Compete Successfully for Capital Budget

November 2013 - Vol.10 No. 11 - Page #12

Historically, pharmacy departments have not been considered capital players in hospital settings. Those roles tend to be reserved for areas such as radiology, laboratory, information technology, and facilities. However, as increasingly more opportunities to improve operational efficiency and patient safety have evolved through pharmacy automation, this is changing and pharmacy competition for hospital capital dollars is escalating. This also coincides with capital budgeting becoming an increasingly important aspect of overall hospital operations. Reductions in third party payments coupled with increases in supply costs, patient demand, regulatory requirements and a desire to maintain sufficient cash reserves are challenging hospital operating margins as never before. At the same time, access to the debt market for hospitals is also becoming increasingly complex. The combination of these factors has resulted in a shrinking pool of available capital.

Because of this, hospitals are being forced to place greater emphasis on long-term financial stability. Since hospitals must continually improve services to keep up with changing patient care needs and technology advancements, there is a perpetual need to purchase new equipment, renovate facilities, and develop new service offerings. Done wisely, these investments create future cash inflows and represent a major investment strategy for hospitals. As part of this overall strategy, capital budgeting has a significant impact on the long-term financial success of health care organizations. At the same time, C-suites are faced with numerous capital wish lists from multiple departments that far exceed the capital resources to fund all of them. With limited and shrinking resources available, the capital budgeting and decision process becomes critical; organizations cannot afford to make mistakes with their investment capital.

Understanding the Capital Process 
In order to successfully advance pharmacy automation initiatives while also supporting organizational goals and needs, pharmacy must be knowledgeable about the bigger picture in terms of where an automation request fits in organizational priorities. Hospital C-suites must balance requests in terms of those that will provide a return on investment (ROI) versus projects that are required to support infrastructure or regulatory requirements but will not deliver an ROI. They also must consider projects that may not have an immediate ROI but are essential, such as those directly impacting patient safety. While all of these capital requests are important, pharmacy should always employ a strategy that seeks to match current needs. For example, linking a capital automation request to a defined organizational need will have the best chance of success, and understanding organizational priorities is essential (see SIDEBAR 1). 

It is clear that capital budgeting is becoming much more of a long range, strategic initiative with forward thinking organizations planning their capital strategy five and ten years into the future. Therefore, pharmacy leaders should be cognizant of where a proposed automation project fits in a long-range plan. Attempting to drop a new pharmacy automation project into a capital plan that is already in place for the next five years may yield little chance for success. To that end it is wise to schedule some time, annually, with your chief financial officer, or other financial services leader familiar with the capital process, to gain a better understanding of longer range capital budget plans. The discussion should include the following questions:

  • Is there an established long-range capital plan in place?
  • How does your CFO anticipate the hospital capital budget changing over the next 3-5 years?
  • What total dollar amount will be allocated to capital?
  • Will there be changes in capital allocation for certain areas of the hospital?
  • Are any capital purchases already earmarked for the next 3-5 years, such as specific technologies, brick-and-mortar investments, or information technology enhancements?
  • Where does the hospital anticipate capital funding sources will come from over the next 3-5 years (eg, philanthropy, cash reserves, operating margin, debt-financed capital)?
  • Are there plans to defer or push out any defined projects on the capital budget timeline? 

Financial Models
In general, to produce an effective capital budget it is imperative to understand the model utilized by the organization, the impact on cash flow, and the weighted average cost of capital (WACC). Usually, hospitals employ three primary models: payback period analysis, net present value analysis, and internal rate of return, each of which has advantages and disadvantages. In the payback period model, the decision is based on whether to accept the capital project if the payback is less than a predetermined limit. In the net present value (NPV) model, the decision is based on whether to accept the project if the NPV is positive, or, to accept the one with the highest positive NPV when analyzing mutually exclusive projects. In the internal rate of return (IRR) model, the decision to accept the capital project hinges on whether the IRR is greater than the WACC. 

A hospital’s assets are financed by either debt or equity and the WACC can be viewed as the average of the costs of these sources of financing, each of which is weighted by its respective use in a given situation. By taking a weighted average, the hospital can determine how much it will have to pay for every dollar it finances. Hospitals can use the same WACC for all capital projects or adjust it based on risk. Thus, it is important to understand how this decision is made. 

Payback Period Analysis
The payback period is the simplest of the three models, as it represents the length of time necessary for the accumulated cash flow from the capital investment to equal or exceed the original investment. Organizations will establish individual payback periods for investments, but the general rule is that a capital investment is acceptable if its calculated payback is less than a specified organizational standard. Payback period analysis is straightforward and is often employed when comparing similar investments. In these instances the investment that returns the initial investment sooner is usually deemed the better project. 

Payback period is the most commonly used financial model in health care due to the rapidly changing nature of related technology. New health care technology is usually expensive and while it may have a useful working life of 10 years, newer versions of the technology can make it obsolete long before its useful life is over. Requests for newer and better technology often result in demand for a new investment. In these situations, many hospital capital committees focus on how long it will take to recoup the initial outlay as one of the key elements in the capital budgeting and decision-making process. However, while the payback period model is easy to use, it is biased toward shorter-term projects, it does not account for the time value of money, and it does not consider risk differences between investments.

Net Present Value Analysis
The net present value model recognizes that the value of current money always exceeds that of future money and seeks to provide a picture of the total value of the capital investment over a defined time period. The NPV formula relies on establishing a discount rate, or the cost of capital, and gives a direct measure of the dollar benefit of the project to the hospital. 

Internal Rate of Return Analysis
Internal rate of return is the rate that makes the present value of the future cash flow equal to the initial capital investment. Restated, it is the discount rate that gives a capital project a zero-dollar NPV. For NPV, the capital investment is generally acceptable if its IRR exceeds the required return for the organization. Many organizations prefer to use rates of return instead of dollars of value. Also, unlike NPV, which requires a market discount rate, IRR only relies on the project’s cash flow. Keep in mind, for decisions where taking on one project means not taking another, IRR may produce conflicting results.Most organizations will utilize a combination of these models for capital budget decision making. For pharmacy automation capital analysis, all of these models are available in easy-to-use computer programs that will calculate all of the model formulas. Payback modelling can provide an indication of the risk and liquidity of a project. The longer the payback period, the longer investment dollars will be  tied up rendering the project less liquid. Furthermore, a longer payback indicates that project cash flows must be forecast further into the future, increasing the risk of the project. NPV is important because it gives a direct measure of the dollar benefit of the project to the hospital. This usually makes NPV the best single measure of profitability for hospital capital analysis. IRR also is a measure of profitability, but it is expressed as a rate of return and provides a gauge of a project’s safety margin (see FIGURE 1). 

Creating Long- and Short-term Plans
Recognizing that hospital capital strategies are now long-range endeavors, it is wise for pharmacy to create a complimentary strategy for capital projects such as automation. Overall, pharmacy should position itself to operate like a business within the larger hospital business. Thus, like any good business it should have long- and short-range strategic plans, and as a part of these plans, capital needs should be addressed. A long-range plan should look 10 years into the future and be anchored by a well-defined mission and vision for the business of pharmacy. The long-range plan should encompass higher-level strategies and address issues such as:

  • Strategic focus for the pharmacy business
  • Specific pharmacy market segments where automation is desirable
  • Market strategy for each of these business segments
  • Opportunities created/problems solved by automation
  • Competencies required to support the automation
  • Technical elements required for the automation
  • Staffing needs for the automation
  • Anticipated costs/benefits from the automation

The long-range plan should be reviewed annually and adjustments should be made based on progress to date, changing market conditions, changing organizational priorities, and changing technology.

In conjunction with the long-range plan, a shorter 3-5 year plan should be developed. This action plan converts the objectives detailed in the long-range plan into actual results. Good strategic planning for automation is a process of moving from general concepts to specific actions. The short-term action plan should address:

  • Specific automation needs
  • Detailed design specifications
  • Vendor proposals 
  • Financing options
  • Delivery timelines
  • Installation timelines
  • Testing and validation processes
  • Training requirements and timelines
  • Overall implementation strategy 

Process Steps
A good place to start long- and short-term planning is to gain a thorough understanding of the organization’s information technology architecture. Most hospitals will have a defined long- and short-term plan for their IT architecture and it is important to make sure that any proposed pharmacy automation plans fit into this schema. Many hospitals currently suffer from making one-off acquisitions of software and automation that may address an immediate need, but do not truly fit into the long-range architectural plan. Once an architectural fit has been established, pharmacy should challenge the current situation by clearly articulating why moving to the desired automation is preferable. Ideally this would include a combination of a positive ROI, improved efficiency and safety projections, and a beneficial combination of financial model analytics.

Next, organizational leadership should be harmonized around the automation change. This is very important in terms of ensuring that all key personnel that need to know about the automation are identified. Most likely, these will be the same people needed for support of the project and should include representatives of engineering, nursing, pharmacy, IT, finance, and senior leadership. At this stage, IT time demands, interface requirements, database management, and on-going maintenance/operational needs should be clearly delineated. 

Finance options should be reviewed and organizational preferences established to determine whether the automation acquisition will be a capital purchase, capital lease, or operating lease. Many organizations prefer capital purchase as the least expensive option over time. However, given the rapidly evolving nature of automation with frequent changes and upgrades, a capital lease option that includes regular upgrades ultimately may prove to be the least costly alternative. Impact on other departments, such as nursing, that involve changes in workflow should be detailed and agreed upon by all parties. Likewise, installation requirements in terms of physical space requirements, power, heat, and lighting should be coordinated with engineering.

Finally, data should be gathered to support the development of a budget proposal or business case that details the pros and cons of the automation investment and creates a sense of urgency for the project. As this can be a complex process, consider requesting support from potential suppliers of the device(s) in question. In addition, there are external consulting resources available to support the project. If there is a standard format for a business case that the capital committee prefers, it is very important to understand and use that format. If there is no preferred format, a good business case should include certain basic elements (see SIDEBAR 2).

Selling the Plan
Producing a great long- and short-term plan and a compelling business case will only prove fruitful if the project can be approved by facility administration, the capital committee, the C-suite, etc. In many cases, you have only one shot to promote the request and pharmacy leaders need to make certain their presentation is persuasive and that the idea resonates with the budget committee to have the best chance for success. Presentations should build on all of the previously described work and should be concise and to the point. Pharmacy leaders should be able to effectively get the message across to the budget committee in 10-15 minutes and an influential presentation will invariably put forth the following: 

  • Demonstrate a need
  • Offer viable solutions to that need
  • Stress the positives associated with the automation
  • Highlight the potential negatives that may occur if the automation is not adopted
  • Make it easy for the C-suite to say yes to the request
  • Use credible data sources for support
  • Recognize and play into any emotion involved with the change (eg, patient or employee safety)
  • Build on a positive track record and history of success
  • Establish clear metrics and processes for evaluation of the impact of the automation

Hospitals are facing rapidly increasing financial challenges, resulting in shrinking capital resources while simultaneously facing escalating demands for capital investments. With advances in pharmacy automation and technology, pharmacy is part of this increasing demand. To successfully compete for scarce capital resources, pharmacy must have a coherent long- and short-term strategy that matches pharmacy automation plans with organizational needs. A compelling business case and successful advocacy plan for selling the automation investment are imperative to the ultimate success of a pharmacy automation project. While obtaining capital resources is increasingly difficult, having a defined strategy and tactics that compliment overall organizational objectives and timelines will significantly improve the chance for a positive outcome.







Further Reading 

  1. Wilson AL, ed. Financial Management Basics for Health-System Pharmacists. Bethesda, MD: American Society of Health System Pharmacists; 2007.
  2. Eberts MW, Mark S, Weber R. Directors Forum - Building Your Financial IQ. Hospital Pharmacy. March 2010;45(3):260-265.
  3. Kaufman F. A Primer on Hospital Accounting and Finance. 4th Edition. Kaufman, Hall & Associates; 2009.
  4. Daly JA. Advocacy: Championing Ideas and Influencing Others. New Haven, Connecticut. Yale University Press; 2011.
  5. Biech E. Thriving Through Change: A Leader’s Practical Guide to Change Mastery. American Society for Training and Development; 2007.
  6. Bradford RW, Duncan JP, Tarcy B. Simplified Strategic Planning. Worcester, MA. Chandler House Press; 2007.

James A. Jorgenson, RPh, MS, FASHP, is the chief operating officer at Visante, Inc and former vice president and chief pharmacy officer at Indiana University Health. He has served on the ASHP Commission on Credentialing as well as the Councils for Legal and Public Affairs and Administrative Affairs and in numerous state-affiliated chapter affiliations. Jim has authored more than 30 publications and has made more than 100 invited presentations, both nationally and internationally. 









Gather Information Early
In order to gain a comprehensive understanding of organizational priorities, it is important for the chief pharmacy officer or pharmacy administrator to engage various decision-makers in the organization in order to become familiar with the thinking and processes that drive operational improvement. When doing so, it is important to ask the following questions:

  • Who are the decision makers on the capital committee? 
  • What are their historical preferences? 
  • What schema do they carry with them in terms of background and knowledge about pharmacy operations and pharmacy automation? 
  • Are they driven by financial, patient safety, or regulatory concerns? 
  • How do they like to see information presented? 
  • Who ultimately has the final say on capital investment decisions? 
  • What infrastructure, upgrades, or safety investments are already spoken for? 
  • How does the automation project fit into the defined short- and long-term hospital goals and strategy? 









Standard Business Case Elements

When building a business case from scratch, the following elements should be included in the framework:

  • Executive Summary – A concise summary (no more than one page) of the key elements of the automation proposal
  • Current Situation – Describe the current situation with associated problems and opportunities
  • Automation Project Description – A clear description of the objective and what it is expected to accomplish; include assumptions, outcome measures, and milestones/timeline
  • Environmental Analysis – Include examples of what other organizations have done
  • Business/Operational Impact – Determine how the automation project will impact key stakeholders
  • Risk Assessment – Potential risks and impacts should be assessed and probabilities presented with a mitigation plan for each risk
  • Financial Modelling – Review the costs and benefits in the context of the desired organizational financial models
  • Implementation Strategy – Project management controls should be detailed, training and personnel needs identified, and additional resources delineated
  • Conclusion/Final Recommendation – Final summation and next steps identified









A Sample Automation Budgeting Project for a Multi-hospital System
With the increasing trend in health care consolidation, many organizations are adding new hospitals to their systems, which introduce inherent challenges involving differing automation and software configurations. In our case example, system X went from 6 to 18 hospitals in a 24-month period, during which, system pharmacy leadership worked to create a long- and short-range strategic plan for the pharmacy service line including specific automation elements. 

The preferred distribution methodology for the system was point-of-care via automated dispensing cabinets (ADCs). However, new hospitals in the system had different vendors, different platform versions, different operational configurations, and a variety of financial configurations including purchases and leases (none of which were co-terminus). 

Pharmacy and IT leadership determined that a joint planning effort around a common automation strategy would yield the best chance for overall success. A clearly defined, long-range IT strategy was confirmed and the automation was chosen to fit within this validated architecture. Vendor options were reviewed and a preferred vendor selected. A single-system pricing matrix was created with a long-range plan to move all hospitals onto the same platform and configuration. The ultimate end goal was a common platform that linked directly to the main hospital information system. Thus, when nurses signed into the system, they would also be automatically signed into the ADC network and the patient profile in the ADC would be the same as the electronic medication administration record (eMAR) in the main information system; all safety elements provided by the ADC would be standardized across the hospital system. 

This long-range concept plan was presented to senior hospital leadership and approved. Pharmacy and IT then began the process of planning a 5-year timeline to accomplish all goals. A variety of stakeholders, including nursing, engineering, and finance, were included in this process. A plan to establish a sequential platform migration based on existing financial terms and available hospital capital resources was established. Specific business plans for each hospital were created and presented to senior system leadership and individual hospital budget committees for review, approval, and inclusion in the overall system 5-year capital plan. Pharmacy and IT worked to keep the plan updated, captured metrics and outcomes, reported to senior leaders and budget committees to ensure that the project remained on the overall capital plan, and ultimately moved forward as planned.


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