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As rising costs impact managed care, a successful manufacturing costing method is being applied to help managers make decisions on capitation contract bidding, cost containment and organizational structure.
Although activity-based costing (ABC) has achieved some success in manufacturing applications, ABC experience in manufacturing may not be sufficient to apply ABC properly in service industries. Prof. Robert S. Kaplan recently pointed this fact out, particularly in reference to the healthcare industry.1
In the healthcare environment of the 1990s, accurate costing has become much more important. Physicians, hospitals, employers, insurers, HMOs, and the government require greater cost effectiveness and accountability. New and more accurate costing methods are now required for financial survival in this managed care world. ABC reflects one of the most significant advances in cost accounting, but its roots are in manufacturing.2 In one form or another, however, ABC is now being used in numerous health organizations including about 20 of U.S. and Canadian hospitals.3
We examine here the results of applying ABC to two alternative treatments in an independent, nonprofit, full-service renal dialysis clinic.4 An initial set of costing assumptions indicated that the dominant treatment was unprofitable while the alternate procedure was profitable. With different assumptions and further analysis, however, both procedures proved profitable. Based upon our experience in costing this clinic, we demonstrate that applications of ABC in healthcare may require additional thought and experiment regardless of one's experience with ABC in manufacturing settings. For readers new to healthcare, the glossary on page 26 may be helpful.
Accurate costing of healthcare services did not become a major concern for most healthcare organizations until the Eighties. Prior to 1983, most healthcare providers operated on a retrospective payment basis. Essentially, they could set their own prices or increase services to maximize revenues and increase profits. Because of the inflationary tendencies present in most retrospective reimbursement systems, Medicare implemented a prospective payment system based upon Diagnosis Related Groups (DRGs). Under this new system, hospitals would receive a fixed payment (revenue) based upon the DRG of the patient, not upon the services or cost of services provided. The importance of knowing the costs of services, and reducing those costs, increased in response to this prospective payment system. Only if DRG payments exceeded costs would hospitals make...