You have been asked to help evaluate some potential changes to the orthopedic de
ID: 1258037 • Letter: Y
Question
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
Explanation / Answer
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
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