Chapter 12:The Hospital Industry

Learning Objectives

• In this chapter, you will learn about:– the role of managed care and prospective

payment as incentives for hospital efficiency– how inefficient hospitals become prime

targets for acquisition by multihospital chains– how competition led to a medical arms race in

the 1980s and cost efficiencies in the 1990s

A Brief History of American Hospitals

• Three important factors served to transform hospitals into the modern medical institutions they have become today: the germ theory of disease, advances in medical technology, an increased urbanization– The development of the germ theory of disease,

first articulated by Louis Pasteur in 1870, revolutionized the treatment of diseases

– Now, hospital technology—especially advances in surgical and diagnostic imaging—provided physicians with the tools that would revolutionize medical intervention

– Urbanization, also played an important role in the centralization of medical facilities

A Brief History of American Hospitals

• When hospitals were financed through taxation and philanthropy, patient fees were only of minor importance– As middle-class use of hospital services

increased, changes in financing were inevitable

• What has become to be known as the modern hospital began to emerge in the twentieth century

A Brief History of American Hospitals, continued.

• 1900–1915: The Flexnor Report (1910) served as a pointed condemnation of medical education. In its wake, bogus medical schools were closed, standards became more stringent, and the goal of scientific medicine was employed

• 1920s: Continued reforms were aimed at driving incompetent physicians out of the profession

• 1930s: The reliance on patient fees caused severe financial problems for hospitals during the Great Depression– The introduction of private health insurance during the

decade would transform medical care financing. – The decade also saw a revolution in pharmaceuticals

• 1940s: Wartime demands resulted in a sharp increase in the number of physicians and nurses in training – The passage of the Hill-Burton Act in 1946 dedicated the

government to replacing the aging hospital infrastructure

A Brief History of American Hospitals, continued.

• 1950s: Vaccines against polio and rubella marked the true beginning of high technology medicine

– These developments, combined with the widespread use of antibiotics, helped change the image of medicine

– Advances in medical research tools highlighted the decade

– 1960s: Congress created Medicare and Medicaid, making the federal government the major purchaser of healthcare services

– The decade also witnessed the beginnings of the investor-owned, for-profit hospital system

A Brief History of American Hospitals, continued.

• 1970s: Explosive growth typified the medical care system– New hospitals and clinics, medical school admissions,

foreign-educated doctors, open heart surgery, transplants, and helicopter ambulances were widespread

– The intensity of medical interventions also increased dramatically

• Intensive care units (ICUs) became widely used• Trauma centers were established in most areas

– All the developments of the 1970s shared one thing in common: they were all expensive

A Brief History of American Hospitals, continued.

• 1980s: By 1982, healthcare expenditures exceeded 10 percent of gross domestic product for the first time

– Medicare initiated a new hospital reimbursement method based on the diagnosis, rather than the services performed

• 1990s:  Managed care has been the dominant factor affecting medical care delivery during this decade– Hospitals are no longer the revenue generators they

once were, but instead they have become cost centers– Horizontal integration—characterized by hospital

mergers and consolidations—transformed an industry once highly fragmented with many stand-alone facilities, into one where multihospital systems are common

The U.S. Institutional Setting

• Hospital Classification– Hospitals are classified according to the length of

stay, the major type of service delivered, and the type of ownership

• Community Hospitals– Under the current classification method adopted in

1972, a community hospital is defined as a short-stay hospital, providing not only general services, but also specialty care, including obstetrics and gynecology; eye, ear, nose and throat; and rehabilitation and orthopedic services

– More than 85 percent of all nonfederal hospitals are classified as community hospitals.

The U.S. Institutional Setting

• Teaching Hospitals– About 20 percent of all hospitals in the United

States have an affiliation with one or more of the nation’s 125 medical schools and sponsor at least one residency training program

– More than 400 hospitals belong to the Council of Teaching Hospitals of the Association of American Medical Colleges

– Most of the teaching hospitals are located in major metropolitan areas with populations in excess of one million

Structure of the Hospital Market

• Economics predicts that competition in most markets improves economic welfare– This improvement in economic welfare comes

as a result of lower prices, improved efficiency, and higher quality

– Competition may be viewed from the perspective of how well a market fits the characteristics of the perfectly competitive model

• Hospital markets may not fit the competitive model very well because so many of the structural characteristics of perfect competition are violated

The Tend Toward Multihospital Systems

• The Theory of Consolidation– Mergers, acquisitions, and other forms of

consolidation occur in the hospital industry for the same reasons that they occur in any other industry

– Firms are said to experience economies of scale when the long run average costs fall as the size of the operation expands• If economies of scale are to result in

improved efficiency, a number of technical advantages must be realized because of increased size

Summary• Hospital care tends to be the most expensive

aspect of healthcare delivery • Dominated by the private not-for-profit hospital, the

industry is responsible for more than one-third of all healthcare spending

• The changes that began in the 1980s pushed hospitals to become competitive and profit oriented– This corporate mentality has led to extensive

local marketing, leveraging debt, multihospital chains, and administrators earning salaries rivaling corporate executives

Chapter 13: The Pharmaceutical Industry

Learning Objectives

• In this chapter, you will learn about:

the underpinnings of pharmaceutical drug pricing– how the government intervenes to promote

the safety of the population– the health of the market for prescription drugs

Drug Costs • This chapter will help you to understand why drugs

are priced as they are and to evaluate the pros and cons of government regulation of the pharmaceutical industry

• An understanding of the biopharmaceutical industry requires us to study its market structure, pricing policies, the effects of government regulation, the effects of cost-containment strategies of third party payers, and the role of international competition

• We will also consider the effects of new drugs, insurance coverage, and advertising on the demand for prescription drugs

The Importance of Pharmaceuticals

• Even though pharmaceuticals still make up only a small fraction of total healthcare expenditures, the proportion devoted to these products has been increasing rapidly in recent years

• Increases in expenditures are partly the result of price increases and partly a result of increases in quantity utilized – The increase in quantity is a mixture of higher

utilization of existing drugs and the purchase of new pharmaceuticals

Market Structure

• Effects of Firm Size on Research & Development Productivity– Larger firms which conduct more

research projects tended to also have more productive research programs • Larger firms were also found to be

more likely to undertake research that integrates process and product development

Government Regulation of the Pharmaceutical Industry in the United

States • Regulation by the Food and Drug Administration

– Federal regulation of the quality of drugs marketed in the United States began with the enactment of the Pure Food and Drug Act in 1906 that created the FDA

– The passage of the Kefauver-Harris Act[J1]  in 1962 greatly strengthened the FDA

• The Kefauver-Harris Act[J2]  required a more stringent regime of clinical testing to launch both NCEs and generic versions of drugs already on the market. The number of new drugs launched per year declined after 1962

• Smaller firms suffered a decline in both their research productivity and market share

Government Regulation of the Pharmaceutical Industry in the

United States• In 1971, the government added a proof of efficacy to the

requirements for the introduction of new drugs– Overall requirements became more stringent, and by

the 1990s the average time from first application to the FDA approval of a drug had risen to over nine years

• The following schedule shows the average time required for the development of an NCE in the late 1980s:– Discovery of an NCE– Preclinical animal testing– File application for authorization for human testing

(approximate time for discovery, preclinical and application approval: 3.5 years)

Requirement for Prescriptions (Rx)

• A second type of regulation intended to promote the safety of the general public is the requirement that a wide range of drugs be available to consumers only when prescribed by a licensed physician

• The argument that the requirement of prescriptions from physicians is not in the public interest is made more plausible when one observes the many near-equivalents to newer prescription drugs that are available without prescription in the over-the-counter (OTC) market

Demand for Pharmceuticals

• Effect of Increased Insurance Coverage for Prescription Drugs– Third party payment now routinely reimburses a

higher proportion of generic drug costs as opposed to brand name drugs in an attempt to make consumers and physicians more cost-conscious

– Medicaid also reimburses only the price of the generic drug when substitutes for brand name drugs are available• In this way, insurance companies can affect

the balance of generic and brand name drugs utilized by altering relative prices to consumers

Demand for Pharmceuticals

• Effect of Direct Marketing to Consumers– Since 1997, direct marketing of drugs to

consumers has been legal in the United States• This makes it possible for drug companies

to create a consumer demand for products that physicians might not otherwise recommend

– Direct marketing to consumers also provides a greater incentive to develop lifestyle products, such as treatment for hair loss or sexual dysfunction

Profitability of the U.S. Pharmaceutical Industry

• Profits are often thought to be higher in the pharmaceutical industry than in most other industries in the United States

• Because the proportion of cost devoted to R&D and the rate of technological change are substantially higher in the pharmaceutical industry than in most other industries, the return on equity tends to exaggerate the profitability of pharmaceutical firms, given the way R&D expenditures are treated on corporate balance sheets

• Even in the case of drugs that receive FDA approval, only a small proportion provide enough revenue through sales to cover the R&D costs incurred in their development

Summary

• At the end of the twentieth century, the United States still led the world in the development of new pharmaceuticals, although the costs of developing new drugs had risen dramatically at the same time that managed care imposed downward pressure on the domestic prices of new drugs

• The flow of new products continues to stimulate demand for pharmaceuticals, as does the increase in third party prescription drug coverage