction costs are $500-600 per square foot. Because of this, when building new healthcare projects, we tend to take functions such as administrative space, facilities management, case management, physical therapy, lab, and pharmacy out of the hospital and into an adjacent medical office building or other business occupancy space.
This way they have functional proximity and adjacency without paying extra to build them. Similarly, when splitting the hospital functions into business occupancy, "adjacent" could actually be within the same building as long as the functions have appropriate fire separation.
Just as we are looking to lower costs by having all licensed personnel work at the top of their license and be well supported, we want I2 space to function "top of license" and house only what is absolutely necessary for that complexity of infrastructure and construction.
- Make Sure Outpatient, Non-Clinical, and Administrative Functions Are Off Campus. We recently helped a capacity-constrained academic medical center position the “highest and best use” functions on its inpatient campus, reallocating twenty-seven departments to liberate 80,000 square feet for new revenue-generating clinical services. For example, by relocating Team Member Health, we were able to backfill the space with much-needed additional PICU (Pediatric Intensive Care Unit) beds. Be mindful that this is often a substantial change management initiative for the organization and may require some level of service and staffing duplication and inefficiencies if current resources are shared and cover multiple departments or services. Weighing the cost benefit of separation for long-term operations versus initial capital cost is vital.
- Benchmarked SF per Planning Target. We recently trimmed more than 20,000 square feet of I2 construction out of a floor plan, saving the client more than $10m in renovation costs. We measured that the proposed design had larger than necessary square footage in several areas, exceeding FGI (Facility Guidelines Institute) and other commonly used benchmarks. Circulation consumes a huge amount of space and often erodes margin faster than any other design element.
Many of these cuts came from asking questions about non-clinical spaces in I2 construction. The following examples show the different types of data we use to pressure-test the true capacity needs of a space:
- Badge swipe data in administrative offices to show how frequently the space is utilized. This helps clarify utilization in the new hybrid work environment to ensure we are not overbuilding space.
- FGI guidelines and internal SF (Square Feet) benchmarks to ensure we are not overbuilding or overdesigning.
- Operational time-stamp data to identify bottlenecks and inefficiencies. For instance, data may highlight delays in OR First Case On-Time Starts - suggesting we are not maximizing our OR (Operating Room) capacity or staff.
- Clinical and operational interviews where we ask about staff locker and lounge space needs, how many guests visit the chapel, whether recovery patients need a private toilet given their procedure type, and so forth.
Ultimately, we foresee that remote monitoring and hospital at home will reduce the size and number of beds in brick-and-mortar inpatient solutions. As we start to anticipate that future, it is important not to overbuild, and build only what we can afford with inpatient projects that produce margins for long-term viability and to fund community mission-driven services.
About the Author
Erin Nelson is a Managing Director in the Ankura Healthcare Real Estate Strategy group. Her recommendations help our clients better serve the needs of their communities, save money through service lines and real estate rationalization, and plan for the emergence of new care delivery models. Erin also leverages predictive analytical models and market analytics to determine space utilization and opportunities for operational improvement. Erin has performed capacity and market analyses for campuses from greenfield micro-hospital sites to multi-campus academic medical centers.
The Ankura Healthcare Real Estate Strategy group helps healthcare providers manage costs and risks to ensure that their investments realize their financial value to the organization today and decades into the future. We are an experienced team of professionals who create targeted solutions using strategic imperatives and data justification. Our investment scenarios include operational metrics to cultivate leadership consensus around future performance targets and financial viability.
© Copyright 2023. The views expressed herein are those of the author(s) and not necessarily the views of Ankura Consulting Group, LLC., its management, its subsidiaries, its affiliates, or its other professionals. Ankura is not a law firm and cannot provide legal advice.