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Learn about productivity measurement, challenges, productivity ratios, total productivity, partial productivity, and managing discretionary costs in health care organizations.
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St. Jude Children’s Research HospitalInternational Outreach Program Seventh Meeting Calvo MacKenna BMT Cost Study December 19, 2007
Agenda • Discuss Chapter 12 and 15 • End of Meeting Administration
Chapter 12 Outline Chapter 12: Measuring Productivity • Productivity • A measurement of inputs required to produce an output • An area where the use of cost accounting ratios provide information for improving management of a health care organization • Cost accounting has begun to focus on the problems related to productivity measurement
Productivity Measurement • The measurement of productivity • Hard to determine in industries, including health care • The difficulties arise from the problems related to quality and outcomes measurement • Outputs are difficult to define in health care • The actions of employees determines how productive the health care organization will be
Productivity Defined • The ratio of any given measure of output to any given measure of input over a specified time period • Most common productivity measure is output per labor hour • Measures only part of the organization’s productivity • Does not account for the amount of capital equipment used in producing the output • Either state the results in dollar terms or in physical units
Total Productivity • The ratio of total outputs to total inputs • The amount of output per unit of input • Usually expressed in dollar terms • Shows the financial benefits of improved productivity • Considers the increase in wages or the price of supplies, as well as the quantity of inputs consumed • Must exercise caution to keep the unit of evaluation constant over time
Total Productivity Total Outputs Total Inputs Total Productivity = • From a finance standpoint we measure productivity as follows, Operating revenue Supplies + labor + capital + overhead P =
Total Productivity Problems • When using dollar amounts, inflation can cause problems • Have to keep the calculations in constant dollars • Potential changes in quality • Productivity measures assume that quality is held constant • The total productivity ratio is inadequate to segregate the impact of case-mix changes from the impact of productivity changes
Partial Productivity • A measure of output compared with a partial measure of input • More frequently measured in physical units • Useful for labor negotiations, monitoring continued efficiency of operations, and identifying places to improve the operations of health care organizations Total Outputs Partial Inputs Partial Productivity =
Partial Productivity Example • We will consider the technician labor hours necessary for a computed tomography (CT) scan • We are assuming that CT scans come in only two types, head and body *N/C = Data not collected
Statistics from Partial Productivity Actual output hours Baseline output hours • Index of output = × 100% = 102.3% • Our output increased by 2.3% over the base period • Index of labor hours = ×100% = 97.7% • We actually worked only 97.7% as many hours in the current period as in the baseline case. • Index of output per labor hour = × 100% = 104.7% • Our output in the current period per labor hour is 104.7% of that in the baseline period. Actual labor hours Baseline labor hours Index of output Index of labor hours
Productivity and Indirect Costs • An alternative to the traditional comparison is to develop a productivity measure based on the comparison of direct costs and indirect costs • Many departments in a health care organization use some resources in direct patient contact and other resources indirectly • If there is a relationship between hours of direct patient care time and indirect time then we can monitor this on a monthly basis to see if productivity is being improved or maintained
Managing Discretionary Costs • A major challenge for management • Costs incurred in departments that are essential to the organization but that do not have simple input-output relationships. • Examples: personnel, marketing, legal, finance, administration, housekeeping and security • Productivity is difficult to assess in these circumstances. • Health care costs can be classified into three broad categories • Engineered costs • Committed costs • Discretionary costs
Engineered Costs • Costs for which there is a specific input-output relationship • These relationships can be readily observed • Normally include the direct materials and direct labor cost • Can be controlled by using flexible budget variance reports • Examples • More patient days require more meals from the dietary department • More X-rays require more sheets of X-ray film
Committed Costs • Costs that cannot be changed in the short run, such as during the coming year • They are generally reviewed as part of the capital budget process • Once committed to they usually do not vary from year to year • Changes in volume of services provided often have no effect on the committed costs • Examples • The depreciation cost on a nursing home building. • Long-term leases • Depreciation on equipment • Insurance
Discretionary Costs • Are costs that are incurred, typically each year, in an amount that is approved as part of the normal budget process • Sometimes referred to as managed costs • The budget for discretionary costs is generally based on negotiation.
Zero-Base Review • Zero-base Budgeting • Requires that all costs be examined and justified • Requires examination of alternatives • Expensive and time-consuming • Usually done once every five years • Most effective in terms of discretionary costs because they do not have a clear relationship between inputs and outputs • Helps you understand what types of objectives are being accomplished by discretionary cost centers and what resources are being devoted to accomplishing the various objectives
Work Measurement • Another approach to dealing with discretionary costs is to perform a review of activities with the hope of converting a discretionary cost center into a engineered cost center • Work measurement is a technique that evaluates what a group of workers needed to accomplish the task efficiently • Example: the mail room • It would be hard to relate mail room costs with patient days. • But you could relate pieces of mail sent out and pieces of mail received and sorted • With the proper measurement of the type of work being performed, it might be possible to reclassify many costs as engineered.
Efficiency and Effectiveness • Effectiveness • A measure of the degree to which the organization accomplishes its desired goal • Measuring effectiveness • A set of goals should be established for the discretionary cost center • Must evaluate to see if the goals have been met • If the goals are met then the department is effective • Efficiency • A measure of how close an organization comes to minimizing the amount of resources used to accomplish a result • For a given result, the organization should attempt to minimize the cost of the resources required
Effectiveness & Efficiency • By examining effectiveness and efficiency one can determine 1. Whether or not the goals were achieved 2. The cost of what was actually achieved • We must look at both effectiveness and efficiency • There can be trade offs between the two • Sometimes to be effective we have to be less efficient • Healthcare tends to sacrifice some efficiency for effectiveness
Effectiveness & Efficiency • Goal is to have effectiveness and efficiency in balance
Effectiveness & Efficiency • Approaches to ensure the efficiency and effectiveness of a discretionary cost department • Thorough review of all budget elements • Development of monitoring tools for assessing efficiency and effectiveness • Introduction of competitive market forces • Leadership • Formalized spending approval mechanism • Promotion of an organizational culture
Chapter 14 Outline Chapter 14: Dealing with Uncertainty • Health care managers make many decisions after first making financial estimates. • Potential revenues and costs are predicted based on a number of calculations, and decisions are based off of these. • A degree of uncertainty is inherent in such estimates. • We will look at four common approaches that help improve the predictions made and used for decisions.
The Expected Value Technique • Expected value analysis • Estimates the costs or revenues based on the likelihood of each possible outcome • Key focus is on the possible events that might occur • Management can take actions to affect the outcomes, but events are occurrences that are beyond the control of managers • A weighted average of the outcomes with the probabilities of each outcome serving as the weights • Outcomes are measured in monetary terms
Using Expected Value • To calculate, first establish a probability distribution for the possible states of nature • Example: • Suppose that there is a 25% chance that the competitor will be a lithotriptor and a 75% chance that it will not, if we buy one. • Suppose that the profits from 1,000 patients are expected to be $50,000, whereas the loss related to 700 patients will be $150,000 Lithotriptor Project
Using Expected Value • To determine the expected value of this project: • The large potential loss is so great that it just offsets the benefit from the probable gain, and the expected financial result is zero. • The hospital may still buy the machine to keep physicians happy and to improve the hospital’s reputation and service to the community
Full Range of Possible Events • In making decisions based on expected value, we must consider all possible states of nature that might occur. • We have only considered 2 options: • We buy and they do not • We buy and they buy • But there are two more options that need to be considered: • We do not buy and they do not buy • We do not buy and they buy
Subjective Estimates • Subjective probability • A probability that is based on a manager’s estimate rather than known odds • All our estimates are based on it • Managers must use their knowledge, experience, and judgment to make a best guess about the likelihood of each event. • There is always a risk that unknown negative factors not taken into account will determine the probabilities. • Therefore, many organizations demand a substantial positive expected value to move forward with a project.
Subjective Estimates Example (pg. 311) • The probability changes Competitor Competitor
Another Expected Value Example • Suppose that we are planning the staff level for the emergency department (ED). • The ED managers know that it is most economical to staff the ED at just the level needed to provide care to all patients who arrive. • The cost per patient is minimized when the staffing pattern is correct for the volume of patients. Cost/Patient ($) Low Medium High ER Cases Probability Staff Staff Staff 20,000-25,000 .10 50 60 70 25,001-30,000 .40 55 50 60 30,001-35,000 .35 60 50 55 35,001-40,000 .15 70 60 50
Simulation Analysis • A tool that can take the various errors in all the estimates into account and provide managers with the likelihood of actual results being substantially different from the budgeted projection. • Avoids ignoring the possibility of unfavorable outcomes compounding other unfavorable outcomes • Helps improve the accuracy of the decisions managers make • Frequently used in health care
Sensitivity Analysis • Allows managers to consider various possible actual results and see their impact on the projection. • Tells a manager how sensitive the profits of the venture are to any given change in one or more variables. • Done using a spreadsheet program, such as Excel • Requires management judgment in determining a reasonable set of “what-if” assumptions.
Probabilistic Example • Based on a manager’s subjective estimate of what is most likely to occur. • The most likely outcome is generally the one the manager has used to make the original estimates for the projection. • When making a projection, the probabilistic nature of the estimate is often ignored. • Does not give the manager a sense of how likely or unlikely the result is to occur.
Simulation Technique • Similar to a sensitivity analysis, except it goes further in generating a value for each variable in the model. • The key to simulation analysis is that the value chosen for each variable is based on a probability distribution. • Managers must indicate how likely they believe a variable is to take on a variety of different values. • Will select each of the values on a random basis, adjusted for probability.
Implementing Simulation Results • The manager must use the simulation results in making a decision. • Relatively profitable and unprofitable organizations can afford to take risks, but those that fall in the middle are in a difficult position. • Most small to medium size health care organizations fall in the middle.
Limitations of Simulation Analysis • Primary concerns • May be prohibitively costly • The model may be built incorrectly • The probability estimates may be incorrect
Network Cost Budgeting • A popular management tool used for planning and controlling nonroutine, complex projects • May be beneficial for some ongoing activities • Uses arrow diagrams, that finds a critical path that determines the least amount of time for project completion • Refers to combining the techniques of network analysis with cost accounting to generate the most cost-effective approach to the project. • Often assumed that the network is laid out in an optimal fashion, but it can indicate other possible timelines. • Use overtime or extra staff reduces the amount of time, but the cost usually increases
Network Analysis • Uses a diagram to show the relationships in a complex project • Arrows represent specific activities that must be done • Crucial aspect: identifying the activities that must be completed before some other activity or activities can commence
Network Analysis Example • Assume that a hospital has determined midway through the year that revenues are below expectations and a financial crisis is anticipated. • The Decision: Select five departments that have the potential for budget cuts that would help offset the crisis • A zero-based review is conducted in each one. • Each element of the budget is reviewed and its role determined • Based on the information from the review, a decision would be made concerning how much to cut from the operating budget of each department.
Network AnalysisExample (pg. 320) • Each activity starts at a numbered point • Each activity has a number at its start and at its completion • The activity can be identified by these two numbers • Examples: Activity 1-2 or Activity 2-4
Network Analysis Example (pg. 321) • An alternative presentation is to place each activity into a “node” • You identify each activity by referring to it by the name or description in the node
Critical Path • Always found as an element of network analysis • To find: it is necessary to determine the expected length of time for each activity • Critical path method (CPM) • A program of techniques that indicates the cost and time for each element of a complex project and indicates cost/time trade-offs where applicable
Critical Path Example • Assumed that an initial plan was developed as follows: • Develop an audit plan, assign staff, schedule audits: 31 days • Audit Department A: 22 days • Audit Department B: 15 days • Audit Department C: 13 days • Audit Department D: 9 days • Audit Department E: 19 days • Review audit results: 31 days • Make budget modification decisions (top management), hear appeals, make final decision: 31 days • All days are shown, including weekend days. • In this plan, it was not assumed that any work would take place on weekends.
Critical Path • Decided there would be two teams of auditors • Fastest approach • One team: Audits A and then E • Other team: Audits B, C, and D
Critical Path Example (pg. 322) • One route or path through the network is 1-2-3-5-6-7-8 • The total days: 130 • The other route or path through the network is 1-2-4-6-7-8 • The total days: 134
Critical Path • Determined by totaling the days required for each possible route through the network and finding the longest one. • All tasks must be undertaken. • The project can be achieved in no less time than the time it takes for the longest path.
Benefits of Planning • Planning takes time • Conducting a zero-base budget review requires a careful audit plan. • Meetings must be held to determine the goals of the audit and the specific audit activities. • Auditors and departments have to schedule a mutually convenient time to do the audit. • Tasks make up Activity 1-2 • A review of the plan by the top management can result in determining how important each activity is • If the activity is important enough, then the individuals involved will be told to set all else aside temporarily. • Audits should begin as soon as the auditors are ready.
Revised Network Example (pg. 323) • Revised network has a new critical path that is only 65 days long. • More than half if the project time has been eliminated by indicating priority. • Reflects the significant benefits that can be obtained by creating and reviewing a plan before starting work on a project.
