Is the Employed Primary Care Clinic Really Losing $950,000? Relevant Costing and Allocation at an Independent Hospital
Northfield Community Hospital is a 240-bed independent nonprofit that owns a four-physician employed primary care clinic, Westside Family Practice, 1.5 miles from campus. FY2024 results: 12,000 visits, net revenue of $175 per visit ($2.10 million); direct costs of $1.70 million (provider compensation $760,000, clinical staff $620,000, supplies and other variable costs $180,000, direct occupancy $140,000). After $1.35 million of allocated hospital overhead - plant operations allocated on square footage, IT on headcount, finance on transaction counts, plus $410,000 of corporate costs including bond interest and executive salaries - Westside reports a $950,000 operating loss. The CFO's board packet labels Westside the system's worst-performing cost center and recommends closing it at fiscal year-end. Roughly 38% of clinic visits lead to hospital imaging, laboratory, or specialty referrals, which finance estimates generate $1.6 million of hospital contribution margin annually. Two of the four physician contracts expire in five months; replacing them would cost about $220,000 in search and signing costs. The clinic lease has 18 months remaining at $140,000 a year with no termination clause. If the clinic closes, $310,000 of clinical staff wages and all $180,000 of supplies disappear; provider compensation ends with the contracts; occupancy does not.
1. Perform the relevant-cost analysis. Should Northfield close Westside? State the answer in dollars and identify the items that should be excluded.
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Relevant cost test. Compare the costs that actually disappear with the revenue and margin that actually disappear.
Avoidable if closed:
- Provider compensation $760,000 (contracts expire, no renewal)
- Clinical staff $310,000 of $620,000 (remainder redeployed to hospital units)
- Supplies and other variable $180,000
- Total avoidable: $1,250,000
Not avoidable: the $140,000 occupancy (lease with no termination clause), $310,000 of retained staff cost, and effectively all of the $1.35 million overhead allocation. Allocated plant, IT, finance, bond interest, and executive salaries do not fall when one four-physician site closes; those costs simply get reallocated to the remaining service lines.
Net effect of closing: lose $2,100,000 of clinic net revenue, save $1,250,000, plus lose an estimated $1,600,000 of downstream hospital contribution margin. Closing destroys about $2,450,000 of annual margin, and adds a one-time $220,000 recruiting/termination cost and a $140,000 lease obligation with no offsetting revenue.
The reported $950,000 loss is an artifact: the clinic generates $400,000 of direct contribution margin ($2.10M - $1.70M) and roughly $2.0 million of margin once downstream referrals are counted. The board is being asked to close a business that is contributing. Recommendation: do not close; re-underwrite the clinic on a contribution-margin basis and fix the two expiring contracts and visit volume.
2. Critique the allocation methodology and its use in this decision. What reporting structure would you put in front of the board instead?
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What is wrong with the current approach. First, the bases are proxies, not drivers: square footage does not cause IT cost, headcount does not cause finance cost, and transaction counts reward the clinic for being busy rather than efficient. Second, $410,000 of corporate cost - including bond interest and the CEO's salary - is a sunk, enterprise-level cost that no manager can control and no closure decision can change. Third, allocating on volume measures creates a death spiral: as visits fall, the allocation per visit rises, the reported loss widens, and the pressure to close intensifies even though cash flow has barely moved. Fourth, full-cost allocation is the right tool for a different job - Medicare cost reporting, rate setting, and payer negotiation - and the wrong tool for keep-or-close, make-or-buy, or pricing decisions.
What the board should see. A three-tier contribution format:
- Net revenue, variable cost, and contribution margin per visit (here $175 - $15 = $160 per visit)
- Direct fixed and traceable cost, giving service-line margin ($400,000)
- A single clearly labeled enterprise allocation, giving fully loaded margin - shown for completeness only
Add a separate downstream-margin line showing the $1.6 million of hospital contribution generated by clinic referrals, and a per-physician panel report (panel size, visits per FTE, wRVUs, referral yield). Show the allocation method in a footnote so nobody confuses allocated cost with cash. Recommend that closure, expansion, and pricing decisions be made at the service-line margin tier, with full cost used only for regulatory reporting and for evaluating whether total revenue covers total cost at the enterprise level.
3. The board asks what volume would make Westside break even. Compute it on both a direct and a fully loaded basis, and assess which target is realistic.
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Variable cost per visit. Supplies and other variable costs of $180,000 / 12,000 visits = $15 per visit. Contribution margin is $160 per visit.
Direct break-even. Total direct cost of $1,700,000 / $175 net revenue per visit = 9,714 visits, or $1,700,000 / $160 contribution per visit = 10,625 visits if you want to cover fixed costs out of contribution after variable costs. Either way it is below the current 12,000 visits, which is another way of saying the clinic is above its direct break-even today.
Fully loaded break-even. ($1,700,000 + $1,350,000) / $175 = 17,429 visits, or 19,063 visits using the $160 contribution figure. That is roughly 4,750 visits per physician. Four primary care physicians running efficient panels typically deliver 3,000-3,500 visits each, so capacity is about 12,000-14,000 visits. The fully loaded break-even is not reachable without adding providers or radically changing the payer mix - which proves the point that full-cost allocation is the wrong decision benchmark.
Realistic levers, quantified. Adding one physician FTE with total compensation and support of about $260,000 requires roughly 1,625 incremental visits at $160 contribution to break even - achievable if the panel fills within 18 months. Moving 12,000 to 14,000 visits with existing staff adds $320,000 of margin. Converting 15% of the 4,560 referral-generating visits to a care-management model that captures more downstream imaging raises the $1.6 million downstream figure. The board should set the target at direct break-even plus a stated contribution to enterprise overhead, not at full-cost break-even.