Service mix, market competition, and cost efficiency: A longitudinal study of U.S. hospitals

• Author: Victoria S. Jordan,Xin (David) Ding,Gregory R. Heim,Xiaosong (David) Peng
• DOI: http://doi.org/10.1002/joom.1050
• Date: 01 January 2020
• Published date: 01 January 2020

RESEARCH ARTICLE

Service mix, market competition, and cost efficiency:

A longitudinal study of U.S. hospitals

Xin (David) Ding

1

| Xiaosong (David) Peng

2

| Gregory R. Heim

3

| Victoria S. Jordan

4

1

Department of Supply Chain Management,

Rutgers Business School, Newark,

New Jersey

2

Decision & Information Sciences

Department, Bauer School of Business,

University of Houston, Houston, Texas

3

Department of Information & Operations

Management, Mays Business School, Texas

A&M University, College Station, Texas

4

Quality, Performance Improvement and

Analytics Director, Kennedy Initiative for

Transforming Care, Emory Healthcare

Correspondence

Xin (David) Ding, Department of Supply

Chain Management, Rutgers Business

School, Newark, New Jersey 07102.

Email: xding@business.rutgers.edu

Handling Editors: Lawrence Fredendall,

Anand Nair, Jeffery Smith and Anita Tucker

Abstract

We examine the longitudinal impact of service mix on cost efficiency in U.S. acute

care general hospitals. We propose two different dimensions of service mix, with

the first dimension capturing internal emphasis on specific service lines

(i.e., specialization) and the second dimension reflecting the deviation of a hospital

from the average level of specialization for hospitals in the same service area

(i.e., differentiation). We hypothesize that as the level of a hospital's specialization

increases, hospital cost efficiency should improve at a decreasing rate. We also

hypothesize that differentiation helps improve cost efficiency in competitive mar-

kets. Lastly, we examine whether acute care general hospitals can use service mix

as an operational lever to improve cost efficiency when specialty hospitals are pre-

sent in the same local markets. We find strong empirical support for the hypothe-

sized relationships.

KEYWORDS

cost efficiency, health-care market, longitudinal study, service mix

1|INTRODUCTION

As the major providers of inpatient-based health care, full-

service acute care general hospitals (we refer to them as hos-

pitals hereafter) are facing challenges ranging from surging

operating costs to growing competition and declining reve-

nues. A recent Bloomberg report suggests more than

600 such rural hospitals in the United States are running the

risk of closing due to a lack of control over rising operating

expenses (Lauerman, 2017). Urban hospitals are also strug-

gling with maintaining efficient operations and staying

financially healthy. In 2016, New York-based Mount Sinai

Beth Israel Hospital announced plans to close its hospital

after accumulating over $200 million in debt (Ramey &

Evans, 2016). Beth Israel's closure represents only the tip of

the iceberg, as 20 hospitals have closed down in New York

City since 2000 (Mogul, 2016).

Since hospital-based services account for 30% of the

overall U.S. national health-care expenditure, it is important

to identify strategies hospitals can adopt to better control

costs and improve efficiency. Considering that an average

nonprofit hospital operates with a profit margin of 2.2% and

an annual expense growth of 4.1%, achieving operational

efficiency and staying financially healthy are critical for hos-

pitals to pursue further performance improvements in pro-

cesses, outcomes, and patient experience (National Center

for Health Statistics 2016, Table 89). Improving hospital

efficiency is necessary to accomplish the overall goals of

improving patient care and population health while reducing

health-care costs, as highlighted in the national quality strat-

egy for U.S. health care (AHRQ, 2017).

In this study, we refer to efficiency as a hospital's ability

to control costs and increase health-care outputs (Ding,

2014). Specifically, we measure cost efficiency using

The authors would like to thank Centers of Medicare and Medicaid Services

(CMS) and the Dartmouth Atlas of Health Care (DAHC) for assistance in

assembling the data. Conclusions and opinions expressed herein do not

reflect official positions of CMS or DAHC.

Received: 15 November 2017 Revised: 30 April 2019 Accepted: 7 June 2019

DOI: 10.1002/joom.1050

176 © 2019 Association for Supply Chain Management, Inc. J Oper Manag. 2020;66:176–198.wileyonlinelibrary.com/journal/joom

operating expenses per patient day, a standard measure of

hospital cost performance. A higher cost per patient day

indicates lower cost efficiency. Operations management

research suggests hospitals can improve efficiency through

leveraging internal operational resources such as increasing

degrees of specialization in certain clinical areas (Ding,

2014; Huckman & Zinner, 2008; Kc & Terwiesch, 2011;

McDermott & Stock, 2011). In addition, efficiency can be

achieved through customizing the supply of service lines to

meet the changing demand arising from the external health-

care market (Newhouse, 1970; Kessler & McClellan, 2002;

Horwitz & Nichols, 2009). Service mix captures the charac-

teristics and range of a hospital's facilities/services and has

been widely used by health-care researchers to evaluate the

nature of a hospital's output (Miller, Sulvetta, & Englert,

1995; Tatchell, 1983). As an operational lever for optimizing

resource allocation across service lines, service mix has two

strategic dimensions: internal specialization (i.e., directing

resources internally to intentionally grow certain service

delivery areas) and market differentiation (i.e., dis-

tinguishing from other hospitals in the market via a unique

breadth and combination of products and services) (Porter &

Teisberg, 2006; Zwanziger, Melnick, & Simonson, 1996).

We refer to these two dimensions as specialization and dif-

ferentiation for short in the following discussion.

Prior literature motivates many research questions associ-

ated with hospital service mix. While a number of studies

suggest that a service mix specialization strategy can lead to

efficiency improvements and address market demands, doc-

tors, and hospital administrators argue that government pol-

icy and local conditions often do not allow them to modify

service mix. Although anecdotal evidence suggests hospitals

increasingly differentiate themselves from competitors

through clinical specialties, values, and cost, it is unclear

whether such a service mix strategy contributes to perfor-

mance improvements longitudinally (Gamble, 2015). Thus,

it is important to answer questions about the limits of service

mix strategy: Will hospitals always achieve high cost effi-

ciency as they specialize their service mix? How does the

external health-care market affect a hospital's cost effi-

ciency? Should hospital administrators adjust service mix

strategy in response to competition in local health-care mar-

kets, especially when specialty hospitals are present in the

same market?

This study aims to answer the above questions by exam-

ining impacts of two dimensions of service mix, namely spe-

cialization and differentiation, on cost efficiency (Zwanziger

et al., 1996). While specialization captures the internal man-

agerial emphasis on specific service lines (i.e., an index

value of hospital days contributed by major clinical areas),

differentiation reflects how hospitals intentionally deviate

from the average level of service mix among hospitals in the

same service market area.

1

We merge hospital financial

reports supplied by the Centers for Medicare and Medicaid

Services (CMS), and health-care market data provided by

the Dartmouth Atlas of Health Care (DAHC) and the United

States Census Bureau, to identify 52,412 records of 3,037

acute care general hospitals in the United States between

1996 and 2013. The unique data set allows us to examine

service mix at different levels of granularity, while consider-

ing local service market competition. We also include addi-

tional data (2014–2016) to examine consequences of the

Accountable Care Act (ACA) in robustness checks.

Our results suggest that the relationship between speciali-

zation and hospital cost efficiency follows a U-shape curve,

after accounting for potential influences of a number of hos-

pital characteristics and market factors including hospital

ownership, size, teaching status, and inflation. We also find

that differentiation improves cost efficiency in competitive

markets where multiple hospitals are competing to fulfill

patient needs in the same hospital service market [measured

by the hospital service area (HSA)]. In addition, our results

suggest that specialization improves cost efficiency when

related specialty hospitals are present in the same service

market area. Lastly, our post hoc analysis suggests differen-

tiation has been boosting cost efficiency post-ACA, indicat-

ing the ongoing shift from volume-based to value-based

hospital reimbursements has transformed the competitive

landscape in health care.

Results from our study have important policy and mana-

gerial implications for aligning hospital operations with

CMS incentive programs. The overall message from our

study is that hospitals' service mix strategy is affected not

only by internal resource availability but also by external

health-care market demand and competition. Our results

show that local health-care market competition contributes

to cost efficiency. The results therefore provide empirical

evidence on the relevance of market competition dimensions

when evaluating hospital cost performance. For hospital

managers, using a service mix strategy to improve cost per-

formance has attracted increasing attention over the past

decade. Although prior literature and anecdotal evidence

point to specialization as a potential operations strategy to

leverage internal resources to improve performance, our

results show that cost efficiency plateaus and then decreases

as the level of specialization increases beyond a threshold,

indicating a tipping point in the efficiency improvement path

through increasing specialization. Therefore, specialization

is not a silver bullet for controlling costs in the health-care

market.

Since hospital performance is subjected to local health

needs, it is critical to consider the external health-care mar-

ket environment when assessing performance impacts of dif-

ferentiation. While facing increasing competition from local

DING ET AL.177