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?
Explanation and Supportive Evidence
Traditional costing methods (like ratio-of-cost-to-charges) use broad averages that obscure where actual money is spent. ABC, however, identifies the activities required to deliver a service and assigns costs based on the consumption of resources by those activities.
Identifies Waste and Redundancy: ABC provides granularity, highlighting the cost of every touchpoint—from patient intake to discharge. For example, the case of UPMC, detailed in the provided reading, shows that using ABC helped them understand the true cost variations for procedures like knee replacements, revealing that non-standardized activities and extended lengths of stay were major cost drivers. By identifying and standardizing these variable activities, organizations can eliminate waste and unwarranted variation.
Drives Process Improvement: When the true cost of a specific activity (e.g., a complex lab test or extended patient waiting time) is known, managers can target that activity for Lean or Six Sigma process improvement initiatives. This leads to operational efficiency and a lower resource consumption per patient.
Focuses on the Patient Journey: By mapping costs to the entire patient journey, ABC reveals that the true cost of poor quality (readmissions, complications) far outweighs the cost of preventative measures. By focusing investments on activities that improve outcomes (and thus avoid costly complications), the overall cost of care per episode can be reduced.
2. Can ABC Be Used to Improve Internal Business Decision-Making?
Yes, ABC significantly improves internal business decision-making by replacing ambiguous average costs with accurate, actionable data.
Sample Answer
Activity-Based Costing (ABC) offers a powerful approach for healthcare organizations to accurately understand and manage their expenses, providing a path toward reversing rising costs and improving decision-making.
1. Can Activity-Based Costing Be Used to Reverse Rising Healthcare Costs?
Yes, Activity-Based Costing (ABC) can be a critical tool in reversing rising healthcare costs, not by directly lowering external prices, but by addressing the internal inefficiency and waste that drive up the true cost of care delivery.