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Copyright 2011 by Kaufman, Hall & Associates, Inc.
Strategic Cost Management: Identifying Opportunities
and Achieving Reductions, Ahead of the Curve
Brian S. Channon, Senior Vice President
Jason H. Sussman, Managing Director
Is your organization effectively positioned to manage its costs? Do you have the systems,
practices, and management controls in place to yield the financial improvement required to
execute your strategies?
The need for rigorous cost management is clear. Accelerated by unsustainable growth in national
healthcare costs, reform and the emerging value-based business model will push hospitals and
health systems to improve quality, access, and outcomes, while reducing expenses.
Many hospitals have been successfully reducing costs during the past few years; thus, as
Moody’s Investors Service notes: “It will become more challenging to achieve further cost
reductions after the ‘low-hanging fruit’ has been identified. Expense pressures may be
particularly deleterious in an environment where revenue growth is expected to continue to be
low.”1
Hospitals and health systems can meet the expense reduction challenges of the coming years and
improve their operating performance ahead of the curve by concurrently pursuing two important
improvement initiatives:
•
•
Cost Management: These initiatives focus on cost reduction and efficiency improvements
of current operations, assuming no changes to the organization’s portfolio of clinical
services.
Cost Structure: These initiatives consider reshaping the distribution of services across the
organization’s geographic market(s) to ensure the right services at the right scope and
scale at the right location, with consideration to access, cost, and quality objectives;2 and
rethinking the current portfolio of services, downsizing or divesting those that are not
core to the organization’s mission.
Described here is the strategic cost management process we use with hospitals and health
systems nationwide to produce the needed results.
Assess Readiness
An organization’s understanding of its current competence with strategic cost management is
critical to the development of the capabilities needed to deliver high-quality services at the
lowest-possible cost. Thus, an objective assessment of organizational readiness is recommended.
This assessment should include both quantitative and qualitative analyses focused on:
• The systems, practices, and controls in place to manage costs
• How the organization uses (or not) these systems, practices, and controls
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Copyright 2011 by Kaufman, Hall & Associates, Inc.
A Sidebar below outlines the assessed elements.
Components of Strategic Cost Management Competency
•
•
•
•
•
•
•
•
Cost management scope: The breadth and depth of how major “cost drivers” are
identified and defined and how corresponding improvement initiatives are planned
and implemented
Target-setting and tracking: The systems and processes used to set targets and
monitor performance
Systems thinking: The prevalent organization and culture of how costs are
considered and decisions made, whether on a departmental/entity/silo basis or
system-wide, as an integrated whole
Alignment: The processes and methods used to ensure alignment and integration of
plans, targets, and financial performance
Accountability and execution: The systems and processes in place that hold
management and staff accountable for delivering targeted results, executing plans,
and generating success
Management controls: The breadth and depth of management controls in place to
hardwire success in meeting cost-management targets
Operational planning: The processes used to plan and drive improvements
Overhead management: The mechanisms in place to right-size overhead
expenditures across the organization
Source: Kaufman, Hall & Associates, Inc.
Leading hospitals and health systems understand the need to optimize each element and are
working aggressively to strengthen their cost management infrastructure and processes. But even
the best-prepared organizations recognize that they have considerable distance to go to make
strategic cost management part of the culture and adaptive to future changes in the industry.
Preparedness, in fact, may be well below the “readiness midpoint” across competency elements
for many organizations. Through identification of the systems and controls requiring
improvement in design and/or application, hospitals and health systems can know where to focus
their efforts to ensure that cost reduction initiatives are as effective as possible.
Understand Your Capital Position and Quantify Your Shortfall
Strategic cost management starts with an accurate analysis of the organization’s capital position,
as commonly prepared as part of an integrated strategic-financial plan. The capital position
analysis compares multiyear uses and sources of funds to identify the organization’s expected
capital shortfall.
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Cost reduction goals should be established to close as much of this capital shortfall as possible.
The goals therefore would indicate the performance levels necessary to fund the organization’s
strategies and maintain its competitive financial performance. In this way, goals are connected
directly to the organization’s current financial position as well as its current and future strategic
capital and other requirements.
All organizations should be thoroughly revisiting their integrated plan to examine the cumulative
projected impact of strategic initiatives and changes due to healthcare reform and the new
business model. Projections of payment, volume, capital costs, capital investment needs, and
other variables are changing and will continue to do so. The size of an organization’s capital
shortfall should be recalculated with the new data at-hand on a regular basis.
Define the Possible Savings and Sources
What cost reductions can your organization actually achieve to resolve its capital shortfall? As
the next step, an assessment of cost reduction opportunities, applying rigorous data-driven
methodologies, is completed to:
• Define the magnitude of productivity and other operational improvement opportunities that
are available and achievable
• Identify the “composition” of the opportunities and their key drivers
A high-level plan that maps out the key cost savings opportunities and activities and positions
the organization to move forward rapidly to implement these savings is recommended. This
approach requires significantly lower investment of resources and avoids the organizational
disruption that characterizes other approaches.
Review of historical trends, application of global and departmental benchmarks, peer department
comparisons, and supplementary drill-down data analysis can be used to define the amount of
possible savings. Use of both internal and external benchmarks helps to build consensus within
the organization around the level of cost reduction that may be available.
For example, one health system used data from three separate analyses to identify its expense
reduction needs and opportunity:
1. An analysis of the operating performance improvement that would be required to support
capital expenditures at a targeted level
2. An analysis of cost reductions that would be required to bring each facility to a 90
percent Medicare revenue-to-cost ratio (which was then extrapolated to Medicaid and
commercial business)
3. An analysis of potential cost savings based on interpretation and application of industry
cost benchmarks
Each of these analyses indicated the level of improvement (i.e., cost reductions) needed to
position the organization to support a greater level of capital investment, enhance operating
performance, and improve the balance sheet. For this health system, the gap between the desired
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Copyright 2011 by Kaufman, Hall & Associates, Inc.
level of capital spending and the level supported by operating performance provided the
“burning-platform motivator” for real cost-reduction and efficiency improvements. If managers
wanted the requested capital, they would be required to meet the cost-reduction targets.
Types of cost-reduction opportunities and their drivers vary by organization, but many are
common to hospitals and health systems nationwide. Staffing and productivity drivers should be
a key focus, as labor costs often constitute half or more of an organization’s operating expenses.
Poor alignment of staffing with patient volume, coupled with poor execution of existing staffing
plans, are among the more common contributors to high costs. The Sidebar below identifies
other staffing and productivity drivers. Examples follow of four different types of cost reduction
initiatives recently identified and implemented at hospitals and health systems.
Key Drivers of Staffing and Productivity Problems
•
•
•
•
•
•
•
Inadequate plans/alignment
Poor execution of staffing plans
Inappropriate/unclear staffing roles, target workloads, and assignments
FTEs that “fly below the radar”
Service and functional redundancy/excess capacity
Insufficient management controls
Use of overtime/premium labor
Source: Kaufman, Hall & Associates, Inc.
Reducing Labor Costs
By addressing both cost structure (doing the right things) and cost management (doing things
right), 10 labor cost reduction initiatives were identified and implemented in a multihospital
health system. Figure 1 is a high-level mapping of the financial impact of these initiatives.
In the cost management domain, the “aligning staffing plans and schedules” initiative-- #1 in the
graph-- ensured that staff work schedules appropriately reflected patient and workload demands
and staffing plans. This project yielded extensive financial return and thus appears at the top of
the high-impact quadrant for cost management efforts.
Cost structure initiatives, such as “consolidating functions or sites/locations” (#7 in the graph),
also yielded a high impact and return. Such initiatives include, among other things, eliminating
duplicative services in over-served markets and consolidating the number of lab locations.
Similarly, initiatives related to eliminating or cutting back on lower priority/non-value-added
functions--#8 in the graph-- provide considerable savings. A structural approach to scrutinize all
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Copyright 2011 by Kaufman, Hall & Associates, Inc.
High Impact
Labor cost reduction initiatives
1
2
1. Align staffing plans and schedules
3
2. Implement targeted operational
improvements
4
3. Reassign work or cross-train staff
6
4. Improve execution of existing staffing plans
5
5. Reduce premium labor use
6. Reduce "indirect" staffing
Low Impact
Cost Management: Doing Things Right
work and functions for their cost/benefit “value” was used, looking at both the importance of the
functions and how well they were being performed.
10
9
Low Impact
Cost Structure: Doing the Right Things
8
7
7. Consolidate functions or sites/locations
supported
8. Eliminate (or cut back) on lower priority/non
value-added functions
High Impact
9. Cut hours of operation or coverage for
department or selected functions within dept.
10. Deploy technology to automate
Figure 1. Labor Cost Structure and Cost Management Opportunities
Source: Kaufman, Hall & Associates, Inc.
Improving Productivity
Figure 2 illustrates FTE and associated dollar savings opportunities identified for one health
system through analysis of internal and external benchmarks and interviews. Productivity
improvements could yield between $15 and $22 million of potential savings, with the top 12
departments accounting for 87 percent of the total.
In terms of the composition of this savings, 40 percent of total savings could be achieved by
improved execution of existing productivity targets. The organization had appropriate
productivity plans and targets, but was not meeting those targets. The involved departments
needed to strengthen monitoring, execution, and accountability to drive lower labor cost.
In a similar number of departments, the existing productivity targets were not set at a level
sufficient to achieve the required level of financial performance.
The remaining portion of the labor-cost improvements (20 percent) could be directly attributed to
a lack of meaningful targets or management controls. Some hospital departments were “flying
below the radar” of cost reduction initiatives.
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Copyright 2011 by Kaufman, Hall & Associates, Inc.
FTE Opportunity
Savings Opportunity
Functional Area
Low
High
Inpatient Nursing Services
62.4
84.3
$
4,113,000 $
5,445,000
Surgical Services
31.9
47.9
$
2,348,000 $
3,628,000
Pharmacy Services
21.9
23.4
$
1,651,000 $
1,757,000
HIM
15.0
15.7
$
706,000 $
739,000
Imaging Services
14.3
19.9
$
862,000 $
1,176,000
Emergency Services
13.4
19.2
$
891,000 $
1,244,000
Cardiovascular Services
11.2
13.5
$
692,000 $
812,000
Fiscal Services
6.0
20.5
$
322,000 $
840,000
Respiratory Care Services
6.0
8.7
$
313,000 $
464,000
Laboratory Services
5.8
11.4
$
400,000 $
806,000
ABC Facility
5.5
12.8
$
772,000 $
1,846,000
Rehabilitation Services
All Other
5.2
7.8
$
348,000 $
523,000
16.7
72.7
$
1,761,000 $
2,826,000
228.9
342.1
$
15,179,000 $
22,106,000
Total
Low
High
Figure 2. Productivity Improvement Savings
Source: Kaufman, Hall & Associates, Inc.
Aligning Staffing Levels to Patient Demand
It is possible to strengthen the relationship between staffing and patient demand. Often, staff
schedules are not geared to when patients arrive at the operating room or emergency department,
for example. Assumed/planned for staff “flexing”-- i.e., adjustment upward or downward with
changes in volume--may not be occurring, as expected. A close review of census-based staffing
grids for inpatient nursing units often reveals a less-than-ideal correlation between staffing and
volume.
Figure 3 illustrates the results of a concerted effort to more closely align staffing to demand in a
hospital’s ICU/CCU. The diamond-shaped points are the values for hours worked by pay period
at specific patient-volume levels. The effectiveness of this effort can be seen by the improvement
in the statistical alignment of staffing to demand as measured by the correlation (R-squared
value) from 73 percent to 83 percent.
In addition to improving the alignment between volume and staffing levels, the data also
demonstrate the department’s ability to improve the efficiency of staffing at every volume level.
This is illustrated by the fact that the “after” line is lower on the chart than the “before” line. This
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Copyright 2011 by Kaufman, Hall & Associates, Inc.
productivity improvement/staff alignment initiative saved the organization nearly 600 hours of
staffing cost per pay period.
R-Squared = 83%
R-Squared = 73%
ICU/CCU
5,500
Worked Hours by Pay Period
5,200
4,900
4,600
4,300
4,000
3,700
3,400
130
150
BEFORE
170
190
Volume by Pay Period
AFTER
Linear (BEFORE)
210
230
Linear (AFTER)
Figure 3. Aligning Staffing to Volume Demand
Source: Kaufman, Hall & Associates, Inc.
Reducing Overhead through Greater “System-ness”
System-level cost reduction opportunities also exist in many organizations. For organizations
with multiple facilities or locations, cost savings can be achieved through selective centralization
or regionalization of administrative and/or overhead services and functions. These include
human resources, accounting and finance, revenue cycle, information technology, marketing,
legal/risk management, and materials management, among others. In some instances, functional
redundancy across facilities may not be needed and can be rationalized to reduce cost.
Consolidation at the appropriate level can improve operations and yield large savings.
For example, Figure 4 illustrates how one multiregional health system reallocated the functions
within human resources, resulting in FTE savings and reduced duplication of services and excess
capacity. The health system eliminated almost nine FTEs by moving several human resource
functions to the regional or system-level offices.
Kaufman Hall Report - Summer Issue, Lead Article
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Copyright 2011 by Kaufman, Hall & Associates, Inc.
A data-driven and objective evaluation of system services from a “total spend” perspective,
regardless of where such services may currently reside, is highly recommended.
Human Resources Current Structure
Current FTES
Organizational Development
Human Resources Info Systems (HRIS)
Employee Relations
Benefits
Compensation
Employee Health
Staff Training
Labor Relations
Employment Recruiting
Workers' Compensation
Hospital A
11.2
X
X
X
X
X
X
X
X
X
X
Hospital B
7.4
X
X
X
X
X
X
X
X
X
X
Hospital C
16.1
X
X
X
X
X
X
X
X
X
Hospital D
18.0
X
X
X
X
X
Hospital A
5.2
Hospital B
3.6
Hospital C
8.0
Hospital D
8.8
X
X
X
X
X
X
X
Hospital E
13.0
X
X
X
X
X
X
X
X
X
REGIONAL
0.0
SYSTEM
6.3
TOTAL
72.1
X
Human Resources Proposed Structure
Recommended FTES
Organizational Development
Human Resources Info Systems (HRIS)
Employee Relations
Benefits
Compensation
Employee Health
Staff Training
Labor Relations
Employment Recruiting
Workers' Compensation
FTE Savings Due to Rationalization of
H.R. Functions
Hospital E REGIONAL
6.4
20.0
X
SYSTEM
11.2
TOTAL (1)
63.2
X
X
X
X
X
X
X
X
X
6.0
3.8
8.1
9.2
6.6
-20.0
-4.9
8.9
Figure 4. Integration of System-wide Human Resource Functions
Source: Kaufman, Hall & Associates, Inc.
Execute Improvement Initiatives to Produce Results
To achieve real cost reductions like those in the examples, the savings opportunities identified
through the process just described should be included in the organization’s strategic-financial
plan, annual budget, and operating plans. Additionally, productivity reporting systems and
targeted metrics must integrate appropriately with the organization’s budget. Staffing schedules
must align with staffing plans that also are reflected in the budget. If “disconnects” occur
between any of these elements, cost efficiencies and reductions will be very difficult to achieve
and expenses will be higher than expected or warranted.
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Copyright 2011 by Kaufman, Hall & Associates, Inc.
Establishment of a strong strategic cost management project infrastructure is critically important
throughout the cost reduction development and implementation process. For example, Figure 5
provides a sample cost reduction work plan and timeline, indicating the major steps during a 12month period and the key deliverables. The tracking of results must be detailed and timely to
ensure that targets are achieved. The Sidebar below itemizes key infrastructure elements for a
high-quality cost management initiative.
Hospitals and health systems have achieved very significant cost savings through our advisory
approach of partnership with the organization to help strengthen, leverage, and complement its
internal capabilities to produce needed cost savings.
Best-Practice Cost Management Infrastructure
•
•
•
•
•
•
•
•
•
Alignment of goals and targets
Development of a work plan and timetable
Establishment of an oversight structure
Appropriate management controls
Stakeholder communication of objectives and progress in meeting targets
Development of the improvement planning process
Structuring of steering committee agendas
Development of improvement plans and progress reports
Effective tracking of results
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Implementation Steps and Timeline
Jan Feb
Mar
Apr
May Jun
Jul
Aug
Sep
Oct
Selected Activities
Refine and launch communication plan
Work with senior mgmt team to create aligned incentives
Set up steering committee and work groups
Deliverables
Project management office created
Agree on methodology for estimating annualized savings
Develop and Refine Initiatives
Selected Activities
Identify and quantify revenue enhancements
Identify and quantify expense savings opportunities
Set improvement targets
Use steering committee for approval process
Deliverables
Target initiatives approved for implementation
Launch tracking and monitoring
Test and Implement Initiatives
Selected Activities
Creator vendor strategies and negotiate new contracts
Develop clinician buy-in strategies
Compile clinical documents and business case
Support education and training programs
Roll out remaining initiatives
Deliverables
Approved targets in annualized savings implemented
Monitor and Hardwire Savings
Selected Activities
Monitor implementation by review of contracts, enacted
policies, and invoices and purchase orders
Deliverables
Monitoring that implementation has occurred
Figure 5. Sample Cost Reduction Work Plan and Timeline
Source: Kaufman, Hall & Associates, Inc.
Curve-Bending Moving Forward
The nation’s hospitals and health systems must lower costs and improve bottom-line results in
order to fund ongoing and future strategies and to meet the requirements of a value-based
business model. Cost structure and cost management improvement initiatives will need to be
pursued concurrently. Planning and analysis related to cost reduction and improvement
opportunities, followed by seamless execution in achieving such opportunities, are more
important now than ever before. These activities will separate those that succeed in bending the
cost curve from the rest of the field. Proactive hospital and health system executives are moving
forward aggressively to reshape and streamline their costs in anticipation of a very different
healthcare environment.
For more information on Kaufman Hall’s Strategic Cost Management Advisory Services, please
contact Brian Channon (bchannon@kaufmanhall.com) or Jason Sussman
(jsussman@kaufmanhall.com) at 847.441.8780.
Nov
Dec
Kaufman Hall Report - Summer Issue, Lead Article
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Copyright 2011 by Kaufman, Hall & Associates, Inc.
References
1. Moody’s Investors Service: “Negative Outlook for U.S. Not-For-Profit Healthcare Sector
Continues for 2011.” New York, Feb. 3, 2011.
2. For more information, see Grube, M.E., and Morrissey, W.M.: “What Should We Be
Offering Where? Next-Generation Planning to Optimize the Distribution of Your
Services.” Kaufman Hall Report, Spring 2011. Available at www.kaufmanhall.com.