As we all know Healthcare in the US is a very expensive business. The per capita medical expenditure is more than any country, yet life expectancy shorter than most other developed nations and many developing ones. While there are many reasons for this high cost of care, it is clear that the final outcome – wellness-based life expectancy- should improve, under an acceptable cost structure.
The quality of a product or service, measured by specific attributes, is based on the underlying process. If the process is ineffective or inefficient, the final output will be sub-par. Automobile transmissions requiring frequent maintenance, or long patient wait-times at the emergency or physician waiting rooms, are indicative of some or many underperforming parts of the underlying sub-processes. While there are various cost drivers in the US Healthcare systems, such as the fee-for-service model, it is indisputable that the underlying operational inefficiencies contribute to an increased cost of services.
In this article, I argue the need to consistently incorporate Six sigma, Lean, and Activity-Based Costing (ABC) principles in Healthcare service delivery. These methodologies have tremendously impacted product and service quality improvements, and transformed manufacturing from a batch-based production model to a lean flow model. Six sigma seeks to improve product or service quality by rigorously analyzing processes to identify and remove root-causes for process failures or defects, continuously measuring process outputs, and analyzing them statistically to reduce process variations. A six-sigma process is one in which 99.99966% of the products manufactured or services delivered are free of defects, or 3.4 defects per million output, compared to a one-sigma process in which only 31% are free of defects. The first step is to base-line the processes, determine fundamental process measures and measure them, identify defect sources, and seek process improvement opportunities. The second step is to develop improved (re-engineered) processes, pilot the new processes and measure and refine the processes, and deploy organization wide.
The batch-based production model is a “push” type of a system; a product is manufactured in batches and “pushed” through, with limited consideration to actual business demands. Inventory accumulates often leading to obsolescence, and unit product costs are minimized based on volumes. Product cost allocation is also based upon the volume produced and not the actual resources consumed to produce the product.
The Lean flow production is based on a “pull” approach, producing to real demand with manufacturing occurring in a non-batch flow sequence production. The ideal lean flow is a batch size of one; the entire flow is dependent on the KanBan type of just-in-time inventory control pioneered by the Japanese manufacturers and now used world-wide.
ABC is a discipline of product costing based upon the actual consumption of resources required to manufacture a product or deliver a service. The traditional method of product or service costing determines the total cost as the sum of fixed and variable costs. The variable cost is based on the volume produced while the fixed cost is essentially treated as a percentage allocation of overhead costs. The overhead cost allocations are based upon department size, total G&A, building foot print and square footage usage, etc., and is usually an arbitrary percentage allocation.
This method of product or service costing becomes increasingly inaccurate because all products or services don’t consume equal amount of resources. For example, one product might take more time in one expensive machine than another product, but since the amount of direct labor and materials might be the same, the additional cost for the use of the machine would not be recognized when the same percentage based allocation is added to all products. Consequently, when multiple products share common costs, there is a danger of one product subsidizing another.
Healthcare service delivery has a similar costing problem because the delivery of an emergency room service will probably require different consumption of resources than that of an ICU, or an operating room, or in skilled nursing or long-term care environments. Thus, the basic question is: how are the different healthcare services costs calculated, what is the overhead allocation method, and how accurate are they? A rigorous cost analysis will provide very important service cost benchmarks for service efficiency and competitiveness.
The logical and effective sequence of initiatives is to baseline and analyze processes, identify and remove process defect sources, re-engineer processes according to lean flow principles, determine baseline process costs, and determine and allocate actual process and overhead costs via ABC.
In this article I provide an example of the application of process improvement and process flow methodologies, and determination of actual process costs at Miami Jewish Health Systems (MJHS). MJHS is a comprehensive provider of Healthcare services consisting of Hospital, Skilled Nursing, Long Term Care, Residential and Assisted Living, Pain Center, Community Services, and others.
Process analysis and re-engineering: A cross-functional team lead by IT has baselined Admissions, Health Information Management (HIM), Accounts Payable, and Finance processes thus far. The team interviewed the process owners, workers, and process input generators and process output recipients to determine the process flows, process inputs and outputs, process decision points, and any current measures. This information was flowcharted and each sub-process was examined from the following perspectives: (i) process is value-added, (ii) process is necessary but non-value added; (iii) process is non-value added. Sequential processes were converted into parallel processes for process cycle time reduction. A final re-engineered process was developed for these functions, reviewed, and piloted. Process measures were also refined appropriately.
The existing processes exhibited the usual legacy characteristics: manual and paper intensive, sequential processes with multiple post-process checks to correct for errors, double data entry into different computer systems with attendant data entry errors, inaccurate or absent process measures, and lack of process standards. For example, baseline Admissions processes contained thirteen variants of the same process. Needless to say, lack of process standardization is a major operational cost driver. The team was able to standardize all variants into one Admissions process and all data entry forms were appropriately standardized and stored in an electronic library.
Process automation: An enterprise content management system (CMS), integrated with the existing EMR system, with automated rule-based workflow was deployed to automate the re-engineered processes. This included receiving all Admissions packets electronically, processing, and routing them. The packets then flow to Nursing, and various other service departments, and is finally received and processed by HIM. The goal of MJHS is to eventually apply the content management solution to all departments to automate to the fullest extent possible. Initial re-engineered process measurements indicate about a 24% reduction in Admissions processing cycle time.
Process costing and overhead allocation: The following method can be used to determine process costs and allocate overheads accurately. Two measures are necessary: (a) the cost per time unit of capacity per resource (CPR); and (b) Time unit necessary per activity per resource (TPR).
CPR can be calculated as = (Total Departmental Expenditure)/(Total Available Minutes).
TPR can be measured using simple time-study or from established benchmarks or in case of IT, Maintenance, or Call-center environments from trouble ticketing systems. Thus, the cost per activity per resource, CPAPR, is (CPRxTPR). The total cost to support all activities for a particular service, for example, IT Help Desk, is a summed CPAPR for all resources supporting that service. This cost can be further decomposed into the time required directly and indirectly to develop or support the product or service.
At MJHS, in the absence of a trouble ticketing system, we have collected and analyzed time study data for every IT service request. The findings allowed us to: (i) determine the distribution of service requests by complexity; (ii) determine appropriate staffing needs; (iii) align staff support with the type of request, (iv) determine service costs by departments. The last item has allowed us to accurately allocate the support costs and overheads appropriately. The following template can be used by IT to accurately determine true service costs. The service areas are illustrative and will vary by organizations. The direct and indirect costs for each service area are calculated as shown above. This costing process can also be very helpful in budgeting, not only for IT but for other departments as well, and will highlight resource consumption cost drivers and potential cost reduction opportunities.
Conclusion: The triad of six sigma based process analysis, lean flow process re-engineering, and activity-based costing will enhance a Healthcare organization’s competitiveness and cost efficiency. These methodologies are well proven in manufacturing and are increasingly being adopted by Healthcare organizations. With the need to lower the upward Healthcare delivery cost spiral, Healthcare organizations will have to adopt these methodologies, the earlier the better.
tomtex says
Shubho, I commend you for your use of ABC and Lean-Six Sigma in your health system. I wrote about a method that combines Time-Driven ABC with Lean in the Jan. 2010 The Journal of Corporate Finance & Accounting. Just like you’ve described, it’s based on the simple, powerful principle “Time is Money”. If would like a copy of the article, e-mail me your mailing address to [email protected]