Alleviating Our Value Deficit

Posted by Elaine Purcell

Fortunately, cutting healthcare costs is hardly a partisan issue. Especially during this time of economic downturn, policymakers and taxpayers alike are looking to cut costs anywhere they can. Regardless, where and by how much these expenses should be cut remains a major point of contention among policymakers across the political spectrum. Given the increasingly high costs associated with the healthcare system, it is not surprising that government healthcare programs have become low-hanging fruit for budget cuts—less than two years after the enactment of costly healthcare reform legislation.

Following the passage of the Affordable Care Act (ACA) of 2010, the Department of Health and Human Services reported that the bill would increase total national health expenditures by more than $200 billion from 2010-2019. In a statement by the Congressional Budge Office (CBO) in May 2010, they stated: Rising health costs will put tremendous pressure on the federal budget during the next few decades and beyond. In CBO’s judgment, the health legislation enacted earlier this year does not substantially diminish that pressure.

ACA’s prospects of cutting costs may appear grim. In 2010 alone the United States spent$2.6 trillion on healthcare – over $8,000 per American. For more than 30 years now, healthcare costs have been growing at a rate 2% greater than the general economy. As an additional portion of the U.S. population gains insurance through expanded government healthcare programs, can we actually afford this new legislation?

A simple answer to this question is derived from basic financial principles: in order to achieve a return on an investment, one must actually make an investment. Nevertheless, the stakes are high and the nuances lie in how to not only achieve a return, but the greatest return from our $200 billion/year investment in the healthcare system.

To achieve the greatest return, we cannot only focus on reducing costs – we must strive to also improve quality. Ranked by the World Health Organization as the highest in costs but 37th in overall performance, the U.S. healthcare system is evidently experiencing a ‘value-deficit,’ which is truly at the crux of our nation’s healthcare problems.

One of the strongest themes pervasive throughout ACA is the generation of more information. More information on the top hospitals and the best doctors. More information on the medications that are most effective for treating certain conditions and patient populations. More information on how health plans’ benefit packages compare to others. According to basic market principles, additional and more accessible information will drive competition, which in turn, will force the suppliers of healthcare services to lower their costs and improve quality.

Regardless, in order to achieve greater competition, healthcare consumers must also change their behavior. They need to better understand their purchasing decisions. It’s ironic that with a commodity as priceless as good health, so many patients passively accept or deny treatments and services provided based on limited information. Patients must have the gumption to research their condition and choose providers or medication based on unbiased and comprehensible information.

Nevertheless, due to the nature of healthcare insurance, few patients are cognizant of healthcare costs. To alleviate this moral hazard, the financial burden must be extended to either the patient or the provider. ACA focuses primarily on the provider through carrot and stick approaches, such as pay-for-performance (P4P) programs, which reward physicians for providing the best care. Further, P4P penalizes physicians for over- providing care, thus making them more accountable for costs associated with the care they deliver.

To alleviate moral hazard on the patient side is more complicated and risky. Healthcare consumers are often more price elastic than one would predict, given that they currently lack the information and training to predict the consequences of foregoing certain preventive measures and early interventions. Nevertheless, applying co-payments on certain procedures and not others (such as mammograms) may encourage patients to be more wary of the amount and type of healthcare they consume.

Ultimately, the simplest equation for alleviating the value-deficit is this: costs divided by quality. Although this is undoubtedly more difficult to achieve than simple division, this basic equation should be the basis for solving the problems of our healthcare system.

Elaine Purcell is a second year graduate student in Wagner’s Health Policy and Management Program focusing on Healthcare Management and Administration. Prior to Wagner, she worked in Washington, DC analyzing healthcare policy during the passage of national healthcare reform.

What Is My Company Worth – Part I

Posted By Joel Wittman, MS,MBA

Given the uncertainty created by Obamacare, health care companies have begun seeking consolidations through mergers and acquisitions as one of their future survival strategies.

This question of the value of a company frequently arises in conversations with owners, principals, and management of health care entities.  “Sure I’d sell my business.  Sure I think that we’d make a powerful team.  One question, though: How much is the business worth?”  The short answer is – it all depends.

To begin to understand the value of a company, the fundamentals of value must be explained.  A correct standard of value has to be established.  Fair market value fundamentals are based on the average price for the average buyer with neither party compelled to buy or sell and both parties being informed of the relevant facts.  Consequently, fair market valuations are typically at the lower range of the market.  Investment value fundamentals, however, are based on a specific price for a specific buyer and are based on an investor specific basis.  Ergo, value is extremely buyer dependent.  A company is worth what a buyer is willing to pay for it.  It’s like a home plate umpire in baseball.  The batter lets a pitch go by and then asks if it was a ball or a strike. The umpire’s answer: “It’s nothing until I make the call.”  It’s the same with the value of a business – it is worth what a buyer is willing and able to pay.

It is not my intention to be facetious about this topic but there is not a clear answer to the question.  There are common valuation techniques that establish parameters and metrics for valuing businesses.  Among these techniques are the calculation of the Net Book Value of a company, the use of Public Market Comparables, the creation of a Discounted Cash Flow model favored by financial buyers, the use of Comparable Transactions of similar companies if the data is available, and ,the most common metric,  the application of a Multiple of Earnings (after the appropriate level of earnings has been established – but that’s for another time).  Which leads to the question of how are multiples established?  Remember, value is extremely buyer dependent: one buyer may be inclined to assign a higher multiple to earnings than another buyer based on the first buyer’s reasons to complete an acquisition.  However, the range of multiples can be tied to the level of risk the buyer is willing to tolerate to “make the deal.”  Each buyer has a specific rate of return they would like to achieve from their investments.  An acquisition is another form of investment and can this investment earn a return comparable to, or greater than, other investment opportunities.

The range of value and assignment of a valuation metric is dependent on the risk of the investment.  The risk reflects the buyer’s required rate of return.  The lower the perceived risk, the higher the value metric; the higher the risk, the lower the metric and, intuitively, the lower the price.  However, there are determinants of risk that are specific to a company and can be managed by the company.  Among these are having:
•    diverse referral sources (the more, the better; the company is not overly reliant on one or two sources for its revenue stream)
•    a diversified product and revenue mix which can lead to a more predictable revenue stream
•    a diversified payer mix – don’t be too susceptible to changes in reimbursement
•    the influence of managed care on the company’s revenue stream – This typically
leads to lower reimbursement.  If a client of a medical staffing company ( such as a hospital) receives a large portion of its reimbursement from managed care payers they are less able and willing to pay full amounts for your company’s services.
•    middle management strength –  One of the most harmful things that you can indicate to a prospective buyer is that “you are the business” and that it cannot function without you.  Buyers are justifiably concerned that there will be a precipitous decline in revenues post transaction if this exists.  It is imperative to develop your management staff to the level of being able to function in your absence.
•     knowledge of your current business trends.  Is yours a stable and growing business that presents lower risk to a buyer?  What are the business trends in your marketplace?
•    knowledge of your competitors – Are they aggressively soliciting business? How many competitors are there in your market?  The fewer the number of competitors, the more predictable is your company’s revenue stream.
•    efficient accounts receivable management – This provides a snapshot of your operating infrastructure and management capabilities to a buyer.  The lower your company’s bad debt expense and days sales outstanding (the average time it takes to convert a sale into cash), the more predictable is your revenue stream, the lower is the perceived risk to the buyer, the higher valuation metric can be assigned to your business. Management and control of these company specific determinants of risk to the extent possible will increase the potential purchase price of a company.

Read my post in next month’s blog to learn about what strategies to implement to enhance the value of an M&A transaction.

Joel Wittman is an Adjunct Associate Professor at the Wagner School of Public service of New York University.  He is the proprietor of both Health Care Mergers and Acquisitions and The Wittman Group, two organizations that provide management advisory services to companies in the post-acute health care industry. He can be reached at