DHA 721 Week 4 Marginal Analysis of a Health Care Decision Example

The $1.3 Million Question: Marginal Analysis of Whether to Keep a Rural Obstetrics Unit Open

[Student Name]

University of Phoenix

DHA/721: Health Care Economics

Week 4 Assignment

[Instructor Name]

[Date]

The rural hospital, its obstetrics unit, births, costs, revenues and options are composites written for a model paper; research findings come from the sources cited.

At a rural hospital in the region, the finance committee reported that obstetrics had lost $1.3 million in the past year on 212 births. The board voted to keep the unit open, but several trustees asked for a clearer analysis before the next budget. The regional vice president was asked to answer one question: what would the hospital actually gain, and what would the community lose, if the unit closed? This paper applies marginal analysis to that question.

Average and Marginal Cost

Average cost is total cost divided by units of service. For obstetrics, the reported total cost of $4.6 million divided by 212 births gives an average cost of about $21,700 per birth. Marginal cost is the added cost of one more birth. In a unit that must be staffed around the clock regardless of volume, the marginal cost is far lower than the average.

Separating the Costs

The unit's costs fall into three groups, and the cost accounting system had to be reworked to see them. Direct variable costs, such as supplies, medications and laboratory tests, total about $0.5 million and rise with each birth. Direct fixed costs, mainly nurse staffing, on-call obstetric and anesthesia coverage and equipment, total about $2.5 million. Allocated overhead, the unit's share of administration, facilities, information systems and depreciation, totals about $1.6 million.

What Closing Would Save

Closing the unit would save the variable costs and most direct fixed costs, but not the allocated overhead, which would be spread across other departments. Avoidable costs therefore total about $2.8 million, after accounting for nurses who would transfer to other units and equipment already paid for. Against those savings, the hospital would lose obstetric revenue of about $3.3 million.

The Real Result of Closing

When avoidable costs are compared with lost revenue, closing the unit would reduce the hospital's margin, not improve it. The unit contributes about $0.5 million a year toward overhead. The reported $1.3 million loss was real as an accounting figure but misleading as a guide to the decision. Closing the unit would have made the hospital's finances worse, because most of the reported loss would have stayed behind.

Downstream Revenue

Births also bring other services. Mothers who deliver locally tend to use the hospital's gynecology clinic and surgery, and newborns often become patients of its pediatric and family medicine clinics. Families form a relationship with the hospital at a birth that often lasts for decades. The obstetric unit also supports the hospital's emergency department, since obstetric nurses and on-call physicians are available when a woman in labor or with a pregnancy complication arrives unexpectedly. The finance team estimated downstream contribution of about $0.4 million a year, which would decline if deliveries moved elsewhere.

The Cost of One More Birth

With staff and space already in place, each additional birth adds about $2,400 in variable costs and brings about $15,600 in average revenue. Each added birth therefore improves the margin by roughly $13,000, until volume rises enough to require more staff. The reverse is also true: each birth lost to another hospital costs the unit about the same amount. This asymmetry explains why low-volume units look so poor on an average-cost basis while contributing more than their reports suggest. The payer mix matters as well: about 60% of births are paid by Medicaid, whose rates are lower than commercial rates, so recapturing commercially insured births would improve the margin faster.

Break-Even Volume

The unit covers its direct costs at about 190 births a year and covers its full allocated cost at about 310. At current volumes it covers direct costs but not overhead. Recapturing women from the county who now deliver elsewhere, about 90 births a year, would bring the unit close to full break-even.

Why Rural Units Close

The hospital's position is common. Hung and colleagues interviewed all 306 rural hospitals in nine states that had at least ten births in 2010 and found that 7.2% closed their obstetric units by 2014; closing units were smaller, more often privately owned and located in communities with lower incomes and fewer obstetricians and family physicians, and women in those communities would need to travel an average of 29 additional miles for delivery (Hung et al., 2016).

What Happens to Patients

Closure has costs outside the hospital. Kozhimannil and colleagues tracked 179 rural counties whose hospitals stopped delivering babies over a ten-year span and compared them with counties that kept the service. Where the county was remote from any city, the following year brought a rise in births at home or elsewhere outside a hospital, in births at hospitals lacking an obstetric unit and in preterm births (Kozhimannil et al., 2018). The region's hospital sits in exactly that kind of county.

Rural Maternal Risk

Rural mothers already face higher risk. Using national inpatient data from 2007 to 2015, Kozhimannil and colleagues found severe maternal morbidity and mortality rising among both rural and urban residents and, after adjustment, a 9% greater probability among rural residents, pointing to workforce shortages, low volume and social conditions such as transportation and poverty (Kozhimannil et al., 2019).

External Costs

These outcomes are external costs of closure: they fall on mothers, infants, families and payers rather than on the hospital's books. A preterm birth can mean weeks in a neonatal intensive care unit at a distant hospital, with costs far larger than the unit's operating loss, paid mostly by Medicaid and borne emotionally by the family. A marginal analysis limited to the hospital's income statement would miss them, even though society bears them.

Options at the Margin

Three options were compared. Closing the unit would reduce the hospital's margin by about $0.9 million, including downstream losses, and add risk for mothers. Keeping it as is preserves access with a modest contribution. Growing volume through outreach to women who now deliver elsewhere, shared call with the academic center and a midwife-led model could move the unit toward full break-even.

The Recommendation

The vice president recommended keeping the unit open and pursuing growth, with a target of 260 births within three years. Certified nurse midwives would share coverage, the academic center would provide backup obstetric and anesthesia call and prenatal clinics would be extended to two neighboring towns.

Conditions That Would Change the Decision

The analysis would change if staffing could not be maintained safely, if births fell below about 150 a year or if a regional plan concentrated deliveries at a nearby hospital with guaranteed transport.

Measures

Measures include births per year, the share of county births delivered locally, contribution margin, staffing coverage, transfers during labor and maternal and newborn outcomes.

Conclusion

The obstetrics unit's reported $1.3 million loss was mostly allocated overhead that closing would not remove. Marginal analysis shows the unit contributes to the hospital's margin and that each added birth improves it. Evidence on closures and rural maternal risk shows external costs the hospital's books omit. Keeping and growing the unit is the better decision.

References

Hung, P., Kozhimannil, K. B., Casey, M. M., & Moscovice, I. S. (2016). Why are obstetric units in rural hospitals closing their doors? Health Services Research, 51(4), 1546-1560. https://doi.org/10.1111/1475-6773.12441

Kozhimannil, K. B., Hung, P., Henning-Smith, C., Casey, M. M., & Prasad, S. (2018). Association between loss of hospital-based obstetric services and birth outcomes in rural counties in the United States. JAMA, 319(12), 1239-1247. https://doi.org/10.1001/jama.2018.1830

Kozhimannil, K. B., Interrante, J. D., Henning-Smith, C., & Admon, L. K. (2019). Rural-urban differences in severe maternal morbidity and mortality in the US, 2007-15. Health Affairs, 38(12), 2077-2085. https://doi.org/10.1377/hlthaff.2019.00805