Costing

Introduction to Time-Driven Activity-
Based Costing in Health Care
Driving HealthCare Value, May 2014

Dublin, Ireland
Professor Robert S. (Bob) Kaplan
Copyright © Harvard Business School, 2013

Measuring Costs: We must overcome several health
care costing problems.
# 1: Confusion of Costs with Prices (Charges)
o Currently, provider expenses are allocated to patient care
based on charges or “relative value units”—neither of which
is a good surrogate for the actual costs incurred
o Costs are not assigned to unbilled or unreimbursed
processes and procedures
# 2: Wrong Unit of Analysis for Measuring Costs

o Currently, costs are measured for organizational units or
individual procedures and events, not for the full cycle of care
to treat a patient’s medical condition.
# 3: Economists, administrators, and policy makers believe many

health care costs are “fixed”
o We wish! If health care costs were fixed, we wouldn’t have a
health care cost crisis.
Copyright © Harvard Business School, 2013 2

Measuring costs using Time-Driven Activity-Based Costing
(TDABC)
• A bottoms-up approach to costing patient care based on the

actual clinical and administrative processes, and resources, used
to treat patients.
• Combines process mapping from industrial engineering with the

most modern approach for accurate and transparent patient-level
costing

Time-Driven Activity-Based Costing (TDABC)
• What activities are performed over the care
Determine cycle for a medical condition?
1 the Care
Process
• Who performs each activity?
• How long does each activity take?
Calculate • What is the cost per unit of time for each type

2 Cost Rates of personnel?
Account for • What is the cost of materials, devices, supplies,

3
Consumables and drugs consumed during the care cycle?
Allocate • What are the drivers that determine the
4
Indirect Costs workload for each indirect department/area?
Patient-level outcomes and costs are measured over a
complete cycle of care for a clinical condition
Assess Assess Schedule

Patient Procedure Recovery
appropriateness risk OR
problem
MD Possible need Shared Pre‐ Tier 1,2 Tier 3

encounter for procedure decision procedure outcome outcome
making testing measures measures
Source: Tim Ferris, MD, personal communication

Measuring Costs: Develop process maps for the care
cycle
Level 1: Overall care cycle
Level 2: Study care cycle
Map 2 : Map 3: Day of Map 8:

Map 1: Map 5: Post-
surgery pre- Map 4: Map 6: Map 7:
Surgical Pre-operative anesthesia Follow-up
operative Operation Discharge Rehabilitation
consultation testing care unit visit
prep
Level 3: Process maps

Process map for initial office visit
Average time

Calculate Capacity Cost Rates (Cost per minute) for each
resource (personnel or equipment)
Registered X-Ray Physician Office

Surgeon Scribe
Nurse Technician Assistant Assistant
Total Clinical Costs ($) $ 546,400 $ 120,000 $ 100,000 $ 64,000 $ 51,000 $ 61,000
Personnel Capacity (minutes) 91,086 89,086 89,086 89,086 89,086 89,086
Personnel Capacity Cost Rate ($/min.) $ 6.00 $ 1.35 $ 1.12 $ 0.72 $ 0.57 $ 0.68

Measuring Patient’s Cost over a Complete Cycle of Care
for a Clinical Condition
Minutes Cost/ *Total
minute
Initial consultation
MD X1 Y1 136.13
RN X2 Y2 68.04
CA X3 Y3 6.17
ASR X4 Y4 15.74
$266.08
Surgical procedure MD X1 Y1 584.99
Anes. X2 Y2 603.89
RN X3 Y3 136.29
Tech X4 Y4 97.82
OR X5 Y5 329.16
$1752.15
Follow‐up or post‐operative visit MD X1 Y1 55.19
RN X2 Y2 13.61
CA X3 Y3 3.09
ASR X4 Y4 1.77
$73.66

Boston Children’s Hospital’s Department of Plastic and Oral
Surgery (DPOS) examined three types of office visits
Simple Skin Excision
Source: Boston Children’s Hospital: Measuring

Patient Costs, HBS case 112-086
TDABC Step 1: Develop Process Maps for each type of office
visit, along with process times & resources (personnel)
Plagiocephaly
Prep, take to
Prep, take to Take history,
Take history,
Check in with
Check in with Consult with
Consult with
room, height
room, height new patient
new patient Helmet Rx
Helmet Rx Check‐out
Check‐out
ASR
ASR MD
MD
and weight
and weight documentation
documentation
3 5 20 18 3 5
Simple Skin Excision

Prep, take
Prep, take Explain
Explain Book surgery (+10
Book surgery (+10
Patient
Patient Take history,
Take history,
to room,
to room, Consult with
Consult with scheduling,
scheduling, if complex pt.),
if complex pt.),
chart prep,
chart prep, new patient
new patient Check‐out
Check‐out
height and
height and MD
MD PA, call to
PA, call to billing, pre‐op
billing, pre‐op
check‐in
check‐in documentation
documentation
6 weight
weight 5 22 schedule
schedule 25.5 patient call
patient call 19 5
20
Craniosynostosis
Prep, take to
Prep, take to Take history,
Take history,
Check in
Check in Pull up CT
Pull up CT Consult with
Consult with Make
Make
room, height
room, height Take photos
Take photos new patient
new patient Check‐out
Check‐out
with ASR
with ASR documentation
scan
scan MD
MD referrals
referrals
and weight
and weight documentation
3 5 5 20 3 40 2.5 5
Ambulatory
Ambulatory
Clinical Registered
Key Y Clinical
Assistant
Assistant
Service
Service
Registered
Nurse
Nurse
Physician
Physician
Representative
Representative

TDABC Step 2: Financial personnel calculate each
resource’s $/minute Capacity Cost Rate
• Costs: All the costs (salary, fringe benefits, occupancy, support resources)
associated with having that person (or piece of equipment) available to
treat patients
• Capacity: The capacity (time) that each resource (personnel, equipment)
has available for treating and caring for patients
• Capacity Cost Rate = Resource Cost/ Resource Capacity

TDABC Step 2: Calculate the costs of supplying each type of
clinical and administrative resource (data disguised), …

… and estimate each resource’s available time to calculate
the Capacity Cost Rates.
Clinical
Resource Surgeon ASR RN Assistant
Weeks per year 52 52 52 52
Less: Weeks unavailable 8 6 6 6
Working weeks 44 46 46 46
Hours per day 10 8 8 8
Less: Breaks, training,
meetings 1.2 1.5 1.5 1.5
Available hours 8.8 6.5 6.5 6.5
Research and teaching 2.2 0 0 0
Clinical hours per day 6.6 6.5 6.5 6.5
Clinical minutes per day 396 390 390 390
Capacity (minutes per year) 87,120 89,700 89,700 89,700
Annual Cost per person $ 522,720 $ 89,700 $ 134,550 $ 71,760
Cost per minute $ 6.00 $ 1.00 $ 1.50 $ 0.80

Plastic Surgery Department Office Visits: Ratio of Costs to
Charges (RCC) Method
Charges $ 12,449,500
Costs 7,469,700
Reimbursement 7,967,680
RCC: Ratio of costs-to-charges 60%
Average reimbursement rate 64%
RCC Costs Charge Avg Reimb RCC cost RCC Profit

Plagio $ 350 $ 224 $ 210 $ 14.00
Neoplasm $ 350 224 210 14.00
Cranio $ 350 224 210 14.00

Time-Driven ABC analysis gives a completely different
picture about the profitability of the three service lines
Personnel process times (minutes) Surgeon ASR RN CA
Plagiocephaly 18 8 23 5
Neoplasm skin excision 22 55.5 20 5
Craniosynostosis 40 10.5 23 10
Medical Diagnosis Avg TDABC

Cost per patient Surgeon ASR RN CA Total cost Charge Reimb Profit
Plagiocephaly $ 108.00 $ 8.00 $ 34.50 $ 4.00 $ 154.50 $ 350.00 224.00 $ 69.50
Neoplasm skin excision 132.00 55.50 30.00 4.00 221.50 $ 350.00 224.00 $ 2.50
Craniosynostosis 240.00 10.50 34.50 8.00 293.00 $ 350.00 224.00 $ (69.00)

Summary of Plastic Surgery Office Resources and Costs
Surgeon ASR RN CA Cost
Annual Cost $ 522,720 $ 89,700 $ 134,550 $ 71,760
Annual Minutes 87,120 89,700 89,700 89,700
Cost per minute $ 6.00 $ 1.00 $ 1.50 $ 0.80
Process Time (minutes)
Plagiocephaly 18 8 23 5 $ 154.50
Neoplasm skin 22 55.5 20 5 221.50
Craniosynostosis 40 10.5 23 10 293.00
Resource Supply 2 2 2 1
Annual Expense $ 1,045,440 $ 179,400 $ 269,100 $ 71,760 $ 1,565,700
Minutes Available 174,240 179,400 179,400 89,700

Plastic Surgery Annual Resource Utilization

Resource Supply 2 2 2 1
Annual Expense $ 1,045,440 $ 179,400 $ 269,100 $ 71,760 $ 1,565,700
Minutes Available 174,240 179,400 179,400 89,700
# visits (year)
Plagiocephaly 5,400
Neoplasm skin excision 2,000
Craniosynostosis 800

Minutes Required 173,200 162,600 182,600 45,000
FTE's Used 2.0 1.8 2.0 0.5
Capacity Utilization 99% 91% 102% 50%
Cost to procedures $ 1,039,200 $ 162,600 $ 273,900 $ 36,000 $ 1,511,700
Unused Capacity Costs 6,240 16,800 (4,800) 35,760 54,000
Total office expenses $ 1,045,440 $ 179,400 $ 269,100 $ 71,760 $ 1,565,700

Suppose we can have the RN perform some of the
Plagiocephaly exam instead of the surgeon.
From Surgeon ASR RN CA Cost

Cost per minute $ 6.00 $ 1.00 $ 1.50 $ 0.80
Neoplasm 22 55.5 20 5 221.50
To Surgeon ASR RN CA Cost

Cost per minute $ 6.00 $ 1.00 $ 1.50 $ 0.80
Neoplasm 22 55.5 20 5 221.50

… which requires one more RN, but saves 0.5 FTE surgeon

New Resource Supply 1.50 2.00 3.00 1.00 $ 1,438,890
Minutes Required 130,000 162,600 269,000 45,000
FTE's Used 1.49 1.81 3.00 0.50
Capacity Utilization 99% 91% 100% 50%
Cost to procedures $ 780,000 $ 162,600 $ 403,500 $ 36,000 $ 1,382,100
Unused Capacity Costs 4,080 16,800 150 35,760 56,790
$ 784,080 $ 179,400 $ 403,650 $ 71,760 $ 1,438,890
Savings $ 126,810
We handle the same volume and mix of patients while spending
$127,000 less on office visits.
Surgeon time released could be used for surgeries – neoplasms,
craniosynostosis – which likely are compensated much better.

Suppose we expect a productivity increase of 6% next year
Process Time (minutes) Cost per procedure
Plagiocephaly 9.40 7.52 36.66 4.70 $ 122.67
Neoplasm skin excision 20.68 52.17 18.80 4.70 208.21
Craniosynostosis 37.60 9.87 21.62 9.40 275.42
Cost per procedure drops by 6% but total spending stays the same:

Resource Supply 1.50 2.00 3.00 1.00 $ 1,438,890
Total minutes required 122,200 152,844 252,860 42,300

FTE's Used 1.40 1.70 2.82 0.47
Capacity utilization 94% 85% 94% 47%
Cost to procedures $ 733,200 $ 152,844 $ 379,290 $ 33,840 $ 1,299,174
Unused Capacity Costs 50,880 26,556 24,360 37,920 139,716
Total office expense $ 784,080 $ 179,400 $ 403,650 $ 71,760 $ 1,438,890
The benefit from the productivity improvement ends up in unused capacity, which
allows us to handle an increased volume of patients without having to add new
personnel
Health care leaders can use TDABC to manage all their costs as
“variable,” based on patient demands and process efficiencies
1. Forecast the number of patients that will be treated for each medical
condition
2. For each medical condition, multiply the forecasted number of patients

by the process times required for each resource over the care cycle.
Sum up across all medical conditions to obtain the forecasted quantity
of capacity (time) required for each resource type.
3. For each resource type, divide the total required time by the resource’s
available minutes (e.g., 90,000 per year), and round up to next integer)
to obtain the quantity of each resource type that must be supplied.
4. Multiply the quantity of each resource type required to meet forecasted

patient needs by the cost of supplying the resource it to obtain the
future amount of spending. This is next period’s budget – obtained
analytically, from the bottom up, rather than by adding (or subtracting)
percentages to last year’s spending by each department.

Assigning the costs of support departments
• To assign the costs of indirect and support departments (imaging,

laboratory, pharmacy, HR, IT, finance, occupancy, housekeeping),
develop process models of the work performed by the resources in
each department.
• Rule of “1”: Any department with more than one person (or one piece
of equipment) has more work to perform than can be handled by a
single person (or single piece of equipment). By tracing where the
demand of work for that department comes from, you have a logical
and defensible basis for assigning the cost of that department by
causal quantitative drivers, NOT PERCENTAGES.

Support Departments: Assigning the cost of the Billing
Department
Consider a billing department, that spends $756,000 per year in
invoicing and collecting from patients and their insurers.
Billing Services $756,000
7 clerks; one billings supervisor
Minutes per year (7 @ 90,000) 630,000
Cost per minute $ 1.20
Version 1.0: Estimate that each invoice takes the same
time, 50 minutes, to produce and collect, independent of
diagnosis or patient’s insurance carrier
Patient billing cost per visit = 50 × $1.20 = $60

Total Knee and Total Hip Replacements are performed in six different
locations
Neustadt
THR: ~ 1550
TKR: ~ 1050
Hamburg Eilbek Rehab: ~ 2.700
THR: ~ 660
TKR: ~ 430
Bad Staffelstein
Rehab: ~ 900
München Harlaching
THR: ~ 180
TKR: ~ 180
Vogtareuth
Harthausen
THR: ~ 420
THR: ~ 310
TKR: ~ 340
TKR: ~ 340
Rehab: ~ 500
Source: qed-online (2011) (1) without revisions
© 2012 Schön Klinik Seite 25

The first pilot was performed at Neustadt with a highly specialized
Orthopedic Department, which performed 3,000 joint replacements/year
520 beds
915 employees 18,000 patients / year
(90 ortho / 190 rehab)

Previous attempts at standardization and cost cutting had
failed.
I became a physician You need to reduce
to cure patients and headcount and cut costs
save lives. and do it now!

Choosing your first pilot site for TDABC
• What medical condition should we select?
• Where should we do the initial pilot?
• Who needs to be involved in the initial pilot?

Select the medical condition:
Knee and hip osteoarthritis
• High volume procedure (6,000 per year

at Schӧn Klinik hospitals).
• Expensive procedure (Willie Sutton

rule)
• Excellent outcomes data base

Select the site: Neustadt
• Had both acute and rehab

facilities at the site: can model
the entire care cycle
• Extensive use of standardized

clinical pathways
• Extensive outcomes data base
• Surgeons knew they were

recognized as a “high
performance facility” with
excellent outcomes

Obtain project sponsorship
Organize the project

Neustadt Clinicians and Finance Personnel colla-
borated to develop the TDABC model
Finance
Cost of Supplying Resources
(People, Equipment, Space)
How we deliver care
today for patients

Step 1/2: Develop process maps and time estimates
for all processes and activities 1. Development of process maps
2. Estimation of process times
3. Identification of relevant resource costs
4. Estimation of the available capacity
Calculation of treatment costs per process

5.
step
6. Determination of direct costs
7. Allocation of indirect costs
Adding
process times

Step 3/4: Identify all relevant resource costs, estimate the capacity and
calculation of the Capacity Cost Rate 1. Development of process maps
(example: nurse)

5.
step
Capacity Costs (€) 4.500,00 €

= = = 0,62 € / min.
Cost Rate(1) Capacity (min.) 7.276 min.
(1) numbers disguised

Step 5: Multiply the Capacity Cost Rate and processing time to determine the
total costs of processes 1. Development of process maps
(examples(1))

5.
step
Professional
min. € / min. total (€)
OP / postop.
group
Physicians 260,0 1,54 400,40
Nurses 400,0 0,58 232,00
Other clin. staff 67,0 0,47 31,49
Administration 19,0 0,46 8,74
Sum 672,63
Professional
min. € / min. total (€)
group
Rehab
Physicians 134,5 1,27 170,82
Nurses 92,5 0,67 61,98
Other clin. staff 376,0 0,47 176,72
Administration 23,0 0,46 10,58
Sum 420,10
(1) numbers disguised

Different assignment of “indirect costs“ with huge impact on
the operating profit
Existing Cost System

„Indirect
„Indirect costs“
costs“ TDABC
Calculation
Depreciation
Depreciation on
on 30 % OR-time
LoS
Building
Building 70 % sqm
Medical
Medical 91 % acute,
Controlling
Controlling LoS
Department 9% rehab
Department
Patient
Patient Number of Capacity Cost
Admission
Admission cases Rate
Department
Department

The previous assignment of costs shows significant differences to the
methodology of TDABC
1. 2.
Existing System Calculation TDABC
Acute Acute
Revenues(1): 10.226 $ Revenues(2): 9.897 $
Costs: 8.924 $ Costs: 8.119 $
Profitability: 12,7 % Profitability: 18 %
(1) PCC – including all revenues of privately and statutory insured patients of the orthopedic department
(2) DRG revenue for a TKR; 1€ ~ 1,41$; all numbers disguised

Variance Analysis
Suppose the personnel cost at Site 2 for knee replacement was

$5,400 while at Site 1 was $4,624
Total Cost Variance = $5,400 - $4,624 = $ 776 (U)
• Site 2 used 3,600 minutes at an average cost per minute of $1.50
• Site 1 used 3,400 minutes at an average CPM of $1.36
•Input price variance = ($1.50 – 1.36) × 3,600 = $ 504 (U)
•Quantity (efficiency or productivity) variance

= (3,600 – 3,400) × $1.36 = $ 272 (U)

We can view the variance analysis graphically
Price Variance
Pure Price Variance Joint Variance
Site 2 $1.50
cost per
minute $ 504
III IV
$1.36
Site 1 cost per
unit
I II
$272 Efficiency Variance
3,400 3,600
Site 1 quantity of Site 2 quantity of
minutes minutes

Personnel Time and Cost Variances: Neustadt versus
Munich
Neustadt Munich Variance

Personnel Costs € 2,058 € 2,988 € 930. U
Personnel Minutes 1,392 2,043 € 962.5 U
Average Cost/Minute € 1.48 € 1.46 € 32.5 F

(my calculation)
The 45% cost difference (unfavorable cost variance of €930) is caused by the
unfavorable personnel productivity variance at Munich.

Benefits from Variance Analysis
Variance analysis
1
Price: Difference in CPM
for each Personnel Type
Variation in
Total
Personnel
Costs
3 2 Quantity: Difference in
Price: Difference in Mix of Number of Minutes
Personnel Types (activity duration and
LOS)

Lessons Learned
With the combination of meaningful cost assignment and process mapping we really
1. understand for the first time the true cost of a medical condition.
With TDABC we have great visibility into areas where substantial and expensive unused
2. capacity exists.
TDABC reveals powerful new ways to improve our processes and to restructure our daily care
3. delivery.
4. The imprecise assignment of costs may result in wrong strategic decisions.
With TDABC we are able to have more constructive and better informed discussions with our
5. medical professionals.
The combination of accurate cost measurement and systematic outcome measurement

6. together with benchmarking is the key to unlock the full potential of value in our organization.
TDABC as a „must“ for an effective management of

resources and for improving value

Time-Driven ABC provides a common platform – a single version of truth
– for productive discussions among clinical & administrative personnel.
By standardizing on this
procedure and we can achieve We can skip this
consistently excellent outcomes process and save $120
at lower cost. per patient.

TDABC helps providers manage their costs
• Eliminate process steps and variations that do not

Process contribute to improved patient outcomes
Improvement • Redesign processes to reduce waste and idle time
and Redesign • Optimize processes and interventions over a
complete cycle of care
• All clinicians work at the “top-of-their license” →

health care personnel, equipment and facilities have
Personnel very different productivities and costs; who should be
and doing the work, where, and how?
Resource
• Use existing capacity to serve larger volume of
Utilization patients or Reduce unused capacity of people,
equipment, and facilities

TDABC also provides the foundation for bundled payment
contracts
Pricing
• Offer Bundle Payment Reimbursement: Understand costs
over the full care cycle to prepare for implementing bundled
payments

HBS Cost Team is currently collaborating with multiple
health care delivery systems
30 hospitals participating in joint replacement program
HBS cost measurement & management project areas
Chronic and Primary Care Episodic Care

•Chronic kidney disease • Bariatric surgery
•Care transitions/preventing • Cervical spine surgery
readmissions • Child birth and pregnancy
•Congestive heart failure • Heart valve replacements and
repairs
•Diabetes
• Head and neck cancers
•Primary and psychiatric care for
• Hysterectomies
patients with intellectual disabilities
• Mastectomies
• Joint replacements
• Neurosurgical procedures
Ancillary and Indirect • Observation patients
• Prostate cancer surgeries and
• Radiology radiation treatments
• Billing • Rotator cuff repairs
• Tonsils & adenoids

Costing

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Introduction to Time-Driven Activity-

Based Costing in Health Care

Driving HealthCare Value, May 2014

Professor Robert S. (Bob) Kaplan

Copyright © Harvard Business School, 2013

# 2: Wrong Unit of Analysis for Measuring Costs

# 3: Economists, administrators, and policy makers believe many

Copyright © Harvard Business School, 2013 2

• A bottoms-up approach to costing patient care based on the

• Combines process mapping from industrial engineering with the

Copyright © Harvard Business School, 2013 3

Calculate • What is the cost per unit of time for each type

Account for • What is the cost of materials, devices, supplies,

Assess Assess Schedule

MD Possible need Shared Pre‐ Tier 1,2 Tier 3

Copyright © Harvard Business School, 2013 5

Level 2: Study care cycle

Map 2 : Map 3: Day of Map 8:

Level 3: Process maps

Copyright © Harvard Business School, 2013 6

Copyright © Harvard Business School, 2013 7

Registered X-Ray Physician Office

Personnel Capacity (minutes) 91,086 89,086 89,086 89,086 89,086 89,086

Copyright © Harvard Business School, 2013 8

Copyright © Harvard Business School, 2013 9

Simple Skin Excision

Source: Boston Children’s Hospital: Measuring

Simple Skin Excision

Copyright © Harvard Business School, 2013 11

Copyright © Harvard Business School, 2013 12

Copyright © Harvard Business School, 2013 13

Capacity (minutes per year) 87,120 89,700 89,700 89,700

Annual Cost per person $ 522,720 $ 89,700 $ 134,550 $ 71,760

Cost per minute $ 6.00 $ 1.00 $ 1.50 $ 0.80

Copyright © Harvard Business School, 2013 14

RCC Costs Charge Avg Reimb RCC cost RCC Profit

Copyright © Harvard Business School, 2013 15

Personnel process times (minutes) Surgeon ASR RN CA

Neoplasm skin excision 22 55.5 20 5

Medical Diagnosis Avg TDABC

Copyright © Harvard Business School, 2013 16

Copyright © Harvard Business School, 2013 17

Surgeon ASR RN CA Cost

Surgeon ASR RN CA Cost

Copyright © Harvard Business School, 2013 18

From Surgeon ASR RN CA Cost

To Surgeon ASR RN CA Cost

Copyright © Harvard Business School, 2013 19

Surgeon ASR RN CA Cost

Copyright © Harvard Business School, 2013 20

Surgeon ASR RN CA Cost

Total minutes required 122,200 152,844 252,860 42,300

2. For each medical condition, multiply the forecasted number of patients

4. Multiply the quantity of each resource type required to meet forecasted

Copyright © Harvard Business School, 2013 22

• To assign the costs of indirect and support departments (imaging,

Copyright © Harvard Business School, 2013 23

Patient billing cost per visit = 50 × $1.20 = $60

Copyright © Harvard Business School, 2013 24

© 2012 Schön Klinik Seite 25

© 2012 Schön Klinik Seite 26

Copyright © Harvard Business School, 2013 27

• What medical condition should we select?

• Where should we do the initial pilot?