In this episode, we are joined by James Stanford, Managing Director at Fitzroy Health, to discuss their new research study on the generation of non-traditional streams of revenue by hospitals and health systems.
Highlights of this episode include:
- Information about the study that interviewed leaders across over 74 different health systems and academic medical centers.
- Why alternative streams of revenue at hospitals is important for struggling operating margins.
- What three classifications were used for revenue optimization strategies.
- Advice for hospitals and health systems looking to develop their own alternative streams of revenue.
- And more…
Mike Passanante: Hi, this is Mike Passanante. And welcome back to the Hospital Finance Podcast®.
Maintaining healthy revenue and operating margins in hospitals has become increasingly challenging. As a result, many health systems have developed new sources of revenue to supplement their traditional service lines.
A new study from Partners HealthCare and Fitzroy Health, a healthcare private equity firm, evaluated the financial impact of 1400 non-traditional revenue initiatives at health systems across the country.
To explain the results of this new research, I’m joined by James Stanford, Managing Director at Fitzroy Health. James has worked across the healthcare sector to launch new businesses, accelerate growth, and transform performance of existing assets.
Prior to joining Fitzroy, James was a Strategy and Marketing Consultant in the healthcare practice at McKinsey & Company.
James, welcome to the program.
James Stanford: Thanks Michael. I’m really glad to be here.
Michael: James, for those who might not be familiar with Fitzroy Health, please tell us about who you are and what you do.
James: Sure! Fitzroy Health, we’re a company that builds new companies in partnership with health systems. And so, we focus on tech-enabled services that we believe, by spending out of a health system, bringing capital management, strategy, market access, that we can turn into national-facing companies that solve operating problems for the health systems we partner with, create profits for those health systems through dividends, and then also generate enterprise value through their equity stakes in those companies.
Michael: James, as I mentioned in the opening intro, this particular study that you conducted looked at alternative revenue streams for hospitals. Why did you decide to undertake that as a study topic?
James: Well, the problem that we were addressing is that operating margins from patient care and hospitals have really struggled. In fact, 2018, we hit a 10-year low according to Moody’s. And at the same time, margins within these hospitals are primarily generated by non-operating revenue—so investment returns, real estate investments.
We believe that there are other ways that health systems can generate new revenues, diversify those revenues they rely on while still serving their patients and staying open.
And so, there’s been a remarkable amount of innovation. And trying to address that problem is happening across the country. And Partners, in particular, was noticing its peers really experimenting in some fascinating ways with new initiatives and gave us an opportunity to really survey that market, understand what’s happening, and then glean lessons that the rest of the field can learn from.
Michael: Before we jump into your study findings, can you just briefly explain for us the parameters and methodology for the study?
James: Yeah, we conducted comprehensive interviews with leaders across more than 74 different health systems or academic medical centers. The leaders included board members, C-suite executives, venture investors within hospitals, innovation executives, et cetera.
And we also pulled from Fitzroy’s database of hospital-backed initiatives and investments that we’ve been tracking since 2014.
Michael: Excellent! So, let’s dive in to what you found as a result of this research.
You were able to classify revenue optimization strategies into three levers—the first being bringing care model innovations to market. Why don’t you tell us about that?
James: Sure! So, this is a lever that we think is about anyone of any reasonable size and scale can pursue because they’re in the business of innovating their own operating models right now. And the things that they do to move into that future landscape represent commercialization opportunities that they may be able to generate new value from.
And so, we’re talking about everything from monetizing data that they’ve generated to the tech-enabled services that they’re building to being able to take on value-based care and share with the rest of the market the new technologies and services that they’ve created to make that happen.
And really, there are four different ways that people make money off of those things. First is consulting. That’s one of the first things everyone looks to do, is to create a consulting firm based on the knowledge that they’ve developed.
Next on the level of complexity would be licensing intellectual property that they have developed.
Third is taking it a next step and co-developing new solutions that can turn into companies that face externally.
And then, the fourth is actually spinning out an asset or a capability that could be the basis around which a new co. is form.
Michael: Okay, the second lever that you identified in the report is transforming cost centers into profit centers. Tell us about that.
James: Sure! Health systems represent very large ecosystems, and due to idiosyncrasies of the market, have insisted really over the last 20 years to own as much as possible of the value chain.
Now, that dynamic is changing as it becomes harder and harder to manage all of those services with equal amount of efficiency and skill. And so there are a number of health systems that are looking to spin those out and get more scale.
And so, when we say transform your cost center into a profit center, we’re talking about taking an internal commercial-grade service to other customers, so they can essentially become a source of new, non-traditional income they haven’t seen before for the health system.
Examples include wholly-owned subsidiaries like Northwell Health in New York. They’re a laboratory management services company. It can be a spin-out of a for-profit company like UPMC has done with Prodigo which is a supply chain management business. It could be an acquisition or a co-development like Cincinnati’s Mercy Health did with Ensemble Health Partners, the RCM company.
Michael: James, the third lever that you identified was generating royalties from drugs, devices and diagnostics. What are health systems doing in that space?
James: So, this is really focused more on the largest research institutions. And they, for a long time, of course, have had sophisticated tech transfer departments that are out-licensing technologies. And to be able to take that to the next generation, there’s some interesting work being done in a number of different academic medical centers in particular to increase the volume, the velocity and the success rate of those early stage life sciences assets.
You see in collaborations like Tri-I/TDI collaboration between Weill Cornell, Rockefeller University, and Memorial Sloan Kettering that is bringing pre-commercial life sciences assets to drug development and kind of jumped trying to cross that valley of death, if you will.
And then, there are other organizations that are placing large, strategic commitments to specific therapeutic areas where they believe they can make a world-beating difference. I think the Children’s Hospital of Philadelphia is an example where they invested tens of millions of dollars in gene therapy start-ups like Spark that generated hundreds of millions of dollars of return.
Michael: James, were there any other key findings that stuck out to you that you’d like to share?
James: Well, I think some of the key findings are that this is an issue that everyone is worried about in spending time. There wasn’t a single one of the 74 interviews who said, “Actually, we are happy right now with our current revenue streams, and we’re not trying to diversify.”
What’s more, over 90% of those respondents said it’s something where they need to actually show returns in the next two to three years just to speak to the urgency that the margin compression is creating for these health systems across the country.
Michael: What advice would you give a health system that’s considering the development of alternative revenue streams?
James: I think a couple of pieces of advice. One is that the successful health systems are those who are staking out that strategic territory where they can commit at an institutional level with what I would call R&D investments. There needs to be a real resource allocation to put some money where the mouth is.
And I say that because there are a lot of instances across the country where health systems have put what I would call innovation theatre tactics into play, giving lip service to innovation, but not really addressing the core, strategic needs of the institution.
And that’s why I want to draw a distinction between what people typically think of when they talk about innovation versus real R&D which is designed to transform the operations of a health system based on the market needs of the future.
That’s one piece of advice.
And I’d say the second piece of advice is that, once you have those senses of where, as a health system, you want to create differentiated value, you then put together a portfolio of initiatives based on risk and reward for those non-traditional revenue-diversifying initiatives, the same way you would for any other investment. And apply that portfolio theory to this new class of assets and be able to manage it with a focus that is most consistent with that strategic imperative I mentioned as well as the discipline that you apply to the rest of your financial investments.
Michael: Sound advice, James.
If someone wanted to get a copy of your white paper, where can they go?
Michael: James Stanford, thanks so much for spending some time with us today on the Hospital Finance Podcast.
James: My pleasure, Michael. Thank you.