Gary Cokins, Founder and CEO: Analytics-Based Performance Management LLC
Gary Cokins (Cornell University BS industrial engineering/operations research, 1971; Northwestern University Kellogg MBA 1974) is the founder of Analytics-Based Performance Management LLC at www.garycokins.com in Cary, North Carolina USA.
His career included being a management consultant with Deloitte, KPMG, Electronic Data Systems (EDS), and SAS.
He has authored several books on enterprise and corporate performance management (EPM/CPM) methods and on analytics.
Gary can be reached at firstname.lastname@example.org
Measuring Patient Level Costs and Profitability
Healthcare organizations need to move away from revenue-centric approaches to cost and profit margin approaches to maintain their financial stability. This requires placing a greater emphasis on measuring, managing and monitoring the cost of providing care and the resulting profit margins. The term “profit” may be foreign to some in healthcare, including not-for-profit organizations, but they need to adopt the practices of commercial companies.
Measuring costs must involve a consumption view of how resource expenditures (e.g., employee salaries, materials, supplies, power) are used for procedures, treatments, surgeries and the like by individual patients. This is accomplished using activity-based costing (ABC).
Traditional costing approaches in healthcare, such as those based on ratio of costs to charges [RCCs] or relative value units [RVUs], are inadequate. RCCs and RVUs use broad averages that violate cost accounting’s causality principle. Costing should reflect the cause-and-effect relationship between costs and the consumption of resource expenditures by cost objects (e.g., patients, procedures, etc.) that cause costs to be incurred.
Many accountants have the misperception that ABC is excessively complex and not worth the effort to implement. They are misguided. ABC is cost modeling. The misperception is due to accountants who have excessively over-designed their cost model well beyond acceptable accuracy requirements. Skilled ABC designers know how to restrict the size and complexity of an ABC model – to right-size it – up to the point where the cost accuracy is “good enough”.
Use data that already exists
A more accurate method of measuring costs is to adopt a comprehensive patient level cost management analytics approach using data that already exists in a provider’s clinical and financial systems. The information technology used in healthcare generates substantial transactional data that can be converted into cost data for each patient, in real time, as costs are incurred. This data is continuously produced, but rarely used. Unfortunately, in healthcare there is usually a large gap between the availability of actual cost data and its usage for insights and decision making.
Healthcare data complying with the causality principle for costing
Comparing patient level billing and net revenue collected for these costs enables profit margin analysis, which allows an organization to know where and on what services it is making or losing money – and by how much and why.
Most managers react to the term “cost allocation” with dismay. They recognize that cost allocations that violate the causality principle simultaneously over-cost and some items and under-costs others. Thus, while the total cost is correct and will satisfy an auditor’s compliance with external reporting for government regulators, individual patient encounters are costed in error. Hence, they are misleading to an organization’s users of the data. The magnitude of cost error for each item can be substantial, often massive, when not using causality to trace, connect, and assign expenses to those items.
Providing managers with accurate cost information will enable them to propose alternatives that can lead to standardized procedures and treatments. They can influence physicians and nurses to apply best practices and treatment protocols based on data rather than helping perpetuate the use of outdated, less effective, and more costly practices.
Barriers and excuses preventing patient level costing
So, why isn’t every healthcare provider organization embracing patient level cost analysis? Three major reasons include (1) the potential to disrupt established ways of doing things, resulting in resistance from the staff; (2) resistance from physicians to changing their treatment protocols; and (3) a lack of urgency in making a change (“we’re getting by financially now”). None of these reasons should be accepted as valid.
Building an effective patient level cost and profit analytics platform is not “rocket science”. All it requires is a few software tools and a clear plan to implement the system and leverage the information for decisions.
A need for leadership vision
The healthcare profession is changing and organizations must evolve to remain competitive. This includes adopting progressive, internal management decision-focused costing practices such as patient level cost analysis. What is needed now is the vision and willpower of a healthcare organization’s leadership to adopt such practices. This will help create a culture where the users of cost information “trust” the information provided by their accountants, see the costs as consistent and reflective of the resources and processes they manage, and, most importantly, use it to gain insights and to make better decisions, enabling their organizations to be financially stable and more competitive.
  For more information on ABC in hospitals see Cokins, G, “Measuring and Managing Patient Profitability”, available at https://static1.squarespace.com/static/58cabefc893fc030cbe93858/t/5956988be58c628dd909bb6b/1498847371925/Cokins+Hospital+ABC+Accounting+HFMA+April+2017.pdf