Quincy Heil is the chief financial officer for General Hospital, located in Port Chester, New York. General Hospital currently is experiencing some financial difficulties because of the pricing pressures created by Health Maintenance Organizations (HMOs) and Medicare. Quincy believes that aggressive cost management is the only way to improve the hospital’s financial performance as there is little room for increasing prices or patient volume. Based on a detailed cost study, Quincy estimates that the per-patient variable cost per hospital-day equals $125. (This cost excludes the cost of any tests, medications, procedures, and other professional services.) Quincy wants the hospital to reduce the average patient length of stay (LOS) from 1.8 days to 1.5 days. Given the current annual volume of 10,000 patients, this would save the hospital 3,000 patient days. In addition, hospital revenue would not be affected because payments are based on the episode (i.e., reason for visit) and are not directly linked to length of stay.

When presented with this plan, the hospital’s chief of staff concurred with the cost savings but pointed out that any pressures to reduce LOS would inevitably lead to some patients being discharged earlier than is optimal from a medical perspective. Early discharge increases the risk of patients not fully recovering and experiencing added complications and discomfort. In short, the chief of staff estimates that reducing the LOS from 1.8 days to 1.5 days will increase the readmission rate (admissions within 30 days of discharge) from 2% to 4%. Based on the current annual patient volume of 10,000 patients, this amounts to about 200 additional patients per year.

In his response to the chief of staff, Quincy pointed out that readmissions typically qualified as a new episode and triggered a new payment from the insurance company or Medicare. Moreover, Quincy indicated that, on average, insurance companies and Medicare pay the hospital $500 per readmission, whereas the hospital’s total incremental costs associated with increasing the readmission rate to 4% were likely to amount to $50,000. The chief of staff, clearly disconcerted by Quincy’s analysis, has decided to raise the issue with you, the hospital’s chief executive officer.

Required:

As General Hospital’s chief executive officer, the decision to reduce length of stay is ultimately your call. What would you do? By how much is hospital profit expected to increase if you decide to reduce length of stay? What other factors are important in this decision?