The cost reduction imperative

No matter how healthcare reform shakes out in the short term, reimbursement reductions and shifts in demand are likely to lead to 15 to 25 percent declines in hospital revenue yields in the next decade, according to Booz & Company modeling. To counter this decline, most hospitals and health systems will need to reduce their cost structures by 10 percent or more. They will need to replace the traditional cost-cutting approach that incrementally reduces costs from one budget cycle to the next with an innovative, forward-looking approach that systematically establishes a much lower cost base as the “new normal” and overcomes the seemingly insurmountable cultural obstacles such change entails.

Don’t Rely on the Past
The tactical cost levers that hospitals usually pull—supply chain savings initiatives, capital spending freezes and benchmark-driven head-count reductions—are neither sustainable nor significant enough to achieve the 10 percent–plus levels of savings they need to survive. Health system executives already recognize this; fewer than 23 percent of them believe these actions deliver substantial results, according to a recent survey by the Healthcare Financial Management Association.

To achieve double-digit cost savings, hospitals must drive out costs by redesigning care delivery and administrative processes; unleash the capacity, service, and clinical quality gains needed to compete in the post-reform marketplace; and support a cost management system that locks in improvements and prevents costs from creeping back.

This kind of transformational cost saving is possible. Other industries—the automotive, aviation, and financial services industries among them—have used similar approaches to achieve step-change cost reduction. But significant barriers of complexity and fear have deterred most hospitals and health systems from taking on the challenge.

Illuminate Complexity, Eliminate Fear
A transformative cost reduction approach first needs a technical component to address complexity—a strategic framework and toolkit that helps managers determine where to invest their efforts and how to improve performance while extracting cost. It then needs a cultural component to overcome the inevitable emotional resistance to change, empowering managers to energize the organization and get results.

Unlike budget cutting, transformational cost reduction starts at the strategic level with explicit decisions about how to allocate resources. These decisions should be filtered through a health system’s capabilities—that is, the small set of internal interlocking strengths that differentiate the system in the marketplace and give it the “right to win.” Through this filter, executives first ask what they should keep, not what they should cut. This is the key to cutting costs and growing stronger.

Once management knows where to focus its cost reduction efforts, it can systematically determine the actions that hold the most potential for savings. These typically include:

•    Redesigning care delivery processes to remove waste, including better matching staffing to demand, automating manual processes, consolidating underutilized operations, and ensuring that everyone is working “top of license.”
•    Standardizing care processes to reduce unnecessary care and costs, for instance, by creating protocols to ensure patients are placed in the most appropriate inpatient setting, identifying clinically-appropriate substitutes for high-cost diagnostic testing and surgical supplies, eliminating redundant and low-value tests and imaging, reducing unnecessary variations in length of stay, and developing new care pathways.
•    Streamlining overhead functions at the core and in hospitals by using demand management to avoid nonessential use of services, as well as process reengineering, shared services, and outsourcing, to ensure the most efficient and effective service delivery.
•    Pursuing care delivery model innovation, such as medical homes and “productized” care for specific episodes, including new reimbursement mechanisms designed to incentivize the right behaviors across the care continuum.

To achieve and sustain the savings associated with these actions, senior hospital executives must lead a robust and transparent change management process that starts by addressing fear and engaging employees on the front lines. This work must be done by employees, not forced upon them. Middle managers should be enlisted to identify and drive operational improvements that hit the savings targets set by senior managers and endorsed by the board of directors. And there should be employee transition programs in place to reduce the pain of workforce reductions and alleviate some of the hesitation that comes with making difficult decisions to reduce labor costs.

When the leaders of hospitals and health systems adopt this approach to cost reduction, transformative change occurs. The light bulbs switch on across their organizations as inefficiencies are revealed, huge savings opportunities come into sharp focus, and the energy needed to overcome fear and inertia is released. This is the right way to capture step-wise savings and deliver the higher levels of patient care and service quality needed to ensure a healthy and prosperous future.

Curt Bailey is a partner with Booz & Company based in San Francisco. He co-leads the firm’s hospital and health systems practice in North America and serves leading healthcare delivery and services organizations.