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Radiology practices face serious challenges to their financial health. Reimbursement is under almost continuous attack, with the latest salvo arising from the Deficit Reduction Act and threats of worse to come in the near future.
Radiology practices face serious challenges to their financial health. Reimbursement is under almost continuous attack, with the latest salvo arising from the Deficit Reduction Act and threats of worse to come in the near future. Competition is increasing from within the specialty as well as from outside of it, with increasing numbers of imaging centers and new entrants into imaging from other specialties. Such competition has also chipped away at revenue, particularly in the more lucrative forms of imaging.
The ability to respond to these challenges is hampered by the high fixed-cost structure of most practices, as well as a lack of flexibility within those cost structures. This is a particular challenge for practices that own expensive assets.
These challenges require a variety of efforts at the practice and national level to preserve and protect the profession. One approach that should be used in any organization is to examine costs and their relationship to how the business is being managed. Are sound principles being used, or is the management philosophy to simply "wing it" and treat the business as a black box?
Many managers suffer from a lack of insight about their costs. While we know how much we pay for machines and salaries, most imaging centers don't have a detailed understanding of how those resources are used. This is often particularly true of larger, more complex institutions.
If you walk into most practices and ask the cost of a myelogram, the answer too often is "I don't know," or even worse, a made-up number that doesn't reflect what is actually occurring within the enterprise. What businesses need to know is how costs are matched to productivity. One of the great strengths of managerial accounting is that it can pry open the black box and show what is really going on inside (Figure 1).
Not all costs are the same in terms of how they affect practice decisions. What do you think it costs to perform one more brain MRI at the end of the day? First, there is the cost of the machine. Let's assume it was purchased for $2 million and that you will keep it for 10 years before replacing it. The MR machine is a fixed cost of the business (see table). At first glance, it appears that performing one more scan won't change that cost. We will ignore wear and tear issues and assume that MR scanners don't wear out twice as fast if you use them twice as much, unlike cars, for example. This means that the MR device acts as a fixed cost and doesn't scale with the number of studies performed.
Now consider a contrast-enhanced study. As in the example above, the MR scanner is used in the same way, and it remains a fixed cost just as with the noncontrast exam. But now it is slightly more interesting. Items like the needle, the dose of contrast, and the bandage are all true variable costs. If you didn't do the extra study, you wouldn't incur these costs.
Sometimes variable costs are also referred to as marginal costs; these terms are often used interchangeably even though there are some technical differences. What's important is to keep the differences between fixed and variable costs in mind, as they can have a significantly different impact on how you do business.
The additional cost of one more noncontrast brain MR scan on a day when you have an empty slot on the schedule is very close to zero, so any additional revenue you make is almost pure profit. At the other extreme, the marginal cost of a neuro-interventional angiography case that uses up multiple expensive catheters, coils, etc., can easily reach thousands or even tens of thousands of dollars. If that amount exceeds your contracted revenue, then you will lose more money the more cases that you perform. This was clearly occurring in one practice that had a very complex contract structure. As the old cliche goes, if you lose money on each case, you can't make it up on volume!
A second important determination to make is whether costs are either indirectly or directly related to the services provided. Indirect costs are often described as overhead and are distributed among all the services performed by an enterprise. To the extent that costs can be allocated directly, you will begin to break the black box open and shed light on how much services really cost.
A large practice with which I was working put all of its mailing costs into an indirect overhead account. However, one section was using more express courier services than all of the other divisions combined. By identifying those costs and categorizing them as direct costs for that section, a more accurate view emerged when its direct costs rose while all the others fell. This approach also helps identify where cost-cutting makes sense and where it might be foolish.
At another site, an expensive piece of equipment was purchased and assigned to overhead so that its costs could be spread through the entire department. However, it was used only for pediatric anesthesia in MRI. A rational appraisal would allocate that cost directly only to those services and thus provide a more accurate cost analysis.
Marginal revenue is another item that requires attention in analyzing a radiology practice. This represents how much the practice is paid for a particular service, such as reimbursement for that additional MRI, myelogram, or brain angiography case. The contribution per case constitutes the marginal revenue minus the marginal cost.
This isn't always a positive number across all the services that are provided in a busy, full-service imaging facility. Sometimes a conscious decision is made to contractually provide some services that lose money. In some full-service hospital contracts, there may be sharp differences between the components that are significant contributors and those that are loss leaders. The point here is not to drop vital services but to have a very clear understanding of what goes on in the practice.
Managerial accounting can help managers understand the risks when a practice takes on a contract that may involve a lot of money-losing cases. It also helps control costs and may identify ways to improve the portions of the practice that make positive financial contributions.
Another analysis that can be useful, particularly with expensive equipment, is to calculate the number of procedures that are needed in order to achieve the breakeven point. This type of arithmetic is standard in purchase and lease calculations. Simply, the number of procedures needed to cover a fixed cost is that cost divided by the marginal contribution per case. This calculation only works with procedures that make a positive contribution. You can't pay for an expensive PET/CT if you lose money every time you use it.
These sorts of calculations can be done for the total cost and/or life of the machine. As leases have become more popular, these are also performed on a time-period basis. Today, you often see breakeven calculations for the number of scans per day and per week, for example.
Many people in diagnostic imaging prefer to display and analyze data graphically rather than as equations or spreadsheets. One way to understand the above concepts is to combine them into a cost-volume-profit diagram (Figure 2). All of the action that occurs can be seen in this figure. Total costs are the sum of the fixed costs and marginal costs per procedure. Revenue is the sum of the individual marginal revenues from each procedure. In this case, the procedure volume is yielding a net profit (revenue minus total costs).
With the graphical approach, you can also see obvious ways to make the service more effective. Lowering fixed costs will reduce risk by decreasing the number of procedures needed to surpass the breakeven point (Figure 3). In Figures 2 and 3, this is the point where total revenue and total cost lines intersect. The service in Figure 2 is riskier-the practice must guarantee more procedures per week to break even. With the service structure in Figure 3, a practice could tolerate a worse slump in procedure volume.
Marginal costs present another issue. If the practice is filmless and is performing noncontrast CT or MR imaging studies, the marginal costs per case should be very low. This means that once the breakeven point is surpassed, the marginal revenue is almost all profit.
Once you start to open the box, you have to be careful and avoid some common errors in cost analysis. The first is that most people start with historical data. These are real data and have a nice feel to them. The problem is that a historical analysis is only useful for making decisions about the future if costs are stable. Ideally, costs should be projected into the future using inflation correction, foreseeable increases in labor costs, and other smart predictions in order to increase their accuracy. If there are obvious costs on the horizon such as upgrades, then an honest analysis requires that they also be included.
A second common error is using the wrong procedure volume when allocating costs. Some centers use a "slot" calculation to get a handle on costs. This involves taking fixed costs and dividing them by the number of slots on the schedule; marginal costs are added to obtain the cost per exam. This will work only if you use the number of potential slots, not the number of slots that are actually used. A more detailed analysis of this can be found in a previously published article (Lexa FJ, Mehta T, Seidmann A. Managerial accounting applications in radiology; JACR 2005;2:262-270).
Managerial accounting offers a powerful toolbox for opening up a radiology practice and matching costs to revenues. These diagrams and calculations can help managers and practices better understand and manage the business as well as make better strategic decisions in the future.
Dr. Lexa is project faculty and country manager of the Global Consulting Practicum and an adjunct professor of marketing at The Wharton School, and a clinical associate professor of radiology, at the University of Pennsylvania.
Fixed costs: Costs that don't depend on number of procedures performed: physical plant, cost of MR machine, core labor costs, among others.
Variable/marginal costs: Costs that directly scale with number of revenue producing procedures.
Direct costs: Some salaries, hardware, contrast agents, film, disposables.
Indirect costs: Office supplies, janitorial work, telephone, heat, most utilities, marketing, insurance, back and front-office salaries.