Demystifying Healthcare Costs

Developing and maintaining hospitals is a capital-intensive affair and therefore, managing costs, achieving profitability and justifiable growth are very important for any hospital venture to be successful. Hospitals face number of challenges as they are exposed to greater risk as compared to other industries, owing to complexity of operations, ensuring appropriate quality of care and humanitarian and ethical issues in providing healthcare.

The operational and financial risks in hospital sector and various challenges faced in this sector also emanate from the growing competition, which puts hospitals under pressure to provide cost effective services along with ensuring good quality of care.

Two critical aspects being:

• Appropriate pricing of services
• Optimal capacity utilisation

Further, due to continuous technological advancement in diagnosis and treatment, hospitals

need to invest heavily on acquiring the most appropriate technology to deliver quality care to the patients. Hospital pricing policy has to ensure the recovery of the capital costs of these equipment and technologies.

Apart from physical resources, hospitals also face the challenge of ensuring that they retain qualified professionals. A FICCI-Kantar IMRB pan India patient satisfaction survey of 5,000 healthcare consumers conducted in 2017, revealed that reputed doctors associated with a hospital was the third most compelling reason for people to choose a particular hospital for treatment.

While volume-based costs may appear to be a reasonable method of costing in several industries, it cannot provide accurate costs in the healthcare industry. Delivery of healthcare being very complex in nature, accurate measurement of costs is difficult. Not all costs in healthcare are proportionate to changes in volume, except the cost of machinery and materials. Better patient outcomes and quality of care, which are powerful drivers of value in healthcare, also have implications on cost.

Costing is a Challenge

Ascertaining types and units of resources consumed and apportioning cost of such resources for each service delivered in a hospital have been challenging for providers. Therefore, it is important to move away from the conventional method of measuring costs to a scientifically designed method, which is able to capture the utilisation of resources for various processes within a hospital.

Time Driven Activity Based Costing (TDABC)

This revised and simplified Activity Based Costing (ABC), has been internationally recognised as an effective methodology for estimating costs of processes used in patient care. TDABC assigns resource costs to patients based on the amount of time resources are used in patient encounters, while other costing approaches rely on arbitrary allocations to some extent. TDABC directly measures the clinical and non-clinical resources for every activity involved in delivery of a service. This helps in not only understanding the actual cost but also the utilisation of resources according to their available capacity.

Volumes Make an Impact

Lower volumes led to higher costs, as the cost of delivery of care in case of less than 100-bed small hospitals was found to be higher than that of the cost incurred by more than 100-bed hospitals. This observation is irrespective of whether the hospital was located in a metro or a non-metro city. Small hospitals face challenges in investment in manpower and equipment, and hence engage with clinical teams on fee-for-services basis (as consultants) and in some cases small hospitals rent equipment even for the routine surgeries.

Volumes impact different components of cost in different manner. Higher volumes do lead to savings in machinery and materials (consumables). However, increase in volumes does not always lead to lower costs, as the utilisation of infrastructure is constrained by capacity utilisation of the clinical manpower.

Any significant rise in volume can lead to new break-even points/levels, as additional investment will be required for:

• engaging additional clinical manpower
• adding capacity, in case major volume of general ward patients is added as this capacity is usually full in established hospitals

Large public hospitals like AIIMS command price advantage in procurement of machinery and materials (consumables). Balancing between cost and accessibility is complex. While real estate cost continues to be a challenge for the hospitals in metro cities, hospitals in non-metros have higher cost of clinical manpower in terms of their remuneration and fringe benefits. Due to limited public infrastructure beyond metro cities, hospitals also invest in creating a support system for the doctors and their families.

Summarising It

Globally, there is a gradual shift with decreasing usage of Fee-for-service model and increasing adoption of the capitation model for out-patient care and diagnose-related-groups (DRG) model for in-patient care. Most countries are moving towards a hybrid model (fixed + variable incentive), which incentivises efficiency of resources/inputs and achievement of clinical outcomes by moving away from indicators linked directly to revenue generation via fee-for-service arrangements.

Challenges for Indian Hospitals

• Cash flow and working capital management
• Achieving operating profitability on a sustainable basis
• Optimising resources and processes and thereby reducing overall cost
• Improving overall margin
• Deriving financial performance indicators for different departments or service lines
• Managing employee cost without affecting the staff turnover ratio
• Analysing and optimising workforce and benefits
• Managing receivables below 90 days
• Improving and maintaining credit rating of the hospital by ensuring healthy financial ratios
• Generating and retaining funds for future capitalisation, modernisation and expansion
• Cash embezzlement, wastage, fraud and leakages