Avoiding 'Builder's Remorse'
By Marc E. Voyvodich And Domenic S. Pesce
Maximizing the Value of Your Facilities Investments
As planning consultants, we have had the privilege of seeing scores of building projects completed over the past two decades. But there are few things more discouraging than the remorse of executives and trustees who realize too late that scarce capital invested in facilities has not met their organization's strategic, service and business goals. There is a reason that accountants refer to facilities investments as "sunk costs."
These are "bet the ranch" projects. Getting it wrong is simply not an option. Based upon our observation and experience in working with hospitals and health systems throughout the various phases of the facilities development cycle, we offer the following suggestions for avoiding builder's remorse.
Strategic and Business Plan Goals
The high cost of hospital construction requires that building projects be accurately linked to organizational goals. The adage that "form follows function" is central in health care facilities planning. Rigorously projecting the service volumes and functions that will need to be accommodated five to 10 years in the future is admittedly an art as well as a science.
Too often the planning process defaults solely to regression trend planning (i.e., using the trajectory of history to predict future performance). Supplementing regression trend line data with predictions about demographics, competitive initiatives, physician recruitment and new service development goals, changes in length of stay (inpatient and outpatient), future technologies, population-based use rate changes, seasonality and peak demand analysis can contribute significantly to the accuracy of volume estimates.
A Strategic Facilities Master Plan
A master plan provides an organization with a "big picture" of all capital projects, so that non-revenue-generating projects can be assessed in context with revenue-generating ones. A facilities master planning process can help ensure that:
- Strategic and financial objectives drive facilities investment decisions
- Plans for individual projects respect a comprehensive long-term plan
- Functionality and operational efficiency are maximized
- Risks are minimized.
Recognize and Accommodate Uncertainty
Uncertainty makes large capital investments and expensive strategic initiatives difficult to evaluate when projecting future performance. Will a competitive hospital close? Will a new freestanding facility compete for market share? How does a health care organization plan for these events?
Planning has shifted from strategic to tactical, toward an almost real-time effort. How can this be reconciled with the need to look a decade or more into the future? The current environment has forced many organizations to be more reactive than proactive, thereby increasing their associated risk. Facilities therefore remain fairly permanent and inflexible, contrary to many well-intentioned architects who tout flexibility.
If the cost of guessing wrong is high, investing more up front to gain additional flexibility for the future may be warranted. Developing contingency options if you get it wrong is also worth thinking through up front. Doing "what-ifs" on expansion and reuse options makes sense during the initial planning phase so that an organization is not "boxed in" if unexpected operational and market realities emerge in the future.
An Operating Statement vs. a Balance Sheet Perspective
Capital investments made in facilities end up on the balance sheet, with related costs depreciated and amortized over decades. But the reality is that the business rationale for investing those dollars is to improve operational performance and/or to improve clinical service market share. In other words, the primary reason for putting new facilities on the balance sheet is almost always to improve their operating performance statement.
On the cost side of the balance equation, the biggest single operating cost for health care organizations is staffing (generally more than 50 percent of the budget), so the issue of staffing efficiencies is central. Other operating costs, such as energy efficiency and whether to have various support services on-site or outsourced are also important. These issues need to be considered, especially in light of space allocation.
However, they tend not to drive operating expenses as much as staffing does. The realities of supply and demand suggest that as expensive as nurses and other clinical staff are today, they are likely to become much more expensive in the future (the current 6 percent nursing shortage is projected by various sources to increase to between 24 percent and 36 percent by 2012). So what is the value of being able to save one full-time employee (FTE) at a current salary level of $65,000?
The answer is startling. Assume a 25-year useful life for a new facility. The cost of a single $65,000 FTE for that amount of time is $2.3 million in current dollars. However, since the facility will be paid for with future cash flow, the more pertinent question is the future value of this clinical FTE over the useful life of the facility. Assuming a salary compensation inflation factor of 4 percent annually, the future value is a bit over $3.3 million.
Few organizations approach the design process with the idea that every group of 10 clinical FTEs is worth $33 million in future operational savings-related returns. They should. For this reason alone, facilities planning and design teams must seek operations expertise. Graphic simulations that display operations within "what-if" design scenarios can test the relative efficiency of design options, but health care organizations rarely use them because they think they are tedious, expensive and time-consuming. This view, however, is far outweighed by the benefits of their analysis and planning, especially considering the cost of facilities.
Capital on Hand
As the composition and scale of a facilities master plan begin to emerge, developing high-level project cost estimates (i.e., uses of funds) and determining potential sources of financing is wise. Remember that there is a considerable difference between construction cost estimates and project cost estimates. All-inclusive project costs significantly "gross-up" base construction costs, adding in costs for site acquisition and development costs and much more (e.g., consulting, architecture and engineering, financing and project management, equipment and furniture, insurance, legal, inflation factors, moving).
Reasonable levels of working capital (typically more than 125 days in cash on hand) also need to be preserved during the building project because project costs often exceed the most pessimistic estimates. An unvarnished understanding of project costs will help boards and management understand the challenges related to accessing capital.
Think Capital Structure, Not Just Debt Capacity
Traditional capital sources include: investments reserved exclusively for the project; unrestricted liquid assets on the balance sheet; debt capacity; and philanthropy. These are certainly core sources of project capital. However, this list can often be extended. For example, if you accept our premise that facilities assets are more appropriately considered as operating tools rather than as balance sheet assets, it is easy to conclude that ownership of facilities assets is not the deciding factor for a facilities project. Instead, accessing efficient developer capital to finance at least portions of a facilities master plan can make sense.
Boards are often reluctant to use developers to finance and own portions of a new facility (e.g., a hospital-based medical office building using a land lease arrangement) because they see them as more expensive, complex and representative of an erosion of control. In most instances, these worries can be mitigated substantially. Weighing the opportunity costs of expending existing capital for investments against financing that could be given by a developer properly frames the decision. Complexity and control issues can be addressed through the lease's structure. Properly written, the lease can provide control over issues ranging from the types of tenants allowed in the space to the preclusion of physicians and other tenants from competing with the hospital in any way.
Other nontraditional capital sources are also emerging. For example, some equipment vendors (e.g., General Electric) are now going beyond providing medical equipment, partnering with hospitals and health systems to provide capital for facilities development. While such sources have obvious strings attached, they should, nevertheless, be considered.
The potential for accessing state and federal grants for projects, while politically complex, is also a realistic and achievable capital source in some circumstances. Working early on with investment bankers will help governing boards gain a clear understanding of debt potential. Positioning a new project as a "story finance" that details the projected financial performance improvement related to an investment, may allow more debt capital than is suggested through a traditional debt capacity analysis. Nontraditional credit enhancement tools such as the Housing and Urban Development's 242 program and the United States Department of Agriculture can also augment access to debt capital.
Additionally, nontraditional debt structures such as participatory bond transactions can make it possible for physicians to buy bonds with yields tied to the future financial performance of the health care organization.
In short, creativity in addressing funding sources for a project is just as important as creativity in the facilities design process.
Rethink Your Operating Mode
There are few better opportunities for rethinking the basic organizational structure of operations than during the facilities planning and design process. This process creates a rare opportunity to package services and operations in new ways into clinical service product lines.
While the idea of product lines (e.g., cancer centers, women's and children's centers, heart centers, centers for joint and muscle disease) are not revolutionary, new facilities give health care organizations the chance to think creatively about how to physically integrate prevention, diagnosis, treatment and restorative services from the patient's perspective.
One trend that is likely to continue in this operating environment is the use of multidisciplinary teams as a core treatment planning process. These teams typically include the patient and family as well as physicians, nurses, therapists, pharmacy staff, etc. Facilities design can either promote or hinder this care model.
New facilities can also help create "focused factory" operational arrangements that pre-empt physicians from unbundling services into offices and private community-based ventures. Other issues, ranging from decisions about what type of nursing model will be used to whether a hospitalist service will be implemented will also influence facilities planning.
Evidence-Based Design
Most major health care building initiatives aspire to be patient and staff friendly. And, most boards and administrators genuinely want to be innovative. These ambitions are often expressed using phrases such as "patient-centered" or "healing" environments. Evidence-based design goes a step beyond these nonspecific ideas. It represents an increasing portfolio of knowledge about how and what specific design features actually have an impact on variables ranging from medication errors and the amount of pain medications required, to lengths of stay, nosocomial infection rates and patient mood levels.
One example of responsive facilities design can be seen in how some hospitals accommodate obese patients. The obesity crisis is having a significant impact on both hospitals and caregivers and is actually exacerbating the nursing shortage. Nurse injuries on the job have also increased with the difficulty of transporting obese patients. To help, contemporary inpatient unit design now incorporates ceiling-mounted harness devices for assisting the safe movement of obese patients.
The Pebble Project, a joint effort of the Center for Health Design in Concord, Calif., and selected health care partners, aims to demonstrate that supportive building design can enhance health and well-being. It offers a growing repository of data documenting the impact of specific design features (go to www.healthdesign.org). Results such as a 75 percent reduction in patient falls and an 80 percent reduction in patient transfers at Methodist Hospital/Clarion Health Partners, Indianapolis, in its comprehensive cardiac critical care unit, as well as a more than an 80 percent reduction in the nurse attrition rate at the Barbara Ann Karmanos Cancer Institute, Detroit, are too significant to be ignored.
Building to the Level of Use
Hospitals have applied the idea of designing and constructing buildings to code requirements consistent with levels of intended use as a facilities cost containment strategy for nearly two decades. A cost differential of $100 per square foot or more between space built to hospital building code versus office code requirements clearly makes a big impact. Such code-specific planning should always be driven by a master plan that anticipates the growth needs of acute care hospital space in the future.
There is nothing more frustrating than being boxed out of key clinical service expansion opportunities by relatively low-value office space that is poorly located on the campus. Governing boards and administrators should also consider the potential impact of this approach on operational efficiency, particularly regarding the ease of use for patients, the medical staff and hospital personnel.
Engage the Community
Hospital building projects are integral to the communities they are designed to serve. The link between the hospital and the community typically encompasses zoning issues, the impact on neighboring properties, road and utility infrastructures, parking, capital campaigns, the project's impact on health care costs and more.
Too often, we see project owners take a defensive "leave us alone" attitude toward the general community during the project planning and construction phases--and this almost always represents a missed opportunity.
Organizations that proactively seek to engage and inform the community during a construction project are typically rewarded for these efforts. Simple ideas such as broad distribution of design renderings, soliciting artwork from the community, construction tours and Q&A forums can make a big difference.
Facilities projects will have a greater potential to gain market share if the community has a sense of ownership, anticipation and pride.
While the earliest stages of the facilities development cycle represent the unique balance of highest value-added and least risk, it is also the area where many organizations invest far too little time and money. The challenge is to have the foresight and discipline to go slow in order to go fast. Setting explicit facilities design goals can provide an extremely useful framework for guiding decisionmaking throughout the process.
Marc E. Voyvodich is chairman and CEO, Stroudwater Associates, Portland, Maine. He can be reached at (207) 756-6090 or mvoyvodich@stroudwater.biz. Domenic S. Pesce is president, Array Healthcare Facilities Solutions, King of Prussia, Pa. He can be reached at (610) 270-0599 or dpesce@arrayhfs.com.
This article 1st appeared in the December 2099 issue of Trustee Magazine.
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