Update on the Value Revolution: A Brief Primer on Time-Driven Activity-Based Costing
William P. Hennrikus, BA; Peter M. Waters, MD; Sohrab S. Virk, BS; Apurva S. Shah, MD, MBA
Department of Orthopaedic Surgery, Children's Hospital Boston, Boston, MA
Despite decades of debate and piecemeal political reforms, the U.S. healthcare system remains astonishingly inefficient, and has simply become unaffordable. Increases in national healthcare expenditure continue to outpace inflation, with healthcare expenditure exceeding 17% of the gross domestic product and continuing to rise.1 Rising healthcare expenditures have compromised both the economic stability of the United States and the treatment of the sick and injured. To date, there has been no convincing attempt to change the unsustainable trajectory of the system, much less a unifying national strategy to effectively contain or reduce costs. There is, however, a clear willingness among government leaders, payers, providers, and patients to change a system that all participants agree is fundamentally broken. In our opinion, the primary focus of reform must be centered on increasing value for patients—defined as health outcomes achieved per dollar spent. Harvard Business School professors Michael Porter and Robert Kaplan have been prominent advocates of value-based healthcare delivery reform.2,3,4,5,6
There is no question that value matters for patients, and that value-improvement is a goal that can unite the interests of all participants in the healthcare system. Through value improvement in healthcare, patients, payers, providers, suppliers, and the government can all benefit while strengthening the economic stability and sustainability of the U.S. healthcare system. Value — not cost reduction — should delineate the framework for performance improvement in healthcare. In our opinion, rigorous measurement and improvement of value is the best way to drive system progress.
Value is a measurement of the relative quality and cost of a service or product. In healthcare, value should be measured in terms of patient outcomes achieved per dollar spent to achieve those outcomes.3-5
Value = Outcomes / Cost
In order to improve value in healthcare, it is critical that the medical community begin rigorously measuring both outcomes and cost at the patient level, over the entire cycle of care. Since value is defined as outcomes relative to cost, value improvement is synonymous with gains in efficiency. Professors Porter and Kaplan assert that “reforms that target cost reduction without regard to outcomes are dangerous and self-defeating, leading to false ‘savings’ and potentially limiting effective care.”2 In contrast, by giving due consideration to health outcomes, reforms that target value improvement respect the integrity of patient care while achieving lasting, meaningful reductions in cost.
Historically, medical investigation has primarily focused on defining and measuring outcomes, the numerator of the value equation. This research has resulted in a tremendous improvement in healthcare quality over the last 50 years. However, measurement of this improvement is difficult as outcomes are inherently condition-specific and multidimensional. In addition, for any medical condition, no single outcome captures the results of care. In truth, the supporters of value-based healthcare acknowledge the fact that outcomes are difficult to measure (outcomes must be risk-adjusted in order to be measured fairly; the “full cycle of care” for many chronic illnesses may be indefinite, etc.). While important work on the numerator of the value equation should continue, physicians and researchers must take an equally rigorous approach to cost, the denominator, in order to improve value. In our opinion, the development of advanced medical treatments has progressed more rapidly than our ability to make those advanced treatments affordable and understand which treatments offer the highest value.
With respect to the measurement of costs, the challenges loom equally large. First, the system of healthcare delivery is inordinately complex, highly fragmented, and highly variable. Second, the involvement of third party payment system (government and private health insurers) perverts incentives in ways that encourage ambiguity in cost data.
Because of the difficulties of measuring costs in the present system, costs are often evaluated at the level of the department, service, or support activity, rather than at the specific patient level. In addition, charge is often used as a proxy of cost. To put it bluntly, as Professors Kaplan and Porter do, “there is an almost complete lack of understanding of how much it costs to deliver patient care, much less how those costs compare with the outcomes achieved.” Efforts to manage such poorly allocated costs have been and will continue to be self-defeating. What is not visible cannot be measured accurately, and what is not measured accurately cannot be managed efficiently. To make costs truly visible, measureable, and manageable, Porter and Kaplan suggest a methodology termed Time-Driven Activity-Based Costing (TDABC).2,7
TDABC is a complicated name for a simple concept:
Total Cost = (Cost Rate Resource A x Time Resource A) + (Cost Rate Resource B x Time Resource B) + …
Multiply the hourly cost rate of each resource that contributes to patient care by the amount of time each resource spends contributing to a specific patient’s care. The cost of all contributing resources can then be summed in order to calculate the real cost of treating a specific patient for a complete cycle of that patient’s care.
In order to calculate medical costs using TDABC, several basic steps are required2:
- Define the medical condition of interest. For acute conditions, investigate all costs related to that condition from the beginning to the end of an episode of care. For chronic conditions, define the cycle of care as a period of time, such as a year.
- Chart the principal activities involved in a patient’s care for the medical condition, along with the locations of those activities. Develop process maps of each activity in patient care delivery, documenting the various providers that directly interact with the patient.
- Obtain time estimates for all interactions between healthcare providers and patients.
- Estimate the cost of supplying patient care resources by estimating the direct costs of each resource involved in caring for patients. The direct costs include compensation for employees,
depreciation or leasing of equipment, supplies, or other operating expenses. Also identify and attribute all the support (indirect) resources necessary to supply the primary resources providing patient care. These data are gathered from the general ledger, the budgeting system, and other IT systems.
- Determine the practical capacity for each employee or resource (hours available for patient care)
- Calculate the capacity cost rate for each employee or resource using data gathered in steps 4 and 5.
- Calculate the total costs of providing care for a medical condition over the entire cycle of care. Begin by simply multiplying the capacity cost rates (including associated support costs) for each resource used in each patient process by the amounts of time the patient spent with the resource. Then, sum up all the costs across all the processes used during the patient’s complete cycle of care to produce the total cost of care for the patient.
TDABC, as designed and promoted by Professors Kaplan and Porter, aims to estimate costs accurately by accounting for the total costs of all the resources used by a patient as she or he traverses the system. This means tracking the sequence and duration of all clinical and administrative processes used by individual patients. Such a task may seem daunting, and rightly so — Kaplan and Porter acknowledge the fact that this is something most hospital information systems today are unable to do. In our opinion, the greatest concern with implementation of a TDABC system in a hospital or medical facility is the tremendous initial effort required to launch such a system. In addition, the fluid nature of medical care necessitates ongoing investment of time in maintaining a TDABC system. From our vantage, TDABC would benefit from a technology solution that seamlessly collects data on process flow, time stamping, and cost rates – thereby permitting efficient real time cost analysis and focus on value improvement.
Fortunately, this type of technology solution does exist and is now available through multiple vendors. These vendors have launched multiple pilot projects and continue to develop relevant software capabilities. In general, the software is designed to process map and time stamp utilizing the principles of TDABC – by leveraging a hospital’s existing information technology systems in order to virtually track patients through the healthcare system and generate reliable time stamps for resource activities. One example of this type of data integration is the use of time stamps from a picture archiving and communication system (PACS) to determine how much time radiology personnel spend in processing patients and analyzing patient imaging. This data is currently gathered by existing information technology systems and can be harnessed to power TDABC analysis. If this type of technology solution proves useful at pilot sites, it could permit hospitals and medical facilities to adopt highly granular and accurate TDABC systems without building from scratch, reinventing, or overhauling entire information technology systems.
The Department of Orthopaedic Surgery at Children’s Hospital Boston (Boston, MA) has initiated a pilot study investigating the use of TDABC in pediatric distal radius fractures. With the assistance of the Harvard Business School, our department has served as one of the early pilot sites for investigative work in TDABC, along with the Department of Plastic Surgery at Children’s Hospital Boston (Boston, MA), the University of Texas MD Anderson Cancer Center (Houston, TX), and the Schon Klinik (Munich, Germany). Directly, TDABC is not expected to reduce costs or improve value – it is simply a tool that permits the accurate measurement of costs. However, it has been our experience that accurate cost measurement does provide the opportunity for substantial value creation. Professors Porter and Kaplan emphasize that accurate costing allows the impact of process improvements in medical care to be readily calculated, validated, and compared. This knowledge permits hospitals, departments, and clinics to utilize medical staff, equipment, facilities, and administrative resources more efficiently, streamline the path of patients through the system, and select treatment approaches that most improve value. Ultimately, the collection of more accurate outcomes and cost data will permit our society to abandon the current inefficient fee-for-service payment system, and move towards value-based reimbursement system, in which providers are reimbursed for creating value and not for providing services. A value-based reimbursement system would realign financial incentives with patient outcomes, driving costs down and quality up.
2 Kaplan RS, Porter ME. How to solve the cost crisis in healthcare. Harv Bus Rev 2011;89:46-52.
3 Porter ME. What is value in healthcare? N Engl J Med 2010;363:2477-2481.
4 Porter ME, Teisberg EO. How physicians can change the future of healthcare. JAMA 2007; 297: 1103-1111.
5 Porter ME, Teisberg EO. Redefining Healthcare. Boston, MA: Harvard Business School Press 2006.
6 Porter ME. Teisberg EO. Redefining competition in healthcare. Harv Bus Rev 2004;82:64-76.
7 Kaplan RS, Anderson SR. Time-driven activity-based costing. Harv Bus Rev 2004;82:131-138.