Gary Bentham, CFO of Bartlett Community Hospital, is preparing for contract negotiation with his largest nongovernmental payer, Antrim Healthcare. Antrim currently accounts for approximately 30% of all patient-care revenue at Bartlett and this percentage is growing. The current contract has been in force for 3 years and expires on June 30 of this year. Gary has given Antrim the required 180-day notification of his intent to terminate but is alarmed by the position taken by Antrim's chief negotiator, Alice Mullins. Alice has told Gary that Antrim is unwilling to increase its present payment schedule beyond 5%. Currently Antrim pays for inpatient care on a diagnosis-related group (DRG) basis using the relative weights employed by the centers for Medicare and Medicaid Services (CMS). The base payment for a case with weight of 1.0 is $4,800. Gary knows that Medicare currently pays the hospital $6,500 for a case with a weight of 1.0. While the outpatient payment from Antrim is more reasonable, Gary is concerned about the hospital's long-term financial position if the Antrim inpatient rate cannot be increased substantially.

Alice has told Gary that she believes the current inpatient rate is reasonable because Medicare patients are much more resource intensive than Antrim's younger patient population. To test this hypothesis, Gary compared the average charge by DRG for Medicare traditional patients and Antrim's patients. Gary was amazed at the similarity when the data analysis was completed. He discovered that on average an Antrim patient consumed 94.5% of the resources of a traditional Medicare patient. Gary further concluded that because the average cost of a traditional Medicare patient with a case weight of 1.0 was $6,200, he would need a payment of $5,859 (0.945 x $6,200)from Antrim to break even. If Alice is serious about their maximum rate increase of 5%, then the best rate that Gary could expect would be $5,040 (1.05 x $4,800), which is well below his estimated cost.

Even after Gary shared his cost analysis with Alice, Alice remains firm in her position. The best inpatient rate that Antrim will offer is $5,040. Alice has told Gary that any rate higher will compromise Antrim's market position and either destroy its margins or lead to a loss of market share.

Gary must now determine what position his hospital system should take with Antrim. He knows that his system controls about 40% of the capacity in their market, with the remaining 60% controlled by a competitive system. Both systems have some excess capacity, but that excess capacity has narrowed in the last few years as both hospitals have purchased smaller hospitals and consolidated them into their operations. There are also two major health plans that compete with Antrim. Both of these plans as well as Antrim have contracts with both systems. Gary knows that his present rates of payment from the other health plans are higher than Antrim's. He is also fairly certain that Antrim's rate of payment to his competitor is higher than their rates of payment to his hospital system.

Gary is attempting to answer the following questions before his next scheduled meeting with Alice. What is his marginal or incremental cost for the Antrim book of business? Could his competitor handle his present Antrim volume and at what cost? If Gary's system were not in Antrim's network, what percentage of his present Antrim volume would he retain? These issues and others are central to his negotiation posture with Alice and have profound implications for his hospital system.