Vol. 34, No. 1, January-February 2004, pp. 51–58 issn 0092-2102  eissn 1526-551X  04  3401  0051 inf orms ® doi 10.1287/inte.1030.0062 © 2004 INFORMS Contract Optimization at Texas Children’s Hospital Chris Born, Monica Carbajal, Pat Smith, Mark Wallace Texas Children’s Hospital, 1919 South Braeswood, MC 4-8300, Houston, Texas 77030 {cmborn@texaschildrenshospital.org, mlcarbaj@texaschildrenshospital.org, pnsmith@texaschildrenshospital.org, mawallace@texaschildrenshospital.org} Kirk Abbott, Surain Adyanthaya, E. Andrew Boyd, Curtis Keller, Jin Liu, Wayne New, Tom Rieger, Bert Winemiller, Ron Woestemeyer PROS Revenue Management, 3100 Main Street, Suite 900, Houston, Texas 77002 {kabbott@prosrm.com, sadyanthaya@prosrm.com, aboyd@prosrm.com, ckeller@prosrm.com, jliu@prosrm.com, wnew@prosrm.com, trieger@prosrm.com, bwinemiller@prosrm.com, rwoestemeyer@prosrm.com} In 1998, faced with mounting financial pressure, Texas Children’s Hospital found its mission in jeopardy. Payors sought to reduce expenditures, while physicians wanted to provide the highest quality patient care, research, and teaching. Working with PROS Revenue Management, the hospital spearheaded an initiative to bring greater analytic capabilities to administrative operations, initially focusing on optimizing the performance of contracts with insurers because of the potential revenue leverage. It did so by (1) quantifying expected future demand through forecasting, (2) establishing risk as an important means of measuring contract performance, and (3) embedding the underlying Bayesian forecasting and nonlinear optimization models in a software system that supports the daily activities of contract negotiators. Direct benefits include revenue improvements of up to $17 million annually on contracts renegotiated with use of the PROS technology. The project’s initial success has spawned efforts to improve the hospital’s planning and operational activities. With a system designed for transfer to other hospital settings and possible enhancement of the diagnosis-related group (DRG) classification system through the use of patient pathways, the health-care optimization technology has the potential for broad impact in the industry. Key words : health care: hospitals; forecasting: applications. I n 1998, Texas Children’s Hospital’s president and chief executive officer, Mark A. Wallace, looked for sophisticated solutions to address decreasing government-payor reimbursements, risky contracts, and rising patient demands. In managing the largest children’s hospital in the United States with an aver- age of 19,000 annual admissions from 1997 through 2001, Wallace tries to balance the business realities of the health-care industry with the hospital’s mission of providing the finest possible pediatric patient care, education, and research. Texas Children’s and its affiliated medical school, Baylor College of Medicine, offer services in more than 40 areas of specialty, including cardiology, neonatology, hematology-oncology, pulmonary, infec- tious disease, and rheumatology. The world’s first set of surviving octuplets, who were the focus of national attention in 1998, were born and cared for at Texas Children’s (The Houston octuplets 2001). The combined weight of the six girls and two boys was just over 10 pounds at birth. Although the smallest of the babies, weighing only 10 ounces, ultimately succumbed to heart and lung failure, the remaining seven children are active and healthy. Among the renowned facilities at Texas Children’s are its cancer center and its heart center. The cancer center employs over 450 staff members and 65 clin- icians and treats every kind of childhood cancer, including leukemia, brain tumors, lymphoma, neuro- blastoma, and bone and soft-tissue tumors. The heart center evaluates infants, children, and young adults with cardiac symptoms, suspected congenital heart disease, or acquired cardiac abnormalities and pro- vides special services ranging from prenatal diagnosis of cardiac abnormalities to heart transplantation. Any hospital that meets this scope of medical needs requires vast and diversified resources. Texas Children’s provides acute care, intermediate care, neonatal intensive care, and pediatric intensive care beds and a collection of surgical suites equipped with specially sized surgical instruments. It maintains an extensive inventory of current and emerging pharma- ceutical agents and the latest in ancillary equipment, including imaging scanners and specialty laboratory instruments. Texas Children’s workforce is over 6,000. The hospital must optimize pricing of its resources to ensure strong operating margins and to continue pro- viding top quality services. Wallace’s search for new and innovative ways to manage Texas Children’s led him to a partnership with PROS Revenue Management. From the outset, 51