Cost Escalation within the Healthcare Sector

CostEscalation within the Healthcare Sector


CostEscalation within the Healthcare SectorIntroduction

Thepersistent rise in healthcare costs within the healthcare sector inthe past few years has made it difficult for many families and firmsto offer health cover for their subjects. It is estimated that todaycitizens spend much more on healthcare than other necessities likefood. In fact, in the United States, spending on healthcare currentlyexceeds 17% of GDP (Kaplan &amp Porter, 2011). The sharp increase inhealthcare spending has been attributed to a variety of factors. On ageneral basis, the sharp increase in healthcare spending is seen asnot necessarily as an increase real spending on healthcare but as aresult of slow economic growth complete with recessions. It issuggested that in general, the period between world financial crisesof the early 1990s and early 2000s were marked by managed healthcare(Levit et al, 2003). The managed healthcare, it is espoused, slowedthe growth of medical spending and the quantity of services used perindividual (p. 156). The rise in healthcare costs has been observedacross all the sectors including hospitals, prescription drugs,physician and clinical services, nursing home care as well as homehealth.

Driversof Cost Escalation in Healthcare

Thefastest growing spending, for instance, in the United States, is thecategory that has witnessed an increased escalation of costs: theprescription drugs followed by hospital services and clinicalservices (Shi &amp Singh, 2014). The escalated healthcare costs inthe hospital services is attributed to an increased population, priceinflations and the quantity of services per person (p. 97). Moreover,the medical labor market has been vibrant leading to an increase inwages of health practitioners. This has the spiral effect ofincreasing the costs of healthcare. As for prescription drugs, theentrance of new blockbuster drugs in the healthcare market have alsoled to an increase in drug costs (Kaplan &amp Porter, 2011). This isso since new drugs are usually traded at relatively high costs toenable manufacturers recoup the initial spending on research anddevelopment (R&ampD). The increased costs in the physician andclinical charges have largely been due to the imaging techniques thathave gained wide applicability in the healthcare practice as well asphysician consultations and the decline in review of policies byvarious regulatory authorities (Tiburt et al, 2013). This finding hasalso been confirmed by AWHP (2015) who observed that technology is amajor driver of healthcare cost the world over (p.3). Moreover, thepersistent shortages of practitioners in healthcare has led to anincrease in service demand thereby putting an upward pressure onhealthcare prices.

Thekey driver of healthcare costs, as far as empirical evidence isconcerned, is prescription drugs. The persistent price increasesobserved in this category has been found to impact directly onmedical cover. It has further been espoused that the increase inprescription drugs is through certain specific mechanisms, whichinclude price inflation, a general shift towards the use of moreexpensive drugs and an increase in the number of drugs prescribed byphysicians (AWHP, 2015). Moreover, the escalating costs ofprescription drugs has been attributed to several other factors.First, the increased number and therefore competition between thepharmaceutical companies have led to an increase in prices of drugsas the advertisement costs are directly transferred to the customers(p. 4). Additionally, there has been an increase in the use ofgeneric drugs thereby putting an upward pressure on the prices oforiginal brands. The overall effect of all this is that there hasbeen a rapid increase in the costs of prescription drugs making itthe key driver of escalation of healthcare costs in general.

Afeasible strategy that managers can use to lower costs is throughmergers and acquisitions in their lines of operations. Mergers andacquisitions in the healthcare sector has been found to be aneffective way of cutting costs especially because it eliminates thecosts associated with the duplication of services and it additionallygives the organization a competitive business strategy which can leadto overall operational efficiency (Stanton &amp Rutherford, 2002).Mergers are an efficient strategy for cost reduction since thehospitals will share the administrative costs and obtain inputsincluding drugs at relatively lower costs (p.3).

ReducingCosts: An Organizational Setting

Differentorganizations have developed different strategies to reducehealthcare costs at their organizations based on the costs incurredat the firm level. At San Fraser Hospital, we have identified costsof buying pharmaceutical products (under variable costs) as the mostcritical cost that has always determined the organization’s profitmargins. Last year, the hospital spent a total of $ 45589 on theseproducts that translated to 78.9% of the total expenditure. Thisoutrageous amount is because the products have always been sourcedfrom different manufacturers and the orders have always been placedonly when the products are on demand at the organization. By the endof this year, we intend to cut the costs of pharmaceutical productsby 10% to $41030. This will be done through various mechanisms, whichinclude adopting a robust supply chain management that incorporatesmyriad inventory management system complete with the total qualitymanagement (TQM) approach to ensure that pharmaceutical products ofthe highest quality are always available for use, by theorganization. Moreover, the long-term strategy of the organization isto merge with Beta Supplies to obtain pharmaceutical supplies fromwithin the organization.


Theescalating costs of healthcare is due to a multiplicity of factorssome of which are external to the organizations. The healthcare costsare driven by prescription drugs, administrative costs, technology,inflation, clinician and physician services, which all vary dependingon organizations. The macroeconomic settings in which they operatealso influences the extent to which the general healthcare costsincrease. From an organizational perspective, mergers andacquisitions represent the best strategy for cutting costs since itaddresses a majority of the drivers of healthcare cost escalation(Stanton &amp Rutherford, 2002).


Associationof Washington Health Plan (AWHP), 2015. Healthcare CoverageHealthcare Cost Drivers. Accessed on 17thJuly 2015 at4.09pm&lt

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Levit,K., Smith, C., Cowan, C., Lazenby, H., Sensenig, A., &amp Catlin, A.(2003). Trends in US health care spending, 2001. HealthAffairs,22(1),154-164.

Shi,L., &amp Singh, D. A. (2014). Deliveringhealth care in America.Jones &amp Bartlett Learning.

Stanton,M. W., &amp Rutherford, M. (2002). Reducingcosts in the health care system: learning from what has been done(No. 9, p. 3). Rockville: Agency for Healthcare Research and Quality.

Tilburt,J. C., Wynia, M. K., Sheeler, R. D., Thorsteinsdottir, B., James, K.M., Egginton, J. S., … &amp Goold, S. D. (2013). Views of USphysicians about controlling health care costs. Jama,310(4),380-389.