How Can Caritas Increase Its Profit (And How Will It Likely Increase Its Profit?)

In yesterday’s post, I reviewed the proposed transaction whereby a private equity firm would acquire Caritas Christi HealthCare System in Massachusetts.  Today, I’ll discuss approaches to improve profitability at any health care facility. Tomorrow, I’ll examine some potential exit strategies for Cerberus Capital, which proposes to acquire Caritas.


By the way, yesterday's Boston Globe had another article accepting the premise that the Caritas acquisition would lead to overall health system cost savings.  

All the benevolent talk of lower overall costs notwithstanding, successful delivery systems have to make money, whether they are for-profit or nonprofit.  Without a bottom line, hospitals can’t make investments in new technology, can’t offer the amenities patients demand, and often can’t even keep up with plant depreciation.  So – profit margin is absolutely necessary – for nonprofits OR for for-profts.

There are two ways for health care systems to improve their profit margin:

1.    Decrease costs

a.     Decrease labor cost through substituting less expensive labor (non-union for union employees; physician assistants for physicians)

b.    Eliminate or downsize programs with negative margin.  

c.     Eliminate or scale back money-losing facilities

d.    Fail to make new capital investments

2.    Increase revenue

a.     Increase number of patients seen

b.    Do more procedures on the patients already in the system

c.     Offer a mix of higher margin services

d.    Demand higher unit prices at the negotiating table

e.    Improve rates of collection

f.     Dissuade patients with “poorly paying” insurance from coming to your facility (and use this capacity for patients with “better paying:” insurance.

Decreasing the input costs of health care is the best way to drive increased margin.  Hospitals which figure out how to offer equally good (or better) health care with fewer resource inputs SHOULD gain a competitive advantage.   Increasing efficiency in any business is good – because it increases the overall value delivered to the customer.

However, in health care (and many other fields), it’s a lot more attractive to increase revenue than to decrease costs. Further, through multi-year labor contracts and commitments not to cut back on existing services and facilities --  Caritas has fixed many of its costs over the first years of this new arrangement.  So, to be profitable the system will need to increase revenue.  Many of de la Torre’s changes at Caritas have tilted toward increased revenue capture, including increasing cardiac surgery, use of robotic surgery, and investment in high cost imaging equipment (that once in place tends to be highly utilized.)  Even the new construction at Good Samaritan which will embed a CT scan in the emergency department will clearly raise overall collections for Caritas (thus increasing health care costs.)   Capital will largely be deployed where businesses like to deploy capital – where it will lead to surging revenue.

Increased revenue for the new Caritas system either means that overall health care costs climb further, or that other health care systems will see lower revenue.  Lower revenue is a terrible hardship for hospital systems, which have high fixed costs and therefore must make deep cuts if they suffer relatively small revenue declines.  Some have suggested that an invigorated Caritas will put more downward pressure on prices at the big Boston teaching hospitals. I believe that an invigorated Caritas will make strategic investments that will lead to higher revenue – some of this would be new revenue altogether, which raises overall costs.  Therefore, I’m skeptical that the new ownership is likely to lead to a diminution in the rate of health care inflation.

On the positive side, Caritas has engaged in a number of global payment (capitation-like) contracts - and these are payment methods where lower resource inputs lead to financial success.

In my next post, I’ll discuss Cerberus’ potential exit strategies, and implications for managing health care costs. 

Link: Previous Post

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Why Acquisition of Caritas Christi HealthCare System is Not Likely To Lower Overall Health Care Costs

(Part One of Three)

I thought my first post back from vacation would be about the passage of health care reform – but the news from Boston that Caritas Christi, a six-hospital system which has been owned by the Catholic Archdiocese of Boston announced that it intended to sell itself to Cerberus Capital Management.  Many commentators have weighed in on the possibility that this would increase provider competition in the greater Boston area, and that the investment from Cerberus would lower overall health care costs.  The initial Boston Globe article  even said that the acquisition would “turn what had been debt and pension payments into cash flow.” The Globe editorialized in favor of the move, although with a small amount of caution.

In today’s post, I’ll examine the transaction, and hypotheses for how this would lower overall health care costs. The second post will concentrate on how hospital systems make money, and the final post will examine different ways Cerberus could benefit from its investment in Caritas Christi over time.

First, the transaction itself:

Cerberus will put up $830 million, which will allow the system to retire its debt, fund its pension plan, and make some investments and repairs to make Caritas hospitals more attractive to patients.   In exchange, Cerberus will gain ownership of the capital assets of Caritas Christi, which it says it wants to make the nidus for acquiring additional hospitals across the country.    Cerberus has pledged to honor existing labor contracts, continue existing programs, and maintain existing facilities for at least three years, during which time it will not receive any return on its investment (although presumably will be able to pay itself management fees).  The facilities will continue to honor Catholic precepts, and not offer full reproductive services.  As for-profits, the facilities will pay local property taxes (worth $7 million per year to Boston alone according to Mayor Tom Menino.) After the three year period, Cerberus will no longer be obligated to maintain programs, and would be free to ‘cash out’ of its investment.

Ralph de la Torre is quoted as saying “We are committed to being a regional, community-based system that lowers costs.’’  

How could this sale to Cerberus lower costs?

1. Substitution of capital for labor
Cerberus’ new dollars could mean that the system could make investments that would allow it to lower the resource cost of medical care in the future.  However, Caritas’ labor costs are fixed through the end of a four year set of union contracts, so the labor savings will at best be minimal.  Therefore, I conclude that it’s not likely that this new capital influx will lead to lower labor costs at Caritas.

2. Use of capital to decrease other input costs
de la Torre specifically notes that capital to deploy electronic medical records can decrease duplication of services.  That’s true – and much remarked upon – but the marginal costs of duplicated services are quite low, and there is an emerging consensus that EMRs make health care better, but don’t really decrease costs a lot.

3.    Better management
Private equity firms often pick up underperforming companies and impose new, highly disciplined management.   In this case, Cerberus says it will maintain the current leadership team, which has been credited with turning Caritas around.  If there is no change, this is not one of the ways the Cerberus investment will lower overall health care costs.

4.    Make Caritas’ facilities more attractive to patients who would otherwise go to more expensive facilities This is the “we’ll take the business from Partners” argument. The Attorney General’s recent report shows huge cost differentials from high cost to low cost providers, without substantial quality differences.  That report confirms that Caritas is a relative low-cost provider.  If patients choose St Elizabeth’s over Mass General in light of these new investments, costs are likely to be lower.  However, if Caritas Norwood Hospital takes business from nearby Milton Hospital (instead of more expensive South Shore or Brigham and Womens), costs for the overall system will instead rise.

My conclusion is that it’s wildly optimistic to suggest that this capital influx will lead to overall cost savings in Massachusetts.  Undercapitalized hospitals generally have lower costs, while well-capitalized hospitals generally have higher costs.  However, it will be very difficult to turn the application down, as an underfunded Caritas clearly cannot compete against the other health care delivery systems, and the system is an important safety net provider and an important source of jobs in many communities.

Next Post: Improving hospital profitability

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April Harvard Business Review

I'm still in Laos - with a plane-worth of reading to do to catch up.  Regular posts will begin next week, although I'll try to send something from the 8000 mile ride back.

Of note, the April Harvard Business Review includes an infographic I wrote (with much editorial assistance from Gardiner Morse of HBR) on the causes of health care cost increases, and a few potential answers.  Here is a URL for a "teaser."  Subscribers can view the entire article on line, and Harvard-affiliated readers can access this through the Harvard Library - but the April issue won't be available until next month.  Many of the topics here will be familiar to readers of this blog.

For nonsubscribers, the issue has an interview with Atul Gawande (recent author of The Checklist Manifesto, noted in the column on the right), and articles on improving the delivery of care by Richard Boehmer of HBS and Tom Lee of Partners and Harvard Medical School.   I'm looking forward to seeing my copy!

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