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Why Strategic Cost Management is Essential for Your Hospital

CONFIDENTIAL AND PROPRIETARYAny use of this material without specific permission of McKinsey & Company is strictly prohibited

May 15, 2014Presentation document

McKinsey & Company | 2

McKinsey is one of the leading global management consulting firms, with deep experience serving providers and the healthcare industry

Depth of provider expertise Over 300 engagements for ~100 providers in past 5 years, e.g.,

7 of the 10 largest U.S. hospital systems 9 leading AMCs and 5 leading children’s hospitals Dozens of independent hospitals and small systems

US Health Reform Center founded by former special assistant to President

Global, cross industry insights▪ Founded in 1926, 94 offices in 55 countries

▪ 20 industry sectors and 7 functional practices ▪ Serve 94% of 100 leading global corporations, and 75% of top 100

US companies

Breadth across health care chain▪ Serve 9 of the 10 largest managed care firms

▪ Governments and health systems in 17 countries and 5 US states▪ 19 of the top 20 global Pharma, biotech, and device companies

▪ Foundations, multilaterals, and NGOs in global public health

McKinsey & Company |

Objective Health is a specialized group within McKinsey, focused on advanced analytics to help health systems make better decisions and achieve sustainable results

▪ Specialized group within McKinsey & Company that uses advisory expertise, advanced analytics, and tools to empower hospitals to improve, survive, and thrive

▪ We provide a unique approach utilizing proprietary healthcare analytics, detailed benchmarks, and extensive hospital expertise to quickly identify and seize the right opportunities

▪ Hospital-specific tools and services help your organization initiate, track, and sustain long-term results

Healthcare Systems & Services

Global Healthcare Practice


▪ Why is strategic cost management important?

▪ Case study: 500 bed health network

Contents


Healthcare cost is trending further upward globally

1 Assumptions: GDP growth of 2% (OECD-Prognosis, 2000-50). Healthcare spending increases 1.9 basis points faster (OECD historical rate)

SOURCES: OECD Policy Implications of the New Economy – 2000-50, 2001; Global Insight WMM, 2000-37; Espicom: World Pharmaceutical Fact Book, 2008; International Monetary Fund; World Economic Outlook Database, October 2009; McKinsey

<10 10-15 >15

Share of healthcare costs as part of GDP%1

Hong Kong

Spain

Italy

U.K.

Australia

5.9

6.0

7.8

8.8

9.3

10.5

Country

Korea

2008

Canada

Germany

France

U.S.

10.8

10.8

11.2

16.1

6.8

8.9

10.0

10.6

10.5

8.17.4

7.5

6.7

8.2

9.7 10.7

11.0

11.6

13.1

12.0

12.7

14.4

2015 2020 2025

8.9

9.0

11.7

13.2

14.0

15.8

2030

12.3

12.3

12.7

18.3

13.5 14.8

13.5

14.0

20.1

14.8

15.3

22.0

16.2

16.2

16.8

24.2

Global trend in healthcare


Operating expenses have grown consistently in recent years and the pace of growth is expected to continue to outpace inflation

7,000

8,000

9,000

10,000

11,000

2013

+1% p.a. +2% p.a.+3% p.a.

+4% p.a.

121110092008

+2% p.a.▪ Represents

10% increase over 2008 rates

▪ 3.4% higher than inflation over same time period

Source: Publicly reported provider financials (includes CYH, HCA, HMA, LPNT, THC,UHS); www.usinflationcalculator.com/inflation/current-inflation-rates

Operating expenses per AA

$ per AA

Historical cost growth


Payor mix

Non-government insured patient days as a percent of total patient days, n =1757

38

40

42

44

46

48

50

52

54

System net revenue ($M)

1500+300-500

1000-1500

500-1000

50-100

100-300

0-50

Larger systems tend to have a better payor mix, with a higher percentage of commercially insured patients

Source: CMS cost reports; OH analysis, 2009 data

▪ Larger systems have done a better job of attracting commercially-insured patients

▪ A larger proportion of favorable commercial payments results in increased operating margin

Payor mix advantage of larger systems


Cost performance as a percent of net revenue

Larger systems have higher margins despite mediocre cost performance, as they spend less of each dollar of revenue

Administrative and clinical cost as a percent of net revenue1,2

System net revenue ($M)

1500+1000-1500

500-000

300-500

100-300

50-100

0-50

45

40

35

30

25

20

15

Average administrative cost

Average clinical cost

Source: CMS cost reports; OH analysis

1 Included costs are all administrative costs as well as clinical costs attributed to the following departments: adults and pediatrics, radiology, laboratory, operating room, respiratory therapy, emergency, medical supplied and drugs charged to patients, physical therapy, ICU, pharmacy, and ECG. Administrative and clinical costs are NOT wage index- and CMI-adjusted.

2 For administrative cost percentage of net revenue, n=1200. For clinical cost percentage of net revenue, n =586, 2009 data

▪ Overall cost as a percentage of net revenue decreases as scale increases despite poorer absolute cost performance

Cost performance by size


As a result, larger hospital systems tend to have better margins

Median operating margin by rating

Percent

Source: Fitch report on non-profit hospitals, 2011; Kaufman & Hall

Median operating revenue by rating

USD, Millions

1.1

1.3

2.0

2.7

2.5

3.1

4.7

4.1

‘BBB−’

‘BBB’

‘BBB+’

‘A−’

‘A’

‘A+’

‘AA−’

‘AA’

1,141

379

198

300

413

470

556

2,245

‘BBB−’

‘BBB’

‘BBB+’

‘A−’

‘A’

‘A+’

‘AA−’

‘AA’

Why size is relevant


Governance and strategy are the two most important factors for assessing a hospital’s continued success

Observed performanceDrivers of performance

▪ High quality management team– Stable and experienced– Record of predictable and

strong performance▪ Competent and experienced board

of directors

Governance1

Strategy2▪ Clearly articulated strategy to

succeed in its market, including:– Clinical service line strategy– Regional/ market

strategyPerspective on how hospital will participate in new business models/partnerships

– Physician alignment/ partnership strategy

– Cost management

Profitability3

Liquidity and leverage4

Drivers of performance


Meanwhile NR/AA has been flat and actually declined in over the past few years

$ per AA

Source: Publicly reported provider financials (includes CYH, HCA, HMA, LPNT, THC,UHS); www.usinflationcalculator.com/inflation/current-inflation-rates

Financials per AA

8,000

9,000

10,000

11,000

12,000

121110092008 2013

Op ExNR/AA

0%

2%

CAGR1 2008–13

1 Compound annual growth rate.

Cost vs NR/AA


Providers are responding in a variety of ways – five are particularly common

Enacting broad-ranging cost control programs, including lean operations, back-office cost control & clinical transformation (“Medicare margin” efforts)1

Engaging in a frenetic wave of transactions (M&A) across the for-profit, not-for-profit, and outpatient-focused spectrum2

Continuing to invest heavily in services & specialists with differential reimbursement & margin (leading to “tragedy of the commons” in places)3

Considering innovative incentive relationships (e.g., ACO-like or “Clinical Integration”), but cautious of appropriate strategic & business model rationale5

Continuing to move towards greater physician alignment through structural options (employment and “employment-like” in strong CPOM1 states)4

Focus of case study


High degree of experimentation with a variety of new reimbursement and risk-sharing models…

▪ Provider system builds a health-plan, leveraging brand name to drive volume to provider system “Provider-led”

integrated network

Select examples Description

ACO ▪ An organization of health care providers accountable for quality, cost, and overall care; share cost savings if performance metrics are met

“Basic P4P” ▪ Payment upside based on performance metrics linked to value creation (e.g. BCSMA Alternative Quality Contract / AQC)

▪ Payor-led affiliation or acquisition of health system which seeks full clinical and operational integration to reduce costs, improve member experience, and manage referral volume

“Payor-led” integrated network

Patient centered medical home

▪ Team of physicians and extenders, coordinated by a PCP, coordinate provide high levels of coordinated care; typically tied to P4P contract

Episodes of care ▪ Covers all aspects of preadmission, inpatient, and follow-up care, including postoperative complications within a set time period for procedures, e.g., hip replacement

Pay for value ▪ Payment bonus tied to efficiency metrics (e.g., reduction in ER visits, imaging)

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Excl

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ty


Business results

Time

People involved

1-3 years

10s 100s 1,000s

Failure to launch▪ Stuck in diagnostics – leaders

unable to align on what to do, where to start

▪ Managers not held accountable for performance

▪ Employees resistant

Failure to sustain▪ No change in day-to-day behaviors▪ Change agents – not the line –

leading the change ▪ No capability upgrade at the site level▪ Improvements not baked into budgets

Failure to scale▪ Multiple bottom-up efforts with

competing methodologies and no overarching blueprint

▪ Limited leadership capacity▪ Waning focus from senior team

Failure typically comes about in one of three areas of a transformation….


…and stems largely from non-technical factors

30 70

14

Other obstacles 14

Management behavior does not support change

Inadequate resources or budget

Employee resistance to change 39

33

OrganizationalHealth factors

% of efforts failing to achieve target impact

70% of change programs fail …… mainly because organizational health gets in the way

Source: Scott Keller and Colin Price, Beyond Performance: How Great Organizations Build Ultimate Competitive Advantage. 2011


HealthPerformance

How an organization aligns itself, executes

with excellence, and renews itself to

sustainably achieve performance aspirations

What an enterprise delivers to

stakeholders in clinical, financial, and

operational results

SOURCE: McKinsey & Company, Objective Health

An organizations performance and health are equally important to sustain and build long term success


Sustainable operational improvement requires focus on 3 interrelated components of change

Mindsets,Behaviors,

and Capabilities

Changes way people think, feel, and conduct themselves in the workplace, both individually and collectively

Installs performance reporting system for management of the operating system and daily performance discussions

Management systems

Improves the end-to-end configuration of material and staff to eliminate waste and bring value to the patient

Operating system

3 components are mutually reinforcing and overlapping, which leads to sustained improvements in performance

Management systems

Mindsets, Behaviors, and Capabilities

Operating system


Lever

▪ Ensure performance tracking with IT tools/data management processes are available to support tracking and measuring of KPIs

▪ Easy–to-access performance reports are available to monitor KPIs

Clear targets & accountability

Right performance tracking

Best practices

▪ Business directions and strategic goals need to be translated into top-level key performance indicators (KPIs)

▪ KPIs must cascade effectively throughout the organization▪ Simple, measurable, achievable, results-oriented and timely goals are

agreed upon throughout the planning process

▪ Regular sequences of performance review meetings are established to track progress and review results

▪ Clear agendas and action items are established for each performance review meeting

Effective review meetings

a

b

c

▪ Encourage open recognition of good performance▪ Conduct coaching and two-way feedback discussions regularly

Reward & recognitiond

A rigorous performance management system needs to be adopted to ensure the improvements identified will stick

MANAGEMENT INFRASTRUCTURE


Understanding & commitment“I know what is expected of me – I agree with it, and it is meaningful”

2

Reinforcement mechanisms“Barriers are being removed and I’m being rewarded for making the changes I am being asked to make”

4Skills required for change“I have the skills and opportunities to behave in the new way”

3

Role modeling“I see my leaders, colleagues, and staff behaving differently”

1

“I chooseto change my mindset and

behavior if …”

▪ Senior leader/ senior team

▪ Symbolic acts▪ Influence leaders

▪ Change story▪ On-going, two-way

communications ▪ Language and

rituals

▪ Structure▪ Systems▪ Processes▪ Incentives

▪ Refreshing the talent pool

▪ Technical and relational skills

▪ Field and forum

SOURCE: McKinsey & Company

The McKinsey influence model is a proven tool for managing change within an organization

MINDSETS AND BEHAVIORS


Empirical research has proven that organizational performance and health are mutually reinforcing drivers

Correlation of Organizational Health and performance gap at a public healthcare system

Organization level Department level

The healthiest organizations and business units tend to financially and operationally outperform less healthy organizations

R2 = 0.50

StrongWeak

Low

High

Health

Per

form

ance

Org Health1

Average Total Return to Shareholders by health quartile (9 year average)

9

16

26

3x

Top quartile

Middle quartiles

Bottom quartile

TRS over time

3X greater TRS – ~$1.2B in value for the average company in our dataset

1 As defined by Organizational Health Index score; n = 272SOURCE: McKinsey Organization Practice / OHI Solution


▪ Why is strategic cost management important?

▪ Case study: 500 bed health network

Contents


McKinsey approach

Performance & culture

1

5

2

3

4

Develop a clear picture of the situation today, both internally and externally (e.g. reform, regional trends) on performance

Where To focus?

Diagnose and develop momentum opportunities, market portfolio changes and organizational readiness

Impa

ct

How to play?

Identify initiatives needed to capture opportunities

Feasibility

Prioritize initiatives that drive the most value and develop overall value proposition

Create an actionable plan and identify organizational enablers to support it

Develop strategy and specific initiatives

Diagnose performance and culture

Operationalize the strategy


In the near-term, CLIENT should choose a few priority practices for focus that have high potential impact and make sense for strategic goal

High-potential practices for focus in next 6-9 months Role Clarity Operational management Process-based capabilitiesFinancial managementSupportive LeadershipStrategic clarityTop-down innovationKnowledge sharingTalent acquisitionTalent developmentPersonal OwnershipRisk management Employee involvementPerformance contractsAuthoritative leadershipInternally competitive Consultative leadership Challenging leadership

Potential impact Degree of ‘fit’ for CLIENTDrives broken outcome?

“Top 10” value desired by employees?

Fixes broken practice?

Aligns with archetype?

“Top 10” interview theme?

Highest potential practices

Source: CLIENT OHI Survey, overall (n=88)


In order to fulfill the mission and vision of the organization, the client focused on execution in six primary areas

SOURCE: Source

Redefine enterprise operating model

Realign executive and clinical structure

Realign approach to physician structure

Align governance (PAC, MEC, SL & PIC)

Develop talent across the enterprise

Initiatives for successStrategies

Improve operational efficiency

Improve labor productivity

Enhance throughput & capacity

Optimize revenue cycle and supply chain

Define, align and integrate data Infrastructure

Shift to fee-for-value

Transition into population health

Evaluate bundled payment models for the market

Cultivate development to offset declining reimbursement

Lead in patient experience

Engage patients through technology including telemedicine

Expand convenience and choice through network reach

Expand patient & family experience beyond our walls

Extend network reach

Define geographic portals to support service line growth

Explore partnerships and affiliations

Realign approach to physician recruitment & development

Revisit marketing approach

Lead in clinical excellence

Coordinate care across the enterprise

Support performance improvement with robust measurement

Enhance research and education

Reduce clinical variation w/ evidence based approach

Green = Leading the competitionYellow = Falling behind our competitionRed = Outlier in the market


Client focused on more than just lean principles, taking on physician preference and behavior related initiatives

▪ In early stages of identifying opportunities to improve patient throughput

Small local system

▪ Applying Lean principles to improve patient flow in the ED, OR, and inpatient floors

Medium-sized regional system

▪ Reducing clinical variability through evidence-based care pathways and order sets

Largest national system

▪ Improving utilization of physician preference supplies by adopting evidence-based practices

National systems

CLI

ENT

FOC

US


The operational excellence assessment has identified $43M - $70M in savings opportunities to date

4.4 - 8.8Clinical Variation

Throughput and Capacity

5.5 - 15.0

Total 42.7 - 70.1

Purchasing and Supplies 1.2 - 3.1

Revenue Cyclemanagement 3.8 - 6.7

Practice Benchmarking

12.4 - 23.2

Hospital Labor Productivity 14.9 - 13.3

Span of Control No savings

Opportunity areasPotential impact (annual)1

$ Millions

CLIENT DATA

▪ Provides enhancement of role clarity, accountability, and ability to execute strategic and operational objectives

▪ Opportunities for improvements in clinical and non-clinical departments, as well as in overall workforce policies

▪ Majority of opportunity in reducing excess length of stay across all floors

▪ Smaller opportunities in ED and OR efficiency▪ Opportunity within each service lines for

improvement▪ Majority of opportunity in high cost supplies▪ Many physician practices losing money beyond

median benchmark; comp relative to productivity and staff expenses driving loss

▪ Performs well today, but can improve with focus on cash collections and denials

▪ Opportunities predominately around managing physician utilization of preference items

Description


Throughput & CapacityExecutive Sponsor –Jason & Dr. MikeBusiness Lead – Ron

Practice BenchmarkingExecutive Sponsor –Dr. Joe & Dr. JohnBusiness Lead – Rob

Span of ControlExecutive Sponsor – Mike & Dr. Rick Business Lead – Casey

Purchasing & SuppliesExecutive Sponsor – Dr. Ian & Dr. FredBusiness Lead – Michael & Herb

Revenue Cycle ManagementExecutive Sponsor – JamieBusiness Lead – Tina

Clinical VariationExecutive Sponsor – Dr. MikeBusiness Lead – Rob

Hospital Labor ProductivityExecutive Sponsor – Chris & Dr. RickBusiness Lead – Jamie

Improve Operational Efficiency to drive value propositionExec Sponsor: Chris

Deliverables: • Set clear objectives and measurement• Set timelines for completion

Data Management and Governance Executive Sponsor – Peter & Dr. JoeBusiness Lead – Tina

Framework for improving Operational Efficiency


Resources required Notes

Mission statement and scope Priority actions

Target outcomes and metrics

Assigned Metric Target/baseline

Team leader and members

Role

Deliverables and key dates

Deliverable Due date

2013 expected capture by service line

Executive champion:

Accountable leader

Responsible individuals

Consult

Dr. Mike

TBDTBDTBD

TBD

Inform TBD

Chris

Total estimated $ impact at maturity

$4.4-8.8MM

▪ Reduce variation in high cost supplies across OR and cath lab

Scope: All credentialed physicians ▪ Improve current blood trans-fusion management to reduce unnecessary utilization

Mission: Reducing clinical variation across all providers to improve clinical quality and reduce cost

▪ Service line Executive directors▪ Clinical analyst team▪ Capitol required: N/A

▪ Each Medical director to sign off on amount of variation to be removed in fiscal 2013

▪ Update preference cards

Jan 13

A team charter should be refined to ensure that there is a clear picture on goals, responsibilities and timelines

Depends on DRG

GMLOS

Depends on DRG

Lab/imaging/blood per case DRG

Average length of stay by DRG

Supply cost per case by DRG


Understanding& commitment

Reinforce-ment mechanisms

2

4

Skills required for change

3

Role modeling

1

SOURCE: Moffitt progress review workshop

▪ Personnel (having the right leaders)▪ Equal accountability▪ Access to leadership▪ Physician role clarity▪ “We vs. They” mentality▪ Sense of entitlement

▪ Physician role clarity/expectations▪ Sense of team (clinical vs. non-clinical)

– Breaking out of individual silos▪ Access to data/benchmarking tools

– Team members becoming comfortable with the data

▪ Understanding the “end game”/larger picture; downstream impact

▪ Focus on the “reason”– Creating the message to get the staff

onboard with initiative▪ Facilitate two-way communication

– Transparency around both good and bad news

▪ Equal accountability▪ Lack of performance management system

▪ Inadequate training– Understanding that management can

be effective even without technical expertise

– Leadership skills▪ Building on individual strengths▪ Establishing the workforce/process in

place to drive success– Anticipating turnover

▪ Prioritization of initiatives

Exercise: Where are our greatest challenges… (CLIENT RESPONSES)


Understanding& commitment

Reinforce-ment mechanisms

2

4

Skills required for change

3

Role modeling

1

SOURCE: Moffitt progress review workshop

▪ Selecting/recruiting the right leaders ▪ Focused leadership retreat▪ Role clarity▪ Building/developing trust

– “Trusting team members to make the right decision”

– Being able to make decisions without having multiple meetings

▪ Formalization of data review process▪ Developing accountability

– Strive for excellence, instead of settling for mediocrity

▪ Ranking of skills▪ Time management/productivity

– Spending and using time effectively (e.g., re-evaluating the necessity of meetings)

▪ Institutional prioritization

Exercise: What can be done to improve… (CLIENT RESPONSES)

McKinsey & Company | 31SOURCE: McKinsey

Case study – Transformation effort led to significant effective-ness and efficiency gains

▪ Refine overarching ‘org design’ (e.g., overall structure, cross-cutting management processes) to align with strategy and key health practices– Strategic clarity – Role clarity – Operational management– Process-based capabilities

▪ Invest in leadership development to build key capabilities– Performance contracts– People performance reviews– Talent acquisition – Talent development

▪ Savings of $15 million achieved in FY13 over baseline projections– “Communication has been the

key to success, focusing on cost management to ensure our commitment to providing exceptional outcomes and patient experience

▪ Deep dive diagnostic – Across all functions to

benchmark current performance and identify key opportunity areas

▪ Identification of key opportunities– Focus on productivity,

patient throughput, and clinical variation

▪ Implementation design– Created end-to-end

implementation plan– Centralized project

management office to manage full scope of analysis

– Developed robust central analytics group to support on-going analysis

▪ Implementation plan to capture full 10-15% savings within 2 years of launch

▪ As part of the strategy to step up its clinical and operational effectiveness and efficiency, a large provider system is transforming all areas of its operations– Focused on maintaining

clinical excellence across all services

– History of overcoming adversary (split from former alliance)

– Finance not viewed as strategic business partner

– “Quality care at all costs” mentality pervades client

▪ Key objectives of the transformation effort– Develop best-in-class

efficiency levels– Actively engage physicians

(employed and non-employed)

– Achieve 10-15% savings (NR)

McKinsey approach

Client impact

Client situation

2012ACFO37Financial Planning &

TargetSetting


Next steps

▪ Question or comments?– Please contact:

▫ [email protected]

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