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Post-Payment Reductions: Build a Revenue Model for Success

Not too long ago I wrote a post for SNFs regarding “what to do” in preparation for October 1 rate reductions.  Since then, I’ve fielded inquiries galore from all kinds of providers looking into a future that likely includes Medicare and certainly, Medicaid rate/payment reductions.  In most cases, the answer that I provide is clearly more confusing and complex than many want to hear.  In an attempt to provide additional clarity across the board, regardless of provider type (SNF, Hospice, Home Health, etc.), I decided to write what I hope, is a simplified approach to creating a level of revenue stability in a tight to declining environment.

The typical reaction from most providers I work with is a quick turn to expense reduction as a means of combatting reducing revenues.  Often times, the immediate actions taken provide only a short-term respite to margin erosion followed closely by a steady erosion of margin.  The reason?  The most apparent and easiest places to cut such as staffing reduce service and quality.  Consistent reductions in care are followed by consistent erosion in revenue via occupancy or alternatively, higher expenses in the form of staff turnover, compliance problems, etc.  The plain fact of health care life and frankly, business life in general is that a company cannot save itself to a consistent profit.

The alternative approach that I recommend providers adapt is a more fundamental, less variable expense focused model; certainly one that doesn’t quibble with incrementalism as a means of dealing with margin via expense reductions.  The start of this approach focuses on three key axioms.

  1. Price = Fixed Cost + Variable Cost + Margin.  In this case, price isn’t truly at the control of the provider.  Substitute Per Diem Net Revenue for price. 
  2. Net Per Diem Revenue is driven up by productivity, especially billable productivity and case mix.  If the equation doesn’t work to produce the margin desired, focus more on productivity and issues such as occupancy and case-mix before attempting to drive down variable costs, unless the variable cost reductions consist of “low hanging fruit” (e.g., too much overtime, agency use, supply and food waste, etc.).  Most providers believe wrongly that a Medicare expenditure reduction translates equally for all providers in the form of rate.  The reality is that some providers, even in spite of rate or expenditure reductions, can make wholesale gains in their Net Per Diem by improving their productivity and case-mix.  Simply put, improving case-mix to higher paying categories, even those impacted by rate cuts, can improve per diem revenue.  While Medicare and Medicaid may provide uniformity in the form of rate reductions, providers and their patient mix are far from uniform.  The proof is in the impact initially to per diem revenue and then what changes can be implemented from a revenue enhancement strategy that still, even with cuts, increases net per diem revenue.
  3. Begin to think of expenses as an investment in revenue or sales, not compartmentalized as a separate unrelated item.  From this view, room may exist to make “investments” that drive more revenue and thus, in proportion, more margin.  Commonly put, this is an ROI approach.

Building a revenue model is fundamentally about maximizing the elements of the business that are tied to sales and tied to payments.  It is less about the concept of “more is better” and all about the concept that “better is better”.  For example, and employing a bit of algebra, the equation in point one above affords me the opportunity to eliminate any of the four item variables and determine what “each” unknown variable should be.  Typically, that means that I start with Fixed Costs as by their nature, they are known and fixed.  I equate these to a per diem.  From this point, I will add-in a margin and my current or anticipated Price expressed as my Net Per Diem Revenue (this number should approximate very closely, a cash value per diem, before expenses).  For example, assuming a fixed cost per diem of $75.00, a net per diem revenue number of $400 and a desired margin (I prefer operating margin, removing non-cash expenses from the calculation) of 20% or $80.00, my variable expenses per diem can equal no more than $245.00.

Using the above example, if my current variable expenses are running higher than $245.00, I will look first, and directly, at ways that I can improve the net per diem revenue number, not at cutting the variable expenses to achieve my margin.  Why?  The simplest answer is that my variable expenses at a certain volume become somewhat fixed and cutting can become an indiscriminate process that is less tied to revenue and margin and more tied to “ease” that ultimately, erodes revenue and margin.  Specifically, I’ll look at five elements that directly correlate to net revenue.

  1. Occupancy or Census – how productive are my variable expenses?  In certain instances, improving net revenue involves right-sizing operations to the proper level.  In this view, the focus is less about cutting variable expenses but more about making sure that my expense levels are tied to the actual volume that the business organically generates.
  2. Marketing/Sales – can I increase my volume, occupancy, census, etc via a more effective marketing/sales effort?  In this case, I will likely make investments but I will match my investments against an expected return that is substantially greater than the outlay, accretive to my net revenue.
  3. Case-Mix Productivity/Payer Mix – do my current level of variable expenses support a higher acuity or a greater level of case-mix acuity?  Productivity is not just about everyone being busy.  It is also about the core competency of the staff and the ability of the organization to do more with the same level of staff.  I recognize that incremental expenses in terms of supplies, drugs, etc. will likely increase but as long as the increase is less than the net revenue increase at the desired margin level (net revenue increase minus incremental expense increase = desired margin), it is worth the investment.
  4. Investment in Variable Expenses – can I improve my staff levels, hire additional people, to increase volume or case-mix acuity?  At certain points, the best answer isn’t reducing variable expenses but actually increasing them if doing so improves my organization’s ability to handle more volume or a different, better paying volume.  I have seen all too many organizations shy away from taking certain, better paying cases simply because the investment in different, more expensive staff seemed out of the question from a budgetary standpoint.  In reality, if a market exists such that the investment can be productive and the volume sustained, the ROI calculation may in fact, support the investment.  Again, as long as the net incremental increase in revenue is greater than the net incremental increase in variable expenses at a level equal to or greater than the desire margin, the investment is worth it.
  5. Investment in Fixed Costs – can I make a plant, property or equipment investment that improves my marketing, my positioning, or increases my productivity and volume/census?  Fixed cost investments can sometimes be the most obvious and the easiest to justify.  Their impact on the per diem side is typically nominal unless the investment was tied to debt and a major project.  Likewise, the ROI is easier to calculate as it can be two-sided; improve revenue or improve efficiency by reducing other expenses or improving productivity. 

While I can’t use current or former work examples with specifics without violating certain privacy expectations, the following are three simple “real world” cases or scenarios that I worked through with organizations that illustrate the principles above.

  • For a home care/hospice organization that consistently missed referral opportunities and experienced fairly large case-mix and volume fluctuations, we simply added two staff positions that served as “intake coordinators” (not the actual titles).  The primary responsibility of these positions was being in the hospitals, nursing homes, etc. where the referrals came from.  Being proactive and working directly with discharge planners, physicians, etc. allowed the organization to develop a more stable pipeline of referrals, better case-mix, and frankly, better care and service.  The return on this investment in short-order was a significantly greater revenue multiple.
  • For an SNF that was traditionally in the mid-ninety percent occupied, we looked at the complement of payers and the allocation of rooms from a revenue perspective.  The room mix was approximately two-third private and one-third semi-private.  To stay full and meet occupancy targets, the SNF relied on poorer quality payers (Medicaid primarily and some hospice) to keep the semi-privates full.  The solution was simple: Right size the room mix to all private which could be occupied by a higher paying mix while increasing slightly, acuity and re-organizing staff.  The fixed-cost investment was fairly minimal as turning the semi-private rooms to privates involved initially, removing a bed, rearranging furniture, and centering the over-bed light into a single position.  The building became more efficient, stayed full with a waiting list, and the overall revenue per room and the net revenue per diem jumped by 30%.
  • For another SNF that was traditionally mid-ninety percent occupied, primarily with private pay and Medicare (virtually no Medicaid), the issue was all about low acuity and insufficient staff capability and infrastructure to support a stronger payer mix.  In this instance, we worked to bring therapy in-house from a contract provider, increased RN staffing and decreased CMA and CNA staffing, expanded therapy services to six days, started taking admissions six days per week and increased acuity and thus, even with pending/current Medicare rate cuts, we were able to jump per diem from less than $400 per day to nearly $450 per day, increasing overall Medicare census and improving staff productivity.  We also jumped Med B utilization which was non-existent and moved the overall revenue level current and pro forma (forward), up by nearly 20%.  The additional expense in new staffing, etc. increase variable expenses per diem by 11%.  The overall change was a positive increase in margin of just shy of 9% which when added to the current margin (cash margin) of 13%, pushed the level above 20%…a level this organization believed, for a non-profit, was unattainable without sacrificing “quality or service”.  In the end, both improved along with the margin.

October 12, 2011 - Posted by | Home Health, Hospice, Senior Housing, Skilled Nursing | , , , , , , , , , , , ,

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