Recently, I finished a really big project that I had been working on for 10 weeks. Most of those weeks included six or more workdays, many of which were 10 to 15 hours long. An intense focus and adrenaline kept me going, but when the project was complete, my focus was gone, the adrenaline was not pumping and I didn't feel like doing anything. I crashed because I could.
As an industry we have just completed a really big project, getting a delay in competitive bidding. Some worked harder than others to win the delay and are due a great deal of gratitude. But we were all stressed by the implementation of competitive bidding.
When any stress ends, there is the tendency to relax. But this is not the time to do that. We need to get back in the game and make something of the next opportunity.
Now that the round one contracting process has been delayed until 2009 and round two won't begin until 2011, for the home medical equipment industry, that opportunity is to make the most of the bid delay.
The delay has a price, and that is a nationwide reimbursement cut on competitively bid items and elimination of the CPI adjustment that would have occurred next year. All providers must prepare for the 9.5 percent cut — now only weeks away on Jan. 1, 2009 — and many providers must also prepare for future rounds of competitive bidding.
So the delay means there are notable opportunities to: prepare for lower reimbursement rates; improve financial ratios to qualify as a contractor; adjust company cost structure; and become a more powerful industry.
After more than a decade of working with activity-based costing and the application of activity costs to DME products, I have a clear understanding of the net profit contribution of each product, the portion of reimbursement that is left after paying for a product and all of the activities associated with that product.
In round one, the bids were at prices so low that the net profit contribution was not sufficient for the winning bidders to sustain such steep discounts in eight of the 10 product categories that were affected. And the two categories that were sustainable (oxygen and enteral nutrition) were just sustainable; they were not attractive.
Accepting the contracts offered this year would have bankrupted many providers. Fortunately, we don't have to watch or experience those tragedies.
Let Logic Prevail
It is widely accepted that the steep discounts offered in round one were the result of providers bidding from fear rather than the logic that is built on the economics. In some cases, providers knew the economics but subordinated logic to fear. Now we have an opportunity to tone down the fear, replace it with logic and submit bids based on realistic and sustainable economics.
Toning down the fear (which is always the antagonist of logic) can only be accomplished if we become a more transparent industry, and that has at least three requirements. First, we have to share information about our businesses.
If one group understands that another group can't bid low enough to put them out of business, its fear level subsides to some degree. To the degree that fear subsides, logic can replace it.
In February, my monthly column* in HomeCare was titled “Thriving Under Attack.” It listed some of the benefits that transparent industries enjoy:
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Managers can better measure their company's performance.
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Managers can offer less defensive bids if they understand the potential of rivals better.
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Managers would learn of best practices.
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Greater transparency fosters greater cohesiveness.
Get Real About Bids
Second, we have to get to know the other providers in the market. One project that I worked on had me telephoning providers in several cities asking a variety of questions. One of them was, “Who are the top five providers in the market?” It was difficult for some of the providers I spoke with to name three.
By getting to know the other players in the market, we replace the unknown with the known. That reduces fear. It also provides an opportunity to enlist others to work with us in our lobbying efforts.
Finally, having a better understanding of the competitive bidding process and a better understanding of the economics of your business can also help to reduce any fear.
As a whole, our industry did not understand the response that the Medicare Modernization Act, which mandated competitive bidding, imposes on CMS when there is an insufficient supply for the demand in a competition area. If there had been widespread understanding that CMS cannot issue a contract when there is an insufficient supply, then fewer providers would have submitted such low bids — if they had bid at all.
Get Real About Bids
Understanding the economics of business and bidding starts with the notion that a gross profit margin analysis of a product is not a sound basis on which to offer any reduction in price.
For example, the gross profit margin on E1390 (oxygen concentrator) is often near 90 percent, but that can't justify a 23 percent discount (the reduction that resulted from round one of bidding) because it is incomplete information.
When subtracting activity costs specific to reimbursement for E1390, the net margin may be 25 to 30 percent. But the costs don't stop there. If we provide a stationary concentrator, we must also provide portables. Portables produce a loss that should be charged against the E1390 profit. Thus, real net margins are less than 20 percent for even the best-managed companies.
We need to know the nuts and bolts of our companies right down to how much of one product's profit is eroded by another product's loss, and which activities are responsible for the profits and losses. The delay offers time to analyze. We must understand all of the mechanics of our bids and all of the mechanics of CMS' contracting.
Submitting bids based on realistic and sustainable economics is not really complex. There are two prerequisites, preparation and discipline. Preparation includes analyzing costs (admittedly, easier said than done), then determining how much cost can be removed and, finally, changing business practices to actually remove the costs.
Even though we know which financial measures CMS calculates in the bid evaluation process, we still don't know the level at which these financial ratios are deemed acceptable. However, some providers have learned what is not acceptable. We do know what industry norms are. With the bid delay, providers whose ratios don't meet or exceed industry norms have more time to improve them.
It generally takes about 18 months for a business to affect its balance sheet. Those providers who need to show a stronger company should already be working to improve its financial condition.
The first step is calculating the 10 financial measures that CMS uses. (See the accompanying list.) Managers must compare these to their chosen targets, which will be specific to each of these ratios.
Whenever a ratio indicates performance beneath the target level, the manager must quantify the difference. That done, a plan can be made to adjust performance. In other words, once a need for improvement is quantified, a plan can be developed to affect the needed change.
A plan to change any financial position in any business is just the answer to these three questions:
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What are the components of the ratio?
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Which general ledger accounts are factors in the ratio?
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What can be done to affect future activity in each of the general ledger accounts?
Change Cost Structure
Another major opportunity to take advantage of during the bid delay is to adjust the company cost structure. Most managers are constantly adjusting the cost structure of their companies. But they are not adjusting it for the purpose of creating the power they will need to operate profitably in spite of discounts in the future.
An addition to the old cliché “The only thing that is certain is death and taxes” should be “reimbursement cuts for health care providers.”
It is a fact that our population is aging and requiring more health services. The demand will grow at a faster rate than taxpayers will fund, however, and that can only bring more cuts. This realization will ultimately cause a paradigm shift in health care business management. The shift will be toward proactive cost reductions to anticipated reimbursement cuts.
Today, we know the severity of the cuts we can anticipate and should use the time we have to adjust our businesses to them.
Since the Medicare Improvements for Patients and Providers Act, or MIPPA, imposes a 9.5 percent cut to the current fee schedule for the items selected for bidding, and it reintroduces the CPI freeze for 2009, we have a known decrease in profit in 2009.
Further, we know that the CPI has increased 5 percent this year, and it will not go down before year-end. Since the CPI adjustment will not happen in 2009, we are facing a 14.5 percent reduction in profit. For providers in competition areas, this will be followed by an additional decrease in profit.
Therefore, each provider can calculate the necessary target for adjusting his or her company's cost structure. Here is the formula:
Percent of revenue from competitive bid product categories × (percent reduction in fee schedule + percent inflation)
In 2009, for example, we know that the reduction in fee schedule will be 9.5 percent, and inflation will eat up another 5 percent, so the “percent reduction in fee schedule” is 14.5 percent.
A provider with 40 percent of revenue derived from the subject product categories would multiply 40 percent by 14.5 percent and know that the company must reduce costs by 5.8 percent of revenue to hold the net profit margin where it is.
40% × 14.5% = 5.8%
(If you want to express this in dollars, multiply the 5.8 percent by annual sales.)
This is a given. It is ludicrous for any provider not to use the time the industry has won for finding ways to reduce these costs. How can it be done? There are two major areas to consider: one is product cost and the other is activity cost. Of all expenditures by DME companies, 47 percent go to products and 53 percent go to activities, so it seems activities have the greatest opportunity for providing savings.
To reduce activity costs, attempt to eliminate activities. Ask why each activity is being done and make it hard to justify its place in the company. Next, if the activity cannot be eliminated, reduce the number of times it is performed. Then find ways to reduce the amount of time it takes to perform an activity once. One way to do this is to eliminate keystrokes, footsteps and miles.
Feel the Power
Finally, we need to use our time to become a more powerful industry.
Providers who have shunned trade associations and political involvement should quickly become active. Those already involved should find ways to enlist others in their markets who are not involved.
Ben Franklin said to his collaborators in sedition, “We shall all hang together or surely we shall all hang.” This year we stood on the gallows and came eye-to-eye with the hangman. If we don't use our time to become more cohesive, transparent and do whatever else it takes to make a more powerful industry, we will get what we will have asked for.
Now that we have won this opportunity, will we use it?
*To read Wallace Weeks' column, “Thriving Under Attack,” visit www.homecaremag.com and select February 2008 from the “Browse previous issues” bar.
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 email at wweeks@weeksgroup.com.
Financial Measures for DMEPOS Competitive Bidding
Here's the information you will need to collect:
- Cash
- Accounts Receivable (net)
- Inventory
- Current Assets
- Accounts Payable
- Current Liabilities
- Equity
- Revenue (net of contractuals)
- Depreciation & Amortization
- Gain or (Loss) on Sales of Assets
- Net Income or (Loss)
In order to compare your financials to the 10 ratios that CMS used in round one:
| The basic interpretation of the financial ratios is as follows: | |
| Current Ratio | Larger is better |
| Collection Period (DSO) | Smaller is better |
| Accounts Payable to Sales | Smaller is better |
| Quick Ratio | Larger is better |
| Current Liabilities to Net Worth | Smaller is better |
| Return on Sales | Larger is better |
| Sales to Inventory | Larger is better |
| Working Capital | Larger is better |
| Quality of Earnings | Larger is better |
| Operating Cash Flow to Sales | Larger is better |
