In The Netherlands the care for the disabled accounts for 10% of total health care costs, or almost 1% of GNP. About half of these costs are devoted to the residential care for the mentally disabled. This study studied the amount of cost inefficiency in a sample of homes operating in 1998. We first apply a data envelopment analysis to our sample and then apply another stage-evaluating the nonradial slack of each input and the effects external factors have on them. After "correcting" for the external effects we find that technical and scale inefficiency disappears and cost efficiency increases by 6%. We attribute these findings with the strict regulation under which Dutch homes operate. Further, this approach can be applied to any service or market that faces governmental regulation.