The Art and Science of Healthcare Capital Allocation

Many business challenges—from customer issues to technology decisions to staffing concerns—can seem like the work of a sideshow juggler. Just as you release one item, you must catch another. This is certainly true for healthcare executives who are constantly juggling capital deployment decisions: You fund one pool of capital projects, only to discover that other needs have found their way to your desk.

CBRE Healthcare’s recent Focus Forum, Capital Deployment Strategies—A Healthcare Perspective, brought together industry leaders who have studied the science of capital allocation and mastered the art of juggling various priorities inherent to healthcare capital investment. Those leaders include Nick Lewis, Chief Facilities & Environmental Safety Officer for Baptist Memorial; Clayton “Mitch” Mitchell, former Senior Vice President of Real Estate & Facilities for Jefferson Health; and Jason Sussman, Managing Director, Kaufman Hall, and author of Strategic Allocation and Management of Capital in Healthcare.

“No Margin, No Mission”

A healthcare organization can’t deliver on its strategic mission without paying attention to its fiscal margins. Capital allocation decisions are guided by the overarching strategic mission of the organization. As Jason Sussman stated, “An effective capital allocation process starts with a financial plan that balances the organization’s strategy, risk and capital capacity.”

Healthcare real estate and facilities professionals’ understanding of their health system’s mission and financial strength will guide their approach to funding facility-related projects.

In this article, we will consider capital allocation in two areas: strategic (i.e., new ventures) and infrastructure (e.g., asset renewal, sustainability initiatives, infrastructure updates). These two distinct areas meet at the intersection of a health system’s mission and its financial capacity.

Key Principles for Capital Allocation

Sussman lists several principles for health systems making capital allocation decisions:

• Develop rational and consistent investment decision guidelines with uniform evaluation criteria.
• Utilize a portfolio approach to capital investment decisions.
• Give unfettered consideration to all potential projects for available funds.
• Complete one batch evaluation of all proposed capital projects on an annual basis.
• Standardize requirements for quantification and articulation of strategic and financial benefits.
• Establish variable analytic requirements based on proposed investment levels, not project intentions (i.e., moving away from routine versus strategic designations).
• Make a portfolio-based evaluation of proposed investments to support approval of individual projects with limited financial return.
• Integrate capital and operating impacts of approved capital expenditures with the annual operating budget and multi-year financial plan.
• Measure actual project performance against business plan projections to ensure process integrity and project success knowledge transfer.

These principles promote an approach where all constituents have a seat at the table, and capital allocation decisions are based upon well-defined and measurable criteria, underpinned by a health system’s strategic mission.

Putting Principles into Practice–A Five-Step Process

For healthcare real estate, project management and facilities leaders, this approach offers a disciplined and value-driven approach to prioritizing capital deployment.

The following five-step process provides an operating framework for capital allocation:

1. Establish a capital allocation management plan.
2. Establish a process for identifying capital needs.
3. Establish decision criteria for allocating capital.
4. Develop a multi-year plan.
5. Establish performance measures and deploy a monitoring system.

Step 1. Establish a capital allocation management plan.

This plan establishes the governance and approach for the allocation process. This includes:

• Develop a calendar that outlines key activity dates built on the principle that allocation is a single, annual event with provisions to handle emergencies and unforeseen opportunities.
• Identify who will be involved in the allocation process. CBRE Healthcare recommends the use of a responsibility matrix for establishing process leaders and stakeholder participation.

Step 2. Establish a process for identifying capital needs.

The capital needs should be collected as a comprehensive, unfettered, single batch of requests organized for infrastructure and strategic capital needs:

Infrastructure capital needs are identified by the facilities team and based upon Facility Condition Assessment (FCA) data, including asset useful life, likelihood of failure, impact of failure and facility aesthetics.

Baptist Memorial’s Nick Lewis has provided an example of a capital planning tool with scoring criteria (Figure 1), which guides his team in establishing a single numeric risk priority number (Figure 2). The risk priority number incorporates the Asset Life Expectancy Multiplier, the Infection Control Risk Assessment (ICRA) Asset Criticality Rating, The Joint Commission (TJC) Compliance Risk Rating and the FCA. The risk priority number serves as a guide to prioritizing the allocation of infrastructure capital.

Figure 1: Baptist Memorial Capital Planning Tool: Scoring Criteria

Source: Baptist Memorial Health Care, 2023.

Figure 2: Baptist Memorial Capital Planning Tool: Master Campus Planning

Source: Baptist Memorial Health Care, 2023.

Strategic capital needs consist of new buildings and expansions and may include projects that will improve operational and cost efficiencies, such as capital needed to reduce a building footprint. Strategic capital needs are typically generated from strategic planning teams and operational improvement initiatives.

Step 3. Establish decision criteria for allocating capital.

The criteria used for prioritizing infrastructure and strategic capital will differ, since infrastructure capital is driven by risk mitigation and strategic capital is focused on business growth and optimization. Technology tools, such as the CBRE Capital Planner, can help establish these criteria and develop priorities, ensuring capital is most effectively allocated.

Infrastructure capital projects are evaluated based upon risk mitigation measures, including likelihood of failure, impact of failure and cost to replace versus cost to maintain. It is best practice to use a single assessment score for prioritizing what is typically a long list of infrastructure projects. This list can best be prioritized using techniques such as the risk priority number described in Figure 2.

Strategic capital projects are evaluated based upon ROI requirements established at the corporate level.

Step 4. Develop a multi-year plan.

The capital allocation plan is best viewed as a multi-year plan driven by the established priorities. The timeframe for the plan varies, but three-, five- and ten-year plans are not uncommon.

Clayton Mitchell highlighted an approach to developing a multi-year plan based an organization’s overall strategic and facility plan. The multi-year plan is then executed through Facility Master Plans and Site Specific Implementation Plans (Figure 3).

Figure 3: Building Strategic Facilities Planning Capability to Accelerate Real Estate Program Execution

Source: Clayton Mitchell, CBRE Healthcare Focus Forum, 2023.

An organization’s real estate, facilities and project team builds its multi-year, comprehensive plan, which addresses both infrastructure and strategic capital needs. It will also provide performance management and reporting benchmarks, which brings us to the final step of the capital allocation process.

Step 5. Establish performance measures and deploy a monitoring system.

An essential element of the capital allocation process is establishing performance measures for projects once they are delivered. The performance measures should reflect decision criteria originally used to prioritize the project. Asking “Did it perform as intended?” will lead to important insights and lessons learned for future projects and accountability that facilities, real estate and project management leaders require.

The Burning Platform: The Juggler’s Final Act

The principles of capital allocation are grounded in a disciplined, mission-based approach. However, the reality can be, as Clayton Mitchell observes, more of a “burning platform.” He points out in some instances, “a hospital comes online, and we use it, we use it, we use it, and we don't come back with any ongoing capital to keep the facility fresh and current. The result is all of a sudden, we hit a failure.” (See lower graphic on Figure 4).

But Mitch points out the need for a new mindset. “We ask what is the sustainment necessary to maintain our portfolio and our infrastructure over time? We try to gravitate from that bottom model (“Typical Sustainment Program”) to the top model (“Desired Sustainment Program”) found in Figure 5. We are working to achieve this shift in mindset within the next 3-4 years. And changing that mindset is really part and parcel of finding the balance between what we can afford from a capital standpoint and the brand that we wish to establish in this market.”

Figure 4: An Example of the Typical “Burning Platform” for Hospital Infrastructure

Source: Clayton Mitchell, CBRE Healthcare Focus Forum, 2023.

Finding this balance between available resources and fulfilling a health system’s mission is not an act for a sideshow juggler. It is the challenging work of healthcare real estate and facilities professionals who understand the direction of their health system and can adopt a principle-based approach that ensures a solid future for community healthcare delivery.