A different future – Part IV: How is a hospital like an airline?

In a couple of my last posts I suggested that the combination of a newly insured segment of society coupled with a glut of hospital beds in many urban areas might produce a situation in which hospital administrators begin to compete for patients. Some people have asked me whether this would remain true if those formerly-uninsured people were provided with a government-sponsored insurance product that provided relatively low reimbursement to doctors and hospitals. After all, why would a hospital want to accept more Medicaid patients when they claim to lose money caring for them today? The answer lies in the difference between fixed and variable costs and the best analogy I can think of is an airline.

Imagine the following scenario: your brother, who lives in New York, is about to turn 50 and you have been invited to attend a party for him. Unfortunately, his wife insists that the party occur on his actual birthday, which happens to be a Tuesday. Now, suppose that you are involved in several big projects at work everyone, including your boss, has been working overtime in order to meet deadlines so, when you ask for time off to attend your brother’s party, your boss begrudgingly agrees but only if you promise to leave on Tuesday and be back at your desk by Thursday morning, at the latest. Relieved to have the conversation with your boss behind you, you go to the airline website to buy your ticket. They are happy, in fact, very happy, to get you to New York by mid-day Tuesday and home by Wednesday night all for the incredible price of $950.00.

Alternatively, suppose that you have no pressing deadlines to meet and so you are able to leave on Saturday, spend a few days with your brother and return to Houston on Thursday afternoon. The airline’s quoted price for this latter trip is $350.00. To make matters worse, or at least more confusing, there are almost certainly people on both flights who paid more and less than you for the same trip.

In order to understand why this is so, one needs to think about the airline’s costs. The airline basically has three kinds of costs. First it has the costs directly associated with flying the plane from Houston to New York whether the plane is full or empty. These are direct fixed costs. They include the salaries of the crew members, or a portion, thereof, a portion of the maintenance costs of the plane, and a portion of the cost of the plane itself. They also include fuel to fly the plane (yes, I know that fuel consumption is tied to weight and winds and engine efficiency and myriad other factors but, when averaged over several trips between Houston and New York, fuel costs are relatively fixed). Then there are the overhead costs that the airline attributes to the cost of each ticket sold. These include executive salaries, the cost of the company headquarters, marketing, and other costs that aren’t actually a part of the cost of flying across the country but are a necessary part of running an airline. Finally, there are the variable costs; the cost of things consumed by the individual passengers who fly on the plane. If more people fly, they spend more on these items and if fewer people fly, they spend less. And what might these things be? To be sure, the occasional airline magazine is devoured by a toddler and they occasionally have to clean or replace their blankets and pillows but for many passengers and on many flights, these variable costs really boil down to a can of Coke and a bag of pretzels.

The airline sets its prices to so that business travelers and people who want to pay more for a bigger seat, two ounces of bourbon, and a hot meal (i.e. first class passengers) cover their fixed costs by paying more for tickets. They recognize that business travelers often have little flexibility in their schedules and so they charge them for convenience. Then, knowing that they have most of their fixed costs covered, they are more than happy to charge you less. The can of soda and the bag of pretzels cost them less than a dollar.

Hospitals are in a similar position. To be sure their variable costs are higher. Pharmaceuticals, especially, newer, high-tech agents, are startlingly expensive but hospitals can, to some extent also tailor their fixed costs to demand. If a particular unit isn’t very busy, they can reduce staffing. There are some limits to this, of course. A nurse expects to earn a certain income and if he or she is sent home repeatedly, his or her income will be affected and he or she will look for another job. In the current environment, many healthcare organizations are hiring nurses.

Nonetheless, if the hospital can cover most of its fixed costs with patients who have managed care insurance and supplemental Medicare policies, they can afford to care for some people with insurance that only covers the variable costs associated with their visit. If, as is predicted, Houston will have up to 30% more hospital beds than will be required to meet demand, hospitals will certainly manage their costs by closing units and reducing overhead where they can but this will only get them so far. Below some critical size, the overhead necessary to run a hospital makes it not just unprofitable but unsustainable so, hospitals will compete for the newly insured, at least in the near term. And for the long term? The best example might be Philadelphia. One should look at what has happened to the number of hospital beds in Philadelphia over the last decade for an example of what happens when a community has too many beds. Hint: the number of beds did not increase.