Stanford News

3/17/97

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Merger mania in medical care not likely to continue, economist says

The pace of mergers among health care institutions is likely to slow or even reverse direction, Stanford economist Victor Fuchs writes in the March 19 issue of the Journal of the American Medical Association.

Fuchs, who has written a number of books on health care, says the recent rapid consolidation of hospitals, clinics and small private practices into larger, mostly managed-care systems was fueled by economic forces that have largely been spent. He lists three forces driving recent medical mergers, alliances and acquisitions:

The stock market is still high, but Fuchs concludes that the other two forces targeted to the health field have subsided. More managers have learned how to function effectively in the new environment, and the consolidations have led to more efficient use of hospital rooms, expensive equipment and specialized physicians.

"The easy pickings are over, and squeezing the incomes of physicians and other health care providers can only go so far," he said in an interview.

Some of the mergers, alliances and acquisitions of the last few years may even break up, he said, "as competition reveals that some organizations have grown too large to be efficient." While consolidation allows economies of scale, he said, the lesson from other industries is that such economies do not increase forever. "Diseconomies of scale often lead to breakups, spin-offs, contracting out and sales of parts of organizations to others," he said.

Finding an efficient size may be more problematic in the health care field than in many others, he said, because what is efficient for one type of care is not for another and can change as new technologies develop. For example, "the scale required for an efficient perinatal service is orders of magnitude larger than the one required for efficient well-baby care because of differences in the importance of specialized equipment and personnel and differences in the predictability of the demand for services."

Despite a recent backlash against managed care, Fuchs said he believes it is here to stay because it has been successful at bringing costs under control. In the 30 years before 1990, health expenditures were rising annually at double the rate of spending in the rest of the economy and threatened to consume 30 percent of the nation's total output of goods and services within 30 years unless something was changed.

The managed-care model rapidly transformed the system from one where most insured patients freely chose among available providers and most hospitals were stand-alone organizations to one where the purchasers of health insurance negotiate fees and prices in advance, patients face financial penalties if they seek care "out of plan," physicians' decisions are subject to outside review, and management and providers often share in the insurance risk.

"Spending has been slowed in three ways: reducing services to patients, providing services more efficiently and squeezing the incomes of physicians and health care providers." Some of the eliminated services "probably did more harm than good" while others probably provided benefits to patients "but if the costs are high relative to those benefits, managed care performs a useful social function in eliminating them," he wrote. Some services whose benefits exceeded their cost may also have been eliminated, he said, which serves only the short-run profits of the managed-care organization.

"In the long run, and with adequate information, even a profit-maximizing organization will want to provide cost-effective services and society will want them provided," he said.

"The challenge is to discover, through trial and (not too much) error, what forms, types and scales of organization can do the most effective job of managing care for the benefit of patients and society as a whole."

The private sector will determine most of the outcome, he said, but only the government can cover the uninsured. Public policymakers also should try to encourage managed-care institutions that are led by physicians and take other steps to preserve professional norms for health care. Professional norms are more important in health care than in most industries, he said, because the substantial knowledge gap between doctors and their patients makes it difficult for consumers to make decisions about health care on their own.

Governments at all levels should also "view with suspicion" mergers and acquisitions that allow an organization to dominate a market, Fuchs said. As with banking, it is possible for some organizations to become so large that government officials will feel forced to bail them out with taxpayer subsidies, should they look like they are about to fail. "This may have played a role in New York State's decision to provide a cash infusion to Empire Blue Cross in 1993," he writes.

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By Kathleen O'Toole