Profit Over People: Healthcare Profit Centers by JohnMValentine

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									Profit Over People
A Study of the Flaws of Creating a Profit Center System for University Teaching Hospitals

John Valentine Economics of Management & Strategy 3/27/06

Valentine 2 "Teaching, research and community service are not profit centers, but they are absolutely necessary.”(Coalition to Stop the Sale of UC Med Centers) Today, a reality that many hospitals in the United States face are growing loses paired with fewer avenues for revenue growth. The “hotel for sick people” in the pre1980 United States has become a distant memory. The consistent inpatient service that many hospitals used as their profit booster caused them to ignore operating efficiency. Since 1980, “profits previously generated from inpatient diagnostic procedures have now been precluded by managed care and sophisticated diagnostic equipment such as MRIs and CT-Scans”(Jackson 1). Hospital stays have been minimized by HMO regulations and technological advances with procedures that can now be performed outside the confines of the hospital. In response to the possibility of shutting its doors and declaring bankruptcy, some university teaching hospitals have begun to reorganize their structure by breaking up each hospital department into a freestanding profit center, with units linked by contractual agreements. While the proponents of the change to profit centers identify the influx of money derived from the centers to fund further research and treatment of indigent patients, they frequently ignore the fact that profit centers create an environment contrary to the goals of a university teaching hospital. Problems with asset specificity, poor patient care, detrimental teaching effects, and added costs collectively explain why creating a profit center undermines the mission and financial health of the university teaching hospital. A brief study of the merger between the university hospitals of University of California – San Francisco and Stanford will place these concerns in context.

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Asset Specificity and the Hold-up Problem The largest change in the profit center strategy, creating freestanding departments, will become the most difficult challenge to overcome. New relationships will be formed between individual units with profit as the main goal. Site specificity costs will be incurred as departments move closer to units with whom they will be interacting. Departments that are experiencing growth will move to expand their physical plant and staff, thus pushing out essential yet profitless units. These dedicated and human assets work together in a market to create the maximum possible efficiency for the company. (Class Slides-Section 4) However, a university teaching hospital should not be a company that looks at profit maximization as its primary intent, and its goals should not mirror a corporation. In a corporation, when a department is hemorrhaging money, it is often eliminated. However, a university teaching hospital must maintain departments that are losing money in order to provide complete and diversified service to patients and students. For example, the University of Michigan Medical System has research initiatives like the Learning Resource Center, Injury Research Center, and the Program for Improving Health Care Decisions. Each of these programs is a non-market commodity, and in some cases they are intermediate non-market commodities. These programs and departments are an output for one division and an input for another department within the organizational structure. (Ichiishi and Radner 3) Non-market and intermediate non-market divisions that teach aspiring doctors have the potential to be discarded in the event of a profit center reorganization if they are found to have minimal

Valentine 4 earnings potential. Also, managing the input and output processes of intermediate nonmarket commodities adds additional transaction costs in the profit center system. Instead of gaining seamless access to another department’s services, divisions will be required to create contracts with each other for the use of their resources. The quasirent value of a division will be high only if they are supported through payments from other internal divisions. A hold-up problem can occur when the market commodity division such as the operating room decides that they can renegotiate their contract with a non-market division. Contract issues can bog down the units in a hospital, thus hurting efficiency.

Patient Care Another side of the teaching hospital that will suffer as a result of profit centers is the area of patient care. There is evidence that for-profit hospitals may be cutting corners to gain profit but also harm patients as a consequence. Although university teaching hospitals can use a profit center system without being a for-profit hospital, the profit mentality is a common thread between the for-profit and non-profit “profit center” hospitals. A Harvard Medical School and Johns Hopkins University study found that “people with kidney failure who had dialysis at for-profit treatment centers were 20 percent more likely to die and 26 percent less likely to be referred for a transplant than patients treated at nonprofit centers”(Grady). Would the profit center structure force a university teaching hospital to decrease nursing staff, spend a larger proportion on executives, and refuse to refer patients to a better facility or doctor to maintain revenue growth? Many of these suggestions could become a reality if the profit center model is

Valentine 5 realized. This structure cannot monetize the loss of life from their deleterious profitmaximizing decisions.

The UCSF – Stanford Merger A decline in federal funding for medical research and decreasing reimbursement from the federal Medicare program led Stanford and University of California - San Francisco to merge, forming UCSF Stanford Medical Care. Under the auspices of this combination were two UCSF Medical Centers as well as every hospital under the Stanford Medical System. The plan called for privatization of the hospital system, with “the expectation that the merger would create five multi-disciplinary service lines during the first five years”(LaDou). The University of California Board of Regents along with an independent panel of experts gave the new system their approval. Their decision was met by harsh criticism by both faculty members and the community. A full page ad in the New York Times read, “"Teaching, research and community service are not profit centers,"but they are absolutely necessary. To preserve them, we must preserve UCSF."”(Carter). The opponents were skeptical of the privatization of these hospitals because they believed that costly breakthrough research would not be present in the combined entity. Research is expensive, and a profit-maximizing mindset could eliminate research not directly related to bottom line profit. Many university professors spoke against the proposed merger. Dr. Vishwanath Lingappa, professor of physiology and medicine at UCSF commented that, “privatizing UCSF could direct its research away from free scientific inquiry toward serving the corporate bottom line, a tragic betrayal of the

Valentine 6 mission of academic medical research”(Carter). Beyond the decline in research opportunities was the impact on the poor, one of the largest consumers of the hospital’s services. A larger percentage of lower income families in the San Francisco area have historically used the UCSF and Stanford hospital systems, and many people felt that privatization would decrease the options of the poor. The University of California system and the public have been trying to find ways to make a profit, but it was difficult without considering the elimination of the teaching aspects of the hospital. Many of these clinics were designed to provide adequate healthcare for lower income families. The reduction in the teaching component of the hospitals would handicap the UCSF and Stanford Medical Schools. The UC Board of Regents approved the merger between the schools in 1997, and in the first year the combined private/non-profit entity recorded twenty-two million dollars in profit. Disaster struck when the results for the first quarter of 1998 when the medical system sustained an eleven million dollar loss. After the large losses were sustained, the merger dissolved in the spring of 1999. (LaDou)

The UCSF – Stanford Merger Postmortem The reasons why the UCSF-Stanford attempt at the profit center model failed can serve as a warning to any hospital contemplating a move in that direction. Among the problems encountered was a lack of faculty support. “The absence of an adequate information base and lack of faculty enthusiasm postponed the creation of service lines except in adult cardiology, pediatric cardiology, and pediatric neurosurgery”(LaDou).

Valentine 7 The faculty did not want to be split into individual profit centers because it put their current research collaborations in jeopardy. The initial public/non-profit system established a close relationship between the doctors helping patients and the researchers in the laboratories. Profit centers force unnatural relationships for potential profit at the detriment of the research and scholarship. Beyond the unwillingness of faculty to change with the system, added costs became the main reason why the profit centers failed in California. With the creation of individual units throughout the hospital system, transaction costs were incurred in drafting and enforcing the contracts. Few contracts are complete, and resources spent analyzing and negotiating settlements in contract disputes weighed on the teaching hospital’s profit potential. Also, units that are allotted the most monetary resources often have the greatest potential for profit. Each unit spent resources lobbying the administration for more money and space in the hospital. These influence costs are present in every hospital system, but would be greater in a profit system model because the livelihood of each unit depends on the profit earned each quarter. (Class NotesSection 4) Lastly, the costs incurred through the management and cooperation of these individual units decreased aggregate profits for the hospital. Proponents for profit centers believe that the only way for hospitals to stay afloat is to divide the system into units so it will be easier to identify and separate underperforming units. The under-performing units would be altered or eliminated in the best interests of profit maximization. The rebuttal to these arguments is found throughout the body of this paper. Is there a way to integrate facets of the profit center model into the current system?

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The Solution A remedy for the financially struggling hospital can incorporate the profit-seeking mentality while upholding the virtues of education and providing services for the poor. Richard Jackson, the CEO of Surgical Information Systems, outlines a number of different actions that could be taken to increase the profit generated by a hospital’s operating room: mentor, measure financial data, monitor efficiencies, market to surgeons that can drive profit, motivate, and manage. An incentive program for over-performing hospital departments will create the motivation for managers and doctors to form a profit mentality without worrying about the demise of their department. Under this plan, services for the poor and laboratories and classrooms for teaching that are the hallmark of a university teaching hospital can be preserved. Motivating departments to innovate by creating incentives is the best solution for the future. -- -The motto of Duke University Medical School and Hospital, “A community of scholars devoted to teaching, research, and patient care,” outlines the three most important tenants of a university teaching hospital. Although essential for a hospital’s survival, profit is not found anywhere in the motto. The creation of profit centers in university teaching hospitals would cause a breakdown of these three principles. Teaching relationships will be severed and faculty will be distressed, breakthrough medical research will be halted because of its drain on finances, and patients will experience higher costs for inadequate services. The additional transaction costs, influence costs, and contract confusion will damper additional revenue gained from the

Valentine 9 profit center strategy. An innovative mindset to revenue generation within the current system spurred by incentives for success is the best configuration for a university teaching hospital.

Valentine 10 Works Cited

Carter, Phillip. "UCSF, Stanford Med Merger Continues to See Resistance." The Daily Bruin (11/13/1996) Grady, Denise. "Treatment of Kidney Failure is Flawed, Two Studies Suggest." New York Times11/25/1999, sec. Health: < 96F958260&sec=health&pagewanted=all>. Ichiishi, Tatsuro, and Roy Radner. "A Profit Center Game with Incomplete Information." Review of Economic Design 1 (1999): 307-343. Jackson, Richard. "The Business of Surgery." Health Management Technology (July 2002) Ladou, Joseph. "The UCSF Stanford Merger." <>. Parsons, Tim. "For-Profit Dialysis Facilities have Higher Mortality Rates and Lower Transplant Referral Rates than Not-for-Profit Facilities." John Hopkins Bloomberg School of Public Health (11/24/1999) <>. "Pay and Die." Science a Go Go (11/29/1999)

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