American Association for Physician Leadership

Strategy and Innovation

Reckoning Value with Time-Driven Activity-Based Costing

Brandon L. Potter, MD | Richard D. Urman, MD, MBA | Mitchell H. Tsai, MD, MMM | Jacob Martin, MD

August 8, 2017


Abstract:

Our healthcare system is built on financial reactivity and razor-thin profit margins. A fundamental reason for this is the industry’s lack of accurate cost accountability. The first step in solving these discrepancies is to understand what it actually costs to provide healthcare services to patients. One solution is Kaplan’s proposed time-driven activity-based costing (TDABC) method. Pilot programs using TDABC have demonstrated not only more accurate cost accounting data but also reductions in process times and incurred expenses.




There is a constant sense of urgency to understand our costs, because alternative payment methods will increasingly replace fee-for-service models.(1) The need to assess costs accurately is particularly critical because healthcare revenues are endangered nationwide. Although bundled payment systems may be an answer for value-based reimbursement, the operational scope of these processes must be addressed and defined. Bundled payments on the micro level are destined for failure, whereas macro-level bundled payments that take into account the natural history of morbidities may have merit.

Many misconceptions regarding healthcare costs and their effects exist throughout the industry. Our current healthcare crisis can be explained in terms of value, specifically in terms of how to better deliver improved outcomes at lower costs. To increase value, a systematic approach is necessary—one that allows us to analyze all aspects of the finances involved. Once the actual costs to deliver clinical care are known, we can then determine how to maximize care per dollar spent.(2)

Top-Down, Bottom-Up Costing

The two most commonly used costing models are top-down and bottom-up. Top-down costs are calculated for each encounter as a proportion of annual expenses. Bottom-up costs are calculated by totaling each provider-level expense with its associated activity.(3, 4) The two common costing methods, relative value units (RVU) and ratio of cost to charges (RCC), are summarized in Table 1.

The RVU method represents the relative work and expertise involved in any given patient service. CPT codes exist for any interaction a patient has with a healthcare provider. The American Medical Association generates RVUs for each of their CPT codes. The process for generating RVUs takes into account the level of service, practice expenses, and malpractice relative risk, all three of which are weighted by geographic location. The CMS reimburses for healthcare based on a patient’s corresponding CPT code and assigned RVU cost.

The RCC method looks at year-end revenues and expenses; the ratio of revenues to expenses is used to back into the cost of patient care. If a hospital’s revenue-to-expense ratio is .80, and the charges for a patient visit were $300, the costs for that visit are calculated as $240. This 80% is used as the ratio of cost to charges.

The advantages of top-down costing are its simplicity to derive, the low expense to facilitate it, and the ease of inputting data. Disadvantages lie in not understanding the changes in costs as conditions change, the inability to differentiate costs between individual components of the system, unknown incremental costs, the risk of averaging effects across services, and force-fitting costs based on historical pricing. These shortcomings may create a zero-sum game for stakeholders, with the lurking potential to undermine interdisciplinary collegiality and patient safety.(3) One striking example of a top-down costing approach failure is the use of per diem reimbursements for hospital stays. Several authors point out how costs in care are more chronologically front-loaded than commonly thought.(4-6)

The advantages of bottom-up costing are its improved cost accuracy, stakeholder-centered focus, transparency, versatility, and predictability. Furthermore, it allows for differentiation of variable and fixed costs. Disadvantages are the resources and expertise needed to facilitate the costing method.

Healthcare institutions have a high fixed-to-variable cost ratio, and hospital administrators need to fully understand the overhead costs for particular activities in order to appropriately assign wages, rents, and administrative costs to the income from clinical interviews, physical examinations, and procedures they perform. Given the varying contribution margins of many hospitals, optimizing current systems may be a more cost-effective way to increase revenue than simply emphasizing increased throughput as the means and the ends.(7) For most institutions, the revenue generated per patient is constrained by bottlenecks in the system. If the costs are unknown, then simply increasing production volume may paradoxically increase fixed costs and amplify inefficiencies. Further, there is little consideration given to clinical outcomes that may or may not follow from lowering total care costs.(8) Again, the value of any accounting efforts lies in understanding the costs.

Time-Driven Activity-Based Costing

Current costing methods have their own tragic flaws: zero-sum game confinements of bundled payments; RCC’s arbitrary charge assumptions; and the bias in favor of specialists or overtreatment with RVUs.(9) An alternative approach offered by Kaplan(8) is time-driven activity-based costing (TDABC). TDABC is a methodology that calculates the cost of resources consumed as a patient moves along a care process. In a sense, it is a hybrid of top-down and bottom-up costing. It optimizes the advantages and minimizes the downside of both accounting systems. Comparisons are shown in Table 1.

With every patient care cycle, TDABC requires two metrics: the cost of each resource involved in their care (top-down) and how much time each resource spends on patient care (bottom-up). The cost of each resource involved in the care of a patient is amortized. The total expenses are tabulated for each service incurred and included over the entire cycle of care for a specific disease process. These services could include treatment by physicians and nurses, x-rays, medical tests, assessments of results, administrative personnel, bookkeeping, rent, utilities, insurance, supplies, marketing, information technology, equipment, training, and research. The total cost per resource is divided by time consumption, resulting in a rate per unit of time called a capacity cost rate (Figure 1).

Figure 1. Top-down progression of time-driven activity-based costing calculations. All resources involved in patient care are included, with subcategories created based on allocated costs. Personnel costs are based on clinical time (e.g., physician clinical time is 40 weeks/year, five days/week, eight hours/day, totaling 96,000 minutes/year. Yearly compensation/minute equals a capacity cost rate of $2.08/min). Administrative and Clinical Services costs are based on clinical time mirroring that of the physician in order to avoid overcharging patients. In a practice with more than one physician this can be distributed accordingly (e.g., administration time is 96,000 minutes/year at a total cost of $1,090,000, giving a capacity cost rate of $11.35/min). Please note rounding errors are present.

Kaplan and Porter propose that a key component of TDABC is the development of process maps called care delivery value chains. Kaplan and Porter collaborated with Albright and Feeley in a pilot study at the University of Texas MD Anderson Cancer Center.(10) Albright and Feeley explain:

Within each segment of care – the outpatient clinic, diagnostic imaging, the operating room, inpatient care, radiation therapy, and chemotherapy administration – we created process maps that also included all the resources involved. Each segment of the process map took approximately 40 hours to complete, with a team consisting of a project manager, a project coordinator, a process mapping expert, financial staff, clinical and business managers, and staff members from each function being mapped.”(8)

Ultimately, the new process reduced operational process time by 16% and decreased costs for the technical and profession staff by 12% and 67%, respectively.(8) Again, TDABC measures the time an individual patient spends with each resource, which is prorated across its capacity cost rate. The cost of each individual resource consumed can be added up to provide the total cost for each patient care episode.

Similarly, a study by the Harvard Business School in conjunction with Boston Children’s Hospital shows how more accurate costs are obtained as diagnoses diverge from a common initial chief complaint.(11) The Department of Plastic and Oral Surgery and the Department of Orthopaedic Surgery at Boston Children’s Hospital piloted case studies as patients with plagiocephaly and distal radius fractures moved through patient care cycles.(11,12) In this pilot study, TDABC provided increased cost accountability compared with traditional costing methods and enabled healthcare team members to understand which morbidities, diagnoses, and procedures consume the most resources. Ultimately, they made better-informed decisions on patient support, operations, negotiating reimbursements, and marketing.

Conclusion

Solid evidence exists for the utility of the TDABC model not only in clarifying important assumptions, but also in individualizing costs for each patient’s circumstances. This allows all stakeholders an “apples-to-apples” comparison of costs preceding change as more physicians work to regulate their own spending.(13) TDABC offers a patient-centered costing model and better defines the opportunities for process improvement. Comparisons across demographics, comorbidities, procedural techniques, throughput, pharmaceutical and device pricing, protocols, and screening tests are some examples of the many other nuances that can be scrutinized to add value. Every stakeholder’s time in the patient care cycle is honored. This might be the most compelling and transformative part of TDABC, in that it addresses the procedural and over-medicalization bias of our current system.

TDABC systems do have some shortcomings. First, the TDABC process is time-consuming and expensive to initiate and maintain. However, M.D. Anderson’s use of TDABC did prove returns were worth their investment—with a 16% reduction in process time, a 12% decrease in costs for technical staff, and a 67% reduction in costs for professional staff.(8) Second, there must be mechanisms for each care provider to accurately and easily assign time to their respective patient care cycles. This will require further investment in information technology and the adoption of supportive platforms that exist for this necessity. Third, there is risk that a truly valuable service, in the global sense, may be viewed as a “loss” on paper due to TDABC’s inherent detailed focus. As costs begin to compartmentalize, there is risk in missing how they relate to a patient’s overall health.(8) For example, the additional time and cost requirement to perform a diabetic foot exam needs to be weighed against the costly and increasingly invasive treatment of an undetected spreading infection. Aggregating and analyzing the vast amounts of data produced by TDABC will be important to hedge against “financializing” an already heavily “medicalized” patient population. The importance of this cannot be understated, given that our healthcare system is built on financial reactivity and razor-thin profit margins. Ultimately, there may be an understandable resistance to welcoming new costing methods with the transparency it brings.

TDABC lends itself to better facility designs, more efficient equipment utilization, and the potential for provider teams to be organized around specific medical conditions. For example, using the TDABC methodology, Boston Children’s Hospital has created better-aligned care delivery.(11) Better coordinating care across specialties, defragmenting processes, reducing redundancy, improving medical optimization, empowering patients, identifying time delays, and rewarding the benefits of preventative care are all improvements realized with the TDABC approach. Further, as healthcare is operationalized along a gradient of skill sets, a TDABC system will, according to Kaplan, “reveal opportunities for appropriately skilled but lower-cost healthcare professionals to perform some of the processes currently performed by physicians without adversely affecting outcomes.”(8) If the goal in “solving the healthcare crisis” is to increase value, our most worthy pursuit is that of understanding our costs.(13) TDABC gives us the means to do so. The ends will require leadership, adaptability, and perseverance.

References

  1. Burwell SM. Setting value-based payment goals: HHS efforts to improve U.S. Health care. N Engl J Med. 2015;372:897-899. .

  2. Gabriel RA, Gimlich R, Ehrenfeld JM, Urman RD. Operating room metrics score card—creating a prototype for individualized feedback. J Med Syst. 2014;38(11):144.

  3. Understanding activity-based costing. In: Qatar Financial Center. QFinance: The Ultimate Resource. London: A&C Black; 2014. Retrieved from https://ezproxy.library.und.edu/login?url=http://search.credoreference.com/content/entry/qfinance/understanding_activity_based_costing/0 Accessed March 2, 2071.

  4. Olsson TM. Comparing top-down and bottom-up costing approaches for economic evaluation within social welfare. Eur J Health Econ. 2010;12(5):445–453.

  5. Macario A. What does one minute of operating room time cost? J Clin Anesth. 2010;22(4):233–236. doi:10.1016/j.jclinane.2010.02.003.

  6. Taheri PA, Butz DA. Health care as a fixed-cost industry: implications for delivery. Surg Innov. 2005;12(4):365-371.

  7. Activity based costing. In: Qatar Financial Center. QFinance: The Ultimate Resource. London, UK: A&C Black; 2014. Retrieved from https://ezproxy.library.und.edu/login?url=http://search.credoreference.com/content/entry/qfinance/activity_based_costing/0 Accessed March 2, 2017.

  8. Kaplan RS, Porter ME. How to solve the cost crisis in health care. Harvard Business Review. 2011;89(9):46-52.

  9. Yun BJ, Prabhakar AM, Warsh J, et al. Time-driven activity-based costing in emergency medicine. Ann Emerg Med. 2016;67:765-772.

  10. Albright HW, Incalcaterra J, Feeley TW. Time-driven activity-based costing and the impact on cost measurement in the face of health reform. J Clin Oncol. 2013;31(31_suppl):262.

  11. Kaplan RS, Witkowski ML, Hohman JA. Boston Children’s Hospital: measuring patient costs (V). Harvard Business Review. 2012;N9-113-057.

  12. Hennrikus WP, Waters PM, Bae DS, Virk SS, Shah AS. Inside the value revolution at Children’s Hospital Boston: time-driven activity-based costing in orthopaedic surgery. The Harvard Orthopaedic Journal. 2012;14:50-57.

  13. Cassel CK. Choosing wisely. JAMA. 2012;307(17):1801.

Brandon L. Potter, MD

University of North Dakota School of Medicine and Health Sciences, 1301 North Columbia Road, Stop 9037, Grand Forks, ND 58202-9037; phone: 701-777-3406; email: potterbl@gmail.com.


Richard D. Urman, MD, MBA

Associate Professor, Department of Anesthesiology, Perioperative and Pain Medicine, Brigham and Women’s Hospital, Boston, Massachusetts.


Mitchell H. Tsai, MD, MMM

Associate Professor, Department of Anesthesiology and Department of Orthopaedics and Rehabilitation (by courtesy), University of Vermont College of Medicine, Burlington, Vermont.


Jacob Martin, MD

Department of Anesthesiology, University of Vermont Larner College of Medicine, Burlington, Vermont.

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