The New Oxygen Math

It has been three months since the 36-month cap on the rental of oxygen equipment went into effect, and most providers have found a way to stay in business so far. However, the industry has faced only the initial challenge associated with this new law, and there is still a significant lack of understanding of how to operate in this new environment.

We should not expect that all is or will be well for O2 providers. There are at least six new challenges that have been heaped on providers’ plates. Each creates operational issues and will have a direct impact on every oxygen company’s income statement.

Challenge # 1 – Immediate Revenue Reduction

This is equal to the reimbursement rate multiplied by the number of patients who reached the capped period on Dec. 31, 2008. I know of providers who have examined their patient data and expected to lose 50 percent of their revenue for oxygen in January alone.

The Office of the Inspector General states that 22 percent of Medicare beneficiaries are served for 36 months or more. That is another way to say that, on average, HomeCare magazine readers collectively lost 22 percent of their revenue for the rental of oxygen equipment in January. Of course, from business to business, the percentage will vary.

It is important to remember that the impact of that lost revenue will not immediately show up in cash flow because invoices that were produced in December 2008 were not paid until January or February 2009. There may even be a few that get paid in March or later. To whatever extent the timing difference is not recognized and accounted for, a provider may have a false sense of safety about the company’s oxygen business.

The timing issue will be a greater problem for providers who are using the cash accounting method. Generally, cash accounting methods are used by smaller companies, which could also be the most vulnerable. The only solution that is adequate to measure the timing difference is to create an accrual accounting statement for management’s use. The reality, however, is that this can be cumbersome for those not skilled in financial accounting.

Another important point to remember about the immediate loss of oxygen revenue is that it goes beyond immediate: It has a rolling impact. I have heard a lot of providers talk about what was going to happen in January. However, some number of patients reached their cap in February, some in March and so on. Unless and until the law is changed, some patients will reach the cap each and every month to come.

Providers should permanently implement a rolling forecast of patients reaching 36 months of service. The forecast should look forward for at least six months, for example, March through August, April through September and so on.

The first bit of data in the forecast tool needs to be the patients who are expected to cap in each month of the forecast period. Other data should include the probability that a patient will reach the cap. The tool should also provide space to assess the equipment in use by the patient, the environment the equipment is in and other needs of the patient for that equipment.

Once the data is collected, the costs need to be affixed for serving the patient in the post-cap era (months 36-60) in order to forecast the revenue and expense impact. Summing that forecast for each month will allow providers to better manage the revenue reduction for their business.

Being proactive is the real key here. However, you can’t be proactive unless you have actionable information.

One final thought about this challenge is that the larger the percentage of patients who are capped correlates to a larger percentage of patients who have exceeded 60 months of service. Each of those patients represents an opportunity to resume the income stream with new equipment.

My observation is that providers who have had 35 to 50 percent of their patients capped also have 25 to 40 percent of these capped patients as candidates for new equipment. Even if these patients do not get new equipment, they represent a new revenue opportunity at best, or an expense reduction at worst, because the provider has met its obligation.

Challenge # 2 – Lower Reimbursement

The lower reimbursement should not be defined as the revenue lost due to the cap or as the 9.5 percent cut, which also started in January, but should in addition take into account the lifetime value of the oxygen customer. Based on the laws affecting oxygen, I estimate providers will experience declines in the reimbursement for rental of oxygen equipment by no less than 14 percent and as much as 27 percent. That also means the lifetime value of a customer declines by the same amount.

Further down on the income statement, the profitability of a provider’s business will also decline because related expenses do not automatically go away. The only opportunity to rid the business of the expenses associated with the O2 patient is to manage those expenses down.

One other effect to note is that the resulting lower net profit reduces the “sustainable growth rate” of a business. SGR is the rate at which a business can grow sales without having to increase its leverage or debt. When a business exceeds its SGR, it will have to find external capital to fund growth. We are in an environment where that is problematic for most. If growth occurs and the capital is unavailable, the company will experience shortages of cash.

To get a handle on this situation, there are four practices that should be used universally and permanently installed in every business.

1. First is the alignment of services provided with the services purchased (paid for). Recently, an Aldi grocery store opened a few miles from my house. What I have learned from this retailer is that they are masters of cost management. The basic premise is that they have aligned what they sell with what they are paid for. To do so, Aldi has unbundled or deconstructed what has been traditionally bundled in other grocery stores. For example, where I normally shop I pay more per item, but the price includes the bag and the bagger. Not at Aldi. You can buy the bag and bag items yourself. No matter how distasteful it is, our industry is being forced to this type of management.
2. Second is creating continuous and significant productivity improvement. Employee productivity is the root cause of all general and administrative expenses. Measuring and managing productivity improvement ensures the reduction of costs. Productivity is measured by dividing revenue by FTE (full-time employees). The value of productivity improvement can be measured by multiplying the percentage improvement by the gross profit margin and then multiplying by the annual revenue. Companies that commit to active productivity improvement initiatives routinely improve productivity by 10 percent per year and, thereby, net profit margins by 3 to 7 percent per year. The keys to such successful initiatives are measuring productivity, sharing it with the team, empowering the team to discover and implement process changes and then rewarding their success.
3. Third is applying activity costs to the product or HCPCS level. It is insufficient simply to calculate activity costs. Once calculated, these are still just numbers. They must be applied at the HCPCS level in order to manage the costs associated with a product such as E1390. Managing activity costs at the product level also incorporates business process reengineering, and goes on to consider length of service, product selection and the alignment of services provided with the services purchased.
4. Fourth is length-of-service management, which is the most powerful tool you have to manage lower reimbursements for oxygen. LOS is the average number of months that patients are on service. It is measured by HCPCS or product category.

The objective used to be to maximize LOS for oxygen patients. Now the objective is to minimize the number of patients who reach the cap and, thereby, the unreimbursed expense associated with them. If you could create the perfect scenario, each O2 patient would be on service for 35 months.

LOS management can be achieved through your marketing function. Providers who manage LOS are precisely targeting who they ask for referrals and what they tell the referral source they want. To know who to ask for referrals and ascertain the most desirable patient characteristics, HME managers mine their databases to identify the common characteristics of patients with the most desirable profile.

Challenge # 3 – Slower Growth

This is a result of two factors: First and foremost is the cap, which drives down the length of service received by the oxygen customer, and second is the 9.5 percent cut. A provider serving beneficiaries for an average of 24 months will see the company’s LOS decline to 20 months.

That is another way to say that the attrition rate will increase from 4 to 5 percent. Therefore, a provider’s current rate of new referrals will first have to cover the higher attrition rate, leaving a smaller portion of the referrals to build the customer census.

Regarding a sustainable growth rate (mentioned in Challenge #2), the reality of slower growth will mitigate some of the risk of growing too fast. So, there may be a spark of good here.

Those responsible for growing a company’s sales are probably accustomed to producing revenue growth rates that are now unattainable given the historical effort. Managers with this responsibility will likely need to lower their expectation, or find a way to increase the effort, improve the LOS or live with a higher level of frustration.

Those who have the opportunity to increase the effort may find good prospects with either geographic expansion or line expansion. Both bring new expenses and risks to the enterprise, so a good business plan modification should be made.

Before you determine to ratchet up your sales and marketing efforts, be sure you understand that growth consumes cash. Since profit margins are declining along with oxygen reimbursement rates, it is more difficult to generate the cash to finance growth. This comes at a time when external capital is virtually non-existent.

When a company can grow rapidly, it may suffer less damage if it exceeds its break-even sales level. The reason is that it may quickly grow above the break-even point. When a company cannot grow rapidly, it is more important to be mindful of the break-even point, because it may take significant time to remedy the situation. Break-even sales is calculated by dividing fixed expenses by the gross profit margin. Before you accept a slower growth rate, be sure you know this level and have a plan to achieve it.

Challenge # 4 – Managing “Warranty” Costs

Providers have essentially been put into the warranty business since no revenue is derived for oxygen rentals after 36 months. Granted, the title to the equipment has not changed, but the revenue goes away while the cost for the efficacy of the equipment remains — and that is essentially warranty management. At present there is insufficient data to allow managers to estimate what those costs might be and, more important, how they would be managed.

This necessitates that managers be quick studies in understanding the costs associated with the efficacy of equipment in the period between 36 and 60 months. To do this, managers would be wise to create a data collection and analysis system.

Data that should be helpful includes (but is not limited to):

• Type of equipment ;
• Make and model;
• Age;
• Patient profile;
• Environment; and
• History of equipment.

Analysis of this data should lead at least to educated guesses about the cost a company is likely to incur when an oxygen patient caps.

One other management action that will be important in the 36- to 60-month period is giving the patient an appropriate expectation. The philosophy of under-promising and over-delivering should play well.

Challenge # 5 – Potential for Legal Battles

As Medicare tells beneficiaries that providers are responsible for the equipment, there is the potential for a huge variety of customer expectations. If those expectations are not met, there is the potential for some sort of legal battle between the provider and customer, perhaps involving CMS. Be mindful again that OIG says 22 percent of beneficiaries are exceeding 36 months of service.

Providers can take three actions to mitigate this risk. One is to know and document the manufacturer specs of the equipment and build practices around maintaining those. Since models change, it may be risky to rely on the manufacturer as the source and therefore to put into their control a written set of specifications.

Another is to carefully document the actions taken to make the equipment comply with the manufacturer specs. You have asset tracking logs and use them in concert with accreditation requirements, but risk mitigation suggests that they include information about how the provider returned the equipment to the required specification. Lawyers tell us “If it isn’t written, it didn’t happen.”

Finally and again, customers must be educated lest they have different expectations.

Challenge # 6 – Relocating Patients

The responsibility for serving relocating patients has an unknown but potentially enormous burden for the provider. Its impact will vary from one provider to another. But just as we don’t have data to suggest how repair and maintenance costs will affect providers, we don’t have data to suggest how large the burden of relocated patients will be. Moreover, we don’t have a structure in the industry to accommodate them.

At this time, the best a provider can hope for is to be able to make ad hoc arrangements with other providers. To improve the situation, an industry structure needs to be created. But this will require a collaborative effort of providers and other stakeholders. It will also take time to assemble.

Until some industry structure is available, those providers serving itinerate markets would be wise to begin networking at industry meetings to develop potential relationships to which they can entrust their patients.

All of these ideas could be taken as another list of “to-do” items. The reality is that’s true. However, there are two important suggestions to consider. First, put these ideas in the context of the monumental change that has just occurred in the DMEPOS industry. Second, implementing these ideas could allow you to cease some activities and replace them with others.

In the end, there should be a net reduction in the number and cost of your activities.

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 email at [email protected].