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STRATEGY EXECUTION IN HOSPITALS - Case study -

Article  in  Journal of International Business and Economics · June 2020

DOI: 10.18374/JIBE-20-2.3

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 JIBE, Volume 20, Number 2, 2020 ISSN: 1544-8037

STRATEGY EXECUTION IN HOSPITALS

- Case study –

Rainer Lueg, Leuphana University, Germany and University of Southern Denmark, Denmark

dx.doi.org/10.18374/JIBE-20-2.3

ABSTRACT

This case study explores management controlling tools such as the Balanced Scorecard, the Boston
Consulting Group Matrix, and Value-based Management. The case looks at a regional hospital that was
recently acquired by a private hospital operator. Users of this study can explore how managers and
medical professionals can jointly improve strategic execution in a hospital, better understand its pockets
of profitability, and position medical services in the market. Open questions will be provided at the end of
the study to motivate students to engage in a discourse based on prior experience and expertise of the
topic. Teachers can use the open questions and the discussion around it to show and explore the limits of
traditional financial control in social enterprises. Students will need to reflect on how following generic
consulting strategies may conflict with the mission of a hospital and the non-business-oriented, political
process of setting public policy by regulators.

Keywords: Hospital; regulation; consultants; Balanced Scorecard; Boston Consulting Group Matrix;
Value-based Management; Economic Value Added; restructuring; case study; teaching notes;
shareholder value.

1. INTRODUCTION

SCRUB is a local hospital that treats emergencies and common diseases. MADDOX Corporation, a
listed, private hospital operator, has just acquired SCRUB. Over the past decade, SCRUB has
specialized in urological surgery, for which it offers traditional inpatient treatments, as well as technically
more advanced ambulatory treatments that will become the new standard for many treatments within the
next decade. SCRUB also offers general medical services, such as an emergency room (ER) that is vital
to the medical care. For this reason, the regional government has obligated MADDOX to continue
providing this general care at the appropriate quality level, or it will revoke MADDOX’ license to operate
the hospital. MADDOX uses a fine-tuned management accounting system to ensure that all of its
hospitals operate at the same standard and intends to restructure SCRUB accordingly over the coming
year.

BALANCED SCORECARD (approx. 40 minutes)

MADDOX sends a team of consultants, headed by an MBA graduate, to start implementing a Balanced
Scorecard (BSC) at SCRUB.

Required
1) A physician at SCRUB feels offended by this engagement. She says: “This is a hospital that is
run by medical professionals to benefit patients. It is not bank that managers can run by numbers to serve
shareholders. So this BSC-thing cannot be applied here!” How can you, as a member of the consulting
team, tell this physician to give the BSC a chance? Elaborate on two issues.

2) Your colleague boasts: “BSC engagements are easy. Let’s see what key performance indicators
they have here at SCRUB, put them into the four generic perspectives that are in all the BSC books, and
we are done.” Is this a suitable approach? How would you derive the perspectives of the BSC?

3) Your team agreed to a set of perspectives for the BSC. Now describe each of the four categories
you have to determine for every perspective.

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4) What problems may occur when implementing and/or using the BSC in a hospital. Think about
three relevant pitfalls your team and SCRUB’s employees might encounter.

Value-based Management (approx. 40 minutes)

MADDOX wants the consultant team to convince SCRUB thata hospital needs to be efficient. Hospitals
bears a responsibility not only towards patients but also towards the society (taxpayers) and the
shareholders. For this purpose, MADDOX wants to calculate the current profitability of SCRUB. SCRUB´s
Total Assets of the last period report at 300 million EUR of which current liabilities are 100.4 million EUR.
The weighted cost of capital (WACC) amounts to 5% and SCRUB had an Operating income (OI) of15
million EUR last year. SCRUB made an investment of 0.8 million EUR for special training for medical staff
(human capital). The chief of medicine expects to see profits resulting from this investment this and the
next year.

Required
5) Calculate residual income (RI), assuming MADDOX defines SCRUB’s investment as total assets.

6) As a next step, calculate economic the value added (EVA) for the year. The investment in human
capital should be deducted for both the year-end assets and the operating income and capitalized in an
asset as well as amortized in the income statement on a straight-line basis over 2 years.

7) Discuss the difference between the results of RI and EVA. Which measure would you
recommend? Why?

8) The janitor at SCRUB runs his department as a cost center. He wants to know why his annual
bonus will not depend on the EVA of his cost center. He demands a thorough explanation.

BCG matrix
MADDOX wants to visualize the expected development of SCRUB’s three main services using the
original BCG Matrix: general care (incl. the emergency room), inpatient urological surgery, and
ambulatory urological surgery. The following data is available:

GENERAL INPATIENT AMBULATORY

(incl. ER) (urology) (urology)
Revenue SCRUB [in million EUR] 180.0 90.0 30.0
Revenue largest hospital within 250 km [in million EUR] 550.0 75.0 5.0
Contribution to total Economic Value Added [EVA; in 2.0 3.2 0.4
million EUR]
Expected real market growth of this medical field [in %] 7% 5% 17%
Relative market share

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Required
9) Name the quadrants (pay attention that the x-axis is inverse, so the “zero” is on the right hand
side!)

10) State in which of the quadrants each service of SCRUB would be (note: it is NOT necessary to
make a drawing, a number will do!). Note: show your calculations for partial points.

11) In one sentence, describe each generic strategy per quadrant as proposed by the BCG.

12) Evaluate if these generic strategies make sense for SCRUB’s services, or if MADDOX should
follow different strategies. For this, firstly, base your evaluation on the “life cycle theory” of these medical
services, and, secondly, discuss the role of cash flows (assume that EVA represents free cash flows).

13) Elaborate on two pitfalls of the BCG matrix other than those that you have already addressed.

2. DISCUSSION OF THE CASE

Approaches to the problems and possible answers are numbered according to the questions
above.

1) Students may elaborate on two of these issues (or others of their choice):
 The physician is right that running a hospital efficiently cannot be done using financial data. This
is why the BSC is quite appropriate: it can integrate much of the non-financial data relevant to a hospital’s
short, medium, and long-term goals.

 The BSC is a technical construct with industry-specific content. The expertise of medical staff is
necessary. The physician and her medical colleagues will be a major source of input.

 The physician wants to effectively help patients, not just perform a process that is her job. The
BSC is good for this, since it shifts the focus from “what to do” toward “what to accomplish”.

 SCRUB is specialized, indicating a high relevance to get this unique strategy on paper, so it can
monitor its strategy execution better.

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 While it is not the physician’s goal to maximize shareholder value, the BSC is an opportunity to
better understand which financial constraints she is facing when helping patients, and what the
opportunity cost of her actions are (prioritizing treatments over another).

2) Students should elaborate on all issues

 First step: derive strategic objectives from vision, mission, and strategy.

 Second step: explain their relationship using a strategy map (or a business model framework).

 Third step: cluster the objectives in 3-6 NON-generic perspectives that suit the strategy.

3) Students should elaborate on all issues

 Objective: What is the strategy trying to achieve?

 Measure: How is success / failure measured?

 Target: What level should the measure be at?

 Action plans / initiatives: Which procedures should employees follow?

4) Students may elaborate on three of these issues (or others of their choice)
 Documentation has high time requirements that is lost for patients

 SCRUB is not committed

 SCRUB treats the BSC like a singular project instead of an ongoing management control system

 Constant monitoring leads to myopia

 The BSC becomes ossified, managers do not dare to make changes that would require
discussion

 Departments sub-optimize KPIs instead of looking at overall strategy

 Managers “game” the KPIs

 The implementation should be done by a trans-departmental task force

 It must be ensured that the BSC is “the” report at SCRUB, not just another one

 The BSC lacks the perspective of Learning & Growth

 Transparency makes employees uneasy

 Compensation is not linked to the BSC

5) Residual Income = Operating Income – [Weighted Average Cost of Capital x Assets]. This results
in 15,000,000 EUR – [5% x 300,000,000 EUR) = 0 EUR.

6) Economic Value Added = Adj. Operating Income – [Weighted Average Cost of Capital x
(Adjusted Total Assets – Current Liabilities)). This results in 5,400,000 EUR, as Adjusted Operating
Income = 15,000,000 + 800,000 EUR – (800,000 EUR / 2), and Adjusted Total Assets = 300,000,000
EUR + [800,000 EUR / 2]

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7) There are two reasons for the difference between RI and EVA:
 EVA subtracts current liabilities from total assets when computing capital. Some current liabilities
are “free” short-term funds and reduce the assets needed to produce income. If current liabilities
represent a source of funds, EVA better reflects the resources that SCRUB employed to generate its OI.

 Under GAAP, training is a period expense that is not matched with its actual consumption. EVA
corrects this misrepresentation.

8) It makes no sense to compensate the head of a cost center based on EVA, because that person
has no controllability over revenues or investment. When this controllability principle is breached,
motivation tends to decrease as the person feels being treated unfairly.

9) According to the original model of the BSG: quadrant 1: question mark; Q2: star; Q3: cash cow;
Q4: dog.

10) Positions: GENERAL is a dog; INPATIENT is a cash cow; AMBULATORY is a star.

11) Generic strategies of the BCG:

 Question marks: Invest if prospects are great over the entire life cycle, else divest.

 Stars: Invest to cope with market growth and to achieve economies of scale.

 Cash cows: Skim to subsidizes other services.

 Dogs: Divest without losing too much cash.

12) First, students need to explain the application of the life cycle theory of services according to the
BCG matrix. Services are assumed to move from the first to the fourth quadrant over time. Second,
students need to explain that cash flows (with EVA as a proxy) are only higher than investment for
services considered a cash cow (in some instances, stars). The cash from the cash cows should
subsidize promising stars and question marks. Third, students should evaluate if the generic strategies
proposed by the BCG matric make sense for MADDOX and SCRUB to follow. A suggested solution can
be seen in the following matrix:

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 AMBULATORY: It makes sense to follow the generic strategy. The medical field is rapidly
expanding. At the moment, it is quite small in terms of EVA, since SCRUB probably has to invest a lot into
new infrastructure. Yet, the relative market share is very high, pointing toward a strong competitive
advantage of SCRUB as well as future scale economies.

 INPATIENT: It makes sense to follow the generic strategy. This service is in direct competition to
the technically advanced AMBULATORY services, and will become a dog soon. The service is a strong
source of cash, and it should subsidize the modern treatments of AMBULATORY.

 GENERAL: The generic strategy makes no sense for SCRUB. Even though the growth in this
medical field is sub-par, GENERAL is still an absolutely vital and stable source of income (i.e., a cash
cow). It is misclassified as a “dog”. This misclassification results from the benchmark of the “largest
hospital within 250 km”, which underestimates the true relative market share of SCRUB. While patients
may be easily willing to travel 250 km for urological surgery (maybe even further!), it is unrealistic that
they could reach an ER at this distance. Furthermore, the regional government makes this line of service
a condition for SCRUB’s operating license, so selling it or shutting it down is out of the question.

13) Students may elaborate on two of these issues (or others of their choice):
 Suggest the use of standard strategies that can miss opportunities or be impractical

 Product life cycles differ in length, which makes it difficult to judge if the portfolio is balanced

 Static view: No showing of forecast to identify strategic gap, stars can become dogs immediately,
e.g. through technology leaps
 Clear definition of SBUs in the “correct” market

 Independence of SBUs: Synergies and economies of scope are not shown even though they may
exist for a company

 Choice and rationale of success factors: Why chose these factors?

 Rationale, e.g.: are large companies more profitable because they now abuse their monopolistic
position OR because they achieved economies of scale before?

 Equal risk for all SBUs: More profit may mean more risk

 No barriers of entry / leave

 Value-laden terms such as cash cow and dog can lead to self-fulfilling prophecies

 Lack of clarity on what makes an industry attractive or where a product is in its life cycle

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