Can Hospitals Survive? Part II

In 1980, while working at the University of Chicago Pritzker School of Medicine, I wrote an article for the Harvard Business Review entitled “The Health Care Market: Can Hospitals Survive?”. This article, and the book which followed, argued that hospitals faced a tripartite existential threat:

1)  ambulatory technologies that would enable physicians to compete successfully with hospitals at lower cost in their offices or freestanding settings, 2)  post-acute technologies that would enable presently hospitalized patients to be managed at home and 3) rapidly growing managed care plans that would “ration” inpatient care and bargain aggressively to pay less for the care actually provided.

I predicted a significant decline in inpatient care in the future, and urged hospitals to diversify aggressively into ambulatory and post acute services.   Many did so.  A smaller number, led by organizations like Henry Ford Health System of Detroit and Utah’s Intermountain Health Care, also sponsored health insurance plans and became what are called today “Integrated Delivery Networks” (IDN’s).

In the ensuing thirty years, US hospital inpatient census fell more than 30%, despite ninety million more Americans.   However, hospitals’ ambulatory services volume more than tripled, more than offsetting the inpatient losses; the hospital industry’s total revenues grew almost ten fold.

Ironically, this ambulatory care explosion is now the main reason why healthcare in the US costs so much more than in other countries.  We use far fewer days of inpatient care than any other country in the world.  But as the McKinsey Global Institute showed in 2008 ambulatory spending accounts for two thirds of the difference between what the US spends on healthcare and what other countries spend, far outstripping the contribution of higher drug prices or our multi-payer health financing system.

Hospital Revenue Growth Comes to an End

Hospitals’ long run of uninterrupted revenue growth has come to an end.  An advanced warning of problems was the cessation of growth in hospitals’ ambulatory volume-  from better than 7% in 1995 to scarcely more than 1% by 2010-2011,  according to the American Hospital Association.   Additionally, inpatient admissions, which briefly spiked upward from 1997 to 2003, began a second leg of decline in 2009, with hospital inpatient volumes down for the last five years.

CitiGroup’s monthly tracking survey suggested that hospitals lost about 4% of their admissions in 2013.  In addition, hospitals are generating low single digit revenue increases.

The resulting dearth of top line revenue growth in the face of continued growth in expenses has catalyzed a spreading wave of hospital layoffs.  What is interesting about these layoffs is that market-leading institutions-from the Cleveland Clinic to Indiana University Health and St. Vincent in Indianapolis to KentuckyOne in Louisville to INOVA in DC to Vanderbilt University- are reducing their staff, suggesting that even a commanding market presence hasn’t prevented cash flow from drying up.

Has Health Reform Played a Role?

Some observers believe the Affordable Care Act has helped slow hospital use.  Health reform may indeed have played a role, but not in the way analysts have suggested thus far.  Non-ACA changes in Medicare policy and a raft of other factors have probably played a larger role.

For example, reduced readmissions may have contributed perhaps 130 thousand  avoided admissions to the 2013 decline.   But against a base of 34 million plus admissions, this is a barely noticeable four-tenths of a percent reduction.  ACO’s, another possible driver, cover not even 6% of the US population.  No-one has yet quantified ACOs’ effect on hospital admissions, but it is likely to be even smaller.

On the other hand, a concerted push by Medicare to reclassify sub-acute admissions as observation stays (which accelerated last October with the ill-fated “two midnights” rule from CMS) may have had a bigger impact on reducing acute admissions than anything in ACA.   Since 2004, observations stays per Medicare beneficiary have grown 34% while acute admissions per beneficiary have declined by almost 8% .

The ACA’s hospital payment reductions (0.5% a year in DRG updates) seemed minuscule in the first couple of years, but the  cumulative effect on hospitals’ revenues, when added to the 2% reduction from the sequester, has unquestionably damaged hospitals economically.  And for hospitals in the two dozen states that elected not to expand their Medicaid programs,  the ACA’s cut in disproportionate share (DSH) payments has been a gratuitous additional source of damage.

However, health reform’s most significant effect on hospitals may be ACA’s soft caps on health plan rate increases.     Insurers have clamped down hard on their hospital contract renewals, even for “unavoidable” institutions like major teaching hospitals and regional IDNs.  This is because they expect to be unable to increase their own revenues to compensate for any future rise in claims costs.  Double digit rates increases have disappeared.

Despite all these regulatory impacts, the fact that the momentum changes in inpatient admissions began in 2003 and for outpatient volume in 1995 argue that other factors have been at work than the fairly recent political ones.   Beyond those mentioned above, the main drivers of the spreading topline weakness for hospitals include:

–       a dearth of new ambulatory technologies that would attract additional patients

–       a sharp cost-shift in health plans toward patients (as enrollment in consumer directed health plans have quintupled since 2007 to over 30 million),

–       the emergence of radiology benefits managers who reduce discretionary imaging use

–       the gearing down and retirement of the entrepreneurial generation of baby boom physicians

Entrepreneurial Boomer Docs Gear Down

The  generational change in medical communities has been underestimated as a potential contributor to the hospital revenue slump. Seventy hour a week entrepreneurial baby boomer docs are retiring and are replaced by frightened, debt-burdened 35 hour a week Gen Y salaried docs.  The baby boom docs began reaching retirement age co-incident with the 2003 slowdown in hospital admissions.  However, many of them were trapped short of retirement by the 2008 stock market crash and freezing of the medical real estate market.

Long before the crash, many baby boom physicians had already, as one of them put it, “taken their foot off the gas”.  They began withdrawing from hospital practice, and insisting that hospitals hire hospitalists to manage their patients.   Elliot Fisher’s 2006 ACO paper noted that 38% of physicians in their national sample had no Medicare hospital billings (sampled in 2002-2004).  That number is certainly higher now.

The result of gearing down of older physicians’ practice activity is that a shrinking percentage of hospital admissions is coming from community docs. A steadily rising percentage of admissions are passing through hospital emergency rooms.  Some 70% of admitted Medicare patients came through the ER in 2011 according to MedPac .

Hospital Strategic Response.

Some hospital managements have responded to the deepening slump with a frenzy of deal-making: merging with other hospitals into larger enterprises that the bankers and consultants have assured them will have “economies of scale” and leverage with payers.  Hospital merger activity doubled in the wake of health reform and continues rising.

Hospitals are also attempting to offset the declining growth in ambulatory volume by buying up the practices of formerly independent physicians and incenting them to use the hospital’s ambulatory services.    According to AHA, the number of docs employed full time by hospitals rose 50% from 2003 to 2012, to about 100 thousand (not counting interns and residents).   According to MGMA, hospitals lost an average of  $206 thousand per employed doc in 2012 (the difference between guaranteed salary and other practice expenses and collected revenues) and many are not generating enough new ambulatory services volume to offset these losses.

The physician practice losses, euphemistically called “physician investments”, are compounded by rising payments for physicians taking night or weekend call in ER’s and ICU’s, medical directorships and other forms of physician subsidy.  Income subsidies to physicians have become hospitals’ fastest growing expense. Today, hospitals’ most urgent cost management challenge is to reduce physician subsidies that serve no strategic purpose.

“It’s Either Make Deals or Run the Business”

Both the merger and practice acquisition booms are questionable long-term strategies.  They also come with a steep opportunity cost.  As one Wall Street analyst said on CNBC last year:  “It’s either make deals or run the business.”  It’s pretty much impossible to do both at once, particularly as the hospital business is changing due to the insurance market and payment reforms accelerated by ACA.

Health reform could add another twelve million folks to the 30 million that already have high deductible coverage. .  It is possible that by the end of the next recession, as many as triple the current 30 million people will be in high deductible plans.   Those plans sharply raise the out-of-pocket cost of using the hospital, our most expensive healthcare site    A sign that this has had an effect:  most hospitals report their sharp rise in bad debts during and after the recession came from insured patients who could not pay their share of the bills.

But the emergence of narrow or tiered networks will have a more significant effect on hospitals- by further reducing hospital bargaining leverage with health plans.    For example, as a Medicare Advantage subscriber, I don’t need every hospital or specialist in the region in my health plan’s network- only my doctor, the hospital he uses and the key specialists I’m likely to need and their hospital(s).    My narrow network MA plan was $4000 a year less expensive than the Medicare supplement plan that would have provided me access to everyone.  Even for a fortunate baby boomer, it just wasn’t worth $4000 of out-of-pocket premium expense to have maximum access.

Hospitals that pursued market consolidation strategies (merging with in-town competitors, for example) will find health insurers raising the out of pocket cost for access to them, and LOTS of patients trying to avoid them, because they have grown so expensive. That means that hospital strategy will have to shift, not only because of value-based purchasing incentives to reduce care defects, readmissions, etc., but because consumer choice based on value will increasingly drive hospital volumes.

Creating value for consumers will require something approaching a revolution in hospital management- whose vanguard we can see in institutions like Virginia Mason and ThedaCare that have adopted patient-centered LEAN operating principles.   Hospitals that spent the last decade working to become “unavoidable” may have trouble refocusing on what patients and their families really need- affordable, reliable and compassionate care.

What Am I Advising Hospitals To Do:

Eliminate Layers of Management between the Patient and CEO

Empower Front Line Caregivers to Eliminate Waste, particularly of Time

Eliminate Avoidable Medical Errors and Care Defects

Smooth and Light the Patient’s Pathway through the Care Episode

Become the Hospital of Choice in Their Communities and Regions

While policymakers continue to debate whether the lengthening pause in overall health cost growth will continue, I believe the hospital contribution to that pause is not “temporary”, but represents a fundamental shift in the hospitals’ position in a tightening health care market.   Coping with this sea change will require a completely different set of competencies, as well as a fundamental change in management philosophy.

Jeff Goldsmith is president of Health Futures Inc, which specializes in corporate strategic planning and forecasting future health care trends.


29 replies »

  1. This has to be the most interesting set of comments I can recall reading in quite some time! Excluding SNL and the tangential issues, I would like to comment on 3 of your 5 pieces of advice for hospitals: eliminating waste, eliminating medical errors, and streamlining care episodes. My organization has been extensively involved in the solution-sets for each of these, and we are seeing significant progress. From electronic efficiencies/error reduction to fully integrated care & disease management, the solutions are here now.

  2. Ya,Its a different thing that peoples are suffring from serious desease and hospitals are taking more money compare to their desease,its sign of that hospitals are survive and your first article is awesome and this on another blast.

  3. “I predicted a significant decline in inpatient care in the future, and urged hospitals to diversify aggressively into ambulatory and post acute services. Many did so……..In the ensuing thirty years, US hospital inpatient census fell more than 30%, despite ninety million more Americans. However, hospitals’ ambulatory services volume more than tripled, more than offsetting the inpatient losses; the hospital industry’s total revenues grew almost ten fold. Ironically, this ambulatory care explosion is now the main reason why healthcare in the US costs so much more than in other countries.”

    Hang on, so we’ve identified the culprit and it’s Jeff Goldsmith!! Let’s raise a possee!

  4. It didn’t cost Virginia Mason or ThedaCare a fortune to go LEAN, just leadership and patience. If what you mean is “it’s going to take $200 million for me to get Epic in my place” and I can only get it from the dwindling base of commercial insurers in my market, it remains to be seen what the ROI is from that strategy. If you look closer, it was the relatively modest investment in clinical data repositories at Geisinger, Kaiser, etc. that enabled their advanced managed care strategies, not the enterprise software itself.

    Like I said I my comments, I’ve got a lot of respect for Ken, but the script is about four years out of date. He has been one of the leading advocates for “go big” and the empirical support for the “economies of scale” part of the argument is really shaky. The leverage part is failing before our eyes.

  5. They didn’t nationalize the hospitals in Canada either.

    The tiered pricing and narrow networks will only work if patients are given multiple choices of care sites, and get a chance to save money by picking well. As alluded to in the post, I chose a narrow network for my MA plan
    (indeed, the only MA plan available was a narrow network) which excluded my local academic health center. It wasn’t worth the $4000 extra cash out of pocket for the Medicare supp plan that would have given me “maximum choice”. And if something terrible happens that requires complex elective care, I get to go to Duke, which is “in network”.

    Systems or AHC’s that have counted on “leverage” to keep their rates up will find little shelter in such a system. There are disparate ingredients of a more price conscious system out there, but they will only bite when the demand for $3500 CT scans ($7000 if there are two adjacent body parts) plummets because people can save money by going somewhere else. The point of this post is that the game is up, and advocates of the “go big” strategy need to begin revising their talks.

  6. I’m curious about all I’ve heard about “narrow networks” on the insurance exchanges. Is that the rule or the exception? I wonder if that means we are having more and more of a 2 tier system – one where patients have choice (perhaps it could even be less costly) because their employers have selected plans that allow or even financially encourage using “centers of excellence” providers, and those who essentially don’t have choice because of narrow networks. I’m just curious about how that will all play out.

  7. Thanks to Jeff, Vince, and others involved in this important discussion about the future ability of our healthcare system to be financially sustainable and to serve our population. Success in the emerging healthcare system that is described in this discussion requires significant resources: financial, human, intellectual, technological, and physical. In many cases, these resources are of a different scope, type, and distribution than the organization currently has. Each organization and each market is at a different stage of readiness and has different options for success. Kaufman Hall does not support mergers in all cases. However, a partnership is sometimes the most efficient and effective way to acquire the enhanced infrastructure necessary to provide care successfully in the new environment.

  8. Isn’t there a more direct threat to the hospital industry, in the form of tiered pricing and domestic medical tourism?
    Several large employers (Lowe’s and Walmart for example) have introduced true tiered pricing for some surgeries, where a patient must pay the difference between the company’s favored provider vs the local hospital.

    Meanwhile, Aetna has introduced a service to its clients which allows patients to survey the prices of outpatient procedures in their city before choosing where to go.

    There is also a growing resistance to the price-gouging practice of adding “facility fees” to simple procedures in any hospital-owned clinic.
    Patients are not winning these ugly skirmishes, but the New York Times is picking up these stories and eventually some state regulators are going to get involved.

    As an outsider to the industry, it seems that hospitals have fought off the declines in admissions by smoke and mirrors in the pricing of outpatient services.

    Personally I go back to Prof Robert Evans, who wrote powerfully that hospitals should be publicly funded and not rely on user fees in the first place. Unfortunately, American hospitals are too expensive to be nationalized, so I do not know what the future holds.

  9. I agree with you, and I also think that many of the high cost services could be delivered in a less costly way. The UK and Canada have done a lot in trying better delivery while still monitoring quality and outcomes. But I agree that consumers deserve and would be better served with more choice and more information so they can make informed choices.

  10. I honestly don’t know how it works in the UK and Canada. My concern is that we keep putting barriers between patients and doctors, and between patients and payments. The recipient of the care is not the one paying for it directly, thus, cost becomes irrelevant. If doctors had to discuss providing potentially expensive treatment with patients (who had to pay something up front) I suspect we would have to be less concerned about “unnecessary”
    care. Not only that, if patients have the capacity to choose their own physician, they can use their own value system to decide what characteristics they like in their physician. Many patients like the partnership approach, others like the paternal approach. As it is now, patients are herded into doctors and practices through networks, without really getting to choose the doctor they are most comfortable with.

  11. It’s probably not a great idea to get into a deep epistemological discussion on the set of SNL. I should just say “uncle” and go out and get ready for the snowstorm (!). But I actually have a ton of colleagues I respect with whom I often disagree. Our arguments are how we learn things.

    What we’re talking about above is one man’s hypothesis about the forces buffeting a $900 billion industry (an industry that’s bigger than Turkey!). Everyone is entitled to an opinion . . .

    But readers should know that those opinions have economic and political dimensions. For example, ObamaCare is really struggling right now. So Jason Furman, the White House economic advisor wrote last mont in the New York Times that ObamaCare is responsible for the remarkable slowdown in health costs.

    Who knows what “really” caused the slowdown? No-one can definitively refute Jason because no-one really “knows” what caused it. What I’ve been saying is this slowdown has been going on for a decade, and is the second such slowdown in twenty years, and ObamaCare (including ACO’s) has been around for, like, fifteen minutes. If we’re patient, we’ll eventually “know” what really caused this stuff.

    The hospital industry is, as Paul Slobodian remarked above, buffeted by
    fads and groupthink. That groupthink is extremely lucrative, as long as you can keep it going. People who argue that it is “inevitable” that fifty organizations will own all the hospitals in the country will earn millions of dollars in fees by helping them all merge together. The scarier the presentation the better! That includes a lot of New York bankers and. . . Kaufman and Hall, who make millions in fees by doing M+A advisory work.

    Some of the people who argue that the ACO movement has already saved us billions of dollars also profit from selling hospitals and physicians IT systems, utilization control tools, and protocols and guidelines to help them become and remain ACO’s. The ACO “movement” is really a multi-billion industry that grinds to a halt of someone “proves” ACO’s actually don’t “work”. Consultants actually have meetings to talk about how to create the next fad, so they can sell their stuff into it.

    I’m just saying. . . Nobody actually “knows” anything about this stuff.
    Folks are entitled to their opinions, and the argument itself is really valuable. I’ve learned not to throw pies at my colleagues because more than once, I’ve come of an argument covered in pie goo. I’m patient enough to let history, and the community decide, what’s really happening and what isn’t. Back to you, Jane. . . .

  12. I wonder if the systems in Canada and the UK allow better relationships between clinician and patient because the GP is the first person seen, the clinic that the patient first sees and is much more accessible than specialty care and has the most incentive to take good care of the patient in the first place. It’s the opposite of having the large systems tethered to hospitals buy ambulatory clinics. Would we be better off if we had more of their incentives, both for patients (including costs) and primary care physicians?

  13. Vince,

    I am so happy to see the term “ignorant slut” introduced into this discourse. It has been many years since I have been able to enjoy it (in its full majesty) on SNL – Point/Counterpoint with Dan Akroyd and Jane Curtain.

    Dan Akryod: “Jane you ignorant slut, when you and the rest of your pot smoking, lesbian friends manage to shut down our nuclear power plants, where will you get electricity to power your vibrators from?

    Dan has left large comedic shoes to fill!

  14. I should have stopped when you agreed with me 🙂

    Let me try to summarize this thread:

    J – There are no studies quantifying effect of ACOs on hospital admissions
    V – Kaufman/Hall did such a study, published in Health Affairs
    J – Well, OK, but their methodology sucks
    V – The bigger point is that the authors represent the Old Guard in hospitals, and they have credibility w/ CEOs/CFOs
    J – I know and respect the authors, but otherwise they are ignorant sluts

    You can have the last word if you wish.

  15. “The problem with medical care is the patient has not been the payor…..we don’t need to get rid of fee for service….we need to restore the essential element that makes fee for service work: the purchaser of services has to be the one who decides whether to “buy” the service or not….and benefit from searching for the highest value provider.”


  16. I think the “fee for value”/ACO model is full of wishful thinking and groupthink. The attacks on fee for service seem to have convinced many, as it sounds very logical. The only problem is, fee for service transactions have been the basis of almost all human trade since civilization began….and remains so to this day. The problem with medical care is the patient has not been the payor…..we don’t need to get rid of fee for service….we need to restore the essential element that makes fee for service work: the purchaser of services has to be the one who decides whether to “buy” the service or not….and benefit from searching for the highest value provider.

  17. “The cost of outpatient imaging done through a hospital, compared to outpatient imaging done at an independent facility is at least 50% more (in my area).”

    Exactly, same in my area.

  18. I know several physicians who have had their practices purchased by hospitals, then given back to them. On physician I know got bought out and had his practice given back TWICE!

    The cost of outpatient imaging done through a hospital, compared to outpatient imaging done at an independent facility is at least 50% more (in my area).

    The movement of physicians to hospital employment will, in my opinion, only increase medical costs through lost efficiency and decreased productivity. And there has been a huge movement of physicians to employed status over the past several years.

    But hey, even though we are losing money on every encounter, we’ll make it up on volume! 😉

  19. They are old friends, and people I respect. I don’t agree with their conclusions. We are nowhere near the “fee for value” transformation they talk about. The incentives mIght change, but all we’re doing right now are demos on tiny fractions of the total population (Medicare plus private insurance).

    As discussed above, maybe 6% of the US population have their care paid for the way Ken talks about. And the HMO, which really does do population health, has shrunk from 31% to maybe 13% of the privately insured market, replaced by PPO’s and high deductible plans.

    Kaufman Hall has been one of the leading advocates of hospital mergers to control markets, and a purveyor of the “economies of scale”/leverage with payers narrative.

    Here too, I think they are wrong, and a lot of the mergers are going to end badly for the reasons I suggested. The fact that market leading IDN’s are laying off folks suggests that they aren’t getting the leverage anymore in their rate negotiations.

    There is a hospital “meme” that there are only going to be fifty owners of hospitals in the US in a few years, and the subtext is “you’d better be one of them”.

  20. Rather than argue the numbers, I think what’s more impactful here is the source of the analysis and conclusions.

    My guess is that the average reader has never heard of Kaufman-Hall. They are well known in the hospital world and have influence with the guys who control the $$, the hospital CEO and CFO.

    The Health Affairs article concludes:

    The Chicago regional study indicates that there is indeed early evidence that the transformation agenda is taking hold.

    That’s the real take away here, IMO, Kaufman-Hall saying this is kind of like Bill Gates saying out loud: “Microsoft is getting its ass kicked in the mobile world — we have about 3% market share, whereas Android and Apple iOS have gone from 0% to 90%+ in 6 years. Wake up guys”

  21. Completely agree with the last paragraph.

    On the ACO impact, what Ken showed in Chicago was based on a minuscule number of ACO lives, and could well have been produced by other factors (e.g. the effect of rising hospital employment of docs by the systems sponsoring the ACO’s, and the resultant slump in “productivity”).

    Many hospital sponsored ACO’s are deliberately concentrating on reducing post-acute expenses to avoid damaging the hospital’s “core’ business, or on reducing readmissions, which probably are not “ambulatory sensitive”.

  22. Jeff, as usual, excellent analysis and directionally on point. The traditional hospital model won’t work for the future.

    You state “No-one has yet quantified ACOs’ effect on hospital admissions, but it is likely to be even smaller.”

    Take a look at the recent Kaufman-Hall analysis of the Chicago area. Like you, Kaufman-Hall are respected hospital-insider consultants.

    Their work was summarized in a Health Affairs article: http://healthaffairs.org/blog/2014/01/06/where-have-all-the-inpatients-gone-a-regional-study-with-national-implications/

    Table 4 gets to the meat of it. When they examined Ambulatory Care Sensitive Conditions (ACSCs), they noted a 3.8% decline in admissions under traditional care models, and a 6.3% decline when ACO style care models were employed.

    Your list of recommendations is fine but doesn’t address the core issue:

    Recognize that the capital intensive, centralized healthcare delivery system model is giving way to a decentralized, home/community, digital model. Disrupt yourself before it’s done to you. As a start, create and empower an internal division, provide them resources, give them independence. Tell them to start building the distributed, digital health care system of the future, and get out of their way.

  23. Great article, a few observations.
    The buying up of doc’s practices has consequences for hospitals, docs and patients. For doctors, many will be able to work in a less stressful environment, make decent money and not have to worry about pouring practice revenues in to the ever-increasing regulatory mire. However, they will be under the hospital’s regulatory control, and as noted above, enticed to refer to hospital based diagnostics, which can be more expensive than private providers.
    For hospitals, they will have to provide malpractice, health insurance, CME benefits and likely some retirement programs for these doctors. Unfortunately, I don’t believe reimbursement will keep pace with the outlay by the hospitals, and eventually, they may have to lay off or cut back pay/benefits.
    For patients, I find very large medical organizations a mixed bag. Large practices are frequently hard to get in to in a timely fashion, much of the personal interaction is lost, and the patient is passed around to many different providers. Addtionally, if the doctors are pressed to refer to hospital diagnostics, patients will likely be paying top dollar for those services. The employed doctors will not have a great incentive to go beyond the 8 hour work day, or provide extra care, and the patient may feel they’re on a production line.
    I think I’m kind of a dinosaur, maybe there are other physicians like me, but I value the physician-owned and operated smaller practices for personalized patient “centered” care. I have a bad feeling we’re heading for the corporate type practice of medicine with all the fancy technology and gadgets, but something will be lost in patient relationships.
    As to whether or not hospitals can survive with declining reimbursement and increasing government control, only time will tell.

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