Thursday, September 16, 2010

What Do Hospitals and Universities Have in Common?

What do hospitals and universities have in common? They both have core businesses that do not turn a profit. That means they must have other sources of income to break even or turn a profit, and their business plans must have multiple sources of income and expenditures. This is not necessarily a bad thing, but hospitals and universities are a huge part of our economy and we would like them to be lean and efficient entities. The issue then is: are there aspects of the way they manage their activities that are not beneficial to us as consumers?

I have already written at some length about the economics of universities in the post, So Why Are Colleges So Expensive? In their case the income from student expenses is a small part of their cash flow. There is no motivation to cut costs, so they might as well charge as much as they can get away with. Any extra money they bring in can be fed into the other business activities.

Schools will tell you that they lose money on students because the tuition doesn’t even cover salary expense. Don’t but it for a minute. Professors at major universities are not hired to teach. They are hired to bring in either money through grants, or fame through publications and high profile activities. If they spend more than 10% of their time on teaching duties it usually means they have gone into semi-retirement and plan to die of old age at their desks. In other words, the salary expenses have very little to do with students.

The issues with hospitals are both similar and different. The cover article in the August 2, 2010 issue of Modern Healthcare, with the heading: Bad for Business, pointed out that over the past few decades hospitals have been treating patients at a loss and covering it or turning a profit from other business activities—predominately investments. The author was concerned that this was an unusual and surprising way to run a business. If your profits do not come from your core activity then what kind of incentives do you have to run that part of your business efficiently.

In our fee-for-service world the incentives are perverse. The easiest way to save expenses is to eliminate unnecessary procedures, but that doesn’t save the hospital money. Rather, it diminishes its income. There is not much incentive there. Cutting costs associated with specific procedures should increase the potential for profit, but the motivation for making difficult decision perhaps dissipates when you can make a healthy profit without taking the trouble.

There is one definite problem with this business model that was pointed out by the author. What do you do when your investments take a downturn and lose money? You raise the cost of your hospital services. What do you do when your investments do well and you realize a large profit? You keep you hospital costs high unless someone forces you to lower them. This is not good.

Neither hospitals nor universities can be said to dwell in a market economy. Markets are for others. A good capitalist will do his best to avoid them.

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