FORMULATING AND MANAGING THE FIRST ELEVEN STEPS

A HOSPITAL’S Step 1. Define the Organizational Structure One-Time

Step 2. Determine Cost Drivers and Controlling Forces One-Time
CLINICAL CARE BUDGET: for Each Department
Step 3. Forecast Revenue from Clinical Care
A TWELVE-STEP PROGRAM Departments
Annual

David W. Young, D.B.A. Step 4. Define Clinical Pathways and Step-Function &
Professor of Management Fixed Costs for Clinical Care Departments One-Time
plus Annual
Healthcare Management Program Step 5. Determine Variable Cost per Resource Unit Updates
Public and Nonprofit Management Program Step 6. Estimate Service Department Step & Fixed Costs
Boston University School of Management Step 7. Calculate Variable Cost per Case Type
Formula
and Step 8. Compute the Surplus (Deficit) for Each Clinical Driven
Principal Care Department
The Crimson Group, Inc., Step 9. Compute Contribution to Hospital Overhead
Cambridge, Massachusetts Step 10. Estimate Administrative Service Costs Annual Updates
Step 11. Compute Hospital’s Clinical Surplus (Deficit) Formula
22 July 2004 Driven

THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.

Step 1. Step 2.
Determine Cost Drivers and Controlling
Define the Organizational Structure Forces for Each Department
Examples Cost Driver Controlling Force
Hospital Administrative Billing Bill Admission
Service Legal Hour Request
Departments
Administrative Patient Clinical Clinical
Service Service Service Care Patient Dietary Meal Day of care
Departments Departments Departments Departments Service Laundry Pound Day of Care
Departments Medical Records Record Admission
Billing Dietary Radiology Surgery
Laundry Medicine Clinical Radiology Procedure MD Order
Fiscal Pathology Pathology Test MD Order
Housekeeping Anesthesiology Ob/Gyn Service
Legal Departments Pharmacy Prescription MD Order
Development Plant Maintenance Pharmacy Pediatrics Social Services Hour MD Order
Medical Records Social Services Emergency Surgery Case (by DRG) Admission
Clinical
Care Medicine Case (by DRG) Admission
Departments Emergency Case type Visit
THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.

Step 3. Step 4.
Forecast Revenue from Clinical Care Define Clinical Pathways and Step-Function
Departments & Fixed Costs for Clinical Care Departments
Clinical Care
FiscalAffairs
Affairs Clinical Care #n
Department
Fiscal Clinical Care #2
Department
Department Department
Department #1 Clinical Care From Step 3
Clinical Care #n
Department
Forecasts Forecasts Clinical Care #2
Department DRG n
Department #1 DRG B
DRG A
Case Type n
Payer Mix NumberCase Type B
of cases Budget
and Prices of DRG A Departmental Budgeted
Step Function Clinical Average LOS
and Fixed Costs Pathways Radiology procedures
Total Revenue
Total Revenue #n Lab tests
Budgeted Department
Revenue Pharmacy
Department #2
Department #1 Etc.
THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.
 Step 5. Step 6.
Determine Variable Cost per Resource Unit Estimate Service Department Step-Function
and Fixed Costs
Patient Clinical EachPatient
Each Patient Eachclinical
Each clinical
Service Service service
service service
service
Departments Departments department
department department
department
Service Clinical Service Need Forecasts Service Need Forecasts
Efficiency Protocols Efficiency Protocols (e.g., number of meals, pounds of (e.g., number of x-rays, lab tests,
(e.g., minutes per medical record) (e.g., minutes per x-ray) laundry, hours of housekeeping) pharmacy requests)
Step-function and Step-function and
Wage rates and Wage rates and fixed costs needed to fixed costs needed to
Supply unit costs Supply unit costs meet needs Budgeted meet needs
Amounts
Budgeted
Fixed cost budget Fixed cost budget
Variable cost per Amounts Variable cost per Fixed
Step and fixed costcost
for budget #n
department
budget Fixed
Step and fixedfor cost budget #n
department
cost budget
Resource unit Resource unit for department #2 for department #2
for department #1 for department #1
THE CRIMSON GROUP, INC.
THE CRIMSON GROUP, INC.

Step 7. Step 8.
Calculate Variable Cost per Case Type Compute the Surplus (Deficit) for Each
ClinicalCare
Care
Clinical Care Department
Clinical
Clinical
Clinical Care #n
Care
Department
Department #n TotalTotal Revenue
Revenue
Clinical Care
Department
Clinical #2
Care #2 Patient Clinical From Step 3 Budgeted Revenue
Department #n
Department service Department #1 #2
Department
Department#1
Department #1 service
departments departments
From Step 7
Minustotaltotal budgeted
From Step 5 MinusMinus
total budgetedbudgeted
variable
variable costscosts
for for
Budgeted variable costs for
Department
Department #2 #n
Case Type n Variable cost per Variable cost per variable cost
Budgeted Department #1
NumberCase Type B
of cases resource unit resource unit Budgeted For cost
variable DRG n
of DRG A variable cost Minus total step function
For DRG B Minus
totaltotal stepandfunction
fixed
For DRG A
Minus step
and
for
function
fixed costscosts
Department
From Step 4 Budgeted
and fixed costs
for Department #2 #n
for Department #1
Average LOS variable cost
Budgeted
Radiology procedures From Step 4
BudgetedFor cost
variable DRG n Equals Department
Lab tests variable Equals Department #2’s #n’s
Pharmacy Forcost
DRG B Equals contribution
Department
contribution to hospital’s
#1’s
tosurplus
hospital’s
for DRG A contribution to hospital’s
surplus (deficit)
(deficit)
Etc. surplus (deficit)
THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.

Step 9. Step 10.

Compute Contribution to Hospital Overhead
From Step 8 Estimate Administrative Overhead Costs
Department #n’s Eachadministrative
Each administrative
Department
contribution
Department #1’s #2’s
to hospital’s Total contribution from
contribution to hospital’s service
service
contribution to surplus
hospital’s (deficit) clinical care departments department
department
surplus
surplus (deficit) (deficit)
Approximate level of activity
Minus step and fixed costs (e.g., number of legal matters,
Fixed
Fixed cost budget
costbudget
budget
Step and fixed cost of clinical service personnel actions, financial reports)
forfor department
department
for clinical service #2
#n
departments
department #1 Step-function and
Minus step and fixed costs fixed costs needed to
meet needs
Fixed cost budget of patient service
Fixed
Step and fixed costbudget
forcost budget #n
department
forfor
patient
department #2 departments
service department #1 Fixed cost budget
Fixed
Step and fixed forcost
cost budget #n
department
budget
Equals contribution for department #2
to hospital’s administrative for department #1
service departments
THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.
 Step 11. Patient
Service
Departments
Clinical
Service
Departments
Clinical
Care
Departments
Compute Hospital’s Clinical Surplus (Deficit) Service Need
Service
Efficiency Service Need
Clinical
Efficiency
Forecasts Protocols Forecasts Protocols
From Step 9 Departmental Average LOS Number & Payer Mix
Wage rates Wage rates Step Function Radiology type of cases and Prices
Contribution and supply
unit costs
and supply
unit costs
and Fixed Costs procedures
Lab tests
Pharmacy Etc. Budgeted
to hospital’s administrative Step-
Revenue
Step- Variable cost Variable cost
service departments and
fixed costs
per
resource unit
and
fixed costs
per
resource unit
From Step 10
Transfer Prices
Budgeted Minus total
Fixed cost budget Minus total variable cost budgeted
variable costs
Per DRG
Fixed
Step and fixed forcost
cost budget #n
department
budget administrative
for department #2 Administrative
Minus
for department #1 costs Service
Departments Departmental
step function
and fixed costs
Approximate
level of
activity Equals contribution Minus step Minus step Equals Department’s
Equals hospital’s to hospital’s administrative and and contribution
to hospital’s
service departments fixed costs fixed costs surplus (deficit)
surplus (deficit) Step-function Minus total
and administrative
fixed costs
Service costs

Equals hospital’s
surplus (deficit)
THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.

STEP 5 DETERMINE VARIABLE COST PER RESOURCE UNIT

A SIMPLE EXAMPLE STEP 5A CLINICAL SERVICE DEPARTMENTS

CLINICAL EFFICIENCY PROTOCOLS
No. nursing minutes per patient day
DRG A

60
DRG B

40
DRG C

50
DRG D

40
Case Mix No. technician minutes per x-ray 40 40 40 40
No. technician minutes per CBC 20 20 20 20
DRG A DRG B DRG C DRG D Total No. units of nursing supplies per patient day 10 3 5 8
STEP 3 FORECAST REVENUE No. units of supplies per x-ray 3 3 3 3
DEPARTMENT #1 No. units of supplies per CBC 4 4 4 4
PAYER #1 WAGE RAGES AND UNIT SUPPLY COSTS
Cost per minute for nurses $0.50 $0.50 $0.50 $0.50
Forecast number of cases 60 200 100 50 Cost per minute for x-ray technicians $0.20 $0.20 $0.20 $0.20
Expected revenue per case $7,350 $1,430 $2,020 $7,650 Cost per minute for lab technicians $0.20 $0.20 $0.20 $0.20
Total Revenue $441,000 $286,000 $202,000 $382,500 $1,311,500 Cost per unit for nursing supplies $3.50 $3.50 $3.50 $3.50
PAYER #2 Cost per unit for x-ray supplies $5.00 $5.00 $5.00 $5.00
Cost per unit for CBC supplies $2.00 $2.00 $2.00 $2.00
Forecast number of cases 100 50 300 150 VARIABLE COST PER RESOURCE UNIT IN CLINICAL SERVICE DEPARTMENTS
Expected revenue per case $6,800 $1,500 $3,000 $7,400 Patient day $65 $31 $43 $48
Total Revenue $680,000 $75,000 $900,000 $1,110,000 $2,765,000 X-Ray $23 $23 $23 $23
TOTAL REVENUE $4,076,500 CBC $12 $12 $12 $12
STEP 5B PATIENT SERVICE DEPARTMENTS DRG A DRG B DRG C DRG D
STEP 4 DEFINE CLINICAL PATHWAYS AND STEP-FUNCTION AND FIXED COSTS FOR DEPARTMENT SERVICE EFFICIENCY PROTOCOLS
STEP 4 A DEFINE CLINICAL PATHWAYS DRG A DRG B DRG C DRG D No. minutes per meal 10 10 10 10
Resources from Clinical Service Departments No. minutes per pound of laundry 1 1 1 1
No. of patient days per case 10 5 6 12 No. minutes per medical record 5 5 5 5
No. units of ingredients per meal 5 5 5 5
No. of x-rays per case 5 1 2 3 No. units of laundry supplies per pound 3 3 3 3
No. of CBCs per case 10 5 3 12 No. units of supplies per medical record 2 2 2 2
Resources from Patient Service Departments WAGE RAGES AND UNIT SUPPLY COSTS
Cost per minute for meals $0.25 $0.25 $0.25 $0.25
No. of meals per case 30 15 18 36 Cost per minute for laundry $0.15 $0.15 $0.15 $0.15
No. of pounds of laundry per case 15 7.5 9 18 Cost per minute for medical records $0.30 $0.30 $0.30 $0.30
No. of medical records per case 1 1 1 1 Cost per unit for dietary supplies $1.50 $1.50 $1.50 $1.50
STEP 4 B STEP FUNCTION AND FIXED COSTS AT FORECAST VOLUME AND MIX Cost per unit for laundry supplies $0.30 $0.30 $0.30 $0.30
Cost per unit for medical record supplies $1.00 $1.00 $1.00 $1.00
Step-function costs (e.g., nursing) $1,000,000 VARIABLE COST PER RESOURCE UNIT IN PATIENT SERVICE DEPARTMENTS
Fixed costs (e.g. departmental administration) 1,500,000 Meals $10 $10 $10 $10
TOTAL STEP AND FIXED COSTS AT ESTIMATED VOLUME AND MIX $2,500,000 Laundry $1 $1 $1 $1
Medical Records $4 $4 $4 $4
THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.

STEP 6 ESTIMATE SERVICE DEPARTMENT STEP AND FIXED COSTS AT FORECASTED VOLUME
STEP 6A CLINICAL SERVICE DEPARTMENTS STEP FIXED TOTAL
Nursing $350,000 $700,000 $1,050,000
Radiology 250,000 800,000 1,050,000 STEP 9 COMPUTE CONTRIBUTION TO HOSPITAL OVERHEAD
Laboratory 320,000 600,000 920,000
Total $3,020,000
Contribution from Clinical Care Departments (assumes 10 with same contribution) $8,383,413
STEP 6B PATIENT SERVICE DEPARTMENTS STEP FIXED TOTAL Minus Step and Fixed Costs of Clinical Service Departments 3,020,000
Dietary $180,000 $600,000 $780,000 Minus Step and Fixed Costs of Patient Service Departments 1,730,000
Laundry 100,000 400,000 500,000 Equals Contribution to Hospital Overhead $3,633,413
Medical Records 150,000 300,000 450,000 STEP 10 ESTIMATE ADMINISTRATIVE SERVICE COSTS STEP FIXED TOTAL
Total $1,730,000
STEP 7 CALCULATE VARIABLE COST/CASE DRG A DRG B DRG C DRG D Legal $250,000 $300,000 $550,000
From Clinical Service Departments Human Resources 300,000 600,000 900,000
Nursing $650 $153 $255 $576 Fiscal Affairs 300,000 850,000 1,150,000
Radiology 115 23 46 69 Total $2,600,000
Laboratory 120 60 36 144
From Patient Service Departments
STEP 11 COMPUTE HOSPITAL'S CLINICAL SURPLUS (DEFICIT)
Dietary $300 $150 $180 $360 Contribution to Hospital Overhead ` $3,633,413
Laundry 16 8 9 19 Minus Estimated Administrative Costs 2,600,000
Medical Records 4 4 4 4 Equals Hospital's Surplus (Deficit) What if this is not enough? $1,033,413
TOTAL VARIABLE COST PER CASE $1,204 $397 $530 $1,171
STEP 8 COMPUTE THE SURPLUS (DEFICIT) FOR EACH CLINICAL CARE DEPARTMENT
Revenue $1,121,000 $361,000 $1,102,000 $1,492,500
Minus Variable Costs 192,680 99,219 211,980 234,280
Equals Contribution to Step and Fixed $928,320 $261,781 $890,020 $1,258,220 $3,338,341
Minus Step and Fixed Costs 2,500,000
Equals Contribution to Clinical and Patient Service Step and Fixed Costs $838,341

THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.

 Step 12. Step 12.
Fix It Fix It
Step 1. Define the Organizational Structure
Step 2. Determine Cost Drivers and Controlling Forces
for Each Department
Step 3. Forecast Revenue from Clinical Care Step 3. Forecast Revenue from Clinical Care
Departments Departments
Step 4. Define Clinical Pathways and Step-Function & Step 4. Define Clinical Pathways and Step-Function &
Fixed Costs for Clinical Care Departments Fixed Costs for Clinical Care Departments
Step 5. Determine Variable Cost per Resource Unit Step 5. Determine Variable Cost per Resource Unit
Step 6. Estimate Service Department Step & Fixed Costs Step 6. Estimate Service Department Step & Fixed Costs
Step 7. Calculate Variable Cost per Case Type
Step 8. Compute the Surplus (Deficit) for Each Clinical
Care Department
Step 9. Compute Contribution to Hospital Overhead Step 10. Estimate Administrative Service Costs
Step 10. Estimate Administrative Service Costs
Step 11. Compute Hospital’s Clinical Surplus (Deficit)
THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.

OPTIONS AND CONSEQUENCES

NUMBER OF CASES VERSUS COST PER CASE
Cost Driver Option Consequences
Case Mix Reduce the incidence Morbidity may improve,
or don’t treat or some patients will suffer
certain diagnoses and/or die prematurely.
Don’t treat all patients Some patients will suffer
Volume
with certain diagnoses and/or die prematurely.

Resources Treat certain case types More outpatient care and

NUMBER
Per Case with a more cost-effective shorter lengths of stay in
OF
mix of resources hospitals. Perhaps fewer tests
CASES
and procedures.
Cost Per Provide resources in a Lower wages, lower supply
Resource Unit less expensive way prices, greater efficiency.
Result is fewer staff and/or
different skill mixes.
Fixed Facility Invest in lower cost LOW MODE HIGH OUTLIERS
Less technology, fewer
Costs capital, reduce
administrators, less qualified COST PER CASE
size/salaries of
administrators.
administrative staff
THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.

Example of New Inpatient Utilization Pattern

NUMBER OF CASES VERSUS COST PER CASE
48 YEAR OLD PRESENTING WITH ATYPICAL CHEST PAIN,
POSITIVE SMOKING AND FAMILY HISTORY, AND NORMAL EKG

CURRENT PATTERN OPTIONAL PATTERN

Admit to Telemetry $2,800 Admit to Observation Unit
$1,000
ALOS = 2.2 days ALOS = 23 hours
Daily EKG x 3 $225 EKG x 2 $150
BUT
NUMBER Enzymes and $175 Enzymes and
OF $75
Full Bloods Limited Bloods
CASES
Cardiology Consult $150 Cardiology Consult $150

Echo $350 Echo $350

Thallium Stress Test $450 Non-Thallium Stress Test $125

TOTAL COST $4,150 TOTAL COST $1,850

LOW MODE HIGH OUTLIERS

COST PER CASE AT AN INCIDENCE RATE OF 5/1000, THE PURCHASER

WOULD SAVE $3.5 MILLION ANNUALLY
THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.
 WHAT ARE THE IMPLICATIONS OF STEP 12
FOR DEPARTMENTS OF PATHOLOGY?
THE PROBLEM:
WHAT HAPPENS, FOR EXAMPLE, WHEN THE
CLINICAL PATHWAY FOR ALL PATIENTS
THEIR COST SAVINGS ARE WITH DRG A
USES LIMITED RATHER THAN FULL BLOODS?
YOUR REVENUE REDUCTIONS!
OR WHEN THE PATHWAY FOR ALL PATIENTS
WITH DRG B
CALLS FOR 2 RATHER THAN 5 CBCs?

THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.

SPENSER REHABILITATION HOSPITAL REPORTING HIERARCHY

(In Thousands of Dollars)

BUT BUDGETING IS NOT ENOUGH. For Month of June 2002

FIRST LEVEL REPORT: MACRO PROGRAM ANALYSIS

For Board and Senior Management
Over or VARIANCE ANALYSIS

ANYONE CAN BALANCE A BUDGET This

Actual
Year
(under) budget
This Year Revenue
Contribution Margin
Revenue Expense Expense
Surplus (Deficit) Month to date Month to date Price Payer Mix Volume/Mix Volume/Mix Net Utilization Unit Cost

THE HARD PART IS BALANCING THE Inpatient-Weberg $2,110 $12,030 $(315) $35
Inpatient - SRH 24,525 147,280 (710) (2,590) (50) (320) 150 (90) 60 (250) (150)
ACTUALS! Outpatient
Research
1,235
1,180
7,570
7,045
(125)
95
(210)
75
Education 3,590 18,960 (235) 245
Ambulance 4,120 25,175 160 (320) (710)
Development 2,245 13,680 180 (160)

TO DO THAT YOU NEED A Administration

Total direct
3,630 22,965
$42,635 $254,705
(70) (730)
$(1,020) $(3,655)

WELL-DESIGNED REPORTING SECOND LEVEL REPORT: PRODUCT LINE ANALYSIS

SYSTEM For Board and Senior Management

Inpatient - SRH Actual

Over or
(under) budget
VARIANCE ANALYSIS
Contribution Margin
This Year This Year Revenue Revenue Expense Expense
Month to date Month to date Price Payer Mix Volume/Mix Volume/Mix Net Utilization Unit Cost
Product Line
Brain Injury $5,340 $35,845 $(625) $(1,380)
Spinal Cord Injury 3,310 19,605 (30) (620) (10) (50) 200 (100) 100 (50) (20)
Stroke Rehabilitation 3,115 18,085 90 (135)
Post-polio Rehabilitation 5,740 33,635 (65) (640)
Pediatric Rehabilitation 7,020 40,110 (80) 185
Total direct $24,525 $147,280 $(710) $(2,590) (30)

THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.

SPENSER REHABILITATION HOSPITAL REPORTING HIERARCHY SPENSER REHABILITATION HOSPITAL REPORTING HIERARCHY
(In Thousands of Dollars) (In Thousands of Dollars)
For Month of June 2002 For Month of June 2002

THIRD LEVEL REPORT: DRG ANALYSIS FIFTH LEVEL REPORT: PHYSICIAN ANALYSIS BY DRG
For Senior Management and Program Managers For Director of Medical Staff
VARIANCE ANALYSIS Over or VARIANCE ANALYSIS
Spinal Cord Injury Over or Contribution Margin Actual (under) budget Contribution Margin
Actual (under) budget Revenue Revenue Expense Expense This Year This Year Revenue Revenue Expense Expense
Physician 1 Month to date Month to date Price Payer Mix Volume/Mix Volume/Mix Net Utilization Unit Cost
This Year This Year Price Payer Mix Volume/Mix Volume/Mix Net Utilization Unit Cost
DRG 1 $245 $1,300 $(35) $(65) 0 0 150 (100) 50 (40) (45)
Month to date Month to date
DRG 2 90 560 (25) (50) (35)
DRG 1 $895 $5,400 $119 $75 0 0 200 (150) 50 160 (91)
DRG 3 75 350 (20) (80)
DRG 2 1,030 7,000 176 (50)
DRG 4 45 280 15 95
DRG 3 760 4,500 (160) (350)
DRG 5 35 110 (5) (30)
DRG 4 625 2,705 (165) (295)
Total $490 $2,600 $(70) $(130)
Total $3,310 $19,605 $(30) $(620)
Physician 2
Etc.

FOURTH LEVEL REPORT: DRG ANALYSIS BY PHYSICIAN

For Program Managers and Physician Chiefs SIXTH LEVEL REPORT: DRG ANALYSIS BY PHYSICIAN AND COST CENTER
VARIANCE ANALYSIS For Physician Chiefs and Physicians
Spinal Cord Injury Over or Contribution Margin UTILIZATION VARIANCE ANALYSIS BY DEPARTMENT
Actual (under) budget Revenue Revenue Expense Expense Spinal Cord Injury Over or
This Year This Year Price Payer Mix Volume/Mix Volume/Mix Net Utilization Unit Cost DRG 1 Actual (under) budget Routine
DRG 1 Month to date Month to date This Year This Year Lab Rad Pharm. PT Care Other Total
Physician 1 $245 $1,300 $(35) $(65) 0 0 150 (100) 50 (40) (45) Month to date Month to date
Physician 2 300 1,775 20 120 Physician 1 $245 $1,300 $(35) $(65) 10 (50) 20 50 (50) (20) (40)
Physician 3 150 780 35 165 Physician 2 300 1,775 20 120
Physician 4 200 1,545 99 (145) Physician 3 150 780 35 165 (40)
Total $895 $5,400 $119 $75 0 0 200 (150) 50 160 (91) Physician 4 200 1,545 99 (145)
Total $895 $5,400 $119 $75
THE CRIMSON GROUP, INC.
THE CRIMSON GROUP, INC.
 WHAT MIGHT A REPORTING SYSTEM
WITH SOME OF THESE CHARACTERISTICS
PLEASE KEEP IN TOUCH
LOOK LIKE IN A DEPARTMENT OF
PATHOLOGY?
David W. Young
• REPORTING HIERARCHY WITH DRILL
DOWN CAPABILITY DWY204@cs.com
• VARIANCES BETWEEN BUDGET AND
ACTUAL RESULTS COMPUTED BY COST
DRIVER
www.davidyoung.org
• IDENTIFICATION OF INDIVIDUALS WHO
HAVE RESPONSIBILITY www.thecrimsongroup.net
• PERFORMANCE COMPARED TO PEERS
THAT’S THE ISSUE IN LOMITA HOSPITAL
THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.