Here's why so many health systems see their cost-cutting efforts fail before they even start

As the healthcare industry migrates toward a value-based payment system, with risk-based models like bundled payments gaining speed, it is vital for hospitals and health systems to reduce costs. However, that process is difficult when organizations don't know their costs.

During an executive roundtable discussion at the Becker's Hospital Review 7th Annual Meeting in Chicago, Dan Michelson, CEO of Strata Decision Technology, said the confusion around "cost" begins with the definition. When hospital leaders discuss costs, some refer to price, while others refer to charges or reimbursement. "When you get in a room, the most important thing is to make sure everyone is using the same definition," said Mr. Michelson.

After arriving at a common definition, organizations need to ensure the cost information they're relying on is accurate. Obtaining correct cost information is often a difficult task in the healthcare industry. To emphasize this, Mr. Michelson shared a quote from a 2013 Harvard Business Review article written by Michael Porter, PhD, an economist and professor at Harvard Business School. "The absence of accurate cost information in healthcare is nothing short of astounding," wrote Dr. Porter. "Healthcare organizations are flying blind in deciding how to improve processes and redesign care."

Dr. Porter's insight is especially astute given the focus on cost reduction in the industry. Mr. Michelson said cost reduction has moved to the top of many organizations' priorities. He referenced a survey of 100 healthcare CFOs and vice presidents of finance that revealed nine out of 10 had a cost savings initiative in place at their organization. However, many organizations aren't satisfied with their progress — 88 percent said their cost saving efforts fell short.

Advanced cost accounting can address many shortcomings in organizations' current cost savings initiatives. "This is where the market is going," said Mr. Michelson. An advanced cost accounting system offers organizations a complete picture, including accurate information on both inpatient and outpatient costs. This type of system relies on relative value units (RVUs), supply costing and activity-based costing, a more accurate approach versus the past standard of ratio of costs to charges (RCC). Advanced cost accounting is also more timely, providing health systems with information on a more real-time basis rather than the old standard, which was on a semi-annual or annual basis.

When healthcare providers have accurate cost data, they can compare/reduce unnecessary variation in cost per case per physician, identify opportunities to streamline administrative processes and understand labor costs. They can also better analyze the cost to care for patient populations and negotiate more favorable contracts with payers.

However, even with cost data in hand, organizations still struggle to reduce spending unless they take a team approach to cost accounting. Cost reduction efforts take expertise from across the organization, including physicians. One way to engage physicians in the process is simply sharing cost data with them on a comparative basis. If a physician has a high cost per case and sees other physicians performing the same procedures for much lower cost, the high-cost physician can at least begin to start the conversation on what is driving the variance and what it would take to bring costs down.

A poll of the nearly 20 executive roundtable discussion participants revealed the majority of their organizations are sharing information on adverse patient outcomes with physicians. However, the vast majority said cost data is not included in that information.

When physicians are included in the cost conversation, systems can achieve savings. Yale-New Haven (Conn.) Health System has implemented an effective approach to driving out costs. A long-time partner of Strata's, Yale-New Haven Health System implemented Strata's solution at all of its hospitals and hundreds of employed physicians. The system uses quality variation indicators (QVIs) to understand differences in cost based on negative quality outcomes. Through the use of QVIs and other measures, the academic health system has reduced spending by about $150 million, while improving the delivery of care — their number one priority.

The need to bring clinical and financial information together is evident, but roundtable participants indicated that in the past investments in accounting systems were leapfrogged by other purchases. However, with the shift to alternative payment models such as the Comprehensive Care for Joint Replacement model — CMS' first mandatory bundled payment initiative — it is vital hospitals and systems know their costs. Without that information from advanced accounting, providers are indeed "flying blind," said Mr. Michelson, echoing Dr. Porter's 2013 finding.

More articles on healthcare finance:

These 10 hospitals have the biggest surpluses — and they're mostly nonprofit
5 health systems with strong finances
The most important thing a hospital CFO does

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