Costs refer to the economic input required to achieve a certain outcome, that is, the amount one spends to produce a service or a product, or the value imputed to a resource. Costs are distinguished from charges, which are the prices of services and do not reflect the actual costs of all inputs. Costs are usually divided into fixed and variable costs. With regard to healthcare, fixed costs are expenses that do not vary with
physician care decisions or treatment—such as rent, salaries, mortgage payments, and fire insurance— and that do not vary with the level of patient activity, or products, and once sunk, they cannot be easily recovered. They are also called
sunk costs because they are beyond the control of the entrepreneur. Other types of costs such as wages of production workers or doctors, medical supplies, drugs, electric power to run machines, and bed-days change with the number of patient visits or products offered for sale. These are called variable costs.
In a world of limited healthcare resources, medical decision makers must make challenging management decisions. Without a systematic
evaluation of benefits of health interventions or programs in relation to their costs, it is difficult to make rational and sound judgments. This entry reviews key elements related to identification, measurement, and valuation of costs.
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By identifying and controlling all relevant costs, healthcare managers are better able to earn a profit and be successful. Fixed costs are those that generally do not vary between payment intervals. Generally, these costs cannot be altered on a short-term basis because of contractual agreements. Variable costs are those that increase with increasing units of service. For example, an increase in the number of patient visits would result in the use of additional materials, extra labor, and wages. One way to determine fixed costs is to consider the expenses that would continue to be incurred if a healthcare facility were to be temporarily closed and no patients were to be treated. In this case, rent, fees, and loan payments would still be due. They generally do not change with increases or decreases in facility activity. It is important to note that fixed costs are unvarying only within a certain range of facility activity. For example, if the facility activity grows enough to require additional space or additional employees, the fixed costs associated with rent or salaries will change as well. Variable costs are those that change as the level of facility activity changes.
Examples of the variable costs within a healthcare facility would be supplies used for each patient visit, and wages for hourly, part-time employees. These costs are driven primarily by the facility's activity and would stop only if the facility were to close for a period of time, such as a month. Once the difference between fixed and variable costs is understood, it is important to know how to distinguish one from the other. For instance, consider a clinic that has fixed costs of $3,800 and variable costs of $7 per patient. To cover its monthly expenses, the clinic would have to earn $3,800 in fees plus $7 per patient treated. If the clinic had only one patient visit per month, it would have to charge $3,807 for that one treatment to cover its fixed and variable costs! If the practice had 1,000 patient visits during the month, its total costs would be $10,800 ($3,800 in fixed costs plus 1,000 patient visits at $7 each).
Figure 1 Variable costs
Therefore, this clinic would only have to charge $10.80 per patient visit to cover its fixed and variable costs. This example illustrates that the amount of fixed costs that each patient visit must cover depends on the total number of patient visits across which these fixed costs are to be spread. For example, for cost control purposes, it is possible to determine a flexible budget using a formula expressed as a linear equation in which the slope is the variable cost per unit (or per direct labor hour). Graphically, this would appear as shown in Figure 1.
By definition, fixed costs do not change with the level of activity. As a result, the budget for cost control purposes would be displayed graphically as shown in Figure 2.
Figure 2 Fixed costs
It is important to note that the costs to be included depend on whose perspective is being used and on the question of whose costs matter? The view can be that of the healthcare facility, the insurance company, the patient, or society. They are not interchangeable. An action that reduces facility cost, such as early discharge, may increase the cost to the patient or insurance company by, for example, the need to pay for home healthcare or a stay at an extended-care facility. If the societal perspective is adopted, then all costs must be considered. If the perspective is that of the facility, costs such as patient and caregiver time would be excluded since they are not part of the facility's financial responsibility.
The measurement of costs is similar regardless of the type of analysis being undertaken. Measurement refers to the resource changes included in the analysis. Resources consumed can be divided in a number of different ways. Typically, these will be amounts of labor inputs or outputs but may also include patients' time.
The most accurate method of cost estimation is that known as microcosting, in which every resource use is identified, measured, and quantified into a unit cost. Microcosting refers to detailed analysis of the changes in resource use due to a particular intervention, like time-and-motion studies. Although many analysts favor microcosting, it tends to be costly. Gross or top down costing allocates a total budget to specific services such as hospital stays or doctors' visits. The simplicity of top-down costing may be offset by a lack of sensitivity, which in turn depends on the type of routine data available. The choice between microcosting and gross costing depends on the needs of the analysis. It is common to use substitute proxies for cost, such as
Medicare or
Medicaid reimbursement. This method has the advantage of using a nationally relevant estimate as opposed to a single facility's cost. Another popular technique is to start with a facility's charges and then multiply them by an adjustment called the cost-to-charge ratio. Although the costto- charge ratio is convenient, it is usually available only for a facility and not for an intervention or diagnosis.
There are two main limitations to conducting a cost study:
1. Costs may vary from one facility to another. They have different purchasing contracts for goods and services. Different staffing levels affect marginal costs and the labor component of variable costs. These may affect the generalizability of the results and may need confirmation before each facility implements changes.
2. The facility may have old costs listed by the accounting system that have not been updated to reflect current market conditions, leading to inaccurate results.
To carry out an economic analysis alongside a study, a researcher can do the following:
- Collect information on the costs and the effectiveness of the alternative interventions from patients in all arms of the trial
- Identify and measure resource volumes, for example, drug quantities for every individual trial patient
- Attach unit costs to each resource item to obtain a mean cost per patient per arm of the trial
- Combine mean patient costs with mean effectiveness measures from the trial to establish the cost-effectiveness of each alternative
Finally, cost studies are typically divided into cost minimization, cost benefit, cost utility, and cost-effectiveness. Cost-minimization studies compare at least two equally effective therapies to find the least expensive. Cost-benefit studies call for converting all outcomes (
pain, emesis, renal failure,
myocardial infarction, death, etc.) to a
monetary value. Cost-utility studies establish the price of a utility metric for each quality-adjusted year of survival. Cost-effectiveness studies decide the cost of avoiding undesirable outcomes (death, ventilation-associated
pneumonia, etc.). Suggestions on carrying out cost-effectiveness studies have been disseminated by the U.S. Public Health Service and the European Society of Intensive Care Medicine.
Catherine Kastanioti
See also Cost-Benefit Analysis;
Cost-Effectiveness Analysis;
Cost-Minimization Analysis;
Costs, Direct Versus Indirect;
Costs, Semifixed Versus Semivariable;
Cost-Utility Analysis
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