For the next five minutes, try to forget about competitive bidding, FEHBP (Federal Employees Health Benefit Plan) adjustments and all of the other provisions of the Medicare Modernization Act (MMA) except the Program Update freeze. Also referred to as the CPI (Consumer Price Index) freeze, this provision gets less attention than any other, yet is the most costly to providers in the long run. It is time to recognize this freeze as an insidious profit destroyer.
Each year prior to MMA, Medicare has adjusted rates in consideration of the rate of inflation. MMA stopped that through 2008. Assuming the economists are correct and that inflation remains at 2.5 percent per year, this provision will remove about twice as much profit from providers as will the FEHBP adjustment.
There are two significant differences that seem to keep this freeze provision from the front of minds. One is that the provision is implemented over a five-year period, and the other is that it is not called a “reimbursement cut.”
However, this provision alone will erase nearly two-thirds of the profit margin of most providers. The table below shows that a company with annual sales of $2 million in 2003, having 40 percent of revenue from Medicare and an average pre-tax profit margin of 7 percent, will lose 66 percent of its profit margin because of this one provision.
The response that providers should have is not “Woe is me,” or “We will overturn the Act.” The proper response is to manage to the environment, and, to that end, there are actions that every company can take.
Reducing the cost of goods is an action that some providers have already begun to implement. Succeeding with this strategy means that a provider must convince a manufacturer to reduce the cost of goods by about 4.5 percent, while the manufacturer is subjected to inflation costs. This means that a manufacturer who experiences a 2.5 percent rate of inflation will have to find a way to produce the goods for 9 percent less, or reduce their profit. Manufacturers may find ways to absorb this burden, but it may be foolish to bet the business on the tactic.
| 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | |
|---|---|---|---|---|---|---|
| Sales ($) | 2,000,000 | 2,080,000 | 2,163,200 | 2,249,728 | 2,339,717 | 2,433,306 |
| Net Income Before Tax ($) | 140,000 | 145,600 | 151,424 | 157,481 | 163,780 | 170,331 |
| Inflation Cost ($) | 19,344 | 40,236 | 62,767 | 87,037 | 113,149 | |
| Inflation Adjusted Net Income ($) | 140,000 | 126,256 | 111,188 | 94,714 | 76,743 | 57,183 |
| Net Profit Margin | 7.0% | 6.1% | 5.1% | 4.2% | 3.3% | 2.4% |
Another way is to improve the productivity of the business. Productivity is calculated by dividing company sales by the full-time equivalent employment (FTE). Increasing productivity requires the company to process more sales with the same FTE, or to reduce FTE if sales remain the same.
With a 2.5 percent rate of inflation and 40 percent of revenue from Medicare, the minimum annual productivity improvement is about 3 percent. So a company with productivity of $120,000 in 2004 must process sales of at least $124,000 with the same people in 2005. By 2008 a company such as the one described must process more than $135,000 per FTE just to stay even with this one provision of MMA.
Getting better productivity can be achieved by targeting sales that use less activity and by re-engineering processes. Re-engineered processes must first please the customer, then increase throughput, or quality, or both. Think about reducing keystrokes, footsteps, miles, phone calls, etc.
Using both of these tactics simultaneously should produce all of the cost reductions necessary for this most expensive provision of MMA.
Wallace Weeks is founder and president of Weeks Group Inc., a Melbourne, Fla.-based strategy consulting firm. He can be reached at 321/752-4514 or by e-mail at wweeks@weeksgroup.com.
