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As laboratory directors, we are under mounting pressure to increase our throughput and reduce our cost, while maintaining the highest quality standards. Adding to this formidable challenge is the increasing competition with very large regional laboratories in the South Florida market. Our facility, Mercy Hospital, is within 25 miles of three large regional labs. We have the only hospital-based large reference laboratory in Miami-Dade County. Mercy is an acute care facility licensed for 483 beds. It provides 35 percent of the laboratory workload. Hospital outpatients represent 25 percent and the reference lab contributes the remaining 40 percent. We are the "core" lab for other small hospitals in the community as well as the choice location for local businesses and their pre-employment drug testing programs.
Our organization was recently presented with an opportunity to in-source a variety of laboratory tests from another local area hospital that was experiencing financial hardships. Due to the situation, we needed a decision in a very short amount of time. The preliminary information from the hospital's financial system suggested that the volume of tests performed in this hospital would increase our utilization by as much as 30 percent across the entire laboratory including blood bank, chemistry, microbiology and hematology and immunology. The magnitude of the potential increase in utilization had the potential of significantly disrupting our organization, so we believed a more detailed review of the impact of this new business was warranted. The objectives of a detailed review were to:
- Determine current utilization and equipment capacity.
- Assess if capacity exists to accept an increase in volume.
- Analyze the affect on labor and non-labor cost when utilization increases above current levels in increments of 10 percent, 20 percent, 30 percent, 40 percent and 50 percent.
- Analyze the affect on profitability when utilization increases above current levels in increments of 10 percent, 20 percent, 30 percent, 40 percent, and 50 percent.
In March 2005 we implemented the ExactCost Activity-Based Cost and Performance Management solution in our laboratory and radiology departments. Using activity-based methods to control cost is relatively new to the healthcare industry, but has been widely adopted in other industries for nearly 20 years.
Activity-based methods serve as a dynamic process that has allowed many other industries to reduce and control their costs, increase productivity and streamline their processes while improving product quality and service. This is because the traditional methods did not provide accurate cost and information useful to an operating manager. The manufacturing sector was the first to adopt activity-based methods. Today, nearly 60 percent of all industries world-wide have abandoned the traditional approaches in favor of the activity-based approach. Healthcare is the largest sector that has virtually ignored this methodology. Healthcare can greatly benefit from systems that monitor and manage what is being consumed and what is being produced within key departments such as laboratory, radiology and surgery.
Activity-based methods encompass both activity-based costing (ABC) and activity-based management (ABM). The value of ABC and ABM is very straightforward. ABC is defined as a cost management approach that links resource consumption to activities that an enterprise performs, and then assigns those activities and their associated costs to customers, products or product lines. ABM uses the resource assignments derived in activity-based costing to answer the question "why do we incur these costs?" so that operating managers can improve their departmental processes and workflows.
ABC is designed to accurately define costs and provide operating managers with the very tool they need to improve operations and lower their costs. For a long time, ABC was thought to be too labor intensive to implement and maintain because it drills down to a very granular level of detail. Many laboratory directors and administrators may have felt that the reward may not be worth the pain that has historically accompanied an ABC methodology. New technology has reduced or eliminated all of the historical concerns because a lot of the information needed to utilize an ABC approach already resides within hospital IT systems. What has been missing is the ability to collect the information from disparate systems and mine this data into the activity dictionaries needed to drive an ABC system.
Using the activity-based cost accounting solution from ExactCost, we were able to determine the true cost of every lab test on an on-going basis. This also provided the ability to evaluate our costs against our reimbursement and allowed us to focus our efforts on driving down our costs.
The first step in our review was to determine the current utilization of all of the workstations across the entire lab to assess if there was enough capacity in our current equipment to accept an increase in volume. Ideally, we wanted to gain the additional volume without investing in new equipment.
To evaluate current analyzer utilization, a comparison was made between the manufacturer throughput specifications and our current test volumes. Maximum analyzer capacity was calculated using the following assumptions:
Analyzer uptime=8 hours/day; 20 days/monthly (160 hours/month).
Using the ExactCost solution we were able to determine that the two highest utilized analyzers, the ADVIA 2120 and Bactec 9240, would reach a maximum utilization of 63.4 percent if we increased our volume by 50 percent.
Our facility performs over 800 different standard and specialized billed tests for a total yearly volume of more than 1.5 million with 84 FTEs.
Given the nature of the tests that would be transferred to our lab, we elected to analyze our top 100 tests (by volume) and their respective analyzers. These 100 tests represented approximately 90 percent of our current monthly test volume.
For each of the top 100 tests we were able to analyze the labor, materials, supplies, administrative and overhead costs by test and by analyzer at a level of detail and accuracy not available in any of our previous systems. Most systems assume labor cost is variable, but with our analysis we identified labor cost as fixed because our policy is not to send people home when our volume decreases. In our analysis, the system determined that, as the volume increases, the labor cost clearly declines.
With our analysis completed, we recommended that all of the new business be accepted because the impact on our operation would be very positive. The bottom line is that we are determining whether or not to pursue this opportunity in the future. However, the use of activity-based methods provided us with a view of our operation that was not possible in the past. Now we have the tools that give us the most realistic and accurate view of our operation, and allow us to make informed decisions and continuously find ways to improve quality and reduce cost.
Alberto A. Rey is the Director of Laboratory Services at Mercy Hospital. He has an M.B.A in Health Care and an MS in Pharmacology, both from the University of Miami.
Paul H. Monge, CRA, is the VP, Clinical Specialists at ExactCost Inc., a provider of Activity-Based Costing and Activity-Based Management Software Solutions for Healthcare enterprises.
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