How Do PPPs Create Economies of Scale?
This leads us to the question: are healthcare products anything like cars? Can they be mass-produced in the same way? The answer depends largely on the type of product in question. Many healthcare products are, indeed, mass-produced. Vaccines-identical goods produced in large quantities with little variation from product to product-are a perfect example of a mass-produced healthcare product. Mass production is also one of the many reasons that the pharmaceutical industry has been so profitable. Pharmacological products can be mass produced, shipped cheaply, and maintain a relatively long shelf life.
Of course, the cost-savings advantages are not the only reason to pursue a PPP. We need only turn to the Covid-19 crisis to see how PPPs have been deployed all over the world to both expand coronavirus testing and to develop a vaccine expeditiously.
But how do economies of scale apply to PPPs specifically? We have already discussed how Gavi, the Vaccine Alliance, was able to create an economy of scale by consolidating demand across entire regions, "bending the cost curve" of vaccination towards affordability. Many healthcare services can also benefit from an economy of scale. Services like dialysis rely on expensive machines whose up-front costs are prohibitive if not spread out among large numbers of patients-this, too, represents an opportunity to build an economy of scale.
We have also seen how Singapore's Health Promotion Board decided to transition from targeting individual hawkers in the Healthier Hawker Program to targeting large chains-which serve far more consumers in far larger quantities-through the Healthy Dining Program. Because PPPs are generally deployed to create large, scalable projects, they offer distinct advantages when it comes to establishing economies of scale. Governments' unique ability to engage large numbers of consumers creates new, innovative opportunities for achieving scale through PPPs.
Of course, the private sector can also create an economy of scale, even in cases where mass production is not possible. Let's examine the case of the Steward Health Care System, a network of hospitals that worked to reduce redundancies and increase efficiency in order to capitalize on the "economy of scale" effect.
CASE STUDY Steward Health Care System60
The case of the Steward Health Care System illustrates the advantages that an economy of scale can provide. In 1985, the Boston archdiocese founded Caritas Christi Health Care, a non-profit established to manage six hospitals in eastern Massachusetts. As the second-largest healthcare system in New England, Caritas served roughly 500,000 patients each year and employed 12,000 personnel. However, like many Catholic hospitals, the Caritas network prided itself on accepting patients regardless of their insurance status. While this practice was in line with Catholic priorities, it also resulted in large percentages of uninsured patients, and by 2010 Caritas found itself in dire financial straits, as uninsured patients are often unable to pay for services. Faced with mounting costs-deferred maintenance, a Catholic church unable to backstop the network due to costs associated with its high-profile sexual scandals, and $495 million in unfunded pension obligations-the network was dangerously close to insolvency. The Caritas network had become a liability. When the network was purchased for $895 million by Cerberus Capital Management, CEO Ralph de la Torre knew that significant challenges lay ahead.61 He was convinced, however, that the newly-formed and newly-improved Steward Health Care System could lure enough patients from Boston's expensive teaching hospitals to restore solvency to the network. De la Torre felt that, if he could convince physicians to refer their patients to its hospitals instead of to Boston's famous-and expensive-teaching hospitals, Steward could become profitable. A large part of de la Torre's strategy relied on consolidating the patient experience vertically-making sure that network doctors would send patients to Steward facilities wherever possible; care managers would collaborate with Steward medical providers; and Steward hospitals would discharge patients into the care of Steward physicians. These strategic moves not only ensured that patients remained within the network whenever feasible, but also created new efficiencies, reducing the burden of information transfer and eliminating redundancies in care. However, it also created a need for improved managerial resources-including technology-and widened the scope of the project to include a more holistic approach to patient care than the traditional service-by-service approach. De la Torre's acquisition of additional hospitals also represented an attempt to develop economies of scale. More properties, he thought, would spread fixed costs-specialized equipment, managerial assets-across a wider base. And as even more patients flowed through the Steward system, the marginal cost per patient would decrease. By consolidating patient care within the network while also spreading costs over a wider patient base, Steward was able to turn the failing Caritas network into a successful, solvent business. Today, Steward is the largest private physician-led healthcare network in the world, operating in nine states, and following a deal announced in 2018, in Malta. |
The Steward case illustrates the benefits of an economy of scale in a more complex paradigm than the one in our car factory example. Simply put, not all healthcare products are as easily scalable as vaccines. Many healthcare products are highly individualized, requiring a treatment plan specifically prescribed to each patient. Doctors must be able to monitor progress and recommend adjustments. To return to the car factory analogy: if you had to design a completely custom vehicle for each customer, your economy of scale would diminish. Of course, in healthcare (as in cars), there are ways to customize products without redesigning them completely-this is called "mass customization," and it represents a middle-ground between mass production and total customization. Many healthcare products fall into this category-developing a specific treatment plan for a patient may be more expensive per unit than producing a thousand identical pills, but it does not mean that there are no scale advantages.
Does the necessity of individualized treatments in healthcare mean that no economy of scale exists for these kinds of products or services? Not necessarily. Steward illustrates how a large hospital network-an entity which is ultimately responsible for developing individual diagnoses and executing highly specific treatment plans-can be scaled effectively. Ultimately, the Steward case also demonstrates how effective management, communication, and strategic thinking can transform a liability into an asset.
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60Trager, Alan M. & Kng, Christine, "Steward Health Care System: Betting on low-cost, high-quality healthcare," PPP Initiative, 2017.
61De La Torre holds an undergraduate degree in engineering from Duke University, an MD from Harvard Medical School, and a master's in health science and technology from MIT. Trained as a cardiac surgeon, De La Torre also served as founder, president, and CEO of the Cardiovascular Institute and Cardiovascular Management Associates at Beth Israel Deaconess Medical Center.