Real-World Application Paper: Activity-Based Costing (ABC) at Aga Khan University Hospital, Nairobi (AKUH, N)

1. Introduction

In the complex and resource-intensive healthcare sector, effective cost management is paramount for financial sustainability, quality improvement, and strategic growth. Traditional costing methods, often relying on arbitrary overhead allocations, frequently fail to provide healthcare organizations with the granular cost information needed for informed decision-making. This paper will focus on Activity-Based Costing (ABC) as a powerful cost management technique. We will explore its real-world application within Aga Khan University Hospital, Nairobi (AKUH, N), a prominent private tertiary care hospital in Kenya, demonstrating how ABC can strategically enhance the allocation of financial resources.

2. Understanding Activity-Based Costing (ABC)

Activity-Based Costing (ABC) is a costing methodology that identifies the true costs of activities within an organization and then assigns these costs to products or services based on their actual consumption of those activities. Unlike traditional costing, which primarily allocates overhead based on volume measures (e.g., patient days, direct labor hours), ABC recognizes that different products or services consume different amounts of support activities.

The core steps of ABC involve:

1. Identifying Activities: Breaking down the organization’s operations into key activities (e.g., patient admission, laboratory testing, surgical procedure, room cleaning).
2. Assigning Costs to Activity Pools: Gathering all costs (both direct and indirect/overhead) associated with each identified activity.
3. Identifying Cost Drivers: Determining the primary factor that causes the cost of an activity to occur (e.g., number of lab tests performed, time spent in surgery, number of patient admissions).
4. Calculating Cost Driver Rates: Dividing the total cost in an activity pool by the total amount of the cost driver to get a rate per unit of activity.
5. Assigning Costs to Cost Objects: Allocating the costs of activities to specific cost objects (e.g., individual patient procedures, specific diseases, patient groups) based on their consumption of activities.

In healthcare, ABC helps understand the true cost of treating specific conditions, performing particular procedures, or caring for different patient types.

3. Application of ABC at Aga Khan University Hospital, Nairobi (AKUH, N)

AKUH, N is a leading private hospital in East Africa, known for its specialized services, teaching and research capabilities, and commitment to quality. As a large, multi-specialty institution, AKUH, N faces significant challenges in accurately understanding its costs due to the diversity of services offered, varying patient needs, and substantial indirect costs. Implementing ABC would provide a more precise view of resource consumption and enable more strategic financial resource allocation.

Strategic Allocation of Financial Resources through ABC:

1. Accurate Service/Procedure Costing and Pricing Strategy:
   • Current Challenge: Traditional costing methods might average out overheads, potentially over-costing high-volume, low-complexity procedures and under-costing low-volume, high-complexity procedures. This can lead to inaccurate pricing.
   • ABC Application: AKUH, N can use ABC to determine the true cost of various medical procedures (e.g., appendectomy vs. complex cardiac surgery), diagnostic tests (e.g., basic X-ray vs. advanced MRI), and patient pathways. For instance, the activities involved in a cardiac bypass surgery would include pre-operative consultations, diagnostic imaging, operating room time, specialized nursing care, ICU stay, medications, and post-operative physical therapy. Each of these activities would have associated costs and cost drivers (e.g., hours in OR, number of ICU days).
   • Strategic Allocation: With accurate cost data, AKUH, N can:
     • Optimize Pricing: Set more competitive and profitable prices for its services, ensuring that prices reflect the actual resources consumed. This is crucial for remaining competitive against other private hospitals in Nairobi.
     • Identify Profitable vs. Unprofitable Services: Pinpoint which services are truly contributing to profitability and which are operating at a loss, guiding decisions on service expansion or re-evaluation. For example, if ABC reveals that certain specialized oncology treatments are significantly underpriced relative to their resource consumption, AKUH, N can adjust pricing or seek alternative efficiencies.
2. Resource Optimization and Efficiency Improvement:
   • Current Challenge: Without detailed cost information, it’s hard to identify specific bottlenecks or inefficient processes that drive up costs.
   • ABC Application: ABC allows AKUH, N to trace costs to specific activities and identify cost drivers. For example, if the cost driver for patient admission is “number of patient forms processed,” and this activity is consistently high-cost, it indicates an opportunity for process improvement (e.g., digitizing forms, streamlining intake). Similarly, if the cost of “cleaning operating rooms” is excessively high, it might prompt an investigation into cleaning protocols or resource utilization within that activity.
   • Strategic Allocation: The hospital can then strategically allocate resources to improve these identified inefficiencies. This might involve investing in new technology to automate processes, re-training staff, or re-designing workflows. By understanding the activities that consume the most resources, AKUH, N can direct its financial capital