How much should cost savings cost?
New York City’s Montefiore Health System spent $40 million since last year working with a consultant to improve its finances by $500 million annually. The system said it expects to start seeing results next year.
The unusually frank disclosure tucked in the academic medical center’s latest financial statement raises the question of how much providers should spend to cut costs, especially at a time when most providers are looking to tame their ballooning expenses. Labor costs—hospitals’ biggest line item—have spiked during the COVID-19 pandemic amid demand for travel nurses and some supplies are priced at a premium.
The pandemic has also had the double-whammy effect of dampening revenue as governments forced hospitals to suspend elective procedures.
Most experts interviewed said there’s no hard and fast formula around how much health systems should expect to spend on a financial improvement program relative to how much they’re looking to save. For systems that hire consultants, bills in the eight figures like Montefiore’s are not uncommon, said Dave Morlock, managing director at Cain Brothers and head of its health system group.
“These engagements are large, they’re involved and they can be very expensive,” he said.
One rule of thumb is health systems should expect a roughly 5-to-1 return on their investment with respect to their consulting spend, said Roger Weems, advisory services market leader for Premier, a publicly traded company that consults for providers. That means a $5 million financial improvement should cost $1 million in consulting fees.
“Don’t ask me where that came from, but it’s been around since ancient times and it’s still loosely used,” Weems said.
He gave the caveat that this guideline doesn’t include any integrated technologies that might be involved.
Experts interviewed said most of these agreements have contingency clauses, where the amount the health system pays the consultant depends on how much financial improvement they actually pull off. Montefiore said this is the case with its own agreement, although it declined to say which firm it’s using.
The appropriate way to structure a consulting agreement depends on the relationship between the health system and the consultant, said Rick Kes, healthcare industry senior analyst with RSM.
If the health system has worked with this specific consultant before and feels confident they’ll perform well, a contingency arrangement might not be necessary. And if the consultant takes the risk of agreeing to a contingency-based arrangement, they’ll probably want a higher reward if things go well.
“It usually comes down to, as corny as it might seem, the trust factor,” Kes said. “Does the health system executive believe the firm can achieve the cost savings? That’s where individual specifics of that circumstance come into play.”
Rob DeMichiei, who served as UPMC’s finance chief for 16 years and is now a strategic adviser for Health Catalyst, said he’s not a fan of contingency contracts because they give away too much upside.
“If there is a significant level of savings, then that accrues to the consultant as opposed to accruing back to the organization,” he said.
The way DeMichiei sees it, there’s enough competition in today’s market and enough capable consultants that contingency contracts aren’t necessary.
Before hiring consultants, health systems should roll out a competitive request for proposal process to ensure they’re getting a price point that’s consistent with fair market value, DeMichiei said. Ultimately, though, he said the consulting spend will be a hard cost that requires a significant return on investment. The savings are less tangible and harder to track.
The volatile pandemic environment has prompted a number of systems to turn to national consulting firms for sweeping financial improvement programs, where the targets are both revenue and expenses and extend broadly across all departments, said Dr. Daniel DeBehnke, chief physician executive for advisory services at Premier.
What Montefiore is doing is “actually exactly what we’re seeing, and we’re seeing it on a large scale,” DeBehnke said.
Montefiore did not grant an interview and declined to say which areas it’s targeting for margin improvement. The system said it began to implement initiatives in the second half of 2021 and expects financial improvement in 2022 and 2023.
As a consultant, Weems, of Premier, said he prefers to steer clear of such all-encompassing financial improvement messaging because it denotes more of a top-down approach that wouldn’t involve existing management. In reality, 90% of the time, consultants don’t go in and discover savings opportunities entirely on their own. They do so through conversations with CEOs and CFOs, who clue them in to what’s happening, he said.
“There is a way to position it strategically where the ownership is clearly with the health system leadership and that we’re just helping to provide external experience and expertise in how to put together infrastructure to do this kind of work and achieve goals,” Weems said.
Likewise, DeMichiei said such wide-ranging financial turnaround programs tend to happen when there’s a change in leadership. He thinks a more effective use of consultants is for niche, targeted areas that need improvement. Rather than having someone overhaul the entire revenue cycle operation, for example, it might be having a consultant improve charge capture or coding. Or rather than overhauling the supply chain management department, a consultant might help with freight management or e-procurement.
The problem with broad-scale financial improvement programs is that it’s more difficult for the health system’s operators to take charge of the solutions and own the results, DeMichiei said. Changes that are vetted and instituted by the management team tend to be more sustainable.
“Putting that all in the hands of a consultant to me is a bit risky,” he said. “Unless you’re in a situation where you’re doing a turnaround or changing out the management team or changing the management team in a specific area, you already employ the experts, which is your existing operating team and executive team and those consultants have to fill in the gaps in these narrow niches.”
Chicago-based CommonSpirit Health, a sprawling system of about 140 hospitals, announced in 2019 a goal of cutting $2 billion from its expenses in four years from a combination of merger-related synergies and performance improvement strategies. CommonSpirit’s finance chief has said COVID-19 forced it to push back its timeline by 12 to 18 months. CommonSpirit draws north of $30 billion in annual operating revenue.
Cost savings from such large-scale undertakings typically take at least two to three years to accrue, said Cain’s Morlock. In Montefiore’s case, it’s going to be a big, complicated endeavor, he said.
“If it was easy to produce these results, the fees for these engagements would be a lot lower,” Morlock said. “The complicated nature of this work is important to put context around.”