Code Red: Two Economists Examine the U.S. Healthcare System

January 14, 2013

Unleashing Innovation in Healthcare Markets

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 11:01 am

I have been absent from the blogosphere for about two months. The fact is, there just isn’t all that much new to write about. Healthcare spending growth continues to moderate, but not by enough to stave off forecasts of doom for Medicare and Medicaid. Nor can employers begin to shift money from health benefits back into wages. But wheels are turning. Health networks are expanding as providers prepare to offer ACOs and/or increase their bargaining clout. A handful of states are poised to start up exchanges with the feds ready to take the reins in the laggard states. Aon/Hewitt is about ready to launch a private sector exchange. We will start to learn whether exchanges save or destroy private health insurance.

The Affordable Care Act has had many detractors but at least it has disrupted the status quo. We needed to see fundamental changes in how we pay for and deliver healthcare services and the ACA has delivered. But ACA has brought us a very particular set of changes. Time will tell if we have chosen the right path.

Even as the industry changes the way it does business, one critical aspect of change is missing. The faces are all the same. The same large systems that dominated the fee for service world seem poised to dominate the shared savings world, and the same insurers that dominated the traditional employer-based insurance market stand ready to dominate exchanges. Value might be created when old businesses play by new rules, but even more value is created when new players are free to enter and perhaps even break the rules.

Entry is the engine that drives economic progress. Entrants bring new technologies to manufacturing and new service models to sales. Threatened by entry, incumbents strive to innovate and improve customer service. This is as true in high tech industries as it is in the service economy. Research confirms that entry is ubiquitous – in a typical manufacturing industry, fully one third of established firms are replaced by entrants within five years. Though the data is not as readily available, turnover in the service sector is likely even higher.

If entry is the engine that drives change, the healthcare sector is out of gas. Turnover in the healthcare sector is slow to nonexistent. Ask yourself, who are the biggest health insurers today? In nearly all states, the answer is the Blues. Who were the biggest health insurers 50 years ago? The Blues. Now name the biggest hospital in your home town and then look up historical data to find the biggest hospital in your town in 1960. Odds are good it is the same hospital.

I have long wondered why turnover is so slow in healthcare, and I think I know part of the reason. In most industries, successful entrants find lower cost ways to deliver products and services. Think Wal-Mart and Lenovo. But find a way to reduce the cost of delivering healthcare and where does that get you? Insured patients won’t take their business to you. Insurers might add you to their provider network, but not if it means excluding traditional providers that dominate the market. And if an insurer did find a way to cut costs, employers would be reluctant to exclusively offer the plan, in part because the tax code makes cheap health care plans seem not so cheap. Given a choice between a cheap and expensive plan, employees would also be reluctant to choose the cheap plan, both because of the tax code and because employers usually subsidize part of the cost of choosing the expensive plan.

There is also a host of regulatory barriers. Many states still enforce Certificate of Need. There are rules governing what allied medical personnel can and cannot do, stifling the search for innovative care models. ACO payment rules under Medicare limit the incentives to cut costs by allowing only for “shared savings” (apparently in recognition of theoretical studies that suggested, contrary to much available evidence, that the HMO full savings model would lead to excessively low quality care.)

I also see a lack of vision in the healthcare management realm. Nearly every sector of the general economy is dominated by “virtual” organizations that keep vertical integration to a minimum. Apple designs products but outsources production and sales. Nike doesn’t make or sell anything (it does design and brand management in-house). Likewise, Wal-Mart and CostCo produce nothing. Pharmaceutical companies outsource research, clinical trials, and even sales and marketing; government relations remain the only task that is nearly always performed in-house. The virtual corporation works because modern telecommunication technology allows independent businesses to coordinate even complex processes, relying on the skills of highly motivated specialized independent business partners, without the need for a vertically integrated corporate bureaucracy.

But healthcare is different. Faced with uncertainty, healthcare providers circle the wagons. They go on acquisition binges and then go business only with the set of providers in the same giant bureaucratic organization. In the Balkanized market that results, entrepreneurs become employees, agile independent firms become part of large bureaucratic structures, and efficiency suffers. We have seen this movie and it does not end well.

I have mentioned how some regulations stifle innovation. Let me mention one more regulation that stands in the way of efficient production. Anti-kickback laws effectively prohibit hospitals from providing financial incentives to independent doctors who deliver efficient care. I suspect the latter is the biggest reason why hospitals are acquiring doctors rather than dealing with them at arms length.

Ironically, the key to unlocking the power of market forces may be a bit more regulation. Of course we need more vigorous antitrust enforcement. But we also need to bring order to the world of electronic medical records. One advantage enjoyed by the integrated firm is the ability to get all of its providers to use the same EMR platform, thereby facilitating the exchange of information that is vital to improving efficiency and quality. Independent physicians are reluctant to adopt EMR, due to the cost, but they also are reluctant to choose a particular EMR system for fear of aligning themselves with a particular hospital that uses the same system. (This would weaken the physician’s bargaining position.) President Bush established a commission to develop EMR standards, but the result was unsatisfactory and incompatible systems continue to coexist. Without enforced compatibility (and either carrots or sticks to assure adoption), the virtual healthcare organization will remain a pipe dream. Even the most visionary healthcare executive will be reluctant to do business with an independent provider if the potential for information exchange is limited.


  1. […] posted on January 14, […]

    Pingback by Unleashing Innovation in Health Care | Wing Of Zock — January 18, 2013 @ 1:01 am

  2. […] of smart points in David Dranove’s argument for why innovation in the health sector is slower and more marginal than in others. Some of the […]

    Pingback by Sunday Links | And Not The Myth — January 20, 2013 @ 1:29 pm

  3. EMR will never be integrated or share a common platform because companies like GE, Siemens, Aprima will spend their ENTIRE FORTUNES lobbying Congress to make sure it doesnt happen.

    EMR companies make money by capturing market share. You dont capture market share by making your system compatible with competing EMR entities. Instead you make it as “black box” as possible and try to convince people that it is superior to all the other EMR systems available.

    Comment by MD — January 29, 2013 @ 2:24 pm

    • Standardization is not uncommon in these situations. DVDs, hi resolution televisions, and cell phones all comply with technology standards, and these were all achieved voluntarily. We may be moving to a de facto standard as Epic seems to be winning the battle for market share.

      Comment by dranove — January 29, 2013 @ 2:30 pm

  4. This is true that the healthcare market has not seen great changes in the past few years and the same companies and hospitals are dominating the market. It is difficult for the new entrepreneurs to enter the market and bring some remarkable change. There are certain factors that have been mentioned here that creating hurdles on the way of healthcare market. But we have to find ways and that will give chance to physicians to start their own business. This needs more regulation and a lot of communication that will open up the way for individual business persons.

    Comment by healthcallin — February 5, 2013 @ 12:12 am

  5. You wrote, “In most industries, successful entrants find lower cost ways to deliver products and services….But find a way to reduce the cost of delivering healthcare and where does that get you? Insured patients won’t take their business to you.” Yes, this lack of demand for lower costs is a key issue. Another key issue is the absence of stockholders to demand cost cutting in not-for-profit hospitals. While these hospitals seem profit oriented when maximizing prices, they do not pursue cost control the way for-profit industries do. After years of watching them, I cringe at the suggestion that healthcare costs could be contained if the profit motive were removed from the industry.

    Comment by Dave B — February 7, 2013 @ 1:19 am

  6. Absolutely… The changes are unavoidable. This past month I was at a Medical Marketing Summit in Orlando. Its a very interesting observance in how the marketing is changing for the medical practices around the world. Larger marginal changes will certainly take place within the next few years. Also wondering how the market will change for those marketing the medical practices. Especially on the search verticals.

    Comment by Axiom Health Seo for Foctors — May 9, 2013 @ 9:20 am

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