Labor Cost Management

Determining the Long-Term Value of Labor Costs

February 15, 2019 2:40 pm

To express labor savings as cash, repurpose capacity and extract long-term value.

Most organizations have the ability to calculate direct cost savings, defined as a budget line-item reduction. It’s trickier to estimate the expected value of indirect savings from a reduction in the time and effort required to complete a task, also referred to as the saved capacity. And in health care, an industry that often calculates costs based on bed numbers, it can be even more challenging.

Many capacity-saving projects end with theoretical savings, looking at how many hours each employee or asset will theoretically save and claiming victory.

Another approach is to take an average hourly labor rate and multiply it by the number of hours expected to be saved. For example, a process improvement might save 500 hours per quarter at a $50/hour rate, equating to $100,000 of capacity per year.

Although a shortsighted cost benefit, the organization in this example could lay off 500 hours’ worth of employees, representing a one-time direct labor budget cost savings.

So how do you express your labor savings as cash? Two ideas are to repurpose capacity and calculate the long-term value.

Repurpose Capacity

Redeploy capacity elsewhere or transfer staff to high-value activities. Convert a portion of the saved time into an “innovation allowance,” a dedicated allotment of hours each week or month that the team can use to solve problems or develop new ideas.

For example, a lab was able to reduce the overall time it took to create a scan by three minutes per scan. For a team that on average conducted 400 scans a day, this equated to roughly 20 hours of time per month. The team repurposed this 20 hours of saved time into a weekly innovation working session used to track and follow up on new improvement ideas that were generated. Managers oversaw the improvements and guided the team’s priorities.

Extract Long-Term Value

Most people agree that capacity savings have real value, but it’s rare for organizations to accurately calculate this expected capacity value savings.

You can estimate the long-term value of capacity savings using one of two assumptions:

Assumption 1. Revenue projections are constant. This assumes near- to mid-term (three- to five-year) revenue projections won’t change. If the required capacity is decreasing, hiring the same number of people or investing in the same assets is not necessary. This bends the cost curve down and reveals a net forecasted profit. Planned profit increases because there is less of an investment to gain the same amount of revenue.

For example, a nursing team was growing at an alarming rate. The manager had received approval to hire three additional nurses, but couldn’t find the talent fast enough. The clinic identified several improvements to increase efficiency, including simplifying the process to replenish medical supplies in clinical rooms and improving alignment between scheduling patients and clinical staff. These improvements enabled the 14-member nurse team to take on the amount of work that would have previously needed 15, meaning the nurse manager could now claim that value based on the team’s new capacity.

Assumption 2. Cost projections are constant. This assumes you don’t change your planned costs over time. If you can increase the productivity of each revenue-producing unit by increasing capacity, you should realize an overall lift in revenue (value per unit).

For example, one clinic was supporting more than 700 active patients at full capacity, and the demand was growing. The clinic implemented a handful of improvements, including removing the need for clinical staff to have to search for and reorder supplies and reorganizing along cross-functional clinical “value streams” by procedure type instead of by function, such as nursing, reception, and medical assistants. As a result, the clinic was able to take on an additional 200 active patients, resulting in an increase in the number of revenue-producing units the same team could support. Because the demand was there, they were able to quantify the additional increase in value.

To estimate the expected financial gain that results from capacity improvements, modify the basic net present value (NPV) calculation to reflect the expected revenue increase or cost decrease over time (see the calculation above).

If a forecast isn’t available to plot your improvements, take a few historical points and estimate what the near-term costs (or revenue) would be based on the most accurate historical data.

The simplest way to forecast future points is to estimate the linear slope of the line of the last few years. Then, use this slope as a constant, which you will multiply by the most recent historical year to forecast the next annual value. Next, multiply your slope constant by the next annual value to estimate forecast Year + 1 and so on (see the exhibit). Then, plot your expected improvements against these to calculate the capacity-gain NPV.

Forecasting Revenue and Cost Related to Staffing

Use this method after wrapping up an improvement effort, and hold your organization accountable. By doing so, you’ll be positioned to take advantage of staffing efficiencies that allow more time for patient care and quality initiatives.

Pat Edmonds and Jeremy Hutton are associates with Point B.


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