The Healthcare Hub

Impact of Rising Healthcare Costs on Hospitals & Cost Control Strategies

Kara L. Nadeau, Healthcare Industry Contributor

Thursday, January 4, 2024

Learn more about the factors driving up healthcare costs and discover practical strategies hospitals can use to manage medical expenses effectively.

Hospitals serve a vital role in their communities but the past few years have presented many significant challenges to their financial viability. Health spending has increased all around as a result of general inflation, rising prices for prescription drugs, higher wages for healthcare providers, and many other factors.

Heading into 2024, only 3% of health system executives have a “positive” outlook on the coming year. On the surface, pressures to improve quality and outcomes contrast with the precarious financial positions hospitals find themselves in today. During 2023, a number of U.S. hospitals closed their doors or announced plans to close. Many question whether this trend will continue this year.

Let's explore the drivers of rising healthcare costs, the impact on hospitals, and steps they can take to rein in health spending.

Table of contents

Factors increasing healthcare costs for hospitals
Impact of healthcare costs on hospitals
The role of supply chain in rising costs
Strategies for healthcare supply chain costs
How hospitals can manage rising costs

Factors increasing healthcare costs

In its recent report, The Commonwealth Fund cited "administrative costs, specialty drugs, and physician and nurse wages" as contributing to excess healthcare spending" in the United States.

But this is just the tip of the iceberg. There are many other underlying factors driving high health spending growth, including an aging population, rising rates of preventable chronic health conditions, and non-acute care provided in high cost acute care settings.

Inflation

Higher general inflation has increased healthcare costs in a variety of ways, with the American Hospital Association (AHA) citing factors such as the rising cost/shortages of raw materials contributing to more expensive hospital supply and medical device costs; higher building material costs and shortages impacting hospital capital expenses; and increases in interest rates, "which may hamper borrowing options and add to overall costs."

Administrative costs

Administrative costs for healthcare services, defined as "what is left over after accounting for clinical activities," compromise 15-30% of healthcare spending. The administrative burden on healthcare providers, including costs for general administration, human resources, and quality reporting and accreditation, is estimated to comprise 15% of overall excess administrative costs in the healthcare system.

Labor costs

The Covid 19 pandemic had a direct impact on increased healthcare spending, particularly those related to labor costs, and these cost pressures continue burden the U.S healthcare system. A recent report on pay trends in the U.S. health care industry revealed how 2022 saw the highest salary budget increases in nearly 20 years.

There is currently tremendous pressure on hospitals and other health providers to increase wages for physician services, clinical services, and healthcare support services. For example, in October 2023, Kaiser Permanente agreed to a 21% pay increase after over 75,000 workers went on strike. During the same month, California Governor Gavin Newsom signed the "nation’s first law creating a statewide healthcare worker minimum wage standard and the first to raise the minimum wage to $25 per hour."

Impact of healthcare costs on hospitals

The high cost of health spending has broad impacts, including higher national health expenditures, Medicare spending, health insurance premiums for private insurers, patient average annual premium, monthly premiums and out of pocket costs, all of which place financial pressures on hospital services. Below are some ways total healthcare costs and spending growth impact U.S. hospitals.

Financial strain driven by rising healthcare costs

As reported in the Becker's Hospital CFO Report, "Health systems face continued weak margins, high expenses and low reimbursements for the next year."

Fitch Ratings's 2024 outlook for U.S. not-for-profit hospitals and health systems noted how labor shortages and salary/wage/benefit pressures are still "compressing margins for a sizable portion of the sector, even as other core credit drivers, specifically volumes and overall liquidity, begin to improve." While "Fitch believes this pressure will remain for the foreseeable future yet slowly resolve," the agency "expects a number of health providers to lag significantly behind any recovery."

Quality of care vs. cost

The transition from volume-based to value-based payments over the past few decades has intensified national focus on healthcare prices, total cost of care, and overall health spending. According to the AHA, the CMS Hospital Value-Based Purchasing Program "affects payment for inpatient stays in more than 3,000 hospitals across the country."

Looking ahead, CMS estimates the total amount available for value-based incentive payments is approximately $1.7 billion for FFY 2024.

Investments in value pay off - studies have shown how quality care improvements can help combat rising healthcare costs.

Researchers from Texas State University conducted an Exploratory Analysis of the Association between Hospital Quality Measures and Financial Performance, which was published in October 2023 edition of the journal Healthcare. Their conclusion: "We can confidently indicate that the effort expended to enhance the patient experience, reduce readmissions, and improve patient safety is associated with improved hospital financial performance."

Influence on hospital staffing and resources

Skyrocketing labor costs for medical care delivery and staffing shortages have been primary factors in increased health spending since the COVID 19 pandemic. Widespread clinician burnout and an increase in those leaving the medical field have forced many hospitals to hire costly contract labor to fill staffing gaps.

Higher labor costs, in turn, have increased the cost of health services. Hospital total expense per patient rose 22.5% from 2019 to 2022.

As a result of financial pressures, many hospitals resorted to layoffs and staffing cuts in 2023, mainly among administrative staff and upper-level management as opposed to patient-facing employees. As Fierce Healthcare reported, "many organizations paired their layoff announcements with notices that they were continuing to aggressively hire nurses and other clinical positions."

M&A, expansions and rising healthcare costs

Mergers and acquisitions among health systems are rebounding back from pre pandemic levels. In many cases, it is financial distress that is driving M&A activity, according to The Advisory Board, which reported how 40% of the 18 healthcare transactions that occurred in Q3 2023 "involved organizations that cited 'financial distress' as a driver for the transaction."

Private equity investors are also increasing acquisition of hospitals and other health services providers, spending $1 trillion in the past decade. The quality of care under private equity ownership has been called into question, mostly recently by researchers from Harvard Medical School, who found:

"Private equity acquisition of hospitals, on average, was associated with increased hospital-acquired adverse events despite a likely lower-risk pool of admitted Medicare beneficiaries, suggesting poorer quality of inpatient care."

Other research have found private equity ownership increases healthcare costs, with researchers stating, "Such ownership is often associated with harmful impacts on costs to patients or payers and mixed to harmful impacts on quality."

The role of supply chain in controlling costs

There is no doubt that supply chain optimization reduces costs for healthcare providers and suppliers alike. The areas for improvement and benefits span the supply chain continuum - from orders placed and invoices paid with no manual intervention, to automated inventory management processes that maintain appropriate supply levels without unnecessary waste.

In the face of higher prices for supplies, the increased costs of labor and logistics, and a pressing need to reduce overall spending in healthcare today, the healthcare supply chain continues to present opportunities to save money.

Invoicing and payments

Anyone outside of healthcare might be surprised to learn that the invoicing and payment processes between providers and suppliers is still highly manual in most trading partner relationships. Many health systems and hospitals still require suppliers to send them invoices via email, and in some cases, postal mail or fax, and in turn, respond with paper check payments.

The American Productivity & Quality Center (APQC) offers these key performance indicator (KPI) benchmarks for organizations in the healthcare industry to measure their accounts payable (AP) performance:

Total cost to perform account payable per invoice processed
Percentage of disbursements that are first time error free
Cycle time from receipt of invoice until payment is transmitted

Consider today how:

$31 is the average cost for paper checks and invoice per transaction
42% of all payments are made via paper check
50% of invoices received via paper or email

Automating the invoicing and payment processes can reduce per invoice costs, improve transactional accuracy and reduce cycle times.

Procurement

While the healthcare industry has made tremendous strides in automating procurement, there is still much work to be done to effectively manage supply formularies and close the gap between contract execution and contract compliance.

In an October 2023 BMJ Global Health article, researchers from the Harvard T. H. Chan School of Public Health, Harvard University, Boston, noted how "improved procurement and supply chain management can reduce costs and address the problem of supply shortages."

A key way to improve procurement management and eliminate unnecessary expense is to drive contract utilization at the point of requisition. Healthcare organizations have a significant opportunity to do so by making it easier for requisitioners to choose the right products from the right sources with directed buying.

Hospital inventory management

Poor inventory management practices, where supply chain teams lack real-time visibility to supplies in their facilities, increase costs for health systems and hospitals in a variety of ways, including excess items expiring on shelves, and costly supplier rush orders to avoid stock outs.

Data suggest that a growing number of hospital leaders recognize the many benefits of supply chain optimization. In a survey of 100 hospital and supply chain leaders:

87% believe it can improve their hospital margins
86% say it can improve care quality

As stated in a recent Association for Health Care Resource and Materials Management (AHRMM) blog post, "Effectively managing a hospital’s inventory has always been important. However, it has become even more important over the past several years." Factors such as supply chain disruptions, shortages, and rising costs have made inventory management a strategic priority for healthcare organizations.

The opportunities for healthcare organizations to save money through improved inventory management practices are substantial:

$25.7B unnecessary U.S. hospital supply chain spending
22.6% average supply expense reduction opportunity for high-performing hospital supply chains

Tackle costs with GHX healthcare supply chain solutions

GHX's collaboration with healthcare providers and suppliers and its proven portfolio of supply chain technology solutions have delivered efficiencies and maximized savings for 20+ years. The company continues to passionately partner with the industry’s most innovative healthcare leaders around a common purpose: improving patient care and lowering the cost to deliver it.

In the past 12 months, GHX has facilitated $128B in transaction volume and $1.7B in healthcare industry savings, representing 85% of medical/surgical products.

GHX eInvoicing and ePay

GHX's working capital optimization solutions - eInvoicing and ePay - eliminate manual accounts payable (AP) processes for healthcare providers by digitizing and automating these invoicing and payment transactions through the GHX Exchange. With them, providers and their suppliers can achieve a touchless procure to pay (P2P) cycle.

GHX eInvoicing digitizes paper and email invoices, matches invoices to purchase orders (POs) for automated exception removal, and delivers invoices into the healthcare organization's enterprise resource planning (ERP) system. The solution helps speed up approval cycles and makes more timely payments possible. eInvoicing users have increased compliant payments and reduced late payment penalties with up to 90% faster cycle times—go from 25-60 days down to 2-5 days.
GHX ePay is a full service payment platform that unifies multiple payment strategies (AHC, credit card, line of credit) to automate a healthcare organization's entire payment process within a single, customizable digital platform. ePay users have seen cash rebate increases of more than 2,000% and payment processing effort reduced by as much as 80%.

Both solutions also turn transactions into actionable data to guide payment decisions. With real-time visibility to invoice and payment status, healthcare organizations can more accurately forecast their cash and liabilities positions.

Case in point: Phoebe Putney Healthcare, a not-for-profit integrated healthcare delivery system serving more than 500,000 residents in Southwest Georgia, transitioned from highly manual paper-invoice processes to 99% paper-free invoices with GHX eInvoicing. The organization was able to reduce AP staffing levels with no additional stress on the remaining staff and captured approximately $300,000 in accruals.

“It is critical in accounting to have a clear line of sight into all of your organization’s expenses," said Lisa Armstrong, MBA, CPA, then accounting manager for Phoebe Putney Memorial Hospital. “With GHX eInvoicing we are capturing all of our invoices. We also can see when we’ve overpaid a supplier and can go after credits rather than having them sit on statements forever.”

Shape demand and control spend

GHX Marketplace, a virtual ecommerce solution, serves as a single purchasing gateway for all clinical and nonclinical supplies and services. It directs users to the preferred sources of supply, at the right price to decrease rogue spend and increase overall compliance and savings. Directed buying through GHX Marketplace drives compliance in three areas:

Clinical Compliance: Item formulary management drives reduction of clinical variation and prevents unapproved items from getting into the supply chain.
Financial Compliance: Direct to the preferred source and ensure right price at the front end of P2P cycle. Ensuring price accuracy ensures savings.
Operational Compliance: Drives purchase activity to contracted items and preferred vendors to support ESG/diversity initiatives, maximize price incentives, increase efficiency, and deliver the perfect order

Commenting on GHX Marketplace, Carmen Winfield, Vice President of Supply Chain, McLeod Health, stated, "It has an Amazon feel, it is really easy to use and you can use it to drive spend compliance...Having one system, having one tool, having it together makes it easier for everyone."

Hospital inventory management software and solutions

GHX Syft Synergy, inventory management software, is a holistic supply chain management platform that provides health systems and hospitals greater visibility and control over their supply inventory - from point of item receipt through to point of use. Syft also offers technology-enabled hospital inventory count services that provide hospital supply chain leaders with summary inventory reports at the building, department and area level, including expired/consigned items.

With this information in hand, hospital supply chain leaders can make informed decisions to maximize inventory assets and reduce costs and waste - prevent over-ordering and overstocking, spot potential hoarding, reduce risk of expired products used in patient care, etc.

Over the last decade, the Syft team has conducted 11,000+ inventory counts, totaling over $21B in inventory. In conducting hospital inventory audits, they have uncovered some startling findings:

$51M worth of inventory at a facility in the Southeast, when leadership believed they had about $5M worth of inventory
Dozens of expired items that amounted to nearly $200,000 worth of inventory at one hospital
A large amount of inventory that had been placed in the wrong area at one East Coast facility, which hospital staff members retrieved and brought it to the correct location.

How hospitals can manage rising costs

To right the ship of financial distress and navigate a fiscally positive course forward, U.S. hospitals must find ways to contain costs and reduce health spending. Here are some strategies and real-world examples.

Strategic financial planning for hospitals

Hospital chief executive officers (CEO), chief financial officers (CFO) and other stakeholders (e.g., physicians, nurses) are taking a more strategic look at their service lines and care offerings to determine where they are making money and where they are losing it. Many are optimizing/expanding financially lucrative services to grow revenues in the face of rising healthcare costs.

Northern Inyo Healthcare District in Bishop, Calif. has achieved 14.3% year-over-year growth by adding new service lines and expanding historic ones. Ascension St. Vincent’s Blount in Oneonta, Ala. added "wound care, a sleep lab, nephrology, 3D mammography, a large-bore MRI and a discount drug pharmacy" in 2023 alone. And Eaton Rapids Medical Center in Michigan recently added "wound care, neurosurgery, robotics and spinal fusions" to its service offerings.

Cost-effective healthcare delivery models

In the face of widespread primary care physician shortages, many patients seek care in costly and resource intensive hospital emergency departments. To save money, hospitals are expanding their delivery networks to include more outpatient care settings where they can provide clinical services at a lower cost. This includes clinics and other non-acute care facilities where patients can obtain diagnosis and treatment for various conditions and receive ongoing treatment to manage chronic illnesses as they would in their doctor's offices.

More healthcare organizations are launching "hospital at home" programs where patients receive hospital level care in the comfort of their homes supported by remote technologies. As The Advisory Board reports, "These programs allow hospitals to free up beds for their sickest patients while reducing care costs for both providers and payers."

Case in point: VA hospitals, health systems (including Presbyterian Health System), home care providers, and managed care programs are implementing the JohnsHopkins Hospital at Home® program, which offers cost savings of 19% to 30% compared to traditional inpatient care.

The 'Payvider' model

Medicare and Medicaid are the primary source of reimbursement for the majority of U.S. hospitals and health systems but cuts and denied claims steadily erode this source of revenue. The AHA reports that "payment denials by Medicare Advantage plans jumped 56% for the median health system between January 2022 and June 2023, contributing to a 28% decline in median cash reserves."

And it is not just public payers that present challenges to hospitals. According to the AHA, some commercial health plans inappropriately deny covered services that are medically necessary. The association is calling on regulators to "conduct greater oversight of problematic payer practices" in both the public and private sectors.

One solution to combat these reimbursement issues is adoption of the "payvider" model where large health systems establish their own health plans. The potential benefits: "the opportunity to build strong bonds with self-funded employer groups, thereby capturing market share and improving their payor mix," adding "diversified revenue through administrative and program fees, and driving "significant cost savings on one of their organization’s largest expenses: their own employee health plan."

Kaiser Permanente has succeeded with the payvider model for many years. In January 2024, St. Louis-based BJC HealthCare and Kansas City-based St. Luke’s Health System announced their merger, which will allow the newly combined health system to "double down on their owned health plans and target Medicare Advantage."

Cost-control measures in hospital operations

With administrative costs representing a significant portion of healthcare spending, it is naturally a target for hospital cost cutting measures. The administrative burden spans the healthcare delivery continuum - from frontline physicians to back office departments and processes (e.g., supply chain, billing, reimbursement, etc.).

When asked where they will reduce expenses in 2024, many healthcare executives cited areas of administrative cost burden.

"Healthcare can employ various strategies to minimize costs without compromising patient satisfaction and the quality of care," stated Ebrahim Barkoudah, M.D. System Chief and Regional Chief Medical Officer of Baystate Health in Springfield, Mass. during a recent interview. These may include optimizing supply chain management, streamlining operational processes, and leveraging technology to improve efficiency."

Vice President of Supply Chain at MD Anderson Cancer Center Michael Prokopis, said his biggest areas of expense reduction in 2024 are:

Encompassing inventory management program, overall
Standardization and optimization of supply usage across all categories
Consolidation of purchased services, many of which will be further augmented by extending forecasting into actionable demand plans.

Using big data for cost reduction

The power of data and analytics is enabling hospitals to identify cost drivers and address them, everything from excess spending on supplies and services, to clinical interventions that contribute to preventable adverse events and longer length of stay.

One emerging trend is the use of analytics to address social determinants of health (SDoH) and their associated costs. SDoH, defined as "the environments where people are born, live, learn, work, play, worship, and age," contribute to wide health disparities and inequities and raise the risk for preventable chronic conditions, such as heart disease, diabetes, and obesity.

A notable success story related to this trend is Roanoke, Virginia-based Carilion Clinic, which leverages risk stratification tools that incorporate payer claims, internal clinical data and external SDoH data to "identify patients for chronic care management programs" and predict "readmission risk using real-time clinical data, census data and even retail data." By identifying at risk patients and responding with appropriate interventions, the Clinic has provided better healthcare to their population while saving millions of dollars in healthcare costs.

AI and ML in cutting hospital costs

Hospitals are increasingly exploring how artificial intelligence (AI), including machine learning (ML), can help them increase efficiency and lower expenses.

Based on its analysis, Accenture has determined that "key clinical health AI applications can potentially create $150 billion in annual savings for the US healthcare economy by 2026," reporting that the top three applications with the greatest near term value being are robot-assisted surgery ($40 billion), virtual nursing assistants ($20 billion), and administrative workflow assistance ($18 billion).

United Health Services CIO Randy Rahman told Becker's his health system is exploring and implementing AI/ML in provider/clinical workflows, revenue cycle, HIM, and IT functions; and leveraging technology/AI/virtual health to improve patient access, reduce the cost of patient registration, scheduling, and visits, and promote remote patient monitoring and self-service.

Holly Muller, DNP, RN. Chief Nursing Officer of Presbyterian Delivery System in Albuquerque, N.M., reported how her health system plans to use "AI technology to limit redundancy in work processes for caregivers and reduce the length of stay in our facilities."

FAQs on rising healthcare costs

Q. What are the biggest expenses for hospitals?

A. Labor, prescription drugs and medical supplies, according to the AHA.

Q. How can hospitals manage rising costs?

A. Leverage technology to maximize human capital by automating and/or eliminating costly, non-value added activities; move care out of high-cost acute settings and into lower cost, less resource intensive non-acute settings; embrace new payer/reimbursement strategics, such as the payvider model; harness the power of data and analytics to identify and address cost drivers, including drugs and supplies.

Q. What role do administrative costs play in the overall increase in healthcare expenses for hospitals?

A. Administrative costs represent a tremendous area of expense for hospitals and contribute largely to national health expenditures. Addressing administrative burden presents a significant opportunity for hospitals to achieve savings without negatively impacting care quality and safety.