Why Do Costs Matter So much more in Healthcare Business Models?

Outside of just the necessity for a good business model, there is a case to be made that Cost represents the most important part of all healthcare business model building blocks.

modelH Canvas 14 Costs Highlight

This idea is further supported by the fact that federal spending for health care programs is growing much faster than other federal spending in comparison to the economy as a whole. In 2011, the most recent year in which most of the countries reported data, the U.S. spent 17.7% of its GDP on health care, whereas none of the other countries tracked by the OECD reported more than 11.9%. And there’s a debate about just how well the American health-care system works. As the Journal reported recently, Americans are living longer but not necessarily healthier. This graph shows the misalignment regarding the spending of U.S. healthcare dollars (as a percent of GDP) with the rest of the world.

Healthcare Spending as Percent of GDP

In 2011, total spending for healthcare in the United States was approximately $2.5 trillion — 16.4 percent of the GDP, according to the CBO. Private financing accounted for 53 percent of that spending, and public sources made up the remaining 47 percent. It has not slowed. According to the Congressional Budget Office’s 2013 long-term budget outlook report, healthcare spending will increase to approximately 22 percent of the gross domestic product by 2038 under current law. This is driven by various factors such as an aging population, new medical technologies and expanding health insurance coverage.  Likewise, the CBO projects spending on federal healthcare programs including Medicare, Medicaid and the Children’s Health Insurance Program will grow much faster than the economy, increasing from their current level of 5 percent of GDP to 8 percent by 2038.

Components of Total Spending Under CBO Extended Baseline

1st – Questions to Ask on the Canvas for the Key Behaviors Block

What are the Questions that should be answered when developing Costs for a healthcare business model?

  1. What are the most important fixed Costs inherent in our business model?
  2. What are the most important variable Costs inherent in our business model?
  3. What drives these Costs and which ones are controllable?
  4. What Costs can be reduced through economies of scale?
  5. What Costs can be reduced through economies of scope?
  6. Which Key Behaviors are most expensive?
  7. Which Key Resources are most expensive?
  8. Which Key Activities are most expensive?


2nd – What tools do you need to understand your business model costs?

What are the Key Costs a business model should identify and what tools do you need to show those costs?

Healthcare costs are out of control and it is hard to tell the good costs from the bad. To do so, we must first agree on what defines value within the healthcare ecosystem. Our definition of value is based on Michael Porter’s work in What is Value in Health Care?   Porter explains this definition as “the patient health outcome achieved per healthcare dollar spent.”  Therefore a value-based healthcare business model must result in:

  1. Increased access to necessary care through an engaged delivery system;
  2. Reduced aggregate cost of care, with a market-driven, balanced incentive and reward model; and
  3. Improved consumer experience yielding an informed decision maker aligned to their risk and reward.

It is this second pillar that we are focused on.

Therefore, what are the Key Costs a business model should identify and what tools do you need to show those costs? It really depends on which side of the model you are looking at … patient, provider, payer, or purveyor. They are all inter-related.

Let’s look at this question slightly different.

In general, you have all the information you need from your business model’s P&L (aka your Income Statement). For example, if your business model is around the provision of care, your items of importance might look like this:

  • Revenue (what you are paid to provide that care)
  • Cost of Goods Sold (aka your actual medical cost)
  • Gross Margin (Revenue – Cost of Goods Sold)
  • Operating Costs (anything that is not specifically part of the delivery of care)
  • Operating Income (Gross Margin – Operating Costs)
  • Other Income and Expenses (Investment Income, etc.)
  • Income Tax
  • Net Income

Which Costs Should I Be Concerned About?

Your base costs are probably from one of these “Standard Expenses”.

  • Salary, Wages and Benefits
  • Professional Fees
  • Rent
  • Utilities
  • Depreciation and Amortization
  • Interest
  • Maintenance

Then you might want to layer on “Expenses Impacting Gross Margin/Profit”. These are industry specific.  In insurance, for example, these are categorized as medical expenses.  In Retail, this would be considered a cost of sales.

Then you will want to add in your “Expense Accruals”.  These are industry specific as well.  For example, insurance companies are required to book reserves for claims incurred but not reported (called IBNR). Keep in mind that Accruals are contingent upon your method of accounting – cash versus accrual accounting.

So How Can I Track My Costs?

Though your business model is still just an idea, you can build “budgeted” expenses in Excel.  When your business model becomes a “business”, you need to start tracking “actual” expenses. Actual expenses are tracked in accounting software such as QuickBooks, PeopleSoft, etc.

This process of budgeted versus actuals will be repeated for as long as you run your business – at least we hope that you follow this method. As such, as you mature, we recommend using the same system for building your budgets that you do for tracking your actuals.  This will make tracking your variance analysis much easier.

As an additional exercise, it is interesting to compare the costs in a proposed business model versus the costs when doing nothing. For example, what are the costs of not changing the old business model – and are they more or less to the User, Buyer, and System.  If they are less, you should question the value of your business model beyond your own financial benefit.

In conclusion, we offer this one word of advice. Accuracy and clarity on your finances will make the difference between your success and your failure. You cannot run a business – any business – without an accurate and timely understanding of where your money is being spent. Having started several healthcare companies, some successful and some not, my biggest learning has been two fold:

  1. Utilize a trustful and qualified financial expert who understands the business you are in, and
  2. Involved that expert from the start.

Take time to incorporate these approaches into the Costs block in your business model canvas. Regardless if your business model is aimed at Patients, Providers, Payers, and or Purveyors, defining the Cost is a fundamental discipline you need in order to make your idea into a successful company.

To your health,

The Team at imagine.GO


About the Author