Laying a strong economic foundation for new hospitals

Article | May 2015 | Kanvic Grey Matter

by Ravindra Beleyur and Vlad Flamind

While the market for healthcare services in India is large and growing, many examples of empty or unprofitable hospitals indicate that despite the opportunity, success is not guaranteed. To lay a strong economic foundation for new hospitals, promoters can first articulate their vision and then put it to the test.

The Indian Healthcare market is characterised by a vast and persistent gap between supply and demand. Over the last decade a tremendous number of hospitals have been opened across country in an attempt to bridge this gap. Many of these ventures have been successful in addressing the needs of the patients and in rewarding investors with healthy returns. However, failures have also been plentiful. Numerous hospitals have failed to achieve profitability, showing that despite the enormous opportunity, success in not guaranteed in the Indian Healthcare sector.

 

If healthcare leaders are to invest in new hospital ventures with confidence, it is important that they are aware of the common pitfalls related to setting-up new hospitals. Furthermore, by conducting thorough strategic and financial assessments, they can lay a strong economic foundation which increases the future returns and mitigates the potential risks.

 

 

The opportunity for growth in the Indian healthcare market is tremendous

 

There is an immense need for additional hospitals in India to improve coverage and relieve overcrowding in existing facilities. Today, there are about 1.6 million hospital beds available across the country. To meet the most basic international standards, India should be equipped with at least 3 million more. In this context, the opportunity for Indian and international hospital promoters is substantial. Demand is vast, largely untapped, and continually expanding.

 

The rapid growth of the Indian population is itself contributing to the increased demand for healthcare, but the rise in consultations and hospitalisations is also driven by increasing affordability, patients’ changing lifestyles and their evolving perceptions of healthcare.

 

Patients are able to spend an increasing amount of time and money on healthcare thanks to improving income levels, better availability of insurance, and schemes supported by the Government.

At the same time, the clinical profile of patients is changing with increasing morbidity from non-communicable diseases such as diabetes, hypertension, or injuries caused by traffic accidents.

 

Demand is also driven by changes in patients’ perception of health and healthcare. Indian patients now have a better awareness of the risks associated with their condition, and of the capacity of allopathic medicine to treat them. They are becoming less inclined to restrict their hospital visits for extreme cases, or to postpone them until pain becomes unbearable. The net effect of all these changes is that more patients are seeking medical care, and tend to visit hospitals more often.

 

 

New hospital promoters need to clarify and test their vision before making any investment

 

Doctors and hospital leaders are well aware of the opportunity and do not lack the ambition to seize it. Most of the time, they also have a solid set of strengths they can rely on to set-up successful hospitals. After many years in the market, they benefit from a base of loyal patients, an established reputation, as well as a network of doctors and potential financiers that could play key roles in their expansion plans.

 

However, confidence in one’s capabilities and in the market opportunity tends to generate a bias for hasty action.

 

As a result, the focus of many healthcare leaders often jumps to acquiring land and premises, building a team of medical specialists, and securing finance for their project. All of this is necessary, but two fundamental questions should be addressed beforehand: 1) What type of hospital could be successful in this location? 2) What returns can be expected from such a project? Leaving these questions unanswered can result in leaders and promoters making critical decisions in the dark.

 

To make the right strategic and financial decisions, healthcare leaders can follow an iterative process based on defining, testing and refining their project. They should start by translating their vision of the new hospital into a well defined concept. This concept should be shaped around a set of critical elements impacting investment, revenue generation and cost structure, and which will be used to draw-up a business model. Once the business model is built, it should be subjected to a series of tests to ensure its economic viability and financial attractiveness. Investment and set-up should only start when the tests show the green light. If the tests are negative, the concept must be revised and assessed again.

Healthcare providers need to look at five major elements to define a hospital concept

 

A hospital concept can be articulated around five major elements:

 

1- Location

 

Expressed in terms of city, district or precise location - if already available - the location is an essential component of the concept. It frames the strategic playing field - or catchment area - by narrowing down the patient population, as well as the hospitals to be considered as competitors. It also has a direct impact on the investment or rental costs the hospital will absorb.

 

2- Patient profile

 

Within the considered catchment area, specific groups of patients should be identified as targets. This can be done by analysing the clinical and non-clinical profiles of the population. Potential patients can be grouped into categories based on their place of residence, age, socio-economic class and insurance coverage or by estimating disease incidence and hospitalisation rates. At this stage, the analysis aims to provide an indication of the local demand for specific healthcare services.

3- Scope of services

 

With an understanding of the local market context, the services to be provided by the planned hospital can be better defined. The scope relates to the medical specialities covered and the depth at which care will be provided. These elements will in turn drive the type of beds, equipment, and medical staff required in the hospital.

 

 

4- Scale

 

Scale is determined by the number of beds installed and by the size of the facilities. It is a critical part of the concept because it has a major impact on the initial investment and cost structure. This is mainly through the equipment, land and building, and human resource the planned hospital will require.

 

 

5- Level of amenities

 

A hospital’s level of amenities contribute to creating a unique experience for the patients as well as their visiting relatives. Their experience is shaped by a number of elements ranging from the the layout and appearance of the premises to the type of non-medical services available. Indian patients are increasingly seeking value outside the purely clinical side of healthcare; convenience, prestige, and comfort now play an important role in their decision making  process. But seeking differentiation in these areas also generates additional costs, making amenities a central part of a hospital’s concept.

 

Once the five elements of the concept are defined, their coherence must be verified. For example, the pricing levels and the scope of services should match the clinical and socio-economic profile of the population in the desired location. Both of them should also be calibrated with regards to the existing competition in the area.

 

Similarly, the scale must be large enough to offer the desired scope of services, but not so large that it prevents achieving a high bed occupancy rate. In this way all the elements of the concept must be analysed in relation to each other. This assessment for coherence must be thorough and should be used to refine the initial concept.

 

 

The hospital concept must be translated into a business model

 

When the concept reaches a coherent shape it can be translated into a business model expressed around three metrics: investment, profitability and value. This step is critical because a coherent concept may not necessarily be viable from an economic and financial standpoint.

 

Investment

 

Investment requirements for a hospital can vary depending on two alternative options. The first is the asset heavy option, in which substantial investment is directed to the acquisition of land, premises and equipment.

 

The second is the asset light option, in which these investments are made by other partners. Instead of owning land, building and equipment, the main promoters choose to rent or lease them, effectively treating them as costs. Going for the asset light option can easily enable over 50% reduction in the initial investment required, shortening the payback period substantially. However, renting or leasing also comes with certain disadvantages including: the inability to benefit from accruals in land value, or the potential need to share equity in compensation for the contribution from the real estate investor or other partners.

Profitability

 

To estimate profitability the cost structure required to run the particular hospital concept and the potential revenue generation should be understood. Estimating profits is a delicate step that should always be anchored in reality. To avoid the trap of wishful thinking, it is necessary to study how hospitals located in the same region, as well as hospitals sharing comparable concepts have performed historically. A critical variable that ought to be approached conservatively is bed occupancy. Generally, after a hospital is set-up, it takes 3 to 5 years to reach a healthy and stable occupancy rate.

 

Value

 

The last element to include in the business model is valuation. Based on investment and profitability estimates, the value of the planned hospital can be derived. This measurement is necessary to determine how much each promoter should contribute to own a given stake in the project, as well as to establish the optimal distribution of equity between partners.

 

 

The business model needs to be tested to determine project attractiveness

 

Once the model is built, the viability of the concept can be tested both financially and strategically. If the tests are negative, the concept must be refined. If positive, investment can be considered.

 

Financial test

 

The financial test revolves around a set of questions aimed at assessing the attractiveness of the investment.

 

The investors must first decide if they are willing to commit the funds required for the hospital set-up. They must then determine whether the project can be financed with an acceptable amount of debt and external equity, and whether the distribution of shares is in line with their expectations.

 

Finally, they must establish whether the expected returns are satisfactory. If the required investment seems too daunting a prospect, unfavourable to their longterm interests, or insufficiently attractive, the concept must be revised.

Strategic test

 

If the financial test is positive, the concept can be submitted to a final strategic test. This last stage will determine whether the concept is fit for the realities of the market by answering two questions: 1) Is the concept what the market needs? 2) Is the leadership team capable of successfully running the hospital?

 

Answering the first question requires a deeper understanding of the supply and demand situation in the catchment area. This understanding should be both quantitative and qualitative to best evaluate the assumptions made when projecting the revenues of the business model.

 

On the quantitative side, the disease incidence and hospitalisation rates of the target population should be compared with the existing supply of beds, medical specialists and services in the area. This is required to ensure that the new hospital has the scale and scope to fill the right gaps in demand. On the qualitative side, existing hospitals in the region should be visited and their patients observed and interviewed. Key areas to investigate include the target patients’ inclination and capacity to pay for healthcare, their preference for certain hospitals, and the key elements that influence their decision making. This on-the-ground knowledge is critical to understanding whether the new concept would be appealing to local patients.

If the concept is indeed aligned with the market needs, the very last question to address is the one of leadership. When setting-up a new hospital, entrepreneurs often go for bigger facilities than the ones they have been running in the past. What is important to realise is that the challenges of leading a 200 beds hospital are quite different from those of a 50 beds facility. The transition requires a shift in the way leadership is exercised, and in the type of people needed to take-on key positions. Managing the entire operation singlehandedly is no longer possible when the hospital scales-up. A leadership team has to be formed, information must be shared, decisions delegated and power distributed.

 

Before investing in a new hospital this team must be identified and aligned with the project’s objectives.

 

If the lights turn green, investment can be considered with confidence

 

If the tests are positive, investors can proceed with confidence. The hospital concept has an economically sound business model, and the prospects for success in the market are high. Action can be taken to plan the hospital construction, approach external lenders and investors, and bring doctors and other key stakeholders on-board. Also, the knowledge gained while building and testing the concept will promote unity around the vision and clarity in execution.