The market for medical care in America is now mature;

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1 Clinical Process Cost Analysis Charles A. S. Marrin, MB, BS, Lisa C. Johnson, MBA, Virginia L. Beggs, MS, and Paul B. Batalden, MD Cardiothoracic Surgery, Quality Education, Measurement & Research, and Pediatrics and Community & Family Medicine, Dartmouth Medical School, Hanover, New Hampshire Background. New systems of reimbursement are exerting enormous pressure on clinicians and hospitals to reduce costs. Using cheaper supplies or reducing the length of stay may be a satisfactory short-term solution, but the best strategy for long-term success is radical reduction of costs by reengineering the processes of care. However, few clinicians or institutions know the actual costs of medical care; nor do they understand, in detail, the activities involved in the delivery of care. Finally, there is no accepted method for linking the two. Methods. Clinical process cost analysis begins with the construction of a detailed flow diagram incorporating each activity in the process of care. The cost of each activity is then calculated, and the two are linked. This technique was applied to Diagnosis Related Group 75 to analyze the real costs of the operative treatment of lung cancer at one institution. Results. Total costs varied between $6,400 and $7,700. The major driver of costs was personnel time, which accounted for 55% of the total. Forty percent of the total cost was incurred in the operating room. The cost of care decreased progressively during hospitalization. Conclusions. Clinical process cost analysis provides detailed information about the costs and processes of care. The insights thus obtained may be used to reduce costs by reengineering the process. (Ann Thorac Surg 1997;64:690 4) 1997 by The Society of Thoracic Surgeons The market for medical care in America is now mature; purchasing decisions are based largely on price. In consequence, the situation resembles that in the air transport industry since deregulation: ferocious competition, price wars, loss leaders, mergers, anti-trust concerns, and bankruptcies. New systems of reimbursement, such as bundled pricing and capitated payment, are exerting enormous pressure on providers to reduce the costs of medical care to survive, but most clinicians and most administrators do not know what the costs really are. Although the incremental approach to cutting costs by using cheaper supplies or reducing the length of stay may be a satisfactory short-term solution, the only strategy likely to succeed in the long term is radical reduction of costs by reengineering the processes of care. Unfortunately, despite the growing popularity of critical pathways, most providers have only a rudimentary understanding of the activities involved in the process of medical care and even less idea of the cost. Thorough knowledge and understanding of both costs and processes are essential if cost reductions are to be both safe and effective. Compounding the problem is the fact that there is no method in common use to link the work of medical care to its costs. Traditional hospital cost-accounting systems are unequal to the task. They were not designed for this purpose and they do not provide enough detail. Accepted for publication March 14, Address reprint requests to Dr Marrin, Section of Cardiothoracic Surgery, Dartmouth-Hitchcock Medical Center, 1 Medical Center Dr, Lebanon, NH The principles of conventional cost-accounting systems were developed in the early days of mass production. The primary objective of these systems was to assign costs to inventory and products sold. In determining the cost of a product, overhead (indirect cost), which is small in comparison, was allocated in proportion to direct costs (eg, labor, materials), frequently by using volume of production as a proxy (volume-based cost accounting). Although these cost-accounting systems were adequate for pricing and inventory control, their shortcomings became increasingly obvious as manufacturing processes became more complicated. Managers and accountants realized that the lack of detailed information and the inappropriate allocation of indirect costs were leading to costly mistakes, such as under- or overpricing of the product, inappropriate and ineffectual cost-containment measures, and even, in some cases, discontinuation of the manufacture of the most profitable product line. The potential for error is even greater in the service industries (such as medical care), in which indirect costs tend to be larger in proportion to direct costs. Activity-based costing [1] was developed to address the limitations of conventional (volume-based) costaccounting systems. In an activity-based costing system, the cost of a product (or, in medicine, a health care service) is the sum of the costs of all activities and resources required to manufacture, deliver, and service that product. The advantages of activity-based costing systems are that they link costs to work and that proper allocation of indirect expenses gives a more accurate picture of the true costs of a process. This report describes the application of clinical process 1997 by The Society of Thoracic Surgeons /97/$17.00 Published by Elsevier Science Inc PII S (97)

2 Ann Thorac Surg MARRIN ET AL 1997;64:690 4 CLINICAL PROCESS COST ANALYSIS 691 nurses in the clinic, the operating room, the recovery room, and the ward; physiotherapists and respiratory therapists; pharmacists, secretaries, and transcriptionists) and by a timed activity study of the nursing care delivered to thoracotomy patients on the ward. All of the activities involved in each step in the process of care were then incorporated in the process flow diagram (Fig 2). Fig 1. Flow diagram illustrating the steps in the process of care for patients undergoing thoracotomy for lung cancer. cost analysis, an adaptation of activity-based costing [2], to an entire process of care, Diagnosis Related Group (DRG) 75, to demonstrate its potential to improve the practice of medicine. Material and Methods Clinical process cost analysis is a method for linking costs to clinical processes. From various software packages suitable for this purpose, we chose NetProphet II (Sapling Corporation, Toronto, Canada) to create the model. NetProphet II allows the user to create and display a graphic representation of a process to which costs can then be linked and used for computer simulations. The software can be run on either a Macintosh or DOS platform. Constructing the model involves several stages. First, a flow diagram of the steps involved in the process of care is developed. The activities performed during each step and the resources consumed in the course of each activity are identified, and the unit cost of each resource is calculated and entered into the model. Finally, the model is validated and run to yield the costs of the entire process of care. Changes in the process can then be simulated to determine the effect on the overall cost. A demonstration project was undertaken in which the method was applied to the operative care of patients with lung cancer (diagnosis-related group [DRG] 75). This group of patients was chosen because of its manageable size (about 50 patients yearly) and the clearly defined beginning and end of the process of care. A multidisciplinary group of experts was convened, which included physicians, nurses, and administrators from various departments: cardiothoracic surgery, anesthesia, operating room, accounting, clinical review services, strategic planning, and quality improvement. Other individuals or departments were consulted as necessary. The core group met weekly for 6 months. Process of Care The entire process of care (from preoperative consultation to postoperative follow-up visit) for patients undergoing thoracotomy for lung cancer was elucidated and represented as a series of steps in a flow diagram (Fig 1). The activities performed in the course of each step were then identified and enumerated from interviews with the individuals involved (surgeons and anesthesiologists; Resources Consumed Information about the resources consumed in the course of each activity was obtained from interviews with the providers and from the computerized data bases of the departments involved. For example, the durations of bronchoscopy and thoracotomy were obtained from the computerized Operating Room Management System. The billing records of recent patients were also reviewed to establish the typical utilization of resources for patients in DRG 75, to ensure complete capture of all activities and to validate the flow diagram. Unit Costs of the Resources The cost of each of the resources consumed was then calculated. Personnel costs, expressed in dollars per hour, were calculated from the total compensation, including fringe benefits and paid vacation, for each individual, prorated for the time spent in each activity. In the case of physicians, the cost of malpractice insurance was also prorated and included. The costs of supplies and ancillary services were obtained from the appropriate department (laboratory, radiology, pharmacy, nutrition, respiratory therapy, same-day program, operating room, postanesthesia care unit, the ward, and housekeeping). The cost of hospital and office space (expressed as dollars square foot used 1 h 1 ) and the cost of equipment (dollars/h) were calculated using standard assumptions and by prorating the costs of plant operations, maintenance, and depreciation and amortization in each case. Finally, the attributable departmental overhead expense was factored in to complete the analysis of process-based cost for each step. For example, the activities, resources, and costs involved in the first step in the process the preoperative office consultation are depicted in Figure 3. Also included are the costs associated with presentation of the case at the weekly lung cancer conference and review by the pathologist of the biopsy specimen. Results The estimated direct and departmental overhead costs (institutional overhead not included) for each step in the process of care for the typical patient undergoing an operation for lung cancer are depicted in Figure 4. The total varied from $6,400 to $7,700. The variation reflects the fact that some diagnostic tests, such as pulmonary function tests, computed tomographic scans, and bronchoscopy, had already been obtained on some patients before they were referred for operation. In such cases, the costs were borne by the referring institution or provider and were not included in our analysis. Moreover, medi-

3 692 MARRIN ET AL Ann Thorac Surg CLINICAL PROCESS COST ANALYSIS 1997;64:690 4 Fig 2. Flow diagram of the process of care for patients undergoing thoracotomy for lung cancer, showing the steps in the process with the activities involved in each step. (CT computed tomography; CXR chest roentgenogram; ECG electrocardiogram; OR operating room; PACU postanesthetic care unit; PFT pulmonary function test; T&S type and screen.) astinoscopy was performed only in selected cases. Finally, there were variations in the length of stay in the postanesthesia care unit (average 2 to 6 hours) and on the ward (average 5 to 7 days). Further analysis using the model identified factors that drove costs. Not surprisingly, the major driver of costs in our model was personnel time, which approximated 55% of the total (Fig 5). Almost half of the calculated total cost of care was incurred on the day of operation, mostly in the operating room, which accounted for 40% of the total. The remainder of the hospital stay accounted for a third of the total, and the cost of care decreased daily from $547 (10% of the total) on the first day to $296 (5% of the total) on the fifth postoperative day (Fig 6). Comment In this study, we used clinical process cost analysis to apply the principles of activity-based costing to a single DRG. Clinical process cost analysis has been used by consultants to the health care industry. It has been advocated for the management of hospital inpatient services [3], and reports have been published of its use in Fig 3. Activities, resources, and associated costs involved in one step of the process: the preoperative office consultation. (Prof. liab. professional liability.) Fig 4. Flow diagram of the process of care linking each step to its total cost.

4 Ann Thorac Surg MARRIN ET AL 1997;64:690 4 CLINICAL PROCESS COST ANALYSIS 693 Fig 5. Breakdown of major costs by category in the process of care for patients undergoing thoracotomy for lung cancer. (Anes. anesthesia; PACU postanesthetic care unit; PAT preadmission testing.) cost analyses of laboratory tests [4], in a case study of costing methods in a dialysis clinic [5], and in a cost analysis of a radiology department [6]. In this report, we describe its application to an entire process of care. As business leaders have pointed out over the last 10 years [7], traditional cost-accounting systems tend to produce distortions in reported costs as a result of errors in calculating (usually underestimating) or allocating overhead. In medicine, for example, per diem hospital cost is typically calculated by dividing the total cost by the number of patient days. However, not all costs vary with the number of hospital days. Those costs associated with hospital admission and registration vary with the number of admissions rather than the length of stay. Nor is the cost per patient day uniformly distributed (see Fig 6). High-acuity patients with short stays generate more costs than patients with longer stays requiring less intensive medical care. The advantage of activity-based costing is that it overcomes this problem by assigning both Fig 6. Breakdown of major costs by hospital day during the process of care for patients undergoing thoracotomy for lung cancer. Average total cost $7,258. (OR operating room.) direct and indirect costs appropriately to produce a more accurate estimate of the actual cost of care. In medicine, analysis of costs is further complicated by the cross-subsidization of activities that has been the inevitable result of rather arbitrary rules about reimbursement. Not only has it been possible, hitherto, to practice medicine or to run a hospital without actually knowing the true costs of care, but charges to wellinsured patients also have been used to make up for losses realized on uninsured or Medicare/Medicaid patients. Activity-based costing eliminates such distortions by reestablishing the link between the activities of medical care and their costs. The major consequence of this study was that new insights into the process of care and its costs led providers to change their behavior and to reduce costs by eliminating unnecessary work. Clinicians are not accustomed to thinking about their work in terms of resourceconsuming activities. In fact, every activity adds cost in a prepaid system of care. Careful interviewing and data collection were necessary to define the activities for each step in the process. This can be tedious; it is certainly labor-intensive and therefore expensive. Nevertheless, the importance of developing a detailed and accurate flow diagram of the process of care before proceeding with the study of costs cannot be overemphasized. It should also be emphasized that the flow diagram of the process of care is not the same as a critical pathway, even though there is some overlap between the two. A critical pathway is goal-oriented and describes the desired care, whereas a process flow diagram is process-oriented and describes the actual care. The actual process of care must be understood in detail before proceeding with the cost analysis. Identifying costs is only the beginning; reducing or eliminating costs is the goal. Only after one understands a process of care and the drivers of costs does it become possible to reengineer the process by identifying non value-added steps and eliminating them. The computer model allows simulations of changes in the process before they are introduced into the clinical arena. As a result of this work, we have already introduced one important change. The data made it clear that efforts to reduce costs should concentrate on the first hospital day, on the operating room in particular (see Fig 6). On average, nonoperative time in the operating room amounted to 83 minutes, at a cost of $466 (20% of the cost of the operation). We therefore decided to concentrate on reducing this non value-added time. In the past, it had been our practice to insert a single-lumen endotracheal tube to accommodate the adult bronchoscope. After bronchoscopy, a double-lumen endotracheal tube was inserted for the thoracotomy. However, we noted that the changeover substantially increased the nonoperative time in the operating room. We now use a pediatric bronchoscope, which can be inserted through the double-lumen tube, in most cases. In some patients, usually those who have not previously undergone bronchoscopy, the better visualization obtained with an adult bronchoscope is desirable. In such cases, we still use an adult

5 694 MARRIN ET AL Ann Thorac Surg CLINICAL PROCESS COST ANALYSIS 1997;64:690 4 bronchoscope and a single-lumen tube, as before. Process simulation using the computer model indicated that this practice change would reduce the average time in the operating room by 30 minutes, saving $240. In fact, such a savings can be realized only if the personnel involved are then assigned to other revenue-producing activities for this half hour or if part or all of an employee position is eliminated. This descriptive study has limitations. Variations in the process of care from patient to patient were addressed by studying the actual experience of several patients to produce a typical process in terms of the utilization of resources. We chose to limit our analysis to patients from the previous year (n 45) to obtain costs that were as current as possible. Moreover, average figures were used after excluding for patients who were day or cost outliers (3 standard deviations above the mean). Considerable variation is the norm in the practice of medicine. However, a distinction must be drawn between intended and unintended variation. Unintended variation is likely to add cost without adding value. Indeed, it frequently decreases value, as when complications of treatment occur. Our analysis entailed a deliberate simplification in which both the patient and the process of care were standardized. This enabled us to make general observations about the process of care and to identify and eliminate activities that did not add value. Although our study captured attributable overhead at a departmental level (such as administrative costs for the operating room or the pharmacy), we were not able to factor in institutional overhead (such as administrative costs for the hospital or the group practice) because we could not obtain activity-specific estimates. As activitybased costing becomes more widely accepted within the institution, the increasing emphasis on process-based management should make it possible to report all attributable overhead, departmental and institutional, for each activity to refine further our estimates of the costs of care. Although our results are not generally applicable, either to other processes of care at our institution or to DRG 75 at other institutions, the method, clinical process cost analysis, is generally applicable. A process of care and its costs will depend on the specifics of the disease (comorbid conditions and the stage of the disease), the provider (because level of compensation affects cost), and the institution. However, many of the activities involved in the process of care, such as obtaining a portable chest roentgenogram or an electrocardiogram, do not vary much within an institution, and there will be little variation in the costs of such activities. If the process of care is envisioned as a series of steps, each involving various activities, a library of costs of standard activities may be developed for each institution, greatly reducing the amount of work involved in subsequent clinical process cost analyses. As experience increases in the use of this technique and as the library of costs grows, the method will become more efficient and less expensive. Indeed, we have already realized gains in speed and efficiency as we have begun to apply the method to other DRGs. Our institution has several advantages that make it easier to conduct studies of this kind than it may be at other centers, especially in nonacademic settings. There is a close relationship between the Dartmouth-Hitchcock Medical Center and the Lahey-Hitchcock Clinic, a multispecialty group practice in which all of the physicians are on salary. The two organizations have made continuous quality improvement and the measurement of outcomes institutional priorities, with involvement and enthusiastic support on the part of the leaders [8]. Finally, there was little difference in charges or in style of practice among the physicians caring for the patients in this study. Clinical process cost analysis is feasible in hospitals where such favorable circumstances do not obtain, but the expenditure of time and effort can probably only be justified for processes of care that are either expensive (such as coronary artery bypass grafting) or are a major part of the work of the institution. The most exciting consequence of this study has been the increase in the team members understanding of and respect for the professionalism and skill of colleagues in other departments. The whole project would have been impossible without an enormous amount of cooperation among various individuals from clinical and administrative departments. This has created a strong esprit de corps, breaking down the us and them mentality and fostering a patient- or process-based (rather than department-based) approach to medical care. In conclusion, clinical process cost analysis applies the principles of activity-based costing to link the costs to the activities of medical care. It affords insights into the process of care that promote changes in the behavior of providers and improvements in the process. It identifies the drivers of costs of the process of care so that efforts to reduce costs may be directed where they will be safest and most effective. We gratefully acknowledge the invaluable assistance and commitment of the following members of the team: Avril Green (Director, Clinical Review Services), Shirley Henry (Manager, Cost Accounting, Hospital Fiscal Services), Martin Hohman (Clinical Coordinator, Operating Room), and Charles Townsend (Information Analyst, Strategic Planning). References 1. Cooper R. The rise of activity-based costing part one: what is an activity-based cost system? J Cost Manage 1988;2: Lawson RA. Beyond ABC: process-based costing. J Cost Manage 1994;8: Upda S. Activity-based costing for hospitals. Health Care Manage Rev 1996;21: Chan Y-CL. Improving hospital cost accounting with activitybased costing. Health Care Manage Rev 1993;18: West TD, Balas EA, West DA. Contrasting RCC, RVU, and ABC for managed care decisions. Healthcare Financial Manage 1996;50: Canby JB. Applying activity-based costing to healthcare settings. Healthcare Financial Manage 1995;49: Johnson HT. Activity-based information: a blueprint for world class management accounting. Manage Accounting 1988;69: Nelson EC, Mohr JJ, Batalden PB, Plume SK. Improving health care: I. The clinical value compass. J Qual Improve 1996;22: