Kaplan and Porter's misguided microanalysis of costs

Why Medical Bills Are a Mystery

By Robert S. Kaplan and Michael E. Porter
The New York Times, April 14, 2012

Rising health care costs are busting the federal budget as well as those of states, counties and municipalities. Policy makers and health care leaders have spent decades trying to figure out what to do about this.

Yet their solutions are failing because of a fundamental and largely unrecognized problem: We don’t know what it costs to deliver health care to individual patients, much less how those costs compare to the outcomes achieved.

Because health care charges and reimbursements have become disconnected from actual costs, some procedures are reimbursed very generously, while others are priced below their actual cost or not reimbursed at all. This leads many providers to expand into well-reimbursed procedures, like knee and hip replacements or high-end imaging, producing huge excess capacity for these at the same time that shortages persist in poorly reimbursed but critical services like primary and preventive care.

We are currently working with several health care organizations, including MD Anderson Cancer Center in Houston, Children’s Hospital Boston, Partners Healthcare in Boston and Schön Klinik in Germany, that are beginning to figure out how to measure costs. They use teams of clinicians and administrators to identify all the processes involved in care, from a patient’s first contact with a health care provider through his or her inpatient stay and outpatient follow-up care. The teams then identify the quantity and unit cost of each resource — clinical staff, equipment, supplies, devices and administrative support — used in each process and add these together to learn the total cost of a patient’s care.

Understanding costs could be the single most powerful lever to transform the value of health care.  This would give payers and providers the data they need to improve patient care, and to stop arbitrary cuts and counterproductive cost shifting.


The Big Idea: How to Solve the Cost Crisis in Health Care

By Robert S. Kaplan and Michael E. Porter
Harvard Business Review, September 2011

The Cost Measurement Process

1. Select the medical condition (including the associated complications and comorbidities).

2. Define the care delivery value chain (charts the principal activities involved in a patient’s care for a medical condition along with their locations).

3. Develop process maps of each activity in patient care delivery (include all the capacity-supplying resources - personnel, facilities, and equipment - involved at each process along the path; identify the consumable supplies such as medications, syringes, catheters, and bandages).

4. Obtain time estimates for each process (in the future, we expect providers will use electronic handheld, bar-code, and RFID devices to capture actual times).

5. Estimate the cost of supplying patient care resources (compensation for employees; depreciation or leasing of equipment, supplies, or other operating expenses; deducting time for teaching and research; identify support resources necessary to supply the primary resources providing patient care; allocate the costs of departments and activities that support the patient-facing work).

6. Estimate the capacity of each resource, and calculate the capacity cost rate (number of days that each employee actually works each year, number of hours per day that the employee is available for work, number of hours per workday used for nonpatient-related work, such as breaks, training, education, and administrative meetings; for equipment resources measure capacity by estimating the number of days per month and the number of hours per day that each piece of equipment can be used; factors such as peak load demands, surge capacity, and capacity acquired for future growth should be accounted for).

7. Calculate the total cost of patient care. (In the final step, the project team estimates the total cost of treating a patient 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. 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.)

Reinventing Reimbursement

If we are to stop the escalation of total health care costs, the level of reimbursement must be reduced. But how this is done will have profound implications for the quality and supply of health care. Across-the-board cuts in reimbursement will jeopardize the quality of care and likely lead to severe rationing. Reductions that enable the quality of care to be maintained or improved need to be informed by accurate knowledge of the total costs required to achieve the desired outcomes when treating individual patients with a given medical condition.

The current system of reimbursement is disconnected from actual costs and outcomes and discourages providers and payors from introducing more cost-effective processes for treating patients. With today’s inadequate costing systems, reimbursement rates have often been based on historical charges. That approach has introduced massive cross subsidies that reimburse some services generously and pay far below costs for others, leading to excess supply for well-reimbursed services and inadequate delivery and innovation for poorly reimbursed ones.

Adjusting only the level of reimbursement, however, will not be enough. Any true health care reform will require abandoning the current complex fee-for-service payment schedule altogether. Instead, payors should introduce value-based reimbursement, such as bundled payments, that covers the full care cycle and includes care for complications and common comorbidities. Value-based reimbursement rewards providers who deliver the best overall care at the lowest cost and who minimize complications rather than create them. The lack of accurate cost data covering the full cycle of care for a patient has been the major barrier to adopting alternative reimbursement approaches, such as bundled reimbursement, that are more aligned with value.

We believe that our proposed improvements in cost measurement, coupled with better outcome measurement, will give third-party payors the confidence to introduce reimbursement methods that better reward value, reduce perverse incentives, and encourage provider innovation. As providers start to understand the total costs of treating patients over their complete cycle of care, they will also be able to contemplate innovative reimbursement approaches without fear of sacrificing their financial sustainability. Those that deliver desired health outcomes faster and more efficiently, without unnecessary services, and with proven, simpler treatment models will not be penalized by lower revenues.

(Robert S. Kaplan is a Baker Foundation Professor at Harvard Business School.)

(Michael E. Porter is the Bishop William Lawrence University Professor at Harvard. He is based at Harvard Business School.)


By Don McCanne, MD

Robert Kaplan and Michael Porter are correct when they say that we need to understand costs rather than prices if we are to improve value in our health care spending. But is their approach on analyzing our costs an efficient method that can be applied throughout our health care system?

Kaplan and Porter propose that we abandon billing based largely on historical prices for itemized services and products. Instead they propose that we continue to focus on the patient as the unit of analysis, but that we should do it around the patient's medical condition. As an example, they would ask how much does each cost factor contribute to the total cost, but not the price, of a total knee replacement?

When a hospital bills for services what we see are the prices, not the costs. Kaplan and Porter recommend a meticulous microanalysis to break the charges down to the hospital's actual costs. However, when a hospital purchases supplies and services, the hospital's costs are the prices they pay for those supplies and services which are certainly higher than the costs for those supplying those resources. Thus this distinction between price and cost can be quite blurred, in spite of their efforts to tease them out.

From the cost measurement process that they describe above, you can see that it requires an inordinate amount of microanalysis, using teams of clinicians and administrators. It is very labor intensive, yet would those costs be applied to the total cost of the given condition in a given patient? Would the total cost include the patient's fraction of the liability insurance for the hospital? Or the patient's fraction of the amortized building costs for the facility? Or the costs of the visitor parking lot for their families and friends to use? Or the costs of marketing to the community? You can see that fixed costs can be difficult to assign to specific patients, and marginal costs may be quite variable.

Further, how many medical conditions would need a separate analysis? Would a total knee replacement in a younger, healthy individual have the same itemized costs as the same procedure in a patient with multiple chronic disorders that would have to be monitored or managed during the admission? How many sub-classifications would you need for total knee replacement because of the varying status of each patient? Can patients really be categorized accurately enough to assign a specific package fee based on actual costs? Or would each patient have to undergo the laborious microanalysis of their use of supplies and services?

If you do not do such a microanalysis on each patient, then you still end up with an inequitable assignment of costs because of the variability of patients within the same clinical presentation category. By the time you define enough clinical presentations that take into consideration all of the variables, you have almost an encyclopedic list to choose from. Then would the total charge still represent the hospital's actual costs plus margin in each and every case? Certainly the hospital's various costs are not fixed in time but represent an ongoing dynamic. How often would you have to repeat these labor intensive studies to make sure that they were current and accurate?

The flaw in this approach is that we are trying to pay for health care by using market principles rather than approaching patients from a public service perspective. We are trying to assign specific complex costs and prices to single individuals with specific given medical conditions, like commodities in markets. This typifies our profoundly wasteful system of financing health care - especially the administrative waste.

There is a far better way. Pay hospitals based on global budgets, much like we do with police, fire, libraries and other public or quasi-public institutions. All reasonable costs are budgeted with appropriate adjustments for needs such as surge capacity and the provision of extraordinary services. Individuals receive appropriate services without regard to the actual costs of the specific services consumed by teach individual. Patients simply get what they need. Efficiencies are attained through the budgeting process. A large hospital in the United States requires hundreds of billing clerks and other personnel, whereas a globally budgeted hospital, as they have in Canada, requires very few billing personnel simply because the costs have been paid through a global budget.

Instead of using market principles with package prices for individuals based on meticulous cost analysis, we should dump the market nonsense and take advantage of the efficiency and equity of global budgeting of hospitals. That is really only possible if we get rid of our fragmented financing system and establish our own single payer national health program.