The Cost of Hospital Inefficiency

Hospitals are facilities dominated by fixed costs. A given hospital has to be able to cover whatever costs are residual from obtaining the land, building the structure, and filling it with the required equipment. There is not much elasticity in those costs. The facility has to be staffed with doctors, nurses, technicians, and various workers. The hospital does have some leeway in staffing levels in the sense that it can, to a certain degree, adjust personnel numbers to be consistent with current business level. However, if you build a 100 bed hospital, you better have access to enough people to care for the case where all 100 beds are occupied.



So if you spend a night in the hospital, blow your nose while in your room, and discover you have been billed $25 for tissue, that should not surprise you. Hospital costs have very little to do with services rendered. Yearly costs must be covered whether there are patients or not. Since patients are the major source of revenue, they must be charged whatever it costs to meet the expenses of the facility.


One would think that given this kind of economic situation, hospitals would be very careful about being efficient and matching their facility to the demand level so they could run at high occupancy and optimize their cash flow. Perversely, healthcare economics is almost always counterintuitive. Or, in other words, things are almost always worse than one could conceive them to be.


Eugene Litvac and Maureen Bisognano have provided an article in the journal Health Affairs with the title: “More Patients, Less Payment: Increasing Hospital Efficiency in the Aftermath of Health Reform.” Their concern is that the influx of new patients expected when 30-40 million more people acquire healthcare coverage will induce an attempt to expand hospital facilities. They argue that that will not be necessary and that simple efficiency measures can easily accommodate this new level of service. They provide this chart to support their conclusion.

Many countries provide excellent healthcare with hospital occupancy rates approaching 90 percent. This is the basis for the authors’ argument.

“Why is hospital bed occupancy just 65 percent and not 100 percent? Why are hospitals frequently overcrowded if occupancy rates are so low? The source of this counterintuitive effect is the presence of periodic swings—artificial peaks and valleys—in hospital bed occupancy, caused by peaks and valleys in elective or scheduled admissions.”

They quote the result of a study of admissions.

“The study’s main finding was that the presumably controllable flow of patients scheduled to come in for elective procedures was in fact more variable from day to day and week to week than the unpredictable flow of patients being admitted as a result of emergencies.”

And what is the result of these artificial peaks and valleys?

“As bed occupancy approaches 100 percent and backups occur in hospital emergency departments, for example, ambulances may be diverted to other hospitals. Stress on hospital personnel may increase, resulting in more medical errors. In contrast, in the case of care valleys, where there are relatively few patients to be treated or housed, hospital resources are in effect wasted. The hospital plant is operating, and the hospital may be fully staffed, but these resources are not generating any revenue or providing any value for the nonexistent patients.”

At this point it is easy to conclude that hospital administrators are not among the best and the brightest, but there may be something else at work here.

“This type of bunching, or inefficient patient flow, stems from the fact that hospitals have traditionally evolved around individual medical or surgical specialties as well as the preferences of particular doctors. For example, a given hospital may derive much of its revenue from cardiothoracic surgery and therefore may be deferential to its cardiac surgeons, who may wish to perform surgery only on certain days of the week. On these peak surgical days, then, when large numbers of elective surgical patients compete for beds with emergency patients, unnecessary overcrowding may be the result.”

The authors’ brilliant suggestion is that hospitals should avoid concentrating elective surgeries on specific days and instead spread the load out. They quote the results from one hospital that discovered that by scheduling more intelligently they were able to raise their average occupancy to 90 percent and still maintain efficiency.


That conclusion is encouraging, but let’s consider the implications. The National Center for Health Statistics tells us that 31 percent of all health expenditures involve hospital care. At $2.5T per year that is $775B. If we have hospitals with an occupancy rate of 65 percent when 90 percent is an attainable goal, then we have about 25 percent more hospital beds—or hospitals if you wish—than we need. We, as patients, are being overcharged to support that excess capacity, and, since half of all costs are picked up by the government, those excess charges are contributing to state and federal deficits.


One interpretation of the hospital scheduling craziness is that the hospitals are not merely stupid, but they realize they have more capacity than the market needs and this makes them beholden to doctors who can steer business in their direction. Unfortunately, profit motives being what they are, this has motivated some to create business that can be directed to the hospitals. And a few hospitals have been known to encourage this practice.


If 40 million newly insured people enter the health system over the next few years, that will only be a 15 percent increase. As the authors point out, the hospital system can handle that increase. That is the good news. The bad news is that we will still have an overcapacity and hospitals will continue to charge us for it.