Laying a strong economic foundation for new hospitals

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Laying a strong economic
foundation for new hospitals

Laying a strong economic foundation for new hospitals kanvic.com
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Laying a strong economic
foundation for new hospitals
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While the market for healthcare services in India is large and
growing, many examples of empty or unprofitable hospitals
indicate that despite the opportunity, success is not guaranteed. To
lay a strong economic foundation for new hospitals, promoters can
first articulate their vision and then put it to the test.
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by Ravindra Beleyur and Vlad Flamind
 
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The Indian Healthcare market is
characterised by a vast and persistent
gap between supply and demand. Over
the last decade a tremendous number of
hospitals have been opened across the
country in an attempt to bridge this gap.
Many of these ventures have been
successful in addressing the needs of the
patients and in rewarding investors with
healthy returns. However, failures have
also been plentiful. Numerous hospitals
have failed to achieve profitability,
showing that despite the enormous
opportunity, success in not guaranteed
in the Indian Healthcare sector.
Ravindra Beleyur (ravi@kanvic.com) is a director and confounder at Kanvic where he leads Corporate
Finance practice. Vlad Flamind (vlad@kanvic.com) is an associate consultant working in Kanvic’s strategy
practice between India and Europe.
If healthcare leaders are to invest in new
hospital ventures with confidence, it is
important that they are aware of the
common pitfalls related to setting-up
new hospitals. Furthermore, by
conducting thorough strategic and
financial assessments, they can lay a
strong economic foundation which
increases the future returns and
mitigates the potential risks.

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The rapid growth of the Indian
population is itself contributing to the
increased demand for healthcare, but
t h e r i s e i n c o n s u l t a t i o n s a n d
hospitalisations is also driven by
increasing affordability, patients’
changing lifestyles and their evolving
perceptions of healthcare.
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Patients are able to spend an increasing
a m o u n t o f t i m e a n d m o n e y o n
healthcare thanks to improving income
levels, better availability of insurance,
a n d s c h e m e s s u p p o r t e d b y t h e
Government.
The opportunity for growth in the
Indian healthcare market is
tremendous
There is an immense need for additional
hospitals in India to improve coverage
and relieve overcrowding in existing
facilities. Today, there are about 1.6
million hospital beds available across the
country. To meet the most basic
international standards, India should be
equipped with at least 3 million more. In
this context, the opportunity for Indian
and international hospital promoters is
substantial. Demand is vast, largely
untapped, and continually expanding
(Exhibit 01).

 
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At the same time, the clinical profile of
patients is changing with increasing
morbidity from non-communicable
diseases such as diabetes, hypertension,
or injuries caused by traffic accidents.
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Demand is also driven by changes in
patients’ perception of health and
healthcare. Indian patients now have a
better awareness of the risks associated
with their condition, and of the capacity of
allopathic medicine to treat them. They
are becoming less inclined to restrict their
hospital visits for extreme cases, or to
postpone them until pain becomes
unbearable. The net effect of all these
changes is that more patients are seeking
medical care, and tend to visit hospitals
more often.
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New hospital promoters need to
clarify and test their vision before
making any investment
Doctors and hospital leaders are well
aware of the opportunity and do not lack
the ambition to seize it. Most of the time,
they also have a solid set of strengths
they can rely on to set-up successful
hospitals. After many years in the market,
they benefit from a base of loyal patients,
an established reputation, as well as a
network of doctors and potential
financiers that could play key roles in
their expansion plans.
!
However, confidence in one’s capabilities
and in the market opportunity tends to
generate a bias for hasty action.
As a result, the focus of many
healthcare leaders often jumps to
acquiring land and premises, building a
team of medical specialists, and securing
finance for their project. All of this is
necessary, but two fundamental
q u e s t i o n s s h o u l d b e a d d r e s s e d
beforehand: 1) What type of hospital
could be successful in this location? 2)
What returns can be expected from such
a project? Leaving these questions
unanswered can result in leaders and
promoters making critical decisions in
the dark.
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To make the right strategic and financial
decisions, healthcare leaders can follow
an iterative process based on defining,
testing and refining their project. They
should start by translating their vision of
the new hospital into a well defined
concept. This concept should be shaped
around a set of critical elements
i m p a c t i n g i n v e s t m e n t , r e v e n u e
generation and cost structure, and which
will be used to draw-up a business
model. Once the business model is built,
it should be subjected to a series of
tests to ensure its economic viability and
financial attractiveness. Investment and
set-up should only start when the tests
show the green light. If the tests are
negative, the concept must be revised
and assessed again (Exhibit 02).

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Healthcare providers need to look at
five major elements to define a
hospital concept
A hospital concept can be articulated
around five major elements (Exhibit 03):
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1- Location
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Expressed in terms of city, district or
precise location - if already available -
the location is an essential component of
the concept. It frames the strategic
playing field - or catchment area - by
narrowing down the patient population,
as well as the hospitals to be considered
as competitors. It also has a direct
impact on the investment or rental costs
the hospital will absorb.
2- Patient profile
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Within the considered catchment area,
specific groups of patients should be
identified as targets. This can be done
by analysing the clinical and non-clinical
profiles of the population. Potential
patients can be grouped into categories
based on their place of residence, age,
socio-economic class and insurance
coverage or by estimating disease
incidence and hospitalisation rates. At
this stage, the analysis aims to provide
an indication of the local demand for
specific healthcare services.

 
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3- Scope of services
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With an understanding of the local
market context, the services to be
provided by the planned hospital can be
better defined. The scope relates to the
medical specialities covered and the
depth at which care will be provided.
These elements will in turn drive the
type of beds, equipment, and medical
staff required in the hospital.
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4- Scale
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Scale is determined by the number of
beds installed and by the size of the
facilities. It is a critical part of the
concept because it has a major impact
on the initial investment and cost
structure. This is mainly through the
equipment, land and building, and
human resource the planned hospital
will require.

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5- Level of amenities
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A hospital’s level of amenities contribute
to creating a unique experience for the
patients as well as their visiting
relatives. Their experience is shaped by
a number of elements ranging from the
layout and appearance of the premises
to the type of non-medical services
a v a i l a b l e . I n d i a n p a t i e n t s a r e
increasingly seeking value outside the
purely clinical side of healthcare;
convenience, prestige, and comfort now
play an important role in their decision
m a k i n g p r o c e s s . B u t s e e k i n g
differentiation in these areas also
generates additional costs, making
amenities a central part of a hospital’s
concept.
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Once the five elements of the concept
are defined, their coherence must be
verified. For example, the pricing levels
and the scope of services should match
the clinical and socio-economic profile of
the population in the desired location.
Both of them should also be calibrated
with regards to the existing competition
in the area.
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Similarly, the scale must be large
enough to offer the desired scope of
services, but not so large that it
p r e v e n t s a c h i e v i n g a h i g h b e d
occupancy rate. In this way all the
elements of the concept must be
analysed in relation to each other. This
assessment for coherence must be
thorough and should be used to refine
the initial concept.
The hospital concept must be
translated into a business model
When the concept reaches a coherent
shape it can be translated into a
business model expressed around three
metrics: investment, profitability and
value. This step is critical because a
coherent concept may not necessarily be
viable from an economic and financial
standpoint.
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Investment
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Investment requirements for a hospital
can vary depending on two alternative
options (Exhibit 04). The first is the
asset heavy option, in which substantial
investment is directed to the acquisition
of land, premises and equipment.
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The second is the asset light option, in
which these investments are made by
other partners. Instead of owning land,
building and equipment, the main
promoters choose to rent or lease them,
effectively treating them as costs. Going
for the asset light option can easily
enable over 50% reduction in the initial
investment required, shortening the
payback period substantially. However,
renting or leasing also comes with
certain disadvantages including: the
inability to benefit from accruals in land
value, or the potential need to share
equity in compensation for the
contribution from the real estate
investor or other partners.

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Profitability
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To estimate profitability the cost
structure required to run the particular
hospital concept and the potential
r e v e n u e g e n e r a t i o n s h o u l d b e
understood. Estimating profits is a
delicate step that should always be
anchored in reality. To avoid the trap of
wishful thinking it is necessary to study
how hospitals located in the same
region, as well as hospitals sharing
comparable concepts have performed
historically. A critical variable that ought
to be approached conservatively is bed
occupancy. Generally, after a hospital is
set-up, it takes 3 to 5 years to reach a
healthy and stable occupancy rate.
Value
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The last element to include in the
business model is valuation. Based on
investment and profitability estimates,
the value of the planned hospital can be
derived. This measurement is necessary
to determine how much each promoter
should contribute to own a given stake
in the project, as well as to establish the
optimal distribution of equity between
partners.

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The business model needs to be
tested to determine project
attractiveness
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Once the model is built, the viability of
the concept can be tested both
financially and strategically. If the tests
are negative, the concept must be
refined. If positive, investment can be
considered.
Financial test
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The financial test revolves around a set
of questions aimed at assessing the
attractiveness of the investment
(Exhibit 05).
The investors must first decide if they
are willing to commit the funds required
for the hospital set-up. They must then
determine whether the project can be
financed with an acceptable amount of
debt and external equity, and whether
the distribution of shares is in line with
their expectations.
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Finally, they must establish whether the
expected returns are satisfactory. If the
required investment seems too daunting
a prospect, unfavourable to their long-
term interests, or insufficiently
attractive, the concept must be revised.

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Strategic test
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If the financial test is positive, the
concept can be submitted to a final
strategic test (Exhibit 06). This last
stage will determine whether the
concept is fit for the realities of the
market by answering two questions: 1)
Is the concept what the market needs?
2) Is the leadership team capable of
successfully running the hospital?
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Answering the first question requires a
deeper understanding of the supply and
demand situation in the catchment area.
This understanding should be both
quantitative and qualitative to best
evaluate the assumptions made when
projecting the revenues of the business
model.
On the quantitative side, the disease
incidence and hospitalisation rates of the
target population should be compared
with the existing supply of beds, medical
specialists and services in the area. This
is required to ensure that the new
hospital has the scale and scope to fill
the right gaps in demand. On the
qualitative side, existing hospitals in the
region should be visited and their
patients observed and interviewed. Key
areas to investigate include the target
patients’ inclination and capacity to pay
for healthcare, their preference for
certain hospitals, and the key elements
that influence their decision making.
This on-the-ground knowledge is critical
to understanding whether the new
concept would be appealing to local
patients.

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If the concept is indeed aligned with the
market needs, the very last question to
address is the one of leadership. When
setting-up a new hospital, entrepreneurs
often go for bigger facilities than the
ones they have been running in the
past. What is important to realise is that
the challenges of leading a 200 beds
hospital are quite different from those of
a 50 beds facility. The transition requires
a shift in the way leadership is
exercised, and in the type of people
needed to take-on key positions.
Managing the entire operation single-
handedly is no longer possible when the
hospital scales-up. A leadership team
has to be formed, information must be
shared, decisions delegated and power
distributed.
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Before investing in a new hospital this
team must be identified and aligned with
the project’s objectives.
If the lights turn green, investment
can be considered with confidence
If the tests are positive, investors can
proceed with confidence. The hospital
concept has an economically sound
business model, and the prospects for
success in the market are high. Action
can be taken to plan the hospital
construction, approach external lenders
and investors, and bring doctors and
other key stakeholders on-board. Also,
the knowledge gained while building and
testing the concept will promote unity
around the vision and clarity in
execution.

Building successful hospitals Kanvic .com
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About Kanvic
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Kanvic is a management consulting firm helping businesses develop winning
strategies, drive profitable growth and achieve operational excellence
to reap long lasting rewards in the fast growing Indian economy. We work
with C-level executives to develop innovative solutions for the business
challenges of 21st century India by bringing in leading edge management
thinking informed by in-depth research and sound analysis.
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Laying a strong economic foundation for new hospitals

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Laying a strong economic foundation for new hospitals