Last year I wrote a piece on what ails the U.S. healthcare system, which was published in Barron's. In response, a physician e-mailed the message that the system's ailments will continue until doctors start taking MBA classes and until healthcare industry MBAs start taking human-being classes. I think he was on to something.
A business analyst who isn't in healthcare would see a typical hospital as a two-headed monster run by professional managers who do not really control the "production workers" responsible for 80% of the facility's operating costs. The professional managers are held accountable for the business' financial and market failures, while the workers are held accountable for "production failures," or acts of medical malpractice. Notwithstanding teamwork rhetoric, physicians' accountability for clinical outcomes conflicts with a hospital's economic imperative to control costs and turn a profit. That creates a permanent fault line through the hospital, turning even basic attempts at progress into tortuous, conflicted affairs.
The most perplexing management problems in other industries pale in comparison to the political, economic and emotional battles that characterize hospitals. Those battles flow from the unique nature of healthcare and related accountability problems. They also result from a century of fragmentation, inefficiency and power struggles between physicians and hospitals.
These problems were taken for granted in the salad days of fee-for-service medicine-before managed care, before the federal government's discovery that Medicare is careening toward bankruptcy, and before the rise of consumerism as managed care and Medicare problems threatened patient choice and self-determination.
In the old days, the disconnection between hospitals and physicians translated into inefficiency and inflation. Under fee-for-service medicine, sloppy physician practices actually made money for the hospital: Substandard medical care or surgical technique-when it doesn't kill patients or entice malpractice attorneys-generates more revenues through longer hospital stays, more drugs and longer detours through the intensive-care unit.
But as the quintessential 1980s pop song pointed out, money changes everything. As reimbursement has changed from fee-for-service to risk-based payment methods such as capitation, physicians' clinical inefficiency causes hospitals to be financially vulnerable. Thus, integrated delivery systems face the challenge of dealing with physician autonomy. Integrated systems and capitation force hospitals to deal with the fact that a major group of nonemployees-physicians-control most of their costs, daily operations and line employees, but physicians have little vested interest in the hospitals' economic success.
Despite waves of backlash against forms of integration, to be effective partners in assuming risk, physicians must be "captive"-hospital employees or participants in exclusive physician-hospital organizations. That's because aligning physician and hospital incentives creates tremendous financial leverage. This idea has been substantiated by every reliable study of physician practice patterns under capitation. The most methodologically sound study was published in 1995 in the New England Journal of Medicine. The study discovered striking differences in hospital utilization based on physician payment method. After adjusting for medical risk, researchers found that in 1993, for every 1,000 non-Medicare managed-care enrollees in California, patients whose physicians were paid under capitation spent 120 to 149 days in the hospital, compared with 232 days for non-Medicare managed-care enrollees in California and 297 days for those across the U.S.
Such differences in clinical practice result in significant financial differences for the risk bearer, whether a traditional HMO or a provider-based plan involving physicians. Hospitalization is always the highest medical cost for any risk-bearing organization. Thus, enormous savings are possible by aligning financial incentives to change hospitalization patterns. For the median California hospital in the study year, an inpatient day carried an operating expense of $1,359. The reduction of 83 days per 1,000 enrollees multiplied by this expense means that a provider-based plan covering 50,000 non-Medicare enrollees could save $5.6 million in inpatient costs. This breaks down to a whopping $9.40 per enrollee per month.
Potential premium savings for the average insured family would be $23.51 per month. With employees typically paying for half the premium through payroll deductions, this difference would soon make or break a plan in a mature, competitive local market.
And those are just the obvious dollars. Physician "ownership" of an integrated system's success also affects other important hospital costs. For years, hospitals have struggled to standardize the purchasing and use of medical devices and supplies. The more successfully they reduce the variety in a class of supplies-for example, the brands of balloon catheters for angioplasty-the lower the hospital's per-unit purchasing and total inventory costs for that class. Captive physicians are more readily included in purchasing decisions and are more likely to comply with those decisions. Such compliance standardizes products and improves utilization, which reduces supply costs significantly. Driven by this logic, Tenet Healthcare Corp. embarked on such a program late last year.
Physicians have resisted such captivity: Independence was the only way for a highly fragmented professional class to retain power in hospital organizations that counted on them to fill fee-for-service beds. But money, indeed, changes everything. Capitation reverses the incentive to fill beds; and managed care-driven by chronic cost and other utilization management problems-propels the system toward capitation.
Physicians' contempt for third-party payers and utilization management is finally ending their complacency toward hospitals and has inspired doctors to link with hospitals to share risk-based contracts. If the traditional HMO is a common enemy, the enemy of my enemy is indeed my friend.
Responding to a common enemy may not be the best impetus for putting healthcare's MBAs and physicians on the same corporate team, but it is nonetheless an impetus for this belated but necessary reform.
Kleinke is a medical economist and author based in Denver. This "Commentary" is adapted from his new book Bleeding Edge: The Business of Health Care in the New Century.