EXECUTIVE SUMMARY

• Activity-based methods serve as a dynamic process that has allowed many other industries to reduce and control their costs, increase productivity, and streamline their processes while improving product quality and service. The method could serve the healthcare industry in an equally beneficial way.
• Activity-based methods encompass both activity-based costing (ABC) and activity-based management (ABM). ABC is a cost management approach that links resource consumption to activities that an enterprise performs, and then assigns those activities and their associated cost s to customers, products, or product lines. ABM uses the resource assignments derived in ABC so that operation managers can improve their departmental processes and workflows.
• There are three fundamental problems with traditional cost systems. First, traditional systems fail to reflect the underlying diversity of work taking place within an enterprise. Second, it uses allocations that are, for the most part, arbitrary. Single step allocations fail to reflect the real work—the activities being performed and the associate resources actually consumed. Third, they only provide a cost number that, standing alone, does not provide any guidance on how to improve performance by lowering cost or enhancing throughput.

The current healthcare market is under tremendous economic pressure. Medicare and Medicaid reimbursements are being reduced each year and profit margins are so small within healthcare in general and in departments like radiology, specifically, that there is truly no room for error.

Activity-based methods serve as a dynamic process that has allowed many other industries to reduce and control their costs, increase productivity, and streamline their processes while improving product quality and service. Traditional methods did not provide accurate cost information useful to operation managers. The manufacturing sector was the first to adopt activity- based methods and, today, many industries world-wide (eg, automotive, airline, and governmental agencies) have abandoned the traditional approaches in favor of the activity-based approach. Healthcare is the largest industry to virtually ignore this methodology, but it can greatly benefit from systems that monitor and manage what is being consumed and what is being produced within key departments, such as radiology.

Activity-based methods encompass both activitybased costing (ABC) and activity-based management (ABM). The value of ABC and ABM is straightforward. ABC is a cost management approach that links resource consumption to activities that an enterprise performs, and then assigns those activities and their associated costs to customers, products, or product lines. ABM uses the resource assignments derived in ABC so that operation managers can improve their departmental processes and workflows and answer the question: “Why do we incur these costs?” Two things happen by implementing ABC and ABM. First, the ABC approach reveals the costs for each activity included in a procedure, test, or service. Second, activity-based methods link all the activities together for a grand total.

ABC is designed to accurately define costs and provide operation managers with the very tool they need to improve operations and lower costs. For a long time, ABC was thought to be too labor intensive to implement and maintain because it gets down to a very granular, almost finite, level of detail. It was this level of detail that led to the remarkable improvements in product quality the world experienced in the 80s and 90s. Many radiology directors and administrators possibly felt the reward may not be worth the pain that has historically accompanied an ABC methodology. New technology has reduced or eliminated the historic concerns because most of the information needed to utilize an ABC approach already resides within hospital facilities. What has been missing is the ability to collect the information from disparate systems and mine this data into the activity dictionaries needed to drive an ABC system.

ABC Compared to Traditional Standard Cost Systems

Traditional approaches used by hospitals and other healthcare organizations for determining procedure, service line, or patient profitability often utilize standard cost allocations. These approaches use either single or multiple cost pools allocated directly or a departmental rate. There are three key problems with this approach. First, it fails to reflect the underlying diversity of work taking place within an enterprise. Second, it uses allocations that are, for the most part, arbitrary. Single step allocations fail to reflect the real work—the activities being performed and the associate resources actually consumed. Finally, they only provide a cost number that, standing alone, does not provide any guidance on how to improve performance by lowering cost or enhancing throughput.

ABC utilizes a multi-stage process that traces resources (salaries, rent, equipment, etc) to the activities those resources perform. This activity analysis converts the traditional view of cost information (dollars by resource acquired) into an activity view (dollars by activity performed). Figure 1 provides an illustration of this process.

ABC then applies activity drivers to trace the activities to the services actually provided (cost objects). Cost objects are the “things” in the question, “What do things cost?” Cost objects within healthcare organizations may include patients, service lines, payers for services, physician groups, and geographic facilities.

ABM focuses on cost drivers and performance measures. Cost drivers are any factor which causes a change to incur in the cost. There may be multiple cost drivers for any activity. Understanding the significance of cost drivers, both individually and in combination with each other, is the key to both understanding what causes cost to occur and identifying specific costs that can be reduced or eliminated.

ABM enhances the concepts of case costing and case management within a hospital. For example, consider a procedure performed in the operating room. The time spent by physicians and the assisting nurses to perform the medical procedure, special imaging, or other ancillary services, as well as the cost of supplies, represents the direct costs for a specific case. However, it does not represent the complete cost of the case— consider the registration process, pre-operative testing (x-rays, blood work, etc), assistance in recovery, and discharge planning. These all represent specific activities and costs which should be considered in measuring the actual costs of providing a service to your patient.

An activity-based model can be described as follows: Amounts are spent (traditional costing ends here!) in order to perform various activities (eg, tracking, operating room time, etc) that create a suite of products or services (eg, filling medical supply orders) which are consumed by internal customers (eg, the operating room staff).

The costs can be significantly different when you evaluate the entire process of a procedure being preformed rather than just the cost of a procedure. This method of costing is designed to be both defensible and understandable for internal (management) and external (regulatory) purposes.

Performance measures are used to measure the output of activities. They include both specific cost measures and non-financial measures, such as clinical outcomes, patient functional status, cycle time, and customer satisfaction. Understanding the impact activities have on key performance measures is critical to achieving an optimal answer, not just the answer with the lowest cost. If the lowest cost is the only objective, simply eliminate the activity which will yield no cost. It will, however, also eliminate any benefit the activity was providing, including reducing costs in other areas (such as preventative maintenance).

Technology as an Enabler to the Budgeting Process and Overall Business Performance Management

Healthcare organizations have systems in place that can be leveraged for implementing activity-based methods. These systems include patient scheduling systems, hospital information systems, radiology information systems, PACS, purchasing systems, billing systems, and many others.What has been needed in healthcare information technology systems is the capability to interface with these existing systems, integrate them, and mine the critical information using an activity-based model.

Moreover, information technology systems have advanced to the point where individuals, such as administrators of radiology, are empowered with the tools that will allow them to drill down into the specific details they need, as opposed to relying solely on general, department-wide data. Today’s newer technologies leverage existing information systems to pull dynamic information together and serve this up to users (radiology administrators, department managers, or supervisors) within radiology departments. The key to these enabling technologies is that they make information from disparate systems accessible, putting it at the fingertips of those who have ownership and accountability for fiscal performance.

In short, what has changed about ABC is that technology has made it much more attractive for the healthcare industry to adopt the methodology. The increased use of activity-based methods will allow administrators and managers to view their operation in ways they haven’t been able to in the past giving them insight that was impossible to gain using the traditional cost accounting or budgeting systems.

Activity-Based Budgets

Radiology administrators are now increasingly evaluated for adhering to their budgets and on the overall financial performance of their facilities.

The activity-based budget is a budget that represents all of the activities performed within an enterprise and their corresponding costs. Through an activity-based methodology, budget practitioners can more accurately determine what resources are consumed by which activities.

With an ABC approach, those responsible for budgeting can identify all activities and sub-activities that occur within the enterprise. This is a much more accurate reflection of a department’s true costs. Looking at an activity-based budget in the world of medicine, one is struck by the fact that variable costs are really not that variable in healthcare. For instance, when volume goes down in your facility do you send people home or ask them not to come in? Do you pay those people you have sent home or asked not to come in? Although there are a few facilities that say they do this, in my experience, the practice is very limited and more often the individuals are actually paid when they are sent home. Due to the lack of variation in variable costs one finds that as volume increases, unit costs will dramatically be reduced and vice versa. Using traditional budgeting methods, volume is multiplied by a unit cost without recognizing that unit costs vary with volume. When we budget a lower volume, our assumptions result in lower profitability or loss. When we budget higher volumes, the traditional systems do not recognize the improved profitability and often do not provide any clue regarding capacity constraints.

A New Way Forward

Activity-based methods can provide a significant benefit to any healthcare delivery organization. By embracing activity- based methods, administrators and supervisors alike within radiology can fulfill many of the items on their wish list of business objectives. ABC will allow administrators to get their arms around necessary detailed cost information and ABM will provide the tool to improve performance.

Implementing an activity-based methodology is a journey that will last many years. Instilling an operational focus into the fabric of your organization will require patience, focus, and commitment. You’ll experience success and failure, frustration and jubilation, but for all your trouble, you’ll be rewarded with the knowledge that your organization is truly achieving world class results in outcomes and cost management.

Additional Reading

Baker J. Activity-Based Costing and Activity-Based Management for Health Care. New York,NY:Aspen Publishers; 1998.

Cokins G. Activity-Based Cost Management Making it Work: A Manager’s Guide to Implementing and Sustaining an Effective ABC System. New York,NY:McGraw Hill; 1996.

Kaplan RS, Cooper R. Cost & Effect: Using Integrated Cost System to Drive Profitability and Performance. Boston, MA: Harvard Business School Press; 1997.

Web sites:
http://www.cam-i.org/
http://valuebasedmanagement.net/methods_abc.html

Paul H. Monge, CRA, is currently the Executive Director of Imaging at ExactCost , Inc., a provider of Activity- Based Costing, Activity-Based Management, and Performance Management Software Solutions for healthcare enterprises. Paul has global responsibilities for the ExactCost radiology solution that focuses on performance improvement and cost reduction. He may be contacted at paulm@exactcost.com.