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Margin improvement partner contingency fee

February 14, 2023 / 4 min read

As costs rise, improving financial performance and operating margins is a top concern for hospital leaders. If your organization is hiring a consulting firm to help meet your financial objectives, beware of contingency fee agreements — you may take on risks that can diminish a successful outcome.

Many hospitals and health systems are pursuing strategic margin improvement initiatives in response to large net losses brought on by permanent expense base increases not funded by corresponding increases in patient service revenue or governmental support. Even organizations with substantial investment portfolios are not exempt from concern as the recent market downturn has resulted in substantial nonoperating losses as well. Both the “haves” and the “have nots” are experiencing financial challenges although the magnitude and the consequences are obviously very different.

Each day, we’re exposed to numerous healthcare organizations throughout the spectrum: reporting large net losses, incurring credit downgrades and/or debt covenant violations, reporting cash flow deficiencies, reducing clinical services and staff, deferring capital investment, and examining every discretionary expense for potential elimination.

Whether the goal is to return to pre-COVID-19 margin levels or to keep the doors open, immediate and significant intervention is required.

As the challenges become more severe, it’s not surprising that many organizations look to partner with a consulting firm to help guide their margin improvement initiatives. These firms often have specific subject matter expertise, enhanced data analytics capabilities, sophisticated project management and financial reporting capabilities, and the necessary bandwidth to supplement a client’s resources to deliver a successful margin improvement project efficiently and effectively.

Selecting the right firm for your margin improvement project is critical. The right contractual model is also extremely important. Many consulting firms propose a contingency fee for these projects, but I don’t feel like this is the best approach for the following reasons:

  1. Contingency fee arrangements require the establishment of various financial baselines and operational metrics to facilitate measurement of future improvements. This activity is imperfect and takes precious time and resources that could be deployed more productively toward achieving project success. In addition, the establishment of baselines is often a contentious activity that can erode trust before the project even begins.
  2. Contingency fee arrangements can pit the client against the consulting team throughout the engagement. As taking credit for ideas and impact becomes instrumental in the determination of fees, a competitive and unhealthy relationship can begin to develop. Optimally, there is full transparency and cooperation between the parties to achieve the project goals. This isn’t always the case in contingency-based arrangements.
  3. Healthcare organizations are intensely sophisticated organizations that have multidimensional measurements of success. Contingency fee arrangements tend to overweight the financial impact and deemphasize other important factors. Clinical quality and patient safety; physician, employee and patient satisfaction; patient access; consistency with mission, vision, and values; corporate compliance; and consistency with strategy are all important factors to carefully evaluate before implementing any initiative. This isn’t always the primary focus in contingency type fee structures.
  4. Oddly, financial incentives aren’t always closely aligned in contingency fee arrangements. I realize that this sounds counterintuitive as economic alignment is often the primary business case for entering into such an arrangement. If not carefully structured and monitored, the consulting firm may have a much different time horizon than the healthcare organization, which can cause short-term decision-making that is not in best interest of the healthcare system. For example, if “investment per physician” is a financial metric that the consulting firm is incentivized to reduce, they may advise against hiring new physicians or investing in certain clinical specialties that may have an adverse impact on this metric short term but may be the right strategy for the organization long term. There are many other examples of this type and protecting the organization from the short-term incentives of the contingency-based consulting firm can be an unfortunate reality of these arrangements.
  5. Knowledge transfer and working side by side with client counterparts is often one of the highest value activities that a consulting firm can bring to a margin improvement project. These initiatives are not only an investment in the financial health of the organization, but they are also a specific and tangible investment in their people. These activities improve the overall acumen of the client staff and position them well to sustain the organizational improvements once the consulting team has moved on. These activities are also a key part of client engagement and serve to enroll the client team in the overall margin improvement journey, which is often extremely taxing on them both personally and professionally. Contingency fee arrangements don’t always source the necessary time for these activities and the client can feel like certain initiatives are being done “to” them versus “with” them.
  6. Client bandwidth has been an important consideration in every margin improvement project that I have led. A well-designed margin improvement project is an inclusive activity that requires significant input and information from many client stakeholders. It’s critical to be respectful and considerate of the client time and effort requirements as various workstreams are being designed and deployed. Overwhelming the client resources with various demands will certainly lead to timeline delays but, more importantly, to an overall cultural resentment that will be difficult to overcome. The contingency fee model can lead to client staff being overwhelmed with requests as the consulting firm seeks to generate immediate, significant, and sometimes indiscriminate, financial value to maximize their fee generation.

Contingency fee arrangements tend to overweight the financial impact and deemphasize other important factors.

Of course, clients can and often do put in protections against some or all of the consequences discussed above. In my experience, it is common for several of these identified concerns to materialize, which is why I recommend against contingency fee margin improvement projects. Our approach is to spend time on-site with the client to evaluate their current state and to develop a project charter, time frame, goals, project plan, and internal and external communication plan to provide structure to the project. From there, we can develop a high-value proposal that aligns with our financial incentives and facilities the powerful and integrated partnership required to achieve the financial objectives while also paying careful attention to the other essential and meaningful considerations.

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