The Hospital Business Model

“A hospital bed is  a parked taxi with the meter running.”

                                                                    – Groucho Marx

Most businesses, whether they provide products or services, operate along fairly similar lines.  The business determines that the market desires more of a product (and for this essay that will mean services as well) and has the means to pay for it.  The business then does what is necessary to provide such a product, lets potential customers know that the product is available (marketing); the product is priced in a manner that is acceptable to customers and so that it provides a profit for the business.  If after the transaction the customer is satisfied, efforts are focused on retaining that customer for future sales.  If the customer is not satisfied and the customer’s expectations were reasonable, the company tries to make things right (repair, replace or refund).  If the customer’s expectations were unreasonable, a refund will still probably occur, but the business probably writes off that customer.

Hospitals, on the other hand, operate on a completely different business model, and I propose that the business model is what has created many of the current problems and driven the desire to reform healthcare.

  1. Few people truly desire what a hospital has to offer. 
  2. When dealing with most businesses, the customer normally has reasonable information as to what the product will cost.  Hospitals, in most cases, cannot tell in advance what the price will be.
  3. In most business transactions the customer and the business negotiate what is being purchased.  In hospitals various other forces such as physicians and insurance companies impact these terms and conditions.
  4. In most businesses the customer pays for the product.  In healthcare a third party often pays for a significant part of the product.
  5. In most businesses if the customer is unhappy, the seller attempts to correct the problem at minimal or no charge to the customer.  If a mistake is made in a hospital it is common that the customer will be expected to bear the cost of correcting the mistake.

Let’s examine each of these in more detail. 

  1. Few of us want to be in a hospital for any reason.  There are exceptions such as those desiring cosmetic surgery and expectant mothers, but most of us prefer to avoid an encounter with the hospital.
  2. Hospitals charge for virtually every item, and horror stories of exorbitant charges for common products like aspirin or Band-Aids are common.  There are two issues; first, the hospital cannot predict exactly what will be consumed to address your medical requirements.  Almost all are determined by a physician, and physician practice is not standardized.  Two patients presenting with the same symptoms and different doctors may be treated by radically different methods.  One may be treated medically, another surgically.  Second, even if there is an attempt to standardize how physicians treat patients, each patient is different.  One patient may require more time in the operating room or may be allergic or nonresponsive to a certain drug when compared to another patient.  These can radically affect the treatment and therefore the price.
  3. Physicians are, in most cases, independent of the hospital.  Some of this may be changing under the current healthcare reform, but that is yet to be determined.  Some of this is intentional while some is caused by regulations intended to maintain checks and balances to protect patients and payors. Currently most physicians in private practice are accorded privileges to practice in a hospital by the Medical Staff.  The Medical Staff is similar to a corporate entity and is responsible for ensuring physicians are appropriately qualified to practice in that hospital.  While the Medical Staff normally reports to the same Board of Directors (or similar entity) as the Hospital Administrator, the physicians are not employed by the hospital.  However, in their practice at the hospital, they determine what procedures, treatments, medications, etc. the patient receives.   This can make it difficult for the hospital (which pays for the supplies and drugs) to control costs.

Insurance companies are also influential and can specify a formulary for pharmacy or certain vendors for other products.  If supplies or medications not within these parameters are used, the reimbursement may be at a lower level.  Some of these costs may be shifted to the patient.

  1. Insurance companies or other third-party payors such as a government agency in the case of Medicaid and Medicare have two other areas of influence.  The first is that there is cost shifting.  This means that a certain procedure, such as ultrasound exam, may be paid at a level well above its cost.  On the other hand certain very expensive services such as a Burn Unit or the Emergency Department may be paid well below costs.  The hospital has no choice but to rely on the payment for one type of service to offset the loss in others.  In other industries a company can close unprofitable product lines, but in healthcare this is not possible.  The second quirk is that third party payors have traditionally demanded discounts.  Over time the prices that hospitals publish have been adjusted to allow for a realistic reimbursement after providing such a discount.  Occasionally this leads to a bizarre and blatantly unfair situation.  Two people have a procedure – let’s use an MRI as an example.  One has insurance and the hospital has to complete paperwork and wait months for payment.  The other pays cash at the time of service and because there is no discount, may be charged significantly more (50 – 150%).  This makes little sense as the hospital does not have to incur the costs for submitting claims and incurs no carrying costs due to delayed payment.
  2. When a surgical case has a complication, and the patient returns, it has been common for the physicians involved in the correction and the hospital to charge for the corrective action.  Unlike taking a car back to the mechanic until the problem gets fixed, each encounter is billed separately.  Medicare has begun limiting those cases that qualify for a second payment, but this problem is not yet fixed.  In some instances it’s clear cut – say a surgical sponge or instrument was left in a patient and surgery is required to remove it.  However, a patient returning with the same symptoms could be experiencing a subsequent occurrence of a particular problem rather than suffering the result of an error.  We often find it difficult to accept that some diseases and conditions cannot be cured and repeat procedures are necessary.

There’s one other unintended consequence of this.  If a mistake is made and not corrected the patient has a valid reason to seek damages.  The practice of not     “making it right” may be a key contributor to the current level of malpractice lawsuits.

The key point is that the business model being used in healthcare is not sustainable.  A new model in which cause and effect or more closely tied is long overdue.  The healthcare industry operates under significant regulation imposed by bureaucracies at the federal, state, local and industry level.  These need to be streamlined while simultaneously maintaining the protections for patients. This will be difficult since bureaucracies were created to address problems and are loath to give up control lest that problem recur.

We need to admit that people need healthcare rather than want it.  We need to accept that healthcare is a unique industry.  Then we need to design a business model that provides a reasonable amount of care for a reasonable price.

 “Health nuts are going to feel stupid someday, lying in hospitals dying of nothing.” 
                                                                                             – Redd Foxx 

Copyright 2010 SF Nowak All rights reserved.

One response to “The Hospital Business Model

  1. Pingback: A Healthcare Mystery | sfnowak

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