Does the size of a hospital affect its efficiency? The evidence suggests that only for small hospitals are there economies of scale and larger hospitals may actually have diseconomies of scale. Evidence from the USA suggests that the optimal size of a hospital is around 190 beds. This suggests that, purely on grounds of cost, large hospitals should not be constructed. Of course, other relevant considerations, such as feasibility of staffing, might outweigh concern about efficiency.
When inefficiency is exhibited it may not be a result of the size of the hospital but operational inefficiency in the system. For example, bed days could be reduced and output maintained. This highlights one of the difficulties encountered when trying to assess the efficiency of hospitals – to assess whether a hospital is scale-efficient you have to assume that it is operationally and economically efficient, which need not be the case.
Another reason why it is difficult to assess the relative efficiency of different pro- viders is that you need to make sure that output is measured consistently across providers. It is difficult to quantify hospital output in a single measure. For example, should outpatient visits receive the same weighting as inpatient visits?
Furthermore, when comparing the efficiency of different hospitals, you should adjust for differences in the types of patient they are treating and, even more importantly, take into account the health outcomes being achieved. Inputs should be measured consistently across providers as well. This is not always the case in practice because hospitals may have different methods of calculating capital costs and because the hospital may not be responsible for (and therefore may not record) all of its costs.
Activity 9.2
In the British National Health Service (NHS), all secondary and tertiary care (i.e. hos- pitals) is provided by publicly-owned autonomous organizations called ‘trusts’. There has been a tendency for these trusts to merge with each other to form larger trusts. The following abridged article by Nigel Edwards and Duane Passman (1997) discusses the economic and management consequences of these mergers. They consider not only economies of scale but also economies of scope (i.e. there may be economic benefits for an organization that originate from the scope or range of services it provides).
When you have finished reading, write notes in response to the following questions.
1 Why might management costs not be halved when two hospitals merge?
2 Besides management cost savings, what other arguments are there for and against hospital mergers?
All mixed up
Mergers have generally been proposed as a means of reducing management costs, or as a major element in programmes of strategic change or service rationalisation. But the evi- dence to support a policy of widespread mergers appears weak. There has been no evaluation of the results of trust mergers, nor is there any systematic study of the advan- tages and disadvantages of integrated trusts or multi-site acute trusts. A review of the international literature found that merged hospital systems in the US did not have lower costs than others. It also suggests that economies of scope and scale are unlikely to be exploited by merged organisations, which may actually experience significant diseconomies with increased size. This appears to be consistent with some of the evidence from both manufacturing and service industries, where there is an increasing trend towards de-merger.
It is not always clear what problem mergers are expected to address. But several plausible reasons for pursuing them can be identified: reducing management costs; a mechanism for replacing the current management team; implementing or promoting strategic change;
improving service integration.
. . . They should: have measurable benefits for patients (even if only indirectly by allowing reductions in overhead costs); act as a catalyst for change and improvement in services – for example, allowing a critical mass of services or skills; provide benefits in cost or service terms that outweigh any loss of contestability; demonstrate long-term benefits that clearly outweigh any inevitable disruption.
Reducing costs
The idea that mergers reduce management costs is based on the theory that duplication can be eliminated. For example, at first sight it appears that the number of executive and non-executive directors and their support structures could be halved and other depart- ments combined. But even if this is the case, the savings associated with top management are not very significant in the context of total trust turnover. Estimates of the available savings range from £200,000–£250,000, though some argue they could be as high as
£400,000–£500,000. However, these figures may not be achieved in the short term: the increased size and complexity of the organisation means that structures cannot simply be halved.
This is a particular issue in mergers that bring together different activities, such as acute/
community or acute/community/mental health, where it may still be necessary to retain very senior managers with specialist knowledge. Even in mergers of similar organisations, communication and co-ordination problems may increase exponentially with size (Sheldon et al. 1996). Second, in industry top managers’ pay is related to turnover not to perform- ance, and it would be reasonable to expect some pay inflation in the new merged trust for most director and second-in-line posts, if not beyond.
There are also significant implementation costs, including redundancy, which, if they involve early retirement, can have major long-term implications. If the elimination of duplication or management cost reductions are needed, other actions could be taken that would be less disruptive, are more certain of success and are less likely to divert the trust from the main business of managing its services. They may also be more rapidly achieved as mergers take at least 18 months to two years to execute.
Changing the team
Some believe there is a strong case for using mergers to change poorly performing trust management. This idea has its attractions, although more for purchasers than providers.
Such a policy could provide a new set of incentives to improve efficiency, although it may also encourage undesirable purchaser micro-management of trusts . . .
Achieving strategic change
Trust mergers can play a crucial part in programmes of strategic change by aligning trust structures to fit new patterns of service, and by ‘internalising the problem’ of duplication and difficulties in rationalising services resulting from competition between trusts and their desire for organisational survival. Mergers also provide opportunities to address medical staffing/critical mass issues.
They can provide a catalyst for change, too – private sector mergers have been found to promote more wide-reaching change. The main mechanisms operating are the introduc- tion of new managers and the engendering of a culture in which previous practice is questioned. One of the most significant effects of mergers of acute trusts is that they reduce the power of vested interests seeking to protect a particular site or service. It is significant that some of the most successful site rationalisation programmes have taken place within multi-site trusts, which have more options for change than a single-site institution.
Mergers may also reduce the inertia that can result from purchasers being locked into particular sites or services. Large trusts with multiple sites and different services can reallocate overheads more easily if purchasers shift work between services.
In these cases the cost savings, quality or improved efficiency gains come from the rational- isation of services rather than the merger. The implication is that mergers must follow strategy and cannot take place in isolation from plans for wider change. It is not clear that these strategies exist in all cases where mergers are being considered.
In these circumstances a decision is being made to trade the advantages of contestability for major – but probably one-off – cost savings, improved quality or efficiency from ration- alisation. If contestability is lost it may be that new methods will be required for ensuring that efficiency and quality can continue to be tested.
Improving service integration
Mergers are not necessarily the best way to achieve improved integration of services between secondary, primary and social care . . . Issues of professional culture and approaches to patient management may have a more significant influence than manage- ment structure on whether services are integrated across the secondary-community/pri- mary interface, and management intervention may only be able to affect this indirectly . . . Implementation issues
The financial and non-financial costs of merger will often be an important factor in whether or not to go ahead, since any other advantages appear not to be particularly significant. Planning and carrying out a merger takes time and will inevitably divert man- agement attention from strategic and operational issues. Such a loss of focus can have adverse effects on many of the activities so important in ensuring the smooth operation of a complex organisation. As a result, any benefits of a merger could be wiped out by the lost opportunities for change in other areas.
Public opinion is also relevant. Mergers may be associated with hospital rationalisation and redundancies. If trusts have a high profile locally, their disappearance could cause public anxiety. Little research exists on the role of health care providers in the local political economy. Though it is not possible to say whether this anxiety is valid, it is certainly worthy of more investigation.
Experience from industry and the NHS suggests that mergers based on a shared vision of the future, and by consent rather than hostile takeovers, are more likely to succeed, take less time to produce benefits, and cost less.
Mergers will not perform well against the criteria unless they are based on clear objectives about the direction of change rather than the search for short-term cost savings. Even then the costs need to be carefully weighed against the benefits. Caution is needed before trusts embrace mergers as the solution to reducing management costs or reconfiguring services . . .
Where there is a well developed strategy for site or service rationalisation, mergers can help by providing a catalyst for change and reducing the commitment to the maintenance of particular sites or services. Ideally, mergers in this context should be by consent and have the support of clinicians. A plan for mergers is not a substitute for a strategic plan for provision, it is merely a way to see it through . . .
Though in some cases mergers will be appropriate, a case-by-case approach is needed and a blanket policy of promoting them without further thought and research is likely to have more costs than benefits.
Feedback
1 Management costs are not necessarily halved because:
• the organization to be managed has increased in size and complexity; communication and coordination problems may be much larger in the new structure
• if the two hospitals had different activities then managers with the appropriate expertise need to be retained from both
• senior managers’ pay may have to be increased to reflect their increased responsibilities
• there may be substantial costs associated with the implementation of the merger; for example, if redundancy payments have to be made then these costs will offset the cost savings gained by the merger
The authors conclude that there may be more effective ways of reducing short-term costs.
2 Edwards and Passman suggest the following potential benefits of mergers:
• they can be used to remove poorly performing staff
• they can be used to implement major strategic changes (hopefully leading to cost savings in the long run)
• they can be used to improve service integration (although there is no evidence that this is the case)
The major disadvantage is that the merger might ‘divert management attention from [other] strategic and operational issues’. It may also cause public anxiety if the hospitals involved have a high public profile.
Edwards and Passman do not rule out substantial cost savings from merger but they believe that they will arise only in the long term and only if the merger fosters the implementation of major strategic change. They feel that there may be better ways of achieving the benefits without the use of slow and costly merger. When considering merging or decentralizing hospitals or other health programmes, health planners should always bear in mind the implementation costs as well as the potential benefits.
Summary
You have learned that health service planners should organize their provider units such that each one is scale-efficient. This entails mergers if there are economies of scale and decentralization if there are diseconomies of scale. The empirical evi- dence seems to show that only in hospitals with fewer than 200 beds will there be economies of scale. Hospital mergers may offer various advantages but cost savings may not be one of them.
Having considered supply and demand functions over the past seven chapters, in the next two chapters you will learn about markets and their failings in health care.
References
Edwards N and Passman D (1997) All mixed up. Health Service Journal June 30th: page 1.
Sheldon T, Ferguson B and Posnett J (1996) Concentration and choice in the provision of hospital services. York: University of York.