The right way to determine laboratory test prices? Start by mapping your processes

by Sam Thurgood
BSc (Hons) Economics, PinpointBPS® Champion

The top-down approach to determining laboratory prices has critical flaws. The solution? Turn the process on its head and start bottom-up.

How you calculate your laboratory test costs not only helps you manage laboratory costs effectively – it can have a dramatic impact on quality too. Traditionally, costs are determined using a top-down, proportional approach. Sam Thurgood, Senior Consultant at LTS argues that exactly the opposite approach is required.

ricing laboratory tests correctly is not just about understanding cost – it’s about ensuring quality. Wrong pricing can directly impact the quality of the service and resources available. In fact, it could even impact other areas of patient care. And with hospitals being a key beneficiary of laboratory services, the reality is that incorrect pricing of tests can negatively impact quality patient care.

Test prices in a laboratory are often underestimated if you only include the cost of processing the sample itself. It is best practice to include the cost of overheads, R&D, consultant time, quality control, investment in infrastructure and technology. By doing this, you are ensuring that the operations in your laboratory fully align with your overall cost structure.

The top-down method – a way of proportionally allocating costs to disciplines within the laboratory – is a common way to approach the laboratory pricing problem, but this approach has its own pitfalls

Be aware of the critical pitfalls of the top-down method

At LTS we have dealt with many notable laboratory pricing initiatives. A recurring theme, which is often not grasped – especially in public sector entities – is that the cost of a test is so often impacted by factors that are not accounted for within the laboratory itself. Modern laboratories are also moving to a system based on technologies, where the distinctions between disciplines are blurred by common equipment platforms and multi-skilling of staff. Direct external costs, reagents and other costs are generally dealt with as consolidated cost lines, meaning that they are allocated proportionately to each discipline within the laboratory based on reagent usage.

Consolidating laboratory costs to determine test pricing may be tempting, but gross generalizations are likely to make it a worthless effort.

Consolidating laboratory costs to determine test pricing may be tempting, but gross generalizations are likely to make it a worthless effort.

By way of example, if costs are assigned based on speciality, how should sodium tests and urine steroid tests be treated? Both tests are conducted in a chemistry laboratory, yet both have markedly different processes, cost drivers and resource requirements. Process is the key to understanding their true costs

Using Excel may be convenient, but it's not necessarily what you need...

An Excel-based top-down exercise – no matter how complex – can never understand the true cost. Why? Here are three key reasons:

  1. It is just too basic for the modern laboratory. Laboratories today are complex environments and simply dividing total discipline costs by units of activity (tests) underestimates the differences in test complexity within disciplines.
  2. Cost drivers are ignored. There are various underlying factors that determine true unit costs and how they vary within a single, yet assumed heterogeneous, discipline of pathology – and not incorporating these factors provides an incorrect basis for test pricing.
  3. There is lack of forecasting capability. Fundamentally, basing any evaluations and decisions on these figures is likely to be inaccurate and negatively impact laboratory demand management, patient care and cost saving initiatives.

When compounded with the fact that pricing of tests is often seen as a secondary activity in a laboratory, all you are left with is a high level ‘guesstimate’ of how much your operations are costing you – and what contributes to those costs. And in most cases, with a hospital as the client of the laboratory, it may even appear that the process of pricing is a waste of time, as the laboratory doesn’t charge the hospital directly. Instead, the issue of correct pricing would seem to apply only to primary care physicians and third party reference work.

True cost per test is not just critical for the lab. It's critical to healthcare.

PinpointBPS® offers the simplest & most detailed way to map your laboratory processes and understand real test cost. As a powerful aid to ISO 15189, it not only assists with performance transparency - it helps your lab with compliance.

In the UK, as in many health systems in the world, there are record service provider deficits. According to the Carter Report, a 10-15% real cost reduction target is required by 2021 and as such, pricing failure directly impacts the allocation of financial resources for patient care. In addition, pathology is one of very few revenue-generating activities for hospitals, where income is generated from diverse areas including GPs, private patients, reference work and other services such as prisons.

In the UK specifically, this revenue is used to subsidise the cost of providing testing for a NHS Trust. Should the NHS not be focused on ensuring maximum margin contribution, which can be ploughed back into NHS services to help sustain and improve patient care at the hospital? Without establishing accurate pricing, the true margin contribution of external pathology income cannot be known. 

A true cost per test also allows clinicians to understand the impact of additional testing that they request, and as such supports the implementation of demand management initiatives such as changes in requesting patterns and the financial impact of over-ordering (request intervals).

Bottom-up pricing beats top-down. Hands down.

How can laboratories increase the accuracy of the price per tests? We recommend turning the pricing process on its head: from the top-down approach to the bottom-up approach. 

The secret to understanding the true cost of your tests lies in understanding your laboratory processes. The correct mapping of the laboratory allows for a holistic understanding of your resource requirements (including staff grade and time, equipment use and infrastructure use). While the task may seem laborious, it doesn’t have to be. A process map that is created correctly only needs to be maintained when changes are made to processes.

Ideally, you should conduct this exercise as a well-planned and professionally executed process-mapping initiative within your laboratory to ensure accuracy. PinpointBPS® provides a world-class method to understand process flows, staff time and equipment. Using this approach to modelling, it is possible to ascertain - in a relatively short timescale - a bottom-up price per test. An accurate price.

Get your lab closer to your real test cost today

Mapping out your laboratory's processes in detail can be a complex task, but as a start, you can lay the foundation for the approach today using this accurate and fine-grained approach:

1. Map all the processes in your laboratory

This means mapping the flow of all the activities in your laboratory to tell the story of a sample from beginning to end. Ensure the flow of activities is mapped throughout the whole laboratory. It may be easier to start with each area of the laboratory, but ultimately you need to arrive at a holistic picture that gives better insight into how your tests (and associated costs) behave. Add the time taken for each activity, and also include the cost components required for each test. Include staff grade and time, equipment usage as well as infrastructure usage.

2. Brainstorm your findings with others in the laboratory

Compile these findings in a single view and discuss it with relevant stakeholders. Even if it is not very detailed or is based on assumptions, this will certainly initiate a discussion that highlights further requirements to focus on going forward.

3. Work with the findings to create an overview

Once the basic direct costs are determined, the next step is to allocate the key elements of the pathology laboratory cost base on a proportional basis to those tests. Allocation of logistics, IT, quality control and other critical activities are key to identifying a true high-level view of the cost per test and understanding the contribution that each test makes towards overheads.

Not only will this exercise provide an accurate direct cost of activities and their various components, but it also allows the laboratory to adjust prices for any changes in cost drivers that may occur, or for new tests that may be introduced. It is critical for laboratories to fully grasp all processes, staff, resources, time requirements and equipment use required to deliver a specific result. 

In short, a laboratory process map provides the foundation for all test costs and makes it much easier to include indirect costs such as corporate overheads

About the author

Sam Thurgood is a Senior Consultant at LTS and works with healthcare clients across a broad spectrum of commercial and financial situations. He has provided advice on joint ventures within the health service; the delivery models of pathology services; on the development of private patient units; the production of business cases to the treasury five case model; and many other scenarios.