The Restructuring of the Hospital Services Industry
Reardon, Jack, Reardon, Laurie, Journal of Economic Issues
As policymakers debate various health care proposals, the pace of structural change among hospitals is accelerating principally via mergers and acquisitions. This paper, after documenting the reasons for structural change, will empirically investigate the current structure of the industry.
The Current Merger Movement in Historical Perspective
Prior to 1870, hospitals were nonprofit institutions serving the poor, the homeless, and the insane [Starr 1982, 144]. Medicine was practiced outside of the hospital by peripatetic physicians attending patients at their home; hospitals served those without resources to pay for the services of a physician.(1)
During the period 1870-1910, hospitals were transformed from the periphery of health care to the center [Starr 1982, 144]. Several reasons account for this transformation [Temin 1988, 80-83]. First, improvements in hospital technologies and new surgery techniques made hospital visits more palatable for patients (and less life threatening). Second, the newly developed germ theory of disease created a need for doctors to work in laboratories in order to diagnose and treat disease. Third, increased urbanization divorced medical care from the home and led to an increased demand for hospital services by the urban middle and working class.(2)
Prior to this transformation, hospitals were nonprofit, operated either by religious denominations, charitable lay boards, municipal governments, or the federal government. As new surgery techniques made surgery profitable, and as the need for physicians to establish professional control over their work environment became more pronounced, proprietary hospitals - managed and operated by physicians for a profit - began to develop [Starr 1982, 157-165]. By 1910, 56 percent of the hospitals in the United States were proprietary [Starr 1982, 219].
The proprietary hospital was small and relied exclusively on the fee-paying middle and upper classes. Over time, however, proprietary hospitals dwindled in number and importance as they were typically converted to nonprofit organizations by their owners. By 1946, only 18 percent of the total hospitals were proprietary [Starr 1982, 219].
In 1945, Congress passed the Hill-Burton Act, which provided federal funds (and matching state and local funds) for the construction of new hospitals and the repair of aging hospitals. The Hill-Burton Act was successful in increasing the number of beds per capita [Temin 1988, 90]; however, it delayed consolidation in the industry since less economical hospitals were provided funds to continue operating [Starr 1982, 351].
The passage of Medicare/Medicaid in 1965 set in motion the forces responsible for the current merger wave. Desperate to win the support of the medical establishment for the passage of Medicare/Medicaid, the federal government promised a generous Medicare reimbursement policy on the basis of cost - to be determined by the hospital - and surrendered direct control of Medicare to Blue Cross and Blue Shield [Starr 1982, 375]. In addition, the federal government allowed hospitals to be reimbursed for a reasonable rate of return on equity capital and also allowed for depreciation to be calculated on the basis of current replacement cost rather than historical cost [Stevens 1989, 296-7].
Under such generous reimbursement conditions, it became very difficult for a hospital not to make a profit [Gray 1991, 33]. To take advantage of the new profit-making opportunities, investor-owned (IO) hospitals developed. Similar to the proprietary hospital, the objective of the IO hospital is to make a profit; however, unlike the proprietary hospital, the IO is largely owned by outside investors.
During the 1970s and the early 1980s, the profits of IO hospitals were relatively high-a dollar invested in an IO returned nearly 40 percent more in earnings than the average for all other industries [Stevens 1989, 337]. High profits facilitated the attainment of both debt and equity in the financial markets at a time when philanthropy and government aid grants to hospitals were declining.(3)
High profits and easy access to debt and equity further encouraged growth by merger and acquisition: the easiest way for a company to grow was to acquire an existing company. In addition, a provision in the Medicare/Medicaid legislation allowed interest and depreciation to be calculated on the basis of purchase price, having the unintended consequence of making a hospital more attractive for a potential buyer rather than the existing owner, since the interest and depreciation could be deducted against taxes [Gray 1991, 33].
Thus, the growth of IO hospitals was abetted by government policy, which made health care lucrative for providers and hence attractive for investors [Starr 1982, 428; Gray 1991, 49].
The IO companies had powerful motives (and still do) for expansion; the price of a company's stock and thereby continued access to financial capital depends heavily on growth in earnings, which is more easily achieved through acquisitions than internal growth [Hoy and Gray 1986, 184-85].
The development of investor-owned hospital systems was a logical outgrowth of the development of the IO hospital. A hospital system is defined as two or more hospitals owned, leased, sponsored or contract managed by a central organization.(4) Hospital systems existed prior to this period; however, they were either proprietary or nonprofit, rather than investor-owned.(5)
The IO hospital systems developed primarily to facilitate the raising of capital in the financial markets. As IO systems such as Humana, Hospital Corporation of America (HCA), American Medical International (AMI), and National Medical Enterprises (NMI) grew, they developed name recognition, largely due to spectacular growth in profits, which in turn accounted for favorable borrowing conditions [Erman and Gabel 1986, 479].
The IO systems quickly grew, first by acquiring small proprietary hospitals, then (briefly) by constructing new hospitals, and after 1976, by acquiring existing hospitals. The IO hospital systems acquired (or built) hospitals in areas with relatively high rates of population growth, low levels of state regulation, and away from areas of low-income population-thus accounting for their concentration in the South, the West, and in suburban areas [Gray 1991, 33].
Two developments in the early 1980s ended the expansion of IO hospitals and the growth of IO systems. One, the federal government curtailed payments for depreciation expenses and began to scrutinize payment practices in hospital takeovers, largely as a reaction to the acquisition of Hospital Affiliates by HCA. Two, the federal government, in an attempt to lower hospital costs, replaced cost reimbursement for Medicare with a prospective payment system in 1984 under which the hospital was allowed to keep any difference between the cost of the operation and the government established price, thus establishing an incentive to reduce costs.
As a result, the large IO hospital systems were forced to retrench and divest.(6) By 1987, HCA, AMI, Humana, and NMI, the largest hospital systems at the time, all became net sellers of hospitals(7) [Gray 1991, 41]. This widespread divestiture caused one commentator to write, ". . . events have challenged the assumption that health care is inevitably moving toward consolidation into a few giant-profit oriented corporations. Dominance by megacorporations now appears a myth" [Stevens 1989, 337]. Another commentator noted that the large IO health systems were no longer, in the late 1980s, the object of much discussion in health policy circles [Gray 1991, 52-53].
In 1992, a second round of mergers and acquisitions among hospitals began, led by the IO hospital systems.(8) The second wave has eclipsed the first wave in size and volume, such that dominance of health care by "megacorporations" no longer appears to be a myth but is a reality.
Two factors explain this second round of mergers: (1) an attempt by the private sector to control escalating costs and (2) the emphasis of the Clinton campaign and later the Clinton administration on reforming the health care industry. Each of these factors will now be explained.
Costs in the health care industry have increased at a rate of 70 percent more than the overall cost of living since 1970 [Scofea 1994, 2].(9) Several reasons account for this increase. First, a dearth of competition in the industry on the basis of price [Ciscel and Chang 1987, 847]. Hospitals, at least until the mid-1980s, did not compete by offering consumers the lowest price, but rather by offering "state of the art" facilities within close proximity to the consumer and the latest technology, including a panoply of new tests and drugs [Collins 1993, 84]. Consumers, rather than comparing services in a context of full information, went to the nearest hospital or were referred to one by their doctors [Reynolds 1989, 226].
Second, third-party payments for medical treatment made both provider and consumer insouciant toward the price of the service. Third, an increase in the aging and elderly population increased the demand for medical services [Reynolds 1989, 219-20].
The attempt to control escalating costs by the private sector was (and still is) spearheaded by the development of Health Maintenance Organizations (HMOs). An HMO pools buyers of health care and provides comprehensive health care for a fixed fee, thus integrating the insurance and provision functions of health care [Folland et al. 1993, 299]. Since the HMO charges a fixed fee, the motivation is strong to reduce costs, largely through preventive care and shopping around for the lowest cost [Folland et al. 1993, 299].
Large corporations, faced with rapidly increasing costs, have in turn pressured HMOs to reduce costs [Bodenheimer 1993, 375]. In addition, throughout the 1980s, declining admissions, reduced patient stays, and over-capacity have further pressured hospitals to reduce costs [Collins 1993].
The IO hospitals have argued that a fast and (relatively) easy way to reduce costs is to merge, thereby eliminating duplicate services and waste and achieving economies of scale in the use of technology, doctors, laundry services, marketing, billing, etc. [Anders and Winslow 1993, A7; Olmos 1994, D4]. In addition, after merging, a hospital can secure discounts from suppliers due to the volume of purchase and secure discounts from contractors for remodeling or rebuilding - theoretically passing the lower costs to the consumer [Erman and Gable 1986, 478].
Thus, one motivating force for many of the mergers and acquisitions appears to be ". . . seek economies of scale or die of duplication and waste" [Spence 1993, 11].
A second factor explaining the current merger wave was the emphasis of the Clinton campaign and subsequently the Clinton administration on health care reform. In September 1993, the Clinton administration offered a health care reform package to Congress, emphasizing cost containment and universal health care insurance. Although the legislation debated in Congress differed substantially from the initial Clinton proposal, it was the campaign rhetoric and the initial proposal that precipitated the mergers and acquisitions.
Specifically to contain costs, the administration proposed the grouping of health care consumers into regional alliances-non profit agencies that would allow consumers the choice of at least three health insurance plans. The administration also argued for global budgets to cap public and private sector health care expenditures and a tax cap on health plans; and finally, the administration argued for a national health board.
The IO hospitals felt that in order to retain some bargaining leverage over price and hence profit, they would have to merge [Collins 1993, 83]; not to do so would attenuate their power vis-a-vis increased government intervention. A hospital becoming part of a system increases its power and the ability to control price and profits, thus increasing the probability of institutional survival [Starr 1981, 434]. There is strong pressure on firms that are not part of systems, regardless of profit status, to reduce costs, and the prevailing thought in the industry is that the most efficacious method to reduce costs is to join a system, preferably an IO system.
Thus, according to the industry, a central goal of the Clinton administration - the reduction of escalating costs in medical care - could be achieved by consolidation [Olmos 1993, D4]. However, as is well known to institutionalists, consolidation by merger does not result in greater efficiency, nor in price decreases [Adams and Brock 1981]. Why is it assumed that the outcome in health care will be different?
Studies conducted during the 1980s failed to find any cost savings by IO system hospitals [Gray 1991, 433; Erman and Gable 1986; Hoy and Gray 1986; Watt et al. 1986].(12) Anecdotal evidence suggests that price reductions have occurred during the current merger wave [Anders and Stout 1994, All. However, irrespective of whether prices are initially lowered, the power of the hospital systems is increased, which can be used vis-a-vis other participants in the health care industry or to influence outcomes; and furthermore, the willingness to offer lower prices in the future is attenuated.
Thus, a policy that relies on competition (in the sense of rivalry) may, in fact, have just the opposite effect; as the assistant attorney general for Maine recently noted, "We could wake up and find that [Clinton's] health care system, which was supposed to encourage competition among providers and lower prices may not have many providers left . . ." [Collins 1993, 83-4].
The Clinton administration has given a carte blanche to the industry to consolidate and restructure, anticipating that increased competition will result in economies of scale and hence lower prices.(13) The Federal Trade Commission (FTC) promises to prevent a merger if prices can be raised with impunity [Collins 1993, 83]. However, the Justice Department and the FTC issued health care antitrust enforcement guidelines in September 1993, immunizing small rural hospitals from antitrust prosection. In addition, 18 states have passed laws giving hospitals antitrust exemption if they engage in collaborative ventures that have community benefits [Burda 1994, 6].
The Current Structure of the Hospital Industry
Table 1 prints data on the 10 largest hospital systems in the United States. The ownership status is as of 1993, however, the data on beds and number of hospitals are for 1992-the latest year for which data is available. The data used in our analysis is obtained from the American Hospital Association (AHA). The AHA conducts an annual survey and identifies which hospitals are part of multihospital systems. An attraction of using the AHA data is that it is based on the universe of multi-hospital systems rather than membership in the AHA [AHA Guide, B2].
The 10 largest hospital systems control 15.4 percent of the total hospitals and 14.8 percent of the total beds. In terms of number of hospitals owned, 7 of the top 10 are IO systems, including the two largest. The remaining three hospital systems are nonprofit and are owned by the federal government. In terms of number of beds, the Department of Veteran's Affairs is the largest hospital system in the United States; its facilities are located throughout the country and are mostly associated with medical schools [Brown and Lewis 1976, 280].
Columbia-HCA is the largest (and fastest growing) IO system in the world. Columbia was founded in 1987 in Dallas, with two financially troubled hospitals. In August 1993, its acquisition of Galen Health Care created the largest health care merger/acquisition up until that time. At the time of acquisition Columbia had 26 hospitals; Galen, an IO health system, was the 6th largest hospital system in the United States, accounting for 1.1 percent of total hospitals and 1.3 percent of total hospital beds. It was spun off from Humana in March 1993 with Humana retaining the health insurance component and Galen retaining the hospital component.
In October 1993, Columbia acquired Hospital Corporation of America (HCA), the third largest health system, with 1.5 percent of the total hospitals and 1.5 percent of total beds. HCA was founded in 1967 in Nashville by a father-son physician team along with two other investors, including Jack Massey, who earlier purchased [TABULAR DATA FOR TABLE 1 OMITTED] Kentucky Fried Chicken and took it public [Brown and Lewis 1976, 130-40]. As for the motivation of the Columbia-HCA merger, Richard Scott, president of Columbia, stated: "The merger is clearly a response to health care reform" [Greene 1993, 2].
Columbia-HCA is not finished yet; it intends to acquire about 500 hospitals, or about 8 percent of the total [Toshmo 1994, A1]. It acquired Medical Care of America in 1993-the largest chain of outpatient surgery centers - and has recently discussed a joint venture with Beverly Enterprises, the largest nursing home chain in the United States [Toshmo 1994, A1].]
Columbia-HCA intends not to dominate a market; rather, it intends to create a significant presence in each market [Greene 1993, 2]. Its strategy of threatening to lower prices by reducing costs as a result of merging has forced other hospitals within the same market to react, principally by merging with other hospital systems or by creating their own systems.
In 1987, the ten largest hospital systems (in terms of number of hospitals) controlled 13.9 percent of the total hospitals and 14.5 percent of the total beds. In 1987, the five largest hospital systems (in terms of number of hospitals) were: HCA with 4.5 percent of the total hospitals, the Department of Veteran Affairs with 2.2 percent, Healthtrust with 1.4 percent, AMI with 1.3 percent, and Humana with 1.2 percent. Since 1987, significant changes in the top five have occurred: Columbia and Galen in 1987 did not exist; HCA and Humana no longer exist as independent entities; AMI, after spinning off Epic Healthcare in 1988, moved its headquarters from California to Texas and currently is one-third of its former size; and in 1994 Healthtrust and Epic Healthcare merged.
In order to assess the impact of the recent merger wave on the health care consumer, it is necessary to construct a definition of the relevant market and a definition of market power.
Pertaining to the relevant market, logic suggests that a person's choice and hence the relevant market is limited to that person's immediate surroundings. Although the consensus is that the relevant market is smaller than a state [Ciscel and Chang 1987, 852], there is disagreement over the precise definition of the market.
Folland et al. argue that except for large urban areas, hospital market areas are likely to be larger than the Standard Metropolitan Statistical Areas (SMSAs); hence use of the SMSA to define the relevant market, except for large urban markets, will understate the degree of competition [1993, 663-65]. Zwanziger et al.  argue that use of political boundaries to define a market will overstate the degree of competition, since every hospital in the area is assumed to compete with every other hospital; in actuality, most hospitals have markets that are rather small [1994, 436].
Zwanziger et al.  present a procedure for determining the geographic market area for any given hospital, a procedure that we recommend for antitrust officials. However, our purpose is to ascertain the presence of hospital systems in urban areas and how their presence has changed in the last five years. The Zwanziger procedure is more appropriate for studying the effect of a single proposed merger/acquisition on competition in a relevant market and also for determining the extent of the relevant market for a single hospital, since it requires detailed interviews with hospital and insurance personnel.
We will use the SMSA as the relevant market, cognizant that the SMSA will overstate the actual degree of competition. Perhaps our results could provide the foundation for a more in-depth study of a particular market.
Neoclassical economists narrowly define power as the ability to raise price above marginal cost and rely on the concentration ratio and the Herhfandal index to ascertain if market power exists. Institutionalists reject this narrow conception of power and utilize a broader definition, "[the] ability to influence the way the economy operates to carry out the tasks assigned to it" [Klein 1987, 1343]. Institutionalists criticize use of the concentration ratio for ignoring important dimensions of economic power [Dugger 1985, 345]. Specifically, if firm A is obtained by a system located outside of the market, no change will be recorded in the concentration ratio. However, firm A, as part of a system, has more power than an independent hospital [Brown and Lewis 1976, 293-94].
Reliance on concentration ratios to ascertain the existence of power can lull observers into complacency [Dugger 1985, 344] since they obfuscate power relationships: a hospital within a system has access to the resources of its parent and is influenced by the attitude of its parent toward pricing and competition. The structure of a hospital system allows each member hospital the ability to shift resources across the markets in which it operates.
It is this ability to shift resources that gives the hospital within a system its power, irrespective of whether it has market power in any one market in which it operates [Edwards 1955]. As institutionalists well know, this power to shift resources is unavailable to the independent firm [Edwards 1955; Dugger 1985]. In addition, as more hospitals join systems, it becomes difficult for the remaining hospitals to compete, thus increasing the probability of independent hospitals joining existing hospital systems or creating hospital systems of their own.(15)
In concurrence with the institutional criticism, we nevertheless calculated concentration ratios for the 21 largest urban areas and present the results in Table 2. We find a wide range in concentration ratios: from a low of 15.3 percent in Chicago to a high of 71.2 percent in Westchester. The mean for the 21 urban markets in 1992 is 30.5, an increase of 13 percent during the five-year period,(16) although not all markets experienced an increase. Only two markets - Cleveland and Westchester - have four firm concentration ratios greater than 40 percent.
Table 3 illustrates the number of hospitals and the number of hospital beds controlled by a hospital system within each of the 21 urban markets. We feel this is a more efficacious indicator of the presence of systems in the relevant market than the concentration ratio. In all but four markets, the total number of beds decreased during [TABULAR DATA FOR TABLE 2 OMITTED] [TABULAR DATA FOR TABLE 3 OMITTED] the five-year period - an indication of the reduction in excess capacity that has been occurring in the industry.(17)
In 1992, the mean for system-owned hospitals was 46.4 percent, an increase of almost 4 percent since 1987; however, not all markets experienced an increase: Atlanta, Chicago, Dallas-Ft. Worth, Houston, West and East Los Angeles, Miami, Northern New Jersey, Seattle, and Tampa-St. Petersburg all experienced significant decreases. The percentage of hospitals owned by systems varies widely: from a low of 14.3 percent in Westchester to a high of 85.4 percent in Phoenix.
It is interesting to note that the mean for system-owned beds increased by almost 10 percent during this period. However, six markets experienced a decrease: Dallas-Ft. Worth, East Los Angeles, Northern New Jersey, San Francisco, Seattle, and Tampa-St. Petersburg.
Based upon this data we suggest that any proposed reforms account for the presence of systems and the significant presence of systems in some markets, i.e., San Diego, West Los Angeles, Phoenix, Detroit. As John Munkirs [1985, 218] has noted, "Fundamental reforms that are not soundly based on the economy's structural and functional realities, no matter how well intentional the reformers may be, will simply not work."
Table 4 presents the percent of total hospitals that are for-profit in each market. A wide range exists: from a low of 4.7 percent in Pittsburgh to a high of 71 percent in Houston. We feel that a significant presence of for-profit hospitals in a market acts as a catalyst for nonprofit hospitals to reduce costs and consolidate operations, thus forcing the nonprofit to act on relatively narrow grounds. This is not the only factor affecting the economic behavior of nonprofit hospitals: since debt has become the primary source of capital for both IO and nonprofit hospitals, nonprofit hospitals are also pressured by the financial markets to perform well [Gray 1991, 4].
Data in Table 4 indicate that the pressure on nonprofit firms emanating from a significant presence of for-profit hospitals differs widely among the urban markets. Table 4 also lists the percent of total beds owned by the four largest systems in each market. Markets with a strong presence of systems also have a high percentage of total beds owned by the four largest systems. Markets that have experienced a decrease in total beds owned by systems have also experienced a decrease in the percent of beds owned by the four largest systems.
Irrespective of whether health care legislation is passed, structural changes are occurring in the industry, and policymakers must be cognizant of these changes. This paper documented the current structure of the hospital services industry and the beginning of a new wave of mergers and acquisitions among hospitals.
[TABULAR DATA FOR TABLE 4 OMITTED]
As of this writing, none of the health care proposals regulate or counteract the power of the rapidly developing IO hospital systems and by the time health care legislation is enacted, it might be too late since the systems will become important interest groups, decreasing the probability of any radical change.
Should we be concerned about the current merger wave? Yes, for several reasons. First, the IO hospital systems have become powerful interest groups at both the federal and state level(18) and will be a significant force as the health care debate continues. As time passes, they will be able to thwart radical change; and if change is inevitable, the systems will be able to fashion it in their own interest.
The Clinton administration eschewed a strong role for the government in harnessing the power of the new systems to the public interest, accepting instead the argument of industry that increased consolidation will result in economies of scale and hence lower costs. But, as Ciscel and Chang [1987, 847] warned several years ago, ". . .the implementation of a competitive strategy that relies heavily on private initiatives can easily fail unless public policy prevents the appearance and exercise of monopoly power . . ."
Second, the larger IO hospital systems are becoming part of the planned sector of the economy in which pricing decisions are made not by market forces, but by corporate planning [Munkirs 1985; Munkirs and Knoedler 1987]. Critics of government involvement in health care argue that the private sector is more efficacious in the provision of health care; however, a private planning sector is rapidly developing, motivated by profit, and is substituting private planning for public planning. As Munkirs and Knoedler [1987, 1703] have argued, (paraphrasing Veblen), ". . . until this opaque fact is made more transparent - our captains of planning will continue to plan, and to plan primarily according to their own self interest." As time passes, the government will be less able to control the direction of the private planning sector.
Third, the structure of the IO system facilitates the transfer of capital within the system, thus increasing the strength of the hospital vis-a-vis other groups such as workers, unions, and communities. An IO hospital is primarily responsible to its shareholders: if revenues fall below expectation, investors can shift resources elsewhere to earn a higher rate of return [Stevens 1989, 360]. The structure of an IO hospital system facilitates the transfer of resources across markets and hence increases the probability of a hospital closure [Starr 1982, 436].
Although earlier studies conducted on hospitals indicate a very low probability of closure within an IO system [Hoy and Gray 1986], such a possibility cannot be dismissed during the current merger wave, since different economic forces are at work.(19) As a case in point, Columbia-HCA has indicated that a primary motivating factor in acquiring hospitals is to reduce excess capacity.
Fourth, the locus of decision making on issues such as hospital budgets, capital investments, personnel, etc., has shifted toward corporate headquarters. The IO hospitals have also adopted standardized management and accounting procedures and performance review measures [Starr 1982, 432]. The transformation of the locus of decision making and the introduction of standardization procedures not only attenuates the physicians' sovereignty [Starr 1982, 445-47], but raises the issue of whether medical decisions will be made in the best interest of the patient and whether adequate medical care will be provided for the indigent.
We are alarmed that none of the current health care proposals contain any provisions for dealing with corporate power and that the Clinton administration has given a carte blanche to the industry to consolidate. We urge that future debate on health care reform focus on the increased presence of IO hospital systems.
We suggest the protection and strengthening of the nonprofit hospital as one method to counter the power of IO hospital systems. This suggestion was made by William Dugger, although not in the explicit context of the hospital industry, to counter the growing hegemony of the corporation [Dugger 1989, 171]. Other researchers in the health care field have urged (for different reasons) the protection and the strengthening of the nonprofit hospital, either because of its traditional values (the emphasis on service and meeting patient's needs rather than making a profit) or because of the benefits of competition between different types of firms [Starr 1982, 434; Stevens 1989, 361; Gray 1991, 324].
We are cognizant of the difficulties in implementing such a proposal - especially the difficulty in obtaining funding, and that it contravenes the popular movement toward privatization. We are also cognizant of the ". . . rise of the corporate ethos in medical care which has permeated voluntary hospitals . . ." [Starr 1982, 448]. This has forced many nonprofit hospitals to establish for-profit subsidiaries and to diversify into other businesses [Starr 1982, 436-39]. Nevertheless, we urge that such a proposal be given serious consideration, for as Relman [1992, 106] has argued,
Medical care . . . is in many ways uniquely unsuited to private enterprise. It is an essential social service, requiring the involvement of the community and the commitment of health care professionals. It flourishes best in the private sector, but it needs public support, and it cannot meet its responsibilities to society if it is dominated by business interests.
Finally, institutionalists should conduct empirical studies on the extent of the loss of control in IO hospitals and how this has affected the morale, productivity, wages, and working conditions of the nurses, doctors, technicians, orderlies, and other hospital workers. Future research should also investigate the extent of vertical mergers and the pricing policies (and other practices) of the IO systems. Any such studies will be a welcome addition to the health care debate.
1. For a more thorough discussion of the historical development of hospitals, see Kett , Shyrock , Starr , and Stevens .
2. Hospitals also increased in number during this period from 178 in 1872 to 4,000 in 1910 [Starr 1982, 219].
3. By 1981, hospitals received more than 70 percent of their operating budgets from debt capital and only 8 percent from philanthropy and grants [Erman and Gabel 1986, 477].
4. This is the definition used by the American Hospital Association (AHA), although it is not the only definition in the literature. Erman and Gabel define an IO system as "three or more hospitals that are owned, managed, or leased by a single IO organization" [1986, 474]. Roice Luke defines a local hospital system as "an organization that operates two or more hospitals within a metropolitan statistical area; and hospitals within each local system must be located less than 60 miles from a flagship hospital" [Greene 1993, 3]. We prefer the AHA definition since it is coterminous with our definition of power, as will be explained in the text. We feel this definition is superior to the other definitions: The Erman and Gabel definition lumps a two-hospital system in the same category as an independent hospital; and the Luke definition restricts a local system to one where the hospital is within 60 miles of a flagship hospital.
5. The first hospital to operate as a system was Youngstown Hospital in 1929. The second hospital to operate as a system was Detroit Grace in 1942 [Brown and Lewis 1976, 28]. See Brown and Lewis  for a good discussion of the early hospital systems.
6. In September 1984, Hospital Corporation of America owned 200 hospitals (2.9 percent of the total), American Medical International owned 115 hospitals (1.7 percent of the total), Humana owned 87 hospitals (1.3 percent of the total), National Medical Enterprises owned 47 hospitals, and Charter and Republic each owned 24 hospitals; the last three corporations owned less than 1 percent of the total number of hospitals respectively [Gray 1991, 35; Statistics 1988, 2].
7. Hospitals, during the mid-1980s, acquired psychiatric and substance abuse centers, which were exempt from the prospective payment system and began to vertically integrate, acquiring in addition to the above: nursing homes, alcohol treatment centers, home health services, etc. [Gray 1991, 41-45; Erman and Gabel 1986, 476].
8. During the period 1980-1992, there were 16 mergers and acquisitions among hospitals per year on average [Burda 1993, 3]. Data for 1993 and 1994, when it becomes available, will document, it is widely believed, a substantial increase in the number of mergers and acquisitions.
9. It should be pointed out that increases in medical care prices do not necessarily reflect improvements in the quality of care nor changes in the total cost of treating an illness; thus, prices can overstate the true effect felt by the consumer. In addition, the medical care price index includes the cost of a hospital visit rather than the cost of a hospital stay and the list price of drugs, which few people pay [Reischauer 1993, 22-23].
10. The first HMO was started during World War II in California for shipyard workers displaced from their home physicians. In 1973, Congress passed the Health Maintenance Organization Act - with amendments in 1976 and 1978 - encouraging the development of managed care. See Folland et al. [1993, 298-319] and Herzlinger [1992, 460-61] for a good discussion of HMOs. Membership in HMOs is expected to reach 50 million in 1994 [Anders and Stout 1994, A1], an increase of 11 million in just two years [Scofea 1994, 4]. In 1970, 3 million people were enrolled in HMOs [Folland et al. 1993, 301].
11. A summary of the Clinton health care proposal can be found in White House Domestic Policy Council .
12. These studies relied on data collected prior to 1984, when the motivation of the hospital was to maximize reimbursement rather than to reduce cost [Erman and Gabel 1986, 480].
13. The Federal Trade Commission and the Justice Department, under the Clinton administration, have continued the laxity toward mergers and acquisitions among hospitals that was apparent during the Reagan and Bush administrations. Data indicate that during the period 1981-1993, only 3 percent of the proposed mergers and acquisitions were challenged, settled, or withdrawn [Burda 1994, 6].
14. The recent merger between Columbia and HCA gives the new company 20 percent of the Florida market and is expected to further consolidation in Florida [Greene 1994, 3].
15. For example, the merger of Rhode Island Hospital and Miriam Hospital - the largest two hospitals in the city of Providence - greatly increased the motivation of competitors to merge or affiliate in order to lower costs [Freyer 1993, A1].
16. There are two reasons why 1987 was chosen as the base year of comparison. First, the latest year for which data is available is 1992, which allows a five-year comparison. Second, 1987 is far enough removed from the recent acceleration of mergers and acquisitions.
17. In 1992, only 65.6 percent of total hospital beds were occupied in the United States [Statistics 1993, xxxvii], indicating that excess capacity is about one-third of total beds. Reduction of excess capacity in individual markets has been a motivating factor in the recent acquisitions of Columbia.
18. As an example, Columbia-HCA has 26 paid lobbyists at the Florida state capital working on (among other issues) tighter restrictions on nonprofit hospitals - the primary competitor of HCA and the chief target of acquisition [Toshmo 1994, A1].
19. Declining admissions and reduced patient stays (due to increased pressure to reduce costs) have forced many hospitals to cut staff and in some instances to close. For example, in Milwaukee, admissions have decreased by 6.4 percent, and patient days have decreased by 18.5 percent since 1984, resulting in the closure of nine hospitals [Sharma-Jensen 1994, D1]. A suggested study is to investigate whether the probability of closure is greater for a hospital that is part of an IO system.
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Jack Reardon and Laurie Reardon are Associate Professor of Economics, University of Wisconsin-Stout, and an independent health care consultant based in Milwaukee. A preliminary draft of this paper was presented at the 1994 Annual Conference of the Western Social Science Association in Albuquerque, New Mexico. The authors thank conference participants and two anonymous referees for helpful comments.…
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Publication information: Article title: The Restructuring of the Hospital Services Industry. Contributors: Reardon, Jack - Author, Reardon, Laurie - Author. Journal title: Journal of Economic Issues. Volume: 29. Issue: 4 Publication date: December 1995. Page number: 1063+. © 1999 Association for Evolutionary Economics. COPYRIGHT 1995 Gale Group.
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