HBSP Product Number TCG

5

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THE CRIMSON PRESS CURRICULUM CENTER
THE CRIMSON GROUP, INC.
Lakeside Hospital

A hospital just can’t afford to operate a department at 50 percent capacity. If we average 20 dialysis patients, it costs us $425 per treatment, and we’re only paid $250. If a department can’t cover its costs, including a fair share of overhead, it isn’t self-sufficient and I don’t think we should carry it.

op yo Peter Lawrence, M.D., Director of Specialty Services at Lakeside Hospital, was addressing
James Newell, M.D., Chief Nephrologist of Lakeside’s Renal Division, concerning a change in
Medicare’s payment policies for hemodialysis treatments. Recently, Medicare had begun paying independent dialysis clinics for standard dialysis treatments, and the change in policy had caused patient volume in Lakeside’s dialysis unit to decrease to about 50 percent of capacity, producing a corresponding increase in per-treatment costs. By February of the current fiscal year, Dr. Lawrence and Lakeside’s Medical Director were considering closing the hospital’s dialysis unit.
Dr. Newell, who had been Chief Nephrologist since he’d helped establish the unit, was opposed to closing it. Although he was impressed by the quality of care that independent centers offered, he was convinced that Lakeside’s unit was necessary for providing back-up and emergency services for the outpatient centers, as well as for treatment for some of the hospital’s seriously ill inpatients. Furthermore, although the unit could not achieve the low costs of the independent centers, he disagreed with Dr. Lawrence’s cost figure of $425 per treatment. He resolved to prepare his own cost analysis for their next meeting.

Do

No

tC

BACKGROUND
Approximately twenty years ago, at Dr. Newell’s initiative, Lakeside had opened the dialysis unit, largely in response to the growing number of patients with chronic kidney disease. The hospital’s renal division had long provided acute renal failure care and kidney transplants, but the the most common treatment for end-stage renal disease was hemodialysis. During dialysis, a portion of a patient’s blood circulates through an artificial kidney machine and is cleansed of waste products.
Used three times a week for 4 to 5 hours, the kidney machine allows people with chronic kidney disease to lead almost normal lives.
The dialysis unit had 14 artificial kidney machines. Because of space limitations, they used only
10 at any one time, reserving the other four for breakdowns and emergencies. Open six days a week with two shifts of patients daily, the unit could provide 120 treatments a week, which meant they could accommodate 40 regular patients.
From 1973, the year that Medicare began reimbursing for dialysis, all dialysis patients at Lakeside had been covered by Medicare. Until recently, the unit had operated at almost 100 percent capacity, even extending its hours to accept emergency cases and to avoid turning away patients.
Patients typically spent their first three months of dialysis in a hospital facility. If there were no complications when this “start-up” period had passed, they were then required to transfer to an independent center.
Most independent dialysis centers were centrally owned and operated, and were organized into satellite groups spread throughout urban and suburban areas. The facilities were modern and attractively designed and, because they were separate from hospitals’ institutional environments, they offered psychological advantages to patients. Centrally managed with low overhead, they could achieve economies unobtainable by similar hospital units. Supplies and equipment were purchased in bulk, for example, and administrators watched staff scheduling and other costs closely. As a result, their per treatment costs were significantly lower than those in a hospital facility. For example, a treatment in a center operating at 100 percent capacity with 40 patients could cost as little as $160.

_____________________________________________________________________________________________
This case was prepared by Professor David W. Young. It is intended as a basis for class discussion and not to illustrate either effective or ineffective handling of an administrative situation.
Copyright © 2012 by The Crimson Group, Inc. To order copies or request permission to reproduce this document, contact Harvard Business Publications (http://hbsp.harvard.edu/). Under provisions of United States and international copyright laws, no part of this document may be reproduced, stored, or transmitted in any form or by any means without written permission from The Crimson Group (www.thecrimsongroup.org)

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LAKESIDE DATA
Lakeside’s direct and allocated costs for the Renal Dialysis Unit in the previous fiscal year are detailed in Exhibit 1. Dr. Newell also obtained the unit’s cost center report for the same fiscal year
(Exhibit 2), which provided a breakdown of the unit’s direct costs.
Dr. Newell intended to use the prior year’s costs to calculate the per-treatment cost at various volume levels for the current year. He also wanted to find the point at which the unit’s revenue would meet its costs. He commented:
I plan to use only those costs that can be traced directly to dialysis treatments, and not any overhead costs.
If the unit’s revenue meets its direct costs, it is self-sufficient. Peter’s treatment cost of $425 is misleading since it includes substantial overhead, and this year’s overhead will differ from last year’s because of the unit’s decrease in volume. Also, even though this year’s overhead can’t be calculated until the end of the fiscal year, I think I can come up with an estimate. First, though, I plan to calculate the “real” cost of a treatment and, from there, define a “fair share” of overhead.

op yo In reviewing the cost center report, Dr. Newell realized that the nature of the costs varied.

Assignment

tC

There are three types of costs I need to consider in this analysis: those that vary in proportion to volume, those that vary with significant changes in volume, and those that remain the same regardless of the unit’s volume. The first and the last are pretty clear. Medical supplies, purchased laboratory services, and water usage all change according to the number of treatments provided. The other non-personnel expenses will stay essentially the same regardless of the number of treatments.
Salary and wages, and employee expense costs are more complicated. Although they didn’t change during the last year, the unit’s number of treatments also remained fairly steady. However, the significant reduction in volume this year might cause a corresponding reduction in salary and employee expenses. Last year, we employed seven hemodialysis technicians, seven nurses, and one administrator (our nephrologists are all on the hospitals’ physicians’ payroll). However, since I had anticipated that volume would fall, I didn’t replace the nurse and two technicians who left in January of this year. So, as of February, our annualized salaries have decreased by $84,000 and our fringe benefits have decreased by $8,400, for a total of $92,400.
Finally, just as a precaution, in case Peter asks, I had my secretary call a hospital equipment supply manufacturer to discuss the resale value of our 14 machines. They told her that machines used for four years or more could not be sold, even for scrap. We purchased all 14 machines five years ago for $210,000.

1. What is the breakeven volume for the dialysis unit? What assumptions are necessary for calculating it?
2. What is a fair share of overhead at the current level of activity in the unit?

No

3. What will happen to total costs and revenues at Lakeside if the dialysis unit is closed? What other options are available and what are their financial consequences?
4. What should Dr. Newell do?

Do

5. What should Dr. Lawrence do?

_____________________________________________________________________________________________
Lakeside Hospital • June 2012
2 of 4
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23.
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General Services
Depreciation
2,275,079
Admin and general
6,042,311
Operation of plant
1,626,535
Laundry and linen
482,869
Housekeeping
1,135,662
Dietary
773,913
Professional Support
Nursing administration
321,118
Physician salaries
1,285,577
Medical supplies
1,241,042
Pharmacy
328,023
Medical records
306,508
Social Services
309,143
Intern/resident services
640,795
Inpatient Care-Special
Operating rooms
3,179,736
Electrocardiology
349,552
Anesthesiology
1,232,988
Radiology
2,909,080
Laboratory
2,173,298
Blood bank
889,190
Physcial therapy
775,470
Renal dialysis
1,050,048
Oxygen therapy
1,065,514
Ambulatory Care
Emergency
446,164
Other (OPD)
1,592,046
Inpatient Care-General
Adults and children
9,620,154
Intensive care
776,834
Total
42,828,649

Cost Center

Direct
Expenses

Do

7,624,138
1,166,839

805,198
1,603,159

1,620,903
79,326
549,354
1,153,768
1,355,247
310,878
198,581
277,267
23,917

364,392
685,510
347,899 1,633,476
153,031 1,394,073
215,218
543,241
254,995
561,503
199,636
508,779
417,985 1,058,780

423,039
102,879
2,275,079

16,881
168,492

258,775
18,155
37,583
188,876
245,890
65,932
58,990
15,550
5,733

27,392
25,886
55,830
46,310
53,510
35,694
95,880

15,252
155,195

163,490
16,590
28,898
173,123
225,301
60,473
40,336
12,320
5,352

25,152
20,589
31,180
36,660
48,967
21,941
78,559

1,546,300 389,047
492,925
94,187
6,128,309 1,778,151

118,542
316,613

424,651
27,760
327,866
579,206
656,483
131,297
61,822
69,550
7,728

280,065
251,790
35,668
105,037
114,791
125,144
143,676

10,887
33,750

11,839
118,397

100,337
12,843
26,489
134,451
173,181
46,556
25,663
9,855
4,013
9,471

15,242

36,880

78,645
418
2,468
7,251
3,904
516
42
279
42

114,008
609
108,405
45,067
46,285
4,385

12,556

3,053
50,878

695

160,381
1,069

177,477
286,031

5,169
65,477

28,864
10,319

344,187
228,382

22,550

1,251,362
3,195,205

4,800,639
428,878
1,782,342
4,062,848
3,528,545
1,200,068
974,051
1,327,315
1,089,431

Total
Expense

138,977 298,354 285,425 206,357 17,244,292
48,721 27,360 29,509
95,159 1,943,673
543,241 561,503 508,779 1,058,780 42,828,649

20,706 52,233
7,123
13,520 171,000 132,791

1,827
731

rP os t

143,015
1,723
12,062
5,169

70

1,645

327,861 311,222 883,269 685,510 937,353 1,191,424
35,011
72,242 100,660
68,186
602,265 1,299,117 1,090,159 685,510 1,633,476 1,394,073

12,094
2,419

177,601
159
5,583
4,688
4,203
1,719
3,506
6,954
318

2,588

19,305
15,884
25,698
25,566
37,727
16,857
60,332

Dietary
No. of
Meals

Intern
Nursing Physician Medical
Medical Social Resident
Admin Salaries Supplies Pharmacy Records Services Services
Hrs. of
Hrs. of
Dir.
Phrm.
No. of Hrs. of
Hrs. of
Service Service
Supp. $
Rev. $ Records Service Service

op yo 4,655

1,591

AlloTotal to be cated AlloDepre- Admin. and Operation Laundry HouseExpenses cated cation
General
of Plant and Linen keeping
Basis of
Sq.
Payroll
Sq.
Lbs.
Sq.
Allocation Footage
$
Footage Processed Footage
2,275,079
85,998 6,128,309
85,998
151,616 1,778,151
78,990
72,626
119,396
602,265
35,036
52,251
32,109
163,455 1,299,117
38,221
88,955
30,550
5,729
316,246 1,090,159
89,557
97,563
72,880
5,586
50,660

tC

No

LAKESIDE HOSPITAL
Exhibit 1. Cost Allocation Report
Prior Fiscal Year

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LAKESIDE HOSPITAL
Exhibit 2. Cost Center Report—Dialysis Unit
Prior Fiscal Year

Oct-Nov

Professional salaries and wages:
Nurses
Technicians
Subtotal
Fringe benefits
Total
Administrative expenses
Salaries and wages
Fringe benefits
Total personnel
Administrative supplies
Major equipment depreciation
Total
Total costs

Dec-Jan

Feb-Mar

$

3,528
83,904
4,232
$ 91,664

$

3,480
81,800
4,052
$ 89,332

$

$

35,000
31,500
$ 66,500
6,650
$ 73,150

$ 35,000
31,500
$ 66,500
6,650
$ 73,150

$ 35,000
31,500
$ 66,500
6,650
$ 73,150

$

$

$

$

$

5,500
550
6,050
1,570
4,375
11,995

$176,809

Number of treatments

Jun-Jul

Aug-Sep

$

3,440
81,612
3,988
89,040

$

3,496
82,400
4,084
$ 89,980

$

35,000
31,500
66,500
6,650
73,150

$ 35,000
31,500
$ 66,500
6,650
$ 73,150

$

5,500
550
6,050
1,570
4,375
11,995

$

$

$

$

$

980

$180.42

5,500
550
$ 6,050
1,570
4,375
$ 11,995

$174,477
956

$182.51

5,500
550
$ 6,050
1,570
4,375
$ 11,995

$174,411
944

$184.76

$

$

$

$

$174,185
940

$185.30

5,500
550
$ 6,050
1,570
4,375
$ 11,995
$175,125
956
$183.19

$

$

$

$

$

Total

3,496
82,280
4,120
89,896

$ 20,896
493,806
24,476
$ 539,178

35,000
31,500
66,500
6,650
73,150

$ 210,000
189,000
$ 399,000
39,900
$ 438,900

5,500
550
6,050
1,570
4,375
11,995

$

$175,041
960
$182.33

33,000
3,300
$ 36,300
9,420
26,250
$ 71,970
$1,050,048
5,736
$183.06

Do

No

tC

Cost per treatment

3,456
81,810
4,000
$ 89,266

Apr-May

op yo Expense Item
Supplies and Purchased Services
Water usage
Medical supplies:
Purchased lab services
Total

This document is authorized for educator review use only by Chunhui Ye, at HE OTHER until December 2015. Copying or posting is an infringement of copyright.
Permissions@hbsp.harvard.edu or 617.783.7860