Why and what a medical student should know about the cost of health services?

By- Dr Subramania Raju Rajasulochana

Imagine the following scenarios:

A clinic is about to expand this year. Should it conduct all of its laboratory work or contract out some of this work to a local laboratory?

The manager of the family planning program with outreach workers (or many service delivery points) wants to determine the least costly way of transporting supervisors to the field: Should supervisors use cars or public transportation?

The same program manager wants to determine whether additional outreach workers should be hired to increase contraceptive use.

A program is facing reductions in donor support. If the program manager decides to charge fees for services. How should prices be set? Which components of the total cost of a service should be recovered? Should different fees be collected in different categories of clinics?

The Health administrator has to decide whether the fixed site is more efficient as compared to a door-to-door vaccination drive for Polio.

Answers to these questions are not simple. It depends on the vital piece of information called  “Costs” of service delivery.  Several key resource allocation decisions for providers, clinics/hospitals, at the program level or related to policy concerns – such as affordability, choices between different technologies and innovations, purchasing of health services, or setting prices of health services- depending on costs.  Conducting a costing exercise can help to monitor costs of ongoing programs, improve budgeting, identify scope for potential cost savings, accurate estimate of resources required for service delivery, and further expansion of specific intervention.

Varied ways of classifying costs

There are a variety of ways costs can be classified, based on the decision maker’s specific needs. Some of the considerations could be: 

focus (Cash flows or resource flows); 

traceability (direct costs or indirect costs); 

management control (committed or non-committed costs); 

relation to budget (budgeted costs or actual costs); 

relation to time (opportunity costs, incremental costs, or sunk costs); 

relation to output or activity (fixed costs or variable costs); and

frequency of occurrence (capital costs or recurrent costs). 

Key considerations for undertaking costing


The costing method depends on the perspective, that is, from whose point of view is the costing being undertaken? It could be from the provider/health systems’ perspective, patients’ perspective, or societal perspective. Health system costing accounts for all inputs such as physical infrastructure, labor, equipment, drugs, consumables, etc to arrive at a unit cost of service delivery. The patient’s perspective includes out-of-pocket expenditure (OOPE) on direct medical services on consultations, drugs, diagnostics, etc as well indirect medical services on food and transport. The societal perspective is broader to encompass health system costs, patient’s OOPE as well as the opportunity cost in terms of loss of wages during illness.

Time horizon

Costing is usually done for a year if the purpose is to estimate resource requirements for service delivery. Costing may be done for 5 years or longer if the purpose is to examine the financial or budget impact of a program or for strategic planning. In a health technology assessment study, the time horizon for costing is for a lifetime.

Gross costing versus Micro-costing 

These are costing approaches for the identification of cost components. Under gross costing, cost components are defined at a highly aggregated level (e.g. inpatient days only), while under micro-costing, all relevant cost components are defined at the most detailed level; it assesses the actual amount of resources to produce each service, usually by identifying activities and the staff time spent, and allocating costs according to this staff time use. 

Top-down versus Bottom-up

These are costing approaches for the valuation of cost components. Under top-down costing, cost components are valued by separating the relevant costs from comprehensive sources (e.g. annual accounts), resulting in average unit costs per patient. On the other hand, bottom-up costing, cost components are valued by measuring both service and resource use directly at the patient level, resulting in patient-specific unit costs.

The combination of the bottom-up and microcosting methodology is the gold standard methodology for the costing of hospital services.  The reason being all relevant cost components are identified and valued at the most detailed level. However, bottom-up microcosting is very time-consuming, especially when hospital information systems are absent or inadequate. 

Calculation of capital costs: Discounting & Annualization

Usually, people prefer to have benefits now and bear costs in the future. In order to account for time preference, costs are stated in terms of their present value using a discount rate, usually 3 to 5%. Further, capital inputs like physical building, equipment, etc require huge investment initially which has opportunity cost and capital goods depreciate over time. Thus, capital costs are “annualized” or spread out over the useful lifetime of physical building or equipment.  

Calculation of recurrent cost

All recurrent inputs such as medical and non-medical staff, supplies, drugs, overhead, etc need to be identified. Quantity and the frequency of usage need to be determined to arrive at the unit price of each of these inputs.

Joint/ shared cost: Apportioning

With regards to joint or shared inputs such as building space, drugs, and supplies, utilities (Electricity/water/internet/telephone), costs are apportioned as per certain allocation criteria.  These criteria could be in terms of time used in various services or space areas utilized for the service or the number of patients. 

Capacity utilization

 It is also important to acknowledge that cost varies with the utilization of health services across facilities.  Capacity utilization is indicated by the number of outpatient consultations or bed occupancy rate. Costs at 100% utilization would be lower as compared to those at 60% utilization. This happens because fixed costs on human resources, space, equipment, and furniture, etc spread thinly as more health services are utilized. 

Inflation adjustment It is important to adjust costs to the rising prices of various inputs over time. Inflation erodes the “purchasing power” of money. Usually, the Consumer price index (CPI) and Wholesale price index (WPI) published on the RBI website are used to adjust current prices to base year prices.

Most medical students at some point in. their career are likely to take resource allocation decisions. I hope these considerations would be helpful to get them started on costing.

Any queries regarding costing in health services can be sent to:

Dr Subramania Raju Rajasulochana

Health Economist

HTAIn Resource Centre,

Department of Preventive and Social Medicine, JIPMER, Puducherry


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