The Fallacy of ROI as a Measurement Tool

Saturday, May 7, 2005 | 0

By David A. Donn, President of David Donn Consulting, Inc.

How often do you see Return on Investment (ROI) being used by managed care service providers to promote the financial benefits of their product? One company says "ROI - 10 to 1" and another says "Our ROI is one of the highest in the industry." But is having a higher ROI a good thing, and should you rely on it when evaluating a PPO, case management or medical bill review company? This paper will debunk ROI as an effective evaluation tool and will show why ROI is a misleading indicator in the managed care service industry.

Medical bill review companies, PPO networks and case management companies have long used ROI to sell their products. The term is a common financial ratio used to gauge management effectiveness. Correctly used, it relates net income to a measure of investments entrusted to management - specifically, the relationship of total assets to net income generated by these assets. The correct ratio would read:

Net income = ROI
Total Assets

True ROI takes into consideration assets, other investment income, debt and accounting considerations where there has actually been an "I" or investment made, to which the investors are looking for their "R" or return. This is not the case in workers compensation managed care, and therein lies the risk of relying on it.

When you purchase the services of a medical bill review, PPO or case management company, you pay a fee for those services. That's it. Some will say "what do you mean that's it, isn't that enough?" In this case, you're not making an investment in your service provider in the true sense of the word, and you're certainly not being paid interest or benefiting from depreciation. You pay a fee and you get a service that hopefully saves you money. As you can see, there is no "I." There is only an "F" for fee. In this day and age of correctness, we should probably change the acronym to "ROF." That would more accurately reflect the ratio. But does it improve the ratio's appropriateness as a value measurement? NO, it doesn't.

Let me explain by way of example: Company A provides medical bill review services and claims it saved a client $250,000 off their medical bill charges and invoiced the client $25,000 in fees. The ROI (really ROF to be correct, but you get the point) would be 10 to 1, right? ($250,000 in savings; $25,000 in fees; divide the savings by the fee and you get 10 to 1). The net savings to the client, less fees, is $225,000.

Company B also provides medical bill review services and claims it saved their client $400,000 with a similar program and invoiced the client $50,000 ($25,000 more than Company A). The ROI therefore is 8 to 1 - lower than Company A's ROI of 10 to 1. But look at the difference in net savings, which is what all buyers should look for with any managed care product. Company B's net savings is $350,000 ($400,000 less the fee of $50,000), which equals $125,000 MORE than Company A, but with a lower ROI. Any managed care services buyer would be more than happy to pay an extra $25,000 in fees to have an additional $125,000 in the bank - it's a no brainer. But if you were focused on ROI, as some managed care companies would like you to be, you would have lost out big.

I have long felt that ROI is a false indicator in the managed care business and that buyers should not rely on it as an effective measurement tool. Buyers should only use it to compare two similar service providers who offer the SAME savings but for a different fee. But then, you wouldn't need a ratio to help you choose the right company. You just need to throw ROI out, and look at your net savings. After all, isn't that the bottom line?

Mr. David A. Donn is the Principal of David Donn Consulting, Inc., a workers' compensation managed care advisory firm that exclusively represenst the employer community, independent of financial relationships with managed care service providers. He previously served as Vice President for the western region for HealthNet Plus (formerly Employer and Occupational Services Group, or EOS), the workers' compensation managed care subsidiary of HealthNet, one of the largest health care companies in the country. Mr. Donn has been a featured speaker at various industry conferences including RIMS, PARMA, CMTA (formerly CMA) and the Industrial Claims Association. He holds a degree in finance from New York University's Stern School of Business.Mr. Donn is located in San Francisco, CA and can be reached at 415-409-3666 or at ddonn@ddcinc.net .

-------------------

The views and opinions expressed by the author are not necessarily those of workcompcentral.com, its editors or management.