an evidence-based approach to funding the elc sector · evidence-based funding of the elc sector...

Jean-Francois Cecile, PhD, MBA Praxiprog Inc. www.delcee.co.uk

An Evidence-Based Approach to Funding the ELC Sector

DETERMINING UNIT COST AND FUNDING RATES FOR TARGET PAY RATES

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Evidence-based funding of the ELC sector – DELCee | Aug. 2018

Contents

Executive Overview ................................................................................................................................. 3

Introduction ............................................................................................................................................ 4

The standard running cost is inadequate to support ELC funding policies ............................................ 5

Issue #1 - The running cost does not differentiate between ELC delivery models............................. 5

Issue #2 - The running cost evens out meaningful information ......................................................... 6

Issue #3 - The running cost ignores the key roles of age groups and occupancy levels ..................... 7

The need for an accurate, comprehensive approach to unit cost calculation ....................................... 8

Accounting for an ELC provider’s occupancy level per age group ...................................................... 8

Accounting for an ELC provider’s adult to child ratio ......................................................................... 9

Solution – a simplified unit cost calculation example ......................................................................... 9

DELCee – Real-world data and the need for tools .............................................................................. 10

Benefit # 1 - Accounting for the contribution of key ELC parameters to unit cost .......................... 11

Benefit # 2 - Visualizing the impact of varying key ELC parameters ................................................. 12

Benefit # 3 - Determining the funding rate through sensitivity analysis .......................................... 12

Conclusion ............................................................................................................................................. 14

References ............................................................................................................................................ 14

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Executive Overview

A tenet of the Scottish 2020 Expansion is the requirement for ELC providers to pay the real

living wage for staff delivering funded hours. An evidence-based, data-driven approach to

determining the funding rate would be welcome to support the implementation of the

Expansion. A key reason why stakeholders in the early years sector have diverging views as

to what an appropriate funding rate should be stems from the fact that available survey data

are based on unreliable, and therefore non-actionable unit cost values.

This white paper discusses several issues with defining the unit cost as a simple running cost:

the result of summing all the costs incurred by

an ELC Provider and dividing by the number of

sold or delivered hours. We then present an

alternative solution based on a novel,

comprehensive approach to defining unit cost

that considers all the key parameters involved

in delivering ELC services, including

occupancy, age groups and adult to child

ratios.

To simplify our description, illustrative

examples will primarily focus on wage costs.

Tools are needed to address real-world ELC

context and data, and cost-structures that

include wages, as well as fixed and variable

costs. To this end, we will provide an

overview of DELCee, a software application

specifically designed for unit cost calculations

and profitability analysis of the ELC sector, as

well as DELCeeSense, a sensitivity analysis

add-on to DELCee designed to help ELC

funders determine the impact of concurrently varying funding rates and an ELC provider’s

staff pay rates.

A better Unit Cost ✓ Key ELC factors are

considered including

➢ occupancy

➢ adult to child ratio

➢ age groups

✓ The Unit Cost reflects

cost structures for various

ELC models

Why use DELCee? Benefits include: ✓ Key ELC parameters are

considered in unit cost

calculations

✓ What-If scenario analysis,

varying funding rate and

staff pay rates

✓ Evidence-based support

for funding policy

implementation

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Introduction

Funding challenges in the ELC sector are a common occurrence across the UK, and a key facet

for the various stakeholders is agreeing on what constitutes an appropriate funding rate.

In Scotland, some specific concerns have been raised regarding the Scottish 2020 Expansion

intended to almost double the number of

funded hours for 3-5 years old and eligible 2-

3 years old (1, 2). The increased government

spending is tied to a requirement for

participating ELC providers to raise their staff

pay rate to the “real” living wage (5).

Discrepant views exist as to how much the

2020 Expansion will cost, how it will be

implemented, and in terms of its overall

impact on ELC Providers, as notably pointed

out by Audit-Scotland (3) and others (4).

As a preliminary step towards determining the funding rate and assessing its impact on ELC

providers, stakeholders need to agree on the actual cost of providing one hour of childcare.

In this white paper we will examine the current - or standard - way of calculating the unit cost

and we will discuss some of its limitations. We will refer to this standard unit cost as a “running

cost”. We will then propose an alternative and better approach to calculating the unit cost

and present some of its benefits.

To illustrate key concepts in this white paper, we will rely on simplified or abstract ELC delivery

contexts. Real-world situations are more complex, and they require the use of tools to

process real data and generate actionable results.

Praxiprog has developed DELCee and DELCeeSense, bespoke software applications to help

ELC providers and funders address these real-world situations; we will provide an overview

of the key features of these tools.

“The limitations in the financial data make it difficult to examine the financial impact of different models of ELC and changes to flexibility. It is not possible to identify any relationships between the cost of funded ELC and the models available”.

*Early Learning and Childcare, p17, Audit Scotland, Feb. 2018

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The standard running cost is inadequate to support ELC

funding policies

Unit cost is usually computed as an aggregated running cost (see 6 for example) as follows:

1) Calculate Total Costs as the sum of all the costs (from past financial statements),

2) Calculate Sold Hours as the sum of all the delivered hours (from past session data),

3) Calculate 𝑈𝑛𝑖𝑡 𝑅𝑢𝑛𝑛𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 = 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡𝑠

𝑆𝑜𝑙𝑑 𝐻𝑜𝑢𝑟𝑠

The running cost defined above is very simple

to calculate; however, it is not accurate

enough, and as a result it is not helpful to

support an evidence-based approach to

determining an ELC funding rate policy,

notably because of the issues listed below.

Issue #1 - The running cost does not differentiate between ELC delivery models

Depending on their business or delivery

models, ELC providers have different cost

structures, especially when it comes to fixed

costs (e.g. rent, mortgage) and, most

importantly, staff costs.

To illustrate this, let’s assume the following cost structure for a Private Provider and a Third

Sector Provider, the main difference between the 2 cost structures being that wages

correspond to a larger fraction of total costs for a typical Third Sector Provider, as shown in

the right-hand chart below.

Figure 1 - Sample cost structures for 2 types of ELC providers

An ELC running cost is

straightforward to calculate from

consolidated financial and

session data …

… but it is a poor indicator of the

actual reality of ELC providers.

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The same data in a tabular format can be used to calculate the running cost, as shown below.

In the example above, the same running cost, shown in the last column and highlighted in

orange, is obtained for both ELC models.

This is clearly an issue since in our example the Third Sector Provider’s cost distribution is

more skewed towards staff costs, and as a result increasing staff wages will have a more

significant impact for that provider than for our example’s Private Provider. More generally,

understanding the impact of the 2020 Expansion on various ELC delivery models, with often

contrasted financial situations, requires a way of calculating the unit cost that can

differentiate between these delivery models.

Issue #2 - The running cost evens out meaningful information

Unit running costs are spread across a wide range of values, however they are usually

communicated as a single, averaged number. For example, the chart below (from 6) shows a

sample distribution of unit running costs for Scottish private and third-sector providers.

If we get about £3.7/hr for an average unit running cost, assessing the impact of raising wages

to the real living wage will not yield actionable results for those providers whose costs are

£2.5/hr or £6/hr for example. This is especially important since it is not uncommon for some

ELC providers to operate close to breakeven conditions, which means that seemingly small

unit cost variations may result in significant financial consequences.

Table 1 – Sample cost structure for 2 types of ELC providers - Tabular view

Figure 2 - Distribution of running costs based on survey results

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Even without averaging the unit running cost, and considering identical cost structures

(namely, when staff costs amount to the same percentage of overall costs), wage costs and

the number of delivered hours can vary in proportion in such a way that the same running

cost corresponds to different staff pay rates, as illustrated with the 2 scenarios summarized

in the table below.

Table 2 - An example of 2 cost structures resulting in the same running cost

This is clearly a limitation that prevents direct comparisons based only on the unit running

cost.

Issue #3 - The running cost ignores the key roles of age groups and occupancy

levels

To illustrate this third issue with the running cost, let’s assume that a nursery setting consists

of 2 rooms: Room 1, in yellow in the figure below, and Room 2, in light blue. Let’s also assume

1 staff that costs £10/hr (we will ignore fixed and variable costs for the sake of simplicity) and

5 children attending either one of the rooms, namely Room 1 in Scenario 1 and Room 2 in

Scenario 2, the other room remaining empty.

Figure 3 - Sample scenarios of settings with rooms based on age groups

Because the running cost doesn’t consider age groups or adult to child ratios, we get the same

hourly running cost in both scenarios (£2/hr), namely the sum of wage costs (£10) divided by

the number of delivered hours (5 hours, 1 hour per child), which is not a helpful or actionable

result.

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As we have set the number of children, occupancy levels will be determined by the age groups

to which the children belong: for example, 5 children between 2 and 3 years old in Room 1

correspond to 100% occupancy (the limit is a regulatory requirement). To visualize the role

of occupancy let’s add extra columns for occupancy levels to the table below.

Table 3 - Tabular view with occupancy levels per age group

The same unit running cost is obtained for both Scenario 1 with a 2 to 3-year-old age group

and an ideal 100% occupancy, and for Scenario 2 with a 3 to 5-year-old age group and a 63%

occupancy. In other words, the running cost cannot be used as an indicator of operational

performance (the capacity to match staff supply and ELC demand) in an ELC setting.

The need for an accurate, comprehensive approach to unit

cost calculation

A better approach to calculating the unit cost needs to include the effect of key ELC factors

such as pay rates and delivered hours, it also needs to account for age group distributions,

adult to child ratios, occupancy levels, as well as for cost structures associated with various

ELC delivery models.

Accounting for an ELC provider’s occupancy level per age group

There are 2 types of occupancy relevant to an ELC provider: 1) physical occupancy and 2) staff

occupancy, and unit cost calculations should consider both types.

1) Physical occupancy relates to how many children an ELC setting can accommodate, based

on its square footage and space requirements per child, in the age group to which the child

belongs. Physical occupancy notably affects how fixed costs are spread over the hours of ELC

delivered within a setting.

2) Staff occupancy indicates to what extent available staff hours (namely, an ELC provider’s

supply) are used to deliver ELC hours (namely, the demand from registered children receiving

the ELC service). Incidentally, it is worth noting that the supply depends not only on working

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hours for the staff delivering the service, but also on the age groups to which the children

receiving the service belong.

In the example shown in Figure 3, the staff occupancies for Scenarios 1 and 2 are 100% and

63% respectively, and as such an accurate unit cost calculation should yield a lower unit cost

for Scenario 1 than for Scenario 2.

Accounting for an ELC provider’s adult to child ratio

The adult to child ratio (ACR) indicates how an ELC provider decides to staff the rooms in their

setting. Although ACR and staff occupancy are related, as you would assign more staff to a

room if more children are expected or registered, they are not identical parameters.

For example, if 2 extra children in a given age group are registered to attend the same room,

more staff may be required and the ACR will be impacted; if one of the children attends 2

days a week while the other one attends full time, then occupancy will be impacted.

Minimum ACRs for age groups are defined by government standards, for example see (7) for

Scotland. However, ELC providers may choose to operate at a higher ACR than the one

prescribed by the standards, for example to improve quality, to offer more flexibility to

parents or to ensure an appropriate continuity of care. As a result, ACRs – one for each age

group - will be significantly different across providers, and therefore an accurate unit cost

calculation must also take ACR into account.

Solution – a simplified unit cost calculation example

Building on the example shown in Figure 3 we will further assume that the setting’s ACR is

0.25 (1/4) for the 2-3-year-old age group, and 0.17 (1/6) for the 3-5-year-old age group. As

we did earlier, to simplify the example we will only consider wage costs, which are enough

for the purpose of the current analysis. We added the ACR and staff occupancy to the charts

in the figure below as extra parameters to the 2 scenarios shown in Figure 3.

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Figure 4 - Unit cost calculation that considers ACR and occupancy per age group

In Figure 4 we used the following definition for the unit cost: 𝑈𝑛𝑖𝑡 𝐶𝑜𝑠𝑡 = 𝑃𝑎𝑦 𝑅𝑎𝑡𝑒∗𝐴𝐶𝑅

𝑂𝑐𝑐𝑢𝑝𝑎𝑛𝑐𝑦 and

the results of the unit cost calculations are also shown for each Scenario. As required for an

accurate calculation, the resulting unit cost is lower for Scenario 1, which reflects the better

operational performance in the setting under that scenario.

To summarize, using the new unit cost definition provides the following benefits:

➢ the unit cost is a true indicator of operational performance (namely: the capacity to

match supply and demand for ELC hours), and a higher occupancy level translates into

a lower unit cost,

➢ the unit cost considers the actual ACR in the setting, a reflection a key operational

context,

➢ the unit cost is calculated from single contributing factors, and as such it can be used

to determine the impact of varying key parameters (ACR, occupancy and pay rate)

independently. This will prove a critical feature to support What-If scenario analysis.

DELCee – Real-world data and the need for tools

The unit cost defined above is a more accurate, actionable indicator of the operational and,

ultimately, financial performance of an ELC provider. It is also more complex to calculate than

the running cost, which is at best a rough and impractical approximation of the unit cost.

In addition to wage costs, which were our

primary focus in the examples above, an ELC

provider’s fixed and variable costs must also be

considered. As such, several additional factors

need to be integrated, including a setting’s

Once the unit cost is calculated,

one needs to turn to a provider’s

fee structure, and integrate funding

rates into that fee structure.

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staffing structure (pay rates, annual leave allowance, pension costs etc.) and its physical

capacity.

Tools are needed to be able to assess real-world impacts of varying funding rates – which are

part of a providers’ fee structure - and pay rates, while at the same time integrating actual

ELC cost structures.

DELCee is a such a tool: a software application developed to meet the specific needs of ELC

providers, funders and investors. A complete description of DELCee is beyond the scope of

this white paper, and we will focus on discussing some of the benefits of using DELCee as

they relate to calculating unit cost and determining funding rates for existing and target wage

costs. Further details about DELCee are available at (8).

Benefit # 1 - Accounting for the contribution of key ELC parameters to unit cost

The figure below shows the DELCee dashboard view. Comment boxes highlight key

parameters considered in the unit cost calculation, as well as in the Fee Structure.

Figure 5 – An annotated screen capture of DELCee's dashboard showing where key ELC parameters are considered.

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The unit cost is shown as the red curve in the chart in the top left-hand corner of the

dashboard view. In line with the sample results shown in Figure 4, the unit cost in DELCee is

a function of occupancy, not a single value.

Benefit # 2 - Visualizing the impact of varying key ELC parameters

Considering the role of key ELC parameters separately enables them to be varied

independently. DELCee includes 2 input modes, for Actual and Model data. In Figure 6 below,

Actual fields shown for 5 ELC parameters are values computed from financial and operational

data. Model fields, above the Actual fields, can be keyed in directly or entered using a slide

bar.

Supporting 2 input modes is key to enabling What-If scenario analysis. For example, if the

actual, blended Pay Rate were at the minimum wage, or £7.83/hr, we could toggle the Model

button and immediately visualize the effect on the unit cost of increasing the Pay Rate to the

real living wage, or £8.75/hr. The figure below shows how switching input mode is achieved

in DELCee.

Figure 6 - The Actual and Model modes available in DELCee for ELC parameters

Benefit # 3 - Determining the funding rate through sensitivity analysis

DELCeeSense is a sensitivity analysis add-on that leverages DELCee’s modelling capabilities.

The figure below shows an annotated screen capture of the tool.

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Figure 7 - DELCeeSense input parameters and result table

At the top of the view are a series of panels for ELC input parameters. Funding rates, pay

rates and market rates (i.e. the rates for non-funded hours) are defined in this panel. Input

parameters can vary within a range of values, using a configurable increment. For example,

in the example shown in the figure above the funding rates were set between £5/hr and £6/hr

for the 2-3 years old age group, and between £3/hr and £4/hr for the 3-5 years old age group.

Once the inputs have been defined, the Control Panel on the left-hand side is used to issue

commands that 1) gather and process the input parameters, and 2) send them to DELCee for

calculation of the unit cost and unit fee.

Results are copied back into the Result Table, as shown in the last 4 columns of the table in

Figure 4 above.

Using DELCeeSense’s Result Table (or, alternatively, using automatically generated charts),

ELC funders or investors can quickly determine the effect on unit fee, unit cost, and unit

operating margin of varying the funding rate for various pay rate values, for example at or

above the real-living wage.

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Conclusion

In this white paper we have presented an actionable, accurate way of calculating an ELC

provider’s unit cost, as an improvement over a flawed and impractical running cost.

Our calculation’s approach is based on including the effect of key ELC parameters separately,

in such a way that their distinctive role in a provider’s operational and financial performance

can be properly determined.

Tools are required to address real-world contexts with various cost and fee structures. We

have presented an overview of 2 such tools:

❖ DELCee, a bespoke and innovative software application specifically developed for ELC

Providers,

❖ DELCeeSense, a sensitivity analysis tool designed for ELC funders to automatically

determine the effect of varying funding rates and other key parameters.

DELCeeSense generates a data-driven, evidence-based assessment of the impact of

funding policies on ELC providers.

References

1. https://www.gov.scot/Publications/2015/12/4790/322740

2. https://www.gov.scot/Publications/2017/10/9506/downloads

3. http://audit-scotland.gov.uk/report/early-learning-and-childcare

4. https://www.ndna.org.uk/NDNA/News/Reports_and_surveys/Annual_Nursery_Survey/2018.aspx

5. https://www.livingwage.org.uk/

6. https://www.gov.scot/Publications/2016/09/8729

7. https://www.gov.scot/Publications/2011/05/16141823/5

8. www.delcee.co.uk

https://www.gov.scot/Publications/2015/12/4790/322740

https://www.gov.scot/Publications/2017/10/9506/downloads

http://audit-scotland.gov.uk/report/early-learning-and-childcare

https://www.ndna.org.uk/NDNA/News/Reports_and_surveys/Annual_Nursery_Survey/2018.aspx

https://www.livingwage.org.uk/

https://www.gov.scot/Publications/2016/09/8729

https://www.gov.scot/Publications/2011/05/16141823/5

www.delcee.co.uk

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www.delcee.co.uk

DELCee and DELCeeSense are Trademarks of

Praxiprog Inc. – US patent No. 62/662414 pending

an evidence-based approach to funding the elc sector · evidence-based funding of the elc sector...

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