Management in clinical diagnostic fields are frequently involved in cost analysis of new procedures due to the constantly changing science and technology. Also due to the health care organization especially the diagnostic division being tightly regulated by accreditation and regulatory bodies bringing a new procedure in-house requires in depth analysis prior to an any decision being taken.
Cost Object:In a clinical laboratory in a small community hospital we currently refer specimens for free PSA (prostatic specific antigen) to a large commercial laboratory. A prominent physician on staff has requested that us to start doing the test in-house to improve turnaround time. To do this, we would need to offer a total PSA and a free PSA together. We currently perform the total PSA in-house. The physician states that if he can have timely results for the paired test, he estimates that it will eliminate the need to perform approximately 60 prostate biopsies a year.
Free PSA (cost activity / object) is available on equipment that we currently use under a reagent rental agreement (we pay only for reagents, as the cost of the equipment is rolled into the cost of the reagents). The vendor has quoted a price of $8.00 per test (not $8.00 per billable test) for free PSA reagents.
Issues to consider in evaluating the profitability of bringing the test ( Free PSA ) in house:1.Effect on direct cost.
2.Possible increase in indirect costs3.Re-evaluation of equipment costs(capital) may be needed4.Rate of re-imbursement from provincial gov. or Finance Dept.
5.Possible Intangibles to be factored into the decision6.Pricing the test7.Is it worth bringing in?Background:In the laboratory, managerial accounting includes activities such as micro-costing (the process of determining the actual cost of performing a billable procedure), performing analyses of services and equipment in order to evaluate their profitability, and budgeting (the compilation of expected expenses and revenue into a financial plan).
A billable procedure is a test that is billed to a payer. The payer may be an individual or a private or government insurance. The charge for a billable procedure includes all the expenses (costs) incurred in generating the test result, including the cost of collecting and processing the specimen, performing the test (reagents, consumables, laboratory and equipment costs), and numerous other costs plus some measure of profit. A nonbillable procedure contributes to the generation of a billable test result, but which is not directly reimbursable. Examples of nonbillable procedures include standards, quality control specimens and repeats (repeat testing in cases of questionable results).
Costing Model:The method used for determining the actual cost to perform a billable procedure used commonly by laboratories is to perform a micro-cost analysis. Micro-costing accounts for all expenses associated with performing a given test including reagents, consumables, laboratory costs, and reporting costs and includes pre-analytical, analytical and post-analytical expenses.
Direct Costs:Direct expense cost includes all costs directly related to performing a test. It includes the reagents, consumables, labor and benefits, etc. Examples of direct costs are shown in Table 1.
Table 1: Examples of Direct CostsSpecimen collection consumables (preps, Vacutainers, needles, etc)Processing consumables (tubes, caps, transfer pipets, labels, etc.
Direct costs are relatively easy to determine and should be calculated using a line-by-line approach. For example, the cost of consumables needed to collect a blood specimen is straightforward:Alcohol Swab $0.10 Needle 0.25Vacutainer tube(s) 0.37 Adapter 0.12Gauze pad 0.02 Band-Aid 0.05Total cost = $0.91If more than one test is performed per collection, the cost of the collection expendables can be spread over multiple tests, thereby decreasing the cost per test. The same can be done for processing costs. Pricing information for the consumables used is available from the utilization reports generated monthly by the finance department.
When calculating reagents costs, the cost of the reagent actually used to run a single test is easy to calculate based on the known volume of reagent used and the cost per volume. These numbers are available from information generated by vendors. The cost of calibrators and controls is also available, but the actual cost of these per test can be determined by using the following formula:Cost of total amount usedTotal number of tests performed (using a particular calibration and/or control run time-table).
E.g. Three levels of control are run once per shift for 9 tests including free PSA and the instrument uses 0.2 ml. of control, the cost of 0.2 ml of control solution is $.91 each.
($.91 X 3) = $ .309Note: Sometimes, when these numbers are very small, they can be included as a factor and not evaluated directly.
Factors used in Laboratory labor cost calculations in this laboratory include time required to perform the test as well s wage and benefit cost. The formula used isX +E.g. Free PSA test takes three minutes of a medical technologist’s time to perform and report, the hourly rate of the medial technologist in this lab is is $16.00 + 25% for benefits (total $20.00 per hour)Technologist Labor costs for Free PSA = $20.00 = $0.33/minute x 3 minutes = $0.9960 minutesThe cost of labor for collections, accessioning/processing, etc. can be calculated in the same way using the hourly rates of the personnel who perform these tasks.
Equipment costs per test can be determined in a similar fashion. Reports of monthly rental costs for rented or leased equipment and any additional ongoing maintenance costs are available from the utilization reports generated monthly by the finance department and purchasing department. Calculating the part of those costs that apply to a single analysis of a single test can be performed by:Total rental &/or maintenance costs over a given periodTotal number of tests performed on the equipment during the same time period.
Depreciation cost for owned capital equipment is calculated as a direct cost, but it does not vary with the number of tests performed (fixed cost). Each analyzer is evaluated independently based on how it is used.
Indirect Costs:Indirect expense cost includes expenses that are part of doing business, but that are not directly related to the cost of the test being evaluated, as shown in Table 2.
Table 2: Examples of Indirect CostsLicensesMarketingLabourMaterialsInformation Systems RequirementsProgramming (ongoing)Maintenance feesTrainingInitialOngoingSupervisory and Administrative salariesSecretarial supportOther facility overhead (as determined by facility)IntangiblesLiability costs (insurance)Public RelationsInvolvement in product linePhysician relationsMarketsNetwork requirementsLong-term survivalMedical InvolvementAn indirect cost is calculated by multiplying the direct cost by a factor that is reasonable assumption of the total indirect cost since line-by-line analysis of all related indirect cost can be too time consuming within a laboratory setting and this is also not considered a practical way fro data collection / reporting in a laboratory. Many laboratories use a factor of 1.3 as is documented / recommended in various reference text books1, but in real life the factor for any given laboratory varies greatly, depending on the type of organization and the overall overhead costs. The finance department is the best source for determining the factor for any institution.
When costing out a test that is being added to the menu of a current piece of equipment, it is sometimes valuable to consider only the direct variable costs involved, as the indirect costs do not change. In that case, the true indirect cost per analysis is not performed, but only the additional direct cost is of significance.
Pricing Formulas:Using the surcharge/cost plus method, the actual cost of performing the test is determined using the micro-costing method. The total cost is then multiplied by a factor (e.g. 1.5 times cost) or a dollar amount is added to the cost (surcharge) to arrive at the final price.
Pricing based on weighted value/RVUs (relative value units) is performed by assigning an RVU to the test. RVUs are generally based on the complexity and time required to perform the test, although other factors such as reagent cost for more esoteric tests may be included. The Formula used for pricing is then as follows:RVU X Fixed dollar amount = Price for the test .
E.g. Free PSA is weighed at 4 RVUs; fixed dollar amount for RVU is $1.50,Price for a Free PSA test = 4 x $1.50 or $6.00.
Pricing may also be determined based on historical data, which may be modified to reflect current market trends and expected adjustments, though that is not a common practice in the precision based work environment of the laboratories.
Revenue projections:Revenue projections for the laboratory are compiled using the following:1.Historical data2.Patients per day forecasts3.Regulatory changes expected4.Growth projections based on changing technologiesMaking Decisions:The evaluation process for bringing in a new test or deciding to continue to perform a test includes a break-even analysis. The break-even point is the point at which there is no profit or loss from performing a test, but that the total of all fixed and variable costs equals the amount of revenue generated by the test. The reasons for performing a break-even analysis are:(1) To determine where to price the test and(2) To determine the volume of tests required to meet the break-even point.
The break-even point is determined by:Fixed costs + Dollar amount of the revenues expected per test -Total variable costsThe break-even analysis formula is based on several assumptions.
Assumptions:1.When costs increase, revenue decrease2.When costs decrease, revenue increase3.When volumes increase, costs and revenue increase4.When volumes decrease, costs and revenue decreaseManagement also needs to consider that many things other than volumes can affect costs. Those include, but are not limited to, changes in method, changes in equipment, changes from manual to automated methods or vice versa, changes in test mix, changes in unit prices for laboratory, consumables or purchased services, and changes in regulations. The best way to be able to hypothesize about these potential changes is to keep in close touch with the purchasing department, the human resource department and the group purchasing organization and to keep abreast of regulatory issues and information via Internet access, publications, and professional associations.
The degree of profitability is evaluated in light of a number of “intangibles”. These may include the following:Intangibles to be considered:1.Is this a necessary new service for the clinicians?2.Is this required to be compliant with the medical diagnostic standards?3.Is there a particular high profile physician who requires this test?4.Will providing this test shorten the length of stay?5.Will providing this test decrease downstream costs by not having to perform expensive interventional procedures that might otherwise be ordered?In some cases it is better to break even while managing to accommodate an intangible than to make a large amount of revenue. Particularly in the government sponsored Social Health Care system of Canada, not all testing is profitable. Our laboratories and hospitals do not have the luxury enjoyed by the commercial laboratories of accepting only “good” business. Instead, we provide the continuum of care and the support services required in the community setting, while having to work harder on at least breaking even on our overall business volume.
Taking all of these factors into account, the make-versus-buy decision can be made with some certainty. If it is determine that it is more profitable to perform the test than to send it elsewhere, and incur the additional cost, the decision is simple enough to bring the test in-house. However, it may turn out that bringing the test in-house is logical on the basis that doing so saves expense downstream, even if the expense to the laboratory is slightly higher. If, on the other hand, there are neither financial nor intangible reasons to perform the test in-house, it should continue to be referred out.
1.Denise M. Harmening: Laboratory – Organization & administration; 2003 Ed, p.180