Are You Offering Health Sector Partners an ROI That Is Too Generous?

As a Community-Based Organization (CBO), you understand the importance of offering an attractive return on investment (ROI) to win business from health sector organizations (HSOs). However, any arrangement that emphasizes generating strong ROI for your partners without considering how the agreement benefits your CBO can damage your financial sustainability.

Too often, CBOs will lose sight of the fact that the more attractive the ROI is to their partner, the less financially advantageous the partnership is to them. Unfortunately, it’s a zero-sum game: The more the health sector organization benefits, the less upside your CBO gets. To avoid offering too high a ROI, you must understand your true costs and price your services accurately. If you don’t, you can fall into the trap of putting your financial sustainability under threat.

The Value Creation Balancing Act

For cross-sector partnership development to be viable, mutual value must be created from the partnership. Value created from a social service is the difference between the financial benefit to the HSO and the cost incurred by the CBO to provide it. If you price your service at a level that covers your costs, the entire value created accrues to the HSO. Alternatively, your CBO will capture the entire gain if your price fully reflects the benefits to the HSO. For a mutually advantageous partnership, the price should lie somewhere between the benefit to the HSO of the service and the cost of providing it. 

The ROI Trap

Giving away too much will result in you falling into the ROI trap; a trap set by a combination of cost unawareness and over eagerness to please the HSO. The financially astute CBO is aware of its costs and how to utilize accurate cost information to price its service. But in its eagerness to secure a contract, a CBO can unwittingly deliver more value to the HSO than has been created. Resulting in a financial loss for itself. To avoid this, you must be skillful at accurately costing your services.

Here are two lessons that will help you protect against below-cost pricing.

Allocate Indirect Costs

When estimating your service costs, first look at the staffing expenses and any materials and supplies that the staff require. These are the direct costs. However, it is important not to stop there: indirect costs should be included in a full accounting. These costs include management overhead, employee benefits, rent, taxes, interest, fees, and any other costs required to deliver the service. The total cost of a service must include line items that are not directly related to delivering it. These indirect costs are necessary to run the organization and can be legitimately allocated to the service line. Often, some added indirect costs are incurred when service volume increases. It is therefore important to build these expenses into the analysis of full costs. 

For example, consider a care coordination service that a CBO provides through hourly-paid community health workers. Direct costs would include labor and expenses, such as mileage for at-home appointments. Indirect costs include program managers and administrative staff, payroll taxes, and vendor charges for payroll processing, among others. Prorated allowances for these expenses are straightforward and should be made for costing accuracy.

Consider Opportunity Costs

Beyond direct and indirect expenses, there are more costs to include. Opportunity costs come into play when services are at capacity. You have limited resources such as people, time, and physical space. These resources must be allocated profitably to create value. At capacity, you must consider the cost of allocating resources to the new partner over existing revenue streams. If the existing revenue exceeds the new opportunity, that cost must be included in calculating the ROI.

To highlight the importance of understanding opportunity cost, let’s look at one example of a finite service you will be familiar with: housing. Suppose the service is designed to reduce the hospital length of stay for high-need and high-cost Medicaid patients. If a hospital is full, and it can back-fill its beds with commercially insured patients who generate more revenue than the public payer, then the cost of a bed night to the hospital of the Medicaid patient is more than the expenses. The full cost also includes the foregone profitability from being unable to have commercially insured patients occupy the beds.

Summary

As a CBO, you have an excellent opportunity to create value. The healthcare sector assumes financial responsibility for an increasing proportion of the total cost of care for high-need, high-cost individuals. Value can be created through substantial reductions in the costs of medical utilization brought about by relatively inexpensive social service offerings. You can share the value created by receiving payments that cover more than your costs. But to do so, you have to understand how to estimate your true costs and price accordingly. There is a great temptation to provide an attractive ROI to the HSO and to underestimate the full costs of providing the service. This can cause you to underprice your services, fall into the ROI trap, and threaten financial sustainability.