The Boston Globe recently ran an article discussing layoffs at Baystate Health, a large health system in Western Massachusetts. The system is planing to lay off 300 employees to try to close a $75M deficit. According to the Globe, the deficits are mainly driven by declining Medicaid reimbursement, but, more interestingly, by a $23M hit to Medicare revenue driven by a mistake made by Partners Healthcare, a health system on the other side of the state.
Here’s the fascinating backstory.
With healthcare mergers now announced seemingly every week, I’ve been giving some thought to scale: How big can/ should health systems be?
Anecdotally, I’m struck that the most impressive healthcare companies in America are super- regional players: Geissinger, Cleveland Clinic, UPMC, etc. They seem to get a lot more attention than the national players with hundreds of facilities.
Leaving aside questions like strategy (e.g. is integration of payers/doctors/hospitals the key to these successes), I’ve wondered whether regional systems are simply the right size to thrive. My suspicion is that even clever organizational structure (a topic which I wrote about last year) can’t overcome barriers that prevent large healthcare companies from innovating and thriving, particularly as companies move to risk and the business of healthcare becomes more complex. Like cellular organisms, large companies can outgrow their life support. (Interestingly, it’s actually the ratio of body volume to surface area [gas exchange, digestion, etc] that served as a constraint to organism size…)
I recently ran across a superb paper- a doctoral thesis written by Staffan Canback. Canback (who now leads the Economist Intelligence/ Canback predictive analytics consulting firm in Boston) wrote his thesis, called Limits of Firm Size: An Inquiry into Diseconomies of Scale in 2000, while a student in London. Canback argues, convincingly, that companies do become more efficient with scale, but reach a point where “diseconomies” begin to mitigate performance. This may seem intuitive: (as Canback notes, if efficiency only improved with scale then we would buy everything from one company that produces everything with great levels of efficiency). We don’t.
I’m dabbling in this complex field, but here are my takeaways:
Classic economic theory proposes that there is increasing efficiency (decreasing unit cost) with scale but that at a certain point diseconomies of scale begin to increase unit cost.
The problem with this curve is that it can’t explain why there tend to be multiple companies of various sizes competing successfully in a given industry. The answer, according to Canback, is that there is a large “sweet spot” in most industries where the benefits of scale are reached and before structural inefficiencies develop. There is then an inflection point, limited to large companies, where diseconomies of scale emerge. The curve looks more like this:
What are the diseconomies of scale that Canback writes about? The ones that begin to increase unit cost at point M2? They are ultimately bureaucratic concerns. Canback quotes the economist Herbert Simon:
“the central problem is not how to organize to produce efficiently (although this will always remain an important consideration), but how to organize to make decisions.”
The first part of this statement essentially refers to the negative derivative of the cost curve, while the second part refers to the upward slope as diseconomies of scale set in.
Here are the four main categories of scale diseconomies:
1. Communication distortion due to bounded rationality
It is impossible to expand a firm without adding hierarchical layers. As information is passed between layers it is necessarily distorted. This reduces the ability of high level executives to make decisions based on facts
2. Bureaucratic insularity
As firms increase in size the senior managers are less accountable to the lower ranks of the organisation and to the shareholders. They thus become insulated and will, given opportunism, strive to maximise their personal benefits rather than the corporate goal
3. Atmospheric consequences due to specialisation
As firms expand there will be increased specialisation, but also less moral involvement of the employees.
4. Incentive limits
Firms can not compensate their employees perfectly.
Here is the relationship between these four limiting factors and undesirable outcomes in large firms.
In a complex, heavily customized relationship-based industry like healthcare, I’d suspect that these difficulties would be amplified.
It would be fascinating to plot the progressive performance of the country’s largest healthcare companies as they grew over time (including not just fiscal performance, but also measures of quality and innovation). I’d be curious to see if it they look like Canback’s charts: doing fine until the magic inflection point at M2…
Photo: Riyaad Minty via Flikr, Creative Commons
In healthcare quality circles it’s become a truism that high surgical volume is linked to improved outcomes. If you want to have the best surgical result, the thought goes, find the surgeon who has done the most cases like yours…
Harvard’s Ashish Jha outlines the case in a recent JAMA Forum:
We have always known that volume matters. The notion is simple and intuitive: practice makes perfect; experience creates better physicians.
…For more than 2 decades, work of leading scholars has shown clearly and convincingly that volume matters. Mortality at low-volume centers for certain procedures is as much as 5 times higher than at the highest-volume centers. Such evidence has prompted quality and safety organizations to encourage patients and providers to use high-volume centers.
For a few years I’ve been fantasizing about what a healthcare insurance/ delivery mutual would look like. I’ve yet to see one but I like the idea a lot.
Here’s the idea behind a mutual: A mutual structure means that the company is owned by its clients or policyholders. Since a mutual’s customers are also its owners, they get to share in any surpluses though they are mostly reinvested in the business. Continue reading
I was recently impressed by the full page ad placed by Time Warner Cable in the Sunday New York Times. They write:
We get it. We know how you feel about cable companies…. We hear you loud and clear…. So we’ve made some changes for the better. Changes that we hope add up to more respect for your time, better value for your money and the kind of experience you expect from a leading entertainment and technology company…
One summer afternoon, when I was eight or nine, I impulsively chose to ride my bike down a steep hill near my childhood home. From the top of the hill my bike accelerated at a frightening rate and I remember for brief moments somehow being airborne before landing in a pile of bent metal and bloody asphalt. My adventure ended with a trip to the children’s hospital for a cast and a sling.
After all of these years what I remember most from that visit was being in pain and almost vertiginously looking down a corridor into the massive, soaring atrium of a hospital packed with people that went on forever.