Cost Analysis

N287E Spring 2006Professor: Joanne Spetz10 May 2006

Costs are…

Expenditures of cashNon-cash expenditures (depreciation)

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

What costs do you have control over?

All costs?Direct costs only?Variable costs only?

It’s very important to be clear about the control you have

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

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

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

Numerical example of discounting

$100 per year to be received for 5 yearsYear 1 - $100 no discountYear 2 - $100 discounted 5% = 100*.95 = $95Year 3 - $100 discounted 5% twice = (100)*(.95)*(.95) = $90.25Year 4 - $100 discounted 3 times = $85.74Year 5 - $100 discounted 4 times = $81.45

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

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

The math problem

Fixed cost + (variable cost * quantity) = price * quantity

AFTER SOME ALGEBRA…

Quantity = (fixed cost)/(price-var cost)

ORPrice =((fixed cost)/quantity) + var cost

What if you go over budget?

Price changeEfficiency changesVolume changesIntensity changes

Creating a standard cost profile

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

SCP for an IV…

Cost category

Quantity

Req’d fixed

Unit cost

Var cost

Av fixed cost

Av total cost

Direct labor .10 .05 $20 $2 $1 $3

Materials 1.00 0 $3 $3 $0 $3

Dept overhead

0 .25 $1 $0 $.25 $0.25

Allocated costs

0 .50 $4 $0 $2 $2

TOTALS $5 $3.25 $8.25

Average fixed cost = fixed units needed multiplied by unit cost

Assume that…

The nursing department was budgeted for 100 IV’sThe department did 90 IV’sTo do these IV’s, the hospital used 15 hours of labor and paid $22/hourWe can examine how this varied from our budget…

Price variance

Price variance = (actual price – standard price) *

actual Q

= ($22 - $20) * 15 = $30

Efficiency variance

Efficiency variance = (actual Q – standard Q) * standard price

Standard Q = Var labor req * IV’s done + budget fixed=.10*90 + .05*100 = 9+5 = 14

Eff var = (15-14)*$20 = $20

Volume variance

Volume variance = (budget Q – actual Q) * av fixed cost

per unit

= (100-90) * $1 = $10

These add up…

Actual direct labor cost = $22*15=$330Standardized cost = 3*90=$270

Difference between these = $60Price variance = $30Efficiency variance = $20Volume variance = $10

These add to $60These tell us what share of overrun

came from price, efficiency, volume!

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 partFor a STP, you can compute: Intensity variance =

(actual SU’s – std SU’s)*std cost per SU=(90-100) * $8.25 = -$82.5This is favorable because fewer IV’s were done than expected.

In this example…

We went over budget

But the intensity variance was favorable

Variations in costs…

Average = mean =x = x/NVariance = ((xi -x)2)/(N-1)

Standard deviation = variance =

If “normally” distributed:68% will be within one std dev95% within two std devs99.7% within three std devs

More measures

Median Half of sample is above Half of sample is below

Percentiles 25th percentile = 25% are below

Use of these statistics

You want to investigate abnormally high or low costsYou 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

Payoff tables

Is the unit behaving properly?

Action In control Not in control

Investigate I I+C

Do not investigate

0 LI = cost to investigateC = cost to correctL = loss with no correction

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)(I+C) = PI+I+C-PI-PC =

I+(1-P)C

It we do not investigate Cost = P(0)+(1-P)L = (1-P)L

Cost comparison

If the cost of investigating is greater than the cost of not investigating, we don’t investigate: If I+(1-P)C < (1-P)L investigate

I + C – CP < L – LP-CP < L-LP-I-CLP-CP < L-I-C(L-C)P < (L-C) – IP < ((L-C)-I)/(L-C) = 1-(I/(L-C))

How to determine P?

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

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

As a nursing manager…

What can you do to control costs?

Identify sources of savings

Develop strategies for change

Identifying sources of savings

Reducing costs does not have to reduce quality

There is wide variation in nursing costs

Survey of 180+ acute care hospitals from ~1998

Total cost per patient day

Labor cost per pat. day

Case-mix index (CMI)

Average of top 25%

$323 $297 1.40

Median $235 $212 1.25

Average of lowest 25%

$188 $174 1.25

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

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?)

How do you compare your hospital’s costs?

Each hospital is unique

Start with national benchmarksOther approaches: Across-the-board reductions Bottom-up campaigns

Cost-saving strategiesBenchmarking Across-

board cutsBottom-up campaigns

Advantages “objective” “fair” “support from staff”

Effective at aggressively reducing cost

Good for morale

Disadvantages

No regard for individual needs

Penalizes top performers

Small cost savings

Staff resents this

Results are arbitrary

Usually focuses on less important causes of high costs

Best strategy:

Combination of strategies!!!

Creating a good report is important

Variance Report

Unit Actual Budget Variance Actual Budget Variance3N $195 $182 ($13) 51 11,070 8.90 8.10 (0.80)3W $217 $185 ($32) 88 2,739 10.10 9.40 (0.70)5N $145 $146 $1 53 11,316 6.80 7.20 0.40CCU $549 $464 ($85) 3 704 19.90 17.30 (2.60)ICU 1 $526 $486 ($40) 13 2,854 21.80 18.90 (2.90)ICU 2 $523 $489 ($34) 23 4,968 20.91 18.13 (2.78)Maternity $171 $180 $9 31 6,746 6.92 6.41 (0.51)6N $163 $149 ($14) 37 8,040 7.70 7.40 (0.30)9E $163 $147 ($16) 20 4,294 7.90 6.70 (1.20)Mother/Baby $322 $249 ($73) 19 4,040 13.10 10.70 (2.40)NICU $299 $309 $10 21 4,419 11.70 12.20 0.50

Total cost per patient day Worked hours per patient dayAverage daily census

Patient days

Problems:1. Comparable units not compared clearly2. Benchmarking by budget assumes budget was good3. No quality metrics4. No staff turnover metrics5. Patient days might miss stays under 24 hours6. No adjustment for turnover of patients7. No acuity adjustment

Creating a good report…Worked Hours per Patient Day, Med/Surg Unit 3N

0

1

2

3

4

5

6

7

8

9

10

Unit 3N Actual Unit 3N Budget Internal benchmark National benchmark

Problems:1. Budget might reflect historical

underperformance2. Why is the internal benchmark 6.8? This is

5N’s actual, but it is comparable?

A better report!Variance Report

Unit Actual BudgetNational

benchmarkVariance -

budgetVariance - benchmark

3N 51 11,070 8.90 8.10 7.77 -9.9% -14.5%3W 88 2,739 10.10 9.40 9.76 -7.4% -3.5%5N 53 11,316 6.80 7.20 7.77 5.6% 12.5%6N 37 8,040 7.70 7.40 8.71 -4.1% 11.6%9E 20 4,294 7.90 6.70 8.91 -17.9% 11.3%Maternity 31 6,746 6.92 6.41 11.18 -8.0% 38.1%Mother/Baby 19 4,040 13.10 10.70 6.80 -22.4% -92.6%CCU 3 704 19.90 17.30 18.87 -15.0% -5.5%ICU 1 13 2,854 21.80 18.90 18.70 -15.3% -16.6%ICU 2 23 4,968 20.91 18.13 18.84 -15.3% -11.0%NICU 21 4,419 11.70 12.20 10.57 4.1% -10.7%

Average daily census

Patient days

Worked hours per patient day

Units grouped by similarity

National benchmark

Unrealistic budget?

Beating the budget but not the benchmark

Another good reportVariance report

Unit Actual BudgetInternal

BenchmarkNational

BenchmarkVariance Budget

Variance Internal

Variance National

ICU 1 20.3 20.1 20.0 18.1 -1.0% -1.5% -12.2%ICU 2 20.8 20.9 20.0 18.1 0.5% -4.0% -14.9%ICU 3 20.0 19.8 20.0 15.8 -1.0% 0.0% -26.6%Tele 1 10.4 9.9 10.4 8.2 -5.1% 0.0% -26.8%Tele 2 10.7 10.2 10.4 9.1 -4.9% -2.9% -17.6%Surg 1 3W 8.5 8.2 8.1 6.5 -3.7% -4.9% -30.8%Surg 2 3E 10.3 8.6 8.1 6.5 -19.8% -27.2% -58.5%Med 1 5N 9.2 8.5 8.1 7.1 -8.2% -13.6% -29.6%Med 2 4N 8.1 7.9 8.1 6.8 -2.5% 0.0% -19.1%Med 3 4S 8.2 8.5 8.1 6.8 3.5% -1.2% -20.6%Med 4 7E 8.7 8.6 8.1 7.6 -1.2% -7.4% -14.5%

Worked hours per equivalent patient day Variance Analysis

Internal benchmarks are important

Compare to national benchmark – can be more aggressive?

Better range of comparisons

Still room to improve!

Some issues & ideas

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

same acuity system

The problem with midnight census

7am – 3pm 24 patients3pm – 11pm 29 patients11pm – 7am 20 patientspatient days

24.3 = average census

So… Actual HPPD Target HPPDPt days 6.26 6.01Blended ADC 5.15 6.01And adjust for admissions, discharges,

transfers

Be logical in figuring out where costs are

uncontrollable controllable

unit pat nurse regulations non-RN laborconfig mix comp. labor

overhead supplies too expensemany per FTE

cost too too FTEsper much many cost per richsupply orderedused direct indirect RN too skill

hours hours high mix

premium agepay mix

Using nursing quality to help benchmarking

Unit Cost PPD Falls Responds to complaints

5E $168 3.6 77

6N $163 2.7 90

4S $185 3.0 81

3W $155 6.3 55Who is the best performer?