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STRATEGY #1
ACHIEVE A POSITIVE COST EXPERIENCE CURVE
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INTRODUCTION
Throughout
my career as a strategic planner I have subscribed to the belief that
in mature markets, the single most effective way to grow a business is
by being the low cost producer for a given level of quality. Assuming
reasonable symmetry of information, demand will literally shift down
the gradient toward the producer of lower than average unit costs.
There
is an immense body of knowledge in the fields of micro-economics and
managerial/cost accounting to support this belief. The question is what
leads one to believe that health care can be flipped from having a cost
experience curve where average unity costs are growing at 10% or more a
year to one with declining average costs. Isn't that a real stretch by
any imagination.
First, let's look at other industries. The
first discovery of the declining average unit cost phenomena was not in
competitive industries, like autos, but in the Defense industries by
Rand Corporation back in the 1960s. What they discovered was that as
manufacturer's moved down the learning curve, they became more
efficient due to better management and economies of scale and their
unit costs dropped. This was not a linear function but logarithmic in
that costs dropped dramatically over short periods of time.
As
students of the art turned their attention to various industries they
discovered the phenomena was widespread. In fact it was most widespread
in industries where technology was being deployed because of labor
savings and information process cost reductions. What had to be
factored into the analysis was not only inflation but also
technological improvement. It was not an apples to apples comparison if
you compared a 1922 Model T with a 1992 Cadillac.
The
enunciation of positive (declining) cost experience trends created a
whole new expectation. It meant we could truly expect more and better
in every industry, year after year. The dividends from this process
could be less price or more quality. The ultimate affirmation of the
Rand research came when Intel's founder articulated Moore's Law that
created the expectation that both performance and price would be
improved every 18 months. It has certainly followed in the computer
industry and there is not letup to be seen.
So, if this is the
case everywhere else, why don't we see this experience in health care
and education and government at large? Do the laws of gravity and
electro-magnetics apply to them or are they of a different cosmos? I
believe the reasons are identifiable, as follows;
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10 REASONS FOR HEALTH CARE'S NEGATIVE COST EXPERIENCE TRENDS
1. COTTAGE INDUSTRY-TOO SMALL SCALE
For all of the large hospital populating every community the fact is that many of these facilities are not scaled economically, provide too diverse services, and the physicians are in relatively small practices.
2. HIGH RATIO OF FIXED COSTS
The specialization of labor results in a high ratio of fixed costs that cannot be spread against high volumes because no one can grow to spread to fixed costs across a larger base.
3. DISCONNECT OF DEMAND BY INTERMEDIATION
The prevalence of third party payors has disconnected demand from the supply function. Even if a provider had lower prices for a known quality, demand would not respond and move down the gradient toward that provider.
4. ASSYMETRY OF INFORMATION
The lack of information in the market about price, quality and all other factors bounds rationality and creates a satisficing situation. This applies to both the demand and the supply side.
5. FRANCHISED OLIGOPOLY
The health care market is divided into cells that have grown up historically around hospitals and doctors in an area of the community. At best the market is divided between two major players and often only one.
6. COST SHIFTING BY THIRD PARTY PAYORS
The federal government's role as the 800lb gorilla and the concentration of demand in a few insurance companies has resulted in those payors using the rigid structure of the industry to shift costs to less powerful players. In the end the uninsured and self-pay patients are paying an average of 27% more than other payors.
7. MONOPOLY PROTECTION OF KEY TECHNOLOGIES
The federal government subsidizes almost all aspects of health care research and education and this development ends up in the hands of patent protected corporations. Key technologies such as new drugs, medical diagnostic and treatment technologies are then charged at a premium to generate more funds to engage in research of other drugs and medical technologies to further the existence of the parent corporation.
8. FRAGMENTATION OF DEMAND
Most of the new jobs are generated by millions of small businesses who buy health insurance through group health insurers. The large self-insured pools are shrinking as the industrial base of jobs shrinks.
9. NON-STANDARD INFORMATION SYSTEMS
The lack of standardization of the data sets has precluded an electronic patient record and information exchange ability. This has allowed control of information on health status to be kept proprietary and inefficient.
10. NEGOTIATED PRICES AND RISK HEDGING
The laying off of risk is not market competitive and prices are negotiated between major playes. In an efficient market, the "market" sets the prices and determines the penalties for risk aversion; it is not done by negotiation in the dark of the night by monopoly players.
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