MINI-REVIEW:
EXPERT OPINIONS
Specialization and Its Discontents
The Pernicious Impact of Regulations Against Specialization and Physician
Ownership on the US Healthcare System
Regina E. Herzlinger
Downloaded from http://circ.ahajournals.org/ by guest on June 16, 2017
K
en Iverson, a technology entrepreneur, almost singlehandedly revived the moribund US steel industry.
His success contains important lessons for health
care. Nucor, the steel-focused factory Iverson managed,
differed from the everything-for-everybody steel behemoths
of yore, like Bethlehem Steel, with its specialty steel products
and relatively small mini-mills, as did his egalitarian, productivity-based management practices. Nucor paid its nonunionized workers like owners, primarily with productivitybased incentives. In contrast, Bethlehem Steel’s unionized
workforce was paid wages, largely regardless of their
productivity.
The results of this revolution in focus and incentives?
Nucor required 1 man-hour per ton of steel and Bethlehem
2.7; Nucor’s workers earned $60 000 ($40 000 from bonuses), and Bethlehem’s $50 000; and Nucor was highly
profitable, earning $100 million in recessionary 2002,
whereas Bethlehem lost $2 billion.1
Nucor did good for its customers, employees, and the US
economy, and it did well for its shareholders, including Ken
Iverson, currently hailed as the second Andrew Carnegie of
the industry.
Sadly, were Iverson a cardiologist or cardiac surgeon, he
could not create the “do good– do well” healthcare-focused
factory equivalent of Nucor.2 Rival everything-for-everybody
hospitals would allege that he was robbing them of their most
profitable business, leaving them with the money-losing
dregs, while federal government regulations would inhibit
doctors’ ownership stakes.3
The combination of negative press and legislative prohibitions creates daunting obstacles for productivity-minded entrepreneurial physicians. For example, MedCath, a partially
physician-owned heart hospital firm, spends up to $200 000
to counter hospital complaints per project per year.4 Not
surprisingly, relatively few focused healthcare facilities exist.
A 2003 study found only 92 specialized hospitals, fewer than
2% of the market, and, more importantly, other physicianowned facilities that integrate care are sparse.5
These results are unfortunate: Specialized healthcare facilities, partially owned by entrepreneurial physicians, represent
the best hope for a higher-quality and higher-productivity
healthcare system. The specialization integrates care that
consumers must now struggle to obtain from a system
organized by separate providers. Along the way, it reduces
costs. And ownership provides an important additional incentive for physicians to provide the best value for the money.
Specialization
When it comes to specialization, the question is not whether
to specialize but rather how to do it. There is widespread
agreement that the healthcare system should provide focused,
integrated care— especially for the victims of chronic diseases and disabilities who account for the bulk of costs.6
Where it does, the results are impressive. For example, when
Duke Medical Center offered an integrated, supportive program for congestive heart failure, annual treatment costs
declined by $9000, nearly 40%. Duke’s new model achieved
these cost reductions by improving participants’ health status—their hospital admissions and lengths of stay dropped,
The opinions expressed in this article are not necessarily those of the editors or of the American Heart Association.
From Harvard University Graduate School of Business, Boston, Mass.
Correspondence to Regina E. Herzlinger, Harvard University Graduate School of Business, Mellon Hall A3-3, Boston MA 02163.
(Circulation. 2004;109:2376 –2378.)
© 2004 American Heart Association, Inc.
Circulation is available at http://www.circulationaha.org
DOI: 10.1161/01.CIR.0000130782.33860.E0
2376
Herzlinger
Downloaded from http://circ.ahajournals.org/ by guest on June 16, 2017
whereas visits to cardiologists increased nearly 6-fold—and
not by restricting access to needed care or reducing providers’
payments.7,8 (From 1995 to 1999, physicians’ inflationadjusted net income dropped, in part because of such strategies.)9 In these ways, specialization helps both patients and
physicians.
But the paradigm for specialization that is currently
favored—top-down disease and/or care management, typically initiated by insurers— has demonstrated scant evidence
of efficacy.10,11 Although sparse, the evidence of specialistinitiated and/or specialist-owned programs is compelling. For
example, Dr Denton Cooley’s price for coronary artery
bypass surgery at his focused Texas Heart Institute center was
approximately 40% lower than the national average with a
case-mix whose severity was at least equal to the average.12,13
The reason is clear-cut: Specialist physicians are in the best
position to understand the needs of other physicians. Notes
the CEO of an orthopaedic surgery practice: “Orthopaedists
. . . in a hospital. . .work in the same operating room [as]
general surgery and obstetrics. Orthopaedics is nuts-andbolts-equipment intensive. It drives them crazy to have a staff
that’s not familiar with a tray of multisize screws and nuts and
bolts.”14
Physician Ownership
The robust US economy provides compelling evidence of the
relationship between ownership and productivity. The economy’s productivity growth bests that of all but smaller, newly
developing economies, such as Ireland or Hungary—a result
akin to a mature elephant’s outrunning a young cheetah.15
Small businesses, created by owner-entrepreneurs, are highly
productive—some becoming titans such as Microsoft, WalMart, or General Electric (founded by Thomas Edison)—
because owners are motivated to create the balance of quality
and efficiency that will increase their market share and profits
through satisfied repeat customers.
These incentives also appear to work in health care. For
example, one analysis found that physician compensation that
was based on net revenues was associated with lower costs,
whereas salary-based compensation was linked to higher
costs.16
Specialization and Its Discontents
Despite the obvious theoretical and practical benefits of
specialized, physician-owned systems of care, however, the
objections raised to them are valid. Because cardiology
accounts for 35% or more of a community hospital’s revenues, its absence will likely significantly damage a hospital’s
financial status.17 Similarly, the overuse that characterized
physician-owned imaging laboratories and physical therapy
facilities appears genuine and persuasive.18
Nevertheless, although the complaints are valid, the diagnoses of the causes of these problems and the resultant cures
are misplaced.
Specialization and Its Discontents
2377
Cardiology services are highly profitable primarily because
the third-party payers that unilaterally set prices have reimbursed them at wrongly generous rates. Conversely, other
services lose money because they set prices too low. The
solution is to fix the pricing mechanism so that prices are
neither excessively generous nor excessively stringent.
The only way to achieve such prices is to permit the market
to set prices and to strip insurance and government bureaucrats of this power. It is not that they are incompetent or venal
but rather that they are incapable of simulating market prices.
As a result, they make costly errors. For example, a 2003
analysis showed that overly generous prices for procedures in
hospital-based outpatient departments cost $1 billion more
than the prices for the same procedures in free-standing
surgery centers.19
Overutilization of services is caused by a system in which
a third party, rather than the user, pays for them. Users who
pay are more sensitive to the value for the money than are
third parties. One careful analysis revealed a 16% decrease in
volume for a 10% price increase in consumers’ payment for
health insurance. Patients were also sensitive to quality
measures, however. Providers who appeared to skimp on
quality to control costs lost patients.20
The best way to achieve user sensitivity to the cost of
services is to switch to a consumer-driven insurance system
in which users select from a wide array of products offered at
different costs. (Currently, in the United States, most large
employers offer a limited number of policies with nearly
identical features except for the cost and ease of reaching
providers.) For example, in the consumer-driven Swiss
healthcare system, one of the most popular insurance options
is a high-deductible policy in which enrollees are frequently
sent copies of their bills for the insured services they
received.21 (The Swiss have universal insurance. The government either gives citizens who cannot afford health insurance
funds or buys it for them.) The resulting transparency is likely
one of the major reasons that the costs of the excellent Swiss
healthcare system, as a percentage of GDP, are 10%, versus
14% for the United States.21
To sharpen these points, let us return to the steel industry
analogy to examine why integrated steel manufacturers did
not complain that Nucor was cherry-picking or act to restrict
Iverson’s ownership interests.
They did not complain that Nucor was stripping out their
most profitable products because prices were set by the
market. Free-market pricing makes it impossible to succeed
simply because the price is excessively high. For example, if
the price is so high that existing firms earn excessive profits,
new entrants will cut prices to gain market share and thus
reduce prices. In a free market, suppliers succeed because
they are productive, not because a third party technocrat has
mistakenly set their prices too high.
Buyers of steel do not complain that manufacturers are
foisting off unneeded steel. Because they pay directly for the
product, they buy only what they need.
2378
Circulation
May 25, 2004
Some may contend that the users of healthcare services
lack the expertise and clout of steel buyers. They should
consider the consumer-driven markets for complicated products such as cars and computers. Despite consumers’ lack of
expertise and group-purchasing clout, both products have
steadily improved in quality and decreased in costs.
Conclusion
Downloaded from http://circ.ahajournals.org/ by guest on June 16, 2017
The right solution for our healthcare system is to encourage
entrepreneurial physicians, not to bind them in regulatory
straightjackets. Creating the level competitive playing field
that would reward or punish them requires market-based
pricing of their services and a consumer-driven insurance
system.
Fortunately, both are becoming a reality. More than a
million Americans already are enrolled in consumer-driven
insurance products, and insurers such as United and Aetna are
offering panels of providers selected for their excellence and
competitive pricing.22–24
Let us cure our healthcare woes the good, old-fashioned
American way, with a market of competitive suppliers—
physicians and other providers—who know what they are
doing and empowered consumers who know what they are
buying and not with a thicket of regulations.
References
1. Henry K. Nucor sets pace for steelmakers. The Hamilton Spectator. May
13, 2002:D10.
2. Herzlinger RE. Market-Driven Health Care. Cambridge, Mass: Perseus
Books; 2000:173–182.
3. Fong T. Competitive risks: specialty hospitals criticized at Justice, FTC
hearings for endangering community facilities. Mod Healthc. 2003;
33:6 –7.
4. Herzlinger RE. MedCath Corporation. Boston, Mass: Harvard Business
School Publishing; 2003:4.
5. US General Accounting Office. Specialty Hospitals. Washington, DC: US
General Accounting Office; 2003:3.
6. Robert Wood Johnson Foundation and FAACT. A Portrait of the Chronically Ill in America. Princeton, NJ, and Portland, Ore: Robert Wood
Johnson Foundation and FAACT; 2002.
7. Snyderman R, Williams RS. The new prevention. Mod Healthc. 2003;
33:19.
8. Snyderman R, Williams RS. Congestive heart failure: comprehensive
heart failure teams reduce health care costs. Health & Medicine Week.
2000.
9. Behind the time: physician income, 1995–99. Medical Benefits.
2003;20:4.
10. Ferguson JA, Weinberger M. Case management programs in primary
care. J Gen Intern Med. 1998;13:123–126.
11. Boult C, Kane RL, Pacala JT, et al. Innovative healthcare for chronically
ill older persons: results of a national survey. Am J Manag Care. 1999;
5:1162–1172.
12. Edmonds C, Hallman GL. CardioVascular Care Providers: a pioneer in
bundled services, shared risk, and single payment. Tex Heart Inst J.
1995;22:72–76.
13. Herzlinger RE. MedCath claims to have saved Medicare $800 per discharge in 2000. MedCath Corporation. Boston, Mass: Harvard Business
School Publishing; 2003:22.
14. Hawryluk M. Congress eyes boutique hospital backers. Am Med News.
May 12, 2003: 6.
15. US Bureau of the Census. Statistical Abstract, 2001. Washington, DC:
Government Printing Office; 2001. Tables 1342 and 1344.
16. Kralewski JE, Rich EC, Feldman R, et al. The effects of medical group
practice and physician payment methods on costs of care. Health Serv
Res. 2000;53:591– 613.
17. Devers KJ, Brewster LR, Ginsberg PB. Specialty Hospitals: Focused
Factories or Cream Skimmers? Washington, DC: Center for Studying
Health System Change, no. 62, April 2003.
18. O’Sullivan J. Health Care: Physician Self-Referrals, “Stark I and II.”
Washington, DC: Congressional Research Services 7-5EPW; December
6, 1996.
19. Office of the Inspector General. Payment for Procedures in Outpatient
Departments and Ambulatory Surgical Centers. Washington, DC: OIG
Report OEI-05-00-00340; January 2003.
20. Harris K, Feldman R, Schultz J. The buyers health care action group:
consumer perceptions of quality differences. In: Herzlinger RE.
Consumer-Driven Health Care. San Francisco: Jossey-Bass; 2004.
21. Herzlinger RE, Parsa-Parsi R. Consumer-Driven Health Care: Lessons
from Switzerland. Harvard Business School Working Paper, 2003.
Available from [email protected].
22. Definity Health has partnered with Medco Health Solutions. Managed
Care Week. 2003;13:8.
23. Health Trust has agreed to make Lumenos product available. . .throughout New Hampshire. Managed Care Week. 2003;13:1.
24. Innovative Products Offer Narrow Provider Networks Targeted to High
Cost Diseases. Managed Care Week. 2003;13:4.
Specialization and Its Discontents: The Pernicious Impact of Regulations Against
Specialization and Physician Ownership on the US Healthcare System
Regina E. Herzlinger
Downloaded from http://circ.ahajournals.org/ by guest on June 16, 2017
Circulation. 2004;109:2376-2378
doi: 10.1161/01.CIR.0000130782.33860.E0
Circulation is published by the American Heart Association, 7272 Greenville Avenue, Dallas, TX 75231
Copyright © 2004 American Heart Association, Inc. All rights reserved.
Print ISSN: 0009-7322. Online ISSN: 1524-4539
The online version of this article, along with updated information and services, is located on the
World Wide Web at:
http://circ.ahajournals.org/content/109/20/2376
Permissions: Requests for permissions to reproduce figures, tables, or portions of articles originally published
in Circulation can be obtained via RightsLink, a service of the Copyright Clearance Center, not the Editorial
Office. Once the online version of the published article for which permission is being requested is located,
click Request Permissions in the middle column of the Web page under Services. Further information about
this process is available in the Permissions and Rights Question and Answer document.
Reprints: Information about reprints can be found online at:
http://www.lww.com/reprints
Subscriptions: Information about subscribing to Circulation is online at:
http://circ.ahajournals.org//subscriptions/