This article examines the hospital cost structure in the USA and identifies opportunities to reduce costs. It finds that medical billing processes and medical supply management are two major cost drivers for hospitals. Through Monte Carlo simulation models, the study estimates potential annual savings from improving these processes. Specifically, eliminating waste in medical supply procurement could save hospitals billions annually. Additionally, increasing efficiency in hospital billing may also reduce administrative costs, though external factors like the US insurance system contribute to high costs in this area. The study aims to bring awareness to escalating hospital expenditures and identify the greatest opportunities for cost improvements.

1. International Journal of Health Care Quality Assurance
Emerald Article: Hospital cost structure in the USA: what's behind the
costs? A business case
Charu Chandra, Sameer Kumar, Neha S. Ghildayal
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IJHCQA
24,4 Hospital cost structure in the
USA: what’s behind the costs?
A business case
314
Charu Chandra
Department of Management Studies, College of Business,
Received 29 August 2009
Revised 10 December 2009 University of Michigan-Dearborn, Dearborn, Michigan, USA
Accepted 23 December 2009 Sameer Kumar
Department of Operations and Supply Chain Management,
Opus College of Business, University of St Thomas, Minneapolis,
Minnesota, USA, and
Neha S. Ghildayal
School of Public Health, Division of Health Services Research,
Policy and Administration, University of Minnesota, Minneapolis,
Minnesota, USA
Abstract
Purpose – Hospital costs in the USA are a large part of the national GDP. Medical billing and
supplies processes are significant and growing contributors to hospital operations costs in the USA.
This article aims to identify cost drivers associated with these processes and to suggest improvements
to reduce hospital costs.
Design/methodology/approach – A Monte Carlo simulation model that uses @Risk software
facilitates cost analysis and captures variability associated with the medical billing process
(administrative) and medical supplies process (variable). The model produces estimated savings for
implementing new processes.
Findings – Significant waste exists across the entire medical supply process that needs to be
eliminated. Annual savings, by implementing the improved process, have the potential to save several
billion dollars annually in US hospitals. The other analysis in this study is related to hospital billing
processes. Increased spending on hospital billing processes is not entirely due to hospital inefficiency.
Research limitations/implications – The study lacks concrete data for accurately measuring cost
savings, but there is obviously room for improvement in the two US healthcare processes. This article
only looks at two specific costs associated with medical supply and medical billing processes, respectively.
Practical implications – This study facilitates awareness of escalating US hospital expenditures.
Cost categories, namely, fixed, variable and administrative, are presented to identify the greatest areas
for improvement.
Originality/value – The study will be valuable to US Congress policy makers and US healthcare
industry decision makers. Medical billing process, part of a hospital’s administrative costs, and
hospital supplies management processes are part of variable costs. These are the two major cost
drivers of US hospitals’ expenditures that were examined and analyzed.
Keywords Hospitals, Cost drivers, Cost analysis, Health services, United States of America
International Journal of Health Care
Paper type General review
Quality Assurance
Vol. 24 No. 4, 2011
pp. 314-328 Introduction
q Emerald Group Publishing Limited
0952-6862
US healthcare costs are increasing at a rate roughly three times inflation. In 2008,
DOI 10.1108/09526861111125624 the US healthcare industry was estimated to be worth $2.3 trillion or 16.5 per cent of

3. gross domestic product (GDP) and is projected to be 17.9 per cent or $2.6 trillion by Hospital cost
2010 (Foster and Heffler, 2009). In 2008, 43.8 million US people were uninsured – 17 per structure in
cent of the total population, up 6 per cent from 2000 (Centers for Disease Control and
Prevention, 2009a). In 2008, employer health insurance premiums increased 5 per cent the USA
– two times the rate of inflation. The annual premium for an employer health plan
covering a family of four averaged nearly $12,700. The annual premium for single
coverage averaged over $4,700 (The National Coalition on Health Care, 2009). Table I 315
shows US national health expenditure and GDP projected to 2010. It also shows
national health expenditure as: GDP percentage; and expenditure per capita, which
shows an alarming growth trend over 50 per cent and the health expenditure per capita
over 45 per cent, respectively. Healthcare is currently a major fiscal problem. If this
trend continues to 2010 and beyond then corporation managers will stop offering
healthcare (some already have) to employees, or they will keep passing along premium
increases to employees as many currently do (Murdock, 2008). If the healthcare burden
is left in the average consumer’s hands then it will cripple the economy. Approximately
44 million US people either cannot afford healthcare, or simply do not have healthcare
for some reason. Consequently, they use hospital emergency rooms as their family
clinic (Lavey, 2006; Centers for Disease Control and Prevention, 2009b). This is
obviously more expensive and inefficient than seeing a clinic family practice physician
(Taheri et al., 2000). But, more importantly, it takes precious time away from patients
with potentially life-threatening problems.
The US healthcare rising cost trend will continue unless the industry can find ways
to reduce the burden placed on the consumer. People cannot continue to afford
healthcare at this increasing rate. One way to accomplish affordable healthcare is to
find ways to reduce costs and run a more efficient operation (Woolhandler and
Himmelstien, 2007). Hospitals comprise about 30 per cent of the healthcare industry’s
expenditure (Figure 1). We examine healthcare’s rising costs, specifically related to
hospital expenditure and focus on key hospital operations. Costs are broken down into
fixed, variable and administrative overhead and spending – areas that are most
out-of-control. Medical billing and supplies processes are significant and growing
contributors to US hospital costs. We identify cost drivers associated with these
processes and suggest improvements to reduce hospital costs in the medical billing and
supplies processes areas. We use Monte-Carlo simulation models to analyze costs
associated with medical billing and supplies processes. These models provide lower
bound saving estimates for implementing improvements in these processes used in US
hospital operations.
We examine the following questions to determine where hospital spending can be
successfully trimmed: what hospital cost is fixed, variable and general overhead? What
hospital spending can be better controlled? How can the spending be controlled and
what savings can be quantified by analyzing hospital spending?
Current industry trends: hospital costs
Current industry trends reveal escalating healthcare costs. The entire US healthcare
industry accounts for 16-17 per cent, or approximately $1.9 trillion dollars GDP (Gold
and Diller, 2006). Of that, hospital costs comprise roughly 30 per cent, which increased
over 9 per cent per year for the past five years and continue to increase (National
Health Expenditure Data, 2004-1960). There are three major expenses in a hospital:

4. 24,4
316
Table I.
indicators
IJHCQA
Healthcare industry
2004 2005 2006 2007 E2008a F2009a F2010a
National health expenditures (NHE) (US$ billion) 1,855 1,981 2,113 2,241 2,379 2,509 2,624
Private health insurance (US$ billion) 646 690 731 775 817 854 892
Gross domestic product (GDP) (US$ billion) 11,868 12,638 13,399 14,078 14,441 14,150 14,647
NHE as % of GDP 15.63 15.67 15.77 15.92 16.47 17.74 17.92
US population (millions) 292.8 295.6 298.4 301.3 304.2 307.2 310.2
Under 65 (millions) 256.5 258.8 261.2 263.4 265.5 267.7 270.0
Over 65 (millions) 36.3 36.7 37.2 37.9 38.7 39.5 40.2
NHE per capita (US$) 6,335 6,701 7,079 7,439 7,818 8,169 8,459
Number of people uninsured, all ages (millions) 42.1 41.2 43.6 43.1 43.8
Number of people uninsured, under 65 (millions) 41.7 41.0 43.3 42.8 43.6
Notes: a E-estimated, F-forecasted
Sources: NHE – Centers for Medicare and Medicaid Services (2009); GDP – Bureau of Economic Analysis (2009); Forecast GDP – BMO Capital Markets
Economics (2009); Population – US Census Bureau (2009); Uninsured Population – Centers for Disease Control and Prevention (2009b)

5. Hospital cost
structure in
the USA
317
Figure 1.
Historical and forecast
NHE and hospital
expenses for the USA
(1995-2010)
(1) fixed;
(2) variable; and
(3) administrative/overhead costs.
We define administrative costs as non-patient contact costs incurred by hospital staff.
These are non-revenue generating activities that need to be allocated to the revenue
generating departments and are typically allocated according to users in each
department or by facility space department staff use. There are some arguments
regarding costs that comprise administration: maintaining medical records; medical
records filing; billing; nursing administration; general and administration departments
(IT, finance and plant operations); supplies ordering; and central services. A 2003 study
shows that hospital administrative costs range from 19.3 per cent to 24.8 per cent
(Mehrotra et al., 2003). The US hospital administrative costs are approximately 8.4 per
cent to 11.1; 60 per cent higher than Canada’s and 97 per cent above Great Britain’s
(Mehrotra et al., 2003). There are several reasons that US administrative costs are high
relative to other countries. Its insurance system consists of more than 1,500 service
providers through which insurance can be obtained. Each company markets, creates
and sells its own insurance to US individuals and companies. To complicate matters
for hospitals and their billing departments, most carriers have different billing
requirements (Mehrotra et al., 2003).
Hospital variable costs are expenses that vary by patient with different medical
needs. In other words, variable expenses can be viewed as expenses that are outside the
physicians’ control. Examples include: laboratory tests; medications; medical supplies
and nursing expenses. Variable expenses account for approximately 35 per cent to 42
per cent of total patient expenses (Roberts et al., 1999). Variable hospital expenses are a
significant issue for hospital managers who are reluctant to make changes to the way
variable spending occurs because cutting them compromise patient care. Supplies are
the second largest expense for hospitals after salaries (McGourty and Shulkin, 2005).
The problem is that many hospital managers allow each department to purchase their
own supplies, causing them to act independently creating wasted time and spending. If

6. IJHCQA staff in each department order their supplies then managers lose purchasing power.
24,4 Hospital staff rely on nurses and doctors to manage inventory as well as patient care,
the latter is where clinicians’ focus should be.
Fixed and administrative costs are the most difficult to differentiate. Because of
fixed costs’ nature, these are also the most difficult spending areas to control. For our
purposes, fixed costs are related to equipment amortization, facilities, building leases,
318 utilities and building maintenance. Capital expenditure amortization can be affected
through capital spending cuts. Conscientious employees and corporate awareness can
help curb utility expenses. Building leases are not changeable unless one can take less
space or somehow adjust the contract. Building maintenance is a requirement and an
ongoing expense that is hard to control. Hospitals can keep the building well
maintained to avoid extremely expensive unexpected repair costs. For these reasons,
we focus on the variable and administrative costs. In the short term, there is more value
that can be extracted from those two cost categories. Based on administrative and
variable costs data, it can be deduced that hospital fixed costs comprise 34 per cent to
46 per cent of hospital expenses. These costs to change the way hospitals operate.
Hospital managers have very little profit margin, not because their revenues are flat or
decreasing, but, because their costs are increasing at a rate more than three times
inflation. Each year, hospital costs are becoming a larger percentage of US GDP. By
2010, healthcare costs will be nearly 20 per cent of GDP. In a country where, for the
most part, people are wealthy, there is a concern because 45 million people cannot
afford to buy healthcare (Lavey, 2006). We look at some specific expenses that can be
reduced through more efficient operations and waste elimination. We use a statistical
model with scenario analysis to determine the potential savings related to changes in
the way hospitals treat their medical supply procurement process. The model is also
used to determine potential savings related to hospital administration costs including
bill processing and the insurance claim process. These two spending areas waste
processing time and money spent. This model clearly pictures potential savings and
since scenario analysis is being used, there will be a most likely outcome and best and
worst-case scenarios.
Method
We use @Risk Program (2007) Monte Carlo simulation modeling software, which is an
add-on tool, with a spreadsheet interface to run scenarios. Various business scenarios
are studied to understand possible outcomes using average estimates and adding an
element of variability to them. By adding variability to the modeling, we can come up
with expected outcomes to give a more realistic view how the proposed changes affect
hospital costs. Owing to hospital operation complexity, we model two business
processes. The first looks into the medical billing (administrative costs) and the second
medical supplies (variable costs). There is other Monte Carlo simulation modeling
software having similar capabilities as @Risk. Standard statistics tools used to
produce similar results (Figures 2 and 3) will require more elaborate efforts compared
to @Risk or other similar software such as Crystal Ball, which are specifically
designed to carry out Monte Carlo simulation and regression sensitivity analysis
shown in these figures. Results shown in Figures 2 through 5 are based on running
Monte Carlo simulation using @Risk simulation modeling software.

7. Hospital cost
structure in
the USA
319
Figure 2.
Supply process model
results for 2000-2004
The first model reviews the hospital medical billing process – a process that is an
administrative expense because it is related to non-patient activities done behind the
hospital scenes. Hospital administrative costs run around 19 per cent to 24 per cent of
total hospital costs, which is significantly higher than other modern hospital cost
structures. The reason this process is significant to analyze is because of the

8. IJHCQA
24,4
320
Figure 3.
Medical billing process
model results for
2000-2004
processes’ cumbersome nature. There are more than 1,500 US companies that market
and sell health insurance, which have multiple products that further compounds the
confusion – a problem primarily because most companies have their own billing
requirements as well. All insurance companies do not require the same data. Hospital
managers remain flexible and abide by this process because as a for-profit business

9. Hospital cost
structure in
the USA
321
Figure 4.
Estimated minimum,
average and maximum
supply cost savings for
years 2000 to 2004
Figure 5.
Medical billing savings
(minimum, mean and
maximum) per year
entity they need customers to generate revenue and remain profitable. The burden
has been placed on hospital staff to comply with insurance carrier requirements.
Figure 6 illustrates a Monte Carlo simulation model used to estimate total annual US
hospital medical billing cost savings based on available estimates of various input
parameters.
The second model reviews hospital supply processes. Supply expenses are part of
the hospital’s variable costs – a significant statistic to consider because hospital
supply expense is the second largest next to salaries ( Johnson, 2004). Supply expenses
comprise 18 per cent of US hospital total operating expenses (Editor, 2005). We look at

10. IJHCQA
24,4
322
Figure 6.
Monte Carlo simulation
model for total US hospital
medical billing savings
hospitals’ current inefficient supply process and offer a solution to make this process
more efficient and save hospitals significant capital. The model uses the streamlined
process and scenario analysis introducing variability in an attempt to measure cost
savings. The reason supplies expense is an important factor is not only because
expenses are so high but also the process is inefficient. Most hospital managers let each
department handle their own supply ordering. Hospitals lose buying power and fail to
use centralized purchasing department staff expertise. Doctors and nurses spend hours
ordering supplies, thereby taking away significant time from patients. Using the
process in this article, hospital managers will be able to free time and use a more
efficient process (Efficiency cure, 2004). Figure 7 illustrates a Monte Carlo simulation
model that estimates total annual US hospital supply cost savings based on available
estimates of various input parameters.

11. Hospital cost
structure in
the USA
323
Figure 7.
Monte Carlo simulation
model for total US hospital
supply cost savings
Analysis
In the current supply procurement process, departments operate independently when
purchasing supplies and assuring adequate stock. Hospitals operate this way
primarily because different departments need different supplies and doctors and
nurses may prefer different product brands. This sounds a reasonable approach at
first, but, from an operational perspective, there are many problems. First, the basic
supply needs in different departments are primarily the same. Department-specific
items are what differentiate them. Second, having nurses and doctors order supplies
causes concern. Supply chain processes in hospitals should be centralized. It will be
more efficient and less expensive than the current process. Hospital departments are
operating in silos as decentralized functions. They need to have communication and
consistency between departments to create an efficient supply purchasing

12. IJHCQA environment. The centralized supply chain process will effectively integrate the
procurement activities across all departments in a hospital as it will force economy of
24,4 scale, economy of scope and improved negotiating capabilities with suppliers for the
entire hospital operation (Efficiency cure, 2004). Both hospital supply chain process
efficiency and effectiveness will be enhanced through centralized supply procurement
business model. This process, however, is not without costs. To implement this process
324 hospital staff may have to invest in inventory management and automated supply
ordering systems. However, these two systems will free up time for doctors and nurses
so they are able to focus solely on patient care. Hospital managers will need to hire a
full-time experienced supply manager in charge of the entire vendor maintenance
process, vendor management procurement process, terms and conditions negotiation,
etc. This process also allows the materials manager to consolidate suppliers, reduce
brand variation and total items and makes the process more efficient (Contino, 2001).
Variable hospital costs are approximately 35-42 per cent of total hospital costs
(Roberts et al., 1999; Alexander, 2006). Supplies are the second largest hospital expense
at 18 per cent of operating expenses (Editor, 2005). Using @RISK software to estimate
cost savings allows users to provide value ranges for any analysis (we use 2000-2004
spending data). Table II lists various inputs to the supply cost model. The variable cost
percentage is the mean value of the ranges given in the literature. Using the @RISK
software, a distribution is fitted to the variable cost percentage that coincides with
value ranges given. Estimated cost savings is a per cent savings estimate after process
implementation discussed above. Savings are conservatively estimated at 10 per cent.
There is also a slight distribution fit to the expense savings to give that value some
variability.
The first graph in Figure 2 depicts outcome values based on the above data.
Standard deviation varies because the potential savings are relatively unknown, but
are perceived to be potentially large. The graphs were done using a lognormal
distribution because multiple factors affect the three input variables. Distribution
shows that with 90 per cent certainty, the result, based on these inputs, by
implementing the new supply process, will save between $3bn and $20bn dollars per
year – significant savings that cannot be ignored. The second graph in Figure 2 is a
regression sensitivity tornado graph, which highlights the variables that carry the
most weight in the outcome analysis. In the healthcare example, estimated expense
savings variable is the biggest cost savings driver by a significant margin.
Our second analysis is related to hospital medical billing processes and related
expenses that are part of the hospital’s administrative expenses. We saw earlier that
the hospital administrative expenses are 19 per cent to 24 per cent of total hospital
expenses (Mehrotra et al., 2003; Alexander, 2006). The medical billing process is
cumbersome and costly to hospitals. Data in Table III were used as inputs to the
medical billing process cost model. Hospital managers have to make sure that different
Variability
Input variables Estimated average (standard deviation)
Table II. Percent hospital care of total healthcare expense 30 5
Inputs to the supply cost Supply cost per cent of total hospital expenses 18 2
savings model Estimated per cent cost savings 10 5

13. paperwork and requests from each insurance company are correct so they will be Hospital cost
reimbursed for their services. Salary per employee was gathered from the Almanac of structure in
Hospital Financial and Operating Indicators (Alexander, 2006).The salary information
was adjusted for wage index and reduced to account for the medical billing specialist’s the USA
lower wage. A statistical distribution was fitted to the medical biller’s salary to account
for salary variability. We also looked at Medical Biller Salary (2006) on Salary.com.
The time savings was an estimate based on the process’s cumbersome nature 325
described in the literature. This conservatively estimates the time saved. A distribution
was also fitted to this number to account for time saving variability. Full-time
employees was also estimated and averaged based on hospital size. Some variability
was also added to this figure because hospitals are managed differently and the
number of employees needed for billing can vary greatly.
The model’s average savings were $900 million to $1 billion dollars a year by
streamlining the medical billing process. The distribution graph in Figure 3 shows that
within a 90 per cent certainty, based on information in Table III, savings resulting from
streamlining the medical billing process will be within $300 million to $2 billion dollars
annually, which are significant. The regression sensitivity tornado graph in Figure 3
shows that the estimated time saved carries most weight. The next largest factor is
employee number and the salary per employee is least.
Figure 5 shows estimated minimum, mean and maximum medical billing expense
savings for years 2000 to 2004.
Findings and limitations
Healthcare industry spending, specifically hospitals, can be improved. We have looked
at three types of hospital spending:
(1) administrative;
(2) variable; and
(3) fixed costs.
We examined medical billing process and expenditures specifically, which are part of a
hospital’s administrative costs. The other analysis was related to hospital supplies
expense processes, which is a variable cost. Based on our research, those two specific
costs were the most problematic that needed to change. Data gathered in the literature,
supported by our analysis, show that changing the medical supply process has a
significant impact on the industry. Waste is endemic to the entire process and needs to
be eliminated. We believe that improving processes will likely result in a cost savings
between $2 and $20 billion. Our other analysis – the hospital billing process – showed
that increased spending in this area is not entirely a hospital inefficiency fault. The
Estimated input Variability
Input variables (mean) (standard deviation)
Medical billing salary (salary.com) ($) 26,813-30,287 3,000
Estimated time saved (%) 30 10 Table III.
Medical billers (employees) 15 4.5 Medical billing process
Number of hospitals (from US Census Bureau, 2005) 7,569 0 inputs

14. IJHCQA health insurance industry with their multiplicity of complex requirements and
24,4 administrative paperwork is a primary factor. But, hospital managers need to confront
the insurance industries. The US administrative costs are double Canada’s, so by
streamlining medical billing processes, we believe that hospitals could save $600-$700
million annually. However, we were limited by meager concrete and current data for
estimating cost savings. We were still able to estimate significant lower bounds for
326 annual savings from Monte Carlo Simulation model based on available data by
improving hospital supply and billing processes in the US healthcare delivery system
facing increasing operational inefficiencies and rapidly escalating costs every year.
We make two recommendations; first, hospital managers need to implement the
new supply chain process immediately. Let clinicians do what they are paid to do and
take care of patients. There is a need to hire full-time supply chain managers to handle
and monitor the entire process through an inventory tracking and automated ordering
systems, which increases buying power. Our second recommendation is to make the
medical billing process consistent and cohesive, which increases process efficiency and
reduces potential errors. We covered only two specific types of spending. A more
comprehensive hospital cost and process study should be done to ensure the greatest
efficiency. More detailed research is needed to examine healthcare system successes in
other countries. Plans to change US healthcare should be based on proven methods
currently in operation to ensure feasibility and cost efficiency. The US service
providers cannot afford to let healthcare costs escalate. If significant changes are not
undertaken to improve this economic sector then this industry will continue to affect
the US economy negatively.
Conclusion
Our study points to an awareness of increasing US hospital operation costs. The US
hospital total operation expenditure fell into three categories: fixed; variable and
administrative, which helps us identify the areas for greatest improvement. We tried to
elevate this awareness to a level where action is undertaken. Solving the problem is
vital to healthcare and the US economy, overall. We only looked at two specific costs
associated with medical supply and medical billing processes, respectively. There are
many other costs to consider and analyze. Using a simple Monte Carlo simulation
modeling framework, we identified major cost drivers within a US hospital associated
with the processes we studied. The model showed significant potential savings in
hospital operations. Inefficiencies can be corrected in an effort to stop US healthcare
costs escalating.
We looked at US hospital spending trends, which are alarming. Healthcare, the US’
largest industry, is 16 per cent of GDP and hospitals are 30 per cent of the healthcare
industry and growing rapidly, around 9 per cent per year. We looked further into
hospital and two particular costs, namely, the medical billing process (administrative)
and the medical supplies spending (variable) were then analyzed. For each cost we
analyzed, @RISK Monte Carlo simulation modeling software was used to simulate the
potential savings from process streamlining. The medical billing process is a challenge
and hospital managers need to confront insurance carriers who have complex
processing claim procedures. A streamlined process will cut hospital administrative
costs significantly. The medical supplies spending process has the greatest savings
potential.

15. Most hospital managers allow departmental staff to purchase supplies. Investing in Hospital cost
an automated supply ordering system and a supplies manager allows nurses and structure in
doctors to concentrate on patient care. A supply chain person would streamline the
process, reduce costs, utilize buying power by negotiating lower pricing and add other the USA
potential benefits to hospitals. Hospital spending is out of control, but the good news is
that this is known. There is time to correct this trend before the problem worsens. All
hospital processes need to be streamlined into the most cost effective method while 327
allowing the highest patient care level possible. That is really the bottom line.
Americans want to say that they have “quality, affordable healthcare”.
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16. IJHCQA McGourty, M.E. and Shulkin, D.J. (2005), Hospital Administrative Costs in the US, available at:
www.ncbi.nlm.nih.gov/entrez/query.fcgi
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Corresponding author
Sameer Kumar can be contacted at: skumar@stthomas.edu
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