Why Understanding Your Costs is Vital

Knowing how much it costs you to provide a healthcare service is critically important to your hospital or health system's future. Without it, you're flying blind.

Transparency can mean different things to different segments of the healthcare industry. For the patient or consumer, it can mean being able to figure out how much they're on the hook for with healthcare services before they receive them, to act as a tool to determine value. It can mean the ability to review standardized quality information across providers to help make a determination on the site of care as well. There have been big strides made in these areas, but we're not there yet, as an industry.

For physicians, it can mean access to quality scores and methodology about themselves and their referral partners. Payers and providers struggle with transparency in what has previously been deemed "proprietary information," such as claims data, and common definitions for quality and cost. We're not there yet either.

But one area that's ripe for exploitation by healthcare providers, whether they're hospitals, affiliated providers or physician practices, is their own cost data. This is not the price for a service that a health entity charges a patient or negotiates with a payer or employer, but rather, what it costs the healthcare entity to provide a given service in terms of labor, infrastructure, materials and equipment.

Likely, you're not too sure about those numbers either. But you can be. And you should be.

That type of granular cost data can provides an area where an organization can have some control and a central touchstone about its ability to compete with others, says Rita Numerof, PhD, president of Numerof & Associates Inc., a consulting firm in St. Louis that focuses on helping healthcare systems deliver better value.

"The idea that most consumers have been shielded by the cost of healthcare is true, but a more fundamental issue is that healthcare leaders and physicians and other payers have also been shielded," she says.

It's Not So Easy
For just about every other service that a consumer buys, transparency is an easy concept to grasp. You know what you're buying, the implied guarantee that's offered when you buy, and the mode of recourse if you're not satisfied. That's difficult to come by in healthcare, where even providers have a tough time understanding what it costs to provide a given service or a bundle of services associated with a condition or diagnosis.

"We are so far from a true market-based model in healthcare delivery that it should be concerning to most healthcare leaders," Numerof says. "Because most of the money flow in healthcare has been at a gross up level, often they can't even see their cost structure from a service line perspective."

While a standardized definition of quality is still elusive, and may stay that way, price (and cost) can become a way to distinguish your organization. And you don't know how low you can go with pricing without knowing what it costs to provide a certain service over a wide variety of payer mixes. Cost can become your lodestar. If you don't know this information, you don't know where you're vulnerable.

More sophisticated organizations are looking at activity-based costing, or what it costs to deliver a certain set of services, in order to get greater insight into the cost of the activity itself, not the labor required to provide it. If providers are gradually moved into a more capitated system, as Numerof predicts, "they [will] need to understand those costs in a more horizontal way."

What's included in activity-based costing are your raw costs of goods, materials, some formula for overhead and indirect costs and the assignment of direct costs which includes the amount of time to deliver that cost and who's delivering it, she adds.

The way you do it, who's doing it, and your expectations on overhead all factor into what it costs to deliver that service. Even if it's approximated, you'll be a lot smarter about what it really costs to provide certain services.

A Lack of Will
But this is new ground. Over the last several decades, says Numerof, most systems have focused on their biggest cost—staffing—as opposed to looking and rethinking care delivery processes, which is the essence of activity-based costing in healthcare.

It's not a problem of lacking talent or skill to do these things, she says, but a lack of will.

"They haven't had the market need to do it," she says. "If you think about it, the systems that have been put in place have been about getting paid and adjudicating claims at the CPT code level. You've got a whole sub-industry segment that has been born out of the desire to optimize coding. This is the way it's operated for the last 12–15 years."

Do they have to now? That is the crux of the argument, after all.

"Depending on the market, some are moving faster than others," says Numerof. "Competition will force the issue, and large employers and entrepreneurs are also forcing the issue. Together those things will make it such that you'll see more and more moving in this direction over several years."

Too, even if capitation is not in the cards for your organization, risk-based contracting certainly will be, and delivering and demonstrating value transparently will be a key part of that. Without knowing what it costs to provide a wide variety of services, you'll be flying blind.