Health Business Blog

If you’ve ever spent time re-engineering an old-line factory, you know the impact of rework. When a factory is managed poorly, products fail inspection the first time and need to be re-run. Sometimes a product is re-run multiple times before it gets out the door. Poor processing can also ruin a product before it reaches the end of the line. That scrap goes right in the trash or, best case, is recycled.

The difference between a smooth running factory with high first-pass yield and an old-fashioned factory with low yield is dramatic. The smooth-running factory produces much more output with the same assets and raw material inputs. If the factories are in the same industry, one will be far more profitable than the other. In fact, the poorly-run factory is likely to be pushed out of business before too long. This is how things work in most industries, and explains why productivity and quality have risen so much over time while prices (in general) have been stable.

Hospitals are different. When a hospital screws up (causing an infection for example), it can charge the customer to fix the problem! Unlike a factory, a hospital can make money from such rework. As a result, while there are differences in profitability among hospitals, the differences are smaller than they would be in a normal industry. Because inefficient hospitals can stay in the market, it also reduces the pressure to make productivity improvements. As a result, costs rise over time.

All this is starting to change. As Medicare and other large insurers start refusing to pay for errors, hospitals themselves will have to pay for rework. If the trend continues –which I think it will– and hospitals can no longer charge for preventable errors, soon hospitals will need to be managed much more like factories. Since we know there is plenty of rework going on in the typical hospital, there will be an opportunity for dramatic differences in hospital profitability, just like in regular businesses.

However, unlike normal companies, which are generally allowed to go out of business if they fail to compete, hospitals tend to be protected. What that implies is that payers will end up increasing payments so that low-performing hospitals can stay in business. That may provide a real opportunity for the best-performing hospitals to reap a windfall. It could also lead to a new wave of hospital acquisitions led by those hospitals that figure out how to eliminate errors.

I don’t have the data to back up this speculation, but I bet I’m right.

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