On a Saturday morning, the family has had breakfast, the kids are watching television. The doorbell rings. One of the kids answers and then yells, “We're going next door to play.” Minutes later a parent walks through the unoccupied room and turns the TV off. When the kids return, the parent says, “You guys have gotta turn the TV off when you stop watching it.”
The parent is practicing resource allocation. The resource is money, and the allocation is for electricity. This is an example of managing. In fact, Dictionary.com defines “manage” as “to direct or control the use of.” Profit-based resource allocation means putting the resources where the profit is. The measure of profit to use is net profit, which takes into account both product costs and activity costs.
We know that the same product can be sold to two customers for the same price yet create a different net profit, because different payers require different levels of activity. Based on that truth, the best analysis of profitability is around product-payer combinations — and HME managers must allocate their resources accordingly.
The catch is that doing so with reasonable accuracy requires the application of activity-based costing, and only about a quarter of the providers in this industry say they have performed activity-based costing. In addition to the growing opinion that all of the industry's providers should be utilizing this method, the activity costs should be applied to product-payer combinations.
For the majority of companies that are not costing their activities (53 percent of their expenditures), there is a simple method that can approximate the application of activity costs to product-payer combinations.
This method requires two revenue reports — Revenue by Product and Revenue by Payer — that any billing system worth having can produce, along with some anecdotal information from your management team. Put the data in electronic spreadsheets and sort it in descending order. Make a list of the significant product-payer combinations.
With the list and a graph similar to the one shown, you can plot your company's approximate net profit of product-payer combinations.
Here's how: Look at the range of products and determine the midpoint of gross profit dollars that come from the range. Those above the midpoint are defined as high gross profit, the others as low.
Take the first combination. Get the reimbursement rate for the product and the cost of goods for the product. Subtract the cost of goods from the reimbursement rate. Determine whether it fits in the high or low gross profit range. Then determine whether that combination consumes a high or low amount of time. For example, if the combintion-produces low gross profit but consumes a large amount of time, it would be categorized in the “C” quadrant based on our graph.
Once the list of combinations has been categorized, resources can be allocated. The combinations in the “A” quadrant are the combinations that should be sold, and your company should be allocating resources toward getting as much of that business as it can. The company should not allocate resources for the kind of business that is in the “C” category. Management may choose to drop it.
While this relatively simple method is better than having no basis for resource allocation, remember that it will yield only a broad estimate of profit for your company's product-payer combinations.
Wallace Weeks is founder and president of Weeks Group Inc., a Melbourne, Fla.-based strategy consulting firm. He can be reached at 321/752-4514 or by e-mail at wweeks@weeksgroup.com.
