| By: Paul Juras

Managing costs requires measuring them correctly and relating them to outcomes. Health care organizations lag in this capability and can learn from other industries.


A June 2010 report from The Commonwealth Fund ( states that “(d)espite having the most costly health system in the world, the United States consistently underperforms on most dimensions of performance, relative to other countries.” That situation continues today, and one can conclude that the high cost of U.S. health care is not due to its superior quality.


So what accounts for this high cost?

The answer is not a simple one. The demographics of the population, the health care reimbursement system, the incentives within the health care system, and the advances in technology and treatments all contribute to costs. According to Kaplan and Porter (2011), however, there also is a source of rising costs that does not attract as much attention, an apparent inability to understand how much it actually costs to treat a patient and then relate those costs to outcomes. This dynamic is similar in several ways to what has occurred in the manufacturing sector.

While some may cringe at the thought of comparing the process of providing care to that of manufacturing a product, there are certainly concepts that can be adapted from the manufacturing sector to help improve the understanding of the process and the cost of providing care. One does not have to look too hard to find examples of this type of adaptation. One of the most notable examples may be the Virginia Mason Production System, which was created by Virginia Mason Medical Center ( It is an adaption of the Toyota Production System which focuses on lean production techniques. If manufacturing production methods can be used to improve the delivery process, perhaps manufacturing costing methods can be adapted by health care providers to improve the understanding of the cost of the delivery process.

I am not suggesting that improved cost measurement has to translate into cost cutting. Rather, I am suggesting poor cost measurement can lead to dysfunctional behavior and lost opportunities on the part of health care providers and administrators. Consider the simple example of when there are two operating-room procedures that are routinely performed within a hospital. Hospital administration wants to attract more patients that need one of the two procedures, but does not have the capacity to increase patient demand for both. Which patient population is administration likely to target? The obvious answer is the population that needs the more profitable procedure. The next question has to be, which procedure is more profitable? If costs are not clearly understood, one procedure might be undercosted and the other overcosted, thereby distorting the profit level of each and possibly leading to an incorrect decision and a missed opportunity.

How does this happen? Think of it like squeezing a balloon. Just as the hospital in the simple example has a certain level of costs, a balloon is filled with a certain amount of air. If you squeeze a balloon the total amount of air does not change, but one part of the balloon gets smaller and another part bulges out. The same is true for costing of procedures. If fewer dollars are assigned to one procedure (the squeeze), then more dollars have to be assigned elsewhere (the bulge).

Sure, each procedure has some unique costs, but many costs of the hospital in this example are fixed, just like the air in the balloon. Think in terms of nursing salaries, the operating room equipment, the beds, machinery, and even support services such as admissions, discharge, and patient transport. The staff, equipment, and facilities are all resources that are acquired and combined in some way to provide patient care and will be there no matter which of the two patient populations is targeted, and all these resources come at a cost. The assignment of some of these costs to each patient is part of the function of the costing system and if the underlying demand for resources, and their related costs, cannot be understood, any analysis that relies on the cost numbers becomes suspect. There is no question that payer mix, the respective power of the payer and the provider in reimbursement negotiations, are among the factors that would enter into the analysis, but those are factors that impact revenue, and the concern here is with understanding the cost of providing care.

In summary, all resources have a cost, and a clear understanding of how the resources and their related costs are consumed is an important step in controlling costs. Perhaps the health care sector needs to start looking to other sectors of our economy, like manufacturing, that have made advances in understanding their costs in order to better align them and their related resources with the strategic goals of the organization.


The author is a Professor of Accountancy at Babson College.

The Commonwealth Fund. “Mirror, Mirror on the Wall: How the Performance of the U.S. Health Care System Compares Internationally, 2010 Update.” Accessed September 17, 2012.


Kaplan, R. S., and Porter, M. E. “How to Solve The Cost Crisis In Health Care.” Harvard Business Review, 89(9) (2011): 46-64.


Virginia Mason Medical Center. “Virginia Mason Production System.” Last accessed September 17, 2012.