PART I

Operations,
Systems, and Financial
Management
Part I of this text provides the reader with a foundation of operations manage-
ment and explains its role in improving health cares financial and business con-
dition. Health care activities and processes are complex. To perform optimally,
they must be managed as a system. Operations and systems management requires
knowledge of process improvement, quality, finance, and many other business
practices. As a service industry, financial outcomes are driven primarily by labor
and supply costs, so an understanding of the income statement and the use of key
ratios to manage these areas is provided. Understanding the concepts of opera-
tions management, and its relationship to financial margins, is also explored.
Chapter 1 offers an overview of the discipline of operations and sys-
tems management and that of management in general. Goals of operations
management, from cost reduction to network optimization, are described, as well
as the key functions and roles performed by operations managers. This chapter
sets the stage for the rest of the text.
Chapter 2 provides an introduction to the health care marketplace. Because
health care organizations are businesses, they must generate revenues and sus-
tain themselves financially, as organizations do in other industries. This chapter
defines the hospital and health care organization and discusses the nature of its
1

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 2 Part I Operations, Systems, and Financial Management

goods and services. This chapter provides an overview of some of the significant
health policies that affect patient operations, including the Affordable Care Act.
The concept of health care production, distinct from operations, is also explored.
Chapter 3 provides a structured introduction to health care finance for the
operations manager. An understanding of the drivers of improved financial per-
formance is essential to effective operations management. This chapter addresses
how hospitals earn revenue, and it defines the basic terms used in health care
finance. Of great importance, it explains the key external financial statements
that represent the financial condition of the organization, which are used as data
sources for a variety of operational analyses in this text.

Financial Supply chain

Management Management

Health Care
Operations
Management

Systems and Process and

Technology Quality
improvement

Figure P11 Operations Management in Health Care

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 1

Chapter
Health Care Operations
and Systems Management
Goals of This Chapter
1. Describe the need for improved decisions and management
systems.
2. Define health care operations management.
3. Describe the roles and responsibilities of health care operations
managers.
4. Examine the management decision-making process.
5. Understand the goals of operations management.
6. Describe the management discipline and where operations
management fits.

Health care operations management is a discipline that integrates scientific prin-

ciples of management to determine the most efficient and optimal methods to
support patient care delivery. Today, most hospital positions are roles that involve
the coordination and execution of operations. This chapter provides the rationale
for operations management and describes its evolving role in helping hospitals
become more competitive.

The Role of Health Care Operations

Management
Health care operations is about management of interconnected processes, or sys-
tems. A system is a set of connected parts that fit together to achieve a purpose.

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 4 Chapter 1 Health Care Operations and Systems Management

Health care operations and systems management is the set of diverse and inter-
related activities that allow for diagnosis, treatment, payment, and administrative
management in health care facilities.
Most hospitals are nonprofit in nature. Nearly 80% of hospitals are considered
nonprofit and exist solely to serve the community in which they operate, down
from 85% a few years ago. As nonprofits, these organizations are exempt from
most federal and state taxation and are not expected to show continuous positive
growth rates or large profit margins, as most publicly traded firms do. How-
ever, if a hospital or health care organization cannot show some return on the
capital or dollars invested, there will be negative consequences. For example, fail-
ure to show reasonable margins will likely cause the public bond market (which
finances most health care growth today) to assign subpar credit ratings; therefore,
the bonds themselves will have poor yields, making hospitals less than stellar
investments for bondholders.
Most important, the term limited profit margins implies that there will be
fewer dollars to invest back into the business to ensure that buildings are updated,
equipment is replaced and technology is modern, and clinical programs will con-
tinue to expand and be enhanced. Without these investments, hospitals will likely
be unable to attract the most qualified physicians and administrators, which will
continue the downward spiral. While some hospitals and health care systems wait
for changes in the public health policy to save them, the more competitive and
successful hospitals are acting now to protect their margins.
In this era of continual pricing pressures affecting the top line of the income
statement, and with a large majority of all hospitals reporting negative profit mar-
gins, it is essential that hospitals begin to look toward more sophisticated business
strategies to succeed. Differentiated marketing programs and strategies, broader
use of advertising, and more careful and precise long-term planning about service
lines are all strategies that must be utilized (Rovin, 2001).
Equally as important, there must be a broader adoption of operations man-
agement techniques into hospital business affairs. Monitoring and maximizing
labor productivity for all medical support and allied health professionals is criti-
cal to maintaining salary expenses. Incorporating queuing theory and scheduling
optimization methods helps drive waste and cycle time out of hospitals. Incor-
porating logistical and supply chain management techniques helps reduce opera-
tional expenses, eliminate excess safety stocks, and generally improve working
capital management. Most important, using technology to further automate and
streamline all processes in hospital operations can help reduce costs and maxi-
mize efficiencies.

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 The Role of Health Care Operations Management 5

Hospitals and other health care organizations cannot rely on extrinsic factors
(such as health policy, federal payer regulation changes, or shifts in managed
care market structures) to change their margin potential. Although these are
important issues, they are covered in other texts and will evolve regardless of
the managerial behavior that hospitals employ. However, equally significant to
these macro-level issues are the micro-economic and organization factors that can
be affected by operations and logistics management. Operations management
can help organizations today.
Think of health care profit margins as a balloon, where a variety of extrinsic,
or external, factors cause deflationary pressure from the outside. On the inside is
the set of decisions and management systems put in place to combat these pres-
sures and essentially inflate the balloon, or expand the margin. In effect, opera-
tions management is the set of intrinsic, or internal, processes and decisions that
help address costs, process, technology, and productivity. Strategic management,
although equally important, is not a focus of this text. Figure 11 shows concep-
tually the margin-expansion role that operations management plays.
Health care is primarily a service sector, in that the industry provides intan-
gible or nonphysical goods, as opposed to physical objects that can be seen or
touched. Hospital services primarily deliver care through providers to patients
and therefore lack a manufacturing or assembling process. These services are
unique and somewhat differentiated from other hospitals, knowledge based, and
have high levels of customer interaction. Of course, there is a physical good that

Reimbursement Managed care

practices mechanisms

Operational management
(cost, productivity, process,
Fragmented technology)
industry Consumer
apathy
Strategic management
(competitive positioning,
branding, mergers)
Federal health Competitive
policy structure

Lack of Incentive
information misalignment

Figure 11 Operations Management Counters the Extrinsic Pressures

Deflating Health Care Margins

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 6 Chapter 1 Health Care Operations and Systems Management

accompanies the service, which is the focus of supply chain management in hos-
pitals that procures, replenishes, and stores medical supplies and pharmaceuti-
cals as well. In this regard, hospitals have a mix of both tangible and intangible
characteristics. All of these attributes make health care operations management
somewhat different from industries that strictly produce and market physical
goods or widgets.
Health care operations management can therefore be defined as the quanti-
tative management of the supporting business systems and processes that trans-
form resources (inputs) into health care services (outputs). Inputs are defined as
resources and assets such as labor and capital, including cash, technology, person-
nel, space, equipment, and information. Outputs include the actual production
and delivery of health care services. Quantitative management implies a heavy
use of analytical and optimization tools, as well as extensive use of process and
quality improvement techniques to drive improved results.
Health care operations management is a discipline of management that inte-
grates scientific or quantitative principles to determine the most efficient and
optimal methods to support patient care delivery. This field is relatively new to
health care, but it has existed in other industries for nearly 100 years.

Key Functions of Health Care

Operations Management
The scope of health care operations management includes all functions related
to the management systems and business processes underlying clinical care. This
includes extensive focus on the following: workflow, physical layout, capacity
design, physical network optimization, staffing levels, productivity management,
supply chain and logistics management, quality management, and process engi-
neering. Table 11 summarizes these key functions and illustrates some of the
critical issues and questions that must be addressed for the health care enterprise.
Health care operations management includes all of these business functions
and provides job opportunities for those with titles such as administrator, sched-
uling manager, operations supervisor, vice president of support services, qual-
ity manager, operations analyst, director of patient transportation, procurement
manager, management engineer, inventory analyst, facilities manager, supply
chain consultant, and so on. Nurses, technicians, and other health providers also
play a key role in managing service operations. Operational management posi-
tions in hospitals will continue to grow as the need for increased cost efficiency
and accountability rises.

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 Key Functions of Health Care Operations Management 7

Table 11 Key Functions and Issues in Health Care Operations Management

Operations
Management
Function Objective or Issue to Consider
Workflow process Are there too many departments or people performing the same task?
Do we have an end-to-end map of our major business processes?
How many manual processes exist?
Are there ways to reduce cycle time, steps, and choke points for key
processes?
Can we improve speed and patient satisfaction?
Physical layout Are our facilities designed with the consideration of speed, capacity,
traffic flow, and operational efficiency?
Are unit or floor layouts designed to eliminate redundancy (e.g., safety
stock on all resources)?
Capacity design How can we reduce bottlenecks to improve patient throughput for
and planning each area?
In which cases should we increase the use of technology to improve
labor productivity?
Physical network Where should we position appropriate par locations, pharmacy
optimizations satellites, warehouses, and supplies to minimize resources and costs?
Do we strategically utilize vendors and their facilities?
How can we design and position optimal locations for clinics or
resources to ensure lowest total costs?
Staffing levels How much output can we expect from our staff?
and productivity Have we maximized the use of automation and electronic commerce to
management increase productivity?
Have we implemented sophisticated analytical models to optimize
labor and resource scheduling?
Supply chain and Have we built collaborative planning and forecasting logistics
management processes to standardize items and reduce total costs?
Should we operate just in time?
Do we use automated, optimized replenishment of medicalsurgical
supplies to increase turns and asset utilization?
How much inventory of each item do we need?
Do we use perpetual inventory systems to ensure stringent internal
controls and accurate financial reports?
Quality, planning, Do we use advanced tools for tracking projects?
and process Are we measuring the right performance indicators to bring visibility to
improvement trends and exceptions?
Do we know how we compare to our key competitors?
Have we identified the quality issues that affect our customer
satisfaction and efficacy goals, in addition to efficiency, costs, and
speed?

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 8 Chapter 1 Health Care Operations and Systems Management

The Need for Operations Management

The Future of Emergency Care report series produced by the Institute of Medicine
of the National Academies describes the problems facing health care today, espe-
cially the emergency care arena. The report outlines several recommendations for
solving the current crisis, and one key recommendation notes, Hospitals should
reduce crowding by improving hospital efficiency and patient flow, and using
operational management methods and information technologies (Institute of
Medicine, 2006, p. 2).
Others outside of the health care industry have also identified weaknesses in
how health care managers administer the processes and systems. IBM has rec-
ognized that the service sector must focus more on applying management sci-
ence to improve processes and outcomes and is collaborating with universities
to implement what it calls services science. Irving Wladawsky-Berger, IBMs Vice
President for Technical Strategy and Innovation, was quoted in The New York
Times as saying,
All those processes [in a hospital] get done in a relatively ad hoc way. If
we want to apply information technology and engineering discipline to
improve the quality of the service to reduce errors and to improve pro-
ductivity, you need people who know how to design a hospital system.
(Holstein, 2006, p. 10)
Clearly, even those on the periphery of the health care system understand the
complexity and the lack of sophistication that currently exist in the industry.
Many other researchers and associations have called for operations manage-
ment to help drive improvements and efficiencies in the health care system (Herz-
lingertt, 1999). The purpose of this text is to help students and practitioners do
just that.

Goals of the Operations Manager

The operations manager may hold any number of the job titles discussed earlier,
but generically the term operations manager will be used to describe all such posi-
tions in this text. A clinic manager who ensures that processes are in place so that
patients efficiently move from registration to treatment rooms to payment is an
operations manager. An administrative director who oversees financial operations
is an operations manager. An operations manager is any individual who directs

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 Goals of the Operations Manager 9

and transforms processes to improve the delivery of patient care. What else do
operations managers do? They have a variety of broad goals and functions in
the hospital, including all of the following: reduce costs, reduce variability and
improve logistics flow, improve productivity, improve quality of customer ser-
vice, and continuously improve business processes. These are outlined in more
detail in the following sections.

Reduce Costs
The primary role of operations managers is to take costs out of the health care
system. Finding waste, improving utilization, and generally stabilizing and reduc-
ing the overall cost of delivering services are essential functions. A hospital with
appropriate tracking and management systemsthat can isolate all personnel,
material, and other resources utilized for delivery of carewill be much more
likely to reduce costs because it understands the underlying cost structure. Iden-
tifying costs and eliminating unnecessary waste and effort is at the forefront of an
operations managers priority list.

Reduce Variability and Improve Logistics Flow

Operations managers continuously look for the most efficient and optimal paths
for movement of resources, whether those resources are physical or information
flows. Similarly, there is a continuous focus on reducing variability. Variability is
the inconsistency or dispersion of inputs and outputs. Variability threatens pro-
cesses because it results in uncertainty, too many or too few resources, and gener-
ally inconsistent results. If there are 10 patients typically seeking care in a specific
clinic within a certain time period, and then 20 appear the following period, it
will be difficult to staff, control waiting times, and manage patient flows.
Improving flow means seeking higher throughput or yields for the same level
of resource input. Throughput is the rate or velocity at which services are per-
formed or goods are delivered. If a hospital typically sees four patients an hour
and can increase throughput to six per hour, this is a 50% improvement in logis-
tical flow and throughput. Similarly, if patient volumes double but a hospital
maintains the same historical inventory levels of pharmaceutical supplies, this
represents significant improvement in material flow, because assets have higher
utilization and turns.
Staffing and resource consumption should be tied directly to patient volumes
and workload: If patient volumes increase, so too should resources. Unfortunately,

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 10 Chapter 1 Health Care Operations and Systems Management

many health care facilities do not understand patient volumes and the variability
that exists from hour to hour and day to day. Managing this variability allows an
adjustment to staffing mix and scheduling to accommodate the changes, with-
out staffing at the peaks (which causes excessive costs), staffing for the valleys or
low points (which will cause long lines periodically due to limited resources and
therefore service quality issues), or staffing for the average (which is the most
common suboptimal approach). Figure 12 shows how variability changes over
time, which necessitates both capacity and demand analyses.
Logistics is defined as the efficient coordination and control of the flow of all
operations, including patients, personnel, and other resources. The role of opera-
tions managers is to facilitate improved logistics and throughput by using stream-
lined process and facility designs to increase capacity, workflow, and throughput.

Improve Productivity
Hospitals have a tendency to hire additional staff faster than in other industries.
This is partly driven by the highly structured organizations that are common in
health care and partly because of the historical lack of focus on costs. In years
past, hospitals were reimbursed by the government and other payers on a cost-
plus basismeaning that whatever the cost to deliver, hospitals would be fully
reimbursed along with a small profit margin.

Are we staffed and

resourced for peaks,
40
valleys, or the
35 average?
Number of patients

30
25
20
15
10
5
0
pm
am

am

am

am

am

pm

pm

pm

pm
30

30

30

30

30

30
0

30

30

30
:3

1:

2:

3:

4:
7:

8:

9:

:
10

11

12

Time of day

Figure 12 Variability Creates Chaos and Inefficiency

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 Goals of the Operations Manager 11

When pricing is guaranteed to cover costs, there is not a tendency to be

overly cost conscious. Even though the industry continues to move toward a
prospective payment system and managed care, the mentality and behavior of many
hospitals have been slow to adapt. Productivity is defined as the ratio of outputs
to inputs. Improving productivity implies a search for higher levels of output
from all employees and other assets. This is one of the most vital roles of an
operations manager.

Improve Quality of Customer Service

Health care cannot become so focused on cost and efficiency that quality starts
to diminish. Improved quality implies reduced medical errors and improved
patient safety, in addition to higher levels of patient satisfaction. Maintenance
and improvement of high quality and service levels, both from patient care and
other business services (such as the cafeteria or admissions), are expected from an
operations manager. Across all industries, higher-quality services lead to the abil-
ity to secure higher prices, which drives increased market shares and operating
margins (Buzzell & Gale, 1987).
Ensuring that services continue to improve patient satisfaction levels while
simultaneously reducing response and waiting times are key deliverables to pro-
viding higher-quality services. The costquality continuum refers to a theoreti-
cal trade-off in which a focus on one side of the equation leads to diminishing
returns on the other. A focus on costs may lead a hospital to reduce services pro-
vided, which may affect overall quality. Operations professionals must balance
both and help to make optimal decisions on many fronts.

Continuously Improve Business Processes

In highly structured organizations, business processes tend to be unique to each
department and are not highly cross functional or integrated. The operating
room in one hospital may handle procurement of goods one way, while the same
hospitals gynecology department handles it another. There is typically no sharing
of best practices internally, standardization of processes that can lead to improved
learning and economies of scale, and very little multidepartment workflow auto-
mation. Each department in large hospitals today operates as an independent
business, which creates multiple efficiency problems. The role of operations man-
agement is to find ways to carry out business processes while improving process
efficiency and effectiveness. Figure 13 shows the operations management pro-
cess of converting inputs into outputs.

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 12 Chapter 1 Health Care Operations and Systems Management

Supplies and
Personnel Technology Equipment
resources

Process tools Analytics and

and management optimization
systems techniques

Health care
services

Figure 13 The Operations Management Process

Competitive Advantage of Operations

Overall, if a hospital is successful at delivering on each of these goals throughout
the facility, it will deliver improved operational effectiveness. Operations effec-
tiveness is a measure of how well the organization is run. It considers both the
efficiency of resource inputs and usage and the effectiveness of overall manage-
ment in achieving desired goals and outcomes (Kilmann & Kilmann, 1991).
Operational excellence is a term often used to describe a business strategy that
focuses exclusively on maximizing operational effectiveness.
A hospital that is operationally effective is heading toward increased competi-
tiveness. Competitiveness is managements ability to respond to environmental
changes (such as changes in reimbursement practices) as well as competitors
actions (such as adding new facilities or expanding existing service lines). If a
hospital can achieve a competitive edge or advantage over other hospitalsand
sustain this positionit will have higher operating margins and be able to con-
tinue improving, expanding, and surviving. Operations management is critical
to this outcome.
Competitiveness is often driven by innovation. Innovation is the continuous
search for a way to do new things or to do current things better. Organizations
innovate by using new technologies or finding ways to change the playing field
so that processes that once were considered essential are no longer necessary. The
electronics industry is an example in which firms continuously innovate. A firm
that was competitive based on analog technology had its perspective of the world
shaken up considerably when digital technology was created, and the products

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 Factors Driving Increased Health Care Costs 13

that the firm once made became completely irrelevant. In addition, continu-
ous innovation often results in hypercompetition, which ultimately is charac-
terized by economics wherein both prices and costs decline (DAveni, 1994).
For example, when digital video disc players were first introduced, prices were
nearly $1,000. Today, they can be purchased for as little as $30 in discount stores.
The prices of smartphones, tablets, televisions, laptops, and many other electron-
ics all follow the same pattern. In health care, innovation also helps to improve
competitiveness.

Factors Driving Increased Health

Care Costs
Imagine that rather than a health care organizations annual budget increasing
between 5% and 15% (the range of industry average annual changes), expenses
could be maintained and even show signs of deflation, or negative price/cost
growth. This would be very beneficial to a hospitals financial condition if it could
reduce costs and maintain similar pricing levels.
The historical argument justifying continuously growing health care inflation
rates typically focuses on five points:
1. Consumers are aging and living longer and are increasingly utilizing a
greater number of services than in prior years.
2. The costs of medical technology and equipment continue to rise, and this
represents a growing percentage of capital budgets for most organizations.
3. The labor costs of key resources (such as physicians and nurses) are gov-
erned by market shortages for these positions, which have increased
steadily in the past few decades.
4. Prices of pharmaceuticals, which represent a sizable portion of medical
treatment plans, continue to escalate to cover high costs of research and
development, long U.S. Food and Drug Administration approval cycles,
and generally high industry margins for pharmaceuticals.
5. Emphasis on strict managed care, which appeared to be the predominant
model a decade ago, is slowly shifting and diminishing in practice.
The result has been a steadily increasing cost of care. For example, the Bureau
of Labor Statistics tracks inflation growth through its consumer price index,
a mathematical calculation of the average pricing changes over time, using a
market basket approach. The general consumer price index for all items in years
1999 through 2005 showed an increase of less than 14% over 7 years, or around

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 14 Chapter 1 Health Care Operations and Systems Management

500

400 414
388 425
400 375
364
351
336
323

300

232
224 229
200 215 214 218
201 207
195

100
2005 2006 2007 2008 2009 2010 2011 2012 2013

Medical care
General CPIall items

Figure 14 Controlling Exponential Price Increases in Health Care

Data from U.S. Department of Labor, Bureau of Labor Statistics, 2014.

2% per year (Bureau of Labor Statistics, 2014). Compare that with the cost of
medical care, which rose nearly 30% in that same time periodalmost double
that of all the other goods tracked. Figure 14 shows this growth over time.
Overall spending for health care in the United States has risen steadily. In
1993, health care costs represented 13% of the national gross domestic prod-
uct; in 2006, this number increased to more than 16.5%; and today it is nearly
1819% of the gross domestic product. Economists project that this will double
again in the next decade (Heffler et al., 2005). While some hospitals wait for
the national debate to continue, it is important to first look at the intrinsic fac-
tors in the organization that are driving excessive costs: redundancy, inefficiency,
bureaucracy, waste, paper, limited productivity, lack of performance monitoring,
poor deployment of information technology, and generally unsophisticated levels
of management.

Learning from Other Industries

Although health care is unique and has its own set of challenges, hospitals can
learn a great deal from other industries that have evolved faster due to technology

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 Learning from Other Industries 15

or process innovation, industry economics, more aggressive competition, reduced

barriers to entry and exit, or just better trained business managers. For example,
if managers looked at a hospital as being similar to the retail industry, they could
better understand how to lay out floors, design configurations to achieve more
efficient movement and handling, and use analytical forecasts to drive all aspects
of the business. There is a lot to learn from the more operationally effective indus-
tries. The tools and techniques that are most similar should be borrowed and
applied to health care where appropriate.
For example, in the airline industry, thousands of planes move through the
sky fairly seamlessly. Planes land every few seconds at major airports throughout
the world, and yet there are very few accidents (as a percentage of total flights),
very high levels of on-time rates (given numerous factors such as weather and
security), and very little lost baggage. Nearly 650 million passengers boarded
planes in 2013 in the United States alone (Bureau of Transportation Statistics,
2014). Airlines have learned to operate using speed and volume as an advantage.
When an airplane lands, there is very little time before it must be turned around
and readied to take off to another destination. This changeover process allows
less than 30 minutes, on average, to completely refuel, check maintenance and
mechanical conditions, validate aviation systems, restock food and supplies,
change over personnel, and unload and reload hundreds of passengers. Think of
this changeover as it relates to the process a hospital goes through when chang-
ing out beds after a patient is discharged (i.e., admitting and bed management
process). A lot can be learned from how another industry approaches a somewhat
similar problem. Table 12 summarizes what operations managers in health care
can learn from other industries.

Table 12 Teaching from Other Industries

Retail Building layout and configuration, customer flows, use of

forecasts and planning, electronic commerce
Airlines Scheduling, logistics, strategic pricing (yield management)
Chemicals Efficiencies, economies of scale, extensive use of linear
programming and quantitative modeling
Electronics Technology innovation, product life-cycle management,
pricing strategy
Telecommunications Command and control center

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 16 Chapter 1 Health Care Operations and Systems Management

Principles of Management
Operations management is one discipline in the broader field of management.
According to most theorists, management concerns itself with four key functions:
planning, organizing, leading, and controlling. Planning involves the establish-
ment of goals and a strategy to achieve them. In health care, planning can be stra-
tegic (such as deciding which geographic region to invest in a new facility), or it
can be operational (such as how many employees to have on staff for each shift).
Organizing includes making decisions about which tasks will be done, where,
when, and by whom. Organizing uses a variety of tools, such as an organizational
chart to manage peoples roles and reporting relationships, process flowcharts for
improving activities, and Gantt charts for managing projects. Leading includes
motivating employees, building support for ideas, and generally getting things
done through people. Providing direction and clarification of expectations, as well
as the role of change management, or preparing the organization for changes to
come, are instrumental in providing leadership in hospital operations manage-
ment. Controlling includes all tasks to monitor and track progress toward goals,
ensure performance improvement, and make corrective changes in strategy where
necessary. The use of status reports, budgets, procedures, and a multitude of other
tracking tools is useful in helping enhance management control.
Managers wear many hats and play many roles. They may serve as a fig-
urehead, make decisions, reward employees, and handle conflicts and solve
problems. Managers help plan tasks, organize and direct them, and continually
adjust and control. Henry Mintzberg (1973), one of the earliest researchers on
management processes, described the nature of a managers work as grouped
around three key themes: informational, decisional, and interpersonal. Infor-
mational refers to collecting, monitoring, and disseminating information from
the external and internal environments to work teams. Decisional refers to mak-
ing key decisions for the organization, such as allocation of scarce resources,
rewards and penalties for employees, and negotiations with employees and
others. Interpersonal includes training and motivating employees, serving as
a spokesperson, facilitating communication exchanges among various groups,
and serving as a liaison.
The study of management continues to evolve. It has moved through a variety
of schools of thought: from scientific management to process focused to human
behavior to decision or management sciences theory to social and open systems
(Certo & Certo, 2005). These schools of thought represent different contexts or
perspectives on which a managers role and tasks should be based. For example,

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 The Scientific and Mathematical Schools of Management 17

the systems theory schools emphasize that a manager views the organization
as a living organism, which is changing and adapting and that operates by an
integrated network of open processes. Behavioral schools tend to view manage-
ment from a psychological aspect, highlighting the importance of understanding
what motivates employees and how human and cognitive factors influence work
environments.
For purposes of operations management and looking for ways to improve
operational effectiveness, the school of thought that is most relevant is that of
scientific management.

The Scientific and Mathematical

Schools of Management
Operations management seeks to apply quantitative and analytical techniques to
achieve the goals of reduced costs, higher quality, higher productivity, improved
processes, and improved logistical flows. The role of mathematics started to drive
concepts of industrial efficiency in what is now known as the scientific manage-
ment era, which began prior to the turn of the 20th century.
Scientific schools of thought historically focused on use of concepts such as
time and motion studies, which measured how long business processes took,
seeking ways to reduce the variability of the results and continuously shrinking
the times and associated costs. Early work by Frank and Lillian Gilbreth helped
drive a focus on continual improvementsfinding ways to do things faster and
with fewer resources. In fact, the Gilbreths research has had a profound effect on
health care as well (Gilbreth & Carey, 1966). In the early 1900s, they were cred-
ited as observing the productivity of surgeons and found that the introduction of
changes in both staffing and workflow could significantly alter physician produc-
tivity. The introduction of a surgical nurseto help provide surgical instruments
and supplies when needed in order to free up the surgeon, thereby improving
overall productivitywas one of the key recommendations made. In addition,
the Gilbreths recommended other hospital improvements, such as a tray to hold
common surgical instruments. These are just two of the contributions made by
scientific management to health care.
Frederick Taylor, one of the original management researchers and the father
of scientific management, was often quoted as saying that scientific manage-
ment is a great mental revolution (Matteson & Ivancevich, 1996). By this, he
meant that a scientific approach encourages a different perspective or outlook

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 18 Chapter 1 Health Care Operations and Systems Management

that can change management behaviors and results. This revolution led to some
key concepts, such as specialization, division of labor, and mass production. The
concept of specialization suggests that if people repeatedly perform just one task,
they will be able to perform that task faster and with higher quality than others,
because they have repeated exposure to the process and have learned from their
experiences. Specialization, in many regards, is what leads hospitals to structure
their organization around units such as nursing or materials management. Con-
tinued specialization helps to produce well-defined roles and tasks, concentrated
work efforts, and higher efficiencies. This is also known as division of labor.
Mass production is the creation of rapid production processes through the use
of assembly-line techniques. Mass production has been embraced by most other
industries, but, in many respects, it is not relevant in health care.
The scientific era has been shown to have several failings and issues, which led
to other schools of thought. The lack of focus on human behavior, alignment of
employee rewards with those of the organization, and understanding the need for
job rotations and expansion all are major issues that well-rounded managers must
consider. Thus, many of the analytical concepts of scientific management remain
vital to health care operations management. First, scientific management suggests
the need for a strong understanding of processes, their costs and resource utiliza-
tions, constraints, and cycle times. Second, scientific management encourages
an initial focus on understanding expected outcomes and subsequently design-
ing management systems and business processes around this operational strat-
egy. Third, the variability of processes has to be smoothed out and consistently
managed. Finally, scientific management shows that in many cases quantitative
approaches can help create mathematically optimal results for common manage-
ment decisions and problems. These four fundamental concepts are the founda-
tion of the operations management discipline.

Management Decision Making

Management decision making is a process in an organization in which decisions are
made (Yates, 2003) and reflects the major processes involved in managing the work
of organizations (Szilagyi & Wallace, 1990). Decisions are the output of the process
and are typically described as a choice between two or more alternatives (Rowe,
Boulgarides, & McGrath, 1984). Decisions can also be described as an action
taken as a result of a process. As Hoch and Kunreuther (2001) stated, The strength
or weakness of managerial decisions is the linchpin of the business enterprise (p. 9).

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 Management Decision Making 19

Herbert Simon (1960), one of the first researchers on decision making in

organizations, described the decision-making process as having three steps:
1. Finding occasions to make a decision.
2. Finding possible courses of action.
3. Choosing among many options.
Browne (1993) described it similarly as that which occurs at the highest level
of an organization (p. 2). Schwenk (1988) described management or strategic
decisions as ill structured, nonroutine, important to the organization, involving
large resource commitments, and generally very complex. A traditional manage-
ment decision process, adapted from Browne, is shown in Figure 15.
Decision-making theory has been defined by many perspectives: sociol-
ogy, psychology, economics, engineering, and business. Because management
decisions are made within organizations, organizational theorists early on
shaped the field by suggesting a rational approach where decision makers
make decisions in the best interests of the organization and emphasize infor-
mation processing. More recently, there has been a strong emphasis on deci-
sion making as a behavioral process, as decisions are made by individuals,
where personality and judgment represent both a source of bias and influence
on decision processes.
Harrison (1987) described decisions as either routine and programmable or
complex and unique. If decisions are routine, then they are procedural and can
use computation and rational models for decision support. This area is well suited
for operations research methods. The latter is more unstructured and relies more
on judgment and general problem-solving approaches. This method has typi-
cally been considered to emphasize behavioral processes over quantitative ones,
because they involve ambiguity, conflict, negotiations, and bias created by the
interaction of individuals and personalities.
Similarly, Allison (1971) outlined three perspectives on strategic decision
making: rational, organizational, and political.
1. Rational. Barnes (1984) was one of the earlier researchers in this area,
which defines decisions as the product of a conscious choice. The ratio-
nal, conscious choice emphasizes a search and selection process that has
limited alternatives, maximizes decision outcomes, and adjusts for risks.
Other researchers have outlined structured methods for organizational
decision makers to follow to reach optimal or maximizing outcomes (see
Christensen, Andrews, Bower, Hammermesh, & Porter, 1982).

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 20 Chapter 1 Health Care Operations and Systems Management

Define
problems and
goals

Identification

Establish
criteria and key
variables

Weigh
criteria

Information
processing/
search
Generate
choices or
alternatives

Evaluate
alternatives

Selection
Choose
optimal or
satisficing
decision

Figure 15 Traditional Decision-Making Process

2. Organizational. Henry Mintzberg (1978) is generally recognized as one of

the leading researchers on decision making from an organizational theory
perspective. This views decisions as the outputs of organizational pro-
cesses, not individual ones, and includes adapting astrategy to the envi-
ronment. The organizational approach emphasizes satisficing. Satisficing
is a process of making a less than optimal decision, but one that can
be supported and is acceptable because it meets the minimal criteria
(e.g., the decision is reached quickly, is adequate, and/or is the result of

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 Management Decision Making 21

consensus between parties). Satisficing terminates the search for alterna-

tive processes early. Ambiguity plays a critical part, as does the concept of
randomness, which leads to models of decision making that are less than
rational and that can be described as organized anarchies or garbage
can models (March & Olsen, 1979).
3. Political. From this perspective, decisions are the result of bargain-
ing among individuals attempting to achieve their own personal goals
(Abell, 1975). This includes social, nonprofit, educational, and other
organizations. Political models tend to redefine the decision processes,
structures, and goals on a continual basis, making evaluation difficult.
Behavioral concepts, such as the roles of judgment, biases, emotions,
and heuristics, are often a component of this perspective. Bazerman
(2005) is one of the prominent researchers on individuals and behavior
in decision-making processes.
From both the organizational and political perspectives, the concept of bounded
rationality has emerged. Bounded rationality suggests that humans or individuals
have only a limited, finite capacity to understand all of the options available to
them and process them in an evaluation mode (Simon, 1979). Bounded rational-
ity can also be described as limits on a humans ability to process and interpret
large volumes of data (Bazerman, 2005). Theory suggests that while rational mod-
els think all alternatives are known, they usually are not and there is no known
probability or consequences of the actions. In addition, goals are changing and the
process is not always as sequential as it would appear. The complexity of decision
processes is also often used to describe why rational models are not appropriate.
There are two components of bounded rationality: search and satisficing
(Simon, 1979). Search refers to how extensively a decision maker searches for
information to guide decision making (Tiwana, Wang, Keil, & Ahluwalia, 2007).
Simon envisioned an aspiration point where managers determine what is good
enough. This process of terminating the search process without incorporating
more extensive information is called satisficing, as discussed earlier. This can cre-
ate biases and risks for managers.
The concept of trade-offs is related to satisficing (Simon, 1965). Trade-offs
represent a cognitive process of balancing the pros and cons of attributes or deci-
sion criteria in an effort to accept less of something to get more of something else
(Luce, Payne, & Bettman, 2001).
Browne (1993) described four models or perspectives in decision theory: nor-
mative, descriptive, analytical, and behavioral. Normative models, or prescriptive
models, describe what managers should be doing to produce optimal outcomes.

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 22 Chapter 1 Health Care Operations and Systems Management

Browne suggested that normative models are the contributions of scientific

management. Simon (1965) argued that rational models of management science
are valuable contributions toward normative decision-making theory. Descriptive
models describe what actually occurs in organizations, not what should occur.
Analytical models, which are the contribution of management science, involve risk
and uncertainty in quantification and in the role of modeling decisions and pre-
dicting outcomes. Finally, behavioral models examine the roles of bias and cogni-
tion in humans, as well as how information is processed and used.
As theory has established, decision making is not necessarily a rational search
and evaluation process, where alternatives are clearly defined, evaluated, and then
the best alternative is selected. Brunsson (1985) argued that decision making
is less about finding the right choice and more about giving an impression of
rationality in organizational processes. He also described other more common
irrational processes used by managers. In decision sciences, decisions are some-
times categorized into one of two types: routine or complex. Routine decisions
have been described as programmable and are sometimes associated with selec-
tion and evaluation methods that can be mechanized or automated (Harrison,
1987). These routine decisions are often supported by methods such as opera-
tions research. The more complex the decisions are, the greater the use of intu-
ition or judgment in the process, and presumably the less likely that methods
such as operations research will be used. Discussion in strategic management
literature about the role of intuition versus analytics touches on this subject but
does not comprehensively address the role of quantitative methods using the
routine-complex dimension (Miller & Ireland, 2005).
In summary, organizational decision-making processes are complex and appear
to be variable in nature. In addition, the complexity of the decision and the
cognitive capacity of the decision makers both influence the form of decision
processes. As a result, some health care organizations may find a quantitative
component of operations management decision making more useful or relevant,
while others may value it to a lesser extent.

Power and Decision Making

inHealthCare
Decisions in health care do not follow the traditional, logical processes used
in industrial organizations. In other industries, where profit maximization and
shareholder wealth are the primary motives, decisions are usually driven by
goal alignment for both managers (those who run the business) and owners

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 Power and Decision Making inHealthCare 23

(shareholders who invest in equity or debt and have a claim on the profits and
assets). Decision making tends to follow cost-benefit models and focus on risk
minimization, cash flows, and return on investment. Although disputes and con-
flicts may arise because of incomplete or imperfect information (as described in
the agency theory of economics), these disputes can typically be minimized by
changing incentives, behaviors, and structural mechanisms.
In health care, however, there is incomplete alignment of goals between differ-
ent agents, or managers, in the organization because of three issues:

1. Goals are unclear. There are clinical goals, financial goals, educational or
academic goals, societal goals, community goals, and so on. The ambigu-
ity that exists in terms of priorities and focus makes goals much less acute
than in other industries.
2. Organizations are complex. In industrial organizations, the organization is
clearly focused on the key aspects of buying, making, selling, and moving
products to the marketplace. In health care, reporting relationships often
involve complex matrices and dual-reporting structures. This is not the
command and control structure, focused on speed and efficiency of
decision making, that might work in other places.
3. Relationships are ambiguous. Many business units in health care are inter-
connected, but they often behave as if they were not. Independent depart-
ments and providers help create an environment that is less team focused
than in other industries, making relationships important for purposes of
mutual support as allies. There are also continuous power struggles in the
health care arena between different factions of employees. This creates
ambiguity in decision making.

Physicians are typically the most dominant players, given their clinical exper-
tise and control over the production of health care services, and they have a
very substantial role in most major organizational decisions (Young & Saltman,
1985). Power conflicts with nurses and other providers are frequent and have
developed (for structural reasons) in the struggle for control over patients, their
care, and overall patient management processes (Coombs, 2004). As such, sev-
eral formal power bases have emerged: business managers, who increasingly are
becoming more professional and sophisticated; physician leadership, which his-
torically dominates the power pendulum; and nursing leadership, which may
have the most intimate knowledge of patients and their needs.
Those who control the production process in most industries tend to have the
most influence and can control decision making for many things. In the production

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 24 Chapter 1 Health Care Operations and Systems Management

of health care (i.e., delivery of treatments and provision of care) physicians are by
far the dominant players, yet their role in most operational management processes
in most hospitals is waning as professional business managers evolve.
Decision making in teaching hospitals and academic medical centers is even
more complicated due to the introduction of another dominant party: academic
faculty and researchers (Choi, Allison, & Munson, 1986). In the largest hospi-
tals, this complexity in decision making is complicated by large business infra-
structures, which may employ hundreds or thousands of individuals in all types
of support functions from admissions to patient finance to facilities.
Three characteristics define this complexity of decision processes: problem-
atic preferences, unclear technology, and fluid participation (Cohen, March, &
Olsen, 1972). These characteristics, together with streams of both problems
and choices, can be combined in unclear decision processes in a garbage can,
where they can often address the wrong problems at the wrong time. This garbage
can tends to allow issues and solutions to resurface in strange ways, which often
results in a lack of clarity and focus.
With all of these dominant players and complexities, many hospitals have
become large bureaucracies. These bureaucracies make it difficult to make impor-
tant decisions, address financial and business issues, change behaviors and busi-
ness processes, and implement new technology.
Sophistication in operations and logistics management requires not only
understanding concepts and their application to health care, but also under-
standing the persuasive and leadership characteristics necessary to navigate the
bureaucracy, influence dominant power groups, engage support for ideas, and
ultimately gain approval for and acceptance of changes. These changes will come
only if business executives achieve more dominant power positions, which can
evolve only as operations and logistics executives are recognized for their contri-
butions, specialized education, professional expertise, and leadership skills. Col-
laboration within these multidisciplinary organizations is just one way to retain
more control in the decision-making process.

The Role of Technology

With its focus on improvements, operations management rests highly on the
use of technology and automation. Many new technologiesincluding mobile
devices, handhelds, scanning capabilities, asset tracking, database management,
health information exchanges, and electronic health recordshelp managers
improve their capture of data and transform it into improved decisions. Deci-
sions about capital investment in new information and management systems are

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 Trends in Operations Management 25

always at the forefront of the modern operations managers mind. Technology

should be considered whenever quality and efficiency is low. Processes that are
repetitive in nature and that can be replaced by less expensive automation are also
suitable for a technology investment. Technology often serves one of three roles:
1. Automate manual processes.
2. Improve transaction processing capabilities.
3. Improve the quality of analysis, reports, and decisions.
Technology has the ability to substantially alter the economics of a process.
Processes that can be mechanized allow for faster production or delivery, with less
resource usagetwo keys to improving operational effectiveness. The decision to
substitute capital, or technology, for laborespecially in areas of business sup-
port servicesis the only way to reduce processing and transactional costs over
the long run.

Trends in Operations Management

There are several trends that are being widely considered and adopted in hospi-
tals. These are depicted in Table 13, and the trends correspond to the role or
function of operations management most closely related to it.

Table 13 Roles and Trends in Health Care Operations Management

Primary Role of Operations Managers Evolving Trends

1. Reduce costs Standardization
Optimization
Resource tracking systems
2. Reduce variability and improve Integrated service delivery
logistical flow Analytics
Supply chain management
3. Improve productivity Information technology; mobile devices;
asset and patient tracking systems
Return on investment
4. Provide higher-quality services Evidence-based health care
Six Sigma
5. Improve business processes Outsourcing
Globalization

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 26 Chapter 1 Health Care Operations and Systems Management

Outsourcing is the contracting of an outside firm to perform services that

were once handled internally. Outsourcing is common in many industries, and in
health care it has been used successfully for cafeteria operations, bookstore man-
agement, investments, and even nursing and other clinical care areas. Outsourc-
ing is not a new concept, but it has a slow adoption rate in health care, where
decisions such as these are often difficult to make, especially when they result in
the dismissal of employees from hospital payrolls. However, outsourcing, when
used selectively to target the right areas, can be beneficial from a cost perspective.
Outsourcing relies on the notion that a hospital should focus on its core
competenciesdelivering clinical careand not on some of the less mission-
centric functions, such as housekeeping, materials management, finance,
and information technology. When analyzing pre- and postperformance
improvement, the evaluation of internally performed or selective outsourcing
costs must be undertaken to ensure that all options are explored and the most
operationally effective process remains.
Integrated service delivery is another trend that has developed over the past
few years. Many researchers have pointed to the excessive cost of care as being
driven by the medical communitys continued desire for specialization and con-
centration on discrete diseases and treatments, rather than integrative, compre-
hensive care (Porter & Teisberg, 2006). In response to this, hospitals are looking
for ways to push care toward more integrative medicine, including higher sharing
of information, resources, and collaboration. The effect on operations manage-
ment will include redesign of business processes and changes in the number and
frequency of logistics networks.
Supply chain management is the integrated management of all products,
information, and financial flows in a network designed to pull products from
manufacturers to consumers. In health care, there has been widespread adoption
of improved sourcing and inventory techniques, designed to lower overall supply
expense ratios (which typically account for 25% to 50% of all hospital costs).
Significantly more detail about the use of supply chain and logistics management
will be covered elsewhere in the text.
Another trend in health care operations management is globalization. The
world is becoming smaller, and vendors from all around the globe are competing
for business in retail and other industries. Health care has only recently felt the
effects, but this trend will continue. When firms look for outsourcing opportuni-
ties (e.g., in information technology), they are now able to turn to vendors as far
away as Ireland and India to help manage their information technology opera-
tions infrastructure. Medical care that may once have required on-site specialists

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 Trends in Operations Management 27

is now only a television away, allowing physicians to practice medicine without

setting foot in the hospital. Vendors for certain medical supplies, pharmaceuti-
cals, and equipment are emerging and starting to compete for business as poten-
tial suppliers, requiring hospital managers to understand global logistics. As more
and more hospital services become automated, the location of the technology
does not matter. This is the true result of globalization, and it will require adjust-
ments by hospital management.
Investments in a hospitals information technology infrastructure are common
today. Electronic medical records, computerized physician order entry, enterprise
resource planning, picture archival communication systems, supply chain manage-
ment, and many other systems are much more prevalent today than in years past.
Investments in many lesser-known technologies for admissions, cashiering, inven-
tory management, and even bed management are also becoming more common.
The basic premise of most technologies is that they provide some return that,
when quantified, is greater than the costs associated with it. In some cases, this
is simple to calculate, as when a system creates known financial value and has
well-defined costs. In others, when the information technology produces vague
benefits (such as extending a systems end of life or improving clinical quality),
the returns are more difficult to measure and quantify and thus are more complex
if creating a cost-benefit comparison. Regardless, the trend in leading hospitals
is to conduct thorough return on investment analyses that clearly define the pre-
and postenvironment and then make comparisons of the delivered or earned
value for the project.
The growth in deployment of resource tracking systems is also interesting. Infor-
mation systems and technology are being developed specific to health care to allow
for tracking of patients, equipment, supplies, pharmaceuticals, bed occupancy, and
much more. Microprocessor chips, bar-coding technology, global positioning sys-
tems, and radio frequency identification systems are all technologies that are being
slowly adopted in larger hospitals. Many of these use existing wireless frequencies
and infrastructure, so they are becoming easier to implement at lower costs. These
tracking systems allow for closer monitoring of utilization patterns, location analy-
sis, stationary or down times, and logistical flows, which thus helps better manage
the number, type, and mix of resources required. Improved operational effective-
ness results from improved utilization and higher asset productivities.
Another trend that is being followed closely in operations management is
that of standardization. Standardization is the use of consistent procedures,
resources, and services to achieve consistent results across multiple departments.
In a system or network, standardization suggests that two hospitals could use the

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 28 Chapter 1 Health Care Operations and Systems Management

same basic medical supplies for multiple procedures, rather than a wide variety
of them, which helps reduce inventory and purchasing costs and creates some
economies of scale. Standardization also refers to the use of common standards
for information systems, as well as personnel and operational processes. Stan-
dardization helps ensure alignment among departments, promote familiarization
and learning curves, and reduce the number of transactions processedall of
which result in lower costs and higher productivity.
Finally, many hospitals practice what is called evidence-based health care.
Evidence-based medicine applies the scientific method to medical practice and
seeks to quantify the true outcomes associated with certain medical practices by
applying statistical and research methods (Centre for Evidence-Based Medicine,
2014). Evidence-based health care, as it applies to logistics or operations, empha-
sizes that prior to decisions being made, the options are conscientiously analyzed
for the effects each would have on operations. For example, if a certain piece of
equipment needs to be replaced, evidence-based medicine suggests that the true
costs and outcomes associated with this item be carefully analyzed over time; a
replacement piece of equipment undergoes the exact same controls to guarantee
and quantify the total effect of this change on the system. Evidence-based health
care, in its use of quantitative methods and in seeking to comprehensively ana-
lyze operations, is completely in alignment with operations management theory.
The use of quality management processes such as Six Sigma, which attempts to
improve processes and outputs through continuous improvement techniques, is
beginning to gain a solid foundation in the health care industry.

Chapter Summary
Operations management is the quantitative management of the supporting busi-
ness systems and processes that transform resources into health care outputs.
Operations management is about coordinating diverse, complicated activities into
a comprehensive system. It is focused on achieving operational effectiveness
defined as lower costs, higher productivity, and continuous process improvement.
There are five key goals of the operations manager: reduce costs, reduce variability
and improve logistics flows, improve productivity, improve quality of customer
service, and continuously improve business processes. Operations management
is a field within the discipline of management, and it evolved initially from the
scientific management school of thought. The process of management decision
making supports the choices for how operations management occurs. The deci-
sions made affect the quality and efficiency of operations. With the increased

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 Discussion Questions 29

emphasis on efficiency and quality in health care organizations, operations man-

agement has progressed to become more comprehensive and valuable. There are
several evolving trends that are changing health care operations.

Key Terms
Competitiveness Operations effectiveness
Controlling Organizing
Costquality continuum Outsourcing
Decision making Planning
Division of labor Productivity
Evidence-based medicine Satisficing
Health care operations management Specialization
Innovation Standardization
Leading System
Logistics Throughput
Mass production Variability
Operational excellence

Discussion Questions

1. What is operations management in health care?

2. How is health care representative of a system?
3. What are the five key goals of operations managers?
4. Does operations management affect a hospitals competitive advantage?
5. What are three of the key trends affecting hospital operations?
6. Who is considered the father of scientific management?
7. How are decisions made in organizations?
8. What are the basic steps of a rational management decision-making process?
9. What are the common sources of cost increases in health care?
10. How does the medical care consumer price index relate to cost increases
for other items?
11. What four things can be learned from scientific management?
12. What are the three reasons decision-making processes in health care are
more ambiguous than in other organizations?
13. How does evidence-based medicine support operations management
techniques?

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 30 Chapter 1 Health Care Operations and Systems Management

Exercise Problems
1. Health care organizations routinely make complex organizational deci-
sions. As an example, a decision to modify the physical layout or space of
a department, or alter the schedules of a nursing unit, will affect patient
care in many ways. Because so many stakeholders are involved, which
process for making management decisions do you think will be followed?
How would you use the decision-making process to make important
decisions such as this in an organization?
2. Richmond Community Hospital currently receives more than 10,000
boxes of pharmaceutical supplies per month. All of these items are
manually inspected and logged to ensure adequate receipt prior to
payment. Eight employees manage receipts and deliveries, while four
employees manually record and track them. A new software package that
allows automated scanning of bar codes will replace all or some of the
employees used for manual tracking, or at least allow redeployment to
other areas of the hospital. What are some of the key questions that must
be explored to fully understand the effects of technology and whether a
capital investment should be made to substitute capital for labor?

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