Value Based Management (VBM)
as a Best Practice for Healthcare Systems
Healthcare systems in the United States are facing nearly unprecedented challenges as well as opportunities. From pending shifts in national health-insurance policies to an increased focus on the quality of care amidst aging “boomer” populations, hospital systems around the country struggle to identify the best value for stretched resources in the face of often having to defend a tax-exempt status. Seeking to balance these dynamics with ongoing priorities around R&D as well as merger and acquisition activity in response to stressed economic conditions nationally, healthcare systems – like other highly-regulated industries – are turning to a Value Based Management business philosophy that aligns management interests to the creation of value by providing an effective formulary of healthcare services and products to minimize cost while maximizing positive outcomes. As a result, the practice of VBM begins by using the ultimate measure of value creation, known as Economic Value (also known as Economic Value Added or EVA).
Economic Value is a financial performance measure of the true economic profit of an enterprise. EV proposes that value is added only if the operations of an organization, commercial or non-profit, return more than its cost of capital. It indicates the financial health of an organization and represents the true profit following allowance for taxes and the cost of capital.
EV = NOPAT – (Capital Invested x Cost of Capital)
where NOPAT is Net Operating Profit After Taxes, Capital Invested represents the total capital employed, and Cost of Capital represents the minimum return required to compensate for the risk of the investment..
Among the virtues of Economic Value are the facts that it:
- can be calculated throughout an organization, down to its smallest operating unit;
- can guide new developments and new opportunities; and
- is a financial analysis tool that can provide critical guidance through varying economic cycles.
Economic Value supplies a useful measure of year-over-year change. If EV in an operation or enterprise is increasing, value is being created. Conversely, if EV is declining, value is being lost or squandered.
In the face of 21st-century dynamics within the healthcare industry, Economic Value provides a range of critical benefits to healthcare systems, such as:
- Ensuring smarter capital deployment by identifying those investments which produce the best economic profit, as distinct from accounting profit;
- Fortifying evidence that a hospital is providing “community benefit“ in support of its continued tax exemption under IRC § 501(c)(3);
- Allowing the evaluation and adjustment of compensation for executives, boards (as applicable) and employees at all levels across the system to maximize long-term value;
- Providing basis for compensation of “disqualified persons“ under the intermediate sanctions provisions of IRC § 4958; and
- Empowering managers at all levels to make better decisions by providing them deepened clarity around operational and value impact at all levels of the organization.
For further information, please contact Al Candrilli or Paul Creasy of the Organizational Consulting Group at (216) 556-2624.