Expectations for Payback

Posted on March 9, 2012

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I was prepared to launch into an exhaustive study on return on investment, internal rate of return and net present value in regard to internal facilities projects and whether they are worth the investment. But hospitals have CFOs for that. Instead, the crux of this discussion centers around expectations for money spent.

Hospitals pondering a capital project consider two types: those that add to the hospital’s infrastructure and those that improve existing infrastructure. Additions might encompass an expansion or new clinic. Improvements might include department renovations or energy performance enhancements. The two are not equally measured, however. Hospitals will often embark on new construction more liberally than spend even half that amount to upgrade existing facilities. Is it because benefactors do no line up to donate for commissioning or systems replacements?

A recent survey of hospital facility directors showed that 32% expect payback of an energy initiative project within two years, and 30% more expect payback within three. Only 38% are willing to wait four or more years for a total project payback.

This can be a high hurdle to overcome. Capital projects for new construction involve 30 years of debt service, often at millions of dollars per year. Yet internal energy improvements are somehow not worth the effort if cost is not recouped in a few years?

I visited a 400-bed independent community hospital and learned its electric bill for just the main hospital building was $229,000 a month. That comes to almost $2.75 million a year, excluding outbuildings and satellite facilities.

Just this month, the American Society for Healthcare Engineering (ASHE) recognized four hospitals for outstanding energy savings in the Energy Star program. Two hospitals reduced energy consumption by 15% over a 12-month period, and two hospitals, St. Francis Eastside (Greenville, SC) and Aurora Medical Center (Oshkosh, WI) saved an impressive 20%. We know more even more is possible.

If the hospital I visited could save 10% of its electricity costs, which is a worthy achievement, we can reverse-engineer a project budget of $744,708 to achieve those results within three years. Honestly, I am not sure how far that will go in an efficiency project.

A hidden benefit is the “compounding” effect of energy savings: the savings do not expire, but continue on because they lower the entire facility baseline into the future. Also, energy savings through a technology or infrastructure project can work independently of operations (without a change in behavior required by a third party like a technician, nurse or physician), making it far likely to realize.

And much like a lean initiative, the increased efficiencies are achieved immediately and benefits seen every day. Unlike a capital project, which takes significant investment upfront (physical infrastructure, staff, equipment) in the hopes of earning more revenue over time based on favorable operations and billing, an energy project is direct savings to the bottom line. One dollar saved in operations is equivalent to anywhere from $5 to $25 of gross revenue depending on which source you believe.

The federal government expects energy prices to increase 2x-4x over the next 25 years. Based on impending inflation and recent oil price creep, even 4x seems to be a conservative estimate. Energy shortages aside, it might make strategic sense for hospitals to reassess the state of their central plants and systems infrastructure. Scrutinize all possible improvement efforts on the table to reduce energy needs. Then give your CFO and COO a call to see if there is a palatable payback plan somewhere between the two and 30 year extremes they will accept. It is time to adjust expectations for improvement projects.

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