Single Specialty Hospitals and Competition in the Hospital Industry

Grant Description: Do specialty hospitals enhance the competitive process in the U.S. hospital industry? The researchers addressed the economic foundations underlying the growing specialty hospital phenomenon. In particular, they addressed the following research questions: 1) How do specialty hospitals compare with community hospital competitors on efficiency? 2) Do specialty hospitals capture economies of scale compared with community hospitals (for some services)? Between inpatient and outpatient services? 3) Do specialty hospitals charge higher prices than community hospitals to non-Medicare patients for the same services? And 4) Does the performance and behavior of multi-hospital systems differ from freestanding specialty hospitals? How do specialty hospitals compare with for-profit community hospital competitors? The objective of this study was to provide evidence on the economic logic of organization of hospital services and specialty hospitals to inform the Congressional debate.

Policy Summary: This study addresses the question of whether physician-owned hospitals limited to cardiac, orthopedic and surgical services are more cost efficient than full-service hospitals with whom they compete locally. Key results, obtained through a stochastic frontier cost function analysis, are the following:

• Overall, greater inefficiency was observed in specialty hospitals than in their full-service hospital competitors
• This effect appeared among orthopedic and surgical specialty hospitals, but not cardiac specialty hospitals
• In both respects, the results are consistent with earlier conclusions reached by MedPAC
• Specialty hospitals averaged a 42.9 percent level of inefficiency (measured as the percentage higher costs observed in specialty hospitals relative to the most cost efficient hospital in the sample) compared to an average of 27.4 percent inefficiency in competitor hospitals
• The higher inefficiency measures among specialty hospitals are driven by orthopedic and surgical hospitals, which as a group, averaged 46.8% inefficiency (compared to 28.1 percent for cardiac specialty hospitals)
• There was no significant difference between cardiac specialty hospital inefficiency measures and those of competitors (however there were few observations on cardiac specialty hospitals on which to achieve a statistical effect)

Considerable policy controversy surrounds the expansion of specialization in the hospital industry through physician ownership of small hospitals specializing in highly profitable service areas. Opponents claim that specialty hospitals engender unfair competition by targeting patient referrals, offering services leading to over-utilization, and limiting the ability of full-service community hospitals to cross-subsidize unprofitable services. Advocates maintain that by focusing on a limited range of services, specialty hospitals offer better care and provide services more efficiently, promoting competition that stimulates higher quality of performance among their local community hospital competitors. This study does not support the notion that specialty hospitals are more cost efficient than their full-service competitors. An additional policy finding of note is that inefficiency measures appear to differ significantly across specialty hospital type. The debate over specialty hospitals has focused on cardiac, orthopedic and surgical hospitals and most of the policy recommendations to date target these three categories of physician-owned specialty hospitals as a group. There is a broad array of differences between cardiac and orthopedic/surgical hospitals in terms of size, extent of physician ownership, and payer mix. The finding of efficiency differences across specialty hospital types complement these structural and operational distinctions, and suggest that policymakers should remain open to the notion that specialty hospitals are not all alike, and should not necessarily be treated in the same way.