Are You Offering Your Health Sector Partner 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). But any arrangement that puts too much emphasis on generating strong ROI for your partners without also considering how the agreement benefits your CBO can damage your financial sustainability.
This may sound obvious, but 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 of a ROI, you must understand your true costs and price your services accurately. If you don’t, you can fall into the trap of bringing your own financial sustainability under threat.
The Value Creation Balancing Act
For cross-sector partnership development to be a viable strategy, there needs to be mutual value 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 just covers your costs, then the entire value created accrues to the HSO. Alternatively, the entire gain is captured by your CBO if your price fully reflects the benefits to the HSO. For 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 you attempt to estimate your service costs, you will first look at the staffing expenses and any materials and supplies that the staff require. These are the direct costs. But it is important not to stop there: indirect costs should be included for a full accounting. These costs include management overhead, employee benefits, rent, taxes, interest, fees, and any other costs that are 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 in the analysis of full costs.
For example, consider a care coordination service provided by a CBO through hourly-paid community health workers. Direct costs would be labor plus other expenses such as mileage to at-home appointments. Indirect costs would include program managers and administrative staff costs, payroll taxes, payroll-processing vendor charges, and IT staff to support mobile devices. Prorated allowances for these expenses are straightforward and should be made for costing accuracy.
Consider Opportunity Costs
There are more costs to include beyond direct and indirect expenses. 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 is higher than 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 that 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 explicit expenses; the full and relevant cost also includes the foregone profitability from being unable to have commercially insured patients occupy the beds.
As a CBO, you have an excellent opportunity to create value. The health care 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 in the value that is created by receiving payments that more than cover your costs. But to do so, it is crucial that you understand how to estimate your true costs and then to 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 thereby threaten your own financial sustainability.