With a lot of uncertainty about the future, hospital leaders are asking: What's the best way forward? How do I succeed in today's fee-for-service system while preparing for — but not getting too far ahead of — value-based payment?

The question has become more pressing since the Centers for Medicare & Medicaid Services and leading payers and providers announced ambitious value-based payment goals. The new goals increase the pressure on hospitals to change, but leave uncertainties about when and how to transition, especially at a granular level.

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Fortunately, there are steps hospitals can take that will help to improve performance now, even in a fee-for-service environment, while preparing them to assume risk in value-based payment models. These steps generally focus on understanding underlying cost structures; managing variation in cost and quality; and delivering predictable, transparent outcomes. Unfortunately, the business model of health care has not valued these elements so, for most health care executives, this is foreign territory. They understandably don't want to get ahead of themselves, and many of them don't score high on a risk-taking scale.

The Time to Act Is Now

Hospital administrators are by nature risk-averse. In the '90s, many health care executives lost their jobs after taking on risk and failing to provide long-term solutions. So, it should come as no surprise that much of the health care world is still functioning on volume and is hesitant to transition to value-based care.

When it comes to making this transition, there is a notion among health care executives that they're having to run the rapids with each foot in a different canoe. This idea is ubiquitous, dangerous and, in many respects, self-defeating. It seems to rationalize failure to take meaningful action. If executives believe that success in a fee-for-service environment associated with transparency is fundamentally at odds with a risk-based approach and ultimately capitation, the canoe image may have resonance. However, I don't believe this to be the case.

In just about every other industry, transparency is an easy concept. A consumer knows what he or she is purchasing, the implied guarantee that's offered with that purchase, and the mode of recourse if satisfaction isn't achieved. That's been difficult to come by in health care delivery, which is so removed from a true market-based model. It's time for providers to offer a more transparent approach to business with increased accountability and efficiency.

By now, almost everyone is familiar with the goals for increasing value-based payments. CMS has declared that by 2018, 50 percent of all reimbursement will come in value-based bundled payment or accountable care-type arrangements tied to outcomes. A private sector alliance committed to 75 percent by 2020.

However, there are other pressures accelerating the move to a more market-based business model. Higher deductibles are making consumers more accountable for their care and thus more active in assessing options on cost and quality when they can. As patients and employers face higher prices and increased cost sharing, price transparency is evolving quickly. Some states now require hospitals to post "real prices," while 12 states have all-payer claims databases.
Concurrently, there is growing concern over the lack of standardized outcome measures that offer insights into real-world clinical practice, effectiveness, safety and quality. A recent look at the variation in ratings among four of the top arbiters — Consumer Reports, U.S. News & World Report, the Leapfrog Group and HealthGrades — reported that no hospital came out as a high performer in all four ratings systems. In fact, only 10 percent of hospitals rated as a high performer by one group were rated as a high performer by another. The fact that standardized outcome measures do not exist for most conditions have prompted the Agency for Healthcare Research and Quality to propose a standardization framework, and states like Massachusetts to implement standard quality measures.

As these pressures continue to mount, providers need to take initial steps that will yield benefits under the current fee-for-service system, but also help them develop the infrastructure needed to be successful in a value-based system. Simply put, build the infrastructure and capabilities you'll need today that also will pay off tomorrow.

Defining Your Cost Structure

It's imperative that providers understand and measure not only the quality and outcomes of the care they are delivering, but the true costs of that care.

Most of the money flow in health care has been at a gross-up level, so providers can't even see their cost structure — or what it costs to provide a given service in terms of labor, infrastructure, materials and equipment. This is yet another sign that we are still far from a true market-based model, and it should concern most health care leaders. Why has this been the case? Simply put, there hasn't been the market need to do it any differently. Until now.

Health care delivery systems, regardless of whether they're protecting margins under fee-for-service or preparing to engage in risk-based contracts, will need to understand and manage their cost structure. As consumers shoulder more of the first-dollar cost due to high deductibles, they will shop more for health care services. Providing transparency of price (and costs) can become a way to distinguish an organization for consumers as well as for payers and employers. Furthermore, greater insight into the underlying cost structure can offer organizations greater control over their ability to compete with others.

As a starting point, delivery organizations need to define activity-based costs. These include the raw costs of goods and materials, overhead and indirect costs, as well as the assignment of direct costs which includes the amount of time to deliver that cost and who's delivering it. Many kinds of activity-based costing techniques have been used for decades in manufacturing and other industries, but have been lacking in health care delivery. Moreover, most attempts by providers have largely focused on their biggest cost — staffing — as opposed to evaluating and rethinking care delivery processes, which is the essence of activity-based costing in health care.

Improving an organization's bottom line remains a priority for providers irrespective of where they are on the path to value-based care. Thus, an organization's ability to drill down into cost drivers and identify cost-reduction opportunities is critical. With an understanding of the precise costs for individual encounters, procedures and episodes of care, providers can home in on specific clinical, technical and process elements, all of which make up the total cost of health care.

Activity-based costing also allows providers to conduct accurate assessments of the profitability of individual service lines, provider relationships or clinical management of specific patient populations. Such information is crucial for making informed decisions about where to invest, especially for organizations interested in owning a niche to set themselves apart from competition.

Organizations with a deep understanding of their underlying cost structure can derive meaningful benchmarks and use them to compete in today's market. Such benchmarks will be essential, especially as the market's appetite for transparent price information grows.
As more health care delivery organizations move to population health management and expand service coordination to every aspect of care, costing of services will extend beyond acute care facilities and physician practices to post-acute facilities and in-home care. However, providers must first understand costing within the walls of their own institution. That knowledge positions them to negotiate at-risk pricing with more confidence that they're market competitive and bottom-line safe.

Managing Variation in Cost and Quality

One of the most important issues in health care delivery is providers' ability to manage variation in cost and quality. Managing variation cannot be addressed by implementing new IT platforms and software suites. Rather, it is a significant cultural shift that challenges the traditional assumptions about how health care is delivered. Today, neither financial administrators nor clinical department heads feel empowered to address clinical and cost variation. Effectively managing variation requires data that have clinical and administrative credibility, are derived from an evidence-based approach to care, and take unique patient needs into account. It also requires embedding accountability into key clinical and administrative roles.

Managing variation in cost and quality is highly dependent on adherence to evidence-based medicine — being able to predict with as much certainty as medically possible exactly which treatments, services and drugs will be required for any given procedure as well as the demonstrated outcomes. At the heart of evidence-based medicine are predictive care paths, the basis for analysis and elimination of variances that cost money and compromise quality. The increasing demand for predictable outcomes and costs has spotlighted the need to balance traditional physician autonomy in clinical decision-making with evidence-based medicine regardless of whether an organization is operating under fee for service or pursuing risk-based contracts.

Once care paths are in place, organizations will need to possess the analytic, process and interpersonal capabilities required for understanding differences among key clinical fields. Changes in roles, accountabilities and skill sets also may be required so that clinicians and administrators managing variation in cost and quality have actionable and timely information. These capabilities will become even more important as the industry rapidly changes. As value-based reimbursement models such as bundled payment and population health continue to incentivize reduced resource use and improved outcomes, organizations will have no choice but to take a more disciplined approach to this task.

However, building the infrastructure and capabilities necessary for managing variation in cost and quality will have a return on investment. A critical assessment of the organization's clinical and financial data should reveal process and capability gaps and provide a path to not only improve care delivery and reduce variation in cost and quality, but also to strengthen an organization's bottom line.

Achieving Predictable and Transparent Outcomes

A number of recent developments have accelerated the need for predictable and transparent outcomes in health care delivery. These include financial penalties for "never events" and excessive readmissions, mandates for the public release of rates charged by hospitals, new policies and regulations such as health insurance exchanges, and tools to help consumers evaluate comparative cost and quality for the care they need.

For a particular service, organizations should be able to clearly define what's included and what's not included as well as to provide quality guarantees irrespective of where that service is offered along the continuum of care. Organizations that can effectively manage the cost and quality of care within the walls of their own institutions and form meaningful partnerships with like-minded external care providers will be well-positioned to achieve this goal.

Differentiation will come from more effective execution of "standard" protocols reflected in new outcome metrics as well as transparent economic and clinical value data. These data also can demonstrate a value story that will resonate with different key stakeholders. Patients will want to understand why the provider is better than the competition, and payers will want to see evidence of consistent outcomes and predictable costs. Institutions that do not provide such economic and clinical value data risk being omitted from consideration, and thus losing out on patients.

The path forward is clearer than many might want to admit. It is a difficult and strenuous journey — one that challenges traditional norms, requires new competencies and introduces fundamentals that haven't been the mainstay of health care delivery. The pay-off for those organizations that invest now will be significant, both in the short term and long term.

Rita E. Numerof, Ph.D., is the president of Numerof & Associates, Inc. in St. Louis.