The costs associated with providing care are intensifying and continue to place significant constraints on performance improvement efforts at legacy hospitals and health systems across the country.

This month’s Spotlight article is part 2 of a 2-part series. Part 1 in the November issue examined key organizational stress factors identified in a recent survey of hospital and health system leaders nationwide, and how volatility in volume and revenue trends are contributing to those pressures. This month, Part 2 delves into trends in expenses, survey data on hospitals’ performance improvement efforts, and recommended strategies to help optimize those efforts.

About the Data

Expense data are drawn from Kaufman Hall’s proprietary database, with data from more than 800 hospitals nationwide. Survey data are from Kaufman Hall’s third annual State of Healthcare Performance Improvement report, jointly published with the Healthcare Financial Management Association.

There is no question that expenses—and rising labor costs in particular—are straining hospitals’ bottom lines, especially when combined with the aforementioned volatility in volumes and revenues. Nearly half of hospital and health system leaders identified rising salaries and wage inflation as the No. 1 factor putting pressure on their organizations’ efforts to control expenses, reflecting increasingly tight labor markets in many areas of the country (Figure 1).

Other common factors cited included capital required to fund strategic growth initiatives at 23%, supply chain (including drug expenses) at 12%, and purchased services at 10%.

Figure 1. Expense Pressures

Expense Pressures

A Look at Expenses

Expense data from 2018 and 2019 illustrate the rough road hospitals and health systems face in trying to get a handle on the high costs of providing healthcare. While year-over-year variances show dramatic fluctuations from month to month, overall expenses continue to creep steadily upward.

Looking back at 2018, overall expense indicators showed unfavorable performance relative to 2017. Those trends have continued this year. Year-over-year variances in expense trends have seesawed throughout the first 11 months of the year, with Labor and Non-Labor Expenses following similar patterns most months (Figure 2).

Figure 2. Year-Over-Year Variances in Key Expense Metrics (January-November 2019)

Year-Over-Year Variances in Key Expense Metrics (January-November 2019)
Source: Kaufman Hall proprietary database

Total Expense per Adjusted Discharge has seen modest year-over-year declines for five months of the year. These decreases have been more than offset, however, by six months of larger year-over-year increases. For example, Total Expense per Adjusted Discharge hit a low of -1.8% year-over-year in April, before jumping to a high of 5.6% just two months later in June. Similarly, year-over-year variances in both Non-Labor Expense per Adjusted Discharge and Labor Expense per Adjusted Discharge dipped in April and spiked in June.

So far this year, Labor Expense per Adjusted Discharge has seen year-over-year increases for six months, and year-over-year decreases five months. Full-Time Equivalents (FTEs) per Adjusted Occupied Bed (AOB), however, have shown no year-over-year increases in 2019. Instead, FTEs per AOB have declined nine months and were flat compared to the prior year in January and June.

This indicates that while hospitals are working to optimize staffing efficiencies, rising salaries and wage inflation are counteracting those efforts and driving overall increases in labor expenses. Labor Expense per Adjusted Discharge saw a low of -3.7% year-over-year variance in April, and highs of 4.9% year-over-year in both June and November.

The rise in non-labor expenses has been more consistent throughout 2018 and 2019. Non-Labor Expense per Adjusted Discharge has increased year-over-year nine months in 2019, jumping to a high of 5.3% in June, following a low of -4.0% in April.

Supply Expense per Adjusted Discharge has shown the most significant increases throughout 2019, with year-over-year increases for 10 of 11 months. March was the only month to see a negative variance for this metric, at -2.0%, followed by a peak year-over-year variance of 8.6% three months later.

Drug Expense per Adjusted Discharge was on the rise for much of the first half of the year, peaking at 7% year-over-year in May, and steadily decreasing for most of the subsequent months. Year-over-year trends in Purchased Service Expense per Adjusted Discharge have been more erratic, with declines three months and increases eight months.

The State of Performance Improvement

Trends in expenses over the past two years—particularly in labor expenses—suggest hospitals are struggling to implement effective performance improvement strategies. Even with historically focused efforts to control labor costs, they continue to represent up to 60% of a health system’s costs, and thus simultaneously pose significant opportunities and threats to cost transformation efforts.

Labor cost and productivity were identified as the No. 1 area for generating the greatest potential cost savings by nearly 40% of survey respondents, while just 10% indicated supply chain and non-labor costs as offering the greatest savings opportunities at their organizations.

Interestingly, healthcare leaders also identified labor cost and productivity as the No. 1 area of greatest success in achieving cost transformation goals (36% of respondents), as well as the No. 1 area posing the most difficulties in achieving cost transformation goals (31% of respondents).

When asked to assess how successful they have been in achieving their cost transformation goals, fewer than 1 in 4 respondents (23%) say their organizations have achieved “most” of their goals (Figure 3). Two-thirds say they have achieved only “some” goals, while 9%say their organizations achieved no goals and 1% claim their organizations achieved all goals.

Figure 3. Success in Achieving Cost Transformation Goals

Success in Achieving Cost Transformation Goals

The greatest proportion of respondents, 44% , say their organizations have set reduction targets of between 6-10%of current costs over the next three years. 40% are targeting between 1-5%, while about 11% are targeting reductions greater than 10% of current costs. No respondents have targeted cost reductions in excess of 20%, and only 4% said they did not need to remove any current costs.


While the survey results confirm that healthcare leaders see cost transformation as a high priority, leaders also need guidance to develop a clearly articulated vision of the future and the steps required to make that vision a reality.

Coupled with recent trends in expenses, these findings illustrate the need for hospitals and health systems to move beyond traditional performance improvement methods, which are rapidly losing relevance. Hospital leaders must think more innovatively on how to manage expenses in the future, and focus on four key performance improvement strategies:

  • Refine and improve your organization’s understanding of costs
  • Deploy external perspectives and benchmarking to identify and drive sustainable cost restructuring efforts
  • Engage clinicians with accurate and actionable data on quality and costs
  • Establish greater accountability for achieving and sustaining performance improvement goals

Legacy providers must find new ways to address mounting cost pressures, driven in part by a tight labor market that continues to drive wage inflation. Improved performance and cost transformation are needed to support critical investments in new strategic initiatives required to position these organizations for the future.

To ensure success, these initiatives must be supported by the appropriate technology and tools, based on reliable data, enhanced by external perspectives and benchmarking, supported by engaged clinicians, and continuously monitored through clear lines of accountability. 

For more information, read the full report: The State of Healthcare Performance Improvement: Strategy, Technology, and Tactics. Or, reach out to us to chat about our Performance Improvement practice.

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