How Big is too Big? On "Diseconomies" in Large Healthcare

With healthcare mergers now announced seemingly every week, I've been giving some thought to scale:  

How big can/ should health systems be?  

Anecdotally, I'm struck that

the most impressive healthcare companies in America are super- regional players

:  Geissinger, Cleveland Clinic, UPMC, etc.  They seem to get a lot more attention than the national players with hundreds of facilities. Leaving aside questions like strategy (e.g. is integration of payers/doctors/hospitals the key to these successes), I've wondered whether regional systems are simply the right size to thrive.  My suspicion is that even clever organizational structure (

a topic which I wrote about last year

) can't overcome barriers that prevent large healthcare companies from innovating and thriving, particularly as companies move to risk and the business of healthcare becomes more complex. Like

cellular organisms

, large companies can outgrow their life support. (Interestingly, it's actually the ratio of body volume to surface area

that served as a constraint to organism size...) I recently ran across a superb paper-  

a doctoral thesis written by Staffan Canback

.  Canback (who now leads the Economist Intelligence/ Canback predictive analytics consulting firm in Boston) wrote his thesis, called

Limits of Firm Size: An Inquiry into Diseconomies of Scale

 in 2000, while a student in London.

Canback argues, convincingly, that companies do become more efficient with scale, but reach a point where "diseconomies" begin to mitigate performance.

 This may seem intuitive: (as Canback notes, if efficiency only improved with scale then we would buy everything from one company that produces everything with great levels of efficiency).  We don't. I'm dabbling in this complex field, but

here are my takeaways:

Classic economic theory proposes that there is

increasing efficiency (decreasing unit cost) with scale but that at a certain point diseconomies of scale begin to increase unit cos

t.

The problem with this curve is that it can't explain why there tend to be

multiple companies of various sizes competing successfully in a given industry

.  The answer, according to Canback, is that there is a large "sweet spot" in most industries where the benefits of scale are reached and before structural inefficiencies develop.  There is then an inflection point, limited to large companies, where diseconomies of scale emerge.  The curve looks more like this:

What are the diseconomies of scale that Canback writes about? The ones that begin to increase unit cost at point M2?  

They are ultimately bureaucratic concerns

. Canback quotes the economist Herbert Simon:

Here are the four main categories of scale diseconomies:

1. Communication distortion due to bounded rationality 

2. Bureaucratic insularity

3. Atmospheric consequences due to specialisation

4. Incentive limits

Here is the relationship between these four limiting factors and undesirable outcomes in large firms.

In a complex, heavily customized relationship-based industry like healthcare, I'd suspect that these difficulties would be amplified. It would be fascinating to plot the progressive performance of the country's largest healthcare companies as they grew over time (including not just fiscal performance, but also measures of quality and innovation).  I'd be curious to see if it they look like Canback's charts: doing fine until the magic inflection point at M2...  

Photo: 

Riyaad Minty

 via Flikr, Creative Commons