Tuesday, January 03, 2012

Efficiency matters even in a high fixed cost industry

I have so much respect for the people at the Dartmouth Institute for Health Policy and Clinical Practice and the excellent work done there that I hate to quibble with their work.  But I fear that Stephen S. Rauh, Eric B. Wadsworth, William B. Weeks,  and James N. Weinstein have overstated an argument, and their view needs correction.

The problem is in a Perspective article in the New England Journal of Medicine, "The Savings Illusion — Why Clinical Quality Improvement Fails to Deliver Bottom-Line Results".  (Aside, thank you, NEJM, for allowing public access to articles of broad public interest.  When will others, like JAMA?) Here is the argument in a nutshell:

[The] management and organization [of the typical health care setting] create a rigid cost structure that is relatively insensitive to small changes in patient volume, resource use, or the severity of patients' health conditions. This fixed-cost dilemma leaves most health care costs insensitive to changes in volume and utilization, so clinical quality improvements typically create additional capacity rather than bottom-line savings. An examination of the different cost layers highlights the distinction between variable costs, such as supplies and medications, where reduced use produces true savings, and fixed costs, such as facilities and ancillary services, where the costs persist despite reduced use.

Because of the rigid cost structures, incremental reductions in resource use are unlikely to generate cost savings for either a health care setting or the health care system. The most meaningful way to achieve savings is to focus on overall reductions in utilization rates for health care services and to eliminate the associated unnecessary capacity.

The mistake the authors make is in presenting a static and incomplete view of cost savings and the financial interests of an individual firm, and also a narrow view of the societal advantages that are produced when an industry leader accomplishes cost reductions.  Indeed, by their logic, no firm in any industry characterized by high fixed costs would ever invest in efficiency programs and measures.

Two years ago, I gave an example from my former hospital's ICUs.  Our staff had accomplished a marvelous reduction in the rate of ventilator associated pneumonia.  We admittedly reduced clinical revenues for that "book of business" as a result.  If we had focused on that financial outcome, though, and chosen not to carry out the VAP reduction program, we would have been too limited in our view.  By reducing lengths of stay, we were able to avoid a huge bolus of new fixed costs:  The clinical capacity we created solved a growing congestion problem and enabled us to avoid the new fixed costs of an expanded ICU, along with the essentially fixed-cost staff, equipment, and supplies that would have been required for that addition.  Every firm faces capital constraints, and alleviating those constraints is as important a financial focus as what might be a short-term reduction in income.  

By the way, on the societal front, we could and did see more patients who would have otherwise gone to higher cost competitors.  That is also a common result in many industries.


Susan Shaw said...

I hate to quibble with you and the Dartmouth Institute authors, but an important piece of this discussion is still missing. We strive to improve quality because its the right thing to do. Once you accept that we allow many forms of harm to occur within our system, the cost arguments become less relevant. Can we face our patients and say, sorry, our financial analysts have taken a look at this - the return on investment for preventing hospital acquired infections just doesn’t meet our budgetary goals this fiscal year.

Yes, fixed costs are high in healthcare - expensive staff provide care in expensive buildings. And yes, hard dollars are only saved if you can actually reduce the amount of interventions, surgeries, diagnostic tests, and medications prescribed while at the same time improving the health of the population you serve (not just deferring a cost until the next budget cycle or beyond). But if the population you serve has an unmet need, being more efficient allows you to do more with the dollars/beds/nurses/tools you currently have. So yes, the total amount spent does not go down, but the value of what you do might just go up!

Tackling variation and appropriateness are where I think we will be able to actually make a significant impact on the amount of money spent in health care AND a major impact on the health of our patients. But the Dartmouth Institute know much, much more about that than I do!

Barry Carol said...

I’ll offer several thoughts on this.

1. In the long run, all costs are variable.

2. As you note, reducing or avoiding costs through improved efficiency can eliminate or at least defer the need to invest in expensive new capacity to serve a growing patient population. We’ve seen this concept work effectively in the electric utility industry.

3. Payers could help to align incentives to improve efficiency by moving away from the fee for service payment model in favor of bundled pricing for surgical procedures and risk adjusted capitation, at least for primary care.

4. Payers could also embrace reference pricing where appropriate. A good example is proton beam radiation for prostate cancer. If it’s no more effective than a less expensive approach, payers should limit their payment to the cost of the less expensive treatment. If providers can collect the difference from patients or their families, fine. Otherwise, they should think two or three times about participating in a cost-ineffective medical arms race.

wrinkledman said...

Susan, you took the words out of my mouth! Well not exactly. I would have said, using Paul's example, what about the fact that fewer people are getting unnecessary pneumonia? Healthcare ought not be a purely financial calculation, an assessment of profit centers. We are people! Are hospital administrators totally mad, mere ciphers or simply heartless?

Paul Levy said...

I don't want you to be left feeling that such would not be my main concern, too. I was just responding to the financial arguments made by these authors.

Indeed, there is a virtuous cycle between quality improvement and financial results. But the motivation for change has to come for clinical reasons, not financial ones.

Before other jump in, though, and say, "You see, that's why we need global payments," please recall that our success in reducing preventible harm and that of many others has been under a fee-for-service arrangement.

Peter said...

In defence of the author's conclusions, look at other industries with large fixed costs, namely automobile manufacture. The Big 3 clearly had problems but neglected to make changes until the Asian and European manufactures drove them bankrupt.

Bringing it back to healthcare, if we are able to introduce initiatives or changes that reduce a surgical procedure time by 10% this is insufficient to alter the cost of providing surgery. Assume a 10-hour surgical day and a 10% improvement in half the cases, this results in a 30 minute saving - which is not enough to schedule another case, nor reduce staff and overhead costs.

Quality should still be pursued because overall it will reap substantial benefits, but on a case-by-case basis it is difficult to argue the immediate financial impact will be beneficial.

This is also why quality should be a core value and not a separate department (and therefore somebody else's responsibility). I also want to stress the difference between quality and quantity - more tests, more interventions, more poking and prodding, etc. is not quality. If you can avoid an intervention you avoid the complications; if you avoid a diagnostic test you avoid the misinterpretion; if you avoid a prescription you avoid the ADR.

Paul Levy said...

I'm so glad you mentioned automobiles. The reason the Big 3 were left behind was because Toyota, in particular, was able to change work flows in its factories to improve efficiency, make better use of capacity, deliver a higher quality, lower cost product.

The point is not to look at this as a case-by-case issue, but to look at how work is organized in the organization, creating a large cumulative effect and a strategic advantage for the innovative firm.

Rauh et al said...

Paul Levy’s January 3rd blog post, “Efficiency matters even in a high fixed cost industry,” commenting on our recent NEJM article, states that by our logic, “no firm in an industry characterized by high fixed costs would ever invest in efficiency programs or measures.” We do not say that, nor do we believe it is a logical conclusion of our thinking. For instance, the VAP reduction program described in the blog post is obviously an excellent example of improved patient care and reduced resource use, which we applaud.

The purpose of our article is to encourage our colleagues to move beyond the simplistic business case models that typically rely on additional revenue from backfill patients to justify improvement projects and to suggest the cost-layering framework to attack the difficult task of dealing with the fixed cost dilemma. The layering framework offers a clear breakdown of cost behaviors (variable versus fixed) to help practitioners better understand cost and avoid the common practice of counting reduced utilization of fixed cost resources as “savings.” With payment reform just over the horizon, the opportunity to rely on volume growth to reduce cost-per-case may be nearing an end, and focus will need to shift to improvements that generate true bottom-line savings. We believe the cost-layer framework can be a useful tool to accomplish this goal.

Stephen S. Rauh
Eric B. Wadsworth
William B. Weeks
James N. Weinstein
The Dartmouth Institute for Health Policy & Clinical Practice

Jeff said...


Totally agree with your last comment. After spending time creating major redesigns with healthcare delivery at a large healthcare system, the keys are 1) designing new delivery models that increase value, 2) further improve or optimize models to maximal safety, outcomes, and cost, 3) Move these new models to lower fixed cost settings when safety can be validated with data. (Addresses cost layer 4 in their NEJM article)

There is no doubt that reducing utilization will be important to reduce healthcare costs, but we still have to design efficient models when appropriate medical intervention is needed. Thanks for your post.

Anonymous said...

Overgeneralized, sensational titles like this make my scientist hairs stand on end. Have we entered the tabloid era of academic journal competition?

Funny, that this one was open access.