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An Opposing Fixed-Cost Structure Argument

Dr. David Edward Marcinko; MBA, CMP™

[Publisher-in-Chief]

As regular readers of the Medical Executive Post know, I am a big fan of hospitalist extraordinaire Robert Wachter MD, from UCSF. I have referenced Bob in several of my own publications and books on www.MedicalBusinessAdvisors.com and print periodicals, etc. In fact, Bob is the guy who coined the very term, hospitalist, and helped launch the movement; or hospital based revolution. 

Fixed-Cost Structure

Now, here’s my take on the oft-used airline analogy – and Bob is pretty much correct on this point. A hospital is different than an airplane. It is very different regarding its cost structure and business model.

For example, Bob states in this post:

Link: www.thehealthcareblog.com/the_health_care_blog/2008/03/average-time-of.html

 “Let’s start by appreciating where this [airline analogy] comes from. Many hospitals, including mine, tend to run full – given the huge fixed costs of operating a modern hospital, being full is probably the only way you can be profitable, just like the airlines.”

And, he also says:

“Queuing theory (don’t tell me you’ve forgotten your queuing theory!) tells us that, when you’re full, you should look for fundamental choke points and do your best to relieve them.”

Well, true enough, but there is more to it than just queuing theory and capacity, it’s also about human psychology and behavioral theory, as well. So let’s examine the airline analogy, relative to hospital under/over capacity and health plan contracts and Medicare reimbursements for a moment. And then, let’s examine the human condition.

Why?

Because most hospitals ought not [should not] be operating at full capacity, and maybe the best patient care is driven by demand (needs) – and not the supply driven (wants) of administrators, stockholders and private [physician owned] hospitals and/or other stakeholders (i.e. hospitalists?).

Of course, a pragmatic caveat worth noting is that that even not-for-profit entities are affected by similar funding and capacity issues relative to foundations, grants, donative intent, giving; etc. And, I am certainly a humane capitalist at heart.

The Faux Airline Scenario

Still, here is my take on the ailing airline industry model.

If an airplane has a single remaining seat, it can be sold at a last-minute discount, and still make a profit, since the fixed costs are covered and the plane will fly regardless of under capacity.  Therefore, hospital administrators and MBAs argue that they should strive to fill every bed, all the time – right? This might be called the fix-cost scenario. But, it is a faux one.

Again … Why?

It’s because MBAs have a cost-volume-profit-analysis (CPVA) or merchandising / manufacturing bias from B-school that is not so easily transferable to the medical services sector. Bob rightfully illustrates this with his everyday examples as a patient-discharging hospitalist.

Now, further appreciate that the less than full airplane may make a return flight at full business fare to recoup the discount loss in our example.

The Healthcare Difference

Not so – in the services or healthcare sector, however! Once locked into a managed care plan, Medicare RRG payment schedule or new MS-DRG reimbursement scheme, no similar upward pricing pressure is available. Competition is not free. Thus, the airplane scenario is wrong; ceteris paribus.

Still, traditional healthcare administrators, management gurus or job-security seeking hospitalists counter that a discounted patient in a hospital bed is better than no patient at all. The reason? Again, it’s because more services can be supplied for additional profit? This is the stuff of CVPA, marginal costs and marginal revenues.

For example, I recently retrospectively reviewed a case where a lovely, but unsophisticated patient, was hospitalized two weeks for an uneventful and solitary pinky toe amputation; under general anesthesia.

Of course, she also had bilateral prophylactic mammograms “just in case” – and – hyperbaric oxygenation therapy despite great circulation and pedal profusion. Throw in some respiratory and physical therapy to assist her breathing and ambulation. Oh, don’t forget the blood transfusion for the mild anemia of chronic disease that her longtime GP knew of and was heretofore unconcerned.  

Pre-Disease Fear Factor

But, here it comes – the supply-side pitch – “we better check it all out because you sure don’t want to loose your leg – do you?”  She was over-treated because she was a middle-aged stable diabetic patient who happened to have health insurance. She is doing fine to the best of my understanding and retrospective utilization review, five years later [Ah! That retro-spectroscope is always correct, isn’t it?].

So, supply {legal and/or misplaced caution?} side economics does rule in some instances; and beyond appropriate [demand] care. And, more care is not necessarily better medical care, as oft iterated.

Back to Capacity

Now, extending our airline analogy back to the business of medicine; suppose your empty hospital bed, my medical treatment room or office time-slot was occupied by a non-compliant and litigation prone patient? Economic considerations aside, don’t the potential medical, legal and emotional entanglements of these situations exceed their marginal benefit? I submit that they sometimes do, indeed.

My Philosophy

Philosophically, one could argue that these possibilities also exist in full fee-for-service environment [full business class plane ticket price] and be quite correct.

Therefore, rest assured that I don’t advocate the wholesale non-treatment of patients in real need. I am noting the dual and conflicting capitalistic and very demoralizing human feelings of “why bother.”

Or – shall we doctors and medical providers accept the socialistic epistemology of laborers who “pretend to work, while the government, insurers, third-parties pretend to pay?”

Indeed – Bob is right when he says – a hospital is not a Hilton Hotel. And, allow me to add … the healthcare industry is not the airline industry (thank goodness).

The New Paradigm

At the same time, medical professionals are struggling to maintain adequate incomes and a certain level of real or perceived “success.” While some specialties flourish, others like primary care barely moved forward, not even incrementally keeping up with inflation.

In the words of Atul Gawande, MD, a surgical resident at Brigham and Women’s Hospital in Boston, and one of the best young medical writers in America, “Doctors quickly learn that how much they make has little to do with how good they are. It largely depends on how they handle the business side of their practice”.

And so, perhaps different definition should emerges which entails a very unusual concept of medical practice “success.”  Here is the linguistic rub on that “patient-centric” business model of healthcare.

“Under my new paradigm as king-of-the-word, the efficient hospital or medical practice is not necessarily the one that makes the most profit – it is the one that produces the most profit at the most appropriate level of patient care and service.”

Assessment

In other words, the futuristic highly efficient physician – or hospital – may be deemed prosperous and “successful” if only 90% of the prior year’s profit is made. Yet, has an office face time – or has a hospital bed capacity – of only 70%.

Then, perhaps we can afford appropriate healthcare for more of our citizenry, and those doctors so-inclined [not me], will have more time for the golf course? 

Candor, intelligence and goodwill to all!

Conclusion

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