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Three Ways to Transform American Healthcare


Three Ways to Transform American Healthcare

Hospitals should adopt these popular business strategies.
Doctor in scrubs with stethoscope around neck
Want to improve U.S. healthcare? Apply these traditional business principles. |

The U.S. healthcare system is a model of inefficiency. It is by far the most expensive system in the world, consuming 18% of our gross domestic product. The results in terms of almost all quality measures, from life expectancy to childhood mortality, are in the lower half of the industrialized nations of the world.

American healthcare more closely resembles England in the pre-industrial age than any other sector of the current U.S. economy.

In the pre-industrial era, people lived in and worked out of their own homes, disconnected from one another. Today, many physicians work in solo or small group offices.

Merchants would travel the countryside to sell handmade goods on a piecemeal basis, analogous to fee-for-service medical practice with its “pay for piecework” reimbursement scheme.

And although physicians today use computers for billing and claims, many still have not deployed fully functional electronic health record systems or connected them with their colleagues’ systems.

The inefficiencies of the U.S. healthcare system have created a pessimism best summarized in a sign I saw in a health services building. In bold letters it said, “Quality, service, cost,” and below, in smaller print, “Pick any two.”

If we can catapult U.S. healthcare into the 21st century, we have the potential to achieve all three. A great place to start is by applying basic business principles to how healthcare is organized, financed, and delivered.

Consolidate Services for Better Quality, Lower Costs

There are about 5,700 hospitals in the United States — nearly one in every community. Most were constructed decades ago, at a time when transportation was more difficult and costly, and inpatient care was relatively inexpensive. Although advances in medical practice have shifted much of the care to outpatient venues and lowered the average number of hospitalized patients in each, few have closed.

In a competitive business world, no business could continue to operate with such low volumes and idle capacity.
Robert Pearl

Most of these institutions offer a full range of medical services — the same services offered by the hospital in the next town or even in the same community. As a result, the number of patients who receive a given service at any hospital is often quite small, the clinical teams inefficiently staffed, and the expertise of each individual less than optimal.

Cardiac surgery in Silicon Valley is a case in point.

Silicon Valley stretches approximately 50 miles from San Jose to San Francisco. Within its boundaries there are 14 hospitals that perform heart surgeries: two academic medical centers, two hospitals that are part of larger health systems, and 10 independent community hospitals. Some facilities are located as little as 1 mile apart.

While the operative procedures performed at these facilities are largely the same, their volumes and outcomes vary greatly. The two highest-volume facilities performed more than 1,000 cardiac surgeries each in 2012, the last year the state of California released its risk-adjusted data. The lowest-volume performed 100.

Not surprisingly, the lower-volume facilities averaged more risk-adjusted deaths. In contrast, the mortality rates for the two highest-volume facilities were about half the hospital average.

Why does quality get better with higher volume? When a hospital does one cardiac surgery a day on average, the physician and the surgical team have to be a “jack of all trades.” But as volume rises, sub-specialization becomes possible. Also, the more frequently a surgical team operates together, the better their communication and coordination and the fewer the opportunities for medical errors. In most areas of medicine, there is a threshold of required volume for optimal outcomes, and one procedure a day does not reach it.

Furthermore, fixed costs for cardiac surgeries are high, so running the service with a low volume becomes very inefficient. Regardless of how many surgeries are done per day, the on-call nurses, technicians, and other staff need to be paid. The operating rooms for these complex procedures are large, and expensive machinery and supplies need to be available. At centers with very low volume, staff, facilities, and equipment often sit idle and the cost per surgery rises as a result. With volume, the fixed costs are spread over more surgeries as those facilities reach economies of scale.

From a business perspective, the next step seems obvious — find a way to eliminate idle capacity by closing the cardiac surgery programs that do the fewest procedures. The volume in the remaining will increase, resulting in higher quality and lower costs for patients.

So why don’t these hospitals consolidate their cardiac surgical programs? Two reasons: from a revenue perspective, these cardiac surgical procedures are among the most profitable; and a cardiac surgery program often is an important part of a hospital’s brand, featuring prominently in its advertising.

Of course, it’s not just heart surgery. Better quality at lower cost could be achieved through consolidation for just about every major surgical procedure performed — from back surgery to hip replacement procedures.

In a competitive business world, no business could continue to operate with such low volumes and idle capacity. However, the market distortions in healthcare make it very difficult to remedy the situation — reimbursement schemes that are largely independent of outcomes; the “insurance effect,” which insulates end users from the true cost of inefficiency; and the lack of easily accessible information on the quality and appropriateness of care at different hospitals.

Eliminate the Perverse Fee-for-Service Payment System

Imagine you’re planning to remodel your kitchen. You hire a contractor and opt to defer entirely to her judgment on the kitchen’s aesthetics and the source of materials instead of requesting a competitive bid or choosing exactly what you want.

You might predict that by the end of the remodel, the contractor would have billed more hours than you expected, marked up the cost of the materials used, and billed twice for construction errors.

That is how healthcare in America works. The fee-for-service payment model reimburses physicians and hospitals based on the volume of services they perform, rather than the appropriateness of the services or the quality of outcomes they achieve.

Basic economic principles state that as supply goes up, costs should come down. But this tenet doesn’t hold true in medical care, not when the supplier also controls — and has the ability to induce — demand, and bills on a “usual and customary” basis. In general, as the number of physicians in a particular specialty in a given geography increases, the volume and complexity of services and procedures rises in parallel, and the price per case remains the same or increases.

Consider back surgery. Some procedures are potentially very beneficial, particularly when there is nerve compression. But when pain is the main indication, non-operative treatments often prove as effective over time.

Surgery can be relatively simple or very complex. The latter involves expensive hardware and implants. For many patients, these more extensive procedures add little to the outcome. But where there are more surgeons — paid by the number and complexity of the procedure — there are not only more surgeries per capita, but also a higher percentage of complex interventions.

It does not have to be like this. There is almost universal agreement among policy experts of the need to move away from a fee-for-service payment model to a model of “pay for value,” incorporating measures of appropriateness of care as well as improvements in health status and health outcomes. There are a multitude of efforts in the public and private sectors now to test different versions, from bundling payments for the total cost of care related to an intervention, to paying a specified amount in advance to cover all of the healthcare needs of an entire population.

It remains to be seen how many of these new models experimenting with alternative payment schemes will be successful, and how soon.

Embrace Technology

Over the past decade, technology has been the greatest driver of improved performance in most industries. Healthcare remains the exception. Three opportunities to personalize and dramatically improve the quality of medical care are available.

The first is a comprehensive electronic health record, which connects physicians and hospitals across the community. Without having information at every point of contact, doctors can’t provide the best medical care. Knowing the medications a patient takes, the preventive screenings a patient requires, and the tests other treating physicians have ordered optimizes the opportunity for the best outcomes and reduces costs associated with inefficiency and redundancy.

For a patient who comes to the Emergency Department on a Saturday night, one of the most important ways to determine whether he is having a heart attack is to compare a new electrocardiogram to the last one obtained to identify changes associated with an acute event.

When this information is buried in a paper record in the primary care physician’s office and unavailable to the emergency room physicians, they can only guess.

The second set of opportunities relate to mobile devices. For routine healthcare needs, most people drive to the doctor’s office Monday to Friday between 9 a.m. and 5 p.m. For many clinical problems, the physician needs to do a physical examination or utilize hands-on interventions — but not always. Seventy percent of rashes can be accurately diagnosed and treated based on a digital photograph. And frequently a patient’s problem can be solved by a physician familiar with him through a secure email or a video visit.

But in general, in the fee-for-service world, physicians don’t get paid unless they see the patient in their office. As a result, this type of modern technology is significantly underutilized.

Finally, organizing and using the masses of data being captured to do predictive modeling holds great promise to move the practice of medicine from art to science. Predictive modeling will help physicians decide which patients in the hospital are likely to worsen and end up in the intensive care unit, so more aggressive treatment can be initiated prior to deterioration. And by comparing information on a particular patient with data from thousands, or millions, of similarly situated patients, physicians know with much greater certainty the probability that this particular patient is having a heart attack or stroke, and the likely outcome of a specific intervention.

Once this information is collected in a fashion that can be aggregated and analyzed, it can be made immediately available to improve patient care.

Moving into the 21st Century

How healthcare is organized, reimbursed, and supported by technology are major opportunities to move American medical practice from a mid-to-late-20th-century paradigm into the 21st century. The fragmentation of medical practice, the fee-for-service system, and the lack of modern information technology contribute to the high cost and mediocre outcomes of the American healthcare system. The problem is not a lack of information on ways to improve, but the difficulties physicians and hospitals encounter in trying to bridge the “knowing-doing” gap.

The Affordable Care Act and HITECH (Health Information Technology for Economic and Clinical Health) Act provide a pathway, tools, and incentives for change, and time will tell how broadly they will be embraced. But regardless of how American healthcare achieves the results, applying basic business principles offers solutions to improve quality, make care more personal, and reduce costs.

Robert Pearl is executive director and CEO of the Permanente Medical Group and a lecturer in organizational behavior at Stanford Graduate School of Business.

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