The average operating margins (i.e., profits) of hospitals decreased from 6.3% in 1997 to 2.7% in 1999 (1). In fact, in 1999, 43% of not-for-profit hospitals had negative operating margins (2). An important aspect of hospital finances is the profitability of the hospital’s surgical cases. It is not known how much variability exists in the profitability of different surgical cases or among surgeons. These data may be important for contracting for additional surgical caseload and for allocating operating room (OR) block time.
Total costs incurred by a hospital consist of both variable and fixed costs. Variable costs equal the incremental amount of money that the hospital spends to care for an additional patient. Fixed costs (i.e., “overhead”) are incurred independent of how many patients are treated. “Bottom up” cost accounting systems that are being used to more accurately track costs have hospital managers separate total costs into fixed and variable components. How overhead costs are actually allocated varies among organizations and will impact cost estimates.
Profitability of individual cases equals payment to the hospital minus variable costs and minus attributable fixed costs (3,4). Contribution margin, used as a measure of profitability because fixed costs are not changeable over the short term, equals payment to the hospital minus variable costs. A positive contribution margin for a surgeon’s cases indicates that the cases contribute to overall hospital profit and coverage of the hospital’s fixed costs.
One way hospitals try to achieve profitability is to maintain relatively high (e.g., 90%) OR utilization to cover fixed costs. “Utilization” is expressed as a ratio. Although there are several definitions of utilization, the numerator refers to the total hours of elective cases and the denominator equals the number of hours the OR is staffed to perform cases. At hospitals in which elective cases are scheduled only if they can reasonably be expected to be completed before the end of the regularly scheduled OR workday (such as at Stanford University Medical Center [SUMC]), block time is often allocated based on surgeons’ historical utilization of that block time. This approach will maximize hospital profitability provided that the contribution margins for all surgeons are equal and positive. If it was the case that contribution margin did not vary significantly among surgeons, hospitals would be unable to improve overall hospital profitability by using contribution margins rather than utilization to allocate OR block time.
However, if contribution margin was to vary significantly among surgeons, then hospitals could choose to increase their profitability by using contribution margins, instead of OR utilization, as the basis for allocating OR block time. Surgeons with the largest contribution margin per allocated OR block would get the most block time. This may be especially useful for hospitals in which elective cases are scheduled only if they can be completed within existing staffed OR block time, utilization of that OR time is already high intense, yet the hospital wants to increase profitability.
Our goal was to analyze hospital financial data to determine whether, and by how much, hospital contribution margin per OR hour can vary among surgeons.
Materials and Methods
The SUMC Human Subjects Committee approved this study. We retrospectively obtained hospital financial data for all patients undergoing elective outpatient or same-day admit surgery with a recorded case duration at SUMC between September 15, 1999 and December 31, 1999. These cases ranged from minor procedures (e.g., outpatient otology) to major cardiothoracic and neurosurgical cases. We used data from a pilot study to estimate that this time period would yield the 2500–3000 cases required to obtain appropriate statistical significance. We specifically only identified elective cases, because these are typically the patients to whom OR time is allocated by OR managers. We did not include patients who were already in the hospital, and who had surgery during their hospitalization. This is because, once a patient is in the hospital, the decision has already been made to care for the patient and use OR time. The hospital cannot increase revenue by adjusting how OR time is allocated for these in-house patients.
Financial data were extracted using the hospital’s financial management software (Eclipsys Corporation, Delray Beach, FL). Details of the database have been described previously (5,6). Briefly, “bottom-up,” or micro-costing, used in this study is a more precise way to measure costs than relying on cost-to-charge ratios. One advantage of bottom-up costing is that total costs can be separated by hospital managers into fixed costs (that do not change in proportion to volume of activity) and variable costs (that do change as the number of patients cared for changes). Actual supply costs, wage rates, and labor effort as measured by hospital department managers were used to compute variable and fixed costs of patient care. Costs were calibrated to actual cash expenses on a quarterly basis. For this study, total hospital variable costs for a case (e.g., labor, drugs, and supplies) were estimated by taking the sum of variable costs attributed to 10 hospital departments: patient ward, radiology, OR, anesthesia, pharmacy, postanesthesia care unit, surgical admission unit, intensive care unit, laboratory, and blood bank.
We computed contribution margin per hour of OR time. For each case, we subtracted variable costs from the total payment to the hospital for the case. This overall hospital contribution margin was then divided by the duration of the case, measured as the number of hours the patient was in an OR. For example, if SUMC received payment for a knee replacement surgery equaling $18,000, and variable costs equaled $10,000, and the case lasted 2 h, then the contribution margin per hour of OR time equaled $4000.
We included in the analysis only those cases for which the case’s surgeon had performed at least 10 cases during the study period. This was done to have enough patients per surgeon to achieve a reasonably accurate overall mean contribution margin for all of a surgeon’s patients. We also excluded cases for which the patient was admitted postoperatively and underwent another operation during the hospitalization. This was done because we were unable to compute contribution margin for episodes of care occurring during the same admission.
At hospitals with an annual global payment (e.g., county hospital), incremental revenue for an additional case is zero. 1
For such hospitals, contribution margin may be thought of as equaling variable costs. In such settings, quantifying the amount of variable costs per hour of OR time by surgeon may be helpful for classifying how costly surgeons’ cases are to the system. For this reason, we also computed the overall mean variable cost per hour of OR time among surgeons’ cases.
Variation among surgeons in the contribution margin per OR hour was assessed statistically with a random effects analysis of variance (7). A “random effects” model implies that each surgeon represents a random sample from the population of all surgeons.
We calculated Cohen’s f, which is an analysis of variance “effect size.” Cohen’s f is expressed as a ratio. In this study, Cohen’s f compares variability in contribution margin (as measured by the standard deviation) among all surgeons in the study relative to the variability for each individual surgeon’s cases. The numerator is the standard deviation among all surgeons’ average contribution margins per OR hour. The denominator equals the standard deviation of the contribution margins per OR hour among each surgeon’s cases.
If this ratio is small, ≅0.1, then the variability in contribution margin per OR hour among all the surgeons is considered small relative to variation in contribution margin per OR hour among cases (8). If f ≅ 0.25, then the variability is considered moderate (8). If f ≥ 0.4, then the variability in contribution margin among surgeons is considered large (8).
We calculated the 95% lower confidence bound for the value of Cohen’s f using the test derived by Wald (9).
We analyzed 2848 cases by 94 surgeons. The mean ± sd of patients’ ages was 51 ± 17 years. Fifty-three percent of the patients underwent outpatient surgery. Among patients with a length of stay of 1 day or longer, the length of stay equaled 3.6 ± 3.7 days. OR time averaged 2.5 ± 1.5 h.
The distribution of contribution margins for all cases is in Figure 1. Contribution margin per OR hour was negative for 26% of the cases.
Cohen’s f equals 0.29, with a lower 95% confidence bound of 0.27. The value of 0.29 indicates (8) moderate variability in contribution margin among surgeons, relative to the variability in contribution margins per OR hour among each surgeon’s cases (Fig. 2).
The average variable cost per hour of OR time also varied among surgeons (Fig. 3). For example, the surgeons performing joint replacement surgery or implantation of brain and spinal cord stimulators, respectively, had the largest and second-largest average variable costs per hour of OR time. Their variable costs were 938% and 700% more than the surgeons (performing outpatient otology and breast surgery cases) with the lowest and second-lowest variable costs per OR hour, respectively.
The calculation of contribution margin has been used in other studies to assess profitability. For example, 57% of a trauma center’s profit was derived from the most severely injured trauma patients, even though those patients only accounted for 28% of the discharges (10). Another study found that various salvage techniques (e.g., coronary stenting) for failed percutaneous transluminal coronary angioplasty were profitable for the hospital under fee-for-service, but not for diagnosis-related group-based reimbursement systems (11).
In this study, we found not only the expected variation in contribution margin per OR hour among an individual surgeon’s patients, but also that there can be moderate variations among different surgeons. Although the presence of the variability may not be surprising, the magnitude of the variability is large enough that OR managers can aim to increase profitability by allocating OR time based on it. Importantly, we show (in the Appendix) precisely how this variability can be effectively used to more optimally (profitably) allocate OR time. Whether this method should be used depends, because it applies to hospitals in which elective cases are scheduled only if they can be expected to be completed before the end of the regularly scheduled OR workday.
For the hospital to be profitable, total revenue must exceed total expenses (variable costs plus fixed costs). Even if revenue for a case exceeds the variable cost for the case (i.e., contribution margin is positive), if there are not enough cases (e.g., losing certain surgeons all together and having hospital beds sit idle) to cover the fixed costs, the hospital may show a loss. The same principle applies to an individual surgeon. If a surgeon has a high profitability per OR hour, but is unable to generate the volume of cases needed to exceed the fixed costs required to support his or her service, then the surgeon’s cases are not profitable for the hospital. Our analytical approach in this study is predicated on the assumption that there are few attributable fixed costs that could be eliminated if a surgeon was given less OR time.
Even though block allocations are sometimes made to surgical services, not individual surgeons, we did not analyze contribution margin by surgical service. This is because some surgeons cross (or overlap) surgical services, and we found that grouping them may become arbitrary (e.g., is the breast cancer surgeon in the oncology service or the general surgery service?). Also, our perspective was that the unit of analysis is the individual surgeon because block time allocation incentives typically would target individual surgeons (12). Lumping surgeons (into one service) can decrease variability in contribution margin and may make it more difficult to elucidate the relationship between individual surgeon’s practices and OR contribution margin.
Our analysis does not apply to a hospital with a mission of having to take care of all of the community’s patients on whatever workday surgeons may choose (13,14). In this setting, surgical suites are managed to care for all patients, even if this requires elective cases to finish past the end of the regularly scheduled day. If all of the surgeons’ patients receive care, OR block time should be allocated based on total hours of elective cases including turnover times (15).
Our contribution margin result (Figs. 1 and 2) is also not applicable to hospitals that are not reimbursed on a per case basis (e.g., Veteran’s Administration or National Health Service in Great Britain). At hospitals restricted to a fixed budget, incremental revenue for an additional case is zero. In this situation, it is the variation in variable costs per hour of OR time that matters.
We found significant variability in the average variable cost per hour of OR time among surgeons (Fig. 3). For example, the surgeons (performing joint replacement surgery) had variable costs per OR hour that were seven- to ninefold more than the surgeons with the lowest and second-lowest variable costs. If such a hospital has its budget reduced, then the administrator would have to reduce seven- to ninefold more OR time to the least costly surgeons to have the same budgetary effect as reducing OR allocations to the surgeons with the greatest variable costs per hour of OR time.
Contribution margin per OR hour may be a useful index for OR managers in deciding how to allocate OR time in some facilities, especially as payments from third-party payers continue to decrease and hospitals struggle with deficits.
Given the moderate amount of variability in contribution margin per hour, OR utilization may be a poor endpoint to manage for administrators seeking to maximize profitability.
If a surgical suite already has a high frequent utilization (e.g., >90%), then adding case volume is likely to increase the length of time patients have to wait to have elective surgery. This increase in waiting time is attributable to little free capacity to quickly schedule new cases (16). OR utilization and profitability are unlikely to be increased by increasing caseload if a surgical suite already has a high frequent utilization (17).
If a hospital began allocating OR time by a surgeon’s contribution margins, then such a surgeon’s OR time may be decreased. Also, for hospitals that are considering using surgeons’ contribution margins to assign block time, the use of per-hour contribution margin may penalize the fast, efficient surgeon with the least attractive payer mix and a resulting negative contribution margin. That surgeon will perform many surgical cases over few OR hours, producing a more negative contribution margin per hour of OR time and risk having his or her OR time reduced.
Importantly, that surgeon would not “look better” if he/she slowed down and spread the negative contribution margin over more hours. The reason is, as shown in the Appendix, that the statistic that should be used for allocating OR time is contribution margin per allocated block. For hospitals with a high frequent OR utilization, this will not differ substantively from contribution margin per OR hour. If the surgeon’s overall contribution margin is small but positive, then “slowing down” would be detrimental to the hospital’s finances. If the overall contribution margin is negative, then the hospital’s finances would improve if the surgeon did not operate.
Our analysis focused on contribution margin for the hospital. There may be situations, for example, in which a surgeon has a high contribution margin per allocated OR block, but the patients have a relatively long and expensive, but poorly reimbursed, length of hospital stay. The analysis takes this into account because we considered hospital contribution margin, not OR contribution margin.
At hospitals with high frequent OR utilization and fixed hours of OR time, to increase the contribution margin for surgical services, rather than trying to get surgeons to do more and more cases (as is done at many institutions), managers need to increase the number of lucrative cases. An important factor that determines contribution margin is revenue per case, which is determined by payer mix.
Some surgeons’ practices may have a large population of patients with poor hospital reimbursement rates. For example, three surgeons in our study had a negative contribution margin per hour of OR time. One of these three surgeons had more than half of their patients with actual reimbursement of just 18% of hospital variable costs. A second surgeon had discounted fee for service commercial plans that reimbursed the hospital less than Medicare rates. The third surgeon had many patients without any reimbursement to the hospital at all.
This reinforces the importance of selectively contracting with the better payers and using whatever negotiating leverage is available to increase reimbursement. Contribution margin data could also be used in decisions about which surgical programs are worth expanding, or directing additional resources to. In addition, because supply costs are an important component of variable costs, decreasing supply costs [e.g., joining a buying group, or developing clinical pathways to standardize supplies (17,18)] can enhance contribution margins.
We did not study intrasurgeon variability according to type of case because in other studies we have found that the great variety of different types of procedures and the large number of surgeons on staff reduces the numbers of like cases available for financial comparison (18,19). For example, we searched backward for one year and counted the number of previous cases that were of the same type of procedure performed by the same surgeon (19,20). We grouped cases together if they were of the same procedure type performed by the same surgeon. “Procedure” was defined by the Current Procedural Terminology (CPT) code(s). If a procedure had more than one CPT code, that combination of codes was considered to characterize a unique procedure. For example, all unilateral total knee replacement cases done by surgeon “Jones” were grouped together. Total knee replacement surgeries done by surgeon “Smith” were grouped separately. In that study, we found that as many as 48% of cases in an outpatient surgery center (and 36% of cases at a tertiary surgical suite) were of a procedure or combination of procedures that has occurred less than five times in the previous year. Lumping together similar CPT code(s) was impractical, because procedures with CPT code(s) that differ only in the final (fifth) digit may have very different surgical complexity.
Because we analyzed financial data from only one hospital, the results from the current study may not be immediately generalizable to other hospitals. Our analysis depends on the accuracy of our cost-accounting system—specifically, the categorization of costs as variable costs. We choose to use this cost-accounting system because it tracks most of the variable cost items. For example, we found that 62% of the cost of OR time is a fixed cost (i.e., related to buildings, equipment, salaried OR and ward labor, and overhead). The remaining costs for OR time were for variable costs (e.g., variable nursing costs and supplies).
Determining whether a resource is fixed or variable affects the derived contribution margin. For example, if surgeon A requires 2 hours of OR time to complete a case and surgeon B only requires 1.5 hours for the same case, has surgeon A actually affected variable costs? Whenever costs are difficult to allocate to individual cases, hospitals may signify them instead as overhead, even though they might actually vary directly with patient activity. As a result, contribution margin per OR hour may vary by differing amounts at different hospitals depending in part on whether labor is accounted for as a fixed cost or a variable cost. Another factor that may differ among facilities is how physician costs are accounted. For example, reimbursement for services provided by hospital-employed physicians (e.g., anesthesiologist, pathologist) may also affect the institution’s total contribution margin per case.
We initiated the study from the viewpoint of a hospital that specifies that its mission (from the perspective of scheduling elective cases) is to maximize total hours of elective cases constrained by a fixed budget for OR time, and needs to increase overall hospital margin.
At a university-affiliated hospital, we found significant inter-surgeon and intra-surgeon variation in contribution margin per OR hour. For hospitals that are able to allocate OR time based on contribution margin (instead of the surgeon’s historical OR utilization), the inter-surgeon variability indicates that it may be possible to increase margins by allocating block time based on contribution margin. The hospital would need to be prepared for the implication that poorly or nonreimbursed elective care will be reduced.
To increase overall profitability, rather than trying to increase surgical volume, hospitals need to give surgeons with high contribution margins more block time and unprofitable surgeons less block time. Whether this can actually take place may depend on local characteristics of the hospital and the mission of the surgical suite and medical staff. For example, allocating OR time based on contribution margin may not be feasible at hospitals with competition for patients necessitating that there be no limit on the number of elective cases performed every workday. In addition, allocating OR block time based on contribution margin is a form of economic credentialing. Medical staffs who are losing money for the hospital are likely to resist such change.
1 For example, assume the annual budget for a hospital is fixed at $40,000,000, regardless of the number of surgical cases performed. If a surgeon performs an extra case, there is no incremental money added in to the budget.
Herein, we show that OR block time can be allocated in an economically rational manner based on contribution margin.
A surgical suite with a capacity of C blocks is to be filled by allocating OR block time to n different surgical services or surgeons. The jth service or surgeon achieves a contribution margin per allocated block of cmj, and wants up to bj blocks. The services’ or surgeons’ contribution margins are sequenced in descending order of margin, wherebyMATH
Our objective is to determine how many blocks to allocate to each service or surgeon to maximize the profit of the surgical suite without having the sum of the allocated blocks exceed C. We assume that the total number of requested blocksMATHbecause otherwise we would allocate to every service or surgeon the number of blocks requested. To solve the problem, we create a set of N binary variables:MATHwith corresponding profitsMATHBecause cm1 ≥ cm2 ≥ … ≥ cmn, then p1 ≥ p2 ≥ … ≥ pN. Consequently, the optimal solution is to setMATHThis means that the surgical service or surgeon with the largest contribution margin per block is allocated as many blocks of OR time as it wants, the service or surgeon with the second-largest contribution margin per block is allocated as many blocks as it wants, and so forth until there is insufficient remaining OR time to satisfy a service’s or surgeon’s request. That service or surgeon is allocated the remaining number of blocks of OR time.
If OR utilization was used as a surrogate for contribution margin, then the derivation would be identical. The service with the most frequent utilization per block would be allocated all of the OR time it wants, the service with the second most frequent utilization would be allocated all of the OR time it wants, and so forth until there are insufficient remaining blocks of OR time to satisfy a service’s request. That service would be allocated the remaining number of blocks of OR time. It should be noted that, if block time is allocated on this basis of OR utilization, it will likely be necessary to allocate it on the basis of surgical groups rather than individual surgeons (11,16). The reason for this is that when utilization is intense, accurately measuring OR utilization for individual surgeons can require unrealistically long time periods of data (11,16).
The derivation assumes that the contribution margin per allocated block is constant over time. If the number of allocated blocks is increased substantially from one period of block time allocation to the next, contribution margins for a surgical group or surgeon may decrease if the group or surgeon has insufficient cases to fill additional block time. Surgical groups or surgeons with a relatively large contribution margin per allocated block have an incentive to not request more block time than they can fill to maintain their contribution margin per allocated block. Otherwise, in the next period of block time allocations, they could get less time than they originally had. Nevertheless, we recommend that in practice the analysis be applied to small (e.g., one block) adjustments in block time allocations.
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