Industry Voice

The Business of Healthcare: An Industry Diagnostic

Corporatisation of hospitals brings with it innovative financing models and greater accountability

G Kali Prasad

The Indian healthcare sector is at the precipice of a monumental change in direction, wherein the decisions made by the industry leaders and policy makers today, will shape the future of the industry. Every aspect of healthcare delivery is being challenged by forces that promise to usher in a new era and may give shape to a completely different model than what is believed to be an ideal model today.

Corporatisation of hospitals brings with it innovative financing models and greater accountability. Rapidly increasing real estate and construction costs can alter the large capex plans being made by most of the established as well as new players into this sector. The Third Party Administrators (TPAs) are pushing hospitals towards greater financial and operational efficiency. Medical tourism has ushered in globalisation in quality of care and processes. Rapid advances in medical technology necessitate knowledge management systems and bring with it novel ethical dilemmas.

We, at E&Y, are really excited about the opportunities and challenges being thrown up by these forces and embarked on a pioneering study of tertiary care hospitals across the country. The intent is to establish baseline benchmarks for measuring and monitoring the operational and financial performance of hospitals. The survey was conducted in 17 hospitals across five major cities of India and covers 270 parameters across 30 departments of a hospital.

According the FICCI-Ernst & Young study (January 2007), the Indian healthcare industry is well poised to grow at a CAGR of 15 per cent, with the private sector being responsible for almost 90 per cent of the growth. The key growth drivers are:

• Strong domestic economy.
• Increasing literacy rates and growing public health awareness.
• Higher incidence of lifestyle-related diseases.
• Shift in focus from socialised to private healthcare.
• Easier financing for a capital-intensive industry.
• Increasing penetration of health insurance.
• Recognition by Government of healthcare as a priority sector.
• Growth of medical value travel, popularly known as medical tourism.

Private hospitals are expected to rake in $35.9 billion (Rs 1,50,000 crore) in 2012 compared to $15.5 billion (Rs 6,500 crore) in 2006. However, the key question is whether the industry fundamentals are strong enough to support this kind of growth.

Our study reveals that the Indian tertiary healthcare industry is currently in the growth phase of the lifecycle of industries with a fixed asset age of only 30 per cent of its economic useful life. Yet, its Earnings before Interest, Tax, Depreciation and Amortisation (EBITDA) margins (average of 17.7 per cent) are far below other industries in a similar phase. In fact, the industry's EBITDA margins are tantalisingly close to those seen in the US hospital industry, which has matured and is experiencing pricing pressures from insurance companies.

With the domestic health insurance premiums growing at 47 per cent, increasingly larger percentage of revenues of hospitals coming from TPAs, hospitals are likely to face greater margin squeeze in the coming times, exacerbated by increasing pressure from insurance companies for price rationalisation and longer credit period.

This will necessitate a closer look at fundamentals such as size of the hospital, choice of speciality and revenue cycle management to maximise return on capital employed.

According to WHO's global burden of disease, the incidence of non-communicable diseases is rapidly rising in India and in 2005 accounted for 61 per cent of total deaths. Out of the total 5.1 million deaths due to non-communicable disease in 2002, 2.8 million were due to cardiovascular diseases. This fact was borne out in our survey, wherein amongst all the single-speciality hospitals most were cardiac speciality and they in fact generated the maximum revenue per occupied bed per day.

However, high cost of delivery coupled with high initial capital expenditure significantly impacted their bottomline, resulting in low EBITDA margins and even lower EBIT (Earnings before Interest and Tax) margins.

When we group the hospitals according to their size (80-140 beds, 141-220 beds and >220 beds), a rather interesting finding emerges, ‘the inverted V-curve’. This implies that there is an optimum size of a hospital which generates the highest profitability.

Our survey reveals that although hospitals with 80-140 beds generate the maximum revenue per occupied bed per day (Rs 12,106) compared to 141-220 beds (Rs 11,411) or >220 beds (Rs 9,039), economies of scale do not work in a linear fashion in healthcare delivery. Hospitals with bed capacity between 141-220 beds are able to keep their cost structure rationalised and hence generate the maximum profitability per occupied bed.

Increasing penetration of health insurance is revolutionising healthcare delivery in India. Currently, less than 1 per cent of the Indian population is insured by private insurance companies and yet our survey reveals that 15.6 per cent of the total hospital revenues come from TPAs or insurance companies.

By 2012, about 32 per cent of the total revenues of the hospital are likely to come from insurance companies and out-of-pocket expenses are likely to decrease to less than 50 per cent of the total healthcare spending compared to about 70 per cent today.

This shift to a larger percentage of revenues coming from credit billing will decrease the gap between A/C payables and A/C receivables and significantly stretch the working capital requirements.

Some of the reasons for low profitability that emerged out of our survey are:

Low Bed Occupancy Rate (BOR): Hospitals, like hotels, have perishable inventory and optimising its utilisation would be the single most important measure to increase profitability.

India currently has 1.1 beds per thousand people, which is woefully low compared to other developing countries like China, Malaysia, Korea etc, where the average is 4.3 beds per thousand. Considering the huge supply-demand mismatch, a low BOR is a rather surprising finding.

Lack of focus on marketing could be a significant driver behind low BOR. Hospitals have traditionally relied on "word-of-mouth" publicity and have grown as a doctor driven practice rather than service orientation with brand identity for the corporate. Our survey reveals that typically hospitals spend less than one per cent of their revenues on marketing.

Average Length of Stay (ALOS): The average length of stay has a significant impact on the profitability of a hospital since a major portion of revenues are generated in the first few days of admission and therefore decreasing the ALOS can help increase the turnover per bed and also the revenue per occupied bed per day. Our survey reveals that the ALOS in tertiary care hospitals is close to five days compared to internationally recommended four days. Low ALOS is also a good surrogate measure to gauge the quality of medical care.

Inadequate planning of hospital facilities: Healthcare delivery is an extremely capital-intensive and rising real estate costs coupled with rapid obsolescence of expensive medical equipment is stretching the break-even periods.

Therefore, prudent planning of healthcare facilities will be the key to profitability. A case in point is the ICU: ward bed ratio.

Our survey reveals that while the average BOR is close to 70 per cent, the average ICU occupancy is more than 85 per cent. This also correlates to our experience in hospitals where the Operation Theatre (OT) has to be kept idle for lack of ICU beds for post-operative care.

(To be concluded in the next issue)

The writer is Partner Ernst & Young New Delhi
With inputs from Dr Rakesh Kapur, Dr Arun K John, Anurag Rastogi, Dr Harsh Vardhan Sharma, Ishan Bhaskar and Neetu Singh E-mail: kali.prasad@in.ey.com