Review of Industrial Organization
12: 703–718, 1997.
1997 Kluwer Academic Publishers. Printed in the Netherlands.
New Evidence on the Performance Advantages of
GARY M. FOURNIER
Department of Economics, Florida State University, Tallahassee, FL
JEAN M. MITCHELL
Graduate Public Policy Program, Georgetown University, 3600 N St., N.W. Washington, U.S.A.
Abstract. This study analyzes the performance effects of proprietary, multihospital systems. It is
shown that the organizational structure of these systems may affect the operating costs of member
hospitals. Estimating a cost function for Florida hospitals and controlling for other factors, the
average costs of HUMANA hospitals are empirically about 17 percent lower, while the costs of other
leading chains are about 12 percent lower than not-for-proﬁt institutions. These results contrast with
earlier studies that found no such differences. Furthermore, the cost differential that exists between
system and non-system hospitals can be largely attributed to technical efﬁciencies arising from chain
Key words: Multihospital systems, organizational efﬁciency, cost functions.
The potential advantages of multihospital system afﬁliation, i.e. combining mul-
tiple hospitals under common ownership, have been discussed extensively in the
literature. These advantages include increased technical efﬁciency from multiplant
economies of scale, pecuniary advantages in factor markets, better access to cap-
ital, and the ability to recruit and retain higher quality clinical and management
personnel (Ermann and Gabel, 1984; Morrisey and Alexander, 1987).
Despite the potential advantages of system afﬁliation, the acquisition activities
of multihospital systems came virtually to a standstill during the late 1980s, a
trend that continued throughoutthe early 1990s (Relman, 1991). This development
suggests either that the advantages associated with multihospital systems may be
somewhat more limited than previously expected, or that investment opportunities
in other types of health care enterprises are more proﬁtable. The limited proﬁts
from the provision of hospital inpatient services can be attributed in part to the
institution of prospective payment systems based on diagnostic related groups
(DRGs) and other cost-containment mechanisms enacted by third party insurers
Authors thank the University of Bergen, Norway for ﬁnancial support, and Sigve Tjotta for
comments on this research. Any remaining errors are our own.