Hospital Finances Operating Room Procedure Areas

Financing Medical Equipment: Purchase vs. Pay-Per-Use?

Innovations in technology have given us better and more powerful medical equipment but have also increased the cost of those devices. A reader recently asked when is it better to purchase medical equipment outright as opposed to pay-per-use financing? As always, the answer is… it depends.

When purchasing a high-cost piece of equipment outright, the hospital (or medical practice) either pays for the entire cost upfront or pays for it in installments. It is like buying a new car – you can either pay cash at the time of purchase or you can finance it over a period of a few years. A second method of acquiring that same piece of high-cost medical equipment is by a pay-per-use contract. In this acquisition model, the manufacturer lends the hospital the equipment for free and instead charges the hospital each time that equipment is used. There are situations when outright purchase is better and there are other situations when pay-per-use is better. For this post, I’ll use the example of a surgical robot but the principles apply to any high-cost piece of medical equipment. The total cost of a surgical robot system varies depending on model, price negotiation, and types of robotic arms used. But we’ll assume a fairly typical $2 million purchase price, $2,000 per operation consumables (eg, robotic arms), and $180,000 annual service contract.

First, create a pro forma

In hospital financing, a pro forma is a document that projects the total costs and total revenue from a proposed new service or piece of equipment purchase over time. Because of the high cost of a surgical robot, no hospital will purchase one just because a surgeon goes to the CEO and says the justification is “Because I want one“. Instead, the hospital is going to want to know whether in the long run the hospital is going to make money or lose money on the surgical robot. However, when I look at a pro forma, it is not just the dollars and cents that are important. There can be non-monetary benefits that can justify purchase of a surgical robot, even if the hospital is not going to make money on the robotic procedures. For example, shortened time in the operating room per surgical procedure, shorter patient recovery vs. non-robotic surgery, fewer surgical complications, improved patient satisfaction, attraction of new patients who prefer to have robotic surgery, etc.

When drafting a pro forma for outright purchase of a medical device such as a surgical robot, you need to look at all of the costs. This includes the purchase price of the equipment, the cost of consumables (such as the surgical arms that can only be used for a fixed number of surgeries), the cost of a service contract, and the cost of personnel. When possible, convert non-monetary factors into dollar-equivalents – for example, determine the cost per hour of an operating room and then include cost savings of a shorter OR procedure time with a robotic versus non-robotic operation. Conversely, if the robotic surgery will take longer than a non-robotic surgery, include this as a cost rather than a cost savings. The type of physicians and the types of procedures will need to be estimated. For example, if the surgical robot will be used by general surgeons, colorectal surgeons, gynecologists, urologists, and ENT surgeons then the relative costs of each of these different types of robotic surgeries needs to be included. Other costs to be factored in can include the cost of any building renovation required to accommodate the new equipment, the cost of training personnel to use the new equipment, the cost of insuring the new equipment, the cost of advertising the availability of the new equipment, etc. The service contract costs must be factored in as well. If a surgical robot is used 18 times per year and the service contract is $180,00 per year, then that works out to an expense of $10,00 per case. On the other hand, if the surgical robot is used 500 times a year, the expense is only $360 per case.

The revenue from a surgical robot will require an estimation of the volume of surgeries performed each year and the expected reimbursement. Reimbursement needs to be stratified by all of the different procedures that will be performed, for example, a robotic cholecystectomy vs. a prostatectomy vs. a hysterectomy. This can be pretty complicated because the reimbursement for an operation such as a cholecystectomy can vary depending on whether it is being paid for by Medicare, commercial insurance, Medicaid, or self-pay (note: self-pay usually translates to no-pay).

Central to a pro forma is the concept of depreciation. This is the expected number of years of life of that piece of equipment before you have to buy a new one. Medical equipment is often depreciated over 5 years. For example, a surgical robot that costs $2 million to purchase and is expected to last 5 years can be depreciated over those 5 years at $400,000 per year. In this example, the pro forma should include tables for each of the 5 years of depreciation. If the hospital projects doing 500 robotic cases per year, then the capital equipment costs would be $800 per case ($400,000 per year ÷ 500 cases per year).

Once you create a pro forma for outright purchase, you then need to create a pro forma for pay-per-use financing. Include all of the costs and revenues you used with the outright purchase pro forma but instead of equipment cost depreciated over the depreciation period (eg, 5 years), include the total annual pay-per-use costs over those 5 years. It is essential to clarify whether servicing the equipment is included in the pay-per-use contract. Usually it is but if the hospital is required to purchase a separate $180,000 per year service contract, then the financial advantages of pay-per-use acquisition can disappear.

Hospitals are unique environments compared to business and manufacturing. Proposals for capital equipment purchases should not be finalized until they have been evaluated and approved by the biomedical engineering department, the infection control department, the staff responsible for structural engineering, radiation safety personnel, etc.

Variables affecting the decision to purchase outright vs. pay-per-use

The decision of whether to buy a piece of medical equipment or pay-per-use is much more complex for a hospital than the decision of whether to acquire a piece of manufacturing equipment by outright purchase or pay-per-use for a factory. There are variables that are inherent in healthcare that do not exist in manufacturing and these variables can have a profound effect on how to pay for a new medical device. Here are some of the variables that the hospital must factor in to the decision-making process.

  1. The number of physicians who will use it. If only one surgeon or one physician group will use a piece of equipment, then there is the risk that if that surgeon or group leaves the hospital to practice elsewhere, then the hospital could be stuck with an expensive device that just gathers dust in a closet. Just like it is risky to put your entire retirement investment portfolio in a single stock (as opposed to a mutual fund), it is risky to base the entire pro forma on the equipment’s use by just one physician.
  2. The number of specialties that will use it. In the example of a surgical robot, it is far better to buy a robot that will be used by general surgeons, cardiothoracic surgeons, urologists, ENT surgeons, and gynecologists rather than just one of these specialties alone. This ensures that the device can be used every day, Monday through Friday, all year. This overcomes specialist slow downs due to medical conferences, outpatient clinic days, procedure seasonality, etc.
  3. The hospital’s cash flow and budget. A $2 million purchase for a surgical robot can wipe out most of a small hospital’s annual new equipment budget. If the hospital lacks sufficient cash to purchase an expensive piece of equipment, then a pay-per-use model may be preferable since there will be an immediate return on investment. Otherwise, it could take several years of use to generate enough revenue to cover the cost of outright purchase.
  4. Anticipated volume. If you anticipate a relatively low procedure volume each year, then it could take many years before you recoup your return on investment for the purchase and you’d be better off with the pay-per-use model. The more procedures you can do, the more likely you will be better off purchasing equipment outright.
  5. Expectation of a new model in the near future. Medical equipment manufacturers usually keep dates of release of new models of their equipment secret until the last minute (sort of like Apple staying mum about new iPhone models until they are ready to be released). Nevertheless, a little detective work can give you an idea of whether a new version is on the future horizon. If so, you are often better off with pay-per-use initially and holding off on purchasing until the new model comes out. This also holds if you would be happy with the older (current) model since manufacturers will generally discount them to clear out their inventory once a new model comes out. The surgical robot model costing $2 million this year might drop to $1.5 million next year when the next model is released.
  6. Commitment by the physicians. I got burned several years ago when our gastroenterologists insisted that we needed to start doing endoscopic ultrasound pancreatic biopsies. We spent a half million dollars on new endoscopic equipment that could only be used for those procedures and also invested in cytology telemedicine so that cytopathologists at another hospital could read the needle aspirates real-time during the procedure. Five years later, the gastroenterologists had not done a single endoscopic ultrasound procedure at our hospital and we basically wasted the money. If there is any uncertainty about whether the doctors will use the equipment, then a per-use model (at least at first) is preferable until the doctors prove that they will actually use it.
  7. Procedure payer mix. A manufacturing company can determine the price it will charge for a product and base it’s pro forma on just one sales price. In medicine, however, the hospital gets paid different amounts by different payers for doing any given procedure or service. This means that creation of an accurate pro forma requires the hospital to not only project the total annual volume of procedures to be performed with a new device but also the projected payer mix for those procedures and the financial margin for each payer. Reimbursement from Medicare and Medicaid is fairly easy to project since they are fixed by CMS. However, each commercial insurance company will reimburse different amounts for any given procedure, depending on the hospital’s negotiated contract with that insurance company. Imagine the complexity of a manufacturer who projects that by installing new factory equipment, it can make and sell widgets. But sales contracts dictate that 30% of customers pay $10 per widget, 15% of customers pay $5 per widget, 25% of customers pay $18 per widget, 15% of customers pay $27 per widget, and 15% of customers don’t pay anything and get their widgets for free. In general, per-procedure hospital reimbursement is highest for commercial insurance, a bit lower for Medicare, lower still for Medicaid, and negligible for self-pay. We once had a surgeon who specialized in surgically implanting very expensive medical devices. When we did the initial pro forma, it looked like the hospital would net a small profit each year on the procedures. But after a couple of years, we noticed we were losing tens of thousands of dollars. It turned out that the surgeon was performing implants on commercially insured patients at a private hospital in town and only operating on Medicaid and self-pay patients at our hospital.
  8. Non-monetary benefits. The decision of whether to purchase a piece of equipment outright or utilize a pay-per-use financing should not depend solely on the expense vs revenue columns on a pro forma. There can be non-monetary benefits that the hospital may value, even if the new equipment does not increase revenue. These can include attraction of new patients, improved patient satisfaction scores, reduced mortality, reduced complication rates, shortened operative times, etc. It is also important to keep the doctors happy because if the physicians really want to use a new piece of medical equipment and the hospital won’t buy it, those physicians will leave to go practice at another hospital that will buy the equipment. In this case, a pay-per-use acquisition model may allow the hospital to keep the doctors happy while eliminating or at least minimizing financial loses.
  9. Connectivity. In an increasingly electronically interconnected world, the ability of medical equipment to connect to the monitors, electronic medical record, scheduling software, and billing software is essential. If there is concern about electronic compatibility, then pay-per-use might be a better option until optimized connectivity issues can be resolved.

The bottom line: its complicated

All too often in hospitals, the person who is the most eloquent, loud, or otherwise persuasive is the one who most heavily influences purchasing decisions. And this person is usually a powerful, silver-tongued physician. The hospital’s best defense against undue influence is the requirement to create a pro forma. This can guide the hospital about whether it is better in both the short-term and the long-term to purchase an expensive piece of equipment outright or utilize a pay-per-use acquisition model. One hospital may find that outright purchase is preferable whereas another hospital in the same town may find that pay-per-use is preferable. An accurate and well thought out pro forma is like a vaccination against future regret. No big-ticket equipment purchase should be put on the hospital’s final annual budget without one.

March 12, 2024

By James Allen, MD

I am a Professor Emeritus of Internal Medicine at the Ohio State University and former Medical Director of Ohio State University East Hospital