Medical Center of Southern Indiana

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1 7 TEACHING NOTE Medical Center of Southern Indiana Community Commitment and Organization Revival Jonathon S. Rakich and Alan S. Wong RESEARCH METHOD AND RELEASE This case study, the Medical Center of Southern Indiana (MCSI), is based on a research project conducted by the authors. It was funded by a research fellowship grant awarded by Indiana University Southeast. MCSI is a 96-bed, acute-care hospital located in rural Southern Indiana. Information was obtained from materials provided by the hospital, newspaper articles, and multiple interviews with hospital senior managers. The case is written from the perspective of the hospital s President and CEO, Kevin Miller, and includes multiple quotes from him in order to provide dynamic insight. Senior management reviewed the case manuscript, and release for educational use and publication was obtained. BRIEF SUMMARY MCSI is located in the rural Southern Indiana town of Charlestown, which has a population of 6,000 people. It is located 15 miles from Louisville, Kentucky, and is within the Louisville Standard Metropolitan Statistical Area, which contains more than 1 million people. The case traces the City of Charlestown/community s initiative to build an acute-care hospital beginning with a vision in 1973 and ground breaking in In 1998, the focus year of the case, the hospital had a complement of 96 beds, 270 full-time equivalent employees (FTEs), and $22.6 million in net patient revenue, with an operating profit of $480,545 the first profit in 6 years. Even with profitability, the issue of the hospital s survival has always been on the mind of community leaders, hospital management and employees, and its medical staff. Used by permission of the authors. All rights reserved. 41

2 42 Strategic Management The MCSI has been like the mythical Phoenix. It was near death and arose again. The case traces the hospital s organization life cycle from conception in 1973, to decline, and finally regeneration in During the late 1970s, MCSI had major financial losses due to low census and intense competition. The hospital was sold to the Hospital Corporation of America in 1985 and subsequently divested to HealthTrust, a for-profit ESOP healthcare system, in That same year, HealthTrust announced that it would close MCSI. In 1991, the City of Charlestown repurchased the hospital. Included in the case are the hospital s mission, present range of inpatient and outpatient services, revenue and patient days generated by physician, and capital expenditures for the period Sections in the case provide the context for student analysis. Included are the health care system, national health care expenditures by sector (e.g., hospital, physician, skilled care), and the rise of managed care (e.g., HMOs, PPOs) that resulted in a new competitive environment. Finally, financial statements (e.g., balance sheet, income statement, and statement of cash flow) are provided for the period The case focuses on the period and presents strategies implemented by the hospital during this period. Strategies include Increasing the number of managed care contracts with insurers Aggressive physician recruitment, retention, and collaboration Improvement of existing services such as emergency department, ancillary services, and outpatient services Adding new service areas: a home health agency, a skilled nursing facility, and geropsychiatric services Significant capital expenditures for equipment and facility upgrading The case ends in 1998, the first year that the hospital had an operating profit since The case decision point is determining what new strategies and/or modifications to existing strategies should be implemented in order to ensure the survival of MCSI. Discussion is designed to take place within the following context presented in the case: 1) the rise of competitive forces and integrated delivery systems, 2) changes in government reimbursement policy, and 3) the increased bargaining power of managed care organizations (i.e., HMOs and PPOs). Evaluation of strategies requires students to assess the 7 years of financial statements and compare selected performance ratios to industry standards that are provided in the case. Industry averages are from the 2001 Almanac of Hospital Financial & Operating Indicators, Ingenix Publishing Group/Center for Healthcare Industry Performance Studies (CHIPS). Benchmark ratios used are rural hospitals with fewer than 100 beds. SUGGESTED COURSE APPLICATION This case is designed for use in business and/or health services management courses at the undergraduate or graduate levels. It can also be used in executive development programs for hospital managers. TEACHING OBJECTIVES 1. Raise the issue of organization survival and reinforce the concept of organization life cycle. MCSI went through the life-cycle stages of emergence, growth,

3 Medical Center of Southern Indiana 43 decline, and regeneration back to growth. The case decision point is what strategies to pursue in order to continue growth and to survive in the present threatening/hostile health services delivery environment. 2. Enhance students understanding of the health services industry including: number of acute-care hospitals and decline of those under 100 beds; aggregate national health care expenditures, specifically in the hospital sector; competitive forces, most importantly that of managed care; and the impact of government reimbursement policies on providers, specifically the change from cost-based reimbursement to prospective pricing. 3. Emphasize the subject of strategic planning. The case includes elements of the hospital s 1998 strategic plan. Porter s five-forces industry analysis (strategic management) model can be applied. The case lends itself nicely to assessment of the threat of new entrants, substitutes, the bargaining power of buyers and sellers, and rivalry. Other strategic concepts that can be applied are those of strategic groups, strategic types (e.g., defender, prospector, reactor), and competitive advantage including resources and capabilities. 4. Enhance students understanding of financial statement and ratio analysis and some of the unique aspects specific to health services. An industry-specific feature common in managed care contracting is that of contractual allowances, for example, which are the difference between charges and negotiated revenues received. This reinforces the difference between accrual and cash flow accounting. TEACHING QUESTIONS AND ANSWERS The case ends with the CEO, Kevin Miller, thinking about the future was the first year MCSI had an operating profit since It was a modest $480,545, based on net patient revenues of $22.5 on gross patient revenues of $39.6 million. The difference of $17.1 million was contractual allowances (discounts) to managed care organizations. Miller reflects on what the hospital should do in the future in the form of questions. The questions, with the casewriters responses, follow. 1. Should MCSI slow down its aggressive expansion strategy of adding new services and consolidate the gains from those presently in place, or continue the aggressive expansion strategy of adding and investing in even more services? MCSI should not slow down its aggressive strategy of expanding new services. It should continue. A critical success factor for hospitals in the present environment is contracting with managed care organizations (MCOs). Since MCOs control the flow and direct patients to those providers with whom they have contracts, loss of this patient flow would be disastrous. An important element is being a full-service hospital. Furthermore, some patient services such as skilled nursing care, home health services, and geropsychiatric services are cost-based reimbursed by the federal government. Miller indicated that without these cost-based services, MCSI would not have survived. 2. Should MCSI reassess present services and retrench those that are not yet breaking even? Maybe it depends. Initial investments in new services may require a period of time to break even or to have a positive revenue cost contribution. Each service should be evaluated keeping in mind that some may be conscious loss leaders and/or be necessary to be a full-service hospital.

4 44 Strategic Management 3. Should MCSI change its fiscal orientation and focus on cost reduction versus revenue enhancement? MCSI is a lean, low-cost organization. It is likely that a cost reduction strategy would not be successful. It makes more sense to pursue revenue enhancement. 4. Should MCSI pursue a joint venture with physicians in limited partnerships? Absolutely yes. There are two factors that are critical to MCSI s success and survival. Managed care contracts is one (see Question 1). The second is the size and capability of the medical staff. Exhibit 2 presents 1998 hospital gross revenue, inpatient days, and outpatient registrations by the highest producing members of the medical staff. The fact that 4 of the 75 active physicians generated 44% of hospital gross revenue should emphasize the importance of hospital physician relationships. Any legal tactic that locks in the physicians to MCSI should be pursued. FINANCIAL ANALYSIS Ratio Formulas An analysis of the financial statements and data exhibits is important. Exhibit 2, for example, presents 1998 hospital gross revenues generated by the top-producing physicians among the 75 who are active members of the medical staff. What is revealing is that 11 physicians generated hospital gross revenue of $29.5 million, which was 74% of the total. More revealing is that four physicians generated $17.2 million in hospital gross revenue, representing 44% of the total. Thus, the hospital is critically dependent on a few doctors. Their bargaining power is very high. Loss of any one of the high-volume physicians would be catastrophic. Physicians, along with contracts with managed care organizations, are the two most critical factors for hospital success and survival. MCSI followed a strategy of expansion and offering new services. As indicated by the capital expense growth rate ratio, it invested heavily in equipment and property, which led to increases in revenue. Expenses also increased, however, leading to several years of negative income before Although MCSI was able to generate positive income in 1998, it could have been an unusual year or an aberration. It needs a few more years of positive income to confirm that increased investments in more services and equipment are finally paying off. Although the asset efficiency ratios show that MCSI had been relatively efficient in managing its assets, its ability to service debt, especially short-term debt, was poor. MCSI had excessive long-term debt in earlier years when compared with fixed assets, but this debt has been brought down close to the industry average by 1998 (see fixedasset-financing ratio series below). The short-term debt situation, however, was still excessive when compared to the industry average in 1998, as implied by the cash-flowto-total-debt ratio series below, since the long-term debt situation is considered average. Thus, it is not surprising to find MCSI s liquidity position worrisome since Profit Margin: (Total unrestricted revenue gains & others Total expenses)/total unrestricted revenue gains & others ROI: Excess (deficit) of revenues over expenses/total assets Free Operating Cash Flow Over Revenue: {[Net patient service revenue Rental income Other revenue) (Total expenses Interest Lease)] [(Net PPE Net

5 Medical Center of Southern Indiana 45 acqu. & startup) (Net PPE Net acqu & startup)] (Total current assets Total current liabilities) (Total current assets Total current liabilities)]} / Total unrestricted revenue gains & others Basically, the free operating cash flow is operating cash flow minus the amount invested in fixed assets and working capital for that year. Free Operating Cash Flow over Total Assets: Free operating cash flow / Total assets Current Ratio: Total current assets / Total current liabilities Days in Patient Accounts Receivable: Receivables / Daily net patient service revenue Days Cash on Hand: Cash & cash equivalents / [(Total expenses Depreciation & amortization Provision of bad debts) / 365 days] Fixed Asset Financing: Long-term debt less current maturities / (Net PPE Net acqu. & startup costs) Cash Flow to Total Debt: Excess (Deficit) of revenues over expenses Depreciation & amortization / Total liabilities Times Interest Earned: Excess (Deficit) of revenues over expenses Interest / Interest Debt Service Coverage: [Excess (Deficit) of revenues over expenses Depreciation & amortization interest] / [Interest ( Principal payments on LT debt)]. Principal payments are given as negative figures on the Statement of Cash Flow. Total Asset Turnover: (Total unrestricted revenue gains & others Unrestricted gifts & bequests) / Total assets Fixed Asset Turnover: (Total unrestricted revenue gains & others Unrestricted gifts & bequests) / Net PPE Net acqu. & startup costs Current Asset Turnover: (Total unrestricted revenue gains & others Unrestricted gifts & bequests) / Total current assets Inventory Turnover: (Total unrestricted revenue gains & others Unrestricted gifts & bequests) / Inventory Capital Expense Growth Rate: (Gross property & equipment 1 Gross property & equipment) 0 / Gross property & equipment CASE OUTCOME The MCSI incurred an operating loss of $805,399 in 1999, as well as a loss in On October 1, 2001, MCSI was sold by the City of Charlestown to Province Healthcare, an integrated for-profit health care system. The hospital s property, plant, and equipment were purchased for $16 million, including accounts receivables. The city paid off the $9 million debt from the proceeds. Province Healthcare was committed to the infusion of $5.2 million in capital in the next month. Province Healthcare owns 18 hospitals, 4 of which were purchased in 2001, including MCSI. Kevin Miller and other senior managers remained after the acquisition. Instructor s Manual for Cases in Health Services Management, fifth edition, by Rakich, Longest, and Darr. Copyright 2010, Rakich, Longest, and Darr.

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