Commissioners need to grasp the relationship between cost, activity and quality - and how providers make decisions. Matthew Bell and Richard Lewis explain

How do you decommission hospital based rehabilitation or pain management and place it into a different setting without destabilising wider provision?

Understanding decision making is more art than science

How do you merge emergency services without endangering access? How do you decrease length of stay for the treatment of heart disease?

What about other choices: merging acute providers, decommissioning services, changing staff mix, adapting quality payments?

The phrase “provider economics” is increasingly creeping into discussions about effective, let alone world class, commissioning. Provider economics refers to the ability of commissioners and strategic health authorities to understand the responses of providers to changes in demand.

Poor scores in the first round of world class commissioning assurance relating to provider cost analysis, market creation and sound financial interventions demonstrate that the techniques of provider economics are poorly understood.

Gaining this understanding requires a combination of hard, quantitative evidence and softer, qualitative evidence. Four areas should be considered.

Provider cost structure

At its simplest, the cost structure of a provider is a function of its activity levels and their relationship to fixed and variable costs. While simple in theory, it is harder to analyse in practice.

There is no systematic source of evidence on fixed and variable costs. The main national cost data - the reference costs - help to set tariffs but offer little help in understanding cost structures. Primary care trusts will generally rely on local analysis such as trust accounts. Graph 1 illustrates one such piece of analysis. It compares labour costs, the largest single NHS cost, across a sample of trusts. Understanding why it varies so much starts to open the door to understanding the implications for different service configurations.

The aim of a commissioner should be to understand the relationship between cost, activity and quality. This means asking the right questions, including:

  • How much time will it take to adjust costs in response to activity changes - which costs are fixed over which time periods?
  • What is the link between costs and revenues - where do costs fall below revenues?

Revenue sources of providers

National sources and the PCT’s own records will help to identify provider revenue, particularly associated with healthcare activity. But a complete view is needed, including that related to training, research, private activity and charitable donations. Trust accounts provide some detail but it is unlikely to be enough to understand the impact of changes to particular services.

Most importantly, none of these sources directly links trust revenue to cost centres. The roll-out of service line management in some trusts should provide a more specific mapping of revenues to activity. However, this information is often not readily available to PCTs.

Key questions to ask include:

  • How does revenue vary with changes in activity?
  • How do revenue streams unlinked to healthcare activity support trust operations (eg medical training; research)?

Decision making by providers

Understanding costs and revenues is only part of a full appreciation of provider economics. In order to understand how providers might react to change, it is necessary to understand how they make decisions.

Understanding decision making is more art than science. This sort of information may feel “soft” but there are ways of using more formal tools and techniques to collect and analyse it (for example relationship mapping).

Of particular relevance to provider economics is the thinking of the board and its strategy.

Motivations within and across boards may be diverse. For example, the board of a successful trust may actively avoid entering risky new business areas.

On the other hand, a chief executive may seek the prestige associated with growth.

Key questions to consider include:

  • At what level in the organisation are various decisions made?
  • Which stakeholders feed into different types of decisions?

Providers and the wider system

Finally, provider economics must place providers in the context of the wider healthcare system. That wider system places constraints on their actions, and also gives opportunities. Length of stay in secondary care is partly a function of the treatment options available locally.

Decreasing length of stay can release considerable capacity but requires an understanding of services beyond an individual trust (see graph B).

Key questions to consider include:

  • Which communities have most access difficulties in priority areas of care?
  • Where are clinical and economic economies of scale and scope greatest?


With the impending financial challenge, commissioners cannot be passive bystanders. They need to understand provider economics as part of a proactive strategy to improve performance.

The four areas set out above provide a framework that can underpin this proactive strategy. Commissioners must be prepared to ask the right questions, and have evidence with which to properly assess the answers.