Healthcare organizations have traditionally encountered great difficulty in accurately capturing the costs of the services and goods that they provide. Traditional costing methods (i.e., direct, step-down, etc.) have proven marginally useful despite decades of use. In general, this has caused problems within healthcare organizations as it obscures the true cost of care and overall profitability. Cost overruns and extraordinary spending by healthcare organizations harm the economic sustainability of the healthcare organization.
More recently, activity-based costing (ABC) has been used to more accurately capture the cost of health care services. However, this costing methodology has also encountered challenges.
For this research discussion, read the following articles:
• “The 100-Percent Solution to Improving Healthcare’s Operating Margins”, available at: https://www.healthcatalyst.com/insights/healthcare-activity-based-costing-transforming-cost
• “Activity-Based Costing: Healthcare’s Secret to Doing More with Less”, available at : https://www.healthcatalyst.com/insights/activity-based-costing-healthcare-improves-outcomes
• “Service Lines and Activity-Based Costing (ABC) Reveal True Cost of Care for UPMC”, available at: https://www.healthcatalyst.com/success_stories/activity-based-costing-in-healthcare-upmc
Respond to the following questions:
1. Can activity-based costing be used to reverse rising healthcare costs? Explain your perspective. Offer supportive evidence.
2. Can ABC be used to improve internal business decision-making? If so, how might this be the case?
3. Can the use of ABC assist in communication with patients and overall patient perceptions of care? How? What obstacles do you see to this communication strategy implementation?
4. What challenges prevent the broader application of ABC in the healthcare industry? Is there a way to overcome them?
Supportive Evidence:
Identifies Waste and Inefficiency: Traditional costing methods hide overhead and waste. ABC, especially Time-Driven ABC (TDABC), measures the cost of time spent on every activity, allowing organizations to identify and eliminate non-value-added activities and excess capacity (Snippet 2.1). The University of Pittsburgh Medical Center (UPMC), as cited in the provided articles, used ABC to gain insight into cost and clinical variation and achieved $3 million in cost savings/avoidance in surgical services by using Enhanced Recovery After Surgery (ERAS) protocols (Snippet 4.2).
Focuses on Process Improvement: By providing granular cost data, ABC shifts the focus from cost cutting to cost management and process improvement (Snippet 1.7). For example, by analyzing costs across an entire patient journey (e.g., a high-risk pregnancy, as mentioned in the Health Catalyst articles), providers can redesign care pathways, leading to improved patient outcomes and decreased cost over time (Snippet 1.1).
Aligns Cost with Quality (Value): The ultimate goal is to move from a volume-based (fee-for-service) to a value-based system (Snippet 2.1). ABC links the cost of care to the outcomes achieved, allowing managers to identify which procedures or inputs produce the best outcomes at the lowest cost, thus driving efficiency and improving the overall value proposition of the service (Snippet 1.6).
2. Can ABC be used to improve internal business decision-making? If so, how might this be the case?
Yes, ABC significantly improves internal business decision-making by replacing unreliable, averaged cost data with precise, actionable intelligence.
How ABC Improves Decision-Making:
Accurate Pricing and Profitability Analysis: ABC provides the true cost for each service line, procedure, or even a specific patient episode. This allows management to set more informed pricing strategies (Snippet 2.2) and conduct accurate profitability analysis to see which services are truly financially viable and which are not (Snippet 2.2).
Optimal Resource Allocation: By determining the exact resources (labor, supplies, equipment) consumed by an activity, ABC identifies where assets should be deployed (Snippet 2.1). It highlights areas of excess capacity (unused resources) that can be utilized or retired, leading to better financial stewardship (Snippet 2.1, 2.3).
Strategic Planning and Service Portfolio Management: Detailed cost data supports strategic decisions like whether to expand, contract, or refine a service offering (Snippet 2.3). For instance, a hospital can use ABC to decide to focus resources on a high-demand, profitable service line while redesigning a less profitable but vital one to improve its sustainability (Snippet 2.2).
Contract Negotiation: Armed with accurate cost data, healthcare providers can enter into more successful contract negotiations with payers, as they have a clear understanding of their financial floor for providing specific services (Snippet 1.6).
Sample Answer
Healthcare organizations can leverage Activity-Based Costing (ABC) to gain a precise understanding of the resources consumed by activities, which provides the foundation for improving financial performance and quality of care. The following response addresses your questions based on the principles of ABC and evidence from its application in healthcare, as discussed in the suggested readings and related literature.
1. Can activity-based costing be used to reverse rising healthcare costs? Explain your perspective. Offer supportive evidence.
Yes, ABC can be a powerful tool to reverse rising healthcare costs.
ABC is not a direct cost-reduction tool but an insight-generation tool that reveals the true cost of care by tracing resources to the activities they support and, ultimately, to the specific patient or service line.