Chapter 21: Contract Negotiations

Analyzing and Negotiating Cost Volume Profit Medical Contracts

[Profit Optimization versus Revenue Maximization]

By David Edward Marcinko
By Hope Rachel Hetico

Every decision you make is a mistakeEdward Dahlberg

Introduction

A cost-volume-profit relationship exists in any healthcare entity and emphasizes the point that the goal of an efficient organization should be profit optimization, rather than revenue or volume maximization. 

The profit of any healthcare facility is what’s left after all financial outflows are removed from all financial inflows. This optimization is reached at the point where patient volume, fee per patient, and costs per patient produce highest profit, not the highest revenue. 

This is the point of maximum efficiency and is where you want to be. It is applicable to capitated, fee-for-service [FFS], or discounted FFS fixed contracts, and be described in the equation below.

The Profit Equation

Medical profit can be defined by the equation:

Profit = (Price x Volume) – Costs

or P = (P x V) – C

whereas:

Revenue = Price x Volume

or R = PV

To increase profits, the doctor must increase price (if possible), increase volume (if possible), or decrease costs (if possible); and ideally the doctor should perform all three maneuvers simultaneously. If we assume that only costs are under the doctor’s control (a not altogether valid strategy), any strategic financial planning process that ignores them will not be beneficial. 

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5 thoughts on “Chapter 21: Contract Negotiations

  1. THE HOSPITAL OF SAINT MACKENZIE THE HOPEFUL

    The Hospital of Saint Mackenzie the Hopeful is a 500-bed facility that was operating at 55% capacity.

    To increase its occupancy rate, it instituted a direct medical contracting program with the Hi-Tech Corporation, a major employer in the area. In order to receive the business, St. Mackenzie’s agreed to offer a 15% discount on all charges. It also agreed to hold its price increases to 5% per year, for three contract years.

    Prior to the contract, the hospital had served about 15% of Hi-Tech’s employees, or a total of 765 admissions per year, with total charges of $3.2 million. After the contract was executed, the hospital admitted 25% of Hi-Tech’s employees, or about 1,275. These admissions were responsible for $5.3 million of charges. In the second and third years, the hospital received 37% of the employees or 1,887 admissions, which accounted for $8.3 million of charges.

    KEY ISSUES:

    1) Consider conceptual reasons why Saint Mackenzie’s operating capacity might have fallen so low in the first place.

    2) Generally, does this pattern typically occur as an abrupt one-time external shock, or a slow internal degradation?

    3) Typically, what is the impact of the shift from retrospective to prospective reimbursement changes?

    4) Are you cognizant of other parameters such as:

    – Patient visits, procedures, and treatment?
    – Payments for out-patient visits, tests, surgery, procedures and diagnostic interventions?
    – Payor mix, acuity rates, populations, and demographics?
    – Per member, month, year and contract rates?
    – Variable, hybrid, and fixed costs?

    Now, consider the following issues facing Saint Mackenzie and ask yourself:

    5) Should the hospital accept the contract?

    6) What are contract pros and cons?

    7) What type of conditions in the contract would contribute most benefit to the hospital?

    8) If it accepts the contract, how long would it take to work itself out of debt?

    Any thoughts on this sample case model after reading this chapter in the BMP 3.0
    Hope

  2. Sources of General Health Economics Statistical and Financial Data

    a. Claritas Connect (online demographic and statistical data reports). Claritas Data Services. 53 Brown Road, Ithaca, NY 14850; (607)257-5757.
    b. Federal Reserve Economic Data (FRED) electronic bulletin board: http://www.stls.frb.org/fred.
    c. “National Economic Trends.” (monthly) St. Louis, MO: Federal Reserve Bank of St. Louis. P.O. Box 442, St. Louis, MO 63166-0442; (314) 444-8809.
    d. Slater Courtnay M. ed. “Business Statistics of the United States.” (annual) Lanham, MD: Bernan Press. 4611-F Assembly Drive, Lanham, MD, 20706-4391; (800) 274-4447.
    e. Slater Courtnay M. and George E. Hall eds. “County and City Extra: Annual Metro, City and County Data Book.” (annual) Lanham, MD: Bernan Press. 4611-F Assembly Drive, Lanham, MD, 20706-4391; (800) 274-4447.
    f. U.S. Department of Commerce, Economic and Statistical Administration, Bureau of the Census Website: http://www.census.gov.
    g. U.S. Department of Commerce, Economic and Statistical Administration, Bureau of the Census. “Statistical Abstract of the United States: the national data book.” (annual) National Technical Information Service. 5285 Port Royal Road, Springfield, VA 22161; (703) 605-6000. http://www.census.gov.
    h. U.S. Department of Commerce, Economic and Statistical Administration, Bureau of Economic Analysis. “Survey of Current Business.” (monthly) Government Printing Office; (202) 512-1800. http://www.bea.gov.
    i. U.S. Department of Labor, Bureau of Labor Statistics. “CPI Detailed Report.” US Department of Labor, Bureau of Labor Statistics. http://www.bls.gov

    The End

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