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Is Cost-per-case Leasing for You?
What leasing programs based on case volume or consumable purchases mean to you.
Dianne Taylor
Publish Date: October 10, 2007

Surgical equipment leasing is more complex than ever. It used to be that you agreed to a fixed monthly payment for a fixed term. Now, you're faced with leases that offer different monthly payments depending on how many cases you do, consumables you buy, or both. Read on to find out if these newer programs make sense for you.

Cash or lease?
The first question is whether leasing makes sense at all. Cash purchases are often better for a facility's long-term financial health because they offer the significant tax benefit of depreciation. For example, if you buy a $200,000 piece of equipment, you may be able to deduct up to $160,000 in the first year if you meet certain IRS requirements, says David Odell, CPA, president of MedBridge Development, LLC, a surgery center/medical facility development company in Santa Barbara, Calif. The only write-offs resulting from most leases are the lease payments, as the vendor still owns the equipment and takes the depreciation. Plus, cash can mean leverage. "I generally find that I can negotiate a better deal with reps when I'm talking cash," says Mike Pankey, RN, MBA, administrator of the Ambulatory Surgery Center of Spartanburg (S.C.).

Lease payments can also reduce a center's profitability and any resultant income distribution to partners, says Shannon Marie Smith, financial healthcare consultant with the Rush Group, LLC, because they are operating expenses.

To compare the feasibility of lease versus cash, have your accountant assess the tax considerations and perform a net present value (NPV) analysis, which converts future lease payments into present dollars (see "Sample Net Present Value Analysis" on page 62). This is important because inflation erodes the buying power of the dollar while money that's invested can grow in value.

Sample Net Present Value Analysis

Cash Outflow

Cash Purchase

Consumable Agreement

Year 1

$55,000

$20,000

Year 2

$20,000

Year 3

$20,000

Net Present Value at 12%

$55,000

$48,037

Key:
1. Cash purchase price of equipment: $55,000
2. Market price for consumables: $45
3. Contracted price for consumables: $55
4. Minimum annual consumable utilization: 2,000 units
5. Discount rate: 12 percent

You agree to pay a $10 markup, or equipment fee, for 2,000 consumables a year for three years. This means your equipment leasing cost is $20,000 per year. Your board requires 12 percent as the minimum internal rate of return on its investments; this is the "discount rate." The mathematical formula for applying the discount rate is fairly complex and not shown. Under this scenario, the consumable agreement would appear to be more favorable. However, your accountant must also consider the tax implications of each scenario; tax benefits are usually accelerated when you make a cash purchase.

Example courtesy David Odell, MedBridge Development, LLC.

Factors to consider
Still, cash isn't always king because much depends on your circumstances. Importantly, your facility may face an excessive cost of capital or lack access to capital altogether. For example, says Mr. Odell, if your cash comes from investors who are expecting a 30 percent rate of return, it may behoove you to consider a leasing program that offers a 10 percent lease rate. Adds Mr. Odell: "Physicians aren't as cash-rich as they used to be, their appetite for risk is lower and it's harder to get capital."

In addition, some hospital department managers lease equipment precisely because payments come out of their operating budgets, enabling them to make their own equipment decisions and avoid time-consuming capital-expenditure approvals. Cost-per-case leases, in particular, can make it easy to categorize these expenses as operating expenses.

Still, before jumping into a cost-per-case or consumables-based lease, experts recommend considering these factors:

  • Volume. With cost-per-case leasing, volume is key. "Will you use the equipment for lots of cases, or will you use it every now and then?" asks Ms. Smith. "If the latter, per-case leasing makes sense because it enables you to get equipment you could not otherwise afford." Nancy Burden, RN, MS, CAPA, administrator of the Trinity Surgery Center in New Port Richey, Fla., chose this option when one of her surgeons wanted to do a couple of radiofrequency denervation procedures for back pain per week at one site. "We couldn't cost-justify a purchase and capital was tight, but we had important reasons for working with this surgeon and his patients," she says.

When case volume grows beyond expectations, however, cost-per-case programs become less attractive, as the monthly equipment expense grows along with the caseload. This prevents your center from realizing the higher profit margin that could result from the higher volumes under a fixed equipment-expense scenario (see "A Matter of Volume: Cost-per-case vs. Operational Leasing" on page 64).

  • Community standing. Vendors sometimes use leasing, including cost-per-case or consumable-based programs, to install state-of-the-art equipment in a facility at very little cost - especially if you have high-profile physicians who speak at national meetings or your center is in a desirable market. "When vendors want to use your facility as a kind of showcase for new technology," says Mr. Odell, "they may make you a deal you can't refuse."
  • Need for flexibility. Leasing agreements that commit you to a certain volume of consumables lock you into one product line, and this can be good or bad. According to Steve Sheppard, CPA, with the Springfield, Mo.-based Medical Consulting Group, vendors may offer price concessions because the agreements protect their business at your facility. In addition, if market prices rise the following year, you'll be protected, but if market prices decline, you might not be able to take advantage of them.

The same concern holds true for technology. If a consumable undergoes rapid technological change and the new technology comes from another vendor, you may not be able to take advantage of it. For this reason, consider what your vendors have in the pipeline first. "The inherent risk is that you lose flexibility of choice, and this can be problematic when surgical preferences, surgeons or technology change," says Dick Minors, vice president of sales for Bloomington, Minn.-based Midwest Surgical Services, Inc., which offers a mobile cataract equipment service.

Use your leverage
Experts say the competitive nature of the surgical equipment business means there are fewer hard and fast rules, leaving room for negotiation. Some tips:

  • Open the bidding. "When physicians are genuinely willing to use the products of more than one vendor and make that known, this tends to have a positive effect on pricing," says Mr. Sheppard. "But if everyone thinks your mind is set on one vendor, other bidders are less likely to make an aggressive proposal."
  • Determine cost of funds. Typically, vendors are loath to let you know how much they'll profit from leasing deals. But, says Mr. Odell, you have every right to know. "I usually ask my sales people to get the percentage over cost they're asking me to pay," he says. "This is known as their cost of funds, and it will let you negotiate a fair deal."
  • Know your case costs. Before entering into a cost-per-case lease, know your case costs cold. "Be sure your average revenue from payers will cover the equipment costs," says Ms. Burden. "You may need a carveout from your usual managed care contract."
  • Define "procedure." Before agreeing to a cost-per-case lease, be sure your equipment payment is based on case volume, not procedure volume. Otherwise, warns Caryl Serbin, RN, BSN, LHRM, president of Surgery Consultants of America, you could get billed for secondary procedures.
  • Estimate case volume carefully. Some vendors no longer track exact case volumes under cost-per-case programs. Instead they agree to a volume estimate and issue a monthly invoice based on this estimate. If this is your vendor's approach, estimate conservatively so you don't get caught with a high monthly equipment expense when case volume fluctuates downward.
  • Cap consumable prices. Cap consumable prices for the duration of any agreement in which you commit to buy these products. At the very least, Ms. Burden advises capping the escalation to no more than 3 percent to 5 percent. Better yet, Mr. Odell says he negotiates a zero escalation. "There is a certain assumption that you will get used to their shavers or other products," he says, "and if they bump up prices at the end of the agreement, you'll be willing to pay."
  • Don't overbuy consumables. "Commit no more than 75 percent to 80 percent of historic consumable volume to these agreements," advises Mr. Sheppard. Mr. Odell warns that the vendor may in turn threaten to increase your markup, or equipment premium, on the products. "But," he says, "it depends on how badly the vendor wants to get the equipment in." And if consumable volume falls below your commitment level, you'll be obliged to purchase products you don't need or pay out the difference.
  • Get a fair buyout clause. Don't sign contracts without reading the fine print, says Mr. Pankey, because you could get wooed by great pricing up front without realizing that there is a significant buyout at the end. "When all is said and done, pay no more than 10 percent to 20 percent over the cash purchase price of an endoscope," he says. "These terms are not fixed and unless you ask, you won't know. Shoot for a low-dollar buyout." Be sure you can also terminate the lease if you discover later that you want out.
  • Keep it brief. Since markets and practices can change in unexpected ways, experts recommend keeping lease durations to three years or less.

Shoot for the stars
Cost-per-case and consumable-based leases work well in some circumstances and not so well in others. Mr. Pankey integrates them into a buffet of programs that together benefit his center. "I used $150,000 of capital to purchase endoscopic light sources, video boxes and computer equipment to demonstrate my commitment. Then, we negotiated a per-procedure charge for the scopes that includes repair costs," he says, "which were as high as $1,800 per year per scope. I say shoot for the stars." Concludes Mr. Sheppard: "Evaluate each situation separately and compare all alternatives. At its heart, a cost-per-case or disposble-based program is a financing technique."

A Matter Of Volume: Cost-Per-Case Vs. Operating Lease

100 cases/month

136 cases/month

170 cases/month

Company A
Cost-per-case Lease

Company B
Fixed-term Operating Lease

Company A
Cost-per-case Lease

Company B
Fixed-term Operating Lease

Company A
Cost-per-case Lease

Company B
Fixed-term Operating Lease

Annual Reimbursement

$600,000

$600,000

$816,000

$816,000

$1,020,000

$1,020,000

Annual Equipment Expense

$39,648

$53,916

$53,921

$53,916

$67,402

$53,916

Year 1 Gross Profit

$560,352

$546,083

$762,079

$762,983

$952,598

$966,083

Year 2 Gross Profit

$560,352

$546,083

$762,079

$762,983

$952,598

$966,083

Year 3 Gross Profit

$560,352

$546,083

$762,079

$762,983

$952,598

$966,083

Present Value of Gross Profit Over 36 Months

$1,497,828

2.5%
[ $38,142]

$1,459,686

$2,037,046

$2,039,462

.01%
[ $2,417]

$2,546,307

$2,582,351

1.4%
[ $36,044]

Volume is key to determining if a cost-per-case lease is right for you. Experts say cost-per-case leases are most attractive at lower volumes, whereas operational eases or cash purchases are more appropriate when volume grows. Under the cost-per-case option, the monthly equipment expense grows along with the number of cases. The lease ends when you achieve the specified number of cases.

Key:
' Assumes annual reimbursement of $500 per case.
''Annual equipment expense is based on a per-case charge of $33.04 for Company A and a fixed monthly charge of $4,493.10 for Company B.
''The present value of gross profit is calculated using a 6 percent discount rate. (See Sample Net Present Value Analysis.)
''The gross profit is simplified for purposes of this illustration and doesn't account for expenses other than equipment.

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