Skip to Content

Stanford GSB News

  • Email
  • Print
  • Share

A Tad of Profit-Making Can Benefit Social Goals

May 2002


For decades, a debate has raged about the quality of care patients receive at hospitals operating with very different business models—and the cost of this care. Do nonprofit hospitals give better treatment because profit is not a motive? Or are for-profit hospitals, in encouraging competition and efficiency, maintaining the same level of care while bringing down costs?

The answers to these questions have implications that reach beyond the health care industry. In recent years, leaders in the nonprofit sector have been considering alternative approaches from the business world for innovative, sustainable solutions to social problems. They are hopeful that the entrepreneurial and business skills that contribute to economic growth can be adapted to address the challenges facing institutions concerned with education, the environment, housing, community development, social services, and the arts—as well as health care. Yet few academics have studied how these approaches from the for-profit world can be most useful to nonprofit and other social-purpose organizations.

Stanford faculty, funded in part by the Center for Social Innovation at the GSB, recently have unveiled some intriguing new research on these questions.

Daniel Kessler, associate professor of economics, law, and policy at Stanford Graduate School of Business, along with Mark McClellan—an associate professor in Stanford's Department of Economics and School of Medicine, who has joined President Bush's Council of Economic Advisers—concludes that even a handful of for-profit hospitals operating in a community can lower health care expenditures without harming the quality of patients' health care.

In "The Effects of Hospital Ownership on Medical Productivity," Kessler and McClellan analyze data on the medical expenditures, mortality, and rates of cardiac complications for the vast majority of non-rural elderly Medicare beneficiaries hospitalized for new heart attacks over the 1985-96 period. They find that areas with a presence of for-profit hospitals have approximately 2.4 percent lower levels of hospital expenditures per patient, but virtually the same patient health outcomes.

In an earlier study of similar data, Kessler and McClellan found that in the least competitive fourth of hospital markets, mortality, hospital readmissions for complications, and costs were higher from 1990 to 1994. However, that study did not distinguish between markets with for-profit business models and those without. From the current study, the authors conclude that for-profit hospitals have spillover effects on their nonprofit and public counterparts: The competition from for-profit hospitals may limit the nonprofits' ability to behave inefficiently.

"Most of the savings are due to the difference in expenditures between areas with no for-profits at all and areas with a very small share of for-profit admissions. Increasing the for-profit share beyond a small amount doesn't generate much extra gain," says Kessler.

Furthermore, the authors show that approximately half of the total expenditure savings achieved by the penetration of for-profit hospitals comes about through reductions in an area's Medicare hospital labor cost index, an intuitively plausible mechanism through which spillovers would occur.

The authors caution that they consider the effects of for-profit hospitals on only one facet of health care markets. Most important, other work has found that for-profit ownership of hospitals may affect other important social and economic outcomes, such as hospitals' provision of uncompensated or charity care, or the propensity of hospitals to exploit Medicare's complex regulated price system. They are also currently studying how the for-profit/nonprofit mix of hospitals interacts with other characteristics of hospital markets, such as the overall competitiveness of the area's markets. "The extent to which we want to encourage for-profit ownership in health care markets is still an open question," says Kessler. "But in the hospital sector, it looks like some for-profit ownership has important social benefits."

—Meredith Alexander

Related Information

The Effects of Hospital Ownership on Medical Productivity
Daniel Kessler and Mark McClellan
National Bureau of Economic Research Working Paper #8537, October 2001