Putting Workforce Productivity in Perspective: Are You Taking What Matters into Account?

It seems barely a week goes by in the news lately without a story of a health system announcing they need to cut labor costs significantly. Even in the absence of dire financial straits, executives are anticipating the need to shore up margins as a hedge against an uncertain future. At roughly half or more of the typical hospital’s total operating budget, workforce constitutes by far the largest expense category, but with staffing levels already leaner than in previous eras of cost reduction, finding ways to cut costs without slashing productivity is a significant challenge. Maximizing the efficiency of clinical and non-clinical staff is at center stage and with it the imperative to set—and meet—productivity targets that optimize workforce output.

Progressive organizations are working to develop productivity targets that are ambitious yet sustainable by taking a multidimensional approach that answers three questions:

• How much of our budget can we afford to spend on workforce?
• What are the right productivity targets for our cost centers?
• How can we maintain target productivity and avoid costly inefficiency?

Begin with Revenue

Many hospitals begin a labor cost reduction initiative by going straight to a cost center benchmark analysis. Although such analysis is important, the first step should be for finance leaders to forecast how much of net patient and operating revenue can be allocated to workforce costs. That threshold determines the overall cost target, which the individual cost centers targets must work together to meet. In fact, finance leaders often ask “should we be targeting top quartile or top decile?” The response should always the same: “which decile aligns with your overall cost target?”

Typically, a sustainable level of investment in labor is below 54 percent, but for some hospitals, market conditions will require even lower levels. Labor inflation rates may make cost reductions necessary to ensure financial viability. A CEO of a large system on the West Coast summed up the challenge at his health system this way: “Today we’re at 55 percent of net patient revenue, and we can make that work for now. But next year, I’ll probably only get a 1 percent increase in overall rates, while my labor inflation rate will increase by 3 percent. So if I do nothing about labor costs, we will fall behind.” Most hospitals face this same dilemma.

Benchmarking as Art, Not Science

Once the parameters for overall labor costs are in place, it’s time to look for opportunities to use staff resources more effectively. Benchmarks give executives insight into each cost center’s performance against organizations of similar size, service mix, and acuity. But benchmarks have to be used wisely. On the one hand, no two hospitals are alike, so there is no perfect comparison. On the other hand, leaders too often zero in on a comparison that defends the status quo instead of seeking insights into improvement. A better approach is to identify a benchmark range for each cost center (e.g., between top quartile and top decile), then set an exact target that reflects the specific circumstances of the cost center at the organization.

The last step is to calibrate overall targets to account for outliers. One health system, for example, faced a large workforce reduction in order to avoid tripping bond covenants. Following the benchmarking process above, it turned out that several larger cost centers would need to reduce overall staffing by a significant percent to fall within the target benchmarks.

When situations like the above occur, an incremental approach is needed to get to target to avoid compromising quality. This health system responded by capping the improvement target at 15 percent of the current productivity, with a plan to get to the final target over a longer period of time. Doing so enabled those cost centers to make changes without negatively impacting patient care, but it also forced other cost centers to set a more aggressive productivity target in order to hit the overall labor cost goal.

A Multidimensional Definition of Productivity

Meeting a benchmark target number of worked hours is essential but certainly not sufficient to optimize productivity. All the inputs need to be taken into account in order to optimize the output: utilizing staff of all levels effectively to provide the best care. Healthcare organizations must understand the cost of work hours, what role is performing specific tasks, the timing of the work, and ultimately what kind of work is being performed. One area that consistently holds opportunity is premium pay. Clinical leaders should evaluate all premium models and ask whether they address current circumstances. There’s a good chance outdated shift premiums still exist that have outlived their usefulness. And there are numerous other considerations that need to be taken into account in developing a multidimensional understanding of productivity. It’s a challenging, and often complex, undertaking, but given the preeminence of productivity in preserving quality of care and financial sustainability in today’s reality, well worth our attention.

John Johnston, CPA, MHA is senior vice president at Advisory Board, Washington, D.C.