This is the practice of minimizing costs to prevent overspending.
How Cost Containment Works
A business practices cost containment by implementing practices to minimize costs. Strategies will improve profits or prevent unnecessary spending without jeopardizing quality or marketing efforts. Examples include limiting:
- Labor spending each month
- Marketing expenses to a percentage of sales
- External contractors
- Daily travel expenses
Businesses can complete a cost-containment analysis to learn if they are overspending by looking into their return on investments. Businesses can negotiate better credit terms, evaluate potential building ownership versus leasing, and analyze marketing costs. Limiting costs should not reduce improvements in sales, profits, or revenues. If cutting costs impact the sustainability of the business negatively, it is not considered cost containment.
Cost containment usually occurs when a business experiences loss in demand or goes through an economic recession. Startups will often use cost-containment strategies to be sustainable until they scale and generate money. However, cost containment practices also exist in the healthcare industry to minimize costs for people seeking care.
Real-World Example Of Cost Containment
As of 2020, the United States spends about 17 percent of GDP on healthcare, and economists expect this number to rise. In the healthcare industry, cost containment exists in insurance as copayments, coinsurance, and deductibles. They aim to minimize costs for patients.
The copayment is the amount someone pays for a service, which is either a flat rate or percentage of the total service cost. The deductible is the amount someone must cover in expenses before the insurance company starts paying. Once someone reaches their deductible, the coinsurance begins where the insurance company contributes to any additional costs.
In Arizona, they have a Medicaid agency called the Arizona Health Care Cost Containment System (AHCCCS) that provides affordable health care programs to residents. To be eligible, residents must meet certain requirements such as income limits. The AHCCCS has the copay amounts for the following services:
- 4 dollars per drug for prescription drugs
- 5 or 10 dollars per visit for office visits
- 75 dollars per stay at an inpatient hospital
- 8 dollars per visit to the Emergency Room for non-emergency reasons
Significance Of Cost Containment
Cost containment strategies can prevent businesses from overpaying for insignificant costs. Managing costs effectively can improve profits and business sustainability. This practice is especially important for startups with limited assets.
In healthcare, cost-containment can help patients cover the cost of their health care needs. In countries like America, without cost-containment elements in insurance, it can be financially straining for some people to pay for costs such as hospital visits and prescription drugs. Cost-containment strategies can also support employers who provide benefits to their employees.
Types Of Cost Containment
There are three main types of cost containment strategies businesses can use. These are implementing price controls such as setting benchmarks for spending on contractors for maintenance. Businesses can also incorporate technologies to reduce labor-intensive activities such as inventory tracking. Lastly, focusing on increasing energy efficiency implementations can reduce utility costs for the long term.
As long as minimizing costs doesn't reduce the business's ability to provide for their customers and the quality of their products or services, it is a type of cost-containment strategy. Sometimes strategies can be temporary while the business is facing difficulties. Additional types of strategies include:
- Reducing overtime hours
- Voluntary unpaid leaves
- Suspending employer 401K match
- Suspending benefits such as food, gym, or travel stipends
- Suspending reimbursement of mileage or cell phone costs
Cost Containment vs. Cost Reduction
Cost containment focuses on managing a business's overall costs to minimize unnecessary spending. Strategies can range to include limiting benefit provisions. In contrast, cost reduction focuses on specific items within the business and aims to reduce their costs to a set percentage. It usually aims to reduce the per-unit cost of producing a product.
Cost Containment vs. Cost Effectiveness
While cost containment refers mainly to minimizing costs, cost-effectiveness has two main meanings. Something cost-effective is worth the value of its cost. Cost-effectiveness also refers to an economic analysis of the benefits of an intervention. It includes looking at the cost-utility and cost-benefit analysis.