Health Care Industry Insights: What are a Hospital’s Gross Margins?

LEK recently released an article about the gross margins of hospitals and how they will be affected by health care reform. Their finds are fascinating, and the article is one of the best on health care I’ve ever read.

Today’s article is intended as a summary of the LEK article. Specifically we will talk about hospital economics today, the impact of Medicaid expansion, insurance exchanges, aging of the population, and cuts to Medicare.

What are Hospital Margins Today?

Hospital Economics Today

The patient breakdown in an average suburban hospital is 50% commercial (employer based), 30% Medicare, 15% Medicaid, and 5% uninsured.

As you can see from the above graph, hospitals make money on commercial patients and lose money on everybody else. If you’re wondering why they bother serving Medicare and Medicaid patients, it’s because a hospital is a high fixed cost business and serving more patients means losing less money.

Also, the average margin for a suburban hospital is around 4% (if that sounds low, remember that many of them are run as nonprofits).

What is the Impact of Medicaid Expansion?

Medicaid Expansion

The new health care law provides health insurance (via Medicaid) to many of the previously uninsured. This has the side benefit of improving hospital margins by approximately 2%, according to the report.

If that was the only change that came from the new laws hospitals would be in pretty good shape, but there are a few more things we need to consider.

What’s the Impact of the Insurance Exchanges?

Insurance Exchanges

Approximately 10% of commercial patients will lose their plans and move over to new plans purchased on the exchange market. For these commercial exchange plans reimbursement rates are lower for the hospital. This lowers the overall margin for hospitals.

What about Aging of the Population?

Aging of the Population

As the population gets older, more and more people move from the commercial to the Medicare segment, lowering the overall hospital gross margin to 2%.

And What About Cuts to Medicare?

Cuts to Medicare

Factoring in planned cuts to Medicare over the next decade, which lowers the margin on Medicare patients, we see that hospital gross margins drop to zero.

Conclusion

The new health care law does improve hospital margins by lowering the proportion of uninsured patients. But the problem is that the combination of cuts to Medicare and aging of the population more than balance that out.

If LEK’s predictions are correct, gross margins for the typical suburban hospital will fall to zero.

Future articles will touch on how hospital gross margins can be improved.

Answering the “How Would You Do This in Practice?” Question in Cases.

Sometimes when you’re in the middle of a case you’ll get asked a question about how you’d do something in practice. For example, you may be talking about growth rates and the interviewer could ask you how you’d figure out a growth rate for a particular product in real life.

These questions are designed to test if you understand if you could quantify an unknown without spending countless hours tracking down the information.

In general there are three ways to do this:

1. Choosing A Proxy.

2. Internal Benchmarking.

3. External Benchmarking.

Choosing a Proxy

As we discussed in the article on market sizing, choosing a proxy is one of the most efficient ways to quantify something. In the example of growth rate for a specific product, the best proxy depends on what the product is.

If it’s a product for which the market is saturated the growth rate may just follow population growth or GDP growth rate (both of which are readily available quantities).

If it’s a product for which the market is new and unsaturated, you’d have to use one of the benchmarking techniques most likely.

The key to using proxies is to use something that is easy to look up (like the change in GDP. population growth, etc.)

Internal Benchmarking

Internal benchmarking is looking at data you have from inside your company. For example, if you’re trying to quantify the growth rate for a new product you could look at the growth rate of an existing product you already sell.

The product you look at could be complementary to the new product (such as razors and shaving blades) or just within the same class (sofas and lamps for example).

Or, you could look at the growth rate of the same product in a different market (if you have access to it) if the two markets are similar.

This data would also be easily available.

External Benchmarking

If you can’t find a good proxy or internal benchmark, use an external benchmark. This would be things like looking at the growth rate of your competitors (based on yearly sales numbers, if available), analyst reports, newspaper articles, business journals, etc.

Conclusion

If you’re asked how to quantify something in a case, don’t panic. This is an opportunity to show off your ability to efficiently discover unknown information. Your best bet is to identify an easy to quantify proxy (such as GDP). If that doesn’t work you could look for internal benchmarks (such as data from other countries or complementary products that you’d have access to) or external benchmarks (such as competitors growth rates, newspaper articles, market research reports, etc.).

I’ve had this question come up many times so, hope it helps!

 

How to Transition in Cases

As we discussed in how a candidate led case should flow, the most important part of a case is the process of elimination portion in which you’re trying to identify the problem. To do this, you’ll usually structure the problem (which usually ends up either looking like an issue tree or a hypothesis tree).

What we haven’t discussed yet is how you’re supposed to transition between various parts of your structure (i.e. from customers to products) so that it’s easy for your interviewer to follow. That’s what today’s article is about.

What Should the Transition Sound Like?

There’s a three step process for transitioning between different parts of your structure:

1. Updating your hypothesis (if necessary).

2. Synthesizing what you know so far.

3. Explaining where you’re transitioning to, and why.

Example

Market Entry

Let’s take a market entry case as an example. You are asked whether an organic foods company should introduce a new organic pizza crust to the Cincinnati, Ohio market.

You start with the market attractiveness portion of your hypothesis, size the market, look at the growth rate, and examine various customer segments and conclude that from a market attractiveness standpoint it looks pretty good. Your transition might sound something like this:

1. Updating Hypothesis. It looks like based on the market attractiveness analysis introducing organic pizza crusts to the Cincinnati market could be a lucrative opportunity.

2. Synthesis. There are approximately 1 million potential customers (around 25% of the urban + metro population), the growth rate in the organic foods market is around 20%, and there’s a fairly well defined customer segment that wants healthy food options.

3. Where to Next? However, to confirm that hypothesis I’d like to move to an analysis of the product. I’m still not convinced that an organic pizza crust is sufficiently differentiated from a normal pizza crust to appeal to the healthy foods segment of this market.

And that’s it! Every time you move from one area to another in your structure you say a similar thing.

By the way, concluding a case is just a special type of transition. That’s why they sound so similar

Conclusion

Transitions help your interviewer follow along as you move between different parts of your structure.

A good transition looks like:

1. Updating your hypothesis (if necessary).

2. Synthesizing what you know so far.

3. Explaining where you’re transitioning to, and why.

Good luck!

Consulting Industry Insights: What are the Upcoming Trends in IT Outsourcing?

IT Outsourcing has been undergoing significant change as of late because of rapid developments in cloud services, automation, coordination, cost cutting, greater buyer experience, and developments in organizational/governance models.

Today’s article will be all about the various trends in IT outsourcing, what they mean, and how they’ll affect the consulting world.
Continue reading Consulting Industry Insights: What are the Upcoming Trends in IT Outsourcing?

How Much Do Consulting Firms Spend on Recruiting?

We’ve all heard the rumors that consulting recruitment is an enormously expensive ordeal.

In today’s article I’m going to attempt to size how much a consulting firm spends on recruiting based on information I’ve read from Duff McDonald & Victor Cheng (we’ll use McKinsey as an example, though they probably spend more than most), perform a sanity check on my calculations, and try to explain why it’s such a large number.
Continue reading How Much Do Consulting Firms Spend on Recruiting?

Tech Industry Insights: What Does Facebook’s Acquisition of Oculus Tell Us About The Future of Startup Funding?

A couple of days ago, Facebook announced that they were buying a virtual reality hardware company named Oculus for $2 billion.

News of the acquisition set off a torrent of outrage on the internet.

Today’s article will be about what Occulus does, why there’s been so much outrage about its acquisition, and what this means for the future of startup funding.
Continue reading Tech Industry Insights: What Does Facebook’s Acquisition of Oculus Tell Us About The Future of Startup Funding?

Business Concepts: Specialization or the Full Product Line

Back in 1979 Michael Goold of BCG wrote a very interesting article about whether companies should specialize or offer a full set of product lines.

The dilemma? Specialization reduces cost, but reduces potential revenues because product offerings are limited. There are certain customers that want specific tailored products, but you can’t satisfy all of them because the cost of the additional products may be more than what they’re willing to pay.

So what did Michael recommend? The old consulting trick: the 80/20 rule.
Continue reading Business Concepts: Specialization or the Full Product Line

Tech Industry Insights: Where Has the Value Migrated in the Post PC Era?

Over the past two decades or so, most of the profits in the tech industry were captured by Intel (CPUs) and Microsoft (software).

However, times have changed. There’s been a movement away from PCs to mobile devices such as smartphones and tablets. As such, profits have moved away from the Wintel monopoly.

But where have they gone?
Continue reading Tech Industry Insights: Where Has the Value Migrated in the Post PC Era?

Consulting Industry Insights: Why Large Scale IT Projects Go Wrong

These days, most consulting projects end up recommending investing in some sort of IT system as a solution. Interestingly enough, recent research by McKinsey & The University of Oxford has shown that:

1. On average, large IT projects (>$15 million) run 45 percent over budget and 7 percent over time, while delivering 56 percent less value than predicted.

2. 17 percent of IT projects end up going 200-400% over budget, threatening the very existence of the companies they’re trying to help.

3. This effect happens across all industries.

Today’s article is about why so many IT system implementations end up failing and what companies can do about it.
Continue reading Consulting Industry Insights: Why Large Scale IT Projects Go Wrong