However, when the total of the costs are tabulated, they create a standard cost of a service. It is "a precise and stable measure of variable cost," explains Selivanoff. "It doesn't mix the cost of waste and excess capacity with the true cost of rendering a service."
True cost is what Mary L. Koenig, CFO at the 25-licensed-bed critical access hospital operated by Vernon Memorial Healthcare in Viroqua, WI, was looking for in 2007 when she discussed switching to PBC with her CEO.
"I explained how process-based costing gives us the opportunity to know what our true costs are for providing services. If you don't know what the true costs are, how are we going to measure our real profitability?" says Koenig. For Koenig's organization, that meant having a consultant from regional consulting firm Wipfli, LLC, on site, interviewing department managers to obtain data, and also capturing data from the hospital's billing system.
"With our old model, we were never really comfortable saying what a procedure costs," Koenig says. The hospital's former methodology consisted of pulling cost data from the general financial ledger or using cost-to-charge ratios from the Medicare cost report, she says.
"We'd look at the Medicare cost report to estimate our costs. A lot of it was fuzzy estimating. You can't be confident until you take a really good look at the cost by procedure—not by department, but by the actual service provided," she says.
Using PBC, the team had to gather billing and claims data as well as interview individual department managers to get estimates on how much time was used on each procedure. In addition, managers helped the accounting staff understand the breadth of resources used to provide various services within each department. The entire process required all the revenue and reimbursement data, as well as payer contract information, payer mix, and overhead costs and maintenance.
"Once we had all the information, we knew where our costs were coming from, whether it was supplies, salaries, unused capacity and so on, we could focus on reducing costs, improving productivity, and streamlining processes to remove waste and drive costs down," she says.
The hospital team started PBC in Vernon Memorial Healthcare's two most profitable service lines—orthopedics and general surgery—to see where it could get some quick successes.