Cost Analysis
N287E Spring 2006
Professor: Joanne Spetz
10 May 2006
Costs are…
Expenditures of cash
Non-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 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
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 revenueproducing 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)
OR
Price =((fixed cost)/quantity) + var cost
What if you go over budget?
Price change
Efficiency changes
Volume changes
Intensity 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
$5
$3.25
$8.25
TOTALS
Average fixed cost = fixed units needed multiplied by
unit cost
Assume that…
The nursing department was budgeted
for 100 IV’s
The department did 90 IV’s
To do these IV’s, the hospital used 15
hours of labor and paid $22/hour
We 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=$330
Standardized cost = 3*90=$270
 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!
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 SU’s – std SU’s)*std cost per SU
=(90-100) * $8.25 = -$82.5
This 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 = 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
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 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
Payoff tables
Is the unit behaving properly?
Action
In control
Not in control
Investigate
I
I+C
Do not investigate
0
L
I = cost to investigate
C = cost to correct
L = 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-C
LP-CP < L-I-C
(L-C)P < (L-C) – I
P < ((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 guess
We 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 Labor cost
patient day
per pat. day
Case-mix
index (CMI)
Average of
top 25%
$323
$297
1.40
Median
$235
$212
1.25
Average of $188
lowest 25%
$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 benchmarks
Other approaches:


Across-the-board reductions
Bottom-up campaigns
Cost-saving strategies
Advantages
Benchmarking
Across-board
cuts
Bottom-up
campaigns
“objective”
“fair”
“support from
staff”
Effective at
aggressively
reducing cost
Disadvantages No regard for
individual needs
Staff resents
this
Good for morale
Penalizes top
performers
Small cost
savings
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
Total cost per patient day
Unit
Actual
Budget
Variance
3N
$195
$182
($13)
3W
$217
$185
($32)
5N
$145
$146
$1
CCU
$549
$464
($85)
ICU 1
$526
$486
($40)
ICU 2
$523
$489
($34)
Maternity
$171
$180
$9
6N
$163
$149
($14)
9E
$163
$147
($16)
Mother/Baby
$322
$249
($73)
NICU
$299
$309
$10
Average daily
census
51
88
53
3
13
23
31
37
20
19
21
Patient
days
11,070
2,739
11,316
704
2,854
4,968
6,746
8,040
4,294
4,040
4,419
Worked hours per patient day
Actual
Budget
Variance
8.90
8.10
(0.80)
10.10
9.40
(0.70)
6.80
7.20
0.40
19.90
17.30
(2.60)
21.80
18.90
(2.90)
20.91
18.13
(2.78)
6.92
6.41
(0.51)
7.70
7.40
(0.30)
7.90
6.70
(1.20)
13.10
10.70
(2.40)
11.70
12.20
0.50
Problems:
1. Comparable units not compared clearly
2. Benchmarking by budget assumes budget was good
3. No quality metrics
4. No staff turnover metrics
5. Patient days might miss stays under 24 hours
6. No adjustment for turnover of patients
7. No acuity adjustment
Creating a good report…
Worked Hours per Patient Day, Med/Surg Unit 3N
10
9
8
7
6
5
4
3
2
1
0
Unit 3N Actual
Unit 3N Budget
Internal benchmark
National benchmark
Problems:
1. Budget might reflect historical underperformance
2. Why is the internal benchmark 6.8? This is 5N’s
actual, but it is comparable?
A better report!
Variance Report
Units
grouped
by
similarity
Unit
3N
3W
5N
6N
9E
Maternity
Mother/Baby
CCU
ICU 1
ICU 2
NICU
Average daily
census
51
88
53
37
20
31
19
3
13
23
21
Patient
days
11,070
2,739
11,316
8,040
4,294
6,746
4,040
704
2,854
4,968
4,419
Actual
8.90
10.10
6.80
7.70
7.90
6.92
13.10
19.90
21.80
20.91
11.70
Worked hours per patient day
National
Variance Budget benchmark
budget
8.10
7.77
-9.9%
9.40
9.76
-7.4%
7.20
7.77
5.6%
7.40
8.71
-4.1%
6.70
8.91
-17.9%
6.41
11.18
-8.0%
10.70
6.80
-22.4%
17.30
18.87
-15.0%
18.90
18.70
-15.3%
18.13
18.84
-15.3%
12.20
10.57
4.1%
National
benchmark
Variance benchmark
-14.5%
-3.5%
12.5%
11.6%
11.3%
38.1%
-92.6%
-5.5%
-16.6%
-11.0%
-10.7%
Unrealistic
budget?
Beating
the budget
but not the
benchmark
Another good report
Variance report
Unit
ICU 1
ICU 2
ICU 3
Tele 1
Tele 2
Surg 1 3W
Surg 2 3E
Med 1 5N
Med 2 4N
Med 3 4S
Med 4 7E
Worked hours per equivalent patient day
Internal
National
Actual
Budget Benchmark Benchmark
20.3
20.1
20.0
18.1
20.8
20.9
20.0
18.1
20.0
19.8
20.0
15.8
10.4
9.9
10.4
8.2
10.7
10.2
10.4
9.1
8.5
8.2
8.1
6.5
10.3
8.6
8.1
6.5
9.2
8.5
8.1
7.1
8.1
7.9
8.1
6.8
8.2
8.5
8.1
6.8
8.7
8.6
8.1
7.6
Internal
benchmarks are
important
Variance Analysis
Variance
Variance
Variance
Budget
Internal
National
-1.0%
-1.5%
-12.2%
0.5%
-4.0%
-14.9%
-1.0%
0.0%
-26.6%
-5.1%
0.0%
-26.8%
-4.9%
-2.9%
-17.6%
-3.7%
-4.9%
-30.8%
-19.8%
-27.2%
-58.5%
-8.2%
-13.6%
-29.6%
-2.5%
0.0%
-19.1%
3.5%
-1.2%
-20.6%
-1.2%
-7.4%
-14.5%
Better range of
comparisons
Compare to national
benchmark – can be
more aggressive?
Still room
to
improve!
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
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
Be logical in figuring out where
costs are
uncontrollable
unit
config
pat
mix
nurse
comp.
controllable
regulations
non-RN
labor
overhead
cost
per
supply
labor
supplies
too
too
much
many
ordered used
direct
hours
too
many
FTEs
expense
per FTE
cost per rich
indirect RN too skill
hours
high
mix
premium
pay
age
mix
Using nursing quality to help
benchmarking
Unit
Cost PPD
Falls
5E
$168
3.6
Responds
to
complaints
77
6N
$163
2.7
90
4S
$185
3.0
81
3W
$155
6.3
55
Who is the best performer?