Developing a Bid You Can Live With

“A bid you can live with” means that it will be competitive — and profitable. A noncompetitive but profitable bid doesn’t win a contract. A competitive but unprofitable bid doesn’t allow survival.

One provider recently asked the question, “How can you not win a bid?” Of course he was suggesting that he would make a very low bid, but, if others do the same, the competition is on again.

Winning bids is nothing without profit, and if bidders proceed without regard to a balance of competitiveness and profit, the spoils will ultimately go to those who didn’t win a contract.

It seems prudent for any company to be well-positioned prior to the bid rather than racing against the clock, and those providers in the 10 MSAs whose bid window will close in a few weeks are certainly feeling the urgency. However, providers serving MSAs slated for bidding in 2009 or later may have more relaxed opinions about developing a bid — but they shouldn’t. It can take months to position a company to submit a bid that is both competitive and profitable.

First Things First

Developing a bid you can live with assumes you have determined that your company must make the effort to win a Medicare contract, having done so after answering essential questions like: How important is it to win the bid? Is the company capable of competing effectively? What will the consequences of winning a bid — or of not winning a bid — be?

The first action that a provider must take is to register as a bidder on the Competitive Bidding Implementation Contractor Web site at www.dmecompetitivebid.com. The request for bid will not be sent just because you hold a Medicare provider number. Registration is a relatively simple process, and the earlier it is accomplished, the less likely it is that you will be left out of any communications regarding bidding.

Second, put a regularly scheduled visit to the CBIC Web site on your calendar at least weekly until the contracts are let.

The next and most important action is to establish a target net profit margin (net income divided by revenue). Achieving this target should be regarded as mandatory, and exceeding it is good.

The target margin relates to the company and all of its product-payer combinations. When we look more closely at most companies that are achieving their target margins, it is common to find that some of their product-payer combinations yield greater than the target margin and others lower than the target, but, collectively, the result is acceptable.

The best practice in margin management is to apply it at the transaction level; that is, each transaction must meet or exceed the target. If it doesn’t, there must be adequate justification to allow the exception.

Using this best practice in the development of a bid for Medicare (or any other fee discounts) means that each item the company bids on must produce the target margin or have adequate justification.

It is impossible to know if a bid will meet the target profit (or even be profitable) if all of the costs associated with the product you are bidding on are not recognized. Traditional financial accounting does not report for each product or item, so the company’s income statement will not produce an accurate sum.

Over the years, however, a method that businesses have used to supplement the income statement is called “gross margin analysis.” This method consists of subtracting the product cost from its revenue and dividing that difference by revenue. The result reveals the gross profit margin for each item at the reimbursement level for different payers.

This is a step in the right direction but it still leaves a possibly fatal information gap.

Gross margin analysis does not allow managers to consider the greatest portion of their expenses. For this industry, it considers only 44 percent of all costs; the other 56 percent are incurred because people are doing the things necessary for the company’s reimbursement. The 56 percent includes labor, taxes, rents, space, insurance and all other general and administrative expenses.

So, if a manager applies an overhead percentage across the board to each item’s gross profit margin, there will be significant inaccuracies because payers require different levels of service for the same product.

For example, documentation of orders for many products is typically more extensive with Medicare than for other payers. Applying an equal overhead charge for each product-payer combination, then, does not consider the different costs associated with different payer requirements. In this example, the Medicare transactions would wind up being less profitable than the method suggests, and other payers would be more profitable.

That could be a huge mistake to make in your Medicare bid.

The management information you really need can be derived from performing activity-based costing and applying the activity costs at the item (HCPCS) level. This is the next step you should take.

Figure Out Costs

Activity-based costing is a method for allocating costs to activities. Activities are simply the things that people (in this case, company employees) do. The common thread running through all company activities is that they consume time. Since we know that time is money, we can measure the cost of an activity based on the time it consumes.

So, how can you calculate your company’s activity costs? Follow these six steps:

1. Develop an “activity dictionary.” This is a list of processes and the activities that support those processes. For each activity, there should be a description of the tasks that make it up. We typically see 10 to 15 processes and 45 to 60 activities in a home care provider’s activity dictionary.
2. Determine the period you will analyze. Two consecutive months is a time frame that works well for most companies. Which two months requires some knowledge of the business; the criteria for selection is that they are recent and indicative of the year as a whole.
3. Collect two pieces of information for each activity. How many minutes, on average, does it take to perform the activity one time? How many times was the activity performed in the period being analyzed? You can get the answers to these questions from interviews with employees who perform the activities, and from mining data the company has (usually electronic but sometimes paper).
4. Next, calculate the cost per man-minute. To do that, use income statements for the two months you have chosen to sum all of the expenses, excluding the acquisition of products. If there is unusual expense, it should be adjusted. Divide the costs by the total number of man-hours purchased. You can collect that information from payroll reports. When you perform this division, you will know the cost per man-hour. Then, simply divide the cost per man-hour by 60 to yield the cost per man-minute.
5. Multiply the cost per man-minute by the number of minutes that it takes to perform the activity one time. This tells you the activity cost. There is no overhead included in this calculation, so it is called the “unburdened” activity cost. “Overhead” is defined differently for ABC than for other business discussions. For purposes of ABC, overhead is the miscellaneous and non-productive uses of time. Miscellaneous time is that which was not counted in the activities. For example, attending a weekly 15-minute staff meeting may be productive but is generally not counted. Attending to a family matter while on the company clock is non-productive.
6. Finally, it’s time to apply overhead to each activity. First, multiply each activity cost by the number of times the activity was performed in the period being analyzed. Then, sum all of the extended activity costs. This number represents the cost of all of the time you accounted for.

Subtract that number from the total expenses you identified in Step 4, and now you know the expenses you didn’t account for. This is the overhead. Dividing the overhead by the sum of the extended activity costs gives you an overhead factor to apply to each of the unburdened activity costs. The sum of the activity cost and its overhead is the “fully burdened” activity cost.

Here We Go

Now it is time to apply the activity cost to each item.

Select an item that you will bid on, then list all of the activities and their fully burdened costs. For each activity, consider that the payer is Medicare and answer the question, “How many times must this activity be performed to get paid one time for this item?”

Multiply the answer to that question by the activity cost. The sum of these products is the activity cost associated with getting the item reimbursed by Medicare.

Adding the sum of the activity costs to the cost of acquiring the product reveals the total cost of being reimbursed by Medicare. When you add your target profit to the sum of the costs of goods and activities, you have now identified your minimum bid.

But you’re not done yet. Another of the actions necessary to developing a bid that is both competitive and profitable — and that can be performed simultaneous to activity-based costing — is assessing the discount that will be necessary to win a bid.

The objective is to discount only enough to win the bid, not to discount all that your company is capable of. One of the reasons this is important is obvious; another is that you need to leave room for your non-Medicare payers to reduce reimbursement.

Since about 40 percent of the other payers mark their fee schedules to Medicare’s, you can expect that they, too, will drop their rates shortly after Medicare’s new fee schedules are posted.

This is unquestionably the trickiest of all the things providers need to be doing. Some tips on getting to the answer of a 5 percent, 10 percent or 20 percent discount follow. But first this caveat: Don’t violate anti-trust laws by discussing prices with other providers unless legal counsel has said it’s permissible. Without discussing prices with rivals, you are left with pure market intelligence.

When assessing the discounting ability of the industry’s publicly traded rivals, be sure not to make the assumption that their size allows them to blow others away. Remember that size is not the determinant of discounting ability; it is profit and information. A company that discounts more than its profit will not survive to reap any benefits of winning a bid, regardless of its size.

Checking Up on Competitors

To collect information on publicly owned rivals, check their Web sites for information like their Securities and Exchange Commission filings and annual reports. Read and analyze them. Another source of information is what is written by investment bankers’ analysts.

These public reports can give insights into company branches in the subject MSAs, but for more detailed information, each branch has to be treated similarly to the privately held rivals in your market.

To assess these rivals’ discounting ability requires greater creativity and effort but can be accomplished in part by asking questions about them. Your marketing reps hear what referral sources say about them, and you need to collect those comments. Former employees and patients of rivals also have insights that should be collected.

Simple observation can give insight into the size of the space these companies occupy, how many employees go to work in the office each day, how many delivery trucks they are running and how many trucks are making multiple runs each day. Their Web site and other marketing materials can provide additional information, and so can their press releases. (Recently, for example, I used the satellite view from Google Maps to count the parking spaces of one company and thereby calculate the number of square feet in its facility.)

All of the information you collect on your rivals should be analyzed to help you form an opinion about their revenue and profit.

Once you have assessed your rivals’ profitability, you can assess their ability to discount. When you have accomplished this assessment for all of the rivals in your market, you can estimate the discount you will need to win a bid.

After you have determined cost, estimated the probable discount from the fee schedule and calculated the probable bid range for an item, you must compare the probable bid to your own minimum bid. Remember that your minimum bid is the cost of goods, plus the cost of activities and the necessary profit margin.

If this comparison shows that your minimum bid is higher than the competition will allow (probable bid range), you know you must remove cost from the business or justify the shortfall from your target profit margin. If, on the other hand, all of these analyses indicate that your minimum bid is lower than the probable bid range, you know you can discount as much as the market may demand and still achieve your target margin.

Building Discounting Ability

At press time, CMS’ bid window for the first 10 MSAs was expected to open at any time, so there are bound to be some providers who will submit bids without being able to accomplish the steps detailed above. There may be a saving grace in the fact that Medicare’s new fee schedule will not go into effect until April 2008.

The time between now and then can be used to complete these steps, and then to commence making any necessary adjustments to the company’s costs. Such adjustments should also be thought of as building discounting ability, which is exactly what providers in the 2007 and 2009 rounds of competitive bidding need to be doing.

Discounting ability is the difference in a company’s current net profit margin and its target net profit margin. For example, a company with a target net margin of 10 percent and a current net margin of 13 percent has discounting ability of 3 percent. On the other hand, a company with a target net margin of 10 percent and a current net margin of 7 percent has no discounting ability.

Companies that are building their discounting ability are not only adjusting their purchasing practices to lower product costs but are also adjusting their business processes to lower activity costs. A good way to know that activity costs are dropping is to see that productivity (revenue divided by full-time employees) is increasing.

Some methods that can produce better productivity include moving from DOS-based billing systems to current operating systems; building on current technology with document imaging, desktop faxing, bar-coding and scanning technology; and installing GPS in delivery vehicles. Business process re-engineering can play a vital role in improving productivity.

And finally, sales efforts should be redirected to the product-payer combinations that make the greatest contribution to the company’s bottom line.

Wallace Weeks is founder and president of Weeks Group Inc., a Melbourne, Fla.-based strategy consulting firm. He can be reached at 321/752-4514 or by e-mail at [email protected].

If You Haven’t Begun, Do This NOW

Answer these questions: Is it important that your company win a Medicare contract? What would the consequences of winning — or not winning — a contract be? Can your company compete effectively and ensure a high level of beneficiary care?

If you decide to bid, then:

• Register with CMS for a bid number. Before you begin, however, make sure you have gathered all the information necessary to complete the registration process. Check the CBIC Web site (www.dmecompetitivebid.com) for the information you will need.
• Get accredited. You must be accredited or pending accreditation to submit a bid, so if you haven’t begun, choose an accreditor and start the process now. The accreditation deadline for first-round bidders is Aug. 31, 2007. (You must meet CMS’ supplier quality standards.)
• Make sure you have all of the financial and other documentation CMS will require along with your bid, including required tax returns, etc., and a current credit report. Check the CBIC site at www.dmecompetitivebid.com for a list.
• Analyze your company’s costs. Activity-based costing is a good way to do this.
• Calculate a bid that is both competitive and profitable. Consider your costs, your target net profit margin, your competitors, the probable bid range for an item and your discounting ability.
• Visit the CBIC Web site often, at least weekly until the contracts are let, at www.dmecompetitivebid.com.