Example 4.

7
Data Envelopment Analysis (DEA)
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Background Information
Consider a group of three hospitals. To simplify
matters, we assume that each hospital converts two
inputs into three different outputs. (In a real DEA,
there might be many more inputs and outputs.)
The two inputs used by each hospital are
Input 1 = capital (measured by hundreds of hospital beds)
Input 2 = labor (measured by thousands of labor hours used
in a month)

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Background Information
continued
The outputs produced by each hospital are
Output 1 = hundreds of patient-days during month for
patients under age 14
Output 2 = hundreds of patient-days during month for
patients between 14 and 65
Output 3 = hundreds of patient-days during month for
patients over 65
The inputs and outputs for these hospitals are given.
Which of these hospitals is efficient in terms of using
its inputs and producing outputs?
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Solution
The idea is that if we focus on any particular hospital,
we want to show it in the best possible light.
That is, we want to value the inputs and outputs in
such a way that this hospital looks as good as
possible relative to the other hospitals.
More specifically, to determine whether a hospital is
efficient, we define a price per unit of each output and
a cost per unit of each input.

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Solution continued
Then the efficiency of a hospital is defined to be

The DEA approach uses the following four ideas to
determine whether a hospital is efficient.
1. No hospital can be more than 100% efficient.
Therefore, the efficiency of each hospital is
constrained to be less than or equal to 1. To
make this a linear constraint, we express it in this
form:
Value of hospitals outputs Value of hospitals inputs

inputs s hospital of Value
outputs s hospital of Value
hospital of Efficiency
'
'

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Solution continued
2. When we are trying to determine whether a hospital is
efficient, it simplifies matters to scale input prices so that the
value of the hospitals inputs equals 1. Any other value
would suffice, but by using 1, the efficiency of the hospital is
the equal to the value of the hospitals outputs.
3. If we are interested in evaluating the efficiency of a hospital,
we attempt to choose input and output prices that maximize
this hospital's efficiency. If the hospitals efficiency equals 1,
then the hospital is efficient; if the hospitals efficiency is
less than 1, then the hospital is inefficient.
4. All input cost and output prices must be nonnegative.

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HOSPITALDEA.XLS
This file contains the DEA spreadsheet model used
to determine the efficiency of hospital 1.
The spreadsheet is shown on the next slide.
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Developing the Model
To develop this model, proceed as follows.
Input given data. Enter the input and output information for
each hospital in the ranges B6:C8 and F6:H8.
Selected hospitals. Enter 1, 2, or 3 in the cell B3,
depending on which hospital you want to analyze.
Unit input costs and output prices. Enter any trial values
for the input costs and output prices in the UnitInputCosts
and UnitOutputPrices ranges.
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Developing the Model
continued
Total input costs and output values. In the InputCosts
range, calculate the cost of the inputs used by each hospital.
To do this, enter the formula
=SUMPRODUCT(UnitInputCosts,B6:C6) in cell B14 for
hospital 1, and copy this to the rest of InputCosts range for
the other hospitals. Similarly calculate the output values by
entering the formula
=SUMPRODUCT(UnitOutputPrices,F6:H6) in cell D14 and
copying it to the rest of the OutputValues range.
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Developing the Model
continued
Total input cost and output value for selected hospitals.
In row 19 we want to constrain the total input cost of the
selected hospital to be 1. To do this, enter the formula
=VLOOKUP(SelectedHospital,Ltable,2) in the
SelectedInputCost cell, and enter a 1 in cell D19. Similarly,
enter the formula, =VLOOKUP(SelectedHospital,Ltable,4)
in the SelectedOutputValue cell. Remember that by
constraining the selected hospitals input cost to be 1, its
output value in cell B22 is automatically its efficiency.
Using Solver: To see whether hospital 1 is efficient,
use Solver as follows.
Objective. Select the SelectedOutputValue cell as the target
cell to maximize. Because the cost of hospital 1 inputs is
constrained to be 1, this will cause Solver to maximize the
efficiency of hospital 1.
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Developing the Model
continued
Changing cells. Choose the UnitInputCosts and
UnitOutputPrices ranges as the changing cells.
Selected hospitals input cost constraint. Add the
constraint SelectedInputCost=1. This sets the value of
hospital 1 inputs equal to 1.
Efficiency constraint. Add the constraint
SelectedInputCost=1. This sets the value of hospital 1 inputs
equal to 1.
Specify nonnegativity and optimize. Under SolverOptions,
check the nonnegativity box, and use the LP algorithm to
obtain the optimal solution as shown.
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Developing the Model
continued
The Solver dialog should appear as shown here.

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Solution
The 1 in cell B22 of this solution means that hospital
1 is efficient. In words, we have been able to find a
set of unit costs for the inputs and the unit prices for
the outputs such that the total value of hospital 1s
output equals the total cost of its inputs.
To determine whether hospital 2 is efficient, we
simply replace the value in cell B3 by 2 and rerun
Solver. The Solver settings do not need to be
modified.
The optimal solution appears on the next slide. From
the value of .773 in cell B22, we see that hospital 2 is
not efficient.
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Solution continued
Similarly, we can determine that hospital 3 is efficient
by replacing the value in cell B3 by 3 and rerunning
Solver.
This solution appears on the next slide.
In summary, we have found that hospitals 1 and 3
are efficient, but hospital 2 is inefficient.

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Efficient or Inefficient?
A hospital is efficient if we can price the inputs and
outputs in such a way that this hospital gets all of the
value out that it puts in.
The pricing scheme will depend upon the hospital.
Each hospital will try to price inputs and outputs so as
to put its operations in the best possible light.
If DEA finds that a hospital is inefficient, then there is
no pricing scheme where that hospital can recover its
entire input costs in output values.
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Efficient or Inefficient?
continued
Actually, it can be shown that if a hospital is
inefficient, then a combination of the efficient
hospitals can be found that uses no more inputs than
the inefficient hospital, yet produces at least as much
of each output as the inefficient hospital.
To see how this combination can be found, consider
the spreadsheet model shown on the next slide.
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Efficient or Inefficient?
continued
We begin by entering any positive weights in the
Weights range.
For any such weights, we consider the combination
hospital as a fraction of hospital 1 and another
fraction of hospital 3.
When we combine these in row 28 with the
SUMPRODUCT function, we find the quantities of
inputs this combination hospital uses and the
qualities of outputs it produces.
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Efficient or Inefficient?
continued
To find weights where the combination hospital is
better than hospital 2, we find any feasible solution to
the inequalities indicated in rows 28-30 by using the
Solver setup shown below.
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Efficient or Inefficient?
continued
Furthermore, we know there will be a feasible
solution because we have already identified hospital
2 as being inefficient.
In reality, once DEA analysis identifies an
organizational unit as being inefficient, this unit
should consider benchmarking itself relative to its
competition to see where it might make more efficient
use of its inputs.