Academic journal article Contemporary Economic Policy

Economies of Scale and Scope: The Case of Specialty Hospitals

Academic journal article Contemporary Economic Policy

Economies of Scale and Scope: The Case of Specialty Hospitals

Article excerpt

I. INTRODUCTION

Economies of scale and scope as measured from cost function estimation have been a classic way for economists to evaluate whether and to what degree multiproduct arrangements, specialization, and firm size are generating production economies. When economies of scale and scope are not present, focused factories (Skinner 1974) can be a production design choice for simplifying an organization's operating tasks to promote production efficiency. The focused factory is commonly interpreted as having three intertwined dimensions of product focus, market focus, and process focus (Ketokivi and Jokinen 2006; Skinner 1974). Nevertheless, in the marketplace we observe wide variation in the scale and scope of organizations, sometimes even within the same industry. Recent empirical work (Bredenhoff, van Lent, and van Harten 2010; Ketokivi and Jokinen 2006; Mukherjee, Mitchell, and Talbot 2004) indicates that the viability of the focused factory concept is somewhat unique to each industry or industry sector based on its particular economic and technological characteristics.

The U.S. hospital industry offers a particularly interesting setting for estimating economies of scale and scope to test the viability of the focused factory concept. Historically, the U.S. hospital industry has consisted of several thousand general hospitals producing a diverse range of clinical outputs. More recently, however, the industry has witnessed the entry of a different type of hospital, one that is organized and managed to provide specific medical or surgical procedures (Schneider et al. 2008). Although the hospital industry has long included facilities that treat patients for specific medical conditions (e.g., rehabilitation or psychiatric hospitals), recent entries into the specialty realm are mostly small, physician-owned hospitals focusing on highly profitable services or procedures for either cardiac or orthopedic conditions. The emergence and growing prevalence of these single specialty hospitals (SSHs) is one of the most recent and prominent examples of the focused factory concept, a concept rooted in classical economic theory regarding the advantages of specialization dating back at least to Adam Smith's presentation of a pin factory (Smith 1776). These SSHs have all three of the focused factory dimensions of product, market, and process focus as they encompass just one physician specialty, operate in a single local market, and ordinarily rely on one key process (e.g., operations in the surgical suite) for their main product niche.

The emergence of SSHs has generated considerable controversy. Proponents of SSHs contend that the general hospital is an outmoded concept that is not aligned with technological advances in patient care and growing competitive forces within the health care industry (e.g.. Schactman 2005). Proponents also argue that through increased focus and specialization of services, specialty hospitals can perform with greater efficiency, promote innovation, and stimulate improved performance among local general hospitals (Greenwald et al. 2006; Porter and Teisberg 2006). Opponents challenge the argument that specialty hospitals can operate more efficiently than general hospitals, asserting that SSHs prosper largely by selecting healthier patients to undergo relatively highly reimbursed procedures (Hwang et al. 2007). In line with this perspective, commentators have suggested that SSHs may lack sufficient volume to capture the production economies necessary to function at levels of efficiency that are comparable to general hospitals (Newhouse 2004). Of course, these opposing arguments are not mutually exclusive so that these and other factors may interact in complex and unidentified ways to establish relative SSH benefits and costs.

The aim of this article is to compare U.S. general hospitals and SSHs with respect to economies of scale and scope. The results of our investigation are both important and timely given that the recently enacted U. …

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