The Importance of Effective Cost Management in Healthcare

Healthcare margins are razor-thin, requiring providers to acknowledge the crucial role costing data plays in various aspects of financial analysis and decision-making within organizations. Costing data is instrumental in generating profitability analysis, service line profit and loss accounting, and ACO/risk payment model analysis. As organizations continue to struggle with margin pressure, providers must be able to evaluate profitability, allocate costs accurately, identify inefficiencies, optimize costs, and assess the financial viability of different service lines or payment models. Even when the CARES Act afforded $100B in funding for hospitals and other healthcare organizations responding to the COVID-19 pandemic, access to these relief funds was reliant upon the ability to articulate COVID-19 costs of care.

In the past four years, expenses have risen more than double Medicare reimbursement creating a cost effectiveness imperative that has left many health systems vulnerable to disruption. According to Kaufman Hall, more than half of U.S. hospitals ended their FY2022 cycle with negative operating margin results. And despite a late Q1 2023 national hospital trend for slight margin improvement, labor cost and productivity, along with rising drug costs and supply chain challenges continue to rattle health systems of all sizes.


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The train has left the station – the healthcare industry is progressively shifting toward risk payment models and value-based care delivery. In a post-COVID world with inflationary pressures coming to a 40-year high in 2022, how should organizations prepare to navigate the demanding industry needs of quality, value and low cost? Organizations must assess whether their finance function is equipped to deliver greater value through efficient data analysis and strategic insight generation. Furthermore, in order to deliver value, they must have accurate, actionable information on the cost to deliver a service or provide an episode of care.

To be able to achieve and maintain financial sustainability, healthcare organizations must take a deeper look and understand how best to modernize their current cost strategy and practices. Most healthcare organizations rate their cost containment strategy as sub-optimal, while a surprisingly large percentage of health systems still use a ratio of cost-to-charges (RCC) as their primary costing methodology. How can an organization identify waste and drive out inefficiency if there is limited access to actionable cost data? Health systems should evaluate readiness and effectiveness across several fronts:

  • Cost control and efficiency: does your costing strategy provide accurate insights into the costs associated with various healthcare services, procedures, and activities? Do you understand your cost drivers which are necessary to implement cost-control measures, optimize resource allocation, and improve operational efficiency?
  • Sustainability: are you using costing data and analytics to set appropriate pricing, understand service line profitability, negotiate contracts with payers, understand managed care contract profitability and identify revenue-generating opportunities?
  • Value-based care and reimbursement models: are you able to measure the value and cost-effectiveness of your services, align offerings with reimbursement models, and negotiate favorable contracts with payers in preparation for value-based and risk payment models?
  • Decision-making and strategic planning: accurate cost information is essential for informed decision-making and strategic planning and should be leveraged to evaluate the financial viability of new services, investments in technology, expansion plans, and partnerships.
  • Competitive advantage: health systems that understand their costs better can optimize pricing, offer competitive rates, and negotiate contracts more effectively.
  • Contract negotiations and partnerships: accurate cost information strengthens an organization’s position in contract negotiations and/or partnerships with payers, suppliers, and other stakeholders. Cost data accuracy and reliability will help demonstrate the value they bring, negotiate fair reimbursement rates, and identify areas for collaboration to improve cost efficiency.
  • Transparency and accountability: an updated costing strategy enables health systems to provide accurate and transparent cost information to patients, promoting trust and accountability.

The overall objective is to create a foundation of trust and integrity for improved financial management and decision-making across the organization that aligns with a value-based care approach. The relevance of cost management strategies and overall effectiveness will continue to be increasingly important to improve operational efficiency, manage resource allocation, reduce costs, and explore new revenue streams. By proactively addressing these challenges and implementing appropriate costing strategies, healthcare organizations can navigate the economic climate, improve financial performance, and mitigate the impact of shrinking operating margins.

About the Author

Shannon Hill is an experienced, value-driven healthcare leader with an extensive background in finance, strategic data, decision support analytics and execution of strategic initiatives. With over 25 years of progressive healthcare finance and consulting experience, Shannon has consistently led and managed program initiatives for healthcare providers delivering measurable success across areas in financial operations, controllership, revenue integrity, financial and clinical decision support and business intelligence analytics.