You have been asked to help evaluate some potential changes

You have been asked to help evaluate some potential changes to the orthopedic department in your hospital. The independent orthopedic group who works in your hospital has approached the CEO with a proposal to establish a joint venture program to perform certain procedures in an outpatient center. Currently, the hospital performs all joint replacements on an inpatient basis, but the surgeons believe that most replacements can safely be done as same-day surgery. Currently, the hospital’s knee replacement volume, revenue and costs look like this: Hospital A

Total Knee Procedures/ year

Medicare

250

Commercial

200

Medicaid

50

Current hospital reimbursement/case

Medicare

$15,000

Commercial

$22,000

Medicaid

$14,000

Fixed Costs

$3,750,000

Implantable device cost/case

$5,000

Other variable costs/case

$2,500

The orthopedic group believes that, if the reimbursement for commercial patients was reduced by 25%, they could attract another 100 commercial cases per year. Their proposal, then, is to establish a joint venture company that will sub-lease operating room time and personnel from the hospital and that all commercial cases would run through this JV. The Medicare and Medicaid cases would stay at the hospital with no change. Because the JV is owned 50/50 by the hospital and the surgeons, they would receive 50% of any net income generated by the JV. You can figure fixed costs and implantable device costs won’t change (the fixed costs would be allocated over to the JV in proportion to the total number of total knees that they do per year). Because it’s actually more resource intensive to discharge a patient in the same day, you should figure that the ‘Other variable costs’ will rise by $500 per case. The ortho group has also let you know that, should the hospital not wish to do this deal, they will take the idea to your cross-town competitor. If the JV is established between your competitor and the ortho group, your hospital would lose all of the commercial cases you currently have, but keep the Medicare and Medicaid cases.

How will you advise your CEO? As you consider how to answer, you should construct an analysis that shows 3 scenarios – 1) status quo, 2) JV with your ortho group at your hospital and 3) a JV established between your ortho group and your competitor hospital. Your analysis should show net income for the hospital for each option.

You have been asked to help evaluate some potential changes to the orthopedic department in your hospital. The independent orthopedic group who works in your hospital has approached the CEO with a proposal to establish a joint venture program to perform certain procedures in an outpatient center. Currently, the hospital performs all joint replacements on an inpatient basis, but the surgeons believe that most replacements can safely be done as same-day surgery. Currently, the hospital’s knee replacement volume, revenue and costs look like this: Hospital A
Total Knee Procedures/ year
Medicare	250
Commercial	200
Medicaid	50
Current hospital reimbursement/case
Medicare	$15,000
Commercial	$22,000
Medicaid	$14,000
Fixed Costs	$3,750,000
Implantable device cost/case	$5,000
Other variable costs/case	$2,500

Solution

Answer - Scenario 1 - Status quo

Reimbursement are often done by Insurance provider taken by patient. Total reimbursement to Hospital A:

Medicare reimbursement - 250 * 15000 = 3750000

Commercial reimbursement - 200*22000 = 4400000

Medicaid reimbursement - 50*14000 = 700000

Total revenue before JV = $ 8850000

Contribution Margin = $ 8850000 - Variable cost

8850000 - (5000+2500) * 500

= 8850000-3750000 = 5100000

Profit Margin = Contribution - Fixed cost

= 5100000 - 3750000 = $ 1350000------This is profit before JV

Scenario 2 -

Total no of commercial cases - 200 + 100(Additional cases) = 300.

Reimbursement per case = 22000 - 22000*25% = 16500

Revenue to Hospital A as per Scenario 2 - Medicare + Medicaid = 250 * 15000 + 50*14000 = 3750000+700000 = 4450000

Revenue to JV (ortho group) based on new commercial surgeries = 300 * 16500 = 4950000

Fixed Cost to Orthogroup = 3750000 * (Total commercial surgeries/ Total surgeries) ---Since out of 600 surgeries , 300 will be taken by ortho group

= 3750000 * 0.5 = 1875000

Variable cost to ortho group = 300 * (5000+3000) ----$500 added to other variable cost

= 300 * 8000 = 2400000

Profit = 4950000 - 1875000 - 2400000 = $ 675000----Remeber half of this profit will be shared with Hospital A which is $ 337500

Profit to Hospital as per Scenaria 2 = Total Revenue - Total Fixed Cost - Total Variable cost

= 4450000 - 1875000 - 300 (5000 + 3000)

= $ 175000

Total Profit = Hospital profit + JV profit

= 175000 + 337500 = $ 512500

Scenario 3 - JV established between your ortho group and your competitor hospital

Total Revenue to Hospital A = Medicare + Medicaid = 250*15000+50*14000 = 3750000 + 700000 = 4450000

Total Fixed Cost = 3750000 - Fixed cost wont change even if cases are less, It can only distribute as in scenario 2

Profit as per Scenario 3 to Hospital A = 4450000 - 3750000 - 300 (5000+2500)

= 4450000 - 3750000 - 2250000

= -1550000 --- Loss of $50000 as per Scenario 3

Net Income as per Scenario 1 - $ 1350000

Net Income as per Scenario 2 - $ 512500

Net Loss as per Scenario 3 - $ 1550000

Now, Hospital should enter in JV. Reason is even it will make less profit but in case it wont enter in JV it will start making loss and would not able to capitalize its Fixed cost. Even though JV is loss making proposition but failure to retain them can lead to huge losses to hospital and Hospital should enter in JV