Hospital cost-reduction efforts are usually tactical, not strategic: Goals are modest, fixes are one-offs and the causes behind inefficiency are not targeted. Such an approach is equivalent to treating symptoms rather than curing the disease. Hospitals' service mission makes addressing clinical utilization (the right people doing the right things in the right way) especially challenging. Managers are reluctant to make decisions that could jeopardize jobs or alienate physicians, and the clinical staff understandably resist anything they believe could compromise quality of care or patient experience.

As a result, cost-reduction initiatives create churn and a demoralized workforce, with few lasting benefits. Budgets may be reduced, but work processes remain the same. Eventually, either costs creep back up or employees are asked to work harder — or both. Not surprisingly, only 23 percent of respondents in a Healthcare Financial Management Association survey said prior initiatives aimed at labor cost management had yielded "substantial positive results" (May 2010).

Lasting, meaningful change is possible. An integrated, strategic approach that attacks costs at the system and facility levels can remove as much as 30 percent of operating costs while ensuring sustainability and maintaining quality. The key is using collaboration between managers and clinicians to improve clinical utilization, reduce overhead and create differentiation.

Managers and Physicians Joining Forces

Physicians are the key to effecting change at this level. In a recent Strategy& survey, more than 80 percent of physician respondents felt there was substantial opportunity to reduce cost of care without compromising quality. Yet, fewer than 20 percent felt they had insight into their cost per case or were able to make comparisons with peers.

Physicians also can have a substantial impact by helping managers create solutions; deliver messages; and provide focus, commitment and accountability among peers. Each service line or specialty needs such a physician champion — perhaps the medical director of a specific service or another influential physician. With that person as the spearhead, facilities can engage more physicians to evaluate different scenarios and achieve consensus.

Better Clinical Utilization

An area ripe for early wins is clinical utilization. Inefficient clinical utilization is characterized by either inappropriate or inefficient care: skill-set mismatch for all layers of medical staff, inefficient workflow and scheduling, inconsistent protocols, variation in supplies and vendors, and unnecessary use of high-cost pharmaceuticals.

Hospital leaders should focus initially on remedying inefficient care. Strategy& research indicates physicians' choices are frequently based on factors that have no bearing on clinical outcome and are made with little understanding of how their choices affect costs. For example, physicians often choose supplies based on personal preference and their history with a particular vendor. And high-cost procedural supplies can add as much as 10 percent to supply costs when they are sourced from multiple vendors with different stock-keeping units. This is not to put the blame on physicians: Health systems often fail to inform physicians about cost and quality.

Standardizing purchasing and use can result in volume discounts and significant cost-reductions. Working with just one or two vendors also enables collaboration between institutions and vendors on pricing, as well as on emerging technologies and innovations. Such seemingly small efforts to reduce inefficient care can lead to the early wins that set the stage for other improvements.

Reducing Overhead

Overhead is another area rich with potential for cost-reduction. Managers must make a series of no-regret moves, including maximizing the use of centralizing, outsourcing and automation. Multihospital networks can achieve efficiency, increase scale and lower labor costs by centralizing nonclinical, non-differentiating functions such as human resources, marketing, finance and purchasing. Individual facilities need to look at employing external expertise and lower cost structures by exploring outsourcing in such areas as information technology, finance, HR, food services, labs and pharmacies.

Creating Differentiation

Differentiation is a more sophisticated and critical aspect of overhead. Managers at both independent facilities and multifacility systems must fully understand what differentiates them from their competitors. They need to consider how to organize their resources according to what population(s) they want to serve, and decide which services to provide. They must determine where they can take advantage of scale and where it is desirable to be unique and subscale.

As consolidation in the health care industry continues and independent community hospitals give way to a greater number of large, multifacility systems, specialization among in-network facilities is critical. A system promoting complementary rather than competitive services across facilities must emerge. For example, there is little need for multiple Level 1 trauma centers in a network in which the hospitals are reasonably close to each other. Instead, each facility should have a specialty: vascular surgery, orthopedic surgery, rehabilitation and so forth. Individual hospitals that choose to remain independent must also assess how they will differentiate themselves. All resources — time, money and staff — need to be prioritized according to the differentiators of patient strategy and go-to-market approach.

In large networks, leaders need to look at competitors, assess resources (from both clinical and facility perspectives) and analyze demographics for each geographic area so they can determine which facility will do what. They must determine what they want to be known for and use that differentiator to inform the clinical service line strategy for each facility.

Fundamental Changes at the Facility Level

For most networks, such a radical change necessitates a fundamental shift in mindset. Executives of individual facilities will need to give up autonomy in strategic decision-making and collaborate with other facilities in their region. The parent organization will have to become more involved in making decisions that are in the best interests of the system rather than allow each hospital to protect its turf. For example, the CEO of an individual facility will have a narrower scope, and his or her focus will shift from setting strategy to executing.

This loss of autonomy for individual CEOs and hospitals may be a difficult adjustment, because it goes beyond eliminating redundancies and completely alters decision-making authority. However, employing a single, unified regional strategy is the only way to take advantage of scale in a multifacility network. A network that is strategically knitted together in name and practice will function better than disparate facilities with overlapping capabilities that sacrifice deep expertise in the pursuit of general excellence.

Opportunities for savings are by no means limited to utilization, overhead and differentiation; they merely represent points on the spectrum. Health system leaders also should examine supply chain management, portfolio rationalization, new payment models and incentive structures. Lasting, high-impact change that meets the needs of all stakeholders depends not just on the focus, but also on the manner in which it is undertaken, which must be strategic, thoughtful, collaborative and deliberate.

Authors' note: For further reading, see Health System Fitness: A Proven Approach to Transformational Cost Reduction by Curt Bailey, Anil Kaul, Brad Fusco and Aneesh Krishna.

Anil Kaul is a partner and Jeffrey Mohr is a principal at Strategy& (formerlyBooz & Co.), Chicago.