The shift to value-based care and consumerism is driving health systems and hospitals to optimize gains from nonpatient service activities and innovation.
This article first appeared in the March 2017 issue of HealthLeaders magazine.
For nonpatient service activities at health systems and hospitals, the evolution of financially lean value-based business models and consumer-driven care is transforming strategies for success.
As this evolutionary process unfolds, healthcare providers are facing new market limitations on mature mainstays of nonpatient service activities such as parking facilities. With patient satisfaction among the rallying cries of the value-based revolution, there are limits on generating revenue from parking garages and campus eateries, which patients prefer to enjoy as conveniences rather than to dread as drains on their wallets.
With these market realities, health systems and hospitals are turning to innovation activities as a vehicle for generating a host of benefits, including clinical care advances that improve quality and lower costs, new revenue stream opportunities, and support for broad strategic objectives.
Satisfaction among patients and employees is one of the primary limitations on traditional sources of nonpatient service revenue, says Stephen Allegretto, CPA, MPH, vice president of strategic analytics and value innovation at Yale New Haven Health System (YNHHS) in Connecticut, which includes an academic medical center, more than 6,300 physicians, and a 600-member multispecialty physician foundation. "We have generated parking and cafeteria income for years. That has been a long-term strategy for us. We need to do that; but the more we charge for parking, the more upset both our patients and our employees are."
To optimize the financial impact of nonpatient service activities, innovation is the most promising pathway to success, Allegretto says. "We have all of these 'other operating revenues' that we have had traditionally, and, as patient service revenue continues to decline, we need to find other revenue sources. … The sources we are talking about are nonpatient revenue, so how do we build those? We are not going to build up nonpatient revenue through parking and cafeteria. We are going to build it based on innovation."
YNHHS posted total operating and nonoperating revenue for the fiscal year ending September 2015 at $3.6 billion. Net patient service revenue was the dominant source of operating revenue at 95.6%.
"We have all of these 'other operating revenues' that we have had traditionally, and, as patient service revenue continues to decline, we need to find other revenue sources."
The potential to generate significant new revenue streams through the development of innovative products and services is tremendous, says Chad A. Eckes, MBA, executive vice president of corporate services and CFO at Wake Forest Baptist Medical Center, an integrated health system in Winston-Salem, North Carolina, that operates more than 1,000 acute care, rehabilitation, and psychiatric beds. The medical center and key Wake Forest University partners such as the medical school generated hundreds of millions of dollars in licensing revenue from medical devices based on negative pressure wound therapy (NPWT) technology.
"It was a substantial amount of revenue and a lot of margin coming from the medical center. So we have had a rich history of seeing what diversified revenue streams can mean to the organization. Our royalties on that ran out in 2012, so then we saw what life is like without having a large nonpatient service revenue, and we really want to create that again," Eckes says.
For the fiscal year ending June 2016, Wake Forest University Health Sciences (WFUHS), which includes the medical center and Wake Forest's medical school, reported total revenue at $2.3 billion with $2 billion from net patient service revenue representing the largest source of income. Other primary sources of operating revenue were grants, public and private contracts, and tuition.
With market constraints on generating revenue from traditional nonpatient services, the impact of nonpatient service activities is becoming more strategic than financial at many health systems and hospitals.
At Southwest General Health Center in Middleburg Heights, Ohio, a 332-licensed-bed nonprofit hospital, top executives have developed nonpatient service activities that support broad strategic goals such as community support and population health gains from a school nurse program and the hospital's LifeWorks fitness center, Vice President and CFO Mary Ann Freas says. "Aside from the typical sources of nonpatient service revenue, Southwest has developed programs that reach out into the community in the example of school health, provide patient convenience in the case of the retail pharmacy, or promote wellness in the case of LifeWorks," she says.
For the fiscal year ending December 31, 2016, Southwest generated total operating revenue at $344.6 million. The operating revenue was segmented into net patient service revenue, $333.3 million (96.7%), and other operating revenue, $11.2 million (3.3%). The LifeWorks fitness center accounted for a third of other operating revenue at $3.1 million, Freas said.
Hitting the nonpatient service activity ceiling
While academic studies have shown that traditional nonpatient service activities contribute significantly to total revenue margins, health system and hospital finance leaders are viewing innovation activities as a more promising option to not only bolster their balance sheets but also move other needles at their organizations.
A pair of academic studies published in the journal Health Care Management Review provide strong evidence that nonpatient service activities can have a measurably positive impact on total revenue margins.
University of Florida research published in 2009, titled "Nonpatient Revenues in Hospitals," examined the financial impact of nonpatient service activities at 143 Florida-based hospitals from 2003 to 2005. The two measures of nonpatient service revenue in the research mirror the revenue categories on financial statements: an "other operating revenue" category for income derived from standard hospital operations such as parking, and a "nonoperating revenue" category for activities unrelated to standard hospital operations such as financial investments.
The UF researchers—Niccie McKay, PhD, and Louis Gapenski, PhD—found that nonpatient service activity accounted for a relatively small portion of total revenue but had a significant impact on hospital financial margins.
"The overall role of nonpatient revenues was assessed by combining other operating and nonoperating revenues. … On average, hospitals in the sample had nonpatient revenues that accounted for 5.4% of total revenues," the University of Florida researchers wrote.
Despite the relatively low level of nonpatient service revenue as compared to total revenue, McKay and Gapenski concluded that the financial impact on operating margins was considerable. "Operating margin would have been 0.2 percentage points less without other operating activities. For nonoperating revenues, comparing average operating margin (3.3%) and average total margin before tax (4.8%) indicates that nonoperating activities contributed 1.5 percentage points. Overall, without nonpatient revenues, average total margins before tax would have been 1.7 percentage points lower," the UF researchers wrote.
McKay—who has retired and holds the title professor emerita at the UF Health Services Research, Management, and Policy department—says nonpatient service revenue remains a potentially decisive factor in whether hospitals have positive operating margins. "My sense is that things haven't changed all that much, in that nonpatient revenues are still pretty important," she says.
California hospital research that Health Care Management Review published in 2013—"Nonoperating revenue and hospital financial performance: Do hospitals rely on income from nonpatient care activities to offset losses on patient care?"—drew similar conclusions.
The 2013 study, which is based on data collected from 2003 to 2007, found "nonpatient care activities contributed substantially to overall profitability" at the 232 California hospitals in the sample. "Without engaging in any nonpatient care activities, hospitals' average total margins would have been 2.4% points lower than they actually were during the five-year study period," the journal article says.
Although the 2013 study is in line with the UF researchers' conclusion that nonpatient service activities boost total revenue margins, the California data showed that few struggling hospitals could rely on nonpatient service activities to boost profitability. "Although nonpatient care activities mitigated some of the losses on patient care services, less than 25% of hospitals generated sufficient income from nonpatient care activities to completely offset patient care losses," the 2013 study says.
As the healthcare industry becomes more patient-centered and consumer-driven, health systems and hospitals cannot expect to generate significant revenue from traditional nonpatient service activities such as food services and parking, Eckes says.
"If you do not want to pay for parking, you can park off-campus and walk, which is an option, and we have shuttles. But for convenience and to be able to have something right next to the building, we have these parking options that have a cost and a revenue opportunity associated with it. Even though we need to offset the cost of these conveniences, we do try to keep them reasonable. It is not like we are suggesting that this is a positive margin maker. We are just trying to keep up with the cost of parking facilities"—the goal being that nonpatient service activity at least covers its own costs, so that those costs do not have to be subsidized with patient service revenue, he says.
The same philosophy, which puts a premium on patient satisfaction and discounts financial return on investment, applies to food services and a hotel that the medical center operates, Eckes says. "Nonpatient services are not just cost- and revenue-related. It's also about meeting patients where their desired customer service level is. For example, putting the Starbucks and those types of items into the facility, number one, is improving the customer experience. It's providing a service that our customers are desiring. … We own a hotel that is available for patients and vendors and others. It is a break-even business that works."
Multiple benefits from innovation
In contrast to traditional nonpatient service activities such as parking facilities, which are constrained by market realities, innovation activities can generate multiple benefits for health systems and hospitals, including improving care, lowering expenses, boosting patient engagement, supporting strategic goals, and establishing new revenue streams.
To support medical technology innovation efforts throughout the Yale community, the Center for Biomedical Innovation and Technology (CBIT) was formed. The top goal for the health system's innovation initiatives is to generate a range of benefits across the entire organization, says Malgorzata "Margaret" Cartiera, PhD, investment and innovation manager at CBIT. "We want to make sure that innovation investments take into account the value-based system that Yale New Haven has in mind. The focus is the patient, and making sure that we are bringing new innovations and innovative advances that will bring value across the system," she says.
At University of Utah Health Sciences (UUHS), which features a 528-licensed-bed medical center and medical school, a surge of innovation activity over the past four years has improved quality of care, reduced costs, and boosted patient engagement.
"We are very clinically focused," says Rachel Hess, MD, MS, chief of the UUHS Health System Innovation and Research (HSIR) program, a research and innovation incubator launched in 2014. "We take research from the get-go and think through how it can be immediately disseminated into a clinical space."
For the fiscal year ending June 2016, UUHS posted total operating revenue of $3.7 billion and net patient service revenue of $1.9 billion.
HSIR participated in research published last year in the Journal of the American Medical Association, establishing new diagnosis criteria for sepsis that are designed to hasten treatment of the deadly infection. The research shows that the new diagnosis criteria cut the response time for administration of anti-infective treatment nearly in half, from 7.8 hours to 3.6 hours.
"The sepsis example started with one of the inpatient hospitalists identifying that there was a delay in receipt of antibiotic therapy that he felt was unduly long in patients identified with sepsis, and that earlier identification would be advantageous and could be achieved," Hess says.
The main financial measure for achieving success at HSIR, which received $607,265 in state funding for fiscal year 2016, is generating grant revenue, she says. "The ROI that is expected over five years is about 500%. … We were brought in to not only support but also to increase grant funding."
Hess adds that HSIR spent only $215,378 of the state money in fiscal 2016 and was able to bring in $1.7 million in additional grant funding.
In 2013, UUHS launched a healthcare information technology incubator program that employs student labor and a skeletal professional staff—the Therapeutic Games and Apps Lab (GApp Lab). The GApp Lab features a lean business model with high potential for return on investment, says Roger Altizer, PhD, director of The GApp Lab and an associate professor of population health science at the University of Utah School of Medicine.
"We have about 35 graduate students every semester on scholarships, and we get that money from private funders who pay us to do research, internal hospital money that pays for projects that they think are going to help patients, and research grants. Even with the research grants, we are making software games and other applications that are patient-facing. We've done over 40 discrete projects in the last three years, and we've gotten a couple million dollars in that type of funded research."
The GApp Lab is a low-cost option for UUHS to develop innovative healthcare IT applications such as mobile electronic medical record software developed at the incubator, he says. "We had a project that we did for $50,000 that received an external bid for a million dollars."
Growing demand for digital patient-engagement tools is a golden opportunity for UUHS and The GApp Lab, Altizer says. "Patient engagement is changing rapidly. From mobile apps to virtual reality, we can change the way that patients can interact with both their providers and with their own health data."
Health systems and hospitals are harnessing innovation activities to advance strategic goals.
ProMedica Health System, a locally owned, nonprofit healthcare network, is utilizing innovation activity to support the Toledo, Ohio-based organization's population health strategy, says Lee Hammerling, MD, chief physician executive and chief medical officer.
For the fiscal year ending December 2015, ProMedica posted total operating revenue of $3.1 billion, with $1.7 billion in net patient service revenue, $1.3 billion in premium revenue from ProMedica Insurance Corporation, and $73 million in other operating revenue.
At ProMedica, investing in innovation activities is essential to the health system's population health strategy, he says. "For years, our health system had been engaging in population health management for our patients. We have now broadened that definition of population health to include what we call the social determinants of health. Traditionally, health systems, hospitals, and doctors have not looked at factors like hunger, the ability to secure food for your family, housing, transportation, behavioral health issues, getting a job, and economic factors that impact the ability of people to access care."
Job creation is a key element of ProMedica's population health innovation activities.
In 2015, ProMedica Innovations, the organization's innovation division, opened its 6,000-square-foot Incubator. For startup partners, job creation must be part of the deal, says Hammerling. "When we talk with a company about helping them in a startup, one consideration is they have to create jobs locally."
Linking innovation activities to job creation in northwestern Ohio is part of ProMedica's population health mission to address problematic social determinants, he says. "We're part of the Rust Belt, and we have had some companies relocate from here. It has been a challenging community, but it is improving."
The ProMedica Innovations Incubator is generating positive results after just one year in operation. "It is at full occupancy with three startup companies, all currently generating revenue. The head count went from seven at initiation and is now approximately 40 people employed in total," Hammerling says.
One of the startups, VentureMed Group Ltd., received FDA approval in June to market a catheter device for treatment of peripheral artery disease. The FLEX Scoring Catheter is selling in the European and U.S. markets, he says.
Although the ProMedica Incubator is operating net-negative at this point, the facility's startup trio is paying for rent and services such as financial consulting, Hammerling says. The health system is projecting a positive return on investment from startups in the Incubator within 10 years from commercialization and licensing of products, he says.
Hitting the innovation jackpot
Innovation income at health systems and hospitals is reflected in both the operating and nonoperating revenue categories of annual financial statements.
In the operating revenue category, innovation activity revenue is shown in the "other operating revenue" subcategory as opposed to the patient revenue subcategory. This revenue is mainly in the form of contracts such as licensing deals and grant funding. In the nonoperating revenue category, innovation activity revenue is linked to equity earnings on investments in startup companies.
Wake Forest hit the medical-device licensing jackpot when a pair of medical center reconstructive surgical faculty members—Louis Argenta, MD, FACS, and Michael Moykwas, PhD—invented NPWT. In 1995, the Food and Drug Administration approved the first Wake Forest-patented NPWT device.
Devices developed with Wake Forest's NPWT technology were marketed with the Wound V.A.C. (vacuum-assisted closure) brand.
"Wound V.A.C. had its licensing fees because it is a product selling for billions of dollars worldwide. That has brought major and significant income into Wake Forest Baptist Medical Center over the last 15 years or so," says Eric Tomlinson, DSc, PhD, chief innovation officer at Wake Forest Baptist Medical Center and president of Wake Forest Innovation Quarter, the university's innovation district.
NPWT is based on the age-old principle of sucking on a snakebite to draw venom from the wound. Using a pump and tubing to create negative pressure in combination with a special dressing, Wound V.A.C. not only draws swelling fluids and harmful bacteria from a wound but accentuates the body's healing features.
NPWT has helped physicians around the world avoid an estimated 1 million limb amputations for serious wounds, according to the Chicago-based American College of Surgeons. In June 2016, the physician association honored Argenta with the Jacobson Innovation Award, calling NPWT "the most important advancement in wound healing in the past 25 years."
Wake Forest has garnered several hundred million dollars in licensing revenue from the sales of NPWT devices worldwide; but as with other inventions and advancements, others tried to grab a piece of the action.
In 1993, Wake Forest established an NPWT licensing agreement with San Antonio, Texas-based Kinetics Concepts Inc. (KCI). As the 2012 expiration of Wake Forest's patent rights approached, the license partners filed several patent-infringement lawsuits in the United States and abroad to protect the intellectual property, according to a Securities and Exchange Commission document that KCI filed in December 2010. The SEC document says Wake Forest and KCI filed nine patent-infringement lawsuits from May 2007 to July 2009.
In October 2010, a federal district court in Texas ruled against Wake Forest in one of the patent-infringement cases; then in February 2011, KCI filed a lawsuit in federal district court seeking a judgment that the company should no longer owe royalties. Wake Forest and KCI settled their patent dispute in July 2014, with the Texas company agreeing to pay $280 million in annual installments. The last payout—a $30 million obligation—is set for this June.
KCI made royalty payments to Wake Forest from 2008 to 2010, totaling $268 million, according to the 2010 SEC document.
Effectively managing product development and the licensing business cycle for inventions such as NPWT is a key element of success for innovation activities at healthcare providers and a core competency at Wake Forest Innovation Quarter, Tomlinson says.
"Now, the license has lapsed. The technology [is] still in the marketplace and still being sold very successfully without a license, so we no longer receive income from that license. And that is one of the challenges for the prioritization of ideas in such a property. You are dealing with a marketplace. The challenge in all of these innovation activities is understanding your market dynamics, the competition, the pricing, the time to market, the cost to market, and who can be your partner. Wake Forest Innovation is populated by people who do that market analysis evaluation prior to making financial investments in technologies," he says.
Innovation licensing contracts involving health systems and hospitals feature several key elements, including provisions for up-front payments to compensate the inventor organization for early development work on an innovation, payment terms for medical workers to conduct clinical trials, and revenue milestones, Tomlinson says. "All of those licensing agreements are fairly well-scripted and heavily vetted. We manage them in a very dynamic manner, paying close attention to each and every license field."
The nonprofit Hospital for Special Surgery (HSS) in New York City has scored revenue success with total knee implant prostheses.
In the fiscal year ending December 2015, HSS posted total operating revenue of $982 million and net patient service revenue of $820 million, or 83.5%. Other operating revenue of $145 million, or 14.77%, is relatively high compared to industry trends because the hospital contracts directly with the organization's physicians as opposed to establishing a financially separate physician group or association.
"Beginning at HSS in the 1990s, with the surgeon-engineer team of John Insall and Al Burstein, we developed the Insall-Burstein 1 [IB1], with a follow-on to that design known as the IB2. Those designs were licensed to the big ortho companies and sold well throughout the late '90s and early 2000s," says Leonard Achan, RN, MA, ANP, chief innovation officer and senior vice president of innovation and business development at HSS.
"Additional innovations were made with a different surgeon and engineer group that led to the 913 knee. That knee design included unique geometries that were anatomically inspired. More recently, as the 913 came off patent, we launched yet another knee design called the PS—a posterior stabilized knee that has additional innovations built into it. These total knee implants represent some 30 years of continuous innovation at HSS around the knee."
Combining medical and engineering expertise has been essential in the development of HSS knee implants, he says.
"The primary key to success is the deep relationship between the surgeon and engineer throughout the design process. This relationship is critical to the process—and one could not adequately do it without the other. This is a unique aspect of the design of these types of medical devices."
Knee implant innovations have generated about $100 million in aggregate revenue at HSS, he says. "The institution has benefitted from multiyear revenues from these distinct total knee implants."
Innovation incubators
Community hospitals can engage in innovation activities that are as robust as programs at health systems with much deeper pockets.
The Fogarty Institute for Innovation on the campus of El Camino Hospital is helping the Mountain View, California-based healthcare provider build a brand that is well-suited to the 443-bed facility's Silicon Valley market. "We had a group recently from the French Embassy who are very interested in cloning what we have, and the Danish government has sent multiple teams here. We are very small, but we have a very large impact and a significant reputation," says Kerry Pope, executive director of mentoring at FII.
"El Camino views themselves as the Silicon Valley hospital, and innovation is a core part of their marketing message to both patients and physicians," Pope says.
FII, which has entirely separate governance and finances from El Camino, generates several other benefits for the healthcare provider, says hospital Chief Operating Officer Mick Zdeblick.
"As a community hospital, El Camino Hospital is committed to being an innovative and locally controlled comprehensive healthcare organization that provides quality, cost-competitive services to improve the health and well-being of our community. Our partnership with Fogarty Institute for Innovation demonstrates this commitment. The location of the 'Fog Shop' on our hospital campus gives our staff and physicians the opportunity to engage with inventors and provide real-time and real-life insight. It's a great way to energize our staff and physicians and bring them along in thinking of ways to improve the delivery of care," he says.
"Several FII incubator companies have conducted clinical trials at El Camino Hospital. Participation in these trials, when it strategically aligns, allows our staff and physicians to test the feasibility of the technology and provide valuable learnings to the company. It also offers our patients, when appropriate, with an opportunity to take part in the latest research studies."
Keeping El Camino's finances separate from FII's finances, which include the potential to generate revenue from private startup companies, helps protect the hospital's nonprofit status, Pope says. "About 80% of FII's revenue is from philanthropy and the balance comes from earned income through providing educational services for corporate partners and other entities. El Camino Hospital is a nonprofit hospital—they have their own discrete financials, and the two are never intertwined."
Financial interactions between the hospital and FII have been limited to facility expenses, according to FII CFO Starr McNamara.
In 2007, FII received $780,000 in loans from El Camino to pay for "tenant improvements" for the institute's office and incubator space, McNamara says. FII pays El Camino $156,000 annually for use of the 13,000-square-foot basement space where the institute's "Fog Shop" incubator is located, and the hospital donates the use of medical office space that is considered a $250,000 noncash contribution to FII, she says.
San Carlos, California-based Prescient Surgical, an FII startup company that received FDA approval for its CleanCision surgical-site device in December 2016, is poised to generate significant cost reductions at El Camino, Pope says. "We're especially proud of that one because of the immediate return to the hospital's bottom line by preventing infections that we know are going to happen. Nobody likes to talk about hospital-acquired infections, but they exist—and every time they happen and they require a readmission, it is $20,000 to $40,000 that the hospital has to eat."
For hospitals, innovation activities generate benefits far beyond direct financial impacts, says Jonathan Coe, cofounder, president, and CEO of Prescient Surgical, which raised $7 million of equity investment to develop CleanCision.
"It's important not to focus too much on the financial piece, because if you are a hospital system CEO, you have to say, 'We need to deliver better care, we need to deliver it at less cost, and we need to deliver it with less variability.' You can't constrain yourself to the existing technologies that are out there and cannot necessarily rely on the external community to drive new innovation. The people outside may not be solving your problems."
New nonpatient service activity imperatives
As health systems and hospitals adapt to the shift toward value-based care, optimization of nonpatient service activity requires generating benefits that can be just as significant as boosting operating margins, Coe says. "I think hospital administrators are realizing they need to go through a phase of housecleaning and figure out how they can improve upon the things that they already have today. It is not so much about how they make more money. It is about how they get more customers by doing the best care and avoiding the costs that have limited their profitability."
Manchester, New Hampshire-based Catholic Medical Center (CMC), a not-for-profit 240-staffed-bed acute care hospital, and home of the New England Heart Institute, has a multipronged strategy for nonpatient service activities, says Edward "Ted" L. Dudley III, executive vice president and CFO. For the fiscal year ending June 2016, CMC posted total revenue of $377.9 million, with net patient service revenue of $355 million and other operating revenue of $22.9 million.
CMC has begun offering laboratory and hospitalist services to acute care and postacute care facilities "to leverage core services we do well and assist those who struggle with cost or finding the needed resource," Dudley says.
From a financial perspective, offering laboratory services to other New Hampshire-based healthcare providers is more helpful in covering overhead costs than increasing nonpatient service revenue, he says. "We have to offer a margin because we can't offer these services for free or below our cost. Our partners can basically take what limited resources they have and put them to better use. … We estimate that annual savings to a small critical-access hospital can range anywhere from $350,000 to $500,000. Part of that is coming from reducing FTEs that they no longer need. For us, the margin might only be $150,000 to $200,000; but still, it helps shed some of our overhead."
"We do not look at this as a gigantic revenue source as much as it is a mission-driven core competency maintaining a healthier playing field for everybody."
Dudley says offering laboratory capabilities and hospitalists as professional services to other healthcare providers is bolstering two strategic goals at CMC: supporting the health system's medical mission and positioning the organization for a wave of consolidation that the C-suite sees on the horizon. "It's not a big moneymaker for us, but it does support the mission of CMC to improve the health of the populations we serve; and, since we draw patients from all over the state, we consider this core to our mission. … What we have adopted as part of our mission in New Hampshire is providing services to those hospitals that don't have the financial wherewithal or capacity to offer the same level of quality at a lower cost."
Having strong healthcare-provider partners generates strategic benefits for CMC and the health system's external counterparts, he says. "We do not look at this as a gigantic revenue source as much as it is a mission-driven core competency maintaining a healthier playing field for everybody in New Hampshire. … The state is on the precipice of having a lot of consolidation, and if our lab and hospitalist services help keep other hospitals core to their mission, then we believe that is in our best interest as well."
Christopher Cheney is the CMO editor at HealthLeaders.