Martin Kleckner III

Once upon a time, not too long ago (the 1990s), investment capital seemed easy pickings. It appeared as though everybody (read, “everybody else!”) could throw together a business plan and get funded. All the old economics rules went by the wayside. Risk-adverse investor policies were supplanted by information technology’s version of a land rush for capturing new market share. With the stock market catapulting, all notions of risk as an inherent part of new ventures to be mitigated and managed seemed a thing of the past. That, however, was never reality. The truth has always been that decisions to invest capital are a discipline and those who spend the money do comply with strict laws of risk aversion.

Picture archiving and communications system (PACS) investment decision makers are likewise risk-adverse investors. Just as in the practice of medicine, there are decision rules, which a chief financial officer, chief executive officer, and the board of directors must commit to. Yet, like the science of medicine, a PACS, as a diffuse technology, has costs and effects dispersed throughout the health care enterprise. Justifying the spending of capital in an information technology venture such as a PACS wherein not all benefits are certain or measurable may render the final “go-no go” decision as somewhat an art as well as a science. The investors, as a result, acting like venture capitalists, are expected to abide by laws of risk mitigation that work in concert with their ongoing quest to optimize their system’s market value.

With that in mind, a PACS investment decision is certainly not based exclusively upon a cost justification analysis. Most PACS plans may be compelling and show promise under the auspices of cost justification, yet many may fail to win funding approval because the plan developers do not understand (1) what the CFO or the Board of Directors are looking for in their ongoing quest for health enterprise value and (2) what capital investment risks must be avoided or managed. So what do they need to see from a PACS plan and proposal in order to justify a decision to invest?

Mitigating Five Risks of PACS

Most health care executives look at much more than cost justification when considering investment. They, like venture capitalists (VC), generally work by specific decision rules. They apply these rules rigorously as they evaluate opportunities to add measurable value to the health care system while at the same time seek to mitigate all risks inherent with them. Available cash and capital sources are limited so their decisions have a direct and substantial impact on the future of the enterprise, not to mention their own personal livelihood. To that end, the PACS development and management team is expected to address specified areas of risk relative to their proposed venture, document how they will be handled, and why they should be trusted as the most credible persons to implement the project.

To begin with a foundation for how health care executives decide that a PACS project is worthy of investment, it is helpful to compare their decision process with that of risk-averse venture capitalists. In general, VC are reluctant to engage the following risks in start-up or early stage ventures.

  • Development: Can the product be developed?
  • Manufacturing: If it can be developed, can it be produced?
  • Marketing: If it can be produced, can it be sold?
  • Management: If the market will buy the product, can a profit be managed?
  • Growth: If the company is managed well, can it grow?

Citing a standard law of venture capital, only two of the above risks may be accepted per investment. The two risks that are typically acceptable are “marketing” and “management.” The development and production risks are borne by the entrepreneurs (or their angels). The growth risk is assumed by the investing public (or perhaps a corporate partner). Therefore investment capital is provided after product development and manufacturing risks have been eliminated.

A risk mitigation guidepost likewise applies the above law of risk aversion when health care executives are evaluating a PACS investment. The five risks are essentially the same except that I call “development” a more customized “PACS, Research, Design, and Development” to fit the intrinsic needs of the health care enterprise. Similarly, “Workflow, Cost Reductions, and Gains in Productivity Initiatives” replace “manufacturing” and “Market Development” is in lieu of “marketing.” The distinguishable characteristic, however, of health care executives (and the Board) as investment decision makers is that they are expected to take on all five risks.

The five PACS venture risks that must be mitigated are shown in Exhibit 1.

Because they must engage all five risks, health care executives must reach a level of confidence that the PACS team has accomplished all that it should to minimize and hold those risks in reasonable check. It is the responsibility of the PACS development team to bring them to that level of confidence as a condition for being funded.

Figure 1. The five risks of a PACS venture.

Risk 1: PACS Research, Design, and Development. Senior executives, as PACS investors, place a considerable amount of credence on the design and development plan. The plan is equivalent to a pilot’s navigation equipment or a ship captain’s nautical map. Their message is fundamentally, “if you don’t have a road map, don’t drive the car.” There are many reasons for this. The most important, all encompassing one is demonstration that the program has been well thought out, objectives have been carefully defined, the articulated value proposition is aligned with the health care enterprise’s mission, and the development team executing the program is the right one for the job. These requisites add much more to the decision equation than a market and financial analysis that measures costs and benefits and calculates a projected return.

The following are the basics of what is required by the Board and senior executives to help assure them that their risks at this stage are mitigated. By addressing the following questions, they can begin to believe that the right development team is in place.

  1. Explain where and why a viable opportunity exists for the PACS. Carefully delineate the health care enterprise’s hurts and needs relative to the provision of radiology services. Describe how and why a PACs will eradicate those hurts. A competently painted picture of current situations and outcomes will help the decision makers to know that you clearly understand the connection between problems being addressed and the solution being proposed. For a simple example, if scheduling ease, appropriateness of testing, or diagnostic accuracy are the target objectives, you may be hard-pressed to justify a PACS as the cost-effective solution.
  2. Provide a compelling road map and description of the future of the enterprise’s diagnostic imaging services. (Do not make a generic radiology business futures report; have it specific to your system and your market.). Include a comprehensive schedule (utilizing a tool such as project manager software) and a time frame for meeting key milestones. Portray a vision that the Board will embrace and own.
  3. Completely identify the resources needed to accomplish objectives and when they will be required.
  4. Delineate all development and program execution risks and then document how failure will be alleviated. Identify potential bottlenecks and problems that will affect development of the PACS. Present the best solutions for these possibilities.
  5. If the PACS program is presented as a means to compete with other health care systems, provide an analysis of how radiology services will be “faster, better, and cheaper” than the competition. Document also how cost savings (revenue gains, if appropriate), service benefits, and competitive advantage will be sustainable. Will investment returns be ongoing or limited?
  6. Describe the feasibility and viability of the PACS. Identify all prospective “fatal flaws” in the business model assumptions. Do not present the program in rose-colored glasses. Your credibility will be enhanced if you present a discussion of possible problems head on.
  7. Following on the above, discuss how your target customers, for example, referring physicians, have defined their requirements and have ownership of the solution. Documented endorsements are key. Their participation in design and development is equally vital. Testimonials of widespread buy-in in the form of written commitments to fully participate are convincing evidence of mitigated risk.
  8. Present empirical studies of other health enterprise PACS projects. Include documentation of actual conversations with the individuals responsible for design, development, and management of their PACS. Visit their sites if possible. Published benchmarks regarding the impact of PACS are scarce, but those that are available can provide a reasonable means to start a prospective assessment and value proposition.

PACS, like most information technology, is considered to be diffuse wherein it can impact the entire health care system and comprises several distinct elements that affect costs and produce an effect on services. Empirical studies of PACS investments throughout the United States, United Kingdom, and Australasia, for example, include analyses of PACS influence on the operations of ancillary departments such as the emergency department and intensive care. The findings, however, are not always consistent. Nevertheless, a pattern is developing whereby earlier studies presenting results of cost neutrality or even savings are being followed by later reports from different sites linking PACS to significantly increased costs. Categories of costs evaluated seem to be generic for most of the studies and thus may be useful as benchmarks. If nothing else, they may serve as an initial guideline for a careful delineation of all anticipated PACS operating impacts. Several good published articles present lists of impacts (both benefits and costs) that are typically contained in empirical studies.

Risk 2: Workflow Management, Cost Reduction, and Productivity Initiatives. How well do you and your team know the business of radiology? Can you transfer that knowledge to a program for resolving existing inefficiencies and reengineer for optimal operational return from the PACS?

A “pre-PACS workflow study” helps guide the implementation plan. A carefully developed proactive program to achieve economies of workflow, costs, and productivity contains baseline data and documentation of current operation inefficiencies. Both are convincing risk mitigation tools. Resolutions of inefficiencies and their economic value can be presented with the aid of detailed flowcharts. There are several qualified consulting groups that provide a good template for how to pinpoint saved steps and activity-based cost impacts. These comprehensive studies serve as effective cost justification analyses.

A financial projection of gained benefits and cost savings is not, by itself, sufficient to instill investor confidence. Very important to funding decision makers is convincing documentation of a carefully laid out program, founded upon the workflow study, to manage the attainment of business development and service objectives, cost reduction programs, and productivity enhancement initiatives. Because most PACS launches are relatively recent, available outcomes studies are not widely available. Thus it is best to develop a means to track cost savings and results relative to objectives on a periodic, ongoing basis. To that end, establish monthly and, after system credibility has been proven, quarterly key management sessions to review attainment of all pertinent milestones (internal and key customer: financial, market development, referring physician-specific, technical).

This process serves two fundamental purposes. It establishes a tool (such as a “balanced scorecard” approach) to enable process management progress including the proactive handling of all forecasted risks. It further provides a means for the Board to determine that the PACS team truly understands the business, and its vital work flows, that it has the capacity to actually deliver on its promises, and that it can react effectively to missed milestones or problems. Finally it establishes credible management checks on the projected financial return and the PACS team’s capacity to stay on track.

Risk 3: Market Development. Development of the PACS market is most effective when the stakeholders (ie, the radiologists and the referring physician community) have established ownership during the design and development process.

Physician acceptance of the product at launch time, despite the usual hiccups, should by extension be tantamount to a formality if precursor marketing and communication are managed properly. Exhibit 2 shows four tactical PACS development and execution areas that are important to market development. Relative to the four strategic “C’s” (the management team, the market, competitive opportunities, and channels of PACS/RIS communication that won the Board’s trust and money), the latter four “P’s” reward the investment and the risks taken.

The most crucial time of the four “P’s” precedes the PACS rollout. Favorable first clinician-customer impressions were hopefully made during the design and workflow study phases. Ownership and endorsements were generated throughout the system’s development. Early pre-launch participation of the target audience should have served as a jump start to the market acquisition process. Typically the best sales tools for physicians include references from their credible peers. Reacting to messages from them entails acts of trust in those who share their same issues and needs. Messages from most others may encompass more of an act of faith. The same goes for the Board as an investor. When luminary, credible referring physicians and radiologists within the PACS market are extensively involved in its design and development, that means the risk of the health care enterprise’s total market buy-in is reduced to a reasonable level.

The PACS should be positioned as solving the most vital problems facing the enterprise, the radiologists and the referring physician community (all being the PACS buyers). These problems will have been identified during the first two risk stages. The “buyers” should be generally homogenous in terms of the key problems defined and how they are being solved. By PACS launch time, the target audience should already be embracing the solution. Otherwise the management team faces the risk of having a black box providing a solution for no existing standard agreed-upon problem.

Finally the price of the PACS and its return (ROI) can vary depending upon how the PACS investment is financed. Payment options include a cash outlay, capital financing, and off-balance sheet techniques such as operating leases or rental. An additional means to fund a PACS encompasses utilization of an Internet-based application service provider (ASP). There are pros and cons to each as shown in Figure I.

Financing options are considered for several reasons such as the following:

  • There are insufficient funds for a cash acquisition and what is available is dedicated elsewhere for other purposes
  • There is a risk of changes in PACS technology and the health care system does not want to be locked into what is currently available
  • The health care system has a high level of debt and the CFO does not want to place additional assets and related debt on the balance sheet
  • Executive financial measures are tied to assets (such as asset turnover, ROA, and debt/capital) and key financial ratio indicators
  • Clinical revenue is fluctuating and market conditions are uncertain
  • The health care system must comply with restrictive covenants of current debt

To facilitate the decision on which finance vehicle to carry the PACS project, it is important to know the health care enterprise’s minimum required rate of return, a designated “hurdle rate” that must be achieved (based upon forecasted cash flow) in order to merit investment. This rate is usually based upon the health care system’s weighted average cost of capital (WACC). For most industries, the WACC is generally derived from how much a business pays in interest to service its debts and how much investors are compensated for placing their money with that business rather than somewhere else. For some health care systems, especially not-for-profits, the latter may reflect a blend of retained earnings and philanthropy.

The health care system CFO may establish a PACS hurdle rate to be the same return designated by the health care system to achieve its long-range plans, such as its rate of growth in retained earnings and endowments, and then add a premium factor for how risky the project is perceived to be. In most cases, this hurdle rate will exceed the WACC.

Risk 4: Management. Investors generally apply a basic formula to help them justify placing their money in a risky project. It is equally applicable to a PACS venture.

P X S X M = V

Where “P” is the PACS problem being solved (what and how big is it?), “S” is the PACS solution (expressly addressing the problem), “M” is the management team, and “V” represents the value of the PACS to the radiology, referring physician, and patient communities as well as the health care enterprise board making the investment.

The most important of the three elements delivering value depends on the decision maker’s perspective. Many will stipulate that the most important of the three components is the problem (P). The value of the PACS is equivalent to the size of the problem being solved rather than the solution itself. If there are no significant cost, productivity, or market problems (defined as the “hurt”), then a good PACS solution presented by an outstanding management team may not be perceived as being of great value. Investors place their money in pain killers not vitamins.

On the other hand, without an experienced management team possessing proven prior PACS start-up successes, optimal value (ROI) may be more difficult to ensure (hence greater risk). In fact, it should be considered the senior executive’s and the Board’s fiduciary responsibility to ensure that the PACS development and management team is the “best and brightest”. An ineffective team may be unable to keep the PACS program on track with its key milestones. A superior management team may be able to compensate for a less than optimal “S” by capitalizing on the product’s existing strengths and still achieve desired ROI. Having a PACS team with the “right stuff” helps mitigate risk.

Risk 5: Growth. If the preceding four risks have been managed properly, then the PACS should be in a position at this stage to benefit with an ongoing blend of “hard” and “soft” savings and benefits plus possible development of new radiology business revenue that had been targeted and managed from the program’s inception. From the investors’ perspective, it is important for the management team to continually measure and document all of these objectives as a matter of course, including any non-quantifiable ones.; The challenge to management is that PACS may not easily create measurable revenue and other benefits to cover operating or capital costs. Moreover, speculative revenue consequences correlating with new imaging capacity or anticipated growth in utilization as a result of PACS generated efficiencies may not have been accepted by the CFO or Board for inclusion in the cost justification argument.

Gains in marketable value and resultant utilization by ancillary sectors of the health care enterprise or the physician community may be realized by proactive programs and marketing. Some reports of PACS impact on the productivity of ER, intensive care, and OR are being published and may be amenable to benchmark studies. They may serve as templates for initiating similar market growth opportunities. Likewise, teleradiology, evidence-based medicine, and data mining programs for clinical research may be feasible given market capacity and data size, respectively.

PACS investment decisions are not based upon cost justification studies alone. To derive a value proposition that will motivate the health care enterprise’s senior executives and Board to invest, the PACS development team must structure and document a plan that is in alignment with the health care system’s investment strategies, mission, business objectives (such as market positioning), patient satisfaction, clinician needs, and capital structure requirements.

The management team, however, must accomplish all of this with a program that the Board is convinced will execute the plan with all prospective risks identified and proactively mitigated. The five key risks for which the investors will require concerted management attention to results are (1) PACS design and development, (2) workflow, cost reductions, and gains in productivity initiatives, (3) market development, (4) effective operations management techniques, and (5) growth strategies that enhance investment return. Senior executives and the Board can not be expected to invest until they are confident that these risks are as low as possible relative to desired return.

Martin Kleckner III is managing principal of La Costa Group LLC, based in Carlsbad, Calif, a multi-partner consultancy providing expertise in health care strategic planning, business development and operations management