• Open access insurance products would be on the ascendancy and exclusive contracts on the decline,
• So many physician practice management firms, home health agencies, and nursing home conglomerates would be in financial distress or even bankrupt, and
• Integrated systems would be disintegrating, or at least divesting the physician practices, HMOs, and PSOs they had been so determined to own?
At one time, many pundits believed that these strategies would be the wave of the future, and health care executives were determined to ride the wave along with everyone else. Unfortunately, the uncertainties of the health care industry (including legislative agendas and managed care developments) brought some of the waves crashing onto the shore, leaving the debris of failed strategies behind.

Why Plan if the Future is so Uncertain?

Risk-averse managers often suffer decision paralysis when the future is unclear. The future is never knowable, however, and doing nothing can be as disastrous as doing something wrong. When asked about the company strategy, a Dilbert character explains, "Our strategy is to detect any trends and react accordingly." Dilbert responds, "Isn't that exactly the same as not having a strategy?"

Strategic planning has changed in the last few years. Traditional planning focused on stable business environments and projections based on historical trends. The new approach to planning accepts uncertainty and seeks ways to mitigate risk. There are three types of uncertainty: reasonably clear trends (such as the aging of the population), "unknowns that are knowable" (i.e., unknowns that can be researched away such as consumers' hospital preferences), and residual uncertainty. It is the residual uncertainty, or "everything else," that makes strategy development particularly difficult.

Even if We Know What to Do, Can We Afford It?

Amidst all of this uncertainty, we can be sure of one thing--financial demands will always outweigh financial resources. Providers are faced with payment reductions, declining margins, and lower credit ratings, making funding sources less available to support strategic initiatives. Yet providers must implement strategies that help them achieve their strategic intent within the parameters of their financial capability, and, at the same time, balance the needs and priorities of the Board, management, physicians, and the community.

The Challenges of Financial Planning Amid Uncertainty

Financial planning is always a balancing act--trying to reconcile financial resources with current needs and future strategic initiatives. In an era of uncertainty, the tightrope walk becomes even more difficult. Writing in CFO Magazine, J. McCafferty contends that "health care CFOs have the toughest finance job in the U.S.," due to the industry's pressures and uncertainties (CFO Magazine, Jan. 1999, pp. 63-71).
One of the most important challenges for the financial team in the planning process is to help other leaders in the organization assess and manage risk appropriately. Business tools such as scenario analysis, decision tree analysis, or game theory can help organizations focus on factors likely to have a material impact on the future, as well as help the organization identify strategies with a low likelihood of success or an unacceptable level of risk.

The financial team can also help the organization avoid common pitfalls in understanding and measuring risk. Such pitfalls include:

Real versus Perceived Risk

Uncertainty can lead to wild speculation and worst case or even doomsday scenarios. For example, a hospital may run scenarios on three independent events: Medicare reimbursement decreases by 10 percent; labor shortages drive salary and benefit expenses up by 25 percent; and the hospital's major admitting practice (10 percent of admissions) moves to a competitor. If each scenario has a 20 percent chance of occurring, the likelihood that all three will occur at the same time is only 0.8 percent. Nevertheless, planning groups often become consumed with the negative scenarios as though the probabilities are cumulative.

Risk of the Status Quo

Waiting for "the facts about the future" to reveal themselves before choosing a strategic direction is a risky proposition leading to strategy by default, as the Dilbert character pointed out. Complacency, conflicting agendas, or lack of leadership can result in planning paralysis. Financial planning can help avoid this pitfall by explicitly gauging the risks of maintaining the status quo alongside the risks of choosing alternative strategies.

Bracketing the Range of Risk

Estimating the upside and downside risks of alternative strategies (i.e., sensitivity analysis) is an important tool in financial planning. A common pitfall is to focus almost exclusively on one end of the bracket or the other (either the adrenalin rush of upside reward potential or the fear of downside losses) in reaching strategic decisions. Determining a "reasonable range" allows management to set parameters to trigger corrective actions when performance falls outside the range.

Risk of Choosing the Wrong Path

In times of uncertainty, decision makers may feel the likelihood of choosing the wrong strategy is greatly increased. Since health care capital is not easily converted to alternative uses, the cost of choosing the wrong strategy is high. For example, investing in outpatient services on the inpatient campus may preclude the availability of capital to develop off-campus sites if the market demands greater geographic accessibility. Decisions must be made with the best available information at the time, and there will always be some decisions that do not work out as planned. The financial team plays a key role in ensuring that the organization maintains adequate financial capability to meet unexpected challenges and to adjust its strategy as the future evolves. To help mitigate the risk of some major strategic initiatives, the team may propose sharing risk (e.g., with partnerships or joint ventures) or shifting risk (e.g., purchasing reinsurance or having a real estate developer build an MOB).

Risk of Throwing Good Money After Bad

There is no guarantee of success for any strategy. Organizations (particularly not-for-profit organizations) are often reluctant to pull the plug on "losing" strategies. Decisions to evaluate divestment versus reinvestment in strategies are critical. By establishing metrics for tracking performance and trigger points for corrective action or divestment, the financial team can help the organization systematically improve the overall financial well being of the organization.

Conclusion

Health care providers will no longer be able to rely on the "wait-and-see" planning approach. Successful organizations will utilize an approach to planning that accepts the inevitability of uncertainty, facilitates the development of sound strategies, and aligns strategic and financial planning. The finance team should play a pivotal role in helping the organization understand, assess, and manage risk in the strategic decision-making process.