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Curriculum Center Browse Bibliography Build EPacket Pricing Structure Distribution Process Management Control in Nonprofit Organizations
Heartbreak of DRGs
Young, David W.
Functional Area(s):
   Finance/Financial Management
   Healthcare Management
Difficulty Level: Intermediate
Pages: 5
Teaching Note: Not Available. 
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First Page and the Assignment Questions:
They're all naive! The hospital administration is telling me that I have to discharge my psoriasis patients within 7 days, since that's all that the DRG legislation allows. Medicare won't reimburse the hospital for treating the patients on an ambulatory basis, which I'm convinced would be much cheaper. So what am I supposed to do?

David Bickers, M.D., Chairman of the Department of Dermatology at University Hospital in Cleveland Ohio, was commenting on the dilemma he and his colleagues faced in attempting to cope with one of the principal features of a recently-enacted policy by Medicare. The new policy reimbursed hospitals a fixed amount per discharge, based on each patient's discharge diagnosis. The diagnosis was classified into one of about 470 “diagnosis-related groups”, or DRGs, and the hospital received the amount associated with that group regardless of what it actually spent to care for the patient.

As a result of this change in Medicare reimbursement policy, hospitals had become much more concerned with controlling their costs than they had been in the past, when Medicare's reimbursement was “cost-based.” Now, the main focus of the hospital's administration was on reducing each patient's length of stay and ancillary services (laboratory, X-ray, etc.) wherever feasible and clinically appropriate. Since many patients with severe psoriasis outbreaks necessitated hospitalization for periods longer than their diagnostic group stipulated, Dr. Bickers and his colleagues found themselves under increasing pressure from the hospital's administration to find ways to reduce the length of stay of these patients.

Dr. Bickers thought the problem was somewhat more complicated, however, than simply pressing for early discharges. He commented:

Many patients with psoriasis can be treated on an outpatient basis without comprising quality of care. In fact, in some instances, avoiding hospitalization can be desirable. One problem in adopting an ambulatory approach, however, is that Medicare does not pay for outpatient care. Another problem is that the hospital administration is not convinced that such an approach would, in fact, be financially desirable.

Despite these obstacles, Dr. Bickers had resolved to prepare a program proposal for an Ambulatory Psoriasis Treatment Center (APTC). He knew that if the proposal was to be convincing to both the hospital's administration and Medicare, it would have to be financially as well as clinically sound.


Psoriasis is a chronic disorder characterized by thickened, red patches of skin, which is. . .


  1. What sort of analytical framework should Dr. Bickers use? What additional information will it require? From where should this information come?
  2. Prepare a financial analysis that responds to the various concerns listed in the case. What are the key assumptions necessary in preparing this analysis? What conclusions do you draw from it?
  3. How should Dr. Bickers present the analysis to the hospital? What factors other than the financial ones should he consider?
  4. What issues, if any, should payers consider as a result of this analysis?