That Costs How Much?

My wife was recently trying to book a flight for business travel. The price of the flight on one airline from Minneapolis to DC varied from $700 to $2000.  How is it possible for the cost to vary three-fold?  The answer is, it doesn’t.  The cost depends primarily on how many people are needed to staff the plane, and how much fuel is used.  The cost of those flights was exactly the same.  It is the price that varies.  The point is, we often say that the $2000 flight costs more, but it depends on what we mean by cost.  The cost to the airline is the same.  The cost to my wife is very different.

The same is true when we talk about costs in healthcare. When you read about healthcare costs, it’s often a challenge to figure out exactly what is being addressed.  Do we mean the cost to the hospital to provide the service?  The cost to the patient?  The cost of the insurance?  Any can be true depending on the context.  However, in the end, what someone (whether a patient family or an insurer) pays for healthcare is ultimately tied to the cost of providing that care.  Just like the cost of a plane ticket is at root tied to the cost of staff and fuel.  Other factors, especially supply and demand, affect the price, but it starts with the cost of production.  So if we want to address the high cost of healthcare – whatever that means – we have to address the high cost of healthcare.

Like any other product, the cost of providing a healthcare service can be broken down into its parts. As in most service industries, labor is the biggest part of the cost.  Doctors, nurses, social workers, interpreters, pharmacists, etc.  These are highly trained individuals, and thus not easily replaced with cheaper labor.  Moreover, much of their work is not readily amenable to automation or outsourcing (though there are numerous examples of both).  Economist William Baumol refers to this as the “cost disease” that helps explain why healthcare costs (along with those of education and live entertainment) tend to rise faster than the cost of other goods and services.  Other main drivers of healthcare costs include equipment (which is typically expensive and rapidly obsolete) and supplies, especially pharmaceuticals.

To figure out the cost of providing a particular service – say, an MRI – you need to know the unit cost of each of the components, and the number of them you use. Unit cost might include a certain number of hours of nurse, radiation technologist, and physician time, a portion of the depreciation of the scanner itself, and medications for contrast or sedation.  You can bring down the cost of the MRI by getting cheaper components (for example, paying the radiologist at a lower rate, or using a less expensive contrast agent), or using fewer of those components (for example, not using contrast).

One more thing. The total cost of providing care is then the sum total of the cost of all of those particular services. The cost of caring for a child with appendicitis, for example, is the sum total of the cost of the various diagnostic tests, medications, and other therapies.  You can lower the cost of an appendectomy by making a CT scan cheaper to do, or you can lower the cost by doing fewer of those CT scans in the first place.  This is the heart of efficiency which, along with effectiveness and safety and patient-centeredness and equity, is one of the core domains of healthcare quality.

Why does this matter? The overall amount of money spent in the US on medical care continues to rise.  For individual families and for society as a whole, medical spending is starting to crowd out other priorities.  Families must choose between medical care and clothing.  States must choose between medical care and education.  You can’t open a newspaper or go on the Internet without hearing that people are unwilling to continue to spend more on healthcare.  Which means we in healthcare need to figure out how to lower the cost of that care.  Not lower the price.  Lower the cost.  We need to be compensated fairly for the service we provide, but we can’t simply advocate for more. We must become more efficient so that we can continue to provide care, and so that our patients and families will continue to be able to access it.  Otherwise someone else – likely someone who is not as knowledgeable about what it takes to provide excellent care, and someone with less personal investment in the outcome of the care – will do it for us.  And we won’t like the result.

But we can do it. Health professionals are smart, creative, and committed.  As an industry we have made healthcare more effective and safer than ever.  We can also, without sacrificing those other domains of quality, make it more efficient.  Otherwise people will forego it – just like my wife declined that $2000 flight to DC.

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