You may have heard the story of the American Airlines olive. In the 1980s, Robert Crandall, then head of the company, calculated he could save the airline substantial money by removing just one olive from every salad served to passengers. He reasoned that customers wouldn’t notice the missing olive, let alone protest. He was right – to the tune of $40,000 a year, or about $100,000 in today’s dollars.
More than two years into the pandemic, many hospitals are confronting one of their worst financial years in decades, according to a report from Health Affairs. As hospital budgets begin to crack, many are channeling the spirit of the American Airlines olive by cutting back in ways they hope their communities won’t notice.
In this blog, we’ll look at the latest trends shaping hospital finances and discuss the low-profile actions health systems and hospitals are taking to trim expenses.
Labor shortages are driving higher costs
One of the main drivers of recent financial shortfalls has been the cost of finding workers. On average, labor expenses account for more than half of all operating expenses for hospitals. These include costs associated with recruiting and retaining staff, benefits, and incentives.
Even before the pandemic, healthcare had a staffing problem. Now, workers are leaving in droves due to burnout, retirement, and other reasons. To fill the void, hospitals are paying a premium for contract workers, including travel nurses.
But this expensive stopgap has caused hospitals’ labor costs to soar. In 2021, U.S. hospitals spent $7.30 million on contract labor, on average, compared to $4.61 million in 2020. The jump represents a 58% increase. This is based on an analysis of 3,164 U.S. hospitals with reported contract labor expenses in 2021.
Average contract labor expense, 2016 – 2021
Fig. 1 – Data is from the Definitive Healthcare HospitalView product. Data is based on 3,164 U.S. hospitals with reported contract labor expenses in 2021. Data is accurate as of November 2022.
Medical and surgical supply expenses inch upward
Along with high labor costs, supply shortages are squeezing hospital finances. Today, the FDA lists nearly 35 medical devices that are currently in short supply due to component scarcities, shipping delays, and demand increases. These shortages include a wide array of crucial supplies, from tracheostomy tubes to saline-flush syringes.
Hospitals often have to pay a premium for alternative products. According to our data, average medical and surgical supply costs for U.S. hospitals increased from $13.0 million in 2020 to $13.5 million in 2021. Medical and surgical supply costs account for more than half of total supply expenses.
Pharma supply costs jump 40% in five years
Hospital pharmacy costs in the U.S. have also grown substantially in recent years. In 2016, the average annual pharmaceutical supply cost was $12.28 million per hospital. In 2021, that number has grown to $17.23 million – a 40% increase.
Rising drug prices and the launch of new products at very high prices are driving dramatic growth in hospital pharmacy spend. In January alone, manufacturers raised the prices of 810 drugs by an average of 5.1%, according to an analysis by GoodRx.
Drug shortages also impact pharmacy spend. When hospitals can’t access drugs because of a shortage, they often turn to higher-priced substitutes. In addition, they use extra resources to lessen the impacts of drug shortages on patient care.
Today, there are more than 120 drugs on the FDA’s shortage list, many of which are crucial to keeping people alive, like oxytocin (which stops postpartum hemorrhages) and lidocaine (which helps prevent cardiac arrhythmia).
Hospital operating expenses increased 24% in the last five years
These factors combined are driving higher operating expenses for hospitals. In 2021, the average hospital operating expense was $207.12 million compared to $167.1 million in 2016 – a 24% jump over five years.
Hospitals in the northeast had the highest average total operating expenses at $347.32 million, while hospitals in the southwest had the lowest at $150.13 million. Below, you can get a closer look at the average operating expense by state.
Average hospital operating expense by U.S. state, 2021
Fig. 2 – Data is from the Definitive Healthcare HospitalView product. Data is sourced from the Medicare Cost Report and is based on 5,960 hospitals with reported total operating expense in 2021. Data is accurate as of November 2022.
Hospitals’ dire finances are spurring layoffs among admins and execs
Many health systems and hospitals have had to make difficult decisions to cut expenses. Labor cuts may seem counterintuitive given the healthcare staffing shortage. But as hospitals endure financial blows, some are shrinking their administrative staff and restructuring or reducing their executive teams.
Decisions to slash administrative and leadership roles draw scant attention compared to decisions to shutter patient care sites or end service lines. Most people know how long it takes to travel to the nearest hospital or clinic. Few know the names of their hospital’s C-suite.
Furthermore, awareness around administrative waste is growing. Today, administrative spending accounts for between 15% and 30% of medical spending, according to research by Health Affairs. And at least half of that spending is likely ineffective or wasteful, meaning it doesn’t contribute to health outcomes.
Big names like Providence, Sanford Health, and Yale New Haven Health are some of the latest systems to trim down administrative or leadership positions. Yet, the publicity was nil.
Cost reduction efforts that close care sites or scale down services tend to, on the other hand, provoke pushback and criticism. For example, the recent closure of Atlanta Medical Center drew national attention as a severe blow to the Atlanta healthcare landscape.
While the implications of administrative and executive shakeups may be felt throughout a health system–these might range from halts or delays in strategic planning to employee disengagement–the disruption they cause to patients is less clear. What’s certain, though: hospitals will have a lot to weigh as they navigate a difficult year ahead. And more olives, as well as many other things big and small, could disappear.
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