John Glaser
Ajit Sett

A lack of good costing data is a barrier to achieving value in healthcare organizations. Learn how to select and implement technologies designed to improve costing.

At a Glance 

Healthcare leaders should address three important questions as they prepare to implement new costing systems:  

  • Do all providers in their organizations' systems, networks, or partnerships share the same definitions of unit of care and of fixed, variable, incremental, direct, and indirect costs?  
  • What are the maintenance processes and protocols for cost center and period matching of revenues and costs?  
  • If some providers within a network or partnership are not using costing systems, can an enterprise derive surrogate cost per unit of care?  

There has never been a greater emphasis on accountability in health care, particularly to the level of sophistication and diversity that will be seen in the years ahead.

In an era of reform, the abilities to make a healthy margin across the continuum of care and to demonstrate value to purchasers will be critical success factors for healthcare organizations. A number of initiatives are realigning economic incentives to encourage more coordinated care and more appropriate utilization. Meanwhile, the nation's healthcare payment structure is changing in three important ways:

  • The level of payment relative to market basket cost will be reduced, even after adjusting for inflation.
  • Payments for services rendered will increasingly be at risk, with portions withheld until contracted outcomes have been demonstrated.
  • Payments will be more holistic (e.g., one payment for all care needed, across care venues, for a chronically ill patient or a patient undergoing a surgical procedure).

Already, many hospitals and health systems are challenged to squeeze out sustainable margins from Medicare and Medicaid.

In short, healthcare organizations must find innovative ways to control or remove costs while meeting goals centered on quality of care, safety, and efficiency.

Today's healthcare costing approaches are inadequate in an era of reform, when having the ability to understand precise costs for every encounter, procedure, or episode of care is essential. There is a critical need for costing data that provide accurate and timely portrayals of the true costs of care-and in a format that clearly shows the impact of innovations in care delivery. Participants at a recent HFMA Thought Leadership Retreat strongly agreed that a lack of good costing data is a barrier to achieving value: 61 percent of the participants believe decision makers at most provider organizations would say costing data are only sometimes accurate, timely, appropriate, and reported in a useful manner (Investing in Value: Business Models, Intelligence, and Risk, HFMA, December 2011). There is no standard method for collection of costing data among healthcare organizations, and the data that are available provide little insight regarding variation and cost related to variation.

Healthcare CFOs and other leaders should consider a number of factors in determining the right approach to costing within their organizations-and when selecting and implementing technologies designed to improve costing.

Zeroing in on Elements of Cost

Understanding the precise costs for every encounter, procedure, or episode of care is an essential part of managing the delivery of services across the contracted continuum of care. Such precision allows for accurate assessments of the profitability of individual service lines, provider relationships, or clinical management of a subset of an organization's population. As provider enterprises restructure their delivery networks to expand service coordination across the continuum of care, costing of services will transcend the four walls of acute care and ambulatory facilities to physician offices and postacute facilities-and in some cases, into partner organizations.

In effect, fundamental variables are changing dramatically for many providers. Competitors are restructuring delivery networks to expand care coordination across the continuum of care and are assuming greater risk related to performance and utilization. Clinical information systems are being implemented more broadly and used by a greater number of physicians, clinicians, and staff. All providers are now focused on meaningful adoption of electronic health records (EHRs). There is a greater focus on aligning physician documentation with charges, and purchasers are increasingly tying payment to outcomes, quality, and appropriate utilization of services.

Traditional step-down and cost allocation models may no longer effectively portray the financial efficacy of an accountable care strategy. Decision making now requires more accurate and more current portrayal of true costs of care in a format that follows how innovations in care delivery are being managed. Cost management efforts also must consider the location of care delivery and the impact of cost reductions on the organization's ability to achieve performance goals.

In this environment, many healthcare organizations are still using essentially the same approaches to costing they were using in the 1970s, relying mainly on techniques to apportion cost elements to care activities (such as determining the ratio of costs to charges). The use of such approaches sufficed in the past, as the imperative for decision making based on cost accuracy was not crucial in a volume-driven payment environment. But as value-based business models are adopted, more modern approaches and standards to perform costing and cost reporting should be adopted. For example, activity-based costing and microcosting, which consists of identifying and costing every resource consumed in rendering a "unit of care," would pave the way for deeper, truer representation of the cost for a unit of care.

Changes to cost reporting usually occur in response to changes to generally accepted accounting principles and other external reporting requirements. One should anticipate accounting rule changes related to accountable care initiatives. For example, providers that participate in shared savings programs will likely assume responsibility for presenting meaningful cost reporting to internal and external stakeholders.

An improvement agenda should address the expansion of the scope, precision, and reporting of care costs.

The Relationships Among EHRs, Revenue Cycle Systems, and Costing Systems

In years past, costing systems were loosely connected to revenue cycle and EHR systems. Data flow was unidirectional; revenue cycle and EHR data were copied into costing systems, but there was no flow of data back into the feeder systems. Although the revenue cycle and EHR systems operated in "real time," the costing system was centered on "batch" analysis.

The payment changes in the years ahead will require not only new capabilities for revenue cycle, EHR, and costing system applications, but also a much tighter and real-time integration among these systems.

The inputs to costing systems essentially come from the EHR, revenue cycle systems, and enterprise resource planning systems. As a healthcare organization's ability to manage its costs becomes a more critical factor for its success, the organization should hold higher expectations for the design, implementation, and adoption of EHR and enterprise revenue cycle management (eRCM) systems.

Among these expectations, five are of utmost importance.

An eRCM system should be able to function as the keeper of all activities. This capability is possible only if the eRCM system is fully integrated with the organization's costing systems and EHR. The eRCM system must integrate well forward to costing systems and then feed information backward to the EHR based on payment and cost experiences.

The eRCM system should be able to demonstrate clearly to the organization's leaders that episodes of care are not all created equal. An episode of care may have more costs and/or more revenue associated with it than reflected in a typical claim. And because payers may define episodes of care differently, there will be payer-specific episode costs and revenue. Costing systems should be able to clearly differentiate between similar episodes of care and present the differentiated true cost of care.

The eRCM system should be able to leverage the embedded contract engine and contract management system to provide a full analysis of the revenue side of the equation. The eRCM system should have the ability to aggregate care data from disparate systems and feed the data backward into the EHR to help guide clinical care decisions.

The eRCM system should be able to support drill-down activities to the patient level with discrete time stamps. It should feed forward more detailed, timely, and accurate information into costing systems, and provide feedback into the EHR to support greater efficiency in clinical operations.

The EHR should truly be an enterprise health record, with providers sharing data throughout the enterprise. Every billable and nonbillable care-related activity should be accounted for in the EHR. Even if a care-related activity has little or no value to the clinical workflow, it should still be possible to account for it within the EHR in a way that does not intrude on the clinical workflow. Having this capability allows a multitude of EHRs across the contracted continuum of care to feed forward the information for all care-related activities needed by revenue cycle management and cost management systems for more accurate and timely costing.

As a healthcare organization works toward understanding and managing the control points throughout its revenue cycle, it should give careful attention to ensuring that care-related activities are documented-that they do not slip between multitudes of cracks in clinical and administrative processes. The organization also should have a plan for taking rapid action each time a control point fails, as every failure has associated costs.

Considerations in Implementing Technology to Improve Costing

Healthcare costing systems will be repositioned as providers-which will assume greater risk for outcomes and payments in an era of reform-collaboratively make decisions based on cost data that were previously unavailable for review or unexamined. As an organization tackles necessary changes to its costing systems and to its management and clinical strategies, it should not underestimate the magnitude of organizational change that will accompany the changes in data, systems, and reporting. Few providers and managers have deep experience with thinking and acting in a world where costs must be considered across a continuum of care and cost decisions must factor in the contract performance ramifications of those decisions.

Healthcare leaders should address a range of questions as they prepare to implement new costing systems. These questions center on the need to have cost data available across the continuum and to address challenges that might arise due to the presence of multiple provider relationships.

Leaders should ask whether the definition of unit of care is consistent among the providers that are collectively assuming utilization and/or performance risks across the contracted continuum of care. A related question is whether costing will take place at the episode level, clinical service level, encounter level, charge code level, or some other level across the contracted continuum of care. The leaders also should consider whether the definitions of fixed, variable, incremental, direct, and indirect costs are common among the providers.

If some providers within a network or partnership are not using costing systems, leaders should ask whether an enterprise can derive surrogate cost per unit of care during the costing system implementation period. For example, if a provider enterprise has recently acquired a home health agency and an outreach lab, and has not yet implemented costing systems, can cost per unit of care be derived during the transition period?

Another important question is whether latency can be systematically removed from cost data. Providers should transition from cost computation models that use previous fiscal years' data as "standard" costs for the current fiscal year to cost computation models that refresh data at least monthly. In an era of significant delivery network and payment model reform, the previous year's data are no longer good proxy for making decisions.

Leaders also should determine what the minimum staffing level should be for the expected volume in each clinical service area across the contracted continuum of care. Making this determination will enable the costing systems to model fluctuations in volume and determine the fixed or variable nature of the labor costs.

Leaders further should consider what the maintenance processes and protocols should be for cost-center and period matching of revenues and costs each time a new provider is added or removed from the contracted continuum of care.

Finally, the leaders should consider what cost-per-unit-of-care validation protocols should be used to feed information back to the enterprise revenue cycle system to model contracts for care alternatives and payment.

Some provider enterprises are achieving even higher levels of variable cost accuracy through increased use of the microcosting model. The type of cost elements that will be subject to microcosting will have an impact on the complexity in cost system implementation. For instance, if labor, materials, and pharmaceutical costs are within the scope of microcosting, existing interfaces to key feeder enterprise resource planning and revenue cycle systems may need to be reviewed or rebuilt. For example, the capture of staffing and utilization data by shift and measurement of labor costs as they are incurred would require tweaks to the payroll, human resources, and revenue cycle systems and interfaces.

Similarly, alignment of items and item numbers across materials management systems (for purchase orders), EHRs (for all care-related activities), revenue cycle systems (for billable and unbillable chargemaster charges), and costing systems will further the true cost-finding agenda.

Some healthcare providers are adopting an activity-based costing model, which identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. This model assigns more indirect costs into direct costs in comparison with conventional costing models.

As the industry emphasizes the identification and capture of all costs to determine the true cost of care, the implementation of EHRs, enterprise resource planning systems, and revenue cycle management systems that can help in identifying all activities pertaining to care will allow providers to reap significant financial, clinical, and operational benefits from these technologies.

Prepare for Tomorrow

As healthcare providers reposition themselves to meet the growing demands for care accountability and affordability, healthy approaches to financial management dictate the need to understand the true cost of providing services. A costing approach that is comprehensive, accurate, and modern is an essential requirement for success. Partial, manual, retrospective assimilation of costs across the contracted continuum of care does little to facilitate effective decision making, nor does it support detailed, timely, and accurate financial reporting to internal and external stakeholders.

Furthermore, the relationships among the EHR, revenue cycle management system, and costing system are becoming ever more important. As data become an enterprise's key strategic asset, healthcare finance executives will need to become significant contributors to their organization's financial data management and reporting strategies.

Healthcare providers have spent decades strengthening their revenue identification and charge capture technologies, tools, and systems. The time to focus on improving costing data in health care-data that can provide accurate and timely portrayals of the true costs of care-is now.

John Glaser, PhD, is the CEO of Siemens Health Services, Siemens Healthcare, Malvern, Pa. (

Ajit Sett is vice president, revenue cycle solutions product management, Siemens Health Services, Siemens Healthcare, Malvern, Pa. (


Publication Date: Wednesday, February 01, 2012

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