Case 10 Denver Health Network
Background
Denver Health Network (Network) is a newly created subsidiary of the Denver Health System (System). The Network consists of five medical group practices. While it was originally placed in a for-profit subsidiary, concerns over Stark Law and the low profit lead to the System placing the Network in a newly created not-for-profit subsidiary. The practices include both primary and specialty physicians with an emphasis on obstetrics/gynecology, surgery, pediatrics, and psychology. Physicians are administratively organized in five groups. Each physician practices at only 3 different locations. The Network is an essential part of the System even though the profit of the Network is minimal. The Network generates a large amount of indirect income with patient referrals and outpatient facility use. Varying ancillary services are either limited at the Network force patients to use other System facilities or are best performed at the Network locations. The ancillary services provided at the Network is done so for one or more of the following reasons; lower cost, increased physician efficiency, and improves patient convenience. The Network has decided to add ultrasound services at three locations.
Approaches
Alternative 1 involves the purchase of an ultrasound machine for three locations for a total of three ultrasound machines. Patients schedule appointments at the clinic they are using for preset times and days. One ultrasound technician works all three locations. Alternative 2 involves the purchase of one ultrasound machine and one van. The machine would be mounted in the van and driven by the technician to the three locations. Patient scheduling would be the same as alternative 1.
Assumptions
The Network is assuming that under both alternatives the total procedures done annual would be the same approximately 2,400. The annual revenue is therefore assumed to be equal. The analysis of the alternatives will be based on cost. The Network is assuming the costs of machinery. The cost of an ultrasound is estimated at $100,000 each. While a discount has been mentioned for purchasing three machines the initial calculations will not include a discount price. The projected useful life of each machine is five years. The cost of the van for Alternative 2 is projected at $40,000. The useful life is assumed to be five years. The variable cost to be used is activity based. The assumption is that the cost driver, volume and cost per unit have been accurately determined.
Calculations
Alternative 1 total cost is calculated based on the operating cost and capital cost. Operating cost is based on variable cost of procedures and maintenance costs. The variable cost calculations are shown on Appendix 1. Alternative 1 variable cost per procedure is $86.15. With 2,400 procedures annually, the annual variable cost is $206,760. The annual maintenance cost is $500 per ultrasound machine for a total of $1,500. The total operating expenses per year is 208,260. The capital cost is based on the cost of the machinery. For Alternative 1 with three ultrasound machines at $100,000 each the total capital expense is $300,000. Alternative 2 total cost is calculated the same as Alternative 1. The variable cost calculations are shown in Appendix 1. The variable cost per procedure is $92.15. With 2,400 procedures done annually the annual variable cost is $221,160. The annual maintenance cost is based on $1,000 for ultrasound maintenance and $1,000 for van maintenance. The annual maintenance cost is $2,000. The annual operating expense is $223,160. The capital expense is based on the cost of the ultrasound machine and the van, $100,000 and $40,000 respectively. The capital expense for Alternative 2 is $140,000. In Appendix 2, the total cost is shown for years one through five before the lifespan of the machines is assumed finished. The expense after five years for Alternative 1 is $1,341,300 and for Alternative 2 is $1,255,800. The difference in expense after five is $85,500.
Recommendation
While the numbers would suggest that Alternative 2 is the best option my recommendation is Alternative 1. The savings of Alternative 2 versus Alternative 1 over five years of $85,500 is not significant enough to be the basis of action. Alternative 2 has possible added costs that will not be need to be considered for Alternative 1. The calculations did not consider the possibility of the van getting into an accident. If this happens the Network will lose revenue for appointments missed, the cost of van repairs, a possible increase of insurance cost, and the cost of recalibrating the ultrasound machine. If the accident is bad enough a new ultrasound machine may need to be purchased.
Alternative 1 has a higher initial cost but is more stable in life expectancy of the ultrasound machines. With three machines the possibility of increasing revenue because of increased capacity capabilities is higher than Alternative 2.