A New Era of Tight Capacity, Part 1 of a 3-Part Series

By David Butz, PhD
Guest Blogger

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In part 1 of this series, Mike Donoghue interviews healthcare economist David Butz.

Mike Donoghue:
GE Healthcare Performance Solutions recently released a new patient care capacity management (PCCM) whitepaper entitled: Management 201: A New Era of Tight Capacity. David - could you explain why we felt the need for this paper, and even more importantly, why we focused on capacity?

Dr. David Butz:
I have long preached that most healthcare costs are fixed. They involve creating capacity and maintaining it 'at the ready'. By capacity, I mean all of the endowments of a state-of-the-art health system: brick and mortar, equipment, a highly-trained workforce, information technology, a network of ongoing relationships and organizational infrastructure, and many other 'hard and soft' assets. The expense of creating these endowments--or capacity--is massive. In contrast, the incremental cost of delivering care is relatively modest. Indeed, the answer to this country's rising healthcare costs is to be better stewards of capacity rather than merely brute-force rationers of care 'on the margin'. I am as zealous as anyone about cutting costs but for far too long we've been going about it in the wrong way.

In healthcare, costs are poorly understood. It's a fixed cost business governed by a purely variable cost, 'fee-for-service' business model. The underlying costs of capacity are obscured, and the disconnect is debilitating. As I tell my business students, the cost of listening to an iPod is incurred when you purchase it, and over time as you buy music, create play lists, and ready the iPod for use. Thereafter, listening to songs is essentially free. In healthcare, because we 'pay by the song', it appears that the way to save money is to listen to fewer songs--to ration care (and reduce utilization). I have bad news for those who manage their systems this way: third-party payers benefit from your efforts, but your system brings in less revenue while saving the system relatively little.

Like many, I consider our 'fee-for-service' business model to be a root cause of the industry's problems. In every other industry, prices reflect capacity costs--essentially, we pay more at peak demand times than off-peak. For example, taverns have happy hours; electric utilities charge more in the summer; natural gas costs more in the winter; and of course we know how the airlines charge. The University of Michigan charges more for a football ticket when the opponent is Ohio State than when it is Kent State! But in healthcare, we 'pay by the song', and it's the same price every day. If we play fewer songs, it doesn't matter because the savings appear the same. It doesn't matter whether we curb demand in the ED at 4pm when capacity is egregiously oversubscribed or at 3am when there is literally zero opportunity cost of the resources used. Rationing care does not lead to more effective utilization of fixed-cost resources.

So how do we move forward and appropriately manage our capacity? Let me be clear: it would be a very bad idea to adopt the peak-load pricing of other industries. Fortunately, there are many capacity management tools available--such as breaking bottlenecks and reducing 'batching' - which are simple, inexpensive, low-risk, and lead to sustained and often dramatic gains. Overall, there are huge opportunities for 'quick wins' that can build momentum for more ambitious efforts.

I enjoyed working with Jeff and Mike on this paper because I think it nicely blends first principles with GE's real-world experience. The three of us sense great urgency. A confluence of macroeconomic forces has created a perfect storm of capacity issues that reflect both over and under-utilization of our nation's healthcare resources. Our goal with this paper is to describe this perfect storm--according to economic principles and practical insights--and to highlight opportunities for improved capacity management.

So Mike, let me now ask you ... As clear as these fixed costs are to hospital and health system leaders, do they seem trapped by the 'fee-for-service' mindset? I'm curious, how do you redirect attention toward this capacity approach when the culture presently seems so focused on rationing care and reductions in utilization? Aren't these leaders getting mixed messages?

"A New Era of Tight Capacity" Blog Links:
A New Era of Tight Capacity, Part 2 of a 3-Part Series
A New Era of Tight Capacity, Part 3 of a 3-Part Series

For More Information
Poll: Why Is It Difficult To Find Beds For Patients In Your Hospital
Self Assessment Tool: Capacity Optimizer Tool


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