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Cost Stickiness and Core Competency: A Note
Ramji Balakrishnan and Thomas S. Gruca
Executive Summary
Traditional models of cost behavior posit a linear relation between activities and costs. In the short run, total costs equal fixed costs plus unit variable costs x activity volume. Because of the model’s ubiquity, it is of considerable interest to examine the validity of this simple specification. Researchers have studied how factors such as scale and scope economies as well as complexity affect the shape of the cost curve. Recent research suggests differential slopes based on whether activity is increasing or decreasing. Because the slope is smaller when activity decreases, costs are said to be “sticky”.
In this study, we examine the behavior of short-term costs for hospitals in Ontario. Although we use the same specification as used in prior research, we focus on departmental level data rather than on costs at the organization level. Therefore, we can examine within-organization variation in cost stickiness. We hypothesize that hospital administrators will be reluctant to trim costs in core activities related to direct patient care both because of the critical nature of these services to the hospital’s mission and because of the (larger) adjustment costs associated with altering this capacity. In contrast, it is much easier and less expensive to adjust capacity levels in outlying support services. Thus, we expect costs related to direct patient care to exhibit greater stickiness relative to costs in support departments.
Our analyses support these conjectures. First, we confirm extant research relating to stickiness of costs at the organization level, albeit in a different setting — that is, acute care hospitals. Further, although extant research on cost stickiness has primarily focused on the behavior of selling and administrative expenses with respect to the sales volume of manufacturing firms, our results show that operating costs are sticky at the hospital level. Second, we document within-organization variation in cost stickiness. We find reliable cost stickiness only in costs associated with direct patient care, a hospital’s core service. Moreover, the estimated coefficient for this core service reliably exceeds that for ancillary and support services. Robustness tests that estimate the equations using hours worked (to focus on labor costs) yield similar inferences. Overall, our evidence is that the extent to which a function represents an organization’s core competency influences the stickiness of associated costs.