Coastal medical center case study

COASTAL MEDICAL CENTER COMPREHENSIVE CASE STUDY

1

INTRODUCTION This comprehensive case study is used as a basis for the exercises included throughout the book.

Coastal Medical Center (CMC) is a licensed, 450-bed regional referral hospital providing a full range of services. The primary service area is a coastal city and three coun- ties with a total population greater than 825,000, located in the Sun Belt. This tri-county area has had one of the fastest growth rates in the country for the last five years. According to the local Health Planning Council, the tri-county population is projected to increase by 15 percent from 2009 to 2015. Appendix A at the end of this case study provides detailed population statistics for the city and tri-county area.

The population growth rate for households (families) has been one to two percentage points higher than the overall population growth. The high percentage of population growth below age 44 shows a young and growing community. Per capita (i.e., per person) income in the tri-county area is high, although growing unemploy- ment is a concern. As the population of the tri-county area increases, the need for

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healthcare services is anticipated to increase. The area’s economy is largely supported by manufacturing, with service companies and agriculture accounting for 35 percent. Unem- ployment is typically 6 percent, although it ranges from 5.5 percent to 7.5 percent. The overall poverty rate is 12.4 percent. A recent study revealed that 40,000 city residents are below 125 percent of the established federal poverty level.

HEALTHCARE COSTS Healthcare costs in the region are high in comparison to healthcare costs in most other areas in the state. In response to what they feel are excessively high healthcare costs, county businesses recently formed a business coalition, hired a full-time executive, and publicly stated their intent to achieve reduction in healthcare costs. The local press has expressed its concern about the high cost of healthcare in the local community and consistently bashes the area’s hospitals and physicians. The coalition refused to allow the three major medical centers in the area to join, despite that each is a major employer.

THE COMPETITION CMC has two major competitors. Johnson Medical Center (JMC) is the largest of a two- hospital for-profit healthcare system, and Lutheran Medical Center (LMC) is the largest of a two-hospital faith-based not-for-profit healthcare system. JMC is located less than two miles from CMC and is a 430-bed tertiary care facility. JMC owns four nursing homes, two assisted living facilities, a durable medical equipment company, a wellness center, an ambulance service, and an industrial medicine business. These facilities are located in the tri-county area and are within a 30-minute drive of the main CMC facility. JMC’s parent company, Johnson Health System, also owns one small hospital in the region.

JMC has 1,920 full-time equivalents (FTEs), which translates to 5.2 FTEs per adjusted occupied bed. JMC recently used a consultant to reduce FTEs, flatten its struc- ture, broaden its control, and improve its operations in general.

JMC has been averaging an occupancy rate of 74 percent. Outpatient revenues are 40 percent of total revenues and have grown at about 6 percent per year for the past two years. JMC had a bottom line (i.e., net income) of $15 million last year. Bottom lines for the two years prior to last year were $11 million and $14 million. Profit margins have exceeded 5 percent or better the past three years. In essence, JMC is a major strong competitor. The organization is reported to have a “war chest” of reserves exceeding $70 million.

LMC is a 310-bed acute care hospital located outside the city limits but within the tri-county area. It does not offer tertiary, intensive services to the extent that CMC and JMC do, but it is a highly regarded general hospital that enjoys an occupancy rate of 75 percent. It is especially strong in obstetrics, pediatrics, general medicine, and ambulatory care. It attracts well-insured patients from the affluent suburban area.

Full-time equivalent

(FTE)

the total number of

full-time and part-time

employees, expressed

as an equivalent

number of full-time

employees

Adjusted occupied bed

the number of inpa-

tient occupied beds,

adjusted (increased)

to account for the bed

occupancy attributed

to outpatient services,

partial hospitalization,

and home services

Profit margin

the difference between

how much money the

hospital brings in and

its expenses

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EXHIBIT CASE.1 One-Year Market Share Analysis Facility Discharges Percentage of Total

CMC 7,819 18%

JMC 8,989 21%

LMC 6,820 16%

All others 19,546 45%

Total 43,174 100%

LMC has 1,180 FTEs and typically operates at 6.1 FTEs per adjusted occupied bed. LMC provides a great deal of indigent care and, in accordance with the philosophy of the church, its budgets are set to generate only a 2 percent annual profit margin.

HIGHLIGHTS OF COASTAL MEDICAL CENTER As a referral center, CMC offers almost every level of care, including a number of tertiary care services, with the exception of neonatology and severe burn unit services. Many of its patients require high-intensity services. For this reason, its costs are the second highest in the entire state. The average length of stay of a patient at CMC is 9.2 days, compared to a statewide average of 6.4 at hospitals of similar size and services. This difference is probably attributable to the intensity of services CMC offers. CMC’s expenses per patient day are also the highest in the state, with the exception of two large university-affiliated teaching medical centers. Its FTEs per adjusted occupied bed (7.5), paid hours per adjusted pa- tient day (35.20), and paid hours per patient discharge (238.5) all greatly exceed those of competitors and the norms of comparable facilities. CMC is presently authorized 2,240 positions but actually employs 2,259 FTEs. Salary expenses per adjusted discharge and adjusted patient day are $2,760 and $491, respectively.

A recent one-year market share analysis for the broader eight-county region re- vealed the data presented in Exhibit Case.1.

CMC has market advantage in substance abuse, psychiatrics, pediatrics, and obstet- rics. JMC has a decided market advantage in adult medical and surgical care.

At a recent administrative meeting, the following CMC utilization figures were reviewed:

◆ Admissions are down 14 percent for the year.

◆ Medicaid admissions are up 11 percent for the year.

◆ Ambulatory care visits are down 10 percent for the year.

◆ Surgical admissions are down 6.7 percent for the year.

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A recent auditor’s report included the following notes:

◆ A significant adjustment was required at year-end to correctly reflect contrac- tual allowance expense (i.e., the amount of money spent in hiring outside contractors). (The data used at the beginning of the year to estimate contrac- tual allowance expense was grossly inaccurate.)

◆ Insurers were not billed for services by certain hospital-based employed spe- cialists ($7 million for the past year) as a result of incompetence on the part of the hospital billing staff.

◆ A total of $1.7 million of Medicaid reimbursement was not authorized. No follow-ups were done and no claims were resubmitted.

HISTORICAL PERSPECTIVE CMC was founded just after World War II using a Hill-Burton grant (see Highlight Case.1) and funds raised locally. From a modest beginning with 100 beds and a limited range of acute care service offerings, the medical center has grown to its present size of 450 beds and now offers a full range of services. Credit for the major growth and past success of CMC has

HIGHLIGHT CASE.1 Hill-Burton Act

In the mid-1940s, many hospitals in the United States were becoming obsolete because they

did not have money to invest in their facilities after the Great Depression and World War II. To

combat this lack of capital and help states meet the healthcare needs of their populations,

senators Lister Hill and Harold Burton proposed the Hospital Survey and Construction Act,

also known as the Hill-Burton Act. This act provided federal grant money to build or modern-

ize healthcare facilities. In exchange, hospitals receiving the grant were obligated to provide

uncompensated (free) care to those who needed care but could not pay for it.

The Hill-Burton Act expired in 1974, but in 1975 Congress passed Title XVI of the Pub-

lic Health Service Act. Title XVI continues the Hill-Burton program by providing federal

grant money for healthcare facility construction and renovation but more clearly defines

requirements the facility must meet. For example, facilities receiving grant money must

prove they are providing a certain amount of uncompensated care to populations that

meet particular eligibility requirements.

*

been given to Don Wilson, who served as chief executive officer (CEO) from 1990 until his retirement in early 2008. Wilson was a visionary and was successful in transforming the medical center to its present status as a tertiary care facility offering high-intensity care including open-heart surgery and liver and kidney transplants.

Wilson’s successor was Ron Henderson. During the past two years, Mr. Hender- son practiced a loose, informal style of management. He seemed to sit back and enjoy himself while others ran the medical center. He was often characterized as a caretaker. The medical center made $15.4 million in 2008 following Mr. Wilson’s retirement (due to an excellent revenue stream and a strong balance sheet), so he was not pressed to make major changes. Mr. Henderson encouraged the board of trustees, medical staff members, and his administrative staff to submit new ideas for improved community healthcare services using CMC as the focal point for delivery. An avalanche of ideas was submitted during the first two years of Mr. Henderson’s tenure. He moved quickly on these ideas and established himself as a person who made swift decisions on new ventures and kept things rolling. He simply let other executives “do their thing” and neither discouraged nor evaluated their work. His strategy was apparently rapid growth and diversity in new businesses. He made major fund commitments to new ideas, but he did little to evalu- ate the ideas with respect to their compatibility with CMC’s mission and its strategic direction, and he usually did not consider the financial implications of these ventures. His approach was “let’s do it.”

Before 2008, CMC was in good financial shape and faced few financial problems. In 2008, however, expenses began to skyrocket while utilization and revenues failed to keep pace. In addition, a hospital census indicated that, on average, 58 percent of CMC’s patients were Medicare patients and 18 percent were Medicaid patients. As a result, the medical center suffered from reductions in reimbursement. Notable among CMC’s exces- sive costs are labor, material, and purchased services. The chief financial officer (CFO) is convinced that a major part of this problem is the presence of three unions, including unionized employees in support services and unionized employees throughout nursing ser- vices. Added to this cost burden is the more than $5 million being transferred to subsidize other CMC subsidiary companies.

During the second year of his tenure, Mr. Henderson began to receive criticism from the board of trustees. Henderson had added 127 new positions despite solid evidence that utilization was experiencing a steep decline. His reasoning was that the declines were temporary and that business would soon be back to normal.

In late 2009, the medical center suffered a deficit of $8.6 million (see Appendix B). Surprised by this major loss, the board of trustees fired Mr. Henderson. They contended that they should have been informed of these serious problems. They felt that there should have been a better strategic planning process in place for the selection of projects, on which millions of dollars had been spent. The board of trustees could not understand how overall corporate net income could drop to a loss of $8.6 million when $15.4 million in profit had been made the previous year.

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GOVERNING BOARD CMC’s governing board has 27 members. All of its trustees are prominent, influential, and generally wealthy members of the community. The board is self-perpetuating. The same chair has served for ten years. Average tenure on the board is 17 years. Committees of the board are detailed in Exhibit Case.2.

One physician-at-large is also included on the board. The chief of staff and the CEO attend all board meetings but are not allowed to vote on board decisions. There are no minority members despite that racial minorities account for about 12 percent of the service area population. Only one of the 27 members of the board is a woman. The average age of the trustees is 66.

PARENT CORPORATION The parent corporation of CMC is Coastal Healthcare Incorporated. This parent board was created through corporate restructuring several years ago, but its role has never been clear. The parent board is made up of “friends” of the most powerful among the trustees of the CMC board. In essence, when corporate restructuring was the “in thing” to do,

EXHIBIT CASE.2 Committees of

the Coastal Medical Center

Board

Committee Size Meeting Frequency Executive 16 Monthly

Joint Conference 24 Monthly

Finance 13 Monthly

Budget 18 Quarterly

Executive Compensation 9 Annually

Construction 13 Monthly

Strategic Planning 16 Monthly

Quality Assurance 9 Monthly

Patient Care 11 Monthly

Ambulatory Care 11 Monthly

Public Relations 9 Monthly

Personnel 11 Monthly

Material and Equipment 11 Monthly

Audit 9 Quarterly

this holding company was formed. By appointing a few CMC trustees to also sit on the parent board and by appointing friends of present CMC trustees, it was believed that the two boards would function as one happy family. However, there has been constant conflict from the beginning regarding the relative powers and roles of the two boards.

The parent company board has 19 members, all of whom are white and male. Back- grounds of the parent board of trustees tend to mirror those of the medical center trustees in that they are prominent and mostly wealthy. Membership includes bankers, attorneys, business executives, business owners, developers/builders, and prominent retired people.

Committees of the Coastal Healthcare Inc. (parent) board are detailed in Exhibit Case.3. The following are some of the conflicts that have occurred between these two

boards over the years:

◆ The parent board refused to approve the appointment of a new hospital CEO selected by the CMC board.

◆ In 2006, the two boards hired separate consultants to develop a long-range strategic plan. Two plans were produced but were never integrated and never really implemented.

◆ Various committees from the parent board often request information about functions of the medical center, which creates conflict because the parent board has a tendency to micromanage CMC’s routine operations.

◆ Separate committees of both boards have worked more than two years trying to revise CMC’s mission statement.

MEDICAL STAFF The medical staff at CMC has historically been a difficult group when it comes to coopera- tion with the board and administration. Patient length of stay is excessively high in most specialties, yet the physicians refuse to be educated on reimbursement and the need to reduce length of stay, excessive tests, and so on. Approximately 90 percent of the medical staff also has privileges at one or more competing hospitals in town.

EXHIBIT CASE.3 Committees of the Coastal Healthcare Inc. Board

Committee Size Meeting Frequency Executive 11 Monthly

Finance 11 Monthly

Strategic Planning 11 Quarterly

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A number of the medical staff members have set up their own diagnostic services, especially the radiologists and neurologists, despite that they have been granted exclusive service contracts at CMC.

In recent years, there has been considerable dissatisfaction among the specialists who represent the majority of the medical staff. They complain that their referrals are decreasing or flat and that CMC is not doing enough to help them establish and maintain a sufficient number. Hospital admissions for specialty services are declining drastically. To compound the problem, the competing medical centers are courting these specialists aggressively with attractive offers, such as priority scheduling in surgery and other special arrangements, all of which are legal.

The medical staff also rated various aspects of medical center operations unsatisfac- tory in a recent survey. The subjects of their complaints were across the board and included key areas such as the following:

◆ Dissatisfaction with nursing services and especially the nurses’ attitudes (Nurses have formed themselves into shared governance councils and are tak- ing issue with both physicians and administration regarding their autonomy.)

◆ Excessive delays in every aspect of operations (e.g., late starts in the operating room, lack of supplies or equipment when it is needed, excessive patient processing time [for example, over three hours for pre-surgical testing for outpatient surgery])

The medical staff also feel they should have more voice in both financial and op- erational matters, especially in capital budgeting. They feel they are asked to provide free services too frequently (e.g., by committees), and many have refused to serve without compensation to offset the practice income they have lost.

There are also quality problems. Two physicians probably should have their privi- leges revoked, three apparently have substance abuse problems, and several are obsolete in their practices and should be asked to retire. The problem is getting their peers to act in these cases. It has also been difficult to get physicians to hold elected offices and accept committee responsibility. Payment of honoraria has helped, but support is still difficult to procure. Over $200,000 is being paid out to entice doctors to serve on committees.

SUBSIDIARY COMPANIES Including CMC, there are 24 subsidiary corporations of Coastal Healthcare Inc.:

◆ Medical Enterprises is a for-profit joint venture with physicians. The com- pany is developing computers that enhance imaging services. Thus far, CMC

has invested $18 million in this company. No cash flow is expected for three to four years.

◆ Coastal Healthcare Inc. has three nursing homes. Collectively, these long- term care facilities are losing almost $1 million annually. Debt service on two of them is very high. Only one is within patient transfer distance of CMC. The second is 70 miles away, and the third is 82 miles away. All three have unions. Almost all of the residents of the two facilities losing the greatest amount are Medicaid patients; there are only a few self-pay patients.

◆ CMC Management Services was formed to sell management and consult- ing services. The company lost $360,000 last year, which was its third year of operation.

◆ Regional Neuroimaging is a joint venture with physicians. The company lost $920,000 its first year of operation. Capital invested by the hospital to date totals $9 million.

◆ American Ambulance is a local ambulance company. Financially, it breaks even, but it does increase admissions to CMC, especially through trauma pick-ups.

◆ Home Health, Inc. provides home health care services in an eight-county area. Its operating loss last year was $290,000. The company has considerable difficulty attracting and retaining professional personnel, especially nurses and physical therapists.

◆ Industrial Services Inc. provides health services to industrial companies throughout the state. Only one of the six operating locations is close enough to generate referrals. None of the operating sites is making a profit despite that the company is five years old.

◆ MRI Enterprises is a successful mobile magnetic resonance imaging (MRI) joint venture with a physician group. It has a consistent, positive bottom line.

◆ Textile Enterprises is a large, high-tech laundry completed three years ago. It was intended to serve the medical center and many other companies in the region. Because of its debt service, union wages, and remote location, the laundry has yet to break even. After three years, it still does not have its first non-CMC service contract.

◆ Coastal Healthcare Inc. owns three hospitals: Caroleen Hospital (60 beds), Grant Hospital (74 beds), and Ellenboro Hospital (90 beds). All are small

Debt service

cash required over a

given period for the re-

payment of interest and

principal on a debt

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rural hospitals purchased to feed patients to CMC. All are unprofitable. Col- lectively, the three of them require $2.5 million in subsidies annually.

◆ Health Partners is a health maintenance organization joint venture with 20,000 subscribers. After three years of operation, its costs are still rising. Last year, it required $2 million in subsidies.

◆ Northeast Clinic is a large multispecialty group of 11 physicians who were fed up with government red tape and sold out to CMC last year. CMC now employs these physicians and is responsible for all medical group operations. It is too early to determine the success of this venture.

◆ Imaging Venture is a recently formed radiology joint venture. Until/if it be- comes successful, it will cost just under $1 million in debt service annually.

◆ North Rehabilitation, a 60-bed inpatient rehabilitation facility, was just opened. It is expected to be successful because CMC will refer all of its reha- bilitation patients to this facility and there is no other rehabilitation facility in the region.

◆ Center for Pain has been a successful outpatient facility and is expected to remain successful. Its space is leased. Overhead is kept low. The physicians are salaried.

◆ Coastal Wellness, a fitness and wellness center, was developed five years ago at a cost of $10 million. It is located in a coastal community and is intended to attract those from the wealthy areas. A significant number of CMC em- ployees and their family members use Coastal Wellness at a lower monthly rate, which is subsidized by CMC. Coastal Wellness is currently underuti- lized, so CMC subsidizes it with $220,000 annually.

◆ Central Billing was formed to attract patient billing contracts from health facilities and physician groups. It has been moderately successful and reached the break-even point this past year.

◆ City Contractors, a separate, small general contracting company, was just formed. It will require about $200,000 annually in subsidy.

◆ Bay Enterprises is a land acquisition and holding company.

EXECUTIVES AND MIDDLE MANAGEMENT CMC employs 20 executives. (Executives are defined as positions above the administrative director level.) Total annual executive compensation is $2.2 million. Each executive has an

executive secretary. The annual average compensation among the 20 secretaries is $35,000, which amounts to an executive-level support cost of $700,000.

Each of the other 23 subsidiary companies also employs executives and support personnel in addition to regular employees. This executive overhead is a drain on CMC because many of the subsidiary companies do not break even and thus must be subsidized.

CMC employs 15 administrative directors, who function between vice president and department directors. Their principal purpose is to handle problems at the department level so these problems do not escalate to the vice president.

There are also 67 director-level positions in the organization. Directors are respon- sible for a particular department or function. Managers are the next level down the line of supervision. There are 31 managers. Collectively, these managers have 68 supervisors working for them.

The compensation and benefits policy of CMC appears to deviate substantially from industry norms. For example, the directors’ annual salaries range from $85,000 to over $170,000.

CORPORATE STAFF The parent corporation consists of the following offices:

◆ Office of the CEO, who has five “assistants to the president” (i.e., an adminis- tration, board, ethics, community, and staff assistant)

◆ Office of the senior vice president for finance (three people)

◆ Office of the senior vice president for corporate affairs (four people)

◆ Office of the senior vice president for corporate development (three people)

◆ Office of the vice president for legal affairs (five people)

◆ Office of the vice president for medical affairs (two people)

◆ Office of the vice president for marketing (two people)

◆ Office of the vice president for strategic planning (two people)

The corporate staff serve as advisers and coordinators, oversee their functional areas at CMC, and, where needed, oversee the various subsidiary companies.

Total FTEs for the parent company corporate staff are 29. Total costs of corporate overhead are $2.3 million annually. In addition, during the past year the cor- porate officers of the parent company purchased the consulting services listed in Exhibit Case.4.

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DUPLICATION OF FUNCTIONS Throughout CMC, functions were duplicated as the organization grew. For example, there are three education departments and three transportation departments. There is both an inpatient and outpatient pharmacy, each with its own director. CMC and 12 of the larger subsidiary companies have separate human resources management functions.

There are 24 boards, one for each subsidiary company, and each board has a large number of committees. Executives from CMC and the parent corporation sit on these boards and their committees.

SERVICE/PROFESSIONAL CONTRACTS CMC contracts with many service providers. Service contracts include housekeeping, food service, record transcription, biomedical maintenance, security, and many others. These contracts are renewed regularly with the same firms. CMC also contracts with countless health professionals. For example, the contract for coverage of CMC’s pediatrics clinic by two physicians is $380,000, and CMC furnishes the facilities and professional and support personnel. Numerous physicians have negotiated arrangements through which they regu- larly receive checks for committee service, advice, and so on. Many of these negotiations are not documented in written contracts.

The hospital-based specialists’ contracts are based on a percentage of gross earnings, with no provision for any type of adjustments to the gross. Several of these arrangements are long-standing but unwritten agreements.

Consultant Purpose Cost Conduct board retreat $35,000

Prepare restructuring recommendations $65,000

Write organization history $60,000

Provide policy advice $25,000

Lobbying $50,000

Compensation (wage/salary) study $72,000

Labor negotiations $120,000

Management development $90,000

Managed care study $47,000

Total $564,000

EXHIBIT Case.4 Consulting

Services Purchased by

Parent Company

MATERIAL MANAGEMENT CMC is organized traditionally, meaning there is no centralized material management function. Purchasing is done throughout the organization from a large number of vendors. The pharmacy, laboratory, and other services do their own ordering, arrange contracts, and handle other supply and equipment matters. For example, the laboratory recently purchased a large computer software package without the knowledge of the purchasing agent or the information services department.

Large stores of inventory can be found throughout the facility. CMC also harbors excessive and obsolete equipment. Central storage occupies a huge amount of space and carries what appears to be an overabundance of many items.

SPECIAL PROJECTS Fifty-three “special projects” in various stages of progress are underway at CMC, ranging from the addition of a new education center to renovation of the food service department. A large number of start-ups are also under development. For example, CMC is considering a joint venture with physicians to build an ambulatory surgery center offering the latest robotic surgery technology. Analysis of the projected costs of these projects, and of the working capital many of them will need before they become profitable, if they ever do, revealed that the organization will suffer severe financial distress if these projects continue. Moreover, there is considerable uncertainty regarding the financial feasibility of many of them. Finally, these projects have not been centrally coordinated, nor has their potential impact on the organization’s mission and strategic direction been discussed. These projects were simply developed on the basis of individual interests of various executives and manag- ers. By his inaction and lack of leadership, Mr. Henderson gave everyone free rein to do their own thing—and they did.

NEW CEO ARRIVES CMC hired an executive search firm specializing in healthcare to look for a new CEO. After a nationwide search, the board of trustees decided to hire Richard Reynolds. Mr. Reynolds appeared to be a no-nonsense CEO who had the knowledge and skills to de- termine the problems at CMC and resolve them. During his first few weeks in the new position, Mr. Reynolds did an exhaustive analysis of CMC with the assistance of a transi- tion consultant and the executives and managers of the organization. The following list highlights his findings:

1. Compared to national personnel standards, a large percentage of the depart- ments at CMC are grossly overstaffed. More than 100 new positions were

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added during the most recent fiscal year, despite that utilization did not justify these positions. The overall administrative structure is top-heavy.

2. Fifty-eight general contracts were identified, many of which are standing contracts with consultants who appear to be receiving large monthly re- tainers but are not providing services. In addition, a total of 121 contracts with physicians were identified. Again, these physicians appeared to be providing few services. The prior CEO apparently made numerous agree- ments to subsidize various physicians and pay them large sums for perform- ing administrative services that are normally done on a voluntary basis by members of the medical staff.

3. Fifty-three major new service projects in the planning or construction phase were identified. An analysis indicated that they would require over $100 million in future commitments, and Mr. Reynolds was not sure that CMC would be able to service the necessary debt. No project priorities existed and no feasibility studies had been done for most of the projects, so there was no way to project the financial impact of these “innovative ideas” on the organization.

4. A large number of duplicate departments were identified. Mr. Reynolds pin- pointed many departments and services that could be consolidated.

5. Sixty-six “special” programs are collectively accounting for a $6 million outflow of cash from CMC. These programs are not directly related to CMC’s tertiary care mission. CMC seemed to have developed every type of program conceivable from one end of the care continuum to the other without considering whether the pro- grams supported its mission or generated a positive cash flow.

6. In material management, Mr. Reynolds found nearly $8 million in “unofficial” inventory stored throughout various facilities of the medical center. There is no centralized material management system for purchasing, storage, distribution, and accountability of materials.

7. While the median operating margin for medical centers of similar size and service was about 2.5 percent the past year, CMC had experienced a multimil- lion-dollar loss. In addition, the medical center’s return on equity was a major problem. The number of days accounts receivable (i.e., average number of days it takes to collect payments that clients owe to the organization) in other medical centers averaged 68 days during the past year; CMC’s accounts receiv- able days were far greater. Most alarmingly, CMC’s cash on hand at any given time represented only 22 operating days. Finally, the hospital’s major bond issue was recently downgraded to the lowest credit rating.

8. Medicare has just notified the CFO that recovery of $4 million is forthcoming due to past errors in the Medicare Cost Report.

Days accounts

receivable

average number of

days an organization

takes to collect pay-

ments on goods sold

and services provided,

calculated as follows:

average accounts pay-

able (in dollars) × 365

(days per year) ÷ sales

revenue (The “normal”

average range is 40

to 50 days. A number

significantly greater

than 50 days indicates

that the organization

is having difficulty col-

lecting payments from

its clients; a number

significantly lower than

40 indicates that the

organization has overly

strict credit policies

that might be prevent-

ing it from taking in

higher sales revenue.)

9. The business coalition is becoming well established and intends to aggressively pursue discounted services through direct contracting.

10. The parent company (Coastal Healthcare Inc.) is not structured nor functions as a local healthcare system. Clinical services and administrative support are not integrated. For this reason, Coastal Healthcare Inc. does not meet the classic definition of a healthcare system provider.

11. Nationally, capitation payment arrangements have not been successful for many hospitals. CMC is not in a favorable position to become an account- able health plan. To become an accountable health plan, CMC would have to partner with primary care and specialty physicians to meet the total healthcare needs of a defined patient population.

12. No value-oriented efforts have been initiated at CMC (e.g., continuous quality improvement, benchmarking).

13. There has been no leadership development for the board of trustees, medical staff, and administration.

14. No formal strategic planning process is in place at the CMC or Coastal Healthcare Inc. (holding company) level.

15. There are no existing physician–hospital organizational arrangements.

GENERAL CONDITIONS Mr. Reynolds also quickly learned that he had taken a position in an organization with a governing board that was generally content to approve anything the previous CEO recom- mended. The medical staff appears no better in that they are principally focused on their own self-interests and show little interest in the affairs of the medical center.

Control systems are lacking, and CMC does not have a comprehensive information system. Moreover, quality of care appears low; a large number of legal cases against the medical center are pending.

With respect to material management, several suppliers have refused to deliver sup- plies because of delays in accounts payable. Mr. Reynolds summed up the medical center’s situation by reporting to the members of the board that there is an immediate cash flow problem, people-related expenses are far too high, material-related expenses are well above those expected, plant-related expenses are excessive, contract amounts are excessive, and accounts receivable are too high. He also remarked that CMC seems to have no sense of direction or overall corporate strategy.

With the help of his transition consultant, Mr. Reynolds surveyed and interviewed his department heads. Given the financial situation and the results of the survey, Mr. Reynolds knew he faced a difficult challenge.

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Mr. Reynolds concluded that the prior CEO had engaged in the “one man rule” concept and had failed to build necessary knowledge and management skills among the vice presidents. Thus, when difficulties occurred in the organization, inertia set in. The reaction of executives and managers was that of indecisiveness and unwillingness to take risk for fear of compromising their job security. He also reported that there are an excessive number of administrative positions.

An examination of CMC’s balance sheet (see Appendix C), financial ratios (Ap- pendix D), and structure led Mr. Reynolds to conclude that the corporation was over- expanded, over-leveraged, and over-dependent on a narrow market. The organization is too expensive to operate, bloated with bureaucracy, inefficient in its services, and unimagi- native in its approach to strategic planning and change.

From his discussion with the leadership team and other hospital staff, Mr. Reynolds believes there is no clear organizational mission and that there is considerable dissatisfac- tion among the leaders. To confirm his beliefs, he had the transition consultant administer a brief leadership survey. Appendix E reports the results of this survey, providing detailed information on corporate culture and job satisfaction. Mr. Reynolds has already decided to do a similar survey of all hospital staff within the next six months to obtain more base- line data on the organization’s corporate culture and its ability to deal with the changes he knows are coming.

NEW BUSINESS INITIATIVES To expand its physician staff, CMC has constructed a hospital-owned medical office build- ing in a growing community five miles from the hospital. This effort has been successful and has attracted a prominent group of orthopedic physicians who are now referring their surgical procedures to the hospital. As part of this expansion and with the growing ortho- pedic workload, CMC is exploring the financial feasibility of opening a physical therapy clinic at this new location.

On the basis of current physician referral patterns, CMC anticipates $250,000 in outpatient physical therapy net income at the new location during the upcoming 12 months.

CONCLUSION As Mr. Reynolds ponders the many problems he had uncovered upon arrival at CMC, he wonders what other problems might be beneath the surface. Every day he uncovers ad- ditional major problems. At this point, Mr. Reynolds is so overwhelmed by the problems that he is unsure of how to proceed. He does know, however, that priorities need to be

set, the deteriorating situation needs to be turned around, and a strategic plan needs to be developed to chart the future of the organization.

EXERCISES Assume you are Mr. Reynolds. Being new to the position, you are faced with major challenges.

The questions and exercises listed at the end of each chapter provide an opportu- nity to gain leadership experience in managing change in a healthcare organization. Most important, you will gain experience in developing a strategic plan.

APPENDIX A: POPULATION AND HOUSEHOLD DATA

Riverside County Metro City Rural County Ocean County POPULATION AND HOUSEHOLD Square miles 609 775 601 485 Population density per square mile 214 1,028 245 111 Population 1992 83,829 672,971 105,986 28,701 Population 2004 129,832 794,569 146,739 53,506 Population 2009 148,289 842,179 163,082 63,543 % Population growth 1992–2004 54.88% 18.08% 38.45% 86.43% % Population growth forecast 2004–2009 14.22% 5.10% 11.14% 18.76% Households 1992 33,431 256,772 36,664 11,882 Households 2004 52,322 310,603 52,448 22,904 Households 2009 59,895 331,539 58,623 27,305 % Household growth 1992–2004 56.5% 20.97% 43.05% 92.76% % Household growth forecast 2004–2009 14.5% 6.75% 11.77% 19.21% Average household size 2.48 2.57 2.8 2.34 Families 35,793 205,123 40,907 16,766 % Urban population 56.5% 98.7% 59.6% 59.9% % Rural population 43.5% 1.5% 40.4% 40.1% % Female population 51.2% 51.5% 50.7% 51.5% % Male population 48.8% 48.7% 49.3% 48.5% % White population 91.1% 67.4% 88.6% 87.9% % Black population 6.5% 28.5% 7.3% 9.5% % Asian population 1.4% 3.8% 3.0% 1.6% % Hispanic origin population 2.7% 4.3% 4.4% 5.2% Other population 1.4% 2.1% 3.1% 2.3% % Population 0–5 years 6.5% 8.7% 8.0% 4.9% % Population 6–11 years 8.1% 9.1% 9.6% 6.0% % Population 12–17 years 8.2% 8.7% 10.2% 6.7% % Population 18–24 years 6.4% 8.9% 7.2% 4.4% % Population 25–34 years 9.7% 14.4% 11.6% 7.3% % Population 35–44 years 17.8% 18.1% 18.7% 12.9% % Population 45–54 years 17.0% 14.6% 15.9% 14.3% % Population 55–64 years 10.2% 7.7% 8.9% 14.4%

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% Population 65–74 years 8.8% 5.7% 5.6% 17.2% % Population 75 years and over 7.3% 5.1% 4.3% 11.9% Median age 41.3 35.5 36.8 50.5

INCOME AND EDUCATION Total household income ($US) $5,145,536,895 $20,994,962,608 $3,656,788,183 $1,650,526,132 Median household income ($US) $49,103 $41,410 $49,270 $42,975 Per capita income ($US) $39,632 $26,423 $24,920 $30,847 High income average ($US) $474,930 $430,207 $348,177 $450,993 Education—% less than high school (age 25+) 11.2% 13.6% 11.5% 12.6% Education—% high school (age 25+) 31.6% 33.9% 35.4% 36.6% Education—% some college (age 25+) 25.5% 26.9% 29.9% 27.1% Education—% college (age 25+) 22.1% 19.3% 16.8% 15.4% Education—% graduate degree (age 25+) 9.6% 6.4% 6.5% 8.3%

EMPLOYMENT AND OCCUPATION Males employed (age 16+) 35,604 201,461 40,722 12,093 Females employed (age 16+) 29, 337 169, 863 30,949 9,654 Total employees (age 16+) 64,941 371,324 71,671 21,747 % White-collar occupations 62.9% 63.1% 61.8% 57.3% % Blue-collar occupations 22.8% 23.6% 25.9% 27.5% % Service occupations 14.3% 13.3% 12.4% 15.2% % Local government workers 7.6% 7.0% 7.4% 7.7% % State government workers 3.2% 2.4% 2.2% 1.6% % Federal government workers 1.8% 3.5% 6.3% 0.9% % Self-employed workers 9.0% 5.2% 6.3% 9.2%

CONSUMER EXPENDITURES Annual expenditures per capita ($US) $18,211.60 $16,580.10 $16,226.00 $18,322.00 Healthcare expenditures per capita ($US) $2,347.20 $2,183.90 $2,105.70 $2,390.30 Healthcare insurance expenditures per capita $428.00 $385.00 $370.00 $482.20 ($US)

COST OF LIVING Consumer price index 147.1 147.1 147.1 147.1 Medical care consumer price index 211.3 211.3 211.3 211.3

APPENDIX B: COASTAL MEDICAL CENTER: STATEMENT OF INCOME (IN THOUSANDS OF DOLLARS)

2008 2009 Operating revenue Inpatient 130,775 131,470 Outpatient 28,923 31,211 Other operating revenue 2,604 2,225 Gross operating revenue 162,302 164,906 Less provisions for allowances Third-party reimbursement programs (31,422) (42,081) Doubtful accounts (5,112) (7,320) Charity care (2,705) (2,993) Total provision for allowances (39,239) (52,394)

APPENDIX C: COASTAL MEDICAL CENTER: BALANCE SHEET (IN THOUSANDS OF DOLLARS)

Net operating revenue 123,063 112,512 Expenses Salaries, payroll taxes, and fringe benefits 61,757 64,858 Dietary, pharmaceutical, and other supplies 17,450 18,534 Purchased services 12,971 14,306 Depreciation and other capital costs 7,281 7,929 Medical specialists 4,091 5,893 Insurance 3,112 3,722 Interest expense and amortization of financing costs 2,408 2,560 Utilities 2,257 2,268 Other 2,336 2,203 Total expenses 113,663 122,271 Income from operations 9,420 (9,759) Nonoperating revenue Interest income 1,268 1,040 Other 81 58 Total nonoperating revenue 1,349 1,098 Net income 10,769 (8,661)

2008 2009 ASSETS Current assets Cash and cash equivalents 2,337 2,964 Accounts receivable 23,781 25,345 Inventories 2,251 2,638 Current portion of assets 3,030 3,947 Prepaid expenses and other assets 1,678 1,729 Total current assets 33,077 36,623 Facilities and equipment Land and land improvements 3,209 3,279 Buildings and improvements 44,053 46,369 Equipment 36,024 38,400 Construction 4,389 15,774 Less accumulated depreciation (36,036) (41,222) Total facilities and equipment 51,636 62,600 Assets of limited use Funds held by trusts 40,475 29,469 Assets segregated for capital purposes 970 10 Donor restricted funds 2,045 2,049 Investment in deferred compensation annuities 6,058 6,212 Total assets of limited use 48,545 37,740 Less assets of limited use and required for current liabilities (3,030) (3,947) Total assets of limited use 45,516 33,793

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Other noncurrent assets Deferred financing costs 2,740 2,536 Due from affiliated organizations 1,587 1,865 Other 326 1,417 Total other noncurrent assets 4,653 5,818 TOTAL ASSETS 134,882 138,833

2008 2009 LIABILITIES AND FUND BALANCES Current liabilities Current portion of long-term debt 1,156 1,073 Advance from donations 2,405 5,155 Accounts payable 2,440 6,690 Accrued expenses 3,030 3,947 Payroll and related fringe benefits 7,647 7,926 Interest payable 2,600 2,228 Other liabilities 1,302 3,074 Total current liabilities 17,549 26,148 Other liabilities Deferred compensation 5,056 6,212 Estimated malpractice liabilities Deferred reimbursement program liabilities 1,978 1,669 Retirement incentive liabilities Subtotal 7,034 7,881 Long-term debt, less current portion 53,717 52,745 Commitments and contingencies Donor restricted fund balances 2,045 2,049 Unrestricted fund balances 54,537 50,010 TOTAL LIABILITIES AND FUND BALANCES 134,882 138,833

2008 2009 Liquidity ratios Current ratio 1.885 1.401 Days in patient accounts receivable 70.5 82.2 Average payment period ratio 42.7 58.3 Days cash on hand 10.9 13.3

Capital structure ratios Equity financing ratio 0.404 0.360 Long-term debt to equity 0.985 1.055 Fixed asset financing ratio 0.613 0.508 Times interest earned ratio 5.47 (2.38) Debt service coverage ratio 5.74 0.503 Cash flow to debt ratio 0.657 0.413

APPENDIX D: COASTAL MEDICAL CENTER: FINANCIAL RATIOS

Activity ratios Total asset turnover ratio 1.203 1.188 Fixed asset turnover ratio 3.143 2.634 Current asset turnover ratio 4.907 4.503

Profitability ratios Deductible ratio 24.55 32.20 Markup ratio 1.42 1.34 Operating margin ratio 0.077 0.087 Return on assets 0.08 0.062

APPENDIX E: COASTAL MEDICAL CENTER LEADERSHIP SURVEY

PERCEIVED CORPORATE CULTURE Item Positive % Neutral % Negative % 1. Leadership 28 9 63 2. Structure 22 14 64 3. Control 66 20 14 4. Accountability 20 7 73 5. Teamwork 26 7 67 6. Organization identity 31 17 52 7. Work climate 17 17 66 8. Risk taking 15 9 76 9. Conflict management 24 24 52 10. Perceived autonomy 51 12 37 11. Results oriented 29 20 51 12. Mutual trust 36 8 56 13. Communication 24 7 69 14. Team spirit 7 21 72 15. Attitudes 21 22 57 16. Vision 19 5 76 17. Reward system 36 27 37 18. Group interaction 20 45 35 19. Value of meetings 26 7 67 20. Faith in organization 28 6 66

SELF-EVALUATION OF POSITION Item True % Partly true % Not true % 1. Sufficient decision-making authority 34 50 16 2. Clear understanding of role 43 30 27 3. Clear understanding of performance expectations 26 44 30 4. Fully use training and experience 27 33 40 5. Mix of management and routine is correct 33 30 37 6. Amount of work is reasonable 28 32 40 7. Work offers challenge, satisfaction, and growth 30 30 40 8. Performance is recognized 38 32 30 9. Compensation is satisfactory 45 35 20 10. Quality work is recognized and rewarded 29 41 30 11. Upward communication is effective 21 40 39 12. Downward communication is effective 17 50 33

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APPENDIX F: HOSPITAL COMPARE QUALITY DATA CMS ID 11111X 22222Y 33333Z State National HospitalName CMC JMC LMC average average Accreditation Yes Yes Yes EmergencyService Yes Yes Yes HeartAttackPatientsGivenACEInhibitororARBforLeftVentri 78% 82% 91% 82% 83% HeartAttackPatientsGivenAspirinatArrival 92% 97% 100% 91% 94% HeartAttackPatientsGivenAspirinatDischarge 95% 98% 96% 94% 95% HeartAttackPatientsGivenBetaBlockeratArrival 90% 91% 97% 85% 86% HeartAttackPatientsGivenBetaBlockeratDischarge 92% 97% 93% 92% 94% HeartAttackPatientsGivenPCIWithin120MinutesofArrival 49% 52% 66% 65% 68% HeartAttackPatientsGivenSmokingCessationAdviceCounseling 83% 98% 98% 98% 99% HeartAttackPatientsGivenThrombolyticMedicationWithin30Mi 63% 33% 100% 40% 50% HeartFailurePatientsGivenACEInhibitororARBforLeftVentr 81% 82% 89% 73% 75% HeartFailurePatientsGivenanEvaluationofLeftVentricularS 93% 97% 96% 92% 93% HeartFailurePatientsGivenDischargeInstructions 46% 37% 58% 39% 49% HeartFailurePatientsGivenSmokingCessationAdviceCounseling 71% 78% 100% 87% 97% PneumoniaPatientsAssessedandGivenInfluenzaVaccination 58% 59% 77% 43% 45% PneumoniaPatientsAssessedandGivenPneumococcalVaccination 44% 60% 83% 39% 49% PneumoniaPatientsGivenInitialAntibioticswithin4HoursAf 53% 61% 81% 72% 73% PneumoniaPatientsGivenOxygenationAssessment 98% 98% 99% 98% 99% PneumoniaPatientsGivenSmokingCessationAdviceCounseling 76% 77% 100% 92% 95% PneumoniaPatientsGiventheMostAppropriateInitialAntibiotic 75% 81% 90% 81% 85% PneumoniaPatientsWhoseInitialEmergencyRoomBloodCultureWa 80% 85% 81% 80% 90% SurgeryPatientsWhoReceivedPreventativeAntibioticsOneHou 62% 75% 74% 80% 81% SurgeryPatientsWhosePreventativeAntibioticsareStoppedWi 62% 75% 74% 80% 81%

13. Cross communication is effective 15 55 30 14. Operations problem solving is timely and thorough 17 43 40 15. Strategic decisions are timely and effective 26 30 44

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