Just Business - Employee Control Fraud, Gresham's Dynamic, and the Race to the Bottom in Health Care

Since Enthoven called for the break up of the physicians' "guild," and handing over its supposed power to managers, (see post here) managers have taken over from physicians and other health care professionals as leaders of health care organizations.  Unfortunately, most of these managers are generic, often lacking knowledge and experience in health care, and understanding of its core values.  Instead, such generic managers may rely on the current management dogma.  The perils of doing so are illustrated by an analysis of the recent expose of conditions at Apple manufacturing plants in China.

The Apple Expose

The New York Times summarized in a landmark article how bad it is to work in factories building Apple products under contract in China.  Workers endure harsh conditions, toiling up to six days a week, 12 hours a day.  Meanwhile, banners remind them to "work hard on the job today or work hard to find a job tomorrow."  Workers may be exposed to hazardous, even poisonous materials (like n-hexane used to clean components).  Workers have died in explosions due to inadequate control of combustible dust. Over 18 workers at one factory attempted or committed suicide within two years.

The article suggested that while Apple managers may be well-intentioned, and "want to improve conditions in factories," the bottom line is more important:

that dedication falters when it conflicts with crucial supplier relationships or the fast delivery of new products.

In fact, because of its rigid insistence on cost control, its suppliers are sorely tempted to push their workers too hard:

Apple typically asks suppliers to specify how much every part costs, how many workers are needed and the size of their salaries. Executives want to know every financial detail. Afterward, Apple calculates how much it will pay for a part. Most suppliers are allowed only the slimmest of profits.

So suppliers often try to cut corners, replace expensive chemicals with less costly alternatives, or push their employees to work faster and longer, according to people at those companies.

'The only way you make money working for Apple is figuring out how to do things more efficiently or cheaper,' said an executive at one company that helped bring the iPad to market. 'And then they’ll come back the next year, and force a 10 percent price cut.'

So,

'You can set all the rules you want, but they’re meaningless if you don’t give suppliers enough profit to treat workers well,' said one former Apple executive with firsthand knowledge of the supplier responsibility group. 'If you squeeze margins, you’re forcing them to cut safety.'

William Black's Analysis: Employee Control Fraud and the Race to the Bottom

Writing in the Huffington Post, William K Black showed how Apple executives' relentless focus on cost could drive a race to the bottom. He began by analyzing Apple executives' explanation for out-sourcing their production:

'We shouldn't be criticized for using Chinese workers,' a current Apple executive said. 'The U.S. has stopped producing people with the skills we need.'

He noted that it is absurd to suggest that the US does not have workers with the technical skills necessary to build Apple products. He suggests, however, that these are not the skills that matter.

The suppliers want engineers and managers who will selectively apply their substantive skills. American engineers and managers cannot be counted on to provide the necessary selectivity. Apple's suppliers' often seek managers willing to order their workers to exceed the lawful workweek, to refuse to pay them for significant portions of the wages they have earned, to unlawfully employ child labor, and even to coerce abortions.

So, in the n-hexane example,

The engineer did not order the workers to use the nerve poison because he hated the workers. It was 'just business.' The nerve poison reduced cleaning time, so an engineer knowingly ordered the workers to use it and scores of other engineers did nothing to prevent the usage.

Note that Black calls this employee control fraud, deceiving the employee that he or she is working in a reasonably safe environment, and that employee health and safety is a concern, when in truth the only concern is the bottom line.

So what Apple executives, and by analogy, other multi-national corporate executives want are underlings, particularly middle and line managers who will do anything, anything to cut costs and improve the bottom line. This will produce the race to the bottom:

What we are observing is the essence of a Gresham's dynamic in which bad ethics drives good ethics out of the market.

Two aspects of this Gresham's dynamic are obscene, and both are produced by neoclassical economics dogma. Calling this process 'creative destruction' is baseless and dishonest. It is the fraudulent destruction of honest businesses, professions, and labor.

Black concluded:

firms that are anti-employee control frauds are likely to commit other forms of control fraud. Apple and its Western counterparts have driven the creation of an Asian network of fraudulent firms that has distorted international trade, hollowed out U.S. manufacturing, and created a bizarre hybrid: quasi-communist crony capitalism. It boggles the mind that theoclassical economists celebrate the corrupt result as the essence of creative destruction. The network is corrupt. It will not play by the rules. Firms like Apple help create the perverse incentives that encourage the network to cheat. Surviving U.S. manufacturing firms are whipsawed by the powerful Gresham's dynamic that the frauds produce. U.S. firms and workers are constantly pressured to reduce wages and workforce to try to compete with the foreign frauds. This is the 'Road to Bangladesh' strategy that has caused U.S. working class wages to stall for decades. Europe is retreating along this same road at an even more rapid rate. The Gresham's dynamic tilts the world in favor of fraudulent firms operating in fraud-friendly nations.

The Race to the Bottom in Health Care
Note that we have written about numerous examples of executives of US health care organizations putting revenue ahead of the health care mission, ahead of workers' morale, ahead of patients' and the public's health. Some of these examples involve executives of nominally non-profit organizations that are supposed to have charitable purposes. (Look under our heading of mission-hostile management.)

In fact, just yesterday, Dr Carl Elliott, writing for the Chronicle of Higher Education, summarized how pharmaceutical companies have out-sourced clinical research. The resulting commercial clinical research have generated conditions as bad for the research subjects as those endured by the Chinese electronics workers above:

If the past decade had an emblematic moment for clinical research, it was probably November 12, 2005, the day when Bloomberg Markets published its cover story, “Big Pharma’s Shameful Secret.” In that issue, Bloomberg reporters laid out the story of SFBC International, a contract research organization in Miami that was paying undocumented immigrants to test the safety of new drugs in a seedy motel. The SFBC owners had converted the lobby into a large waiting area with plastic chairs, and they were housing their research subjects six to a room. The medical director of the research site was unlicensed to practice medicine; the Institutional Review Board that approved many of the studies was owned by the wife of the company vice-president; and the converted motel, which had been cited for fire and safety violations, was eventually demolished. Nonetheless, SFBC had become an astonishingly successful enterprise. Just a few years before the Bloomberg Markets report, Forbes had named SFBC one of the most admired small businesses in America. Virtually every major pharmaceutical company had tested drugs with the company. In fact, with 675 beds, the converted motel was the largest research facility in North America.

Note: see our relevant posts here on SFBC International, and on contract research organizations.

Moreover, such out-sourcing has produced the sort of race to the bottom described by Black, but this time involving one of the US most important health care institutions, academic health care:

the more important reason is money. In medical schools, faculty members are often expected to generate their own salaries, either by seeing patients or getting grants and contracts. Likewise, academic departments are often expected to be financially self-sufficient, with as little support as possible from central administration. 'Eat what you kill' is the phrase used, without irony, by medical school deans and department heads. And if you are not killing it with NIH grants, you probably need to be killing it with AstraZeneca or Pfizer.

This system has not been good for human subjects, but it has not been good for academic physicians either. According to a recent study of over 5,000 faculty members at U.S. medical schools, 51 percent of respondents said that the administration is only interested in me for the revenue I generate.' Thirty-one percent said that their institution discourages altruism; 27 percent said that it does not reward clinical excellence; and over half said that it does not value teaching. Nearly half of respondents were considering leaving their current jobs; almost a third were considering leaving academic medicine altogether. Asked if their values lined up with the medical schools where they worked, over half said no. And just in case you are wondering why these physicians are not standing outside the building with picket signs, protesting the injustice of the system, the survey offers another clue. Thirty percent of respondents agreed with the statement, 'I am reluctant to express my opinion for fear of negative consequences.' [This was from an abstract by Pololi L et al.  See our relevant post here.]

Of course, this survey does does not exactly match up with the happy propaganda disseminated by the media-relations offices at most medical schools. Instead, it offers a picture of alienated, demoralized physicians, unhappy in their jobs, pressed to work according to values that repel them in order to prop up an institution that views them primarily as instruments to generate profit. In this environment, contract research makes perfect sense. It may not require much intellectual work, but it pays the bills and keeps the authorities happy. And if medical schools don’t really value intellectual work anyway, that may well be enough.

So the pressures on medical school faculty are little different from those on corporate middle management.  Their only role is to make money, mainly so that the top leaders can become multi-millionaires, and woe unto them if they object.
Summary

What is missing in all this is any organized opposition to the race to the bottom. As long as top executives can make nearly unlimited money, as long as they can do so by making their subordinates put revenue ahead of all else, as long as there are no countervailing forces, the race to the bottom will continue.

To stop it, we need some combination of efforts by honest government regulators, professional and trade organizations, civil society organizations including non-profit organizations and NGOs that really care about patients' and the public's health, and finally an activated, and properly outraged public.

As long as we think that a laissez faire policy allowing continual market dysfunction to continue, the good times for executives will keep rolling, over all of the rest of us.

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"Conspiracy Theory" Proven - Taking UCSF Private

Students and faculty at the University of California have come up with a vivid, and prescient example of how the hired executives and bureaucrats have taken over higher and health care education. 

"Run in the Interests of the Administration"

Two weeks ago, the Orange County Register reported:

Over the past few months, the University of California has raised undergraduate tuition by 18 percent, awarded raises of as much as 23 percent to a dozen high-ranking administrators and announced a possible 81 percent tuition increase over the next three years.

Students haven't taken the news well.

At campus rallies across the state, thousands of students and their faculty supporters have decried the actions, staging raucous rallies and 'Occupy'-style sit-ins that in some cases have ended in clashes with law enforcement. They've also descended en masse on UC regents' meetings, disrupting proceedings and even forcing officials to retreat to a private room.

Behind the angry chanting and acts of civil disobedience is a growing sense that the 10-campus UC system is no longer a public institution accessible to the middle class, but rather a sprawling bureaucracy of hospitals and auxiliary research institutions buffeted by an ever-expanding roster of administrators.

The problem, as the student activists see it, is that none of these functions translates directly into expanded course offerings or improved student-to-faculty ratios, even as their tuition dollars help sustain the system.

'The university is now being run in the interest of the administration,' said UC Irvine student activist Anne Kelly, a Ph.D. candidate in earth system science. 'They're promoting their own internal growth, asking us to sacrifice with higher tuition – but administrators have had raises.'

In higher education, as well as in health care education and in health care in general, the pattern is the same: rising costs without any obvious increase in quality or quantity of services. As in health care, however, the pain never seems to extend to administrators/ managers/ bureaucrats/ executives. Worse, as their numbers grow, these insiders seem to run organizations more for their own benefit, and less for the mission.

One Manager Per Faculty Member

Furthermore, UC faculty have data:

The students' growing frustration is fueled by UC employment data that show that almost three-fourths of UC's 152,500 employees last year were designated 'non-academic personnel,' according to an annual UC employment report.

In the report, UC characterizes the growth in its non-academic staff as the inevitable byproduct of 'an increasingly complex university system that 'requires greater professionalization of its staff, who must meet higher technical and competency standards.' Non-academic personnel includes everyone from custodians and food-service workers to accountants and plant operators. [The question begged is whether it was the managers and executives that caused this complexity - Ed.]

UC Davis horticulture researcher Richard Evans, who has independently analyzed UC personnel data, offered a different take on the data, publishing a tongue-in-cheek piece for UC faculty in 2010 entitled 'Soon every faculty member will have a personal senior manager: Is this a good way to spend money?'

'Data available from the UC Office of the President shows that there were 2.5 faculty members for each senior manager in the UC system in 1993,' Evans wrote in his piece. 'Now there are as many senior managers as faculty. Just think: Each professor could have his or her personal senior manager.'

In his analysis, Evans compared the number of UC employees classified as either 'senior management' or 'managers and senior professionals' with the number of tenure-track UC faculty members.

As of spring 2011, UC employed 8,144 senior managers, managers and senior professionals, and 8,521 tenure-track faculty members, according to the latest available UC data.

This pattern is similar to that seen in some data we discussed a long time ago about the ever rising numbers of administrators/ managers/ bureaucrats/ executives in health care.  In 1988, Alain Enthoven advocated in Theory and Practice of Managed Competition in Health Care Finance, a book published in the Netherlands, that to decrease health care costs it would be necessary to break up the "physicians' guild" and replace leadership by clinicians with leadership by managers (see 2006 post here). Thus from 1983 to 2000, the number of managers working in the US health care system grew 726%, while the number of physicians grew 39%, so the manager/physician ratio went from roughly one to six to one to one (see 2005 post here). Health care went from being controlled by clinicians to controlled by a growing volume of managers.  Most of these managers were generic, in that they had little if any knowledge of, experience in, or sympathy to the values of health care. These generic managers have used the same techniques advocated for the management of supermarkets or automobile manufacturers to manage health care organizations, despite all the obvious differences in context, goals, values, and people involved.

A "Conspiracy Theory" About the Privatization of the University

At the University of California, the Register reported that there is a "conspiracy theory" about the next step to increase the domination of the managers:

The salaries and size of UC's administrative staff, in particular, have fueled conspiracy theories among students and faculty that the system has deliberately sought to 'privatize' itself – in other words, to compete with private universities on all fronts, from the scope of its non-instructional programs to executive compensation to the amount of tuition that students pay.

Three years ago, the head of a UC faculty group advanced the privatization theory in a multi-part series called 'They Pledged Your Tuition.'

Of course, the administrators denied, sort of, anything so far-fetched:

For its part, UC denies all such allegations, saying that while the university has arguably become privatized, outside influences beyond its control are entirely to blame.

"It is not something we advocate, not something we want,' Klein said. But, 'he added, 'times have changed; the economic model has changed.'

Not Just a "Conspiracy Theory" - UCSF Chancellor Advocates Privatization

It only took two weeks, however, for the notion of administrators taking the university private to go from "conspiracy theory" to official plan. Yesterday, the San Francisco Chronicle reported,

UCSF Chancellor Susan Desmond-Hellmann told the regents, delicately, that she wants out.

Under her proposal, UCSF's medical school, hospital, clinics and research facilities would remain a public university connected to UC, the chancellor assured the regents. But the tendrils connecting the two entities should be thinner than they are today.

Desmond-Hellmann said she envisions a relationship like those of UC Hastings College of the Law, Lawrence Livermore National Laboratory and Lawrence Berkeley National Laboratory, which contract with UC for health and pension services. While ultimately accountable to the regents, they are autonomous with their own boards of directors.

Referring to 'alternative governance models' and 'examining UCSF's financial relationship with UC,' the chancellor and campus executives talked of their ambition to become the world's leading innovator in the health field - a goal better achieved, they hinted, without the rest of the university weighing it down.

To Health Care Renewal readers, that UCSF would be proposed as the first part of the University of California to privatize should not come as a shock. After all, Chancellor Desmond Hellmann came not from academia, but from the world of for-profit biotechnology. She was a former president for drug development for Genentech.

Two and one half years ago I suggested that "hiring a lavishly compensated top executive from a biotech firm known for its high drug prices to run a public health sciences university does considerably blur the line between academic medicine and the health care industry." Furthermore, three months ago I noted that Dr Desmond Hellmann seemed be advocating that the university's focus turn to product development, so that it would start to emulate a contract research organization. Now it appears that Dr Desmond Hellmann wants to traverse the line between government and the private sector, so that the organization could "make a ton of money," and "focus on spinning innovations into business deals," according to the San Francisco Chronicle.

What any of this has to do with the university's fundamental mission to discover and disseminate knowledge, and with this health care university's mission to take the best possible care of its patients is not clear.

Summary

Turning UCSF into a private, quasi contract research organization might conceivably yield some good research and drug development. Why a formerly academic organization would be better at this than a purpose-built CRO is hardly proven. Whether UCSF recast as a CRO would yield better research, leading to better patient outcomes than would have resulted if it continued as a state government sponsored health care university is also hardly proven.

Turning UCSF into a quasi CRO, however, would likely be very much in the self-interest of its administrators/ managers/ bureaucrats/ executives who would be freed from any constraints on their incomes, and the disclosure of same that were previously obligated by the messy representative democracy to which they formerly had to answer.

On the other hand, it is hard to conceive of how such a privatization would be good for students or patients. In fact, it is not the least bit clear why a medical, nursing, or other health professional student would want to study within what would basically be a contract research organization. It is also unclear whether patients seeking care from such an organization could trust it to put their interests, rather than the organization's revenue and the self-interest of its administrators/ managers/ bureaucrats/ executives first.

We are now a good 30+ years into our ill-fated American experiment about the effects of turning medicine commercial and making health care a commodity. So far, it has yielded the highest costs in the world, but declining access, mediocre quality, and demoralized professionals. Turning one of our once proud and  prestigious state government sponsored academic medical institutions into a private contract research organization would be a powerful symbol of our final national health care decline.

Let us hope that the students and faculty whose "conspiracy theory" about privatization proved true will now mount a more effective protest before UCSF falls into the muck.

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"Barbarians at the Gate" - Making Private Equity Less Private, and Understanding Its Effects on Health Care

One good byproduct of the tumultuous everlasting 2012 campaign for the US presidency has been to shed light on a number of political and economic issues that had previously been ignored, especially those relating to the global financial crisis or great recession.  In turn, many of these issues may be relevant to our understanding of our ongoing health care dysfunction. 

The latest issue to achieve prominence was the nature of private equity firms.  Current presidential contender Mitt Romney used to work for Bain Capital, a private equity group.  As we discussed here, Bain Capital owned a variety of companies, including some important health care corporations.  More importantly, attacks on Mr Romney's record at Bain by other candidates have lead to a broader discussion of the nature of private equity.  This discussion is very relevant to health care, since private equity firms have taken over a number of important health care corporations, and more recently, have begun to take over formerly non-profit health care organizations.

Therefore, we will summarize what has become known about private equity, and then consider its implications for health care.

Understanding Private Equity as Re-Branded Leveraged Buy-Out Firms

- Private Equity Firms are Just Re-Branded Leveraged Buyout Firms

The first good statement to this effect I found was by Merrill Goozner in the Fiscal Times(1):

Private equity is actually a misnomer, since the modus operandi of those investors is no different than the leveraged buyout firms that pioneered junk-bond financing in the 1980s.

As reported by the Los Angeles Times(2):

'Being known as a leveraged-buyout-deal shop wasn't the most attractive label out there,' said Colin Blaydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth's Tuck School of Business. 'Private equity has a much nicer ring to it.'

In fact, according to Forbes columnist Robert Lenzer,(3) the famed investor Warren Buffet called this re-branding

'Orwellian': Buffett wrote that 'private equity' is a 'name that turns facts upside-down: A purchase of a business by these firms almost invariably results in dramatic reductions in the equity portion of the acquiree’s capital structure compared to that previously existing.'

I must admit I always thought private equity firms simply collected large amounts of capital from investors, then used the pooled capital to buy out troubled firms. I assumed that because these investors therefore had a large personal stake in these firms, they would want to increase at least their financial value. I also thought that leveraged buy-out firms ceased to exist after all the bad press they got in the 1980s. It turns out I was wrong on all counts. Probably, a lot of other peoples' beliefs about private equity were similarly wrong.

Once the equation of private equity and leveraged buyout firms is made, understanding what they do and its implications are easier.

- Leveraging the Buy-Out

The modus operandi of leveraged buyout firms is to make their purchases of troubled corporations mainly with borrowed money. As Merrill Goozner put it(1),

Private equity firms generally finance anywhere from 60 to 90 percent of their purchases with borrowed cash.

Note that,

Interest payments on those debts are treated just like any other expense, and are therefore deductible from earnings.

- Then Leveraging the Acquired Company

If this leveraging were the only leveraging done in a leveraged buy-out, the implications might not be that big, except for the acquiring firm. After all, when the leveraged buy-out firm borrows the money, it then becomes obligated to pay it back. However, then comes the tricks.

One important trick was described in the following example by economist Dean Baker on the Beat the Press blog(4),

To take a simple example, suppose a public company (let's call it Gingrich Inc.), has $1 billion a year in profits. If Gingrich Inc. paid taxes at the full 35 percent rate (fat chance), it would have $650 million [thanks Robert] a year to either keep as retained earnings or to pay out as dividends to its shareholders.

Now suppose that a PE company (we'll call it Romney Capital) steps in. The current price to earnings ratio in the stock market is around 14, so Gingrich Inc. would have a pre-takeover market value of approximately $9.2 billion (14*$650 million). Romney Capital then arranges for Gingrich Inc. to borrow $6 billion which it pays out as a dividend to itself. This means that the Romney Capital has just gotten back almost two-thirds of its investment.

A somewhat less vivid description of the process appeared in a post by Robert K Lifton on the Huffington Post(5):

Most often, in order to increase the return on capital invested by the fund, the fund will borrow a significant portion of the purchase price of the business. And sometimes, if it can, the fund will take back as a distribution immediately upon closing the purchase of the business, a portion of its investment in the purchase price, reducing its own investment and enhancing its return on the investment left in the business. This distribution may come from the company's existing cashable assets or from money that the company is caused to borrow.

Thus, it appears that while the leveraged buy-out (or private equity) firm borrowed money to finance the purchase of a company, it can almost immediately get out of its obligation to pay off that loan, by making the acquired company its own loan, and using proceeds from that to end the LBO firm's debt. The leverage, and the obligation to pay back a debt has almost magically been transferred from the LBO or private equity firm to the acquired company. That has big implications, as Lifton wrote(5):

This additional leverage also creates additional risk; if things don't go right the business will not be able to pay the carrying costs of the debt, the lender will take over the business and the fund will lose its investment. Sometimes, that results in the acquired company placed in bankruptcy proceedings either to liquidate its assets to pay off the debt or to restructure, a process Bain also experienced.

- Selling Assets to Further Reduce the Private Equity Firm's Debt

LBO firms have another trick up their collective sleeves. As Dean Baker continued his example(4),

Now suppose that the Romney Capital arranges to sell off some of Gingrich Inc.'s assets, such as real estate or a highly profitable subsidiary, and then uses the proceeds to make a payment to the Romney Capital rather than leaving the money under the control of Gingrich Inc. Such sales may allow Romney Capital to recoup the rest of its investment and possibly more.

Of course, the result is

Gingrich Inc. is then left as a highly indebted company with few assets.

In this story, Romney Capital may have earned a substantial profit on a limited investment (it recouped most of its money almost immediately when it loaded Gingrich Inc. with debt), without doing anything to improve the operation of Gingrich Inc. If Gingrich Inc. manages to stay in business and generate profits, then this will increase the return. Romney Capital may be able to resell the company and treat the whole sale price as profit.

On the other hand, if Gingrich Inc. goes bankrupt, this will primarily be a problem for creditors, since Romney Capital has already gotten its investment back. In effect, Romney Capital might have secured large gains entirely by financial engineering, while creating no value whatsoever.

Let me underscore that. The LBO model (now also the private equity model) enables the acquiring LBO firm to avoid any losses, by shifting all the risk and obligations to the acquired firms. This puts these firms at considerable jeopardy.

- Tactics to Prepare Acquired Firms for Sale

Of course, LBO/ private equity firms want to do more than not lose money. To make real money, they must be able to sell off the firms they acquire. To do so, they must make these firms, or their components, seem attractive, at least in the short term. To do this, they employ a standard set of tactics out of the generic management playbook.

So, per the LA Times(2),

layoffs are part of the playbook that elite investment firms use to squeeze cash out of struggling companies.

Also, per Lifton(5),

To increase the profits of the acquired company, the fund may reduce the number of employees, reduce pay levels or curtail work time.

In addition, per Josh Barro writing for the Forbe blog(6), other tactics can include

downsizing, increased automation, offshoring, and the like.

- The Private Equity/ Leveraged Buy-Out Version of the Anechoic Effect

It is striking that while Mitt Romney worked at Bain Capital in the last century, and private equity has been around, if not growing, since then, the current presidential campaign seems to be the first occasion which prompted any real public discussion about the nature of private equity, and its significance for the larger political economy. Thus private equity/ LBO seem to have been anechoic for a very long time (like much about how our current health care system operates seems to be anechoic.)

This version of the anechoic effect seems to have been deliberately created by the private equity/ LBO firms.

A Washington Post commentary(7) quoted Mitt Romney,

You know I think it's fine to talk about those things in quiet rooms,...

As a New York Times story(8) put it, these firms are lead by

a group of Wall Street executives who prefer to operate out of the spotlight

A story in Politico(9) called private equity/ leveraged buy-out firms

one of the most secretive redoubts of the American economy

The article went on to suggest that these firms may well have something to hide:

Josh Kosman, author of 'The Buyout of America: How Private Equity Is Destroying Jobs and Killing the American Economy.' [said] 'Most private equity firms are because once you look behind the numbers, there is much they don’t want you to see.'

Furthermore,

Private equity companies often tend to have confidentiality agreements with their investors (Bain would not comment on what agreements it has). Several equity experts interviewed for this story thought any disclosures from Bain were likely to spook its investors.

The private equity business model is based on taking companies out of the public markets, where reporting requirements are strict and investors punishing, making changes that will hopefully make them more profitable and then selling them or taking them public through an IPO.

The part that happens behind the curtain is not always pretty, and private equity firms have learned over the years that it’s hard to tell a complicated story in the media. The goal of private equity is to keep things private.

'It’s had very little consciousness in the political realm until Romney came along because these guys are smart enough not to try to become Treasury secretaries,' said Bill Cohan, a former Wall Street banker-turned-investigative journalist who wrote 'Money and Power: How Goldman Sachs Came To Rule The World.'

In addition, Dean Baker suggested that the confidentiality is used to hide how private equity/ leveraged buy-out firms remove capital from acquired companies(4),

The sort of asset stripping described here, which harms creditors by taking away potential collateral for their loans, violates the law. However it is extremely difficult to prevent, especially with private equity companies that have to make few public disclosures.

Thus secrecy/ confidentiality/ deception should be regarded as one of the main tactics used by private equity/ leveraged buy-out firms.

Implications for Health Care

Mitt Romney's candidacy has generated a surprising amount of discussion about the effects of private equity/ leveraged buy-out firms on the political economy. Many are worried that despite his claims, such firms cause more job loss than job creation. In the Huffington Post(10), Robert Creamer wrote that private equity/ LBOs have contributed to the sense that ordinary people who play by the rules suffer while well-connected insiders prosper:

It just doesn't make sense to them that a relatively tiny number of people -- who don't build a product or create a service -- can make massive amounts of money, while ordinary people who work hard and play by the rules see their incomes flat-line.

Their view is simple. They create cars, or food, or houses or computers -- or they provide police protection, or care for sick people, or teach our kids. Why should they be asked to sacrifice when guys who basically gamble for a living -- as Wall Street speculators -- make incomprehensibly large sums of money?

There seems to be a good argument that the tactics used by private equity/ leveraged buy-out firms might be bad for the general political economy.

Moreover, these firms often take over health care corporations, drug and device companies, health care information technology companies, health insurance companies, for-profit hospital chains, etc. There is reason to think that their standard tactics used on such targets are likely to be particularly bad for health care.

Many health care corporations depend on a long-term view to be successes. To develop new products, drug, device, and health care IT companies must pursue research and development projects that take years. All health care companies depend on highly trained, specialized workers and professionals. To sustain these sorts of employees requires a long-term attention to their development. So private equity/ leveraged buy-out firms' short-term focus, transfer of debt and risk to the acquired companies, and emphasis on short-term generic management cutting costs techniques including lay-offs, outsourcing, etc clash with the sophisticated long-term focus these companies require.

These health care organizations often require the complex interplay of many components. Private equity/ leveraged buy-out firms' efforts to sequester and sell particular assets may disturb this complex system.

Health care quality, and successful research and development require transparency. Extreme emphasis on secrecy by private equity/ leveraged buy-out firms threatens such transparency.

Even more pointed concerns may arise when private equity/ leveraged buy-out firms endeavor to take over non-profit health care organizations. We plan to discuss these in a subsequent post.

The NY Times(g) noted that in the 1980s, leveraged buy-out firms

were branded as 'barbarians at the gate' - the title of a book [by Burrough and Helyar, link here] about the takeover of RJR Nabisco by Kohlberg Kravis Roberts.

Now 30 years later we are finally having a conversation about the role of these firms in the greater political economy. We in health care should be having a parallel discusion about their role in our sphere. I submit that their role was not likely productive. Since health care should not merely be looked upon as a means to make money, but as a public good, we ought to be talking about how to restrain private equity/ leveraged buy-out firms from doing it more damage.

References

1. Goozner M. Private equity's edge: buy now, deduct taxes later.  Fiscal Times, Jan 9, 2012.  Link here.
2, Hamilton W. Private equity industry: a bad rep, but is it deserved. Los Angeles Times, Jan 12, 2012. Link here.
3. Lenzer R. Why Warren Buffet disdains the private equity crowd. Forbes, Jan 14, 2012. Link here.
4. Baker D. NPR does fluff piece for private equity. Beat the Press, Jan 13, 2012. Link here.
5. Lifton RK. Mitt Romney and Bain Capital: understanding the reality. Huffington Post, Jan 13, 2012. Link here.
6. Barro J. The discussion we should be having about Bain. Forbes, Jan 12, 2012. Link here.
7, Robinson E. Reexamining the myth of no-fault capitalism. Washington Post, Jan 16, 2012. Link here.
8. Lattman P, Lowrey A. As Romney advances, private equity becomes part of the debate. New York Times, Jan 10, 2012. Link here.
9. Hagey K. Mitt Romney's Bain Capital days: a black box. Politico, Jan 11, 2012. Link here.
10 Creamer R. Why the Bain Capital controversy is so damaging to GOP chances this fall. Huffington Post, Jan 16, 2012. Link here.

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Hospital Executives - What Will They Think of Next?

Health care organizations are now most often run by people with management, not clinical backgrounds.  It seems like business schools have taught managers to sign on to whatever the latest management fashions are.  So what are the latest fashions in hospital management?  Here are a few hot items.

Retreading Pharmaceutical Representatives

My jaundiced reading of the business news suggests that most executives think that marketing is the most important part of their organizations, and that clever marketing can sell any product or service. For example, the pharmaceutical industry spends about twice as much on marketing as it does on research and development (despite pharma executives' protestations that they run research driven businesses) (see this post). So it should be no surprise that now hospitals are using "hospital representatives" to market referrals to their institutions to doctors.

From last week's USA Today:

n northwest Indiana, Carrie Sota visits five or six doctors' offices every workday as part of her new sales job.

But Sota isn't selling the physicians on a prescription drug or a medical device. She's promoting her hospital — the University of Chicago Medical Center.

Sota, 30, is one of four employees the academic medical center has hired in recent months to make 'sales calls' on physicians in the hope that they will send more patients to the hospital. 'We are trying to build meaningful relationships,' said Sota, who was previously a saleswoman for a small medical device company.

The University of Chicago Medical Center is one of a growing number of hospitals nationwide hiring former drug and device sales reps to visit doctors' offices to persuade them to use their services over competing facilities.

Rather than handing out samples of prescription drugs, the sales reps call on doctors armed with the latest information on how their facility is reducing hospital-acquired infections and improving patient-satisfaction scores.

In visits that can last five to 20 minutes, reps try to win doctors' loyalty by helping them get better times on operating room schedules or easier patient referrals to hospital-based specialists. The sales reps can also carry messages back to the hospital, such as a doctor's request for a new medical device to be available in surgery.

The article suggested a few problems with this approach. First, the point of the marketing is not to improve the match between patients' needs and the services the hospital provides. Rather, it is to generate referrals that have the potential to provide the maximum revenue:

While hospitals have always tried to woo doctors to refer patients to them, the institutions are growing more direct in their efforts. The hospitals mine data to see which doctors have the most profitable, well-insured patients, and then they assign those doctors to a sales rep.

So in particular,

Many of the physician liaisons focus on specialists, who bring in patients for services with the highest profit margins, including orthopedics, cardiac care and cancer care, [Duke University Health System physician liaison manager Christine] Perry said.

Second, the hospital reps have incentives based on revenue, not on value to the patient:

About two-thirds of Tenet's liaisons are former drug and device sales reps, and they can make tens of thousands of dollars in bonuses if doctors increase their referrals to the hospitals.

Third, across the system, the revenues generated may be much less than the costs incurred, since most of the marketing will only succeed in moving patients from one hospital to another:

Paul Ginsburg, president of the non-partisan Center for Studying Health System Change, said, 'When you look at the health system, this is a waste of resources. It's a zero-sum game.'

He added: 'The net results of changing physician-referral patterns is that one hospital gains at a cost of others, and all the hospitals burn resources to pay (sales)people who take up the doctor's time.'

Of course, the reps could succeed in persuading doctors to refer patients to specific hospitals for services the doctors originally did not think the patients needed. That would be good were the patients to need those services, but bad if they were not.
Fourth, we have discussed (for example, here and here) how pharmaceutical representatives use sophisticated psychological and emotional manipulation, despite claims that all they do is provide unbiased information and educational, to influence physicians to prescribe drugs. Again, this may result in patients getting drugs whose benefits do not outweigh their harms. It is possible that hospital representatives will do something similar:

'These people are really good and really assertive and very sophisticated,' said Stephen Newman, Tenet's chief operating officer.

Unbundling Payments

The airlines decided a while ago that they could make more money by charging passengers for each checked bag, and even for those little meals on plastic trays. It looks like hospital executives have discovered a new way to unbundle.

As reported last month by the St Louis Post-Dispatch, hospitals have begun charging often hefty "facility fees" for patients seen as outpatients in hospital clinics or hospital owned practices, even for very minor procedures or just office visits, and even for Medicare patients. (Private physicians who see patients in their own offices cannot charge such fees to Medicare patients, and most private insurance companies will not cover such fees.):

A few weeks after Allison Zaromb took her 4-year-old son Meir to see a dermatologist in an outpatient office at the SSM Cardinal Glennon Children's Medical Center campus, she received separate bills from the doctor and the hospital.

The cost for a 3-minute procedure to treat Meir's warts totaled $538, which included a $220 bill for physician services - and a separate bill for a $318 hospital 'facility fee.'

Zaromb, a periodontist who lives in University City, is now suing SSM Health Care Corp. and Cardinal Glennon Children's Medical Center in a proposed class action lawsuit on behalf of other patients

More generally,

With the proliferation of hospital-owned outpatient centers and hospital-owned physician practices, hospital 'facility fees' have become increasingly common. Such hospital facility fees often involve greater dollar amounts than the fees charged by physicians.

Technically, it all appears to be legal:

Under federal regulations, health systems are permitted to charge a hospital facility fee for an outpatient service if it's done in a clinic that is 'hospital-based' - meaning that the clinic is owned and operated as part of a hospital or health system, regardless of whether the clinic is physically located on the hospital grounds.

This technique does seem to be a way to increase revenue. But one person's revenue is another person's cost, so it also seems to be a great way to further increase the already high cost of US health care. It is not obvious, however, that these increased costs will lead to increased quality of care or value for the patient:

'From a consumer's perspective, when you go see your doctor, you go see your doctor - whether it's in an office inside a larger hospital complex or right across the street,' [Zaromb's lawyer John] Phillips said. 'The doctor's practice remains the same. ... They're making the doctor's office a ‘hospital-based' clinic for one reason: to make money by charging a facility fee, not to improve consumer service.'

Negotiating the Costs of Medical Devices

One of the favorite topics on Health Care Renewal, at least before we found even more outrageous subjects, was the stratospheric cost of medical devices. For example, look at posts from 2005 here, here, here, and here. So last month we found out that hospital executives have come up with a revolutionary idea to combat the high cost of devices. They will actually try to see what prices the device companies charge other hospitals, and then negotiate the prices down, as Reuters reported as big news in late November:

Implantable devices make up a sizable chunk of typical hospital budgets, and administrators are devising new ways to limit that cost as they brace for cuts to government reimbursement and treat more patients who can't pay for care.

That means methodically working through each category of device, from heart valve replacements and stents to spinal products, to see where they can negotiate lower prices. It also means creating databases of shared information on pricing between hospitals.

Imagine that! Of course, the notion that buyers ought to bargain with sellers to get the best price goes back a few years. However, only in 2011 did it apparently occur to hospital executives that they ought to negotiate the prices of one their most expensive purchases. This suggests that there has been something profoundly wrong with the basic assumptions underlying the commonly accepted wisdom that making the health care system more of a market will lead to more financially efficient care. 

Summary

In 1988, Alain Enthoven advocated in Theory and Practice of Managed Competition in Health Care Finance, a book published in the Netherlands, that to decrease health care costs it would be necessary to break up the "physicians' guild" and replace leadership by clinicians with leadership by managers (see 2006 post here). Thus from 1983 to 2000, the number of managers working in the US health care system grew 726%, while the number of physicians grew 39%, so the manager/physician ratio went from roughly one to six to one to one (see 2005 post here). Health care went from being controlled by clinicians to controlled by a growing volume of managers.  Most of these managers were generic, in that they had little if any knowledge of, experience in, or sympathy to the values of health care. These generic managers have used the same techniques advocated for the management of supermarkets or automobile manufacturers to manage health care organizations, despite all the obvious differences in context, goals, values, and people involved.

So these generic managers have brought us such "innovations" as the "hospital (marketing) representative," and the "facility fee" for outpatient visits, but only thought to negotiate device prices in 2011. But that is why we pay them the big bucks.

How many more arguments do we need that health care organizations ought to be lead by people who understand the health care context, share its core values, and are accountable for how these organizations affect patients' and the public's health?

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Another Hospital Putting on the Ritz

The usual definition of a hospital is an institution which treats the sick and injured,.  That is a messy business, so some hospital executives seem to yearn to be doing something a little more - shall we say - upscale.  For example, the Chattanoogan reported:

Erlanger Health System will launch in October one of the most ambitious employee training initiatives in its 120-year history. All 4,500 employees will participate in a new service excellence program based on the legendary Ritz-Carlton service model.

'This is not a program. This is the beginning of long-term cultural transformation,' says Erlanger CEO James Brexler. 'Our board and leadership team believe this initiative is one of the most significant developments in the continued evolution of Erlanger.'

The Erlanger Health System strategic plan, adopted by the board of trustees last year, identified service excellence as a priority. Funding for the initiative was approved in this year’s operating budget. The corporate university of Ritz-Carlton was selected to help take Erlanger’s patient experiences to the next level.

A hospital, of course, provides services to patients. However, it seems glaringly obvious that the sort of services required by the sick and injured, especially the critically ill, are very different than those people who go to four-star hotels. Providing care to a patient on a ventilator (breathing machine), for example, hardly resembles providing spa services to a wealthy hotel guest.

Furthermore, Erlanger Health System is a public, non-profit health system with a mission that involves service to the poor:

To deliver excellence in medical care to improve the health status of our region, while providing vital services to those in need, and training to health professionals through affiliation with academic partners

The Boston hotel in the Ritz-Carlton chain, its flagship property, boasts that it:

features hotel rooms and suites in Boston designed as sanctuaries of urban luxury.

Where is the parallel to providing health care services to "those in need" who are acutely ill and injured?

By the way, a few days after the Erlanger, Ritz-Carlton connection was announced, the Time Free Press noted questions about how the contract was awarded:

Erlanger officials defended the no-bid procedure Monday, saying the hospital was correct in bypassing a competitive bid process and awarding a 'professional services' contract to Ritz-Carlton.

'Tennessee law says government entities do not have to bid professional services,' hospital spokeswoman Susan Sawyer said.

Even early in the process, Whisman said, 'it was so clearly the Ritz going forward.'

'There was a lot of board support, executive-level support and steering committee support,' she said. 'Ritz had it all.'

Furthermore, how well the money will be spent may be difficult to find out:

In October, a Ritz-Carlton speaker is expected to lead several four-hour sessions, each of which will hold 400 employees, hospital officials said.

The bill for those sessions is $288,000. On Thursday, Sawyer said Ritz-Carlton prohibited the media from attending the sessions because of proprietary information the hotel chain prefers to keep secret.

It is not that the hospital system has money to burn, as the Chattanoogan just revealed:

Erlanger Health System officials reported a $1.3 million loss for July,...

In addition,

Admissions were under budget by 1.6 percent for the month and ahead of the previous year by 3.8 percent.

So, in summary so far, a public hospital system that is currently experiencing budgetary challenges is spending hundreds of thousands of dollars for the Ritz-Carlton luxury hotel chain to train its employees in secret sessions about "service excellence," and the hospital system's management thinks this is a top priority.

In my humble opinion, this illustrates a larger problem with the leadership of health care. Health care organizations are often lead by ultra generic managers, that is, managers trained in such fields as marketing, public relations, and finance, but without any experience or training in actually taking care of patients. (The supremacy of generic management is strange given that patient care itself has become so specialized.) The utter lack of gut feeling for what health care is really about seems to lead to managers thinking that hospitals are like automobile assembly plants, or in this case, like luxury hotels. I cannot but help believe that such ultra generic managers, who do not appreciate the values of health care professionals, and do not understand the health care context, are going to make some very bad decisions, and are an important cause of health care dysfunction.

I cannot help believe that the Erlanger CEO, Mr James Brexler, (whose most advanced degree was a "Masters of Public Affairs from North Carolina State University") was entirely off base when he was quoted:

'This is not a flavor-of-the-month thing,' continues CEO Brexler. 'This is a strategic priority and business imperative. We are committed to this. We are excited about it. Our staff is excited. Our physicians are excited. The results, we believe, will be evident to our patients and their families.'

True health care reform would make sure health care leaders actually understand health care and uphold its values.

PS - Long ago, we noted the trustees of another hospital system who seemed to think that Ritz-Carlton experience was perfect background for hospital executives.

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