The recession has forced the organizations of almost every industry to reduce their costs, increase their profit margin, gain efficiency, and maximize their value-creating potential. Of course, the prices of the products and services fluctuate due to the change that is incurred in the development and provision of those products and services. Health care organizations are facing high costs, especially in the United States, so they do feel the need to adopt certain costing techniques that fulfill the customer requirements and organization’s profit, along with overcoming the losses that are faced. Although there are various costing techniques, now we will discuss three types of costing methods.
First, let’s talk about Activity-based costing (ABC); which is the method that redefines cost pools around the activity composition of an organization that makes up the costs by using casually defined drivers of resource consumption (McNair, 2007). In other words, we can say that Activity-cased costing diagnoses the basic activity or cost centers in the organization; and allocates the costs to the products or services that are offered based on the number of transactions, dealings, or events happening in the manufacturing and provision process of those products or services (12 Manage, 2009).
For example, there is product A and product B. Product A requires more research, more engineering, more testing, more setups than product B; so based on the additional activities over product A, the company would estimate the costs of resources that are used in the additional activities and would then would set a certain cost level for that product only.
The cost drivers depend on the product type, activities required by the product, market competition, and the demand of consumers. Talking about the products or services of health care organizations, the cost drivers could be the increased sophistication of medicines, high quality, high reliability, successful testing, and the importance of that medicine.
Moreover, the organizations can reduce the costs by analyzing the activities and efforts required on specific products, eliminating the unnecessary activities required for the product, achieving efficiency, and taking the products with their relevant requirements, and avoiding the same strategies or activities for all the products. In addition, this method can bring on continuous improvement by letting the employees know the relevant activities that add value to the products and activities that are irrelevant and invest more in the products that provide sound profits than others.
Another type of costing technique is Price-led costing, which determines the costs of the necessary constituents of the finished product by going back to the development of that product (Fahrenbach, 1999). The organizations charge the price depending on the total costs incurred by the product, and the market charges the price that the companies ask. But the company can’s just simply demand the prices as they want, the prices would depend on the company’s interplay of the competitive forces in the market. In short, the company’s price would be determined by the dynamics of the particular marketplace.
As far as the health care organizations are concerned, they can reduce the costs by outsourcing. Since they cannot easily allocate the defined allowable to the production or marketing department and usually manufacture and market the medicines that are mostly demanded and used often. So, to become efficient and reduce costs, they can outsource certain functions, for instance, packaging, labeling, or even the whole manufacturing process. It is because once they have developed the formula of a certain medicine, they can outsource its production to reduce costs, and that’s what is done by many pharmaceutical companies today.
The third type of costing technique is Target costing; which is quite often used by companies these days. This technique usually supports the production of high-quality products that contain the features and functions that are desired by the customers. The drivers of this costing method are the market, its demand, customer requirements, competitive offerings, and the idea that how much the customers can pay for a particular product (Ansari, Bell, and Swenson, 2006).
Companies before selling the products have already determined a certain level of profit margin that they want to achieve by considering the factors such as their strategy, shareholder’s expectations, and demands of other stakeholders including customers. The equation of this method can be stated as Total Cost = Price – Profit; it means that the resulting target cost is obtained by emphasizing the product, its design, its quality, and making continuous improvement throughout its lifecycle. For instance, a sports car manufacturing company can set target costs by considering the consumer’s demand – quality, price, design –, basic goal to achieve certain profit level, to meet shareholder’s expectations, competition, and other strategies related to the car manufacturing and distribution.
This method benefits the companies by reducing the costs of their products greatly, lining up the costs of functions with customers’ willingness to pay, and meeting customers’ needs and requirements. There are four steps of this (Bird, Albano, and Townsend, 2003) method, defining the product, setting the target, achieving the target, and maintaining competitive costs; it means that the companies first define the prices of their products than that costs, hence try to achieve their level of price and remain competitive by offering such features that are required by the customers who are willing to pay for them.
Similarly, the health care organizations can reduce their costs by developing the product and setting up the price based on the customer’s desires; mainly, it can be done on the machinery or medicines that come under the luxury items and are used by customers out of their basic needs. Such companies can provide great quality to the customers, ask a relatively high price, and maintain their profitability and competitiveness.
Therefore, we discussed three types of costing techniques that can be used by the organizations to cut down their costs and achieve profitability; moreover, it has now become a basic need for the companies – especially health care ones due to increasing costs – to adopt to such costing methods and remain competitive in the market.
Ansari, S., Bell, J. and Swenson,D. (2006) A Template for Implementing Target Costing. Cost Management 20 (5); p. 20-28. Web.
Fahrenbach, J. (1999). The ABCs of price-led costing. Best’s Review, (Life/health insurance edition) 100 (5), 69-70. Web.
McNair, C. J. (2007). Beyond the Boundaries: Future Trends in Cost Management. Cost Management 21 (1); p. 10-22. Web.
Bird. H.M.B., Albano. R.E, and Townsend. W.P. (2003). Target Costing: Delighting Your Customers While Making a Profit.. Web.
12 Manage. (2009). Activity Based Costing (ABC). Web.