Understanding Costs
Understanding Costs
Understanding and managing costs are core managerial tasks. Whatever the mission of the organization, cost control must be a priority. As evidence mounts that many healthcare firms are inefficient, cost control in the healthcare industry is becoming increasingly important. A firm is inefficient when its costs are higher than the quality of its services warrants, when the quality of a firm’s products is lower than the cost of its services warrants, or when the quality of a firm’s products is lower and its costs are higher than the quality and costs of comparable competitors.
Costs Perspective
Cost is a complex concept because it is difficult to measure and depends on the perspective of the beholder. For example, consumer will characterize the cost of a prescription in terms of their out-of-pocket spending and ancillary costs, such as the value of time spent filling a prescription. Most people want to focus on costs from the perspective of the organization in which they work, but shifting costs to customers or suppliers seldom represents a good business strategy. The difficulty of measuring cost components also complicates the concept of costs.
Factors that Influence Costs
Factors that influence costs are:
- Outputs. Firms that produce large volumes of a good or service may have lower costs than firms that produce small volumes. Large firms that have a cost advantage have economies of scale.
- Input Costs. Higher input prices mean higher costs.
- Technology. Advances in technology always reduce the cost of an activity. Adopting a new technology would be pointless if it increased the costs of a process.
- Efficiency. Increases in efficiency always reduce the cost of an activity. Production of almost every healthcare good or service can be made more efficient.
Variable and Fixed Costs
Variable and fixed costs are important concepts for day-to-day management of healthcare organizations. For example, an advantage of growth is that fixed costs can be spread over a larger volume of output. The idea is that lower average fixed costs result in lower average total costs, so profit margins can be larger. In the long run, all costs are variable. Buildings and equipment can be changed or built. The way work is done can be changed. Additional personnel can be hired. The entire organization could shut down, and its assets could be sold. In the short run, some costs are fixed. An existing lease may not be negotiable, even if the building or equipment no longer suits your needs. Misclassification of costs can result in odd incentives. For example, fixed overhead costs are often allocated on the basis of some measure of output, which can make growth appear less profitable than it is because the overhead costs allocated to a unit increase as it grows. So that unit managers are not discouraged from expanding, allocated fixed costs should not vary with output.
