Providers continue to measure the impact of the DRA. But the news isn’t all bad, especially for hospitals. Memorial Hermann saw an opportunity to build a new revenue stream and seized it.

While the doors of freestanding imaging centers are closing in response to the Deficit Reduction Act (DRA), opportunity is knocking for hospital imaging service line managers who understand the demands of this customer-driven market.

“We’ve seen a lot of doom-and-gloom media coverage around the Deficit Reduction Act,” said James Polfreman, CEO of the Outpatient Imaging Division of Houston-based Memorial Hermann Healthcare System. “It’s true that a multitude of independently owned facilities will go out of business or be consolidated by venture capital firms or hospitals. We’ve all been affected by the reductions in Medicare technical payments driven by the DRA, but hospital executives who understand the business of outpatient imaging have an enormous opportunity to act as a consolidator and to profit accordingly.”

Effective in January 2007, the DRA slashed outpatient imaging payments by mandating that Medicare pay the lower of the technical rates covered in either the Medicare Physician Fee Schedule or the Hospital Outpatient Prospective Payment System. The Congressional Budget Office originally estimated that the cuts would result in a savings of $2.6 billion over 5 years, but some specialty groups and private organizations estimate that the cuts will go much deeper, totaling as much as $6 to $13 billion over a 3-year period.

While the DRA has had an impact on all providers of imaging services, imaging remains a profitable service line, representing a significant portion of revenues at most hospitals. By leveraging their physician base and payor relationships, hospitals can now recapture the business they lost to independent providers. The key, says Polfreman, is to avoid the mistakes hospital-based imaging centers made in the 1980s.

“Historically, hospitals located their imaging centers within the hospital facility itself and operated them as a hospital department,” said Scott Smith, operations director of Memorial Hermann’s Outpatient Imaging Division. “They were reimbursed by insurers based on a percentage of charges for the imaging procedures they performed. Over time, insurance companies went to fixed-fee payments, reducing the profit margin for imaging services.”

Smith points out that managed care contracts represent 70% to 80% of revenues at most freestanding imaging centers. “They’re really feeling the impact as they renegotiate their contracts with insurers, many of which are set at a percentage of Medicare. If Medicare reduces reimbursement, their managed care contracts go down as well. For independent imaging centers already operating on a small margin, the Deficit Reduction Act represents a significant loss that is virtually impossible to absorb.” At the Economics of Diagnostic Imaging National Symposium held in late October 2007, Harvey L. Neiman, MD, executive director of the American College of Radiology, reported that nonradiologists are already feeling the effects of the legislation and closing their self-referred imaging businesses.

As freestanding imaging centers close their doors across the country, Polfreman believes that hospitals are ideally positioned to recuperate their lost outpatient imaging business. Even before the DRA took effect, he and his team proved it could be done.

“The industry has come full circle since the late 1980s and 1990s when hospitals lost tremendous market share to freestanding imaging centers offering superior service,” he said. “Over time, physicians developed financial relationships with the imaging centers and began referring to them. As a result, payors witnessed a dramatic increase in utilization, especially in advanced modalities, which ultimately prompted the Deficit Reduction Act.”

A New Model

Over a 10-year period from 1993 to 2003, Memorial Hermann Healthcare System lost about 40% of its outpatient imaging business to privately owned freestanding centers. In 2004, recognizing its loss in the market, Memorial Hermann’s leadership made a strategic decision to actively pursue the outpatient imaging market. During the past 2 years, the 14-hospital not-for-profit system has reported a 20% annual growth rate in outpatient imaging services.

How did they do it? Memorial Hermann gained vital knowledge of the local market by bringing on board a leadership team with experience in retail outpatient imaging. When Polfreman and his team set about reengineering Memorial Hermann’s imaging business, they based their new centers on a franchise model and designed a business structure with expansion and scalability in mind.

“We knew that in order to be successful, we had to outperform the strongest of the independent freestanding competitors,” said Polfreman. “We also knew that we needed an organic structure that would allow for rapid growth and give us the ability to react quickly to changes in market dynamics. To achieve this, we set up the Outpatient Imaging Division as a separate business entity.”

Memorial Hermann’s Outpatient Imaging Division went beyond innovations in business structure to oversee the design and construction of the imaging centers themselves. “The trick is to build on what we have learned,” Smith said. “For years, we watched the out-migration of patients from hospitals to freestanding imaging centers because of ease of access and superior customer service. Mixing inpatient and outpatient imaging was a huge customer dissatisfier, with long waits due to unpredictable inpatient imaging needs and schedule interruptions caused by emergencies.”

Once Memorial Hermann identified attractive markets in Houston, the system’s Outpatient Imaging Division moved quickly to open freestanding imaging centers. “We threw out the traditional hospital imaging services paradigm and reengineered our centers with the total customer experience in mind,” Polfreman said. “We based our customer service model on successful retail chain stores and on the service industry. Any hospital or hospital system can use the same model and succeed.”

Advantages: Purchasing Power, Staffing

Hospitals also can reap rewards in the imaging business by taking advantage of their size and patient volume for greater leverage in negotiating their managed care contracts. “When hospitals renegotiate their managed care contracts, they’re negotiating their inpatient rates as well, which offers more leverage,” Polfreman said. In addition, surgical services and other hospital departments benefit from the effect of downstream revenues generated by hospital-owned imaging centers.

James Polfreman, CEO of the Outpatient Imaging Division of Memorial Hermann Healthcare System, based its new centers on a franchise model.

Hospitals have additional advantages on the equipment side. “We can share outpatient imaging modalities with our hospitals and gain price breaks on new technology thanks to volume purchasing power,” he added. “We’ve also realized benefits in recruiting staff members. Hospitals that operate several freestanding imaging centers can attract the best technologists by offering them more opportunities for advancement and more choices in work location than freestanding imaging centers can. Many employees prefer to work close to home.” In a departure from the typical hospital imaging business model, new hires at Memorial Hermann’s outpatient imaging centers are selected based on attitude first, then on technical skills.

Memorial Hermann recently opened its 10th freestanding full-modality outpatient imaging center, including MR, CT, mammography, ultrasound, and x-ray, backed up by a mobile PET/CT unit. All 10 centers operate in growing suburban markets with easily accessible locations, free parking, a spa atmosphere, and a strong focus on exceptional customer service. In addition, the centers’ geographical dispersion makes the health care system’s imaging business attractive to managed care companies. “Today, we operate facilities within 30 minutes of almost everyone in Houston,” said Smith.

The Outpatient Imaging Division’s success has been phenomenal in terms of business turnaround, and Polfreman and his team have been recognized internally with three Memorial Hermann President’s Awards for growth and operational excellence. The group also was recognized with the President’s Cup, Memorial Hermann’s most prestigious internal award for non-acute care hospitals, given annually to the division or business unit that epitomizes excellence and innovation in the health care system’s four key strategies: quality, growth, operational excellence, and the customer experience.

“The real silver lining in the DRA cloud is that hospitals are better able to monitor their quality than private freestanding imaging centers are,” said Polfreman. “Thanks to high patient volume, they can contract with skilled subspecialist radiologists, and they can afford to purchase the most advanced scanners by leveraging discounts gained through bulk purchases. In the end, this leads to better outcomes for our patients, which is our ultimate goal.”

Karen Kephart is a freelance writer and brand consultant in Austin, Tex. She specializes in health care and finance.