Health Policy$ense

The System is NOT the Solution: Higher Costs in Hospital Systems

In 1997, the consultant Tom Peters proclaimed in his book The Circle of Innovation “the system is the solution”. Fifteen years later, Peters recanted, stating “systems have their place: SECOND place.” What was now more important was leadership and culture.

At the same time (roughly, 1993-2015), hospital executives have been busy building bigger hospital chains that aggregate freestanding facilities and smaller systems. The promise has always been economies of scale and lower-cost operations that justify their growing market power and reduced competition.

Not so, according to research my colleagues and I recently published online in Medical Care Research & Review. We find that hospital systems lead to higher operating costs compared to freestanding community facilities. Moreover, the bigger the system the higher the costs. Thus, the story of hospital system formation is one of diseconomies of scale.

This finding is not new. Academic researchers have been skeptical of the system argument for years. However, we show that the result holds up over an extended period (1998 - 2010), has not changed between an earlier period of consolidation (1998-2003) and a later period (2004-2010), and holds regardless of the measure of “system-ness” used. Compared to freestanding facilities, operating costs are higher in members of hospital systems, in members of larger hospital systems, in members of national hospital systems, and members of decentralized hospital systems (the majority of system members).

We find some hospital systems are lower cost than others.  Costs are lower in systems where there are fewer hospitals, where the system is more centralized, and where the system is organized like a local hub-and-spoke model (e.g., around an academic medical center).

Why is all of this important? First, recalling Tom Peters’ recent epiphany, the logic of integration is more important than the structure of integration. Hospital system success may rest on capabilities such as leadership, culture, collaboration, and human resource management. None of these are necessarily generated by the formation of hospital systems.

Second, the higher costs of system membership have persisted regardless of the innovations that have swept through the hospital industry. Despite the changes in information technology (e.g., electronic medical records) and vertical integration with physicians, hospital systems are still more expensive places of care.

Third, health reform is now attempting to transform how providers are organized and paid in an effort to contain costs. Hospitals are establishing medical homes, physician networks, accountable care organizations (ACOs), and hospital systems. These solutions are interrelated and often rely on a continuum of providers and increased system size to manage the risks that are assumed. To succeed, providers will need to go beyond larger integrated structures to act in concerted fashion and promote standardization and collaboration across the continuum.

Our research suggests these capabilities may be in short supply. In an adjoining commentary, Ralph Muller, CEO of the University of Pennsylvania Health System (UPHS), and Greg Kruse argue that even small, centralized, hub-and-spoke systems like UPHS—which appear to be the lower-cost systems—face significant challenges in standardizing activities across a handful of facilities. Taken together, the article and commentary suggest that small may be beautiful, but not gorgeous.

For those interested in the research findings and the adjoining commentary, contact Rob Burns at burnsL@wharton.upenn.edu.