Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 7

Target Costing; Health Care VIP-MD is a health maintenance organization (HMO) located in North Carolina. Unlike the traditional fee-for-service model that determines the payment according to the actual services used or costs incurred, VIP-MD receives a fixed, prepaid amount from subscribers. The per member per month (PMPM) rate is determined by estimating the health care cost per enrollee within a geographic location. The average health care coverage in North Carolina costs $368 per month which is the same amount irrespective of the subscriber’s age. Because individuals are demanding quality care at reasonable rates, VIP-MD must contain its costs to remain competitive. A major competitor, Doctors Nationwide, is entering the North Carolina market in early 2010 with a monthly premium of $325. VIP-MD wants to maintain its current market penetration and hopes to increase its enrollees in 2010. The latest data on the number of enrollees and the associated costs follow:

		Projected	Average
	Enrollment	Enrollment	Monthly Cost
Age	in 2010	in 2011	in 2010
1-4	45,688	48,977	$ 11,147,872
5-14	82,456	84,663	10,059,632
15-19	95,873	95,887	8,436,824
20-24	66,246	67,882	9,539,424
25-34	133,496	132,554	26,432,208
35-44	166,876	175,446	38,882,108
45-54	85,496	90,889	22,741,936
55-64	99,624	101,923	28,691,712
65-74	156,288	161,559	48,918,144
75-84	67,895	72,465	33,132,760
85 years and older	23,499	26,849	24,086,475
	1,023,437	1,059,094	$262,069,095

Required

1. Calculate the target cost required for VIP-MD to maintain its current market share and profit per enrollee in 2010.

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2. Costs in the health care industry applicable to VIP-MD and Doctors Nationwide are expected to increase by 6 percent in the coming year, 2011. VIP-MD is planning for the year ahead and is expecting all providers, including VIP-MD and Doctors Nationwide, to increase their rates by $15 to $340. Calculate the new target cost assuming again that VIP-MD wants to maintain the same profit per enrollee as in 2010.

Step 1 of 3

Target costing is a costing strategy where company gathers information about the price of the competition and then deducts the profit that company is desiring. And the cost that then comes is the target cost.