The Case for Time-Driven Activity-Based Costing in Healthcare's Shift to Value-Based Care

Time-Driven Activity-Based Costing (TDABC) offers a more efficient way to manage costs in healthcare, supporting the transition to value-based care (VBC). By simplifying cost allocation through time as the central driver, TDABC ensures accurate pricing for complex services and improves operational efficiency. The method helps identify inefficiencies, optimise resources and ensure financial sustainability, making it a valuable tool for healthcare providers aiming to deliver high-quality care while controlling costs.

Key Points

• TDABC simplifies cost allocation by using time as the primary cost driver.
• It ensures accurate pricing in value-based care models through efficient cost management.
• TDABC helps identify inefficiencies, improving resource allocation and operational efficiency.
• The method supports financial sustainability in healthcare by ensuring correct cost allocation.
• TDABC provides transparency, fostering trust between healthcare providers and insurers.

Attending any healthcare summit, such as J.P. Morgan’s annual conference (J.P. Morgan 2024) or the HIMSS Global Health Conference & Exhibition (HIMSS 2024), you will find Value-Based Care (VBC) at the forefront, alongside the rising provenance of artificial intelligence (AI). While the concept of VBC has been around for a while, its adoption has been slower than many advocates would have hoped. Yet the healthcare industry is nearing a tipping point, driven by rising costs, payer incentives and a broader push toward delivering measurable outcomes.

Redefining Healthcare Economics

Value-Based Care represents a significant departure from the traditional fee-for-service model. Instead of compensating providers based on the volume of services rendered, VBC shifts the focus to patient outcomes and quality. Providers are rewarded for achieving specific health goals, improving patient satisfaction and delivering holistic, effective treatment.

This model encourages preventive care, evidence-based practices and better coordination among healthcare professionals. In essence, it transitions the emphasis from quantity to effectiveness, aiming to enhance patient well-being while controlling costs.

For instance, under the traditional fee-for-service model, a patient with diabetes might be billed separately for every visit, test and treatment. In contrast, a VBC approach would incentivise the provider to manage the patient’s overall health, rewarding them for keeping blood sugar levels under control and reducing hospital admissions. This shift in focus encourages comprehensive, preventive care, leading to better long-term outcomes for the patient.

VBC Gains Momentum

The VBC market has experienced substantial growth—and for good reason. Amid rising healthcare costs and an inflationary environment, a system that charges for results delivered rather than services rendered holds significant merit.

The global VBC market, valued at €11.8 billion ($12.2 billion) in 2023, is projected to reach €41.9 billion ($43.4 billion) by 2031, reflecting a compound annual growth rate (CAGR) of 14.6% (Dialog Health n. d.).

In the United States, the Centres for Medicare & Medicaid Services (CMS) projects that by 2030, the vast majority of Medicaid beneficiaries—recipients of state-backed health insurance for individuals with limited income and resources—will be in care arrangements accountable for both quality and total cost of care (HFMA 2024). This marks a significant shift toward VBC models.

Investment trends further underscore this momentum. Private capital inflows into value-based care companies increased more than fourfold between 2019 and 2021. These investments are driving a market expected to reach €966 billion ($1 trillion) in enterprise value across payers, providers and investors [Abou-Atme et al. 2022]. For healthcare institutions and investors alike, VBC presents a compelling opportunity to achieve operational efficiencies while delivering measurable outcomes.

The Cost Conundrum in Healthcare

Providing healthcare services is a cost-intensive endeavour, with a significant portion of expenses classified as indirect costs—costs not directly attributable to a specific service or procedure. For instance, while the cost of a syringe would be considered a direct cost for administering an injection, the electricity required to power the hospital or clinic where the injection takes place is an indirect cost. Other examples include facility maintenance, staffing expenses, equipment depreciation and technology overhead.

To ensure financial sustainability, hospitals must price their services in a way that not only covers direct costs like the syringe but also accounts for indirect expenses such as electricity and operational costs, along with a profit margin. This task poses one of the more significant challenges in healthcare financial management: accurately allocating or apportioning indirect costs across various services.

VBC adds another layer to these costing complexities. In managing diabetes, for example, the provider is likely to be compensated based on the patient’s ability to achieve and maintain target blood glucose levels, reduce complications and enhance quality of life. Multiple services—consultations, diagnostic tests, medications—will contribute to delivering this outcome. These services and their respective costs, including the indirect portion, must be determined to ensure correct pricing. Failing to do so risks financial losses, misallocated resources and potentially suboptimal patient care.

Cost Allocation Techniques: From ABC to TDABC

How much of the indirect costs should be included in the total cost, or in other words, allocated to each product or service? This is the question that various cost allocation techniques aim to answer across industries. At their core, these techniques attempt to establish causality between consumption and allocation. Some methods are more refined and granular than others. Activity-Based Costing (ABC) is one such method on the granular end of the spectrum, designed to identify activities and their associated cost drivers.

To illustrate, consider a factory with a €10,000 electricity bill that produces two products. Together, these products require 2,000 labour hours—1,500 hours for Product A and 500 hours for Product B. In this case, labour hours (the cost driver) can be intuitively linked to electricity costs, assuming production as the sole activity for simplicity. Hence, under ABC, the electricity bill is allocated as follows: Product A, using 75% (1,500/2,000) of the labour hours, is assigned €7,500, while Product B receives the remaining €2,500. This method works well for simple scenarios with limited products and activities. However, the situation becomes far more complex when thousands of product types and numerous activities are involved.

Imagine a factory producing a variety of products, each requiring multiple activities such as assembly, packaging and quality control, with numerous cost drivers interacting simultaneously. Identifying and allocating costs for every driver and activity would be prohibitively expensive and time-consuming. Enter Time-Driven Activity-Based Costing (TDABC)—a streamlined variation of ABC that uses time as the centralcost driver, eliminating the need to track multiple variables for each activity.

TDABC: A Simplified and Scalable Solution

TDABC simplifies cost allocation by using time as the central cost driver. Indirect costs are pooled together, summed up and divided by the total available capacity (in hours) to determine a cost-per-hour rate. Costs are then allocated based on the time required to complete each service or activity.

Assume the aforementioned factory has a total available capacity of 20,000 operating hours and incurs €100,000 in total indirect costs. Using TDABC, the cost-per-hour rate is calculated as 100,000/ 20,000 = €5 per hour.

Now, suppose Product A requires:

• 2 hours for assembling,
• 1 hour for packaging and
• 0.5 hours for quality control, totalling 3.5 hours per unit.

The indirect cost for producing one unit of Product A is 3.5 × €5 = €17. The same approach can be applied to determine costs for other products.

TDABC in Healthcare

TDABC streamlines cost allocation, ensuring it is efficient, broadly accurate and scalable across a multitude of different product or service types. This makes it ideal for healthcare, where various services and cost drivers interact, requiring a cost-effective allocation solution. This is especially relevant for Value-Based Care (VBC), where multiple activities and procedures combine to achieve a particular health outcome.

To understand how TDABC works in healthcare, consider an oversimplified example of a hospital that performs only knee replacement surgeries. Each surgery involves several stages: pre-operative consultation, imaging, surgery and post-operative care. Below is a breakdown of time and costs for each stage, focusing on the activities involved, time spent and the resources used.

Assumptions

1. Indirect Costs: The hospital’s total indirect costs (including staff salaries, equipment, electricity, facilities etc.) are €500,000 per month.
2. Available Time: The hospital has 10,000 hours of total available staff and facility capacity per month.
3. Cost Rate per Hour: €500,000 ÷ 10,000 hours = €50 per hour.

The knee replacement process involves the following stages and activities, with associated times:

Total Indirect Cost Per Patient

Adding the costs across all stages on a TDABC basis:

• Pre-operative: €50 (consultation) + €25 (imaging) + €25 (admin) = €100
• Surgery: €100 (surgeon) + €50 (anaesthesiologist) + €100 (nursing) + €100 (facility use) = €350
• Post-operative: €50 (physical therapy) + €100 (recovery monitoring) = €150

Grand Total Indirect Costs for Knee Replacement = €100 + €350 + €150 = €600 per patient.

It is important to note that these are indirect costs only; direct costs will be added to determine the total package costs. Additional adjustments can be made for variations, such as more complex surgeries requiring extra time or resources.

In a VBC model, additional services needed to achieve the desired outcomes—such as follow-up consultations and physical therapy sessions—can also be priced on a per-patient basis or packaged together at an average cost. This can be done according to the specific VBC payment scheme being used, allowing costs to be allocated in a similar manner without the need for extensive data gathering and analysis.

Advantages of TDABC

VBC is a transparent methodology that ensures indirect costs are allocated efficiently and equitably, allowing providers to price packages accurately. It offers unique benefits for providers navigating the shift to VBC:

1. Improved Cost Accuracy: ensures that all direct and indirect costs are reflected in pricing and aligned with outcomes.
2. Operational Efficiency: identifies inefficiencies, such as administrative bottlenecks or resource underutilisation.
3. Simplified Bundled Payments: facilitates accurate cost calculation for entire episodes of care.
4. Financial Sustainability: supports pricing models that safeguard margins in outcome-based reimbursement systems.
5. Data-Driven Decisions: enables resource optimisation and process improvements.
6. Provider-Payer Trust: Transparent cost structures strengthen relationships with insurers.

Real-World Applications

A systematic review by Etges et al. examined the application of Time-Driven Activity-Based Costing (TDABC) in real-world healthcare settings, evaluating its impact on value-based healthcare (da Silva Etges et al. 2020). The review analysed 26 studies, with 18 reporting that TDABC contributed to value-based initiatives, particularly in identifying cost-saving opportunities. The findings suggest that implementing TDABC leads to improved cost assessments, enabling healthcare providers to identify inefficiencies and optimise resource allocation. By providing precise cost information, TDABC supports the shift towards value-based healthcare, focusing on delivering high-quality care while controlling costs.

The study concludes that TDABC is a valuable tool for healthcare organisations aiming to implement value-based care models, as it facilitates a better understanding and management of costs associated with patient care (da Silva Etges et al. 2020).

In healthcare settings, TDABC serves as a powerful tool for optimising both costs and value. The University of Texas MD Anderson Cancer Centre used TDABC to analyse the costs of treating head and neck cancer patients. By mapping each step of care and allocating costs based on time and resource use, the centre identified inefficiencies, enabling more effective resource allocation without compromising quality (Kaplan et al. 2011).

At Brigham and Women's Hospital, TDABC was used to identify cost-saving opportunities in surgical procedures. By accurately measuring the costs of different activities, the hospital was able to redesign care processes, resulting in improved patient outcomes and reduced costs (Kaplan et al. 2011).

A Strategic Imperative

For healthcare organisations, TDABC is more than a costing methodology—it is a strategic tool. As providers embrace value-based models, the ability to understand, allocate and manage costs will be critical to sustaining financial health and delivering superior outcomes. TDABC offers a scalable, transparent and efficient framework to meet these demands, positioning healthcare providers for success in an increasingly value-driven landscape.

Conflict of Interest

None