1. Chapter 12:The Hospital Industry

2. Learning Objectives In this chapter, you will learn about:
the role of managed care and prospective payment as incentives for hospital efficiency
how inefficient hospitals become prime targets for acquisition by multihospital chains
how competition led to a medical arms race in the 1980s and cost efficiencies in the 1990s

3. A Brief History of American Hospitals
Three important factors served to transform hospitals into the modern medical institutions they have become today: the germ theory of disease, advances in medical technology, an increased urbanization
The development of the germ theory of disease, first articulated by Louis Pasteur in 1870, revolutionized the treatment of diseases
Now, hospital technology—especially advances in surgical and diagnostic imaging—provided physicians with the tools that would revolutionize medical intervention
Urbanization, also played an important role in the centralization of medical facilities

4. A Brief History of American Hospitals
When hospitals were financed through taxation and philanthropy, patient fees were only of minor importance
As middle-class use of hospital services increased, changes in financing were inevitable
What has become to be known as the modern hospital began to emerge in the twentieth century

5. A Brief History of American Hospitals, continued.
1900–1915: The Flexnor Report (1910) served as a pointed condemnation of medical education. In its wake, bogus medical schools were closed, standards became more stringent, and the goal of scientific medicine was employed
1920s: Continued reforms were aimed at driving incompetent physicians out of the profession
1930s: The reliance on patient fees caused severe financial problems for hospitals during the Great Depression
The introduction of private health insurance during the decade would transform medical care financing.
The decade also saw a revolution in pharmaceuticals
1940s: Wartime demands resulted in a sharp increase in the number of physicians and nurses in training
The passage of the Hill-Burton Act in 1946 dedicated the government to replacing the aging hospital infrastructure

6. A Brief History of American Hospitals, continued.
1950s: Vaccines against polio and rubella marked the true beginning of high technology medicine
These developments, combined with the widespread use of antibiotics, helped change the image of medicine
Advances in medical research tools highlighted the decade
1960s: Congress created Medicare and Medicaid, making the federal government the major purchaser of healthcare services
The decade also witnessed the beginnings of the investor-owned, for-profit hospital system

7. A Brief History of American Hospitals, continued.
1970s: Explosive growth typified the medical care system
New hospitals and clinics, medical school admissions, foreign-educated doctors, open heart surgery, transplants, and helicopter ambulances were widespread
The intensity of medical interventions also increased dramatically
Intensive care units (ICUs) became widely used
Trauma centers were established in most areas
All the developments of the 1970s shared one thing in common: they were all expensive

8. A Brief History of American Hospitals, continued.
1980s: By 1982, healthcare expenditures exceeded 10 percent of gross domestic product for the first time
Medicare initiated a new hospital reimbursement method based on the diagnosis, rather than the services performed
1990s:  Managed care has been the dominant factor affecting medical care delivery during this decade
Hospitals are no longer the revenue generators they once were, but instead they have become cost centers
Horizontal integration—characterized by hospital mergers and consolidations—transformed an industry once highly fragmented with many stand-alone facilities, into one where multihospital systems are common

9. The U.S. Institutional Setting
Hospital Classification
Hospitals are classified according to the length of stay, the major type of service delivered, and the type of ownership
Community Hospitals
Under the current classification method adopted in 1972, a community hospital is defined as a short-stay hospital, providing not only general services, but also specialty care, including obstetrics and gynecology; eye, ear, nose and throat; and rehabilitation and orthopedic services
More than 85 percent of all nonfederal hospitals are classified as community hospitals.

10. The U.S. Institutional Setting
Teaching Hospitals
About 20 percent of all hospitals in the United States have an affiliation with one or more of the nation’s 125 medical schools and sponsor at least one residency training program
More than 400 hospitals belong to the Council of Teaching Hospitals of the Association of American Medical Colleges
Most of the teaching hospitals are located in major metropolitan areas with populations in excess of one million

11. Structure of the Hospital Market
Economics predicts that competition in most markets improves economic welfare
This improvement in economic welfare comes as a result of lower prices, improved efficiency, and higher quality
Competition may be viewed from the perspective of how well a market fits the characteristics of the perfectly competitive model
Hospital markets may not fit the competitive model very well because so many of the structural characteristics of perfect competition are violated

12. The Tend Toward Multihospital Systems
The Theory of Consolidation
Mergers, acquisitions, and other forms of consolidation occur in the hospital industry for the same reasons that they occur in any other industry
Firms are said to experience economies of scale when the long run average costs fall as the size of the operation expands
If economies of scale are to result in improved efficiency, a number of technical advantages must be realized because of increased size

13. Summary
Hospital care tends to be the most expensive aspect of healthcare delivery
Dominated by the private not-for-profit hospital, the industry is responsible for more than one-third of all healthcare spending
The changes that began in the 1980s pushed hospitals to become competitive and profit oriented
This corporate mentality has led to extensive local marketing, leveraging debt, multihospital chains, and administrators earning salaries rivaling corporate executives

14. Chapter 13: The Pharmaceutical Industry

15. Learning Objectives In this chapter, you will learn about:
the underpinnings of pharmaceutical drug pricing
how the government intervenes to promote the safety of the population
the health of the market for prescription drugs

16. Drug Costs
This chapter will help you to understand why drugs are priced as they are and to evaluate the pros and cons of government regulation of the pharmaceutical industry
An understanding of the biopharmaceutical industry requires us to study its market structure, pricing policies, the effects of government regulation, the effects of cost-containment strategies of third party payers, and the role of international competition
We will also consider the effects of new drugs, insurance coverage, and advertising on the demand for prescription drugs

17. The Importance of Pharmaceuticals
Even though pharmaceuticals still make up only a small fraction of total healthcare expenditures, the proportion devoted to these products has been increasing rapidly in recent years
Increases in expenditures are partly the result of price increases and partly a result of increases in quantity utilized
The increase in quantity is a mixture of higher utilization of existing drugs and the purchase of new pharmaceuticals

18. Market Structure
Effects of Firm Size on Research & Development Productivity
Larger firms which conduct more research projects tended to also have more productive research programs
Larger firms were also found to be more likely to undertake research that integrates process and product development

19. Government Regulation of the Pharmaceutical Industry in the United States
Regulation by the Food and Drug Administration
Federal regulation of the quality of drugs marketed in the United States began with the enactment of the Pure Food and Drug Act in 1906 that created the FDA
The passage of the Kefauver-Harris Act[J1]  in 1962 greatly strengthened the FDA
The Kefauver-Harris Act[J2]  required a more stringent regime of clinical testing to launch both NCEs and generic versions of drugs already on the market. The number of new drugs launched per year declined after 1962
Smaller firms suffered a decline in both their research productivity and market share

20. Government Regulation of the Pharmaceutical Industry in the United States
In 1971, the government added a proof of efficacy to the requirements for the introduction of new drugs
Overall requirements became more stringent, and by the 1990s the average time from first application to the FDA approval of a drug had risen to over nine years
The following schedule shows the average time required for the development of an NCE in the late 1980s:
Discovery of an NCE
Preclinical animal testing
File application for authorization for human testing (approximate time for discovery, preclinical and application approval: 3.5 years)

21. Requirement for Prescriptions (Rx)
A second type of regulation intended to promote the safety of the general public is the requirement that a wide range of drugs be available to consumers only when prescribed by a licensed physician
The argument that the requirement of prescriptions from physicians is not in the public interest is made more plausible when one observes the many near-equivalents to newer prescription drugs that are available without prescription in the over-the-counter (OTC) market

22. Demand for Pharmceuticals
Effect of Increased Insurance Coverage for Prescription Drugs
Third party payment now routinely reimburses a higher proportion of generic drug costs as opposed to brand name drugs in an attempt to make consumers and physicians more cost-conscious
Medicaid also reimburses only the price of the generic drug when substitutes for brand name drugs are available
In this way, insurance companies can affect the balance of generic and brand name drugs utilized by altering relative prices to consumers

23. Demand for Pharmceuticals
Effect of Direct Marketing to Consumers
Since 1997, direct marketing of drugs to consumers has been legal in the United States
This makes it possible for drug companies to create a consumer demand for products that physicians might not otherwise recommend
Direct marketing to consumers also provides a greater incentive to develop lifestyle products, such as treatment for hair loss or sexual dysfunction

24. Profitability of the U.S. Pharmaceutical Industry
Profits are often thought to be higher in the pharmaceutical industry than in most other industries in the United States
Because the proportion of cost devoted to R&D and the rate of technological change are substantially higher in the pharmaceutical industry than in most other industries, the return on equity tends to exaggerate the profitability of pharmaceutical firms, given the way R&D expenditures are treated on corporate balance sheets
Even in the case of drugs that receive FDA approval, only a small proportion provide enough revenue through sales to cover the R&D costs incurred in their development

25. Summary
At the end of the twentieth century, the United States still led the world in the development of new pharmaceuticals, although the costs of developing new drugs had risen dramatically at the same time that managed care imposed downward pressure on the domestic prices of new drugs
The flow of new products continues to stimulate demand for pharmaceuticals, as does the increase in third party prescription drug coverage