Cost Analysis

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Cost Analysis

• N287E Spring 2006
• Professor Joanne Spetz
• 10 May 2006

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Costs are

• Expenditures of cash
• Non-cash expenditures (depreciation)

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Ways to divide and analyze costs

• Direct vs. Indirect
• Direct costs
• Salaries, supplies, etc.
• Indirect costs
• Benefits, depreciation, support departments
• Variable vs. Fixed
• Variable costs
• Fixed costs
• Semi-fixed costs (step function)
• Semi-variable

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What costs do you have control over?

• All costs?
• Direct costs only?
• Variable costs only?
• ? Its very important to be clear about the
  control you have

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Making decisions about the future requires
information about

• Avoidable costs
• Variable costs and some fixed costs
• Sunk costs
• Fixed costs that cannot be undone
• Incremental costs (marginal)
• Opportunity costs
• Other things you could have done

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A note about opportunity cost

• Other things you could have done have value
• Return on alternate investments
• Return from basic investment
• This is why is discount future earnings and costs

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Discounting future earnings

• 100 received this year is more valuable than
  100 received next year
• You could take the 100 this year and invest it
  to get interest for next year
• Thus, future earnings are discounted
• If discount rate is 5, then next year is worth
  5 less than this year

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Numerical example of discounting

• 100 per year to be received for 5 years
• Year 1 - 100 no discount
• Year 2 - 100 discounted 5 100.95 95
• Year 3 - 100 discounted 5 twice
  (100)(.95)(.95) 90.25
• Year 4 - 100 discounted 3 times 85.74
• Year 5 - 100 discounted 4 times 81.45

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Measuring costs in a hospital

• Units are categorized by
• Direct or indirect cost
• Revenue-producing or not
• Nonrevenue units are usually indirect costs
• Indirect costs are allocated to revenue-producing
  units to make pricing decisions

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Ways to allocate indirect costs

• Step-down method
• The department with the least service from others
  allocated first
• Go in order form least to most
• Problem results vary by order of allocation
• Double-distribution method
• Go through the loop twice
• Simultaneous equation method
• Create equations for allocation and solve the math

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The math problem

• Fixed cost (variable cost quantity) price
  quantity
• AFTER SOME ALGEBRA
• Quantity (fixed cost)/(price-var cost)
• OR
• Price ((fixed cost)/quantity) var cost

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What if you go over budget?

• Price change
• Efficiency changes
• Volume changes
• Intensity changes

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Creating a standard cost profile

• A standard cost profile (SCP) is a cost breakdown
  for a single item/task

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SCP for an IV
Average fixed cost fixed units needed
multiplied by unit cost
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Assume that

• The nursing department was budgeted for 100 IVs
• The department did 90 IVs
• To do these IVs, the hospital used 15 hours of
  labor and paid 22/hour
• We can examine how this varied from our budget

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Price variance

• Price variance
• (actual price standard price) actual Q
• (22 - 20) 15 30

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Efficiency variance

• Efficiency variance
• (actual Q standard Q) standard price
• Standard Q
• Var labor req IVs done budget fixed
• .1090 .05100 95 14
• Eff var (15-14)20 20

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Volume variance

• Volume variance
• (budget Q actual Q) av fixed cost per unit
• (100-90) 1 10

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These add up

• Actual direct labor cost 2215330
• Standardized cost 390270
• ? Difference between these 60
• Price variance 30
• Efficiency variance 20
• Volume variance 10
• ?These add to 60
• ?These tell us what share of overrun came
  from price, efficiency, volume!

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Standard treatment protocols

• A cost sheet for a larger product
• E.g., an inpatient stay or diagnosis
• It looks like a SCP, for the most part
• For a STP, you can compute
• Intensity variance
• (actual SUs std SUs)std cost per SU
• (90-100) 8.25 -82.5
• This is favorable because fewer IVs were done
  than expected.

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In this example

• We went over budget
• But the intensity variance was favorable

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Variations in costs

• Average mean ?x Sx/N
• Variance (S(xi -?x)2)/(N-1)
• Standard deviation ?variance s
• If normally distributed
• 68 will be within one std dev
• 95 within two std devs
• 99.7 within three std devs

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More measures

• Median
• Half of sample is above
• Half of sample is below
• Percentiles
• 25th percentile 25 are below

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Use of these statistics

• You want to investigate abnormally high or low
  costs
• You want to do investigations only when the
  payoff is worth it
• Payoff defined by cost of investigation and
  potential benefit of correction
• You can use statistics to determine your cutoff
  for investigation

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Payoff tables
I cost to investigate C cost to correct L
loss with no correction
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Payoff tables and statistics

• If P probability of being in control
• (1-P) probability of not being in control
• If we investigate
• Cost P(I)(1-P)(IC) PIIC-PI-PC I(1-P)C
• It we do not investigate
• Cost P(0)(1-P)L (1-P)L

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Cost comparison

• If the cost of investigating is greater than the
  cost of not investigating, we dont investigate
• If I(1-P)C lt (1-P)L ? investigate
• I C CP lt L LP
• -CP lt L-LP-I-C
• LP-CP lt L-I-C
• (L-C)P lt (L-C) I
• P lt ((L-C)-I)/(L-C) 1-(I/(L-C))

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How to determine P?

• We can guess P based on distribution of data, or
  just make a best guess
• We can focus on cases a certain number of
  standard deviations from mean to define P

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When analyzing cost data

• One can examine
• Prior period values
• (variance over time)
• Departmental values
• (variance within and across departments)
• There are many numerical examples in Cleverly

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As a nursing manager

• What can you do to control costs?
• Identify sources of savings
• Develop strategies for change

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Identifying sources of savings

• Reducing costs does not have to reduce quality
• There is wide variation in nursing costs

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Survey of 180 acute care hospitals from 1998
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Even the best performers have variance

• Hamel Hospital
• Total nursing cost per patient day 186
• 21 below 235 median
• Within the hospital, cost variance per patient
  day (compared to Hamel)
• Critical care 7.4 better than median
• Med-surg 3.8 better than median
• Intermediate care 42.1 worse than median

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Where do differences comes from?

• Differences do not appear to come from
• Shifting tasks to support departments
• Reductions in skill mix
• They do appear to come from
• Reduced overtime
• Reduced per-diem
• Fewer FTEs overall (is this good or bad?)

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How do you compare your hospitals costs?

• Each hospital is unique
• Start with national benchmarks
• Other approaches
• Across-the-board reductions
• Bottom-up campaigns

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Cost-saving strategies
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Best strategy

• Combination of strategies!!!

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Creating a good report is important

• Problems
• Comparable units not compared clearly
• Benchmarking by budget assumes budget was good
• No quality metrics
• No staff turnover metrics
• Patient days might miss stays under 24 hours
• No adjustment for turnover of patients
• No acuity adjustment

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Creating a good report

• Problems
• Budget might reflect historical underperformance
• Why is the internal benchmark 6.8? This is 5Ns
  actual, but it is comparable?

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A better report!
Units grouped by similarity
Unrealistic budget?
National benchmark
Beating the budget but not the benchmark
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Another good report
Still room to improve!
Internal benchmarks are important
Better range of comparisons
Compare to national benchmark can be more
aggressive?
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Some issues ideas

• Use the internal best performer to get ideas for
  improving other units
• Make units data comparable
• Use the same acuity system
• Make sure national benchmark has same acuity
  system

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The problem with midnight census

• 7am 3pm 24 patients
• 3pm 11pm 29 patients
• 11pm 7am 20 patients?patient days
• 24.3 average census
• So Actual HPPD Target HPPD
• Pt days 6.26 6.01
• Blended ADC 5.15 6.01
• And adjust for admissions, discharges, transfers

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Be logical in figuring out where costs are
uncontrollable controllable unit
pat nurse regulations non-RN labor config mix co
mp. labor overhead supplies too expense
many per FTE cost too too FTEs per m
uch many cost per rich supply ordered used di
rect indirect RN too skill hours hours high
mix premium age pay
mix
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Using nursing quality to help benchmarking
Who is the best performer?