Wanted: Slightly Used Hospitals

By Janice Castro

Rick Scott remembers the first time he offered to buy HCA, the Hospital Corp. of America, based in Nashville, Tennessee. He offered $5 billion. Scott, then a 34-year-old Fort Worth, Texas, lawyer, had $125,000 in the bank. They laughed, he recalls fondly. "One guy in Dallas said, 'What are you going to do, Rick? Put it on your MasterCard?' "

A few months later in 1987, Scott quit his law-firm job, founded a company he called Columbia Hospital Corp. and started to buy individual hospitals for a living. Within five years, he and his investment partners raised enough money to buy 38 of them, scattered from El Paso, Texas, to Miami, acquiring along the way an enviable reputation for delivering high-quality care with low operating costs. Last September, in a $4.3 billion deal, he took over the 71 Humana hospitals. Last month, with particular satisfaction, Scott changed the name of his firm to Columbia/HCA Healthcare, having just completed an $8 billion merger with his original, elusive target. In so doing he added HCA's 95 hospitals to Columbia's sprawling, 26-state chain.

In less than seven years, Scott has built the largest hospital firm in the country. Columbia now owns 197 hospitals and projects 1994 revenues of more than $11 billion. Scott's original $125,000 investment is worth $266 million, and Columbia, based in Louisville, Kentucky, is still growing briskly in every region where it has gained a foothold. Within 10 years, Scott expects to own 500 hospitals. "But," he hastens to add, "we could have 1,000. It's possible. Nobody ever thought we'd get this far this soon."

Even as Congress mulls ways to reform the $1 trillion American health-care system, the nation's health sector, through the likes of Rick Scott, is rapidly reforming itself. Health inflation, for example, has slowed dramatically. Medical costs rose just 5.3% last year, the smallest increase in 20 years -- largely because enrollment in managed-care plans, which seek to curb wasteful treatment, is growing so quickly. More than half of all American workers are enrolled in such health plans, up from 27% in 1988. Most striking, more than a third of companies offering health benefits to their workers actually reduced their medical bills last year or saw no increases from the year before, according to a study by the Foster Higgins consulting firm. The competition to serve patients has become so intense that when Columbia, which operates 47 hospitals in Florida, bid on a contract to serve the public employees of Lee County, Florida, last fall, the chain had to offer a 40% discount to win the business.

The pressure to hold down costs has brought about dramatic changes in the $360 billion hospital industry. In the old days (10 years ago), insurance companies and Medicaid and Medicare generally paid hospitals whatever they charged. Almost all of the more than 6,000 American hospitals were tax-exempt nonprofits with few incentives to curb their expenses. Now most hospital patients are insured by plans that demand discounts, limit payments and closely monitor care to see whether patients are spending too many days in the hospital or having too many tests. A wrenching shakeout is transforming the industry from a wasteful, overbuilt mess, which has left nonprofit hospitals $100 billion in debt, to a more efficient, cost-conscious business. On any given day, more than a third of all hospital beds in the U.S. are empty. Managed care and advances in medical treatment have helped shorten hospital stays and have shifted simple surgeries and other procedures into outpatient settings. Many hospitals have become obsolete. Every year 50 close their doors. Scott says that's not enough: "You could close 30% of the hospitals in this country today and nobody would miss them, as long as people could go to a good hospital nearby."

- Wastefulness is what drew Scott to the hospital industry in the first place. After studying the business as an attorney handling several hospital sales for clients, he was confident he could do a better job managing these institutions. One patented Scott method of making his hospitals more efficient is to buy an underused, competing hospital and shut it down, shifting the patients into his remaining facilities nearby. In 1988, shortly after buying his first two hospitals in El Paso, he asked his bank for an $11 million loan to buy a nearby hospital that was nearly empty. "They were serving only 50 patients a day and were already $11 million in debt. My bankers said I was crazy, borrowing money to close something down. I told them, look, if just 40 of those patients come to the hospital I have three blocks away, we'll take in $6 million a year in new revenues."

He got his loan and his new patients. The underused hospital was converted to commercial office space; his two remaining El Paso facilities became more profitable. Says Scott: "Hospitals have high fixed expenses because of all the equipment and skilled professionals you need to run them. Any time you can make a hospital busier, you can increase your cash flow and reduce your average costs per patient while also improving quality. When you get sick, go to a busy hospital. That's the one that always has everything you need, from the specialists to the equipment, because it can afford them."

Columbia has grown one city at a time, buying hospitals, then adding outpatient surgery centers, rehabilitation facilities, diagnostic testing labs and other health services in the surrounding communities. The strategy is vertical integration, a coordinated system to offer patients whatever they need, from X rays to transplants, in the setting that makes the most sense. By building substantial market share, Columbia has gained negotiating clout with its suppliers and contractors. Because the company buys $1.8 billion worth of hospital goods every year, for example, Columbia is able to demand deep discounts. Says John Hendelong, who follows the health-care sector for the Donaldson, Lufkin & Jenrette investment firm: "The Clinton Administration wants a more streamlined health-care system, and this is exactly what Columbia is building. They have been able to control costs without hurting quality." Columbia runs several teaching hospitals and research centers as well, including the University of Louisville, University of Chicago and University of Miami hospitals. At the Louisville facility, Columbia provides $40 million in charity care each year. The state reimburses $25 million; Columbia absorbs the remainder.

Is Columbia getting too powerful? Some health experts are worried that its aggressive management of costs may eventually lead the company to cut corners on care. Scott has been criticized for allowing doctors who work in some of his hospitals to become part owners of the facilities. Critics say this practice sometimes gives doctors an improper incentive to hospitalize patients, since the physicians share in the company's profits. Robert O'Leary, chairman of American Medical International, a competing firm that runs 35 hospitals, maintains that the Columbia practice is highly questionable.

Scott defends Columbia's strategy by noting that the doctors in question own less than 2% of the company. O'Leary's firm, meanwhile, engages in another controversial strategy: buying physician practices, which looks to some critics like a quid pro quo to encourage effectively franchised physicians to send their patients to AMI hospitals. Such arrangements have been investigated in some states. In most cases, the deals have been ruled legitimate if the doctor retires or leaves the practice within a year of selling it to the firm. Still, the possibility lingers that doctors associated with both firms may occasionally have a conflict of interest when it comes to deciding on the best way to treat patients.

One way or another, though, hospitals must become more efficient, as demand for medical services threatens to overwhelm the resources available to pay for them. Getting costs down is critical to maintaining quality treatment. Columbia's hospitals have done that more effectively than most others, and Scott believes the bigger his company gets, the better it can afford to provide cost-efficient care.