Hospital industry

The Hospital Industry

The Flexnor Report

• The publication of the Flexnor Report in 1910 served as a catalyst for general reform in healthcare delivery

• This report was a critical review of medical education in the United States

• The response of the medical establishment led to changes in the accreditation processes of medical schools and an improvement in the quality of medical care

A Brief History of American Hospitals

• Three important factors served to transform hospitals into the modern medical institutions they have become today: the germ theory of disease, advances in medical technology, an increased urbanization– The development of the germ theory of disease,

first articulated by Louis Pasteur in 1870, revolutionized the treatment of diseases

– Now, hospital technology—especially advances in surgical and diagnostic imaging—provided physicians with the tools that would revolutionize medical intervention

– Urbanization, also played an important role in the centralization of medical facilities

A Brief History of American Hospitals

• When hospitals were financed through taxation and philanthropy, patient fees were only of minor importance– As middle-class use of hospital services

increased, changes in financing were inevitable

• What has become to be known as the modern hospital began to emerge in the twentieth century

A Brief History of American Hospitals, continued.

• 1900–1915: The Flexnor Report (1910) served as a pointed condemnation of medical education. In its wake, bogus medical schools were closed, standards became more stringent, and the goal of scientific medicine was employed

• 1920s: Continued reforms were aimed at driving incompetent physicians out of the profession

• 1930s: The reliance on patient fees caused severe financial problems for hospitals during the Great Depression– The introduction of private health insurance during the

decade would transform medical care financing. – The decade also saw a revolution in pharmaceuticals

• 1940s: Wartime demands resulted in a sharp increase in the number of physicians and nurses in training – The passage of the Hill-Burton Act in 1946 dedicated the

government to replacing the aging hospital infrastructure


• 1950s: Vaccines against polio and rubella marked the true beginning of high technology medicine

– These developments, combined with the widespread use of antibiotics, helped change the image of medicine

– Advances in medical research tools highlighted the decade

– 1960s: Congress created Medicare and Medicaid, making the federal government the major purchaser of healthcare services

– The decade also witnessed the beginnings of the investor-owned, for-profit hospital system


• 1970s: Explosive growth typified the medical care system– New hospitals and clinics, medical school admissions,

foreign-educated doctors, open heart surgery, transplants, and helicopter ambulances were widespread

– The intensity of medical interventions also increased dramatically

• Intensive care units (ICUs) became widely used• Trauma centers were established in most areas

– All the developments of the 1970s shared one thing in common: they were all expensive


• 1980s: By 1982, healthcare expenditures exceeded 10 percent of gross domestic product for the first time– Medicare initiated a new hospital reimbursement

method based on the diagnosis, rather than the services performed

• 1990s: Managed care has been the dominant factor affecting medical care delivery during this decade– Hospitals are no longer the revenue generators they

once were, but instead they have become cost centers– Horizontal integration—characterized by hospital

mergers and consolidations—transformed an industry once highly fragmented with many stand-alone facilities, into one where multihospital systems are common

The U.S. Institutional Setting

• Hospital Classification– Hospitals are classified according to the length of

stay, the major type of service delivered, and the type of ownership

• Community Hospitals– Under the current classification method adopted in

1972, a community hospital is defined as a short-stay hospital, providing not only general services, but also specialty care, including obstetrics and gynecology; eye, ear, nose and throat; and rehabilitation and orthopedic services

– More than 85 percent of all nonfederal hospitals are classified as community hospitals.

The U.S. Institutional Setting

• Teaching Hospitals– About 20 percent of all hospitals in the United

States have an affiliation with one or more of the nation’s 125 medical schools and sponsor at least one residency training program

– More than 400 hospitals belong to the Council of Teaching Hospitals of the Association of American Medical Colleges

– Most of the teaching hospitals are located in major metropolitan areas with populations in excess of one million

The U.S. Institutional Setting• Hospital Spending

– Most hospital spending is by third party payers. Government sources pay more than 60 percent of all spending, with Medicare and Medicaid providing approximately three-fourths of that amount. Private insurance pays about 30 percent

– Because Medicare and Medicaid costs comprise such a large percentage of the total hospital bill, government reimbursement rules play a big role in determining the financial stability of the hospital sector.

The role of the Not-For-Profit Organization in the Hospital Industry

• The Not-For-Profit Organizational Form– A not-for-profit hospital does not have

shareholders in the typical sense of the term• Equity capital does not come from the sale of

stock, but from donations • Nature of Competition in the Not-For-Profit

Sector– The popularity of the not-for-profit organizational

form in the hospital industry may seem a bit odd given the dominance of the for-profit firm in the rest of the United States economy

The role of the Not-For-Profit Organization in the Hospital Industry

– A second argument is based on the notion that profit-maximizing hospitals will not undertake any activity where the marginal revenue is less than the marginal costs

• Many argue that even with the preponderance of not-for-profits in the industry, the profit-maximizing objective is a reasonable operating assumption – Decision making in a not-for-profit hospital

resembles decision making in a for-profit hospital

The Tend Toward Multihospital Systems

• The Theory of Consolidation– Mergers, acquisitions, and other forms of

consolidation occur in the hospital industry for the same reasons that they occur in any other industry

– Firms are said to experience economies of scale when the long run average costs fall as the size of the operation expands• If economies of scale are to result in

improved efficiency, a number of technical advantages must be realized because of increased size


• The Empirical Evidence on Consolidation

– Most of the empirical research on the growth of hospital systems and efficiency is based on data from a time period when cost-plus reimbursements were the standard practice

– As hospital reimbursement shifted from retrospective to prospective payment beginning in the mid 1980s, the efficiencies of the multihospital system have become more evident

– Dranove and Shanley (1995) focus on the marketing strategy used by hospital claims to promote brand name identity


• This strategy, similar to the one used by international franchises in the fast food industry, has as its goal to create a perception of standardized quality in the minds of potential customers

– Mobley (1997) examines the differences in merger activity between for-profit and not-for-profit hospitals

• Her findings indicate that for-profits and not-for-profits seem to have different motives for consolidating to compete in these market areas

• Consolidation activity presents a challenge to antitrust policy– If consolidation leads to efficiency gains, then patients

could benefit from higher quality care at lower prices

Summary• Hospital care tends to be the most expensive

aspect of healthcare delivery • Dominated by the private not-for-profit hospital, the

industry is responsible for more than one-third of all healthcare spending

• The changes that began in the 1980s pushed hospitals to become competitive and profit oriented– This corporate mentality has led to extensive

local marketing, leveraging debt, multihospital chains, and administrators earning salaries rivaling corporate executives

Health & Medicine

Hospital industry