Hospitals Get Serious about Operations

By Mango, Paul D.; Shapiro, Louis A. | The McKinsey Quarterly, Spring 2001 | Go to article overview
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Hospitals Get Serious about Operations

Mango, Paul D., Shapiro, Louis A., The McKinsey Quarterly

The income statements of hospitals have been ailing. The cure? Serious attention to operating efficiency.

Walk into most hospitals in the United States today, and you observe NW a true logistical anachronism. Patients arrive in the admissions area at 5:00 in the morning, only to wait two hours before they are checked in and two more before someone preps them for surgery. At lunchtime, the traffic jam spills over into the operating rooms, where patients routinely arrive late because of the admissions delays. The surgeons, anticipating this, come later than scheduled for operations in order to avoid wasting time. By midafternoon the bottleneck has shifted to the recovery area and the intensive care unit (ICU), forcing groggy patients to wait back in the operating rooms. Frederick Winslow Taylor was worrying about inefficiencies of this kind in factories a century ago.

To understand why such problems persist in health care, you must go back at least to the mid-1980s. In those days, insurers still paid whatever fee hospitals demanded, and federal and state governments still subsidized the expansion of capacity by adding a "capital pass-through" term to their Medicaid and Medicare payments. Although much of US industry was applying modern logistics techniques, hospitals--like many service providers--felt no competitive pressure to do so.

Hospital care becomes a commodity

In the late 1980s, managed-care organizations began negotiating lower fees and sharper incentives. Medicaid and Medicare followed this lead--a transformation that culminated in the Balanced Budget Act of 1997. In reaction to this more austere environment, the $400-billion-a-year hospital industry made almost every large-scale change it could think of, from mergers and acquisitions to slash-and-burn cost cutting. A few hospitals even launched their own insurance plans. But none of these measures worked very well. Mergers in particular neither improved the productivity of hospitals nor helped them achieve enough local-market bargaining power to offset the influence of either the mammoth health maintenance organizations (HMOs) or the essentially bargain-proof federal and state governments of the United States. Meanwhile, at least in many of the hospitals we have seen, reimbursement rates per unit of activity dropped markedly in the latter half of the 1990s (Exhibit 1).

Competitive prices were accompanied by price structures that rewarded fast turnaround times. No longer would HMOs and the government pay hospitals on a "per-patient, per-night" basis; instead, they began paying largely by the illness. That and other related changes led to a sharp decline in the proportion of patients who spent the night in a hospital bed and to shorter stays for those who did (Exhibit 2). This shift in patient activity to the front end of the process placed huge demands on those parts of hospitals that deliver acute care: the emergency rooms, the operating rooms, and the ICUs. Such demands led in turn to the bottlenecks and long delays those departments endure today.

Once upon a time, the chief executive officers of many hospitals would have responded by expanding capacity: new operating rooms, for instance. But these days, many hospitals are already losing money on ongoing operations, so CEOs naturally shy away from capital-intensive expansion for fear of losing still more. The few who want to expand find that debt markets are far less welcoming to hospitals than they were in bygone years. Just in the past 18 months, the ubiquity and seriousness of these problems have become clear to people in the industry. The average US hospital runs its operations in the red, suffers from overcrowding in critical areas, and can't expand without ratcheting up financial risk.

What will help hospitals escape this quandary? The answer is the one cure that their CEOs have been too distracted to attempt: detailed, day-to-day attention to operations and logistics.

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