Susan M. Reese

Hospitals can use four strategies to reduce nursing labor costs without jeopardizing quality of care.

At a Glance

Four strategies that hospitals should consider to reduce nursing labor costs without jeopardizing quality of care are the following:

  • Use net cost variances to drive authorized FTEs by skill level  
  • Manage supplemental labor  
  • Control distribution of nonproductive time throughout the year  
  • Monitor rate and efficiency variances  

As the buzz words "value-driven health care" have reverberated through the halls of Congress during the many months of debate on healthcare reform, it has become clear that hospitals will face increasing pressure to simultaneously reduce costs while improving quality of care.

The Centers for Medicare & Medicaid Services (CMS), for example, awarded bonuses totaling $12 million late last year to 225 hospitals for delivering the type of high-quality care that will reduce growth in Medicare expenditures. CMS also has said that it will no longer reimburse hospitals for preventable hospital-acquired conditions, or so-called "never events." Today, patient outcomes are already directly affecting hospital revenue.

Nursing, as the largest component of healthcare workers, plays a critical role in contributing to value-based quality care and patient safety. A growing body of research shows that nursing workforce characteristics have a considerable impact on patient outcomes. A higher number of RN hours per patient day, an optimal skill mix, and higher levels of nursing experience have been linked to decreased patient mortality rates, fewer adverse events, and lower hospital costs. Now more than ever, it's crucial for hospitals to focus on efficiently managing their nursing workforce so that the right number of nurses with the best possible skills are always delivering care-without deviating from labor budget targets.

Most healthcare organizations attempt to manage their labor costs with a simple productivity metric that measures hours worked to fluctuating patient census or other unit of volume. But that approach doesn't provide managers with critical information about the costs and quality-of-care implications related to workers' skill level, source of labor, and use of nonproductive time. Incorporating the following strategies into your labor management process can significantly reduce labor costs without jeopardizing quality of care.

Strategy No. 1: Use Net Cost Variances to Drive Authorized FTEs by Skill

The ideal staffing model for hospital departments with volatile workloads is to employ 75 to 85 percent of the FTEs needed to do the predicted volume of work. A department that uses only FTEs and part-time workers to meet forecasted work volumes will have higher labor costs. As patient volume drops, for instance, departments may be paying for employees whose attendance is not needed. Or some managers may send employees home without pay, creating worker dissatisfaction and, ultimately, retention problems. But employing too few workers is also costly if quality of care is compromised or departments must constantly pay for premium labor to supplement staff.

Departments should identify and evaluate the impact-both the financial impact and the impact on quality of care-of having too few or too many employed FTEs each pay period. Examine trends over multiple periods and anticipate changes in the unit. This information allows executives to make cost-effective and timely adjustments to employment levels before a serious quality or budget problem arises. "Evaluating the impact of employment levels on revenue and quality of care gives us valuable on-the-spot analysis to help drive sound decision making," says James Trzcinski, director of management services at the Ohio State University Medical Center.

The first step is to establish a targeted number of employed FTEs by skill level to patient volume per department or specialty area-basically, a plan for authorized positions at the budgeted workload volume. As patient census increases or decreases, employed FTEs by skill also will increase or decrease. This will become the department's flexible employment plan for full- and part-time staff by skill. The plan can be used each pay period to calculate the net cost variance between the optimum plan for employed FTEs and actual employed FTEs. The net difference between the cost of the department's actual employment level and required supplemental labor-as opposed to the expected costs for optimum-employed FTEs and expected supplemental labor-is the cost of being over- or under-employed. The variance represents the financial impact of being above or below the budgeted number of employed FTEs for the current patient volume.

Say an employment plan calls for employing 10 FTEs and one employee leaves, forcing a manager to fill the open position with supplemental labor. Tracking the net cost variance between the budgeted employment plan and the actual labor costs over multiple consecutive pay periods allows a manager to determine whether it would be more cost-effective to hire a new employee or to continue using supplemental labor. In addition, closely monitoring the use of supplemental labor provides an early warning signal that the department may be relying on too many outside nurses and, thereby, running the risk of developing quality problems.

The net cost variance helps managers identify trends that support a decision to increase or decrease employed FTEs by skill, which is a much more reliable method for determining authorized position levels than, say, the frequently used metric of the department's productivity percentage. A productivity measurement only speaks to the gross productive hours, without detailing the status of the worker providing the hours. For example, a department could be 100 percent productive using only full-time and part-time employees, or 100 percent productive using only supplemental labor. Productivity metrics do not help support employment decisions. Therefore, using workload-adjusted optimum-employed FTEs by skill to calculate the net cost variance is critical to good decision making.

"At Ohio State University Medical Center, we have included these metrics on the standard department-level productivity reports managers receive every two weeks," Trzcinski says. "This information is especially useful in our weekly posting committees as we review requested positions. The senior leaders of each hospital meet weekly to review all new, vacancy, and conversion position requests. My staff and I are the internal consultants to these committees, providing recommendations using productivity and other related information. We use both the flex-target FTE and salary dollar variances as the key criteria for initial review. For example, in one medical/surgical nursing unit at Ohio State University Medical Center, a staff nurse resigned to accept another position, and the manager requested approval to refill the vacancy. The biweekly productivity report supported the request based on looking at FTEs alone. However, the department was not meeting its flexible salary dollar target.

"A quick review of the rate variance indicated that the department was paying much more than it had budgeted per hour actually worked," Trzcinski says. "We also determined that the department was using minimal overtime and contract/agency labor. This led to the conclusion that the staff mix must be at issue. Namely, the department was likely using an RN-rich staff mix. As suspected, the manager had been opting for working part-time RNs beyond their typical scheduled times, rather than using less expensive, nonlicensed patient care associates [PCAs], who were qualified to do the work." Rather than refilling the vacancy with an RN, the medical center determined that a PCA would be more appropriate, thus allowing the manager to eventually meet her hourly salary targets.

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Strategy No. 2: Manage Supplemental Labor

Many managers have the mistaken impression that they should avoid using supplemental labor whenever possible. But used judiciously, supplemental labor provides flexibility to departments with variable staffing needs and may be a much less expensive option than hiring FTEs. However, effective management of supplemental labor is essential to avoid runaway labor costs. And to maintain quality of care, it is necessary to monitor the types of supplemental labor a department uses, and how often supplemental labor is used. The risk of medical errors is increased when departments rely too heavily on labor resources who are less familiar with the department's policies and procedures, such as agency nurses, or when too much overtime exhausts staff.

To manage supplemental labor, a detailed plan is needed to determine the amount of each type of labor-pool, per diem, overtime, agency, float-in, extra part-time-that the department expects to use for different patient volume levels. Use the current budgeted plan for supplemental labor usage as the baseline and flex the supplemental labor plan up and down to support increases or decreases in workload. Each pay period, compare the department's current distribution of supplemental labor and associated costs against the flexible budget for supplemental labor. If there is a discrepancy, determine why. Is the department using too many agency nurses because it's the easiest way to fill staffing gaps in a hurry? Are additional incentives needed so staff nurses will be interested in working overtime? Is the size of the float pool insufficient to support the department's needs? Once this information has been determined, identify opportunities to align use of supplemental labor with budgeted targets.

For example, consider an overlooked but cost-effective source of supplemental labor: part-time employees who will work extra hours. Usually paid straight time, part-time workers are familiar with a unit's procedures and patients and are less likely to make medical errors than temporary workers, such as agency workers or float employees from another department. Make it worthwhile for part-timers to volunteer for extra shifts, but closely monitor their hours so they maintain their part-time status.

Make sure to keep track of which employees work overtime or extra hours so the distribution of supplemental labor among employees is fair and does not contribute to conditions that would jeopardize quality care or contractual agreements. Giving too much overtime to too few employees creates burnout and the potential for medical errors.

Strategy No. 3: Control Distribution of Nonproductive Time Throughout the Year

Most healthcare organizations budget an average of 10 to 12 percent of their total paid labor hours as nonproductive time, which includes holidays and vacations and may include orientations, off-site meetings, and educational sessions. Failing to manage employees' nonproductive time, though, leaves gaps in coverage that require budget-breaking use of supplemental labor and potential quality lapses.

Determine how many employees can be absent at any given time without adversely affecting patient quality or the department's operation. Use that quota to develop fair and equitable policies to distribute time off, rotating preferred weeks for vacations and holidays among all employees. Consider involving employees in setting policies for managing nonproductive time for their departments. Such "shared governance" is a much-discussed concept in nursing today and is espoused by hospitals that have achieved Magnet status. Giving employees a say in when they can take time off goes a long way in improving job satisfaction, providing a sense of control over work life balance, and reinforcing that their contributions are valued by the organization.

Strategy No. 4: Monitor Rate and Efficiency Variances

The discovery that labor costs are over budget during a specific pay period warns managers they have a problem. But knowing the gross dollar variance is of little use in uncovering the root cause for the variance and developing a plan to remedy the problem. Managers should understand what portion of the total labor cost variance is due to rates-paying too much for the labor used-and what portion is related to efficiency-paying for more labor than expected. Tracking both types of variances can uncover hidden quality issues.

One oncology unit, for instance, was seriously out of compliance with its planned employee skill mix, which the manager wouldn't have spotted without examining rate and efficiency variances. During one pay period, the clinical professionals, which included therapists and dietitians, worked 267 more hours than expected, while the RNs worked 120 fewer hours than anticipated and secretarial staff reduced their work schedule by 136 hours. Although the total number of hours worked in the department matched the budgeted labor projection, the greater number of hours worked by the highly compensated clinical professional staff created the cost variance-and a potential quality problem. The manager realized that she had been compensating for the shortage of RNs on her staff by using clinical professional staff at higher levels than anticipated.

If the manager had not looked at both rate and efficiency variances, she might have assumed that the high labor costs for that pay period were due to the unit's large number of tenured RNs who were compensated at the high end of the pay scale. Instead, she discovered that her employees' skill mix was out of balance and began recruiting RNs to her unit in earnest. Properly managing skill mix when providing patient care is essential to maintain regulatory compliance, avoid monetary and operational penalties, and ensure safe, quality care.

"We use the efficiency and rate variance information as a first step in trying to determine why salary variances don't look favorable," says Trzcinski of Ohio State University Medical Center. "Then we know where to investigate next." Adds Donna Brown, management engineer at the University of North Carolina Health Care: "Now we can identify the specific skill group contributing to a cost variance."

Ideally, the rate and efficiency variance calculations are standard accounting calculations with formulas readily available. These calculations should be done at a very granular level. Here are examples of two formulas that may be used:

Formula No. 1: (Actual Rate - Budgeted Rate) X Actual Hours = Rate Variance

Formula No. 2: (Actual Hours - Budgeted Hours) X Budgeted Rate = Efficiency Variance

The unit level calculation is not nearly as valuable in understanding the underlying issues as when the calculation is computed at the skill level. Teach managers to interpret rate and efficiency variances so they can identify the true underlying issue causing the total cost variance. Then hold these managers accountable for addressing the problem.

Tools Frontline Managers Can Use-with Results that Strengthen Hospitals

It has never been more important to identify meaningful labor management metrics and provide these metrics to frontline managers. Giving managers the tools to provide the right amount of labor resources-both employed and supplemental-at the right time is essential to providing a high-quality care environment that will ultimately improve patient outcomes at no additional cost to the organization.

Susan M. Reese, RN, is senior industry consultant, health care, Kronos, Inc., Tarpon Springs, Fla., and a member of HFMA's Florida Chapter (

Publication Date: Monday, August 02, 2010

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