Capital Optimization: Linking Investment with Strategic Intent/Response from the Feature Authors (2004)

SUMMARY * With operating margins showing some improvement in 2003, Y2K being a distant memory, and many critical capital investment decisions delayed as long as possible, hospitals have been on a relative spending spree, building new facilities, renovating operating rooms and inpatient units, and investing in new medical and information technologies. However, with pressure on both cost and revenue expected to continue, if not increase, this spending spree may be short-lived, and hospitals must improve their capital planning efforts; align them with their mission, vision, and strategies; and ensure that capital is available when unplanned or even expected needs arise. This article explores some of the challenges that hospitals face in their capital planning efforts and, more importantly, suggests the necessity for hospitals to integrate capital and strategic planning. Capital planning must be driven by an organization's strategies; however, we also argue that an organization's ability to execute its strategies is highly dependent on the existence of a cohesive capital prioritization and planning process. In this article, we explore a number of issues critical to developing a comprehensive capital plan, including estimating capital costs, evaluating and designing strategies to contend with risk, saving for the proverbial rainy day, and recognizing the role and value of philanthropy, while challenging some conventional thinking of hospital executives with respect to investment, growth, and planning. OPERATING MARGINS IN 2003 for the country's strongest not-for-profit healthcare systems reached their highest levels since 1997, according to Standard & Poor's median financial indicators (Modern Healthcare 2004). This statistic represents a growing gap between what S&P describes as the difference between the haves and the have-nots. AA-rated hospitals had a median operating margin of 3.1 percent, an increase from 2.2 percent in 2002, while A-rated hospitals posted a median margin of 3.5 percent, up from 2.8 percent. The median total margin for AA credits grew to 4.5 percent from 2.4 percent because of stock market gains, while total margins for other ratings categories showed little or no change. S&P also noted that it does not expect capital improvements to continue at hospitals because of cost pressures, tightening revenue, declining insurance coverage, and other factors (Modern Healthcare 2004). After years without money to make capital improvements, hospitals are, comparatively speaking, on a spending spree-building surgery centers, renovating operating rooms, purchasing innovative medical technology, and even installing new computer systems. While it is expected that hospital executives intend to increase their capital spending over the next five years, the growth in capital spending-however much needed-may be short-lived. The expected rise in interest rates will make borrowing more expensive, as not-for-profit hospitals frequently raise capital by issuing tax-exempt bonds. For-profit hospitals that do not raise money by selling bonds tend to finance projects through operating revenue. The expectation that hospitals can plan to finance the projects with cash from operations is increasingly unrealistic, given declining reimbursement from both commercial payers and the government. Clearly, this will require that hospitals establish a more disciplined process for prioritizing both the need and the use of capital. WHERE TO SPEND MONEY? It is likely that hospitals will look to spend money on those areas that are expected to yield revenue in the short term. Such areas include operating rooms, surgical suites, and medical and diagnostic equipment. Other needs related to computer systems and other information technology, as well as replacement or renovation of aging facilities, may indeed fall lower on the list of priorities, as investment in infrastructure tends to lag behind medical technology. …