Research

Quality vs. Cost? The Commercialization of Nursing Home Care
by Jane Brown, Fuqua MBA 1997

J. Rex Fuqua Professor of International Management, Will Mitchell, discusses the findings and implications of his paper with CASE

For-profits have come to dominate the U.S. nursing home sector. Why? And what effect does this reality have on quality of care? More broadly, what can we learn from this industry about the roles of nonprofit and for-profit firms competing in the social service marketplace? Fuqua Professor Will Mitchell discusses his research team’s answers to these questions derived from their analysis of several thousand nursing homes over seven years.

CASE: Why did you choose to study the market dynamics between for-profits and nonprofits in the U.S. nursing home sector?

Dr. Mitchell: The U.S. nursing home industry is a robust, dynamic industry that has an important social role in our society. It also represents two emerging trends in the U.S. and economies around the world: an increasing prevalence of for-profits in traditional nonprofit sectors and the growth of chains, especially in the service sector. Together, these two trends suggest that for-profit chain affiliates are coming to dominate many service sectors that were once served by independent nonprofit organizations. Notably, while for-profit nursing home chains have become common, nonprofits are still a significant part of the elder care industry, making the industry an important one for research.

The nursing home industry has many facilities. The government inspects over 19,000 for-profit, nonprofit, and government nursing homes annually. This standardized information provides us the opportunity not only to compare nonprofit and for-profit performance in terms of quality and cost, but also to examine the effects of competition on performance and exit (either through closures or acquisitions) of individual facilities. [page 5,6]

CASE: Why are for-profit chains increasingly dominating traditional nonprofit sectors?

Dr. Mitchell: There is not a simple answer. There are three major factors to consider: the role of the nonprofit sector, benefits of the for-profit organizational form and the reasons for seeking chain affiliation. Generally, nonprofit organizations are common in new markets and in markets where information asymmetry exists between producers and consumers. In new markets, nonprofits provide services and goods to customers that may not be otherwise available because for-profit businesses are not willing or able to take on the risk of creating a market. In a market where consumers do not have the same information as the sellers, nonprofit status is a signal of quality because consumers often simply do not trust for-profit businesses not to cut corners. This is a major competitive advantage for nonprofits. Industries ranging from natural food retailing to semiconductor design to the Internet were created by nonprofit organizations.

When a new market demonstrates its commercial viability, for-profits often begin to enter the market and compete on service and/or cost with early entrant nonprofits. Typically, for-profit organizations have greater commercial expertise such as access to capital, professional management, entrepreneurship, and marketing knowledge than their nonprofit competitors. Without this expertise, nonprofits may have a problem competing on cost against for-profit competitors. Also, for-profits work with the simple objective of maximizing return on investment versus nonprofits, which must balance the multiple objectives of various stakeholders. As a result, for-profits often simply are more efficient in terms of narrow cost-benefit analyses than non-profit organizations.

Despite any efficiency advantages, though, for-profits also may cut corners on broader cost-benefit issues, such as uncompensated quality of care, which is why there can be a real tension when for-profits begin to dominate an industry. Non-profits often continue to be important parts of an industry when such issues are particularly important. Medical services are a major example of this case, as non-profit hospitals and other health care facilities often provide services that go well beyond a simple cost-benefit analysis. Especially when consumers need to take the quality of services at least partly on trust, because then non-profits often have long term advantages.

Finally, companies seek chain affiliation in order to gain economies of scale in areas such as marketing, operations, and management support. Quite simply, chains tend to be more efficient than independent facilities because they can spread costs over larger scale. At the same time, though, chains tend to standardize their systems and services, so that they can obtain the economies of scale. As a result, chains may provide less variety than independent facilities. All of these reasons for the emergence of chains may reduce cost or competition or both. Therefore, independent nonprofits are also facing competitive pressure from both for-profit and nonprofit chains. How these three factors play out in local markets varies, but it appears that they are creating a successful environment for for-profit chain affiliates. [pages 1,2,3]

CASE: What differences did you uncover between for-profit chain affiliates and nonprofit facilities in the U.S. nursing home sector?

Dr. Mitchell: We used health deficiencies that inspectors found in annual inspections of the facilities as indicators of quality (more deficiencies indicate poorer quality) and staffing levels as indicators of cost (staffing is the largest component of the nursing home cost structure). Based on these indicators, independent nonprofits have higher quality and greater costs than for-profit chains, controlling for a wide range of facility, resident, and market characteristics. Additionally, nonprofits and for-profits tend to separate into different quality-cost segments in local markets. That is, rather than trying to emulate their for-profit competitors by lowering costs, nonprofits appear to occupy the high quality-high cost segment relative to for-profits. Notably, greater for-profit competition at the local level leads to improved quality and greater staffing in both nonprofit and for-profit facilities.

At the same time, local markets are highly dynamic, with a great deal of acquisition activity. More competition leads to acquisition of nonprofits by both nonprofit and for-profit chains, though acquisition of nonprofits by nonprofits is more common. Quality and staffing do not decline when nonprofits are acquired by other nonprofits; however, quality and cost do sometimes decline when the acquirer is a for-profit chain. [page 23,24

One might ask, then, how nonprofits and for-profits differ in terms of price. One might expect that if non-profits are focusing on higher quality-higher cost services, perhaps they tend to charge more than for-profits. However, a recent study of the private-pay portion of the market (since Medicare and Medicaid payments are largely fixed by public policy), found that for-profits charge substantially more for basic care, while nonprofits charge more for intensive care. Thus, nonprofits appear to be a superior organizational form for consumers – they offer higher quality and lower prices in some market segments, despite higher costs, and the higher costs result from services that provide consumer value.

CASE: Given consumers’ preference for nonprofit nursing homes, why do for-profits dominate the industry?

Dr. Mitchell: It appears that nonprofits have declined as a proportion of the U.S. nursing home sector due to constraints intrinsic to their organizational form. First, in general, due to internal managerial limits, nonprofits appear to be less responsive to market demands because they find it difficult to expand beyond an existing size. Secondly, nonprofits face substantial structural limits on expansion, arising from for-profits’ better access to capital and from the greater incident of for-profit chains, which provide opportunities for managerial skills to support expansion as well as a higher profile for attracting customers. Thirdly, strategic constraints limit nonprofit expansion. Nonprofits are best suited to the high-end of the market – Medicare and private-pay residents. This segment is only one third of the market while the remaining two thirds is lower revenue Medicaid patients. Nonprofits’ higher cost structure would make it difficult for them to compete with for-profits in this segment, even if they could overcome the managerial and structural limits on expansion. [pages 24,25,26]

CASE: Are nonprofit nursing homes losing ground to for-profit chains?

Dr. Mitchell: We did not see nonprofits exit at a higher rate during our study period of 1991 to 1997. Instead, they are entering the nursing home industry at a stable rate with quality and cost levels greater than those in the past several years.

CASE: What are the strategic and public policy implications of your research findings?

Dr. Mitchell: From a strategy perspective, it is interesting to note that increased local competition appears to improve service quality and staffing in both nonprofits and for-profits. Also, local competition tends to reinforce the differences in cost and quality observed in the industry overall, with nonprofits continuing to stake out the high-cost, high-quality market. For-profit competition does appear to have down-sides as well, however – when there is a for-profit takeover of a nonprofit, the facility eventually has diminished quality, implying that the for-profit corporation may not be the optimal form of organization in the provision of nursing home care. Nonetheless, from a policy perspective, commercial pressures do not appear to diminish the charitable role of nonprofit nursing homes. They seem willing to operate at lower margins to maintain their higher quality and higher cost model. Moreover, the low number of nonprofit exits, the ongoing entry of nonprofits at even greater quality and cost levels than those in recent years, and the role of nonprofit chains in acquisitions help allay fears that the social service sector, particularly the nursing home industry, is being taken over by the for-profit form.

CASE: The Balanced Budget Act of 1997 created a new prospective payment system that rewards low cost. How are nonprofits responding to this new environment?

Dr. Mitchell: I can only speculate about this question at this point, but it is a very important issue. Basically, nursing homes in both the for-profit and non-profit sectors have come under increasing financial pressure as a result of caps on reimbursement. It is important to recognize the even for-profit homes operate with very narrow margins – this is not a high-profit business by any means. The Act creates greater incentives to cut costs but in all honesty there is not a lot of fat to cut. There are at least anecdotal stories of increased failure rates among for-profit facilities and chains in the tighter reimbursement regime. Similarly, non-profit boards are working harder than ever to find charitable sources of funding to supplement the payment that they receive from their residents and their families. This is an important policy issue: how much public support are we willing to provide via Medicare and Medicaid for our growing elderly population? At present, both the private and non-profit sectors are facing real limits in their ability to provide the level of care that we would like our parents (and, eventually, ourselves) to receive.

To read more about Dr. Mitchell’s research, download his recent working papers.

Funding provided in part by the Center for the Advancement of Social Entrepreneurship at the Fuqua School of Business.