Figure it out: Recognizing costs, priorities key to conquering budget challenges

When it comes to planning and implementing a hospital supply budget, perhaps a little neurosis among materials managers is good. Anxiety is another story, however, and for what it’s worth, hand-wringing angst is all too common during budget season.

Considering that fastidious attention to expenditures is nothing out of the ordinary for materials managers, the unrest is a bit surprising. Seeking the lowest possible prices, slimming down inventory and extracting every ounce of available savings is a typical day at the office. So what is it about the budget process that causes them to reach for the antacid?

There are many forces contributing to the pressure, but a primary cause could be the big buildup to budget time. Each year, finance time is treated as an obligatory ritual of monumental importance. It’s a feeling that is somewhat misguided, observes financial expert Steve Berger.

"The budget is seen as something that must be done once a year," said Berger, president of Lake Forest, IL-based Healthcare Insights. "It’s not – it’s a living document that must be dealt with on a constant basis."

Adding to the 12-month cycle of budget stress are external variables that can adversely affect a hospital’s revenue stream.

"In many states, Medicare is the single largest budget item," Berger said. "During budget time from January through April, I look at headlines in the newspapers that say ‘State Has Budgetary Problems; Medicare Targeted.’ Urban hospitals seem to be hit the hardest."

Because hospitals lean heavily on federal and state funding sources when determining their annual budgets, revenues are jeopardized when these projections fall short, said John Webb, consultant with Libertyville, IL-based Cap Gemini Ernst & Young.

"They [Hospitals] still count on a lot of money coming from those sources and when there’s an economic downturn, it becomes a real issue," he said. "Hospitals typically invest in new technology from profits and even if they’re not profitable, it’s money reinvested. If the states are having problems and can’t supply the funds, it has an immediate impact on healthcare."

Medicare reimbursement is declining and malpractice costs are escalating, which depresses the budget even further, Webb said.

"Malpractice insurance costs so much now that it is conflicting with other initiatives and wipes out the bottom line," he said. "A lot of hospitals have to contend with ever-shrinking resources."

Even so, hospitals have been dealing with financially draining provisions of the Balanced Budget Act of 1996 for several years and only lately do they appear to be regaining their footing, Berger said. Suburban hospitals have shown the most improvement in recovering from external strains, but they still need to handle internal challenges as well, he said.

"There’s a big ‘if’ to suburban hospitals being healthier – it depends on their ability to control costs," Berger said. "You can have great location with a great payer mix and still not be doing so hot."

New technology puzzle

While revenues and corresponding appropriations give materials managers the framework for their decision-making, the crux of their work comes in setting priorities and discerning how these concerns fit into a hospital’s overall cost picture. At the forefront is prioritizing new technology acquisitions, said Dee Donatelli, vice president of clinical consulting for Richmond, VA-based Owens & Minor’s OM Solutions. Donatelli, an RN, is also a long-time materials manager and materials management consultant.

"Emerging technology is a huge financial challenge," she said. "The main questions are: ‘Is it affordable and what is the appropriate utilization of it?’"

Rationale over whether to get hold of the latest orthotic hip or newest coronary stent should focus on necessity above all else, said Donatelli, who served as director of materials management at St. Joseph and St. Francis hospitals in Wichita, KS.

"Criteria-matching with physicians can help determine which new products are the ones everyone needs," she said. "We often fall short of the ability to effectively communicate with physicians on new product utilization."

Donatelli suggested that sound policy surrounding new technology introduction might include swapping products one-for-one, with obsolete products being the most expendable.

"When someone asks for a new widget, ask what they’re willing to give up to get it," she said. "Ideally, when something comes in, something should go out. It doesn’t always work, however; it’s hard to deny physicians new technology that is demanded by the public. Reasonableness is the most you can ask for."

Because they serve as caretakers of inventory, materials managers need assistance from the administration in achieving prudent supply management, Donatelli said.

"Putting the right processes in place for effective product utilization is not just the materials manager’s job," she said. "MMs are customer service representatives. They don’t drive utilization. There has to be ownership and it has to be assigned. Loss of accountability is loss of control."

Budget linkage

As a former hospital CFO, Steve Berger is both a student and teacher of healthcare budget science. He teaches regular classes for health system executives on financial issues, which he says are just as educational for him.

One thing he’s learned is that people find budget issues mystifying.

"Everybody knows what a budget is, but they can’t define it," he said. "My definition is that a budget is ‘a quantitative expression of a plan of action.’ Basically it’s what the administration wants – defined in dollars."

Although an annual budget is composed and implemented each year, it shouldn’t be considered a standalone document, Berger said. It needs to be anchored to a long-term plan of action, specifically three-to-five-year strategic and financial plans. The strategic plan is the roadmap and the financial plan determines if there are enough funds to take that road.

"By having something to tie it back to, the budget will be stronger because of that link," he said.

Yet based on feedback from Berger’s students, not many hospitals are making that connection.

"One hundred percent of hospitals have strategic plans because the Joint Commission requires them – but only about 30 percent are actually using them," he said. "So there’s little linkage between the annual budget and the strategic plan."

Two major budget components – volume and unit cost – are the keys to quantitative expression, Berger said. Volume drives gross and net revenue as well as variable expenses and when multiplied by unit cost reveals the total cost. He offers this example of how the numbers work: If volume is $100 and the unit cost is $50, the total cost is $5,000. If the plan of action includes a 10 percent rise in costs, the volume is $110. With inflation at about 3 percent, the unit cost becomes $51.50. By multiplying $110 by $51.50, the total cost becomes $5,700.

"If you’re in budget crunch, there are a couple ways to go – either leave the volume alone, or look at whether you have to pay that extra 3 percent on the unit cost side," Berger said. "The materials manager can make an impact through negotiations. If that fails, change vendors. You might find yourself saving even more than 3 percent."

IT systems critical

Prevailing over the budget challenge is nearly impossible without reliable data, Donatelli said, and information technology provides the best means for facilitating it. The IT platform allows departments to share the data necessary for ascertaining costs, yet based on what she has seen, many hospitals still use antiquated systems. Consequently, they are struggling to get a grip on costs.

"Too often, when I ask how much money is spent in the cath lab and which vendors are being used, it’s not captured in an information system," Donatelli said. "We’ve survived despite ourselves when we don’t our understand costs. Where do you cut back when you don’t know where your dollars are going?"

Not only does a strong IT system make an effective repository for critical data, it serves as a communications medium for fiscal decision-makers. With Web-based infrastructures, modifications can be made to budget numbers in "real time," allowing all users to view the changes as they happen.

Texas Children’s Hospital in San Antonio, for example, has been using a Web-based system from Pleasanton, CA-based PeopleSoft for three years and reports marked improvement in all aspects of budgeting practices. Where reports were once generated on spreadsheets and constantly passed back and forth via e-mail, everyone now has access to all information in the repository.

"You can look at prior year ledgers, use them to forecast what the end of the year will look like and make extrapolations from that with respect to budget numbers," said budget coordinator Chuck Mazac. "It’s easily refreshed – you can get updates at the end of each month, which gives you a good piece of information to work with for finishing the year. It provides a snapshot of what the budget looks like without having to constantly pass messages back and forth. It’s much faster."

Similarly, Berger has developed an online software system called INSIGHTS that allows users to put his budget guidelines into practice. It multiplies volumes by cost per unit and factors in inflation. It also ties in with the hospital’s plan of action by scoring all major capital improvement requests – the major element of the strategic plan.