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ISB PGPMAX: Strategic profitability Management (SPM)

Final Exam – Boston’s children’s Hospital – Measuring patient costs

Course Name: Strategic profitability Management (SPM)

Submitted by: Sri Rama Murthy Battula

PG ID: 81920030
1. Analyse the market and competitive forces faced by BCH. What are BCH’s strengths,
weaknesses, opportunities and threats (SWOT)?

Market and Competitive forces faced by BCH

- US market was undergoing health reforms where insurance coverage for health care by
mandate and subsidy by government. In turn insurance companies and Medicaid
providers are putting tab on raising health care costs through various control mechanism.
- Health care payments are not value based Insurers have introduced alternate quality
contracts and preferring bundled payment mechanism for entire hospitalisation over
existing free-for –service reimbursement model of BCH.
- Cost of health services are not aligned with purchase of quality and value of health
services insurance companies are indiscriminate about reimbursements between
speciality paediatric hospitals like BCH and cross subsidised services of hospitals having
paediatric wards in adult hospitals.
- Similar quality and complexity of health care in different places are compensated
discriminately and at different rates. BCH is on disadvantage having integrated set-up and
infrastructure of research, training and speciality care for rare diseases. Moreover, BCH is
renowned for handling low income patients and complex cases put them in wrong side of
competition with hospitals running child care wards in adult hospitals.
- As a freestanding paediatric hospital BCH is having tremendous pressure for doing
balancing act of retaining market reputation of superior research and market leader
position as well as low cost services at par with the competitors.
- State and local governments are gradually reducing the medical reimbursements to
health care providers like BCH. This has forced BCH to move to low intensity services at
satellite health centres. Focus has shifted to better patient outcome through decreasing
unnecessary overheads and judicious use of resources.

Swot analysis of BCH

Strengths
- BCH is top rated paediatric hospital in US acclaimed for ranked specialities, and world
largest hospital based paediatric research centre.
- Reputed as last resort for children with rare diseases and well known for novel
treatments and therapies for debilitating conditions. This attracts more patients outside
the community also.
- Well noted for very less number of after surgery/treatment errors and complications.
After treatment visits are comparatively very less and lot cost saving to patients unlike in
other hospitals.
Weaknesses
- Being freestanding paediatric hospital BCH cannot follow cross- subsidising tactics
followed by its competitive adult hospitals having paediatric wards only.
- Infrastructure with research, training and speciality services attracts more complex and
high resource intensive health cases jacks up the cost of services.
- Integrated cost tracking for all health services is not available across all the sections.

Opportunities
- Alternative quality contract with bundled pricing for full care service health cases can be
USP of BCH in long run for their market growth.
- Transparent SCAMPs and efficient treatment with no after treatment complications and
fewer visits shall score over cross-subsidizing tactics of competitors.

Threats
- Risk adjusted global payments by insures for higher costs of BCH will get reimbursements
less and will have severe pressure on costs and in turn on profits.
- Increased Co-pay on patients by the payors to compensate the higher costs of BCH will
have negative effect on flow of patients to the hospitals.
- High complex and resource intensive cases only will increase in BCH which may lead to
‘Death spiral’ like situation in long run.
- Challenge for the hospital to handle the intense local and national pressure to reduce the
costs.
 2. In this industry situation, why should clinical department heads, such as Drs. Meara and
Waters, be interested in developing more accurate costs for their procedures?

- As bundled pricing is being contemplated internally as well as externally in insurance

companies, it becomes more logical to know what are levers of costing and drivers of
costs before going for all-in bundled reimbursements. If the hospital cannot control
prices it will have adverse impact on flow of patients and revenues.
- In this situation financial managers with limited medical knowledge and nuances of
complexities of clinical procedures could not gauge the costs and prices properly. Clinical
departments’ heads Dr. Meara and Dr. Waters should step in with their clinical
procedures acumen to safeguard not only health of the patients but also financial health
of the hospital.
- Criticality of medical procedures, activity flows and resource allocation are major
ingredients of costing analysis. Clinical heads only can give insights, inputs in costing.
- Pressure on financial condition of hospital have spiralling effect on compensation and less
allocation of funds to research and teaching which is core for department/clinical heads.
- Nuances of clinical procedures, only clinical heads will throw some light on how
competitors are able to reduce the costs and prices to clients.

3. Use the Excel spreadsheet to calculate the costs and margins of the three different office
visits using: a. The RCC method
b. The TDABC method

RCC method: Ratio of cost to charges method (excel sheet attached)

Actual charge (multiply by) RCC ratio =RCC cost
RCC margin = Average reimbursement – RCC cost
RCC RCC Average RCC
Medical Diagnosis Cost per patient visit Charge ratio Cost reimbursement Profit
Plagiocephaly 350 60% 210 224 14
Neoplasm skin excision 350 60% 210 224 14
Craniosynostosis 350 60% 210 224 14
TDABC method: Time –driven activity based costing depends on costs and time spend by each
individual/resource in the clinical procedure. Capacity cost rate is estimated by annual cost of a
person and total minutes of time spend

Resource Surgeon ASR RN CA

Weeks per year 52 52 52 52

Less: Vacation & Holidays 6 4 4 4

Less: Training and Leave 2 2 2 2

Available weeks per year 44 46 46 46

Hours per day 10 8 8 8

Less: Breaks, training, meetings 1.2 1.5 1.5 1.5

Available hours 8.8 6.5 6.5 6.5

Less: Estimate of Research &
Education time (%) 25% 0% 0% 0%

Clinical Hours per day 6.6 6.5 6.5 6.5

$ $ $
Cllinical minutes available per day $ 396.00 390.00 390.00 390.00
$ $ $
Clinical minutes available per year $ 87,120.00 89,700.00 89,700.00 89,700.00
         
$ $ $
Annual Cost per person $ 5,22,720 89,700 1,34,550 71,760
$ $ $
Capacity cost rate ($ per minute) $ 6.00 1.00 1.50 0.80

It is product of Time spent on each activity and rate to produce the charges

Medical Diagnosis Cost per

patient visit Surgeon ASR RN CA Total cost
$ $ $ $
Plagiocephaly 108.00 8.00 $ 34.50 4.00 154.50
$
Neoplasm skin excision 132.00 55.50 30.00 4.00 221.50
$
Craniosynostosis 240.00 10.50 34.50 8.00 293.00
          
Medical Diagnosis Cost per Charg Average Total TDABC
patient visit e reimbursement cost TDABC margin
Plagiocephaly 350 224 154.5 69.5
Neoplasm skin excision 350 224 221.5 2.5
Craniosynostosis 350 224 293 -69

TDABC margin is estimated Average reimbursement – Total TDABC cost

4. What explains the difference in costs using the two methods?

RCC and TDABC methods give two different costs due to the costs are allocated. The TDABC costs
consider the actual demands the different treatments place upon the hospital’s staff planning,
whereas the RCC costs offer only an approximation based on a department-wide ratio.
The RCC method uses a simple ratio to determine a uniform cost for the procedures, ignoring the
variety of labor and time demands that exists. The plagiocephaly treatment requires less time
and labor than the others, resulting in a lower cost under the TDABC method, while the complex
craniosynostosis treatment requires more time and labor than the others, resulting in a higher
cost. The cost for the neoplasm skin excision is close to the RCC cost because it requires an
average amount of time and labor.

Ratio of cost to charges (RCC)

- RCC approach assume costs are proportional to charges
- Easy to calculate; simple proportion demonstrating relationship
- RCC measures cost to charge ratio, not cost to reimbursement ratio
- Not so accurate method

Time Driven Activity Based Costing (TDABC)

- Bottom-up approach to costing that estimates costs based on time used for services
- Better cost allocation; easily breaks down costs to identify service line problems; allows
charges to be more reflective of costs
- Takes tremendous effort to implement and launch this costing system; requires constant
re-evaluation
- Accurate method
The three treatments in the illustration are charged with same rate though having varying
expenses
5. Suppose DPOS dedicates the following resources to handle all office visits: 2.5 surgeons, 2
Ambulatory Service Representatives, 2 Registered Nurses, and 1 Clinical Assistant. During the
year, the office performs 4,400 Plagiocephaly visits, 2,200 Neoplasm visits, and 1,800
Craniosynostosis visits. Calculate the quantities and cost of used and unused capacity for the
four types of personnel, and the total cost of unused capacity for the year. How can Dr. Meara
reduce the costs of unused capacity?

Annual
  Surgeon ASR RN CA Quantity
Plagiocephaly 18 8 23 5 4400
Neoplasm skin
excision 22 55.5 20 5 2200
Craniosynostosis 40 10.5 23 10 1800

Surgeo
Total Capacity n ASR RN CA totals
$
Number of personnel 2.5 2 2 1 7.50
Total clinical minutes(per year) 217800 179400 179400 89700  
Surgeo
Total spent(yearly capacity) n ASR RN CA totals
Plagiocephaly -4400 79200 35200 101200 22000  
Neoplasm skin excision -2200 48400 122100 44000 11000  
Craniosynostosis -1800 72000 18900 41400 18000  
Total Capacity (used) 199600 176200 186600 51000  
Unused (minutes) Capacity 18200 3200 -7200 38700 52900
169450
Cost of used capacity 1197600 176200 279900 40800 0
Cost of unused capacity 109200 3200 -10800 30960 132560
104.01
Percentage of utilisation % 91.64% 98.22% % 56.86%

Surgeon's unused time % 34%

Surgeon's unused capacity cost
% 82%

In the case we can see surgeon’s unused time contribution is 34 per cent and at the same time
cost contribution for the unused capacity is 82 per cent. This clearly indicates there is buffer in the
number of surgeons used for the task.it can be brought down from 2.5 to 2.3 to save on unused
time and reduce unused cost capacity. (Attachment worksheet cost and quantities XLSX)
Surgeons are costly resources and their time should be used judiciously by following ‘Just in time
method’. Tracking real time basis the information of appointments and cancellation/no show of
patients appointments will cut down the unused time. The quality extra time of surgeon can be
used for other cases, units or departments and it will help increase volume and bringing down
average cost.
Clinical assistants is a semi-skilled category and utilization is sub-optimal at 57 percent. It shows
there are high number (i.e Craniosynostosis) and lot of slackness is there. It can be brought down
from 1 to o.6. Upon training they can be utilized for some duties of registered nurses to bring
registered nurses utilization from 104 per cent to 98 % and above. These clinical assistants are
semi-skilled can be recruited on usage basis/part –time.
Registered Nurses are doing over-time and utilization capacity is more than 104 per cent. To keep
a check and bring utilization to optimal level, certain task are to be shared with clinical assistants
and Ambulance service staff at the initial admission as well as discharge of the patient. Cost –wise
also it will be advantage as Clinical assistants and ambulance services are comparatively at lower
level.
6. Use the Excel spreadsheet to calculate the costs and margins of the three different
orthopaedic casts using the TDABC method.
Procedure Percentage
(figures in Total costs Average Average
dollars $) TDABC reimbursement Average profit profit(%)
Long leg cast,
cotton
padding 165.45 366.10 200.65 121.3%
Long leg cast,
Gore-Tex
padding 349.71 408.80 59.09 16.9%
Petrie long
leg cast 308.98 126.70 -182.28 -59.0%
Clubfoot cast
(6 total visits,
incl. initial &
final) 721.42 1183.00 461.58 64.0%

The profit margin in the RCC/RVU is approximately 100$ more than those found using the
TDABC method. (Attached work sheet costs and revenues xlsx).But doing TDABC methods it
is easy to understand the nitty-gritty of process flow while evaluating costs and margins with
different scenarios.

7. Compare the TDABC costs and margins with those calculated using the hospital’s existing
RVU system. What differences occur and why?
From the above table in question 6 we can see lot of pitfalls because of RVU system. The profit
per centage of long leg cast and cotton padding is 121 % where gore tax padding is only 16.9 %.
Through RVU calculation, we can see anomaly in the exhibit the cost of direct material increased
only 4 dollars where in actual the gore tax padding material is over 100 dollars in comparison to
cotton padding. In case of Petrie leg cast the profit is negative because it takes double the
number of labours and material as well as the initial procedures in cotton padding and gore tax
padding of long leg cast are compulsory. But in calculation through RVU system, labour was not
increased significantly whereas the direct material usage was less compared to actual
requirement. This type of costing will land BCH a loss of 182 dollars loss in every Petrie leg cast.
Notwithstanding that there will be lower charge to patients and much lower reimbursement
from the insurer.
-In case of clubfoot cast which involves multi visits and higher number of labour and materials
TDABC calculation gave 64 per cent profit whereas RVU system has calculated 91.16 per cent
profit.
-The difference are found in direct and indirect costs, labour and in the direct material.
Differences of TDABC and RVU system exists because of different allocation of bases and
methods are used to calculate costs.
8. Should the two TDABC pilots be extended throughout the hospital or should senior hospital
management just allow such local initiatives to arise spontaneously, based on local physician
interest?
-Only senior hospital management that is actually involved in these treatments can
determine costs better instead of financial department following the random RCC method
based on weightage.

- With a ultimate goal of high quality care, over the patient’s entire care cycle with few
complications and better outcome for patients and lower costs to the payors and insurers.
The TDABC pilots have to be compulsorily extended throughout the hospital to reap full
benefits and negotiating power with the payors and insurers.

-As BCH is competing with reduce unused capacity, change staffing and experiencing the loss
of revenue and patients. Have more accurate costing estimates so can come up with more
accurate reimbursement models, such as bundled-pricing that will definitely help BCH in
transformation that the hospital is intend to bring through PPSQ and SCAMPs across the
departments.

- This type of initiatives will increase the transparency and earn credibility among the payors
and insurers as well as BCH will have cutting edge over competitors, moreover facilitate in
the renew of contracts.