An Examination of Organizational Change and Structure in The Healthcare Industry

AN EXAMINATION OF ORGANIZATIONAL CHANGE AND
STRUCTURE IN THE HEALTHCARE INDUSTRY
by
Alyssa Suzanne Pozniak
A dissertation submitted in partial fulfillment

of the requirements for the degree of
Doctor of Philosophy
(Health Services Organization and Policy)
in The University of Michigan
2006
Doctoral Committee:
Associate Professor Richard A. Hirth, Chair
Professor Francine Lafontaine
Professor John R.C. Wheeler
Associate Professor Jane C. Banaszak-Holl
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2006
Acknowledgements
Many thanks to my committee for their assistance and support throughout my

graduate school career. I also would like to thank the excellent people at the Kidney
Epidemiology and Cost Center (KECC) at the University of Michigan who allowed me to
use their rich datasets, provided me with excellent answers to my numerous data and
programming queries, and made it an enjoyable and stimulating workplace. I am also
very grateful to KECC and the Rackham Graduate School for providing funding for this
dissertation.
Finally, this acknowledgement would not be complete without a huge
thanks to my great friends and wonderful family for their patience, faith, and
encouragement.
ii
Table of Contents
Acknowledgements............................................................................................................ii
List of Figures.................................................................................................................... v
List of Tables..................................................................................................................... vi
Abstract............................................................................................................................vii
Chapter I. Introduction................................................................................................... 1
References to Chapter 1...........................................................................................4
Chapter II. Modeling the Likelihood of Chain Acquisition Among Independent
Dialysis Facilities............................................................................................................... 5
Abstract................................................................................................................... 5
Introduction............................................................................................................. 6
Rationale for Acquisition in the ESRD Industry.....................................................6
Literature Review.................................................................................................. 12
Hypotheses............................................................................................................ 17
Data and Methods..................................................................................................23
Results................................................................................................................... 31
Discussion............................................................................................................. 37
References for Chapter II ......................................................................................55
Chapter III. Effect of Chain Acquisition on Facility Outcomes and Treatment
Patterns............................................................................................................................59
Abstract.................................................................................................................59
Introduction...........................................................................................................60
Literature Review..................................................................................................60
Hypotheses............................................................................................................66
iii
Methods and Data.
72
Results................................................................................................................... 77
Discussion............................................................................................................. 82
References for Chapter III................................................................................... I l l
Chapter IV. Change for Chains? Franchising as an Organizational Structure in
the Healthcare Industry................................................................................................ 115
Abstract............................................................................................................... 115
Introduction..........................................................................................................116
New Contribution................................................................................................ 117
Franchising Defined............................................................................................ 117
Why Firms and Individuals Choose to Franchise............................................... 120
Franchising in Healthcare Industries................................................................... 122
Feasibility of Franchising in Healthcare............................................................. 133
Recommendations for Future Research.............................................................. 142
References for Chapter IV................................................................................... 147
Chapter V. Conclusion................................................................................................. 152
Summary of Findings.......................................................................................... 152
Study Limitations................................................................................................ 153
Future Research................................................................................................... 155
References for Chapter V .................................................................................... 157
List of Figures
Figure 2-1.............................................................................................................. 42
49
Figure 2-2.......................................
Figure 3-1...............................................................................................................89
List of Tables
Table 2-la..............................................................................................................43
Table 2-lb ............................................................................................................. 45
Table 2-2................................................................................................................47
Table 2-3..........................................................................................................................48
Table 2-4................................................................................................................50
Table 2-5a..............................................................................................................51
Table 2-5b..............................................................................................................52
Table 2-6................................................................................................................53
Table 2-7................................................................................................................54
Table 3-1................................................................................................................88
Table 3-2............................................................................................................... 90
Table 3-3............................................................................................................... 91
Table 3-4............................................................................................................... 92
Table 3-5............................................................................................................... 93
Table 3-6............................................................................................................... 95
Table 3-7............................................................................................................... 97
Table 3-8............................................................................................................... 99
Table 3-9..............................................................................................................101
Table 3-10............................................................................................................103
Table 3-11............................................................................................................105
Table 3-12............................................................................................................107
Table 3-13............................................................................................................109
vi
Abstract
Given the rapid growth in US healthcare expenditures, it is critical to understand

the myriad of organizational forms that could be employed to help reduce costs while
also providing high quality care. To this end, this paper examines the antecedents of
acquisition by a chain and the effect of chain membership on cost, quality, and treatment
patterns. An alternative organizational form - franchising - is examined also to better
understand its use and potential within the healthcare industry.
Using data from the renal dialysis industry, results suggest that higher than
average costs and higher quality outcomes are both significant determinants of
acquisition of dialysis facilities by chains, suggesting a mixed motivation of turn-around
and cream-skimming strategies. The findings regarding poor financial health are similar
to results reported in other healthcare sectors, but the increased likelihood of chain
acquisition among higher quality facilities appears to be unique to the dialysis industry.
Significant differences between predictors of acquisition by small and large chains
reinforce the importance of using a richer classification for chain status than a simple
binary variable.
Building on these findings, the effect of chain acquisition on dialysis facilities
subsequent costs, quality, and treatment patterns were examined.
Using propensity
scores to control for pre-existing characteristics that may also affect outcomes, results
suggest that acquired facilities consistently have more patients achieving quality targets
vii
than non-acquired facilities for the first five years post-acquisition. These results differ
from findings in other healthcare industries that do not find a positive relationship
between organizational change and quality outcomes. However, there was no discemable
difference in costs between chain-acquired and independent dialysis facilities.
In addition to these findings on chain behavior that can contribute to the general
healthcare organizational literature, this paper examined franchising, an organizational
form common in other industries, that has been largely absent within the healthcare
industry. The increased popularity of consumer-driven health plans and other patientfocused trends are likely to facilitate healthcare franchising, but compliance with
healthcare fraud and abuse laws, the price inelasticity associated with health insurance,
and other barriers may prevent franchising from becoming commonplace in healthcare.
viii
Chapter I
Chapter I. Introduction
The Centers for Medicare and Medicaid Services (CMS) End Stage Renal
Disease (ESRD) program is the only disease-specific coverage offered through Medicare,
regardless of patients ages. With just 10,000 patients enrolled upon the programs
initiation in 1973, the ESRD program was hailed as a life-saving benefit for people with
kidney failure who would otherwise die without dialysis treatment or a kidney transplant.
However, what started as a small program has grown rapidly. The ESRD population has
increased by over thirty-fold since the programs inception, to nearly 325,000 dialysis
patients in 2003 (U.S. Renal Data System 2005). By 2030, the ESRD patient population,
including transplant patients, is expected to reach more than two million (Szczech and
Lazar 2004).
The number of dialysis facilities also has increased substantially to accommodate
the growing ESRD population. Between 1988 and 2003, the number of dialysis facilities
more than doubled, from 1,815 to 4,591 (U.S. Renal Data System 2005). However, the
number of facilities that are chain affiliated grew at a much faster rate them overall
facility growth. Over this same fifteen year time period, chain-affiliated dialysis centers
increased eleven-fold - just 248 (14%) of dialysis providers were chain-affiliated in 1988
versus 2,822 (61%) in 2003 {Ibid.).
There are several ways that chain acquisition can result in increased value for
both chain and facility, including improved resource allocation, increased market power
and presence, and other operational and managerial efficiencies that promote higher
quality as well as lead to economies of scale and scope (Pautler 2003). Accordingly, the
high prevalence of chain affiliation among dialysis providers is not unique to the
industry; for example, over half of all nursing homes and hospitals also are chainaffiliated.
Despite the hypothesized benefits, however, dialysis industry observers have
raised concerns that chain facilities that acquire enough dialysis facilities in a market may
exert monopoly power (Taylor 1999), particularly given the non-uniform growth among
dialysis chains that has resulted in a few large chains dominating the industry. In 2003,
63% of prevalent dialysis patients received care from a unit owned by one of the six large
dialysis chains. The largest chain, Fresenius, treated nearly a quarter of all dialysis
patients (U.S. Renal Data System 2005). Furthermore, three recent mergers consolidated
the six largest chains into just three.1
Despite the prominence and continued growth of chains in the dialysis industry,
little research has been performed to better understand the factors associated with chain
acquisition. Additionally, little is understood about the impact of chain acquisition on
outcomes, and no empirical research has yet examined whether the purported benefits
associated with chain membership are realized by the chain-acquired dialysis facilities.
1 Renal Care Group (4th largest in 2003) acquired National Nephrology Associates (6th largest) in April
2004, Davita (3rd largest) acquired Gambro (2nd largest) in December 2004 (official as o f October 5,
2005), and Fresenius acquired Renal Care Group in May 2005 (U.S. Renal Data System 2005). Dialysis
Centers Inc (5* largest), the largest non-profit chain is not involved in any merger.
More broadly, it is critical to understand the myriad of organizational forms that

could be employed to help reduce costs while also providing high quality healthcare.
Although chains are arguably the most common organizational form found in the
healthcare industry, there are other organizational structures that also could be used. One
such type is franchising, a well-established and successful business model used in many
industries with diverse products and services.
Some healthcare sectors have
experimented with franchising but, overall, it has largely been overlooked as a viable
business model.
This thesis examines the characteristics of independent (i.e., non-chain affiliated)

dialysis facilities that are associated with chain acquisition; the analysis is accompanied
by an examination of how various outcomes change between these two facility types
post-acquisition. Chapter IV follows with an examination of the economic theory behind
franchising, a description of the healthcare sectors that have experimented with the
organizational form, and exploration of healthcare specific-factors that are likely to
facilitate versus hinder its further use. The thesis concludes with a summary of findings,
limitations, and areas of future research.
References to Chapter I
Pautler, P.A. 2003. Evidence on Mergers and Acquisitions. Antitrust Bulletin 48(1): 119221 .
Szczech, L.A. and Lazar, I.L. 2004. Projecting the United States ESRD Population:
Issues regarding Treatment of Patients with ESRD. Kidney International Supplement
(90):S3-7.
Taylor, M. 1999. Mich. Attorney General Sues Gambro. Dialysis Firm is Accused of
Monopolizing Market in Western Mich. After Acquisition Spree. Modem Healthcare
29(39):22.
U.S. Renal Data System. 2005. USRDS 2005 Annual Data Report: Atlas of End-Stage
Renal Disease in the United States, National Institutes of Health, National Institute of
Diabetes and Digestive and Kidney Diseases, Bethesda, MD.
Chapter II
Chapter II. Modeling the Likelihood of Chain Acquisition Among Independent

Dialysis Facilities
Abstract
Chain-affiliated providers are a large segment of the dialysis market and have
steadily increased over the past several years.
Although chain affiliation may yield
benefits in terms of achieving economies of scale and scope, there are also concerns
regarding patient outcomes and cost to the primary payer (i.e., Medicare, private
insurers). This paper examines the motivation behind the acquisition trend by analyzing
the provider characteristics that affect the likelihood of chain acquisition among dialysis
facilities between 1997 and 2003. Results indicate that higher than average costs and
higher quality outcomes are both significant determinants of dialysis chain acquisition,
suggesting a mixed motivation of turn-around and cream-skimming strategies.
The
findings regarding poor financial health are similar to results reported in other healthcare
sectors, but the increased likelihood of chain acquisition among higher quality facilities
appears to be unique to the dialysis industry. Market competition was not a significant
predictor of acquisition, although sensitivity analyses of market size suggest that, in
general, facilities in more competitive markets are more likely to be acquired than those
in less competitive markets. A lower prevalence of Medicare patients increases the odds
of acquisition by a small chain but was not a significant predictor of acquisition by a

large chain. This study thus reinforces the importance of using a richer classification for
chain status than a simple binary variable.
Introduction
This Chapter examines the characteristics of independent (i.e., non-chain
affiliated) dialysis facilities that are associated with chain acquisition. The next section
delineates the rationale for acquisition in the ESRD industry followed by a review of the
relevant literature. The hypotheses tested in the analyses are presented along with the
data used and methods employed. The Chapter concludes with results and discussion of
the findings.
Rationale for Acquisition in the ESRD Industry

Conceptual Framework
Assuming that both the dialysis chain and the independent dialysis facility are
profit maximizers, each will individually decide whether or not to engage in a chain
acquisition. The independent facilitys owner(s) will set a minimum price (P/) that they
are willing to accept from a chain. P/ reflects the net present value (NPV) of the facilitys
expected cash flows, discounted at interest rate r/ over time i:
oo
Equation 2-1:
NPV/
(Revenue,/-Cost,/)/(l+r/)'
=i
P/
The chain will set a maximum price (Pc) that it is willing to offer to the
independent facility.
Pc reflects the NPV of the facilitys profit under the chains
ownership, discounted at interest rate rc over time i:

Equation 2-2:
NPVC
(Revenue^-CostJC)/(I+ rc)'
1=1
Pc
A chain will acquire an independent dialysis facility if and only if Pc > P /. Figure
2-1 illustrates this outcome and reflects what is observed empirically. We do not observe
instances where a facility does not want to sell to a chain, or where a chain does not want
to buy a facility. Rather, only when both firms expect an economic gain will a chain
acquisition occur. Regardless of how these financial synergies are distributed between
the two firms, a chain will acquire a dialysis facility only if the two firms are more
valuable together than apart.
The decision to sell is relatively straightforward if the independent facility is
owned by a group of passive investors who are all motivated to sell for financial gains
(i.e., facility owners following a for-profit strategy). If there is a single owner, however,
the decision to sell her dialysis facility to a chain may be complicated by non-financial
concerns, such as her (dis)utility from giving up control in the facilitys day-to-day
operations or reduced hours of work (Riley and McGraw-Walsh 2006). Furthermore,
these and other non-pecuniary issues are likely to be more of a concern for actively
involved (versus passive) owners.
Regardless of the owners involvement and
motivation, however, it is assumed that she is aware of the pros and cons associated with
selling her unit to a chain and that if she is willing to sell, the former outweighs the latter.
Economic theory suggests several ways that chain acquisition can result in
increased value for the chain and facility, such as improved resource allocation, increased
market power and presence, lower cost and better use of capital, reduced transportation
and transaction costs, and other operational and managerial efficiencies that lead to
economies of scale and scope (Pautler 2003). By spreading fixed costs (e.g., medical
records systems and other administrative tasks) across more patients, the average cost
faced by chain-affiliated dialysis facilities will fall.1 With a larger total patient base, the
chain also may be able to offer additional services, such as different dialysis modalities,2
that an independent facility could not. For instance, one chain-affiliated facility may
serve all of the chains peritoneal dialysis patients in the market. This joint production of
different dialysis modalities throughout the chain-affiliated units translates to economies
of scope and more treatment options for the patient and referring nephrologist. Chain
affiliation also can lead to easier and less costly access to capital and labor resources as
well as economies of promotion through brand identity for the newly acquired facility
(Dranove and Shanley 1995). The brand identity associated with the chain name also
translates to lower search costs for consumers and a marketing advantage for the chainaffiliated unit. However, although patients are free to change facilities, the advantage of
branding (or, more broadly, advertising) may be dampened among dialysis patients since
most stay at the facility to which they were initially referred by their nephrologist due to
the severity of their illness and ties to their doctor.
1 It also is possible for chains to become too large and thus inefficient, causing average costs to increase
with chain growth rather than decline.
2 Although the vast majority o f patients (91% o f incident patients in 2003) receive in-center hemodialysis,
there are other treatment modalities, including continuous ambulatory peritoneal dialysis (CAPD),
continuous cycler-assisted peritoneal dialysis (CCPD), and home hemodialysis (U.S. Renal Data System
2005).
The CMS payment system for ESRD services

The financial benefits associated with chain membership are especially salient for
dialysis providers when one considers CMS payment system for ESRD services, which
is composed of two parts: Composite Rate and Separately Billable payments. Begun in
1983, the Composite Rate (CR) payment covers a bundle of services associated with
routine dialysis care (e.g., dialyzer and other supplies, labor, specified laboratory tests).
All facilities administering dialysis receive the same CR payment, with a few minor
exceptions.3 Despite frequent recommendations from the Medicare Payment Advisory
Commission (MedPAC) and dialysis providers for annual increases (Medicare Payment
Advisory Commission 1999; 2000; 2002; 2003; 2004b; 2005), there have only been five
adjustments to the CR payment since its inception. The most recent increase (1.6%)
occurred in January 2005, resulting in an average CR payment of $128.35 per treatment
for
freestanding
dialysis
facilities
and
$132.41
for
hospital-based
facilities
(approximately 18% of facilities) (U.S. Renal Data System 2005). Consequently, the CR
payment amount has decreased substantially in real dollar terms since its inception,
resulting in CR costs being higher than the CMS CR payments for most dialysis
facilities (Buckelew 2003; Hirth et al. 2003; Medicare Payment Advisory Commission
2002).
Facilities also receive a separate payment for providing dialysis services that are
excluded from the CR payment bundle. There is a large set of services that comprise
these Separately Billable (SB) items, but broadly speaking, they consist of injectable
3 Differences in CR payment occur based on facility setting (hospital-based facilities receive slightly more
than freestanding facilities), geographical area (over 50% of the CR payment is adjusted for differences in
local labor costs), and, starting in 2005, a limited set o f patient characteristics (Final Rule H. Section
623 Payment for Renal Dialysis Services 2004).
drags (e.g., intravenous iron and vitamin D), laboratory tests, and supplies. Nearly 70%
of Medicares SB payments are for one specific injectable drag used to treat anemia:
Epogen (Epoetin alfa, or EPO), a synthetic form of the hormone erythropoietin (Hirth
et al. 2003).
Although CMS has a fixed payment amount for EPO, there is no regulation on the
acquisition price paid by the facility to Amgen, the sole manufacturer of the drag.4 That
is, facilities (or chains) that are able to buy in bulk may be able to negotiate a lower price
with Amgen while still receiving the set payment rate from CMS. The Kidney Disease
Outcomes Quality Initiative (K/DOQI) guidelines recommend a minimum hematocrit
(the percentage of red blood cells in whole blood) of at least 33% for dialysis patients.5
There are no analogous recommendations regarding how EPO is administered, though,
and the EPO doses to achieve similar hematocrit values vary widely.6
To curtail excessive EPO doses, CMS has imposed limits on EPO payments based
on hematocrit values, but they are not uniformly enforced by the fiscal intermediaries
with whom Medicare contracts to process claims. Accordingly, the outlays for EPO are
sizeable, with Medicare expenditure for EPO totaling approximately $1.6 billion in 2003
(U.S. Renal Data System 2005). Although SB payments are less than two-thirds of CR
payments ($77 SB payment/treatment versus $125 CR payment/treatment in 2000)
(Hirth et al. 2003), most facilities have a payment-to-cost ratio greater than one for the
SB services and are therefore able to cross-subsidize the losses incurred from the CR
services.
4 Amgen was recently able to extend its patent for Epogen to 2016.
5 http://www.kidnev.org/professionals/kdoQi/guidelines undates/doaiuphd i.html. accessed July 12, 2005.
6 For example, less EPO is needed when administered subcutaneously versus intravenously to attain
equivalent hematocrit levels.
10
Concerns about chain growth in the ESRD industry

As discussed above, chain affiliation has potential benefits for both the dialysis
chain and the dialysis provider. However, industry observers have raised concerns that
parent companies that acquire enough dialysis facilities in a market may exert monopoly
power (Taylor 1999).
The usual concerns of underproduction and overcharging by
monopolistic firms are especially pertinent since the demand for dialysis is highly
inelastic (the only alternatives are kidney transplant or hospice). Monopolists set their
price-cost margin higher in markets where they face less elastic demand (Cabral 2000).
However, monopolists potential to over-charge is limited to the approximately 25% of
the patient population that is privately-insured, self-pays, or has other non-Medicare
coverage (U.S. Renal Data System 2005).
Since CMS has a set payment level for the CR, a monopolist would not be able to
extract a higher price from them. However, a monopoly would be able to earn positive
economic profits by demanding prices higher than its marginal costs from other payers namely private health insurers - where there is no legally mandated ceiling on payment
amounts. For example, Gambro implemented this type of price discrimination in 1999
after acquiring six dialysis facilities in western Michigan (Taylor 1999). Shortly after the
acquisitions, Gambro, which at the time was the second largest dialysis provider in the
world, enacted non-compete clauses (i.e., doctors were prohibited from referring patients
to non-Gambro dialysis facilities) and exclusive contracts with area nephrologists,
followed by a nearly five-fold increase in prices, from an average of $135 for dialysis
treatments to as much as $610. Meanwhile, other Gambro units in similar geographical
areas, but without monopoly control, did not alter their price structures. Alternatively,
11
rather than raise prices, facilities in a fixed price environment also can respond to lower
competition by decreasing services or amenities to increase profits (Held and Pauly
1983).
Opportunities for economies of scale from acquisitions may be limited, however.
For instance, independent facilities that outsource services (e.g., billing) effectively
achieve the same economies of scale as a chain with several units (Dranove 1998).
Housekeeping and other labor-intensive services also have a diminished potential to
experience large savings since they exhibit low fixed costs to begin with (Ibid.). It is also
possible for companies to unknowingly expand beyond the scale of production that
minimizes cost, producing diseconomies of scale rather than cost savings. To remain
competitive and attract referring nephrologists and their patients, facilities also may offer
more services than is optimally efficient.
Prior studies have found no evidence of
economies of scale for large hospital mergers (Ibid.) and even shown diseconomies of
scope exist in the home healthcare industry (Gonzales 1997).
Literature Review
Measuring chain affiliation
Despite the prominence and continued growth of chains in the dialysis industry,
little research has been performed to better understand the factors associated with chain
acquisition.
This may be a result of the mixed findings on the importance and
significance of chain status in previous studies as well as the high correlation between
chain affiliation and ownership status (i.e., for- versus non-profit).7 Virtually all of the
previous ESRD-related literature that examines chain affiliation has used chain as a
7 In 2001, over three-fourths of all dialysis chains were for-profit (U.S. Renal Data System 2005).
12
dichotomous independent variable. The potential under-specification caused by using a

simple binary variable rather than allowing for differences between large and small or
national and regional chains often resulted in insignificant results for chain status which
consequently received only a cursory inspection. For instance, Griffiths et al. (1994)
concluded that for-profit facilities were significantly more efficient than their non-profit
counterparts in producing dialysis treatments, but chain affiliation did not have a
statistically significant effect on costs.
Schlesinger et al. (1989) found significant
differences in ESRD practice patterns between for-profit and non-profit dialysis facilities
across a variety of model specifications, but the coefficient of a binary chain status added
to the models was consistently insignificant. Hirth et al. (2000) also used a binary chain
variable among their potential determinants of technology adoption at ESRD facilities.
However, unlike Griffiths et al. and Schlesinger et al.'s findings, the binary chain status
had a significant effect in some of their models.
Dor et al. (1992) used seven classes of chain affiliation - based on the number of
units in the chain - in their statistical cost function of ESRD providers. They found
economies of scale at the firm level: chains with more units had lower costs than chains
with fewer units. There was an exception to this monotonic relationship though, with one
large chain having higher costs despite its large number of ESRD units. With this single
anomaly, a simple binary variable for chain would likely have yielded insignificant
results, reinforcing the importance of correct categorization of chain affiliation.
Hirth et al.'s 1999 update of Dor et al.s study also included richer chain
affiliation definitions by using four chain categories. They found that small chains (i.e.,
two to ten units) did not have significantly different costs than independent facilities, but
13
facilities affiliated with chains owning eleven to seventy-two units had 8.7% higher costs
(p=0.089). Meanwhile, the two largest chains had lower costs than independent facilities,
but only one was significant (p=0.003). Accordingly, the authors conclude that a simple
binary variable for chain affiliation is inadequate and may bias results.
Ozgen and Ozcan (2002) also used chain size in their analysis of how chain
affiliation and other facility characteristics affect the efficiency of providing dialysis
treatments. Using six classes of chain membership, they found that facilities affiliated
with the largest, second largest, or other large chain were significantly less efficient
compared to independent, non-chain affiliated providers; meanwhile, facilities affiliated
with small or mid-sized chains were not significantly different than the independent
providers.
Researchers in other healthcare industries also have reported significant
differences when chain status is modeled as a multi-category variable. For example,
Tennyson and Fottler (2000) differentiated between national and regional hospital
systems to examine how profitability changed for Florida hospitals once acquired. The
authors found a significant association between chain affiliation and hospital financial
performance when regional versus national chain membership were differentiated, but the
relationship became insignificant when a binary variable for chain status was used
instead.8 As the authors emphasize, lack of chain differentiation in previous studies may
help explain the inconsistent findings in the literature regarding differences between
chain-affiliated and independent hospitals.
8 However, when Anderson et al. (2003) applied a similar differentiation to nursing home chains,
distinguishing between national and regional nursing home chains did not yield a significant difference
between the two chain categories versus independent nursing homes regarding efficiency o f the unit.
14
Banaszak-Holl et al. (2002) employed three levels of chain size to investigate

how quality at a nursing home changes after the unit is acquired by a chain. Although
there were no significant differences between differently sized chains in the number of
deficiencies, the authors did find differences between chains with regard to the number of
patients with pressure ulcers.
Determinants of chain acquisition

As evident from the above studies, most research that includes chain status used
the measure as an independent variable to predict a variety of outcomes. However, some
studies have also used chain status as the dependent variable when exploring the
determinants of chain affiliation and acquisition. None of these studies examined the
dialysis industry, but research from the hospital and nursing home industries has yielded
interesting results.
Using hospital financial conditions to predict their likelihood of
acquisition by a chain, McCue and Furst (1986) found that chains purchased hospitals
that were financially distressed, and Phillips (1999) found similar results for non-profit
hospitals acquired by for-profit chains.
Menke (1997) looked at three broad categories for possible determinants of chain
acquisition of hospitals: favorable market conditions, less efficient management, and
coinciding missions of hospital and chain. Like McCue and Furst, Menke also found that
chains tended to acquire financially troubled hospitals. Sloan et al. (2003) used a variety
of hospital characteristics to predict hospital conversions, mergers, and closures. The
authors found that low profit margin was an important antecedent to ownership
15
conversion:
hospitals that closed had the worst prior financial status, followed by
hospitals that converted and then by hospitals that merged.

Banaszak-Holl et al. (2002) also examined determinants of chain acquisition in
the nursing home industry using quality and market indicators. Like the researchers that
studied the hospital industry, their results also supported a turn around theory: nursing
homes with more health deficiencies are more likely to be acquired by chains than homes
with better quality indicators, ceteris paribus.
Finally, Danzon et al. (2004) recently examined determinants of acquisitions and
mergers in the pharmaceutical industry from 1988-2001.
Although perhaps less
applicable to the dialysis industry than results based on other healthcare sectors, the
authors also found financial trouble (i.e., relatively low expected growth rate of earnings)
to be a precursor to mergers among pharmaceutical companies.
New contribution to the literature

Although previous researchers have studied determinants of chain acquisition in
other healthcare sectors, there have been no studies that look specifically at the ESRD
industry.
To better understand the motivation behind chain growth among dialysis
providers and how it compares to what has been found in other sectors, this paper
examines the independent facility factors that influence acquisition by a dialysis chain.
In addition to the standard treatment of chain as a binary variable, chains are also
differentiated by size.
16
Hypotheses
Most studies examined above support a turn around theory regarding chain
acquisition strategy (Banaszak-Holl et al. 2002; McCue and Furst 1986; Menke 1997;
Phillips 1999; Sloan et al. 2003). That is, facilities with less favorable characteristics are
more likely to be acquired by a chain than those with more favorable characteristics,
ceteris paribus. Similar results are expected in the ESRD sector. Three categories of
potential predictors of dialysis chain are considered:
facility performance (financial,
treatment patterns, and clinical); market factors; and payer mix.
Hypothesis 1: Facility performance

HI a: The worse the financial performance at the independent dialysis facility, the more
likely a chain will acquire the facility, ceteris paribus.
Poor financial health of the acquisition target is a consistent predictor of
ownership change in other healthcare industries (Danzon et al., 2004; McCue and Furst
1986; Menke 1997; Phillips 1999; Sloan et al. 2003; Tennyson and Fottler 2000). A
chain may reason that with its newer technology, expertise, and management skills, it will
be able to acquire a financially troubled dialysis facility at a discount and then raise its
value by improving its performance. Meanwhile, the owner of the independent facility
may want to turn her facility over to a company better able to manage it (Riley and
McGraw-Walsh 2006). Through economies of scale (via bulk purchasing), the dialysis
chain may be able to lower the cost of Epogen and other injectable medications at the
facility, thereby increasing the payment-to-cost ratio for the lions share of separately
17
billable services. Many of the large chains also own and operate their own laboratories,
presenting another cost-savings measure to the dialysis facility.
Average composite rate (CR) cost/treatment (adjusted to 2003 dollars) is used as a
proxy for a facilitys efficiency. Ideally, financial variables that capture profitability,
leverage, and liquidity of the facility would be included to gain better insight into the
financial health of the dialysis facilities. Unfortunately, as a recent MedPAC report
highlights (Medicare Payment Advisory Commission 2004a), unlike Medicare cost
reports for other healthcare providers, dialysis facilities do not include such financial
information on their cost reports.
Bad debt is collected on the dialysis cost reports and was considered as a proxy
for uncompensated care. Although meaningful to CMS, the cost report measure of bad
debt is not capturing all uncompensated care since providers are only permitted to report
allowable bad debt, which ...must relate to specific Medicare deductibles and
coinsurance amounts.9 Only 17% of the observations reported any reimbursable bad
debt, and the non-zero values were extreme, ranging from $1 to over $900,000.
Therefore, the measure was not used. Facility age, as measured by the years since
Medicare certification, was used as a proxy for capital depreciation.
From HI a, it is expected that older facilities with higher CR cost/treatment are
more likely to be acquired by chains than younger facilities with lower CR
cost/treatment, ceteris paribus.
9 Provider Reimbursement Manual Part II - http://www.cms.hhs.gov/manuals/publ52/PUB 15 2.asp.

accessed July 12, 2005.
18
Hlb: The worse the treatment patterns at the independent dialysis facility, the more
Related to a facilitys financial health are its treatment patterns. For the ESRD
industry, this includes staffing ratios, availability of dialysis stations, scope of services
offered, and other patient amenities.
At some cost, dialysis facilities with a low
percentage of skilled staff may be less desirable to patients and payers than those that
employ more registered nurses (RN). Similarly, a facility that does not offer multiple
dialysis modalities could benefit from a chains established treatment protocol that might
allow for alternative dialysis treatments.
A binary variable reflecting whether a facility only offers hemodialysis (i.e., no
peritoneal, training, or home dialysis sessions) was included as a measure of the variety
of services offered at the facility, as was a binary variable indicating whether a facility
reuses dialyzers, a cost savings measure with mixed quality implications10 (Agodoa et al.
1998; Fan et al. 2005; Feldman and Escarce 2000; Robinson and Feldman 2005). The
number of stations per patient was included as a measure of facility amenities. To
measure staffing differences, the RN-to-patients ratio and the percent of skilled labor measured as the percent of labor comprised of doctors and RNs - also were included.11
From Hlb, it is expected that facilities that offer hemodialysis (HD) only, reuse
dialyzers, offer fewer amenities, and have worse staffing practices (i.e., lower percentage
of skilled labor and fewer RN per patient) are more likely to be acquired by chains than
10 For example, Fan et al. (2005) found no differences in survival among dialyzer reuse versus single use
whereas Robinson and Feldman (2005) reported several studies that found reuse to be associated with a
modest increase in mortality.
11 This hypothesis implies that chains change these factors after acquiring the facility. This will be
explored more fully in the following Chapter that examines these and other outcomes post-chain
acquisition.
19
facilities that offer multiple dialysis modalities, do not reuse dialyzers, offer more
amenities, and have better staffing practices, ceteris paribus.
Hlc: The worse the clinical performance at the independent dialysis facility, the more
Just as poor quality nursing homes were more likely to be acquired by a chain
compared to high quality homes (Banaszak-Holl et al. 2002), it is expected that dialysis
facilities will follow the same pattern.
Poor performing facilities may seek chain
membership to access the chains skill at improving care. Although dialysis patients
might not know their facilities overall clinical outcomes, the referring nephrologists are
likely to be aware and responsive to poor quality outcomes. Additionally, CMS Dialysis
Facility Compare website12makes it easier for patients and their caretakers to learn about
their facilitys quality measures and how it compares to other providers. This increased
transparency may act as another incentive for facilities to improve clinical care.
In response to the previously mentioned K/DOQI guidelines regarding dialysis
adequacy, dialysis providers began reporting two measures on CMS claims: patient
hematocrit (HCT) in 1996 and urea reduction ratio (URR) in 1997. Because diseased
kidneys do not produce enough hormones to stimulate red blood cells, anemia is common
in dialysis patients. K/DOQI standards recommend HCT levels of 33% or greater for
dialysis patients. To calculate URR - a measure of how much waste is removed from the
body during dialysis - urea levels are taken before and after dialysis. K/DOQI guidelines
recommend a minimum URR of 65% for dialysis patients.
12 www.medicare.gov/Dialvsis/Home.asp. accessed August 15, 2005.
20
From Hlc, it is expected that facilities with a lower percentage of patients

achieving adequate dialysis and anemia management are more likely to be acquired by
chains than facilities with a higher percentage of patients achieving adequate dialysis,
ceteris paribus.
Hypothesis 2: Facility market factors

H2: The weaker the facilitys market competition, the more likely a chain will acquire a
facility in that market, ceteris paribus.
Unlike many other medical treatments, dialysis is unique in that it is a lifesustaining but chronic treatment with virtually no substitutes. Because of the inelasticity
of demand, dialysis chains may have an easier time gaining market control than chains in
other industries (e.g., Gambro in western Michigan) (Taylor 1999).
Furthermore,
certificate of need (CON) laws can pose substantial barriers to entering the dialysis
market, allowing facilities already in practice some protection against new competition.
Not only may a chain be more capable of dealing with the legal issues involved with
compliance of CON laws than an independent facility owner, but a chain that already has
a presence in the market also would benefit from an increase in its market share through
acquiring the unit whereas the independent owner cannot similarly increase her market
share.
It follows, then, that dialysis chains would be more interested in acquiring
facilities in markets where there is relatively low competition, ceteris paribus.

To measure this, the Herfindahl-Hirschman Index (HHI) was used to measure
market concentration.13 The HHI uses the sum of the square of each competing firms
market share (i.e., the dialysis treatments performed at each facility) to determine market
13 http://www.usdoi.gov/atr/Dublic/testimonv/hhi.htm. accessed July 12, 2005.
21
concentration.
The m easure ranges from nearly zero, reflecting nearly perfect
competition, to 10,000, indicating a pure monopoly. To capture the concentration of

chains, all facilities in the market that were owned by the same chain were treated as one
firm in the HHI calculation.
Although other researchers that use market measures in their analyses of health
providers commonly use 10-20 mile distance to define the market (e.g., (Hirth et al.
2003; Mobley and Freeh 1994; Shen 2003), it could be argued that the dialysis facilitys
market is larger due to the absence of any substitutable treatments. Few of the previous
dialysis-specific studies included market characteristics in their analyses, so several
market definitions are considered. Specifically, facilities within 5, 15, 25, 50, and 100
miles of the facilitys zip code are tested.
From H2, it is expected that facilities in markets with a higher HHI (i.e., less
competition) are more likely to be acquired by chains than facilities in markets with a
lower HHI, ceteris paribus.
Hypothesis 3: Facility paver mix

H3: The fewer Medicare patients at a facility, the more likely a chain will acquire the
facility, ceteris paribus.
Finally, type of payer is considered. Broadly speaking, there are three payers for
ESRD services: Medicare, Medicaid, and private insurance. Uninsured and Medicaid
dialysis patients become Medicare eligible after their first 90 days of dialysis, so they are
negligibly different from Medicare patients. However, Medicare is the secondary payer
for the first 33 months of dialysis for those patients who begin treatment with private
22
health insurance.
As previously discussed, unlike Medicare treatments, there is no
regulation concerning the price charged by dialysis facilities to private insurers.

Accordingly, the price charged to private insurers is higher than the Medicare payment
rate. It is reasonable to assume, therefore, that both chains and sellers consider the payer
mix at a facility in their decision to acquire and sell, respectively. Assuming that the
chain is able to negotiate better payment rates from private insurers than an individual
seller, chains will value the privately insured patients more than the facility owner.
Correspondingly, a lower percentage of Medicare patients (that is, a higher percentage of
privately insured patients) will increase the odds of chain acquisition, ceteris paribus.
Data and Methods

Data
Tables 2-la and 2-lb list the variables used in the analysis and their data source,
respectively. The motivation behind their inclusion and more detailed information on the
variables follow.
Dependent variable
The dependent variable is a binary variable coded 1 if an independent facility is
acquired by a chain in that calendar year and coded 0 if it remains independent.
Following Banaszak-Holl et al.'s (2002) methodology, chain status and affiliation were
manually checked and recoded where necessary.
Several false positive chain
observations were found (i.e., only one occurrence of the chain in a year) and
subsequently corrected so only chain affiliations with more than one facility per year
23
were considered to be chains.
Additionally, misspellings of chain affiliation were
corrected so that an accurate tally of affiliated facilities could be calculated.

To capture better differences between chains, additional analyses modified the
dependent variable to account for acquisition based on chain size (i.e., the number of
outlets each year). Because of the relatively small number of acquisitions per year, the
dependent variable was differentiated between just two chain size categories: acquisition
by a large chain (i.e., one of the five largest chains) versus acquisition by a small
chain (i.e., all other chains). The dependent variable is coded 2 if an independent
facility is acquired by one of the five largest chains (large chain), 1 if an independent
facility is acquired by any other chain (small chain), and 0 if it remains independent.
Other facility characteristics

In addition to the key variables previously mentioned, facility size (i.e., total
number of treatments), ownership status (non- versus for- profit) pre-acquisition, setting
(rural versus urban), year, presence of CON law, and ESRD Network affiliation also were
included in the analysis. All dialysis providers pay fifty cents per dialysis session to
support the federally contracted ESRD Networks mission of ...promoting and
improving the quality of care to patients with renal disease....14 The eighteen ESRD
Networks are used instead of state or Census region since they are a more meaningful
geographic categorization for the dialysis industry.
14 http://www.esrdnetworks.org/. accessed July 12, 2005.
24
Patient characteristics
Average patient age, percent African-American, percent in first year of dialysis,
and selected comorbidities were included to control for differences in patient population
across facilities.15 Hirth et al. (2005) found that larger patients require more time on
average to dialyze, translating to higher costs compared to smaller patients. However, the
authors also found that underweight patients were associated with higher dialysis costs.
Therefore, the mean body surface area (BSA) of patients - a function of height and
weight - at the facility was used as measure of patient size (Du Bois and Du Bois 1916),
and the percent of patients with a body mass index (BMI) below 18.5 kg/m2 was used to
identify underweight patients. Additionally, the percentages of patients at the facility
with each of the following diagnoses were included in the analysis: HIV positive status,
drug dependence, myocardial infarction (MI), pericarditis, and peripheral vascular
disease (PVD). These comorbidities and weight measures were significant predictors of
dialysis facility CR costs in previous dialysis-related research.16
Data sources
Cost Reports
Cost reports for freestanding dialysis facilities (Form CMS-265-94) received by
CMS through September 30th, 2004, were used in the analyses to identify chain affiliation
each year, as well as several of the covariates (see Table 2-lb). These data are available
publicly via the Healthcare Cost Report Information System (HCRIS) and updated
15 As mentioned earlier, patients are free to change facilities but most do not. Accordingly, patient
characteristics at facilities do not change drastically from year to year.
16 See Addendum in the Kidney Epidemiology and Cost Centers (KECC) Methodology for Developing a
Basic Case-mix Adjustment for the Medicare ESRD Prospective Payment System:
http://www.sph.umich.edu/kecc/DDs/Case Mix Methods Report Final appdx 040105.pdf. accessed August
12,2005.
25
quarterly.17 Each HCRIS quarterly update includes all cost reports submitted to CMS by
freestanding dialysis facilities from 1993 to the most recent quarter; that is, September
2004. A single cost report encompassed the entire calendar year for most facilities, and
the methodology for pro-rating cost reports that spanned over two calendar years is
explained elsewhere.18 Because not all of the cost reports for 2004 were submitted at the
time of the data download, cost reports filed in 2004 were excluded from the analyses.
All cost reports go through a series of reviews and audits. For example, the fiscal
intermediaries have thirty days to accept or reject a cost report after it is submitted by a
provider, usually focusing on key cost report fields, signatures, and consistency with
previous years (Medicare Payment Advisory Commission 2004a). Once received from
the fiscal intermediaries, CMS audits approximately 15% of cost reports, although the
proportion of CMS audits varies across provider type. The status of a cost report can
take one of four values: as submitted; settled without audit; settled with audit; and
reopened.
Unique to the freestanding dialysis facilities, CMS is required to audit each
facilitys cost reports at least once every three years. However, there is no evidence that
such frequent and regular auditing takes place since only 15% of the freestanding dialysis
facility cost reports reported a settled with audit or reopened status during the study
period. Since two consecutive years of audited cost reports would be needed due to the
one year lags used in the analysis, the usable audited cost reports would be even smaller.
Therefore, although it would be desirable to use a sub-sample of audited cost reports to
17 http://www.cms.hhs. gov/data/download/hcris rnl/default.aso accessed on December 22, 2004.

18 See page 3 of KECCs Methodology for Developing a Basic Case-mix Adjustment for the Medicare
ESRD Prospective Payment System: http://www.sph.umich.edu/kecc/pps/Case Mix Methods Report
Final appdx 040105.pdf. accessed August 12, 2005.
26
address whether potential inaccuracies in non-audited cost reports bias the results, this
was not possible.
Dialysis facilities are legally obligated to complete cost reports annually.
Nevertheless, some facilities (i.e., 157) had missing cost reports over the study period. In
such cases, the missing values for the covariates were imputed by using the facilitys
mean value of the measure. However, because HCT values got increasingly higher per
facility over time, missing HCT values were computed by using the mean of the previous
and following year.
To determine the missing years dependent variable value - whether or not the
facility reported being a chain - the preceding and following years chain values were
examined. If both years surrounding the missing year had the same value (i.e., either
both Yes or both No), the missing year was assigned that value.
If the two
surrounding years were different, (i.e., if the preceding year reported No and the
following year reported Yes), the missing year was assigned No for chain affiliation
so that it would not be the event year.19 If more than two consecutive years of data were
missing for a facility, values were not imputed and subsequent facility-year observations
also were omitted from the sample (i.e., six facility-year observations among three unique
facilities).
The results were not sensitive to the missing year imputations and
methodology.
In addition to freestanding dialysis facilities, there are also hospital-based dialysis
facilities, which comprised approximately 18% of all dialysis facilities in 2003 (U.S.
Renal Data System 2005). Hospital-based facilities also are required to submit annual
19 Chain-affiliated units rarely become independent, so the scenario of the preceding year reporting Yes
and the following year reporting No was not an issue.
27
cost reports to CMS (Form CMS-2552-96) which also are available through HCRIS.
Although both freestanding and hospital-based facilities provide similar services, the
hospital-based cost reports have dissimilar reporting methodology and also face unique
incentives to shift cost and game reimbursement (Magnus and Smith 2000). However,
the largest impediment to using the hospital-based cost reports for this analysis was the
absence of any information on the chain status of the dialysis unit.
Even if this
information was requested from the units, the interpretation might still be ambiguous
since many of the hospital-based dialysis units are satellite facilities of a multi-hospital
system. That is, one of the dialysis units belonging to HCA (a large national hospital
chain) may be affiliated with a dialysis chain as well. Therefore, hospital-based dialysis
providers are excluded from the analysis.20
Medical Evidence Forms

Since 1995, Medicare has required facilities to complete Medical Evidence Forms
(MEF) (Form CMS-2728) for all incident dialysis patients, regardless of payer.
In
addition to listing the absence/presence of over twenty comorbid conditions, the form
also reports the patients medical insurance coverage, age, gender, race, height, and
weight.
20 Although hospital-based dialysis facilities are not included in the sample, they are included in the market
variable calculations since it is assumed that they compete with the freestanding dialysis facilities for
nephrologist referrals and patients. However, because chain status for hospital-based facilities is
unavailable until 2001, they are all treated as independents. By classifying chain-affdiated hospital-based
facilities as independent facilities, the HHI will suggest a more competitive market than it actually is. To
control for this potential bias, the percent of hospital-based treatments in the market also was included as
a control variable.
28
CMS physician supplier and institutional claims

The percents of patients at a facility achieving HCT levels of at least 33% and
URR of at least 65% were computed from the CMS physician supplier and institutional
claims. Both measures of adequate dialysis were initially included in the model, but
because one-year lagged URR measures were not available until 1999, the sample size
was considerably smaller (2,411 versus 3,351) when URR was included in the model.
Using only five years of data instead of seven negated the significance of some of the key
variables, including both URR and HCT.21 Therefore, URR was omitted from the
analyses to ensure adequate power, allowing two additional years (1997-1998) and 940
additional facility-years to be used with HCT instead.22 Because some patients started
dialysis before 1995 and therefore did not have a MEF, CMS claims also were used to
supplement the MEF patient comorbidity data.
AARPs State Profiles

Reforming the Health Care System: State Profiles published by the American
Association of Retired Persons (AARP) Public Policy Institute was used to determine
which states had CON laws (AARP 1998).
21 URR had a marginally significant effect when HCT was excluded from the model in the truncated
sample (p = 0.063), but neither quality standard had a significant effect when entered together HCT:
p=0.1476; URR: p=0.099).
22 Researchers have also used glomerular filtration rate (GFR) - an indicator of kidney function that
measures renal excretory function - in their analyses to measure quality at a facility. However, the only
measure o f GFR available is from when a patient begins dialysis and therefore does not capture any
facility treatment effects. Therefore, GFR was not included in the analysis.
29
Annual Facility Surveys

Finally, data collected by the ESRD Networks and reported on the Annual
Facility Survey (AFS) (Form CMS-2744) were used to determine Medicare certification
date for facility age, rural versus urban setting, and ownership type. The number of
dialysis treatments reported by hospital-based facilities on the AFS was used to construct
the market variables (i.e., HHI and market size).
For all variables, values from the preceding year were used in the analysis to
predict acquisition. For example, data from 1998 were used to create lagged values for
the 1999 observations.
Because one-year lagged values for HCT, one of the key
covariates, were not collected until 1996, results are reported for seven years (19972003).
Methods
A discrete time hazard model is used to model the conditional probability that
facility i is acquired by a chain at time t, given that it has not already been acquired
(Allison 1982; Allison 1995):
Equation 2-3:
log [P(</(l-P)] = a, + Pixi + ... + P*x,f* + e
Each facility-year is treated as a distinct, independent observation (Ibid.). A

facility continues in the sample until it becomes acquired by a chain or is lost to followup since it is no longer at risk of being acquired.
Equation 2-3 represents the
30
convergence of independent facilities that want to sell and chain organizations that want
to buy, or in other words, when both parties answer yes in Figure 2-1.
The effect of the covariates (Pipk) can be interpreted as the change in the log
odds of being acquired associated with a one-unit change in the kth covariate.
Correspondingly, exponentiated coefficients PiPk on the covariates Xi-Xk can be
interpreted as the ratio of odds of being acquired associated with a one-unit change in the
covariate, holding the other covariates fixed. For the multinomial model, the reference
category is independent facilities that were not acquired (i.e., dependent variable=0).
Results
Descriptive analysis
As Table 2-2 illustrates, most dialysis facilities are chains: of the 3,978 unique
freestanding dialysis facilities in operation between 1997 and 2003, 3,058 (77%) report
being chain-affiliated on their first cost report filed during the observation period.
Because they were never at risk of being acquired by a chain during the observation
period, they were not used in the analysis. Of the remaining 920 independent facilities,
411 (45%) were acquired by a chain sometime during 1997-2003; 166 by small chains
and the remaining 245 by large chains.
A small number (53) of chain-affiliated facilities become unaffiliated with a chain
during the study sample.
Some of these facilities stay independent while others
eventually are re-acquired. Future analyses may want to include these observations to
examine if independent facilities that were previously chain affiliated are similar to
always independent facilities.
However, because of the relative infrequency of this
31
phenomenon, facilities that report chain-to-independent are considered chains for all
periods subsequent to the first period in which they report a chain affiliation (i.e., they do
not re-enter the model once they become independent).
The 920 unique facilities correspond to 3,351 facility years (Table 2-3). Because
the unit of observation is facility-year, facilities can appear up to seven times (19972003) in the model. There was a small but steady decline in the percent of independent
facilities acquired each year, with a prominent drop in 2000.23 As Figure 2-2 shows, the
prevalence of chains in the entire ESRD industry follows an upward trend over time,
including 2000. Therefore, since chains continued to grow, one explanation for the dip in
2000 is that chains opted to merge with existing chains or build new facilities rather than
acquire existing independent ones. In addition, because there are a few large dialysis
chains that dominate the market, just one or two deciding not to include acquisition of
independent facilities in its growth strategy for 2000 also could cause the observed dip.
As Table 2-4 shows, chain acquisition was not uniform across all ESRD
Networks. For example, although both Network 2 (New York) and Network 14 (Texas)
had 91 independent facilities in the sample, only 25 (27%) of those in Network 2 were
acquired by a chain versus 55 (60%) chain acquisitions in Network 14. Even in similar
geographical regions, (e.g., Networks 1 and 2), there was still a sizable difference in the
percentage of facilities that were acquired by a chain (79% versus 27%, respectively).
Tables 2-5a and 2-5b list descriptive statistics at the facility-year level (i.e., the
unit of observation) overall and by acquisition, respectively. Overall, the facilities that
were acquired by a chain had similar values to facilities that remained independent. The
23 Meanwhile, new independent facilities represented 11%-20% o f facilities for each year in the sample (not
shown).
32
facility-year observations had an average of $169.80 CR cost/treatment. The sizable

standard deviation of CR cost/treatment ($75.86) is largely due to new facilities: over
half of the facilities reporting CR cost/treatment over $400 were in their first year of
operation.
As Table 2-5b shows, the average values between independent and chain-acquired
facility-year observations are mostly the same, with a few exceptions. Facilities acquired
by a chain had fewer patients achieving K/DOQI quality targets (% pts with HCT > 33%)
and higher CR cost/treatment the year prior to acquisition compared to facilities not
acquired by a chain. More independent facilities that were acquired by chains were forprofit compared to those not acquired. Independent facilities that became chain members
were also slightly younger than facilities that remained independent. Treatment patterns
and other facility characteristics were similar between the two groups.
Acquired facilities were in slightly more competitive markets than those that
remained independent (HHI of 2220 versus 2403, respectively).
Most patient
characteristics did not vary by acquisition type. However, acquired facilities had slightly
fewer patients with myocardial infarction (MI), a higher percentage of African American
patients, and more new dialysis patients compared to non-acquired facilities.
Multivariate analysis
Results from the discrete time hazard model using the binomial and multinomial
chain outcome are shown in Tables 2-6 and 2-7, respectively. Odds ratios are presented
in lieu of the parameter estimates for ease of interpretation. Additionally, all continuous
variables are standardized, so a one-unit change in a covariate corresponds to its
33
respective standard deviation w ith other covariates held at their mean.
For the tw o
categorical covariates (i.e., network and year), odds ratios are not of particular interest
since the comparison is only relative to the omitted category. Therefore, only results
from the likelihood ratio tests of joint significance for network and year are reported in
Tables 2-6 and 2-7.
As shown in Table 2-6, poor financial performance at an independent dialysis
facility was a significant predictor of chain acquisition:
holding other covariates
constant, a $75.86 (one s.d.) increase in CR cost/treatment was associated with a 24%
increase in the odds of being acquired (p<0.01).
Older facilities, who may have a
relatively out-of-date capital stock, were associated with a decreased odds of acquisition
(p<0.05).
Of the facility treatment patterns, only one of the measures - stations per patient,
an amenity from the patient perspective and an inefficiency from the facility prospective
- was a significant predictor of chain acquisition. Specifically, facilities with a higher
number of stations per patient were less likely to be acquired by a chain ceteris paribus,
(p<0.05). Although not significant, the effect of dialyzer reuse and of percent of skilled
labor are in the hypothesized direction (i.e., reusing dialyzers and a smaller percentage of
skilled labor both increase the odds of chain acquisition). Higher RN-to-patient ratios
and offering a variety of modalities (instead of HD only) had the opposite effect on
acquisition than hypothesized, but were not significant.
The HD only binary variable was replaced with a continuous variable, reflecting
the percent of HD treatments, to see if a different specification might change the results.
The odds ratios for the percent HD treatment was slightly larger compared to the binary
34
variable results (0.86 versus 0.81, respectively) and was nearly significant (p=0.07, not
shown). That is, a 23% (one s.d.) increase in the share of HD treatments at a facility
translated to a 14% reduction in the odds of acquisition, holding other variables constant.
Therefore, even though HD is the most common modality, offering other treatments at
the facility may be an important predictor of chain acquisition and should be explored
further in future studies.
Independent facilities with better clinical outcomes were significantly more likely
to be acquired by a chain than facilities with poor outcomes. Specifically, a 26% (one
s.d.) increase in patients with HCT >33% increased odds of chain acquisition by 30%
(p<0.01), ceteris paribus.
Facilities in larger markets were significantly more likely to be acquired than
those in small markets (p<0.01), but the level of competition in a facilitys market, as
measured by HHI, was not a significant predictor of chain acquisition. The results were
similar when market was defined within 5, 15, or 25 miles of the facilitys zip code (not
shown). However, the HHI of a 100 mile radius market was significant (p=0.049) but in
the opposite direction as hypothesized: facilities in less competitive markets (i.e., higher
HHI) were less likely to be acquired (OR=0.81, results not shown).
Rather than a set distance, the 5, 10, and 15 closest dialysis facilities were also
considered for the market definition. Instead of the HHI, the maximum distance to the
nearest facilities was used, which is inversely proportional to population density (e.g.,
maximum distance is near zero for New York City zip codes, but over 1,000 miles for a
facility in rural Wyoming). Market size was no longer significant, but greater distances
decreased the odds of chain acquisition for all three market measures (results not shown).
35
Payer type (% Mcare treatments) was not a significant predictor of chain

acquisition, but was in the hypothesized direction (i.e., facilities with fewer Medicare
patients are more likely to be acquired). The categorical variables year and network were
highly significant as a group, and a higher percentage of HIV+ and PVD patients was
also a significant predictor of chain acquisition. Finally, larger facilities were also more
likely to be acquired by a chain, although the relationship was not quite significant at the
p=0.05 level (p=0.06). Alternative specifications of facility size were examined, but the
non-significant results were robust to replacing the continuous measure with tertiles and
decile categories (not shown).
Holding other covariates constant, fewer stations per patient and higher RN-topatient ratios made acquisition by a small chain more likely (Table 2-7). Larger facilities
and larger markets also increased the likelihood of small chain acquisition, as did a rural
setting and fewer Medicare patients. The presence of CON regulations significantly
increased the odds of acquisition by a small chain (p<0.01) but was insignificant and
associated with a decreased odds of large chain acquisition. This suggests that CON
laws and other barriers to entry are more of an impediment to growth via new facilities
for small chains than their larger competitors. The higher caseload of HIV+ patients
associated with an increased odds of acquisition by a small chain mirrors the binary chain
outcome results.
The percent of patients with HCT>33% was not a significant predictor for small
chain acquisition despite being highly significant in the binomial model. However, the
odds ratios in the two models are similar, and the percent of patients with HCT>33%
remains a significant determinant for large chain acquisition. The only other significant
36
key variable associated with acquisition by a large chain is whether the facility offers
multiple modalities (opposed to offering only HD). As found in the model with a binary
chain specification, facilities that only offer HD are significantly less likely to be
acquired by a large chain, ceteris paribus (p<0.05). The odds of being acquired by a
large chain based on market size are similar in magnitude to the binomial model (1.37
versus 1.44, respectively). However, it is not quite significant in the multinomial model
(p=0.06), due in part to the smaller number of events and corresponding larger standard
errors in each of the two acquisition categories.
Discussion
Unlike findings in other healthcare sectors that examine the effect of quality
indicators on the likelihood of acquisition, dialysis chains were more likely to acquire
facilities that had better quality outcomes. Taken alone, this result would raise concerns
among policy-makers and payers that chains are cream skimming the high performing
facilities in order to gain access to the market or reduce competition rather than to
improve quality or reduce costs.
However, this conclusion is not supported by the
finding that dialysis facilities with higher CR cost/treatment were more likely to be
acquired than lower cost facilities, ceteris paribus.
Taken together, the results suggest a mixed logic motivating dialysis chain
acquisitions that differs slightly from the turn around hypothesis supported in the
nursing home (Banaszak-Holl et al. 2002) and hospital (McCue and Furst 1986; Menke
1997; Phillips 1999; Sloan et al. 2003) literatures. One reason for this discrepancy may
be attributed to different industry characteristics. Most of the studies that support a turn
37
around strategy for hospitals use data from the 1980-2000, a period when the industry
was declining.
Meanwhile, the dialysis industry has been steadily growing to
accommodate the increasing ESRD patient base. Additionally, there are no substitutes
for dialysis centers as there are for both hospitals and nursing homes (e.g., outpatient
surgical centers, assisted living facilities, home health agencies).
Although it is assumed that all chains and independent dialysis facility owners are
profit maximizers, different buyers and sellers may focus on different components of the
economic gain resulting from chain acquisition, also contributing to the mixed findings.
For instance, some sellers may be nearing retirement and looking to cut back on their
workload while others may be new to the industry and interested in gaining the
managerial help and efficiency offered by chains. As one author observes, the decision
to sell ones business is very personal... p. 65 (Riley and McGraw-Walsh 2006) and,
unfortunately, information on the sellers age, experience, and other potentially important
factors are not available.
From the buyers perspective, larger chains may be more concerned with
increasing the number of their units with higher quality indicators whereas smaller chains
may be more focused on facility location (i.e., facilities near their existing locations).
The multinomial chain outcome attempted to address these potential differences. The
smaller sample for each of the chain size categories (166 and 245 facilities were acquired
by small and large chains, respectively, versus 411 total acquisitions on the binomial
model) may have contributed to the loss of significance for several of the variables of
interest (e.g., CR cost/treatment, percent of patients with HCT>33%), but the odds ratios
were similar. However, given that there are more significant predictors of acquisition by
38
a small chain than a large chain, the results also suggest that the small chains may target
specific facilities whereas the large chains may simply be more interested in firm growth.
Future analyses that include additional growth strategies (e.g., chain-to-new-chain
conversions) and examine geographical differences in large versus small chain growth
may be able to better capture differences. Additionally, larger samples would also allow
further delineation of the chain definition (i.e., more than two size categories).
Like HCT, URR is another measure of adequate dialysis and is frequently used as
a quality indicator in the ESRD literature. However, because it is clinically different
from HCT (i.e., EPO is not used to reduce urea), URR may have a different effect on
chain acquisition behavior. As additional years of URR data become available, this
alternative quality measure should be included in future research to better understand
how different quality outcomes affect the likelihood of dialysis chain acquisition.
The results did not support the hypothesis that facilities in less competitive
markets were more likely to be acquired by a chain. Rather than trying to take over an
already highly concentrated (i.e., low competition) market, chains may be looking to
decrease the competition in a market.
Therefore, acquiring a facility in a less
concentrated market (i.e., lower HHI) allows the chain to make inroads into the market
and, through additional acquisitions of or building new facilities in the market, eventually
gain market power. This supports similar findings in the hospital and nursing home
literature regarding markets and chain acquisitions and mergers (Banaszak-Holl et al.
2002; Sloan et al. 2003).
Rather than using the markets HHI, future analyses that use the potential change
in HHI attributable to a chain acquisition may better address how competition affects
39
chain acquisition. However, the 91 unique chains in existence during the study period
translates to a formidable number of calculations (i.e., 91 potential changes in HHI for
each of the 3,351 observations). Alternatively, examining the change in HHI if the
facility was acquired by the chain that currently holds the largest share in the market may
provide useful insight without the sizable number of calculations.
Surprisingly, the percent of Medicare treatments did not have a significant effect
in the binomial model, although a smaller percent of Medicare treatments was a
significant predictor of acquisition by a small chain. This suggests that chains may not
have any more bargaining power with private insurers than independent providers.
Alternatively, non-Medicare treatments might be mis-specified. For example, there is
anecdotal evidence that some providers avoid areas with a large managed care presence,
such as California and Florida, since it decreases payment rates relative to other
commercial carriers (Sullivan 2002).
Only measuring Medicare treatments will not
detect differences in types of private health insurance, and unfortunately, there are no
data on the nature of private health insurance coverage among dialysis patients.
However, future research may be able to use the prominence of managed care in the
dialysis facilitys market as an approximation of how many of its patients under age 65
are likely to have managed care coverage.
This study offers several important implications for health services researchers as
well as policy-makers. The different significant predictors of acquisition between small
and large chains reported in Table 2-7 reinforce the importance of chain status
specification beyond a simple binary variable.
Future research on chains in any
healthcare sector with a strong chain presence (i.e., dialysis facilities, nursing homes,
40
hospitals, etc.) should take into account the factors that differentiate chains from one
another.
Chain size was used in this study, but other possible differences include
geographical location and ownership control as well as different market specifications for
rural versus urban settings (Hirth et al. 2003).
This research limited analysis to the antecedents of chain acquisition since it was
previously unexplored within the dialysis industry and largely neglected in other
healthcare sectors. However, the consequences of chain acquisition on dialysis facility
performance remain unanswered.
To remedy this, the next Chapter examines how
facility treatment patterns and clinical and financial outcomes change post-chain
acquisition.
41
Figure 2-1. Schematic of the acquisition process.
Independent
dialysis facility
wants to sell?
No
Yes
Dialysis chain
wants to buy?
Yes
No
42
Table 2-la. Variable definitions.
Dependent Variables
Was independent facility
acquired by a chain?
acquired by a large chain, a small
chain, or not acquired?
Independent Variables
Facility financial characteristics
CR cost/treatment (2003 $)
Facility age
Facility practice patterns
Offer HD only
Definition
O=not acquired
l=acquired (regardless of size)
0=not acquired
l=acquired by "small" chain
2=acquired by "large" chain (1 of 5 largest chains)
Definition
facility's prior year composite rate cost/treatment,
age of facility, determined by year certified by
Medicare
binary variable=l if facility only offers hemodialysis
% skilled labor
% skilled labor measured by (MD+RN)/(all staff)
RN-to-patient ratio
Stations per patient
Reuse dialyzers
FTE RN relative to # patients at the facility

Number of dialysis stations per patient
Binary variable=l if facility reports reusing dialyzer
Facility clinical performance characteristics

% pts with HCT >33%
% of patients with hematocrit (HCT) of > 33
Market
HHI
market size
HB facilities in market
Payer mix
Mcare treatments
Market competition via Herfindahl-Hirschman Index

(HHI), measured by number of dialysis sessions within
50 miles of facility zip code
Size of market, measured by total number of dialysis
tx in market
% hospital-based facilities in market
% of dialysis treatments at facility paid for by
Medicare
43
Table 2-1 a. Variable definitions, continued.
IndeDendent Variables
Facility size
For profit
Rural
Year
Network
Certificate of Need (CON)
HIV+
PVD
pericarditis
drug dependence
MI
Age
African-American pts
Female pts
lowBMI
BSA
pts in 1st year of dialysis
Definition
facility size measured by annualized number of
treatments
binary variable=l if for-profit ownership
binary variable =1 if facility is in rural location
year dummy variable (1997-2003)
dummy variable for 1 of 18 different ESRD networks
dummy variable for whether facility's state has CON
law
% of patients at facility with HTV+ diagnosis
% of patients at facility with peripheral vascular
disease (PVD)
% of patients at facility with pericarditis
% of patients at facility with drug dependency
% of patients at facility with myocardial infarction
(MI)
% of patients in 5 age groups (age groupings based on
KECC-BCMA)
% black patients at facility
% female patients at facility
% pts underweight (BMI <18.5 kg/m2)
average BSA of patients at facility
% patients at facility who began dialysis in the
current year
44
Table 2-lb. Data sources.
Dependent Variables
acquired by a large chain, a small
chain, or not acquired?
Facility age
Offer HD only
% skilled labor
RN-to-patient ratio
Reuse dialyzers
Data Source
Freestanding Dialysis Facilities Cost Reports (Form
CMS-265-94)
Form CMS-265-94
Data Source
Form CMS-265-94
Form CMS-265-94 and Annual Facility Survey
(AFS) (Form CMS-2744)
Form CMS-265-94
Form CMS-265-94
Form CMS-265-94
Form CMS-265-94
Form CMS-265-94

CMS physician supplier and institutional claims
% pts with HCT > 33%
Market
HHI
market size
HB facilities in market
Forms CMS-265-94 and CMS-2744

Forms CMS-265-94 and CMS-2744
Form CMS-2744
Payer mix
Mcare treatments
Form CMS-265-94
45
Table 2 -lb . Data sources, continued.
Data Source
Facility size
For profit
Rural
Year
Network
Form CMS-265-94
Form CMS-2744
Form CMS-2744
Form CMS-265-94
Form CMS-2744
AARP: Reforming the Health Care System
HIV+
PVD
pericarditis
drug dependence
MI
Age
African-American pts
Female pts
lowBMI
BSA
pts in 1st year of dialysis
CMS claims and Form CMS-2728

Form CMS-2728
Form CMS-2728
Form CMS-2728
Form CMS-2728
Form CMS-2728
Form CMS-2728
46
Table 2-2. Chain affiliation at facility level.
N
Percent
always independent facility
509
13%
independent facility acquired by chain
411
10%
always chain-affiliated facility_________3,058_____ 77%
3,978
100%
47
Table 2-3. Frequency of dialysis facility acquisition, by year.
1997 1998 1999

Independent facilities
not acquired by chain
Independent facilities
acquired by chain
Percent of independent
facilities acquired
Total
2 0 0 0
2 0 0 1
2 0 0 2
2003 Total
383
387
392
444
457
459
418 2,940
92
78
71
19
51
46
54
19% 17% 15% 4%

475 465 463 463
% 9%
508 505
1 0
411
% 12%
472 3,351
1 1
48
Figure 2-2. Prevalence of dialysis chains, 1997-2003.
3,500 -|
Chains
Dialysis facilities
K3Independents
1997
1998
1999
2000
2001
2002
Year
49
2003
Table 2-4. Network affiliation at facility level, 1997-2003.
Network
(1 CT)-New England
(2 NY) New York
(3 NJ) Trans-Atlantic
(4 PA) Pennsylvania
(5 VA) Mid Atlantic
( 6 NC) Southeast
(7 FL) Florida
( 8 MS) Mississippi
(9 IN) Tri-State
(10IL) Illinois
(11 MN) Upper Midwest
(12 MO)
(13 OK)
(14 TX) Texas
(15 CO) Inter-Mountain
(16 WA) Northwest
(17 N-CA) Trans-Pacific
(18 S-CA) Southern California
Total
All
Always
independent independent
facilities
facilities
4
19
91
6 6
14
2
14
37
53
34
93
43
54
35
46
2 2
78
36
23
2 0
40
59
34
15
63
35
91
36
24
19
34
27
2 1
8 6
920
Independent
facility
acquired by
chain
15
25
1 2
23
19
50
19
24
42
3
19
19
28
55
5
7
11
1 0
50
509
36
411
50
Percent of
facilities
acquired by
chain
79%
27%
8 6 %
62%
36%
54%
35%
52%
54%
13%
32%
56%
44%
60%
2 1 %
2 1 %
48%
42%
Table 2-5a. Descriptive statistics of covariates, overall (facility-year level).
Covariate (one-year lagged value)

Facility characteristics:
Facility age
% Mcare treatments
Facility size (treatments in 1,000s)*
% skilled labor
RN-to-patient ratio
% Facilities:
Offer HD only
Reuse dialyzers
For Profit
Rural
Market measures (Market=50 miles):
HHI
market size (treatments in 1,000s)
% hospital-based (HB) facil in market
Patient characteristics:
% patients (pts) with diagnosis of:
HIV+
peripheral vascular disease (PVD)
pericarditis
drug dependence
myocardial infarction (MI)
% patient aged:
< 18 yrs old
18-44 years
45-59 years
60-69 years
70-79 years
80+ years
% African-American pts
% female pts
% pts underweight (BMI <18.5kg/m2)
mean BSA
% pts in 1st year of dialysis
Mean
61%
169.80
6.14
74%
10.16
32%
0.1
0.3
Overall
N = 3,351
S.D. Minimum Maximum
26%
75.86
6.26
16%
8.55
14%
0.22
0.22
0%
56.10
0
0%
0.05
0%
0
0
100%
737.93
26
100%
70.59
98%
2.5
1.5
2380
596
15%
1836
793
18%
136
0
0%
10000
3000
100%
1%
40%
2%
2%
15%
5%
13%
3%
3%
9%
0%
0%
0%
0%
0%
72%
100%
25%
74%
100%
0%
16%
26%
24%
24%
10%
29%
48%
1%
9%
9%
8%
10%
7%
27%
10%
0%
0%
0%
0%
0%
0%
0%
0%
25%
100%
100%
100%
100%
100%
100%
100%
6%
1.82
32%
5%
0.06
18%
0%
1.46
0%
100%
2.31
100%
53%
75%
89%
23%
69%
Assuming three treatments per week per patient, average facility size corresponds to
approximately 67 patient-years per facility-year observation.
Table 2-5b. Descriptive statistics of covariates, by acquisition (facility-year level).
Covariate (one-year lagged value)

Facility age
% Mcare treatments
Facility size (treatments in 1,000s)
% skilled labor
RN-to-patient ratio
% Facilities:
Offer HD only
Reuse dialyzers
For Profit
Rural
Market measures (Market=50 miles):
HHI
% hospital-based (HB) facil in market
Independent
facility
N = 2,940
Mean
S.D.
62%
168.72
6.27
74%
10.13
32%
0.1
0.3
26%
72.57
6.31
16%
8.53
15%
0.22
0.22
53%
74%
89%
23%
69%
Independent facility
acquired by chain
N = 411
Mean
S.D.
59%
177.49
5.18
75%
10.35
31%
0.1
0.29
25%
95.81
5.81
16%
8.7
14%
0.24
0.19
49%
76%
93%
22%
66%
2403
599
15%
1843
802
18%
2220
573
15%
1779
731
17%
% patients (pts) with diagnosis of:
HTV+
peripheral vascular disease (PVD)
pericarditis
drag dependence
myocardial infarction (MI)
% patient aged:
< 18 yrs old
18-44 years
45-59 years
60-69 years
70-79 years
80+ years
% African-American pts
% female pts
1%
40%
2%
2%
15%
4%
13%
3%
3%
9%
2%
41%
2%
2%
13%
7%
13%
2%
2%
7%
0%
16%
26%
24%
24%
10%
29%
47%
1%
9%
9%
8%
10%
7%
27%
10%
0%
17%
25%
25%
24%
9%
33%
48%
1%
10%
10%
8%
10%
6%
28%
11%
% pts underweight (BMI <18.5kg/m2)

mean BSA
5.7%
1.82
32%
5%
0.06
18%
6.3%
1.82
34%
7%
0.06
19%
T a b le 2 -6 . O d d s r a tio s a n d 9 5 % c o n f id e n c e in te r v a ls (C l) w ith b in a ry c h a in o u tc o m e .
Variable
Intercept
CR cost/treatment
Facility age
% Mcare treatments
Facility size
% skilled labor
RN-to-patient ratio
Odds
Ratio
0.08
95% Cl
Lower
Upper
0.21
0.03
1.30
1.24
0.85
0.92
1.16
0.97
1.05
0.83
1.10
1.05
0.73
0.80
0.99
0.84
0.93
0.69
1.54
1.48
0.98
1.07
1.36
1.12
1.19
0.98
0.81
1.11
1.38
1.17
1.11
0.62
0.82
0.88
0.83
0.57
1.06
1.51
2.16
1.66
2.19
0.89
1.44
1.03
0.73
1.10
0.84
1.08
1.89
1.25
1.11
1.22
1.02
0.92
0.89
1.00
1.05
0.91
0.79
0.76
1.22
1.43
1.15
1.06
1.04
0.93
0.83
0.80
0.79
0.69
0.66
1.10
1.01
0.97
0.89
0.96
1.13
1.04
1.05
0.73
0.81
0.96
0.89
0.91
1.08
1.14
1.33
1.21
1.21
BSA
1.08
1.04
0.90
0.88
1.29
1.21
Offer HD only (ref=N)

Reuse dialyzers (ref=N)
For Profit (ref=N)
Rural (ref=N)
CON (ref=N)
Market measures:
HHI
% HB facilities in market
Patients with diagnosis of:
HIV+
PVD
pericarditis
drug dependence
MI
Patients aged:
< 18 yrs old
18-44 years
45-59 years
60-69 years (ref)
70-79 years
80+ years
% African-American patients
% female
Likelihood ratio test of categorical variables

Year
Network
* Significant at 0.05 level
** Significant at 0.01 level
*** Significant at 0.001 level
***
**
**
*
**
*
*
***
***
Table 2-7. Odds ratios and 95% confidence intervals (Cl) with multinomial chain outcome.
Variable
CR cost/treatment
Facility age
% Mcare treatments
Facility size
% skilled labor
RN-to-patient ratio
For Profit (ref=N)
Rural (ref=N)
CON (ref=N)
Market measures:
HHI
HIV+
PVD
pericarditis
drug dependence
MI
Patients aged:
< 18 yrs old
18-44 years
45-59 years
60-69 years (ref)
70-79 years
80+ years
% female
BSA
Acquisition by
small chain*
Odds
95% Cl
Ratio Lower Upper
Acquisition by
large chain*
Odds
95% Cl
Ratio Lower Upper
1.24
1.26
0.86
0.95
0.97
0.68
1.61
1.63
1.08
1.30
1.21
0.84
0.79
0.65
0.97 *
1.36
0.97
1.17
0.69
1.08
0.78
1.00
0.52
1.72 **
1.20
1.38 *
0.92 **
0.98
0.81
1.18
0.97
0.90
0.80
0.73
1.17
1.12
1.05
1.48
1.60
1.91
3.89
0.70
0.89
0.79
1.16
1.20
1.59
2.46
3.25
12.59 *
0.69
1.01
1.30
0.78
0.44
0.49
0.69
0.74
0.49
0.18
0.96 *
1.46
2.28
1.25
1.04
0.83
1.63
0.94
0.61
1.03
0.71
1.13
2.58 *
1.26
0.95
1.37
1.10
0.74
0.98
0.85
1.22
1.91
1.42
1.17
1.19
1.14
0.83
0.93
1.04
0.94
0.97
0.64
0.74
1.33 **
1.51
1.34
1.08
1.15
1.05
1.22
0.94
0.96
0.87
0.91
1.00
0.81
0.81
0.70
1.22
1.48 *
1.10
1.14
1.07
0.96
0.82
0.84
0.76
0.61
0.64
1.22
1.10
1.11
0.92
0.83
0.77
0.74
0.65
0.60
1.14
1.05
0.99 *
0.95
1.01
1.06
1.16
0.72
0.79
0.82
0.93
1.27
1.30
1.37
1.46
0.85
0.92
1.19
0.94
0.66
0.74
0.97
0.78
1.09
1.14
1.46
1.15
0.95
1.13
1.10
0.75
0.86
0.87
1.21
1.49
1.39
1.12
1.04
1.02
0.94
0.83
0.83
1.33
1.29
1.24

Year
Network
3 j3 **
1.06
0.98
0.70
1.61 **
1.51
1.01
1.05
0.86
1.29
1.07
0.87
1.31
***
***
* Reference category for dependent variable is "not acquired".

166 and 245 facilities were acquired by small and large chains, respectively.
54
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Held, P.J. and Pauly, M.V. 1983. Competition and Efficiency in the End Stage Renal
Disease Program. Journal o f Health Economics 2(2):95-l 18.
Hirth, R.A., Banaszak-Holl, J., Fries, B.E., and Turenne, M.N. 2003. Does Quality
Influence Consumer Choice of Nursing Homes? Evidence from Nursing Home to
Nursing Home Transfers. Inquiry 40(4):343-361.
Hirth, R.A., Chemew, M.E., and Orzol, S.M. 2000. Ownership, Competition, and the
Adoption of New Technologies and Cost-Saving Practices in a Fixed-Price Environment.
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Hirth, R.A., Held, P.J., Orzol, S.M., and Dor, A. 1999. Practice Patterns, Case Mix,
Medicare Payment Policy, and Dialysis Facility Costs.(Changing Treatment Patterns).
Health Services Research 33(6): 1567-1592.
Hirth, R.A., Roys, E.C., Wheeler, J.R., Messana, J.M., Turenne, M.N., Saran, R.,
Pozniak, A.S., and Wolfe, R.A. 2005. Economic Impact of Case-Mix Adjusting the
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Hirth, R.A., Wolfe, R.A., Wheeler, J.R., Roys, E.C., Tedeschi, P.J., Pozniak, A.S., and
Wright, G.T. 2003. Is Case-Mix Adjustment Necessary for an Expanded Dialysis
Bundle? Health Care Financing Review 24(4):77-88.
Magnus, S.A. and Smith, D.G. 2000. Better Medicare Cost Report Data are Needed to
Help Hospitals Benchmark Costs and Performance. Health Care Management Review
25(4):65.
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Investor-Owned Chains. Health Services Research 21(4):515-527.
56
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Hospitals. Healthcare Financial Management 53(9):52-55.
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57
Shen, Y.C. 2003. Changes in Hospital Performance After Ownership Conversions.

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Conversions, Mergers, and Closures. Inquiry 40(l):39-56.
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58
Chapter III
Chapter III. Effect of Chain Acquisition on Facility Outcomes and Treatment

Patterns
Abstract
There is extensive research within the healthcare literature on how financial
factors change after a healthcare organization changes ownership. However, little is
known about how organizational changes affect other factors, such as treatment patterns
and quality. Furthermore, none of these outcomes has been examined among dialysis
providers, despite substantial growth in chain affiliation among facilities. This paper
examines how dialysis facilities costs, quality, and treatment patterns change after being
acquired by a chain one to five years after acquisition. After using propensity scores to
control for pre-existing characteristics that may also affect performance, results suggest
that chain acquisition has no significant impact on dialysis facilities composite rate costs
per treatment.
However, chain-acquired facilities consistently have more patients
achieving quality targets than non-acquired facilities for the first five years post
acquisition. These results differ from findings in other healthcare industries that do not
find a positive relationship between organizational change and quality outcomes. Chain
acquired facilities also had less skilled labor than independent facilities post-acquisition,
but there were no differences in staffing ratios or non-labor treatment practices.
59
Introduction
As highlighted in Chapter I, the prevalence of chain-affiliated dialysis facilities
has increased substantially over the last twenty years, from just 14% of dialysis providers
in 1988 to 61% in 2003 (U.S. Renal Data System 2005). Despite this drastic growth in
chain-affiliated dialysis units, little is understood about the impact of chain acquisition on
outcomes.
Furthermore, no empirical research has examined whether the purported
benefits associated with chain membership are realized by the acquired dialysis facilities.
This study examines how dialysis costs, quality, and treatment patterns change after a
chain acquires an independent dialysis unit. One through five years of follow-up are
examined to determine if any effects are transitory versus permanent.
Because this is a direct extension from the previous Chapters analyses, the
motivation behind and expected benefits from chain acquisition are identical to the
Rationale for Acquisition in the ESRD Industry section presented in Chapter n.
Therefore, this Chapter proceeds directly to a review of the findings from other
healthcare sectors regarding how organizational change affects a variety of outcomes.
The hypotheses tested in the analyses are then presented, followed by the methods
employed and data used. After the results are presented, the Chapter concludes with a
discussion of the findings.
Literature Review
There has been a proliferation of organizational changes throughout the healthcare
industry over the past twenty years, including ownership conversions, chain growth, and
horizontal and vertical partnerships. Accordingly, there is a growing body of research
60
that examines how various organizational changes affect outcomes. Most of this research
focuses on changes in ownership (i.e., profit status) rather than changes in chain status,
which is the focus of this analysis. Even though these two organizational changes are not
identical (i.e., a change in chain status does not necessarily mean a change in profit status
or vice versa), there is a high correlation between chain affiliation and ownership status
(i.e., for- versus non-profit) . 1
Therefore, a summary of the extensive literature on
ownership conversion is presented below to supplement the relatively sparse body of

literature on how outcomes change after chain acquisition.
Changes in ownership
Comparisons of various outcomes between different types of ownership has
received considerable attention within the hospital industry (Sloan 2000; Sloan 2002).
As Sloans extensive summaries highlight, though, the literature yields inconsistent
results regarding financial differences between non-profit and for-profit hospitals. Not
surprisingly, research that examines how these financial characteristics change after an
ownership conversion also has mixed findings. For example, Mark (1999) reported
greater profit margins for converted hospitals compared to hospitals that did not convert,
regardless of the ownership change (i.e., non-profit hospitals that converted to for-profit
status, and for-profit hospitals that converted to non-profit status both had better profit
margins than before ownership conversion). Similarly, Sloan et al. (2003) also found that
regardless of the direction of ownership conversion, hospitals had higher rates of return
after a change in ownership (although not all differences between pre-and post
conversion were statistically significant). Meanwhile, Shen (2003) found no significant
1 In 2001, over three-fourths o f all dialysis chains were for-profit (U.S. Renal Data System 2005).
61
changes in hospitals profit margins after converting to non-profit status, but slight
increases in profit margins for hospitals that converted to for-profit or government
hospitals.
Like the financial outcomes studies, the effect of hospital ownership conversion
on quality (as measured by various patient outcomes) is also varied. Shen (2002) was
among the first researchers to examine patient outcomes after hospital conversions. She
found that for-profit conversion led to worse acute myocardial infarction (AMI) mortality
and complication rates compared to the hospitals pre-conversion state, but that this
relationship did not hold for non-profit hospitals that converted to government ownership.
Sloan (2002) also reported higher complication rates among pneumonia patients in
hospitals that converted to for-profit ownership, but found no effect on inpatient
mortality. Using the same samples as Sloan (2002), Picone et al. (2002) did detect an
increase in patient mortality but it did not occur until one to two years after the hospitals
conversion to for-profit ownership.
More recently, Farsi (2004) found that hospital
conversions to for-profit ownership had adverse effects on in-hospital mortality of AMI

patients, while conversions from for-profit to non-profit ownership had adverse effects of
congestive heart failure (CHF) survival rates.
In addition to financial factors and patient outcomes, researchers also have
examined ownership conversions effects on other outcomes. For example, hospitals that
convert to for-profit status are associated with reduced inpatient and outpatient visits
(Shen 2003) and decreased staffing ratios (Mark 1999; Shen 2003), but greater
involvement by doctors and nurses in decision making (Anderson et al. 2003). These
findings did not hold for conversion to non-profit status, though: Mark (1999) found that
62
these hospitals do not reduce staffing ratios and Shen (2003) reports only significant
reductions in outpatient visits.
Given the different financial motives between non-profit and for-profit hospitals,
researchers have also examined how ownership conversion affects uncompensated care.
Thorpe et al. (2000) found a reduction in uncompensated care among hospitals that
converted to for-profit ownership. Shens 2003 examination of unprofitable care yielded
more mixed results.
Although hospitals that converted to for-profit status were
significantly less likely to keep a trauma center, they also had more Medicaid inpatient
discharges and an increased share of emergency department outpatient visits than pre
conversion.
The effect of providers organizational characteristics on various financial and
patient outcomes has been examined in the ESRD-related literature, but many researchers
focused solely on ownership status and ignore chain affiliation. For instance, Farley
(1996) found that for-profit ESRD facilities responded to competition differently than
non-profit ESRD facilities, but chain affiliation was not included in the analysis. De
Lissovoy et al. (1994) also failed to control for chain status in their study which found
differences in Epogen dosing between for-profit and non-profit ESRD providers.
Similarly, Frankenfield et al. (2000) omit chain status in their analysis of ESRD facility
size and profit status effect on patient outcomes (i.e., adequacy of dialysis and anemia
management) and conclude that neither facility size nor ownership status is an important
predictor. Meanwhile, Brier and Aronoff (2002) base their findings that profit status
matters for anemia management but not for dialysis adequacy on models omitting
provider chain affiliation. Irvin (2000) and Garg et al. (1999) both conclude that patients
63
at for-profit facilities have a significantly higher relative risk of dying than patients at
non-profit facilities without controlling for chain status, and Devereaux et al. (2002)
come to similar results via meta-analysis of current publications.
Changes in chain affiliation

Although ownership conversion is arguably the most common organizational
change examined in the healthcare industry, change in chain affiliation also has been
studied. Dranove and Lindrooth (2003) examined cost savings after hospital mergers
(i.e., hospitals have common ownership and do business under a single license and may
consolidate facilities) and system affiliations (i.e., hospitals have common ownership but
maintain separate physical facilities). The authors found no cost savings after hospitals
consolidated into systems but reported cost savings for merged hospitals two to four
years after the change in affiliation. Unlike Dranove and Lindrooth, Holmes (1996)
reported higher plant costs among Michigan nursing homes that changed chain
affiliation, but no significant increase in per diem patient costs.
Non-financial outcomes also have been examined after a change in chain
affiliation. Ho and Hamilton (2000) found no significant difference in inpatient mortality
rates of heart attack and stroke patients at hospitals that became acquired by a hospital
system. However, the authors did find that rates of readmission within 90 days of a heart
attack rose after hospitals merged or became acquired by a system and that some hospital
acquisitions led to early discharges of normal newborns, especially for merging hospitals
in highly concentrated markets. Together, these findings suggest that chain acquisitions
have a detrimental effect on at least some measures of hospital quality.
64
Epstein (2003) reported improved mortality, complication, and home discharge

rates after within-market hospital mergers. However, her out-of-market merger findings
were consistent with Ho and Hamiltons conclusion that mergers negatively impacted
patients via increased complications and likelihood of discharge. Banaszak-Holl et al.
(2 0 0 2 ) examined how chain acquisition affected nursing home outcomes using the
incidence of pressure ulcers and number of state-issued health deficiencies. The authors
found that chain acquisitions caused short-term declines in performance, but that there
was little long-term effect on nursing home quality attributable to the chain acquisition.
Instead of clinical or quality outcomes, Currie et al. (2005) looked at changes in
hospital nurses output, wages, hours, and effort after chain acquisition. The authors did
not find consistent evidence of chain acquisitions effect on the first three factors but
report that nursing staffs effort (as measured by nurse hours normalized by patient days)
significantly increased after the hospital was acquired by a chain. This supports the
decreased staffing ratios observed after a for-profit hospital conversion reported by Mark
(1999) and Shen (2003), too.
New Contribution to the Literature

Most of the previous studies have focused solely on how financial outcomes
change after ownership conversion or, more recently, chain acquisition.
Although
researchers have begun to look at other factors, studies that examine non-financial
outcomes post-organizational change are far less common, as are studies that examine
changes in chain affiliation (versus ownership conversion).
Therefore, this research
contributes to the healthcare literature by examining non-financial outcomes (i.e.,
65
treatment patterns and quality outcomes) in addition to financial outcomes (recognizing

that outcomes do not change in isolation) post-chain acquisition.
Although previous researchers have studied how outcomes change post-chain
acquisition in other healthcare sectors, there have been no studies that look specifically at
the dialysis industry.
Given the rapid growth in chain-affiliation in the industry
previously mentioned, there is a need to understand better if the hypothesized and

theoretical benefits of chain affiliation are realized empirically. Therefore, this research
will contribute to the dialysis literature by providing insight into how dialysis chain
acquisition affects outcomes. Including outcomes similar to those found in other studies
(e.g., quality outcomes and labor practices) also will facilitate comparisons between these
findings within the dialysis industry and other healthcare sectors.
Hypotheses
Three categories of dialysis-related outcomes are considered: facility financial
performance; clinical/quality; and treatment patterns.
Hypothesis 1 (HI) - Facility financial performance: Chain-acquired dialysis facilities

will have better financial performance post-acquisition than independent dialysis
facilities, ceteris paribus.
If financial difficulty is a precursor to organizational change - as suggested by the
previous Chapters findings as well as other studies (e.g., Danzon et al., 2004; McCue
and Furst 1986; Menke 1997; Phillips 1999; Sloan et al. 2003; Tennyson and Fottler
2000) - it is expected that financial outcomes will improve after the change.
66
The
financial improvement will be realized through the chains economies of scale and scope
(e.g., increased market power and presence, lower cost and better use of capital, reduced
transportation and transaction costs, etc.). This turn around theory, discussed more
thoroughly in the previous Chapter, is supported empirically (with the exception of
Holmes 1996 study) in other healthcare sectors for ownership conversion (e.g., Mark
1999; Sloan 2003; Shen 2003) and chain acquisition (e.g., Dranove and Lindrooth 2003).
Although comparable findings do not exist for the ESRD industry, similar results are
expected.
Average composite rate (CR) cost per treatment ([CR cost/tx], adjusted to 2003
dollars) is used for the financial outcome. Ideally, financial variables that also capture
facility profitability would be included to understand better how other aspects of financial
health change post chain-acquisition.
Unfortunately, as a recent Medicare Payment
Advisory Committee (MedPAC) report highlights (Medicare Payment Advisory

Commission 2004), unlike the other Medicare cost reports, dialysis facilities do not
include such financial information on their cost reports; hence a more complete financial
analysis is not possible. It also would be informative to look at uncompensated care as
other researchers have done with hospital conversions (Shen 2003; Thorpe et al. 2000) to
contrast findings with other industries. Data on bad debt from the dialysis cost reports
was considered as a proxy, but the same caveats that restricted its use in the previous
Chapter also prevented it from being used as a financial outcome for this analysis.
From HI, chain-acquired dialysis facilities will have smaller CR cost/tx post
acquisition than independent facilities, ceteris paribus.
67
Hypothesis 2 (H2):
Facility clinical/qualitv performance:
Chain-acquired dialysis
facilities will have better clinical outcomes post-acquisition than independent dialysis
facilities, ceteris paribus.
Although the empirical results on chain affiliations effect on patient outcomes in
other healthcare sectors are not as consistent as financial outcomes, they broadly suggest
a decreased or short-lived improvement, if any, in clinical outcomes after an independent
provider is acquired by a chain (e.g., Ho and Hamilton 2000; Epstein 2003; BanaszakHoll et al. 2002). However, characteristics unique to the dialysis industry may yield
different results on how an organization change affects quality outcomes.
The proportion of patients at a facility achieving hematocrit (HCT) levels of at
least 33% (the minimum level recommended by the Kidney Disease Outcomes Quality
Initiative (K/DOQI)2) is the clinical outcome used for measuring quality (%HCT>33).
There are a variety of ways to treat low HCT levels due to anemia in dialysis patients, but
the most common method is with Epogen (Epoetin alfa, or EPO), a synthetic form of
the hormone erythropoietin, which virtually all dialysis patients receive. Although CMS
has a fixed payment amount for EPO, there is no regulation on the acquisition price paid
by the facility to Amgen, the sole manufacturer of the drug. 3 And unlike HCT levels,
there are no analogous recommendations regarding how EPO is administered, and the
EPO doses to achieve similar HCT values vary widely. 4
Furthermore, the K/DOQI guidelines are still below normal levels (healthy
kidneys release enough EPO to have hematocrit levels of 37%-52%), so higher HCT
2 http://www.kidnev.org/professionals/kdoai/guidelines updates/doaiuphd i.html. accessed July 12, 2005.

3 Amgen was recently able to extend its patent for Epogen to 2016.
4 For example, to achieve similar hematocrit levels, less EPO is needed when administered subcutaneously
versus intravenously.
68
levels (caused by higher EPO doses) are not harmful to patients. To curtail excessive
EPO doses, CMS has imposed limits on EPO payments based on hematocrit values (i.e.,
claims submitted for patients with hematocrit values of 36% or higher risk not being paid
by CMS), but they are not uniformly enforced by the fiscal intermediaries with whom
Medicare contracts to process claims.
These ESRD specific factors - CMS near universal financial coverage of EPO
and lax restrictions on the drugs dosing levels - coupled with a chains potential
purchasing power with Amgen suggest that unlike the nursing home and hospital
industries, chain affiliation will have a positive effect on dialysis quality outcomes. This
is also consistent with the turn around theory mentioned above (i.e., ownership
conversions are associated with improved outcomes).
From H2, chain-acquired dialysis facilities will have higher %HCT>33 post
acquisition relative to independent facilities, ceteris paribus.5
Hypothesis 3a (H3a): Facility labor treatment patterns: Chain-acquired dialysis facilities

will have fewer high cost labor components post-acquisition relative to independent
dialysis facilities, ceteris paribus.
Considering labor costs are the highest expense item at dialysis facilities, it is
expected that an organizational change may be accompanied by decreases in high cost
areas.
For example, to the extent that unskilled labor is an adequate substitute for
registered nurses (RN) and doctors (MD), the same services could be provided more
efficiently by increasing less-skilled labor (e.g., license practical nurses (LPN), nursing
5 Because EPO is one of the separately billable items excluded from the CR payment bundle, the increase
in quality hypothesized here is not incongruent with the decrease in composite rate cost/treatment
hypothesized in (HI).
69
aides) and decreasing RN, MD, and other higher cost labor. Dialysis staffing ratios also
may decrease after an organizational change, similar to what was found in other
industries (Currie et al. 2005; Mark 1999; Shen 2003). Provided that neither of these
staffing changes jeopardizes clinical outcomes, a chain-affiliated facility would be able to
provide the same (if not higher) level of care while also reducing their payroll expenses.
The ratio of RN to patients (RN-pt ratio) and the percent of skilled labor
(%skilled), measured as the percent of labor comprised of MD and RN, were used to
detect staffing treatment pattern differences between chain-acquired and independent
dialysis facilities. From H3a, chain-acquired dialysis facilities will have smaller %skilled
and RN-pt ratio post acquisition relative to independent facilities, ceteris paribus.
Hypothesis 3b (H3bl: Facility non-labor treatment patterns: Chain-acquired dialysis

facilities will have fewer high cost non-labor components post-acquisition relative to
independent dialysis facilities, ceteris paribus.
Three non-labor treatment patterns were examined:
stations per patient (an
amenity from the patient perspective and an inefficiency from the facility prospective)
(stat/pt), whether the facility offers multiple dialysis modalities (HDonly); and whether
the facility reused dialyzers (reuse). Although patients may appreciate more flexibility
for scheduling dialysis appointments, providers might view a high ratio of stations per
patient as excess capacity. Consistent with the cost reducing hypotheses from HI and
H3a, it is expected that chains would decrease the ratio (that is, fewer stations per patient)
at the newly acquired facility. 6
6 Like the staffing changes, the reduction is assumed to not negatively affect clinical outcomes.
70
Considering that the vast majority of patients (91% of incident patients in 2003)
receive in-center hemodialysis (HD) (U.S. Renal Data System 2005), a chain might view
the other modality types (i.e., continuous ambulatory peritoneal dialysis [CAPD],
continuous cycler-assisted peritoneal dialysis [CCPD], and home hemodialysis) as
unnecessary to offer. Generally speaking, only the healthier dialysis patients are eligible
for home or peritoneal dialysis. For this small sub-group of patients, the dialysis facility
may incur additional expense if extra personnel are required to train, administer, and
manage the non-HD patients. Furthermore, providers face a financial disincentive to
offer non-HD modalities: although the CMS CR reimbursement is the same, there are
fewer separately billable items for these modalities, translating to considerably lower
reimbursement to providers compared to HD.
Whether a facility reuses dialyzers - a cost savings measure with mixed quality
implications7 (Agodoa et al. 1998; Fan et al. 2005; Feldman and Escarce 2000; Robinson
and Feldman 2005) - is the final measure of facility treatment patterns that was
examined. Like the hypothesized reduction in excess capacity as well as CR and labor
costs, it is hypothesized that newly acquired facilities are more likely than independent
facilities to employ this cost savings measure.
From H3b, chain-acquired dialysis facilities will have fewer stat/pt, are more
likely to continue or begin offering HDonly, and continue or begin to reuse dialyzers post
acquisition relative to independent facilities, ceteris paribus. Taken as a whole, H3
suggests a turn around strategy regarding chain acquisition which has been reported in
the nursing home (Banaszak-Holl et al. 2002) and hospital (McCue and Furst 1986;
7 For example, Fan et al. (2005) found no differences in survival among dialyzer reuse versus single use
whereas Robinson and Feldman (2005) reported several studies that found reuse to be associated with a
modest increase in mortality.
71
Menke 1997; Phillips 1999; Sloan et al. 2003) literatures. This approach also received
partial support in the previous Chapter regarding dialysis chain acquisition.
Methods and Data

Methods
The goal of this analysis is to estimate the effect of chain acquisition on financial
performance, clinical outcomes, and treatment patterns at dialysis facilities. Based on the
findings reported in the previous Chapter, there are significant differences between
independent and chain-acquired dialysis facilities (e.g., dialysis facilities with higher CR
cost/tx and higher HCT>33% were more likely to be acquired, ceteris paribus),
suggesting that chain acquisition is not a random event.
Accordingly, a simple
comparison between chain-acquired and independent dialysis facilities that does not
control ex ante for observable facility characteristics may result in a downward bias in the
estimated effect of chain acquisition on the outcomes of interest.
Therefore, to control for the endogeneity associated with chain acquisition, a
propensity score methodology is used (Rosenbaum and Rubin 1983; Rosenbaum and
Rubin 1984; Rubin and Thomas 1996; Rubin 1997). Rosenbaum and Rubin introduced
the propensity score methodology in their 1983 seminal article as subject
probability of assignment to the treatment group (z =
i s
conditional
), given a set of observed
covariates (x). Additionally, it is assumed that given the xs, the
Z j s
are independent.
The propensity score and independence assumption are represented empirically in

Equations 3-1 and 3-2, respectively;
72
Equation 3-1: pscore = e(X j) = probability ( Z j = l I Xi=xO

N
Equation 3-2: pr(zi,...,zn I xi,...,xn) = f|e (x ,.)z'{ l-e (x , )}1_Zi

i= i
By balancing the covariates that influence treatment assignment, propensity

scores create a quasi-randomized experiment p. 2,267 (D'Agostino 1998) and facilitate
a direct comparison of outcomes between groups that have similar pre-existing
characteristics (Rosenbaum and Rubin 1983). In other words, among facilities with a
similar probability of being acquired (i.e., same propensity score), those that remained
independent can act as controls for the facilities that were acquired by a chain.
Two steps were required to use propensity scores for this study.
First, the
predicted probability of chain acquisition for each dialysis facility / given a vector of
covariates k was derived using a discrete time hazard model. The logistic equation is
shown in Equation 3-3:
Equation 3-3: log [P/(1-Pi7)] = a, + pix,7] + ... + p*x* +
This analysis is identical to the work presented in the previous Chapter, and further
details of the data and methodology used can be found in Chapter II.
After the propensity scores (i.e., the predicted probability of chain acquisition)
were generated, the observations were sorted by propensity scores within each year in
order to form groups of facilities with similar probability of being acquired. 8 Classifying
8 Because this analysis examines outcomes post-acquisition, the propensity scores for facilities in the last
year of data (2003) were omitted.
73
propensity scores into quintiles removes over 90% of the bias due to differences in
predictors (Cochran 1968), and this strata has been employed frequently in other health
services research (Indurkhya et al. 2006; Mojtabai and Graff Zivin 2003; Steams et al.
forthcoming; White and Seagrave 2005).
However, as Table 3-1 shows, there are
relatively few events (i.e., chain acquisitions) in each year. Using quintiles (or even
quartiles) would result in a small number of acquisitions in each propensity score strata,
making comparisons between control and treatment facilities difficult. Therefore,
facilities were assigned to textiles (i.e., low, medium, and high propensity to be acquired)
instead. 9 Figure 3-1 shows the distribution of the propensity scores by acquisition for all
observations. Distributions by year were similar (not shown).
For the second step, the propensity score subclasses are included as covariates to
model the effect of chain acquisition on the outcomes of interest, one through five years
after acquisition. That is, five different regression were mn for each dependent variable,
reflecting a different year post-acquisition. The empirical model used for the analysis is
estimated by Equation 3-4:
Equation 3-4: Yj, = a + ACQ/Pi + P S ^ + CENjrp3 + BLY;p4 + y, + p., + e;,
where
Yp
= outcome of interest for dialysis facility j t year(s) after baseline
A C Q j = binary variable that equals 1 for dialysis facility j if it was acquired by a chain at
baseline, 0 otherwise
9 Although not as robust as quintiles, tertile sub-classification removes 79% o f the bias due to differences in
predictors (Cochran 1968).
74
PS7
= 3-level categorical variable that equals 1, 2, or 3 if dialysis facility had low,

medium, or high propensity to be acquired at baseline, respectively
CENy, = binary variable that equals 1 if dialysis facility j is censored in year t, 0

otherwise
BLYy = baseline value of dependent variable for dialysisfacility j
yt
= year dummy
p,
= intercept for dialysis facility j
and t=l, 2, 3, 4, or 5 (i.e., year(s) after baseline). Table 3-2 shows the sample size for
each year of follow-up.
The term baseline is used to refer to the year (1997-2002) when the event
took place (i.e., when the facility was either acquired [ACQ=1] or remained independent
[ACQ=0]).
Due to the steady growth in the ESRD patient population, dialysis facilities rarely
exit the market, and, as explored more fully in the methods section in the previous
Chapter, facilities with less than three consecutive years of missing data were included.
So if one assumes that the data are correct and the facility did, in fact, exit the market, it
seems important to control for this relatively infrequent (i.e., approximately 3% of
observations in each year of follow-up) and atypical event. Therefore, the variable CEN
was included to control for observations that were censored from the sample.
There are different implications for two facilities both reporting 70% of their
patients meeting quality guidelines two years after baseline but one starting at 35% and
the other at 60%. Therefore, the variable BLY was included to control for the dependent
75
variable measured at baseline.
Finally, y, controls for year-specific effects, and p,
controls for within-provider correlation.

Two of the treatment pattern outcomes (modalities offered and dialyzer reuse)
were measured as binary variables. Equation 3-5 reflects the model specification for the
binary outcomes:
Equation 3-5: prob(event)/, =fn(a + ACQ/Pi + PS/P2 + C E N ^ + BLY/P4 + y, + p, + zjt)
In order to control for within-provider correlation, two binomial models were

used to examine each outcome. For the modalities offered, the first model examines
facilities that offered multiple modalities at baseline (i.e., HDonly=0) and the second
model examines facilities that offered a single modality at baseline (i.e., HDonly=l).
Similarly, for dialyzer reuse, the first model examines facilities that did not reuse
dialyzers at baseline (i.e., reuse=0 ), and the second model examines facilities that did
reuse dialyzers at baseline (i.e., reuse=l). By using two binomial models rather than a
single multinomial model (i.e., 0 to 1 , versus
to 0 , versus no change) for each outcome,
within-provider correlation could be controlled for (i.e., a providers treatment practices

in one year are not independent from its previous years treatment practices) while
analyzing how factors changed at newly-acquired chain and independent dialysis
facilities that originally had similar treatment patterns.
76
Data
The regression performed in the first step of the analysis uses the same data and
sources as those introduced in Chapter n, and Tables 2-la and 2-lb list the data
definitions and sources, respectively. Table 3-3 lists similar information for the data used
to estimate the effect of chain acquisition on the seven outcomes of interest. 10 CR cost/tx,
RN-pt ratio, and stat/pt are log transformed so that the dependent variables follow the
normal distribution.
Results
Table 3-4 shows the results from the logistic regression used to generate the
propensity scores as well as the means of the covariates by propensity scores. 11 As
expected from the results presented in Chapter II, the likelihood of chain acquisition is
directly related to the percent of patient with HCT > 33% (i.e., the mean values increase
with propensity score [PS]), suggesting that facilities with more of their patients
achieving quality guidelines had a higher propensity to be acquired.
Although not
significant in the regression, dialyzer reuse and for-profit status also show a positive
association with the likelihood of acquisition. Higher CR cost/treatment was a significant
predictor of acquisition, so, not surprisingly, facilities with a high PS had considerably
higher CR cost/treatment than either of the other two PS subgroups ($180 versus $163
and $166 for medium and low PS, respectively). However, facilities with a medium PS
had slightly lower CR cost/treatment than facilities with a low PS ($163 versus $166,
respectively). The significant findings reported in Chapter II on the effect of facility age
10 The data sources are the same as those presented in Table 2-lb.
11 Although not all of the covariates are statistically significant, they are included to account for systematic
differences among dialysis facilities before chain acquisition occurred.
77
on chain acquisition is reflected in the gradually decreasing mean facility in the PS

tertiles, and a similar trend is observed for percent of skilled labor and whether a facility
is restricted by certificate of need (CON) legislation.
The results for the outcomes of interest are presented in Tables 3-5 through 3-13.
Because CR cost/tx, RN-pt ratio, and stat/pt are log transformed, their coefficients
represent the percent change in CR cost/tx, RN-pt ratio, and stat/pt, respectively.
Findings are highlighted below and implications discussed in the subsequent section.
Excluding PS Tertiles
For each outcome, two regressions were run for each year of follow-up (Tables 35 through 3-13): the full model excluding the PS tertiles ([i.e., no PS] columns 2 and 3);
and the full model as specified in Equations 3-4 and 3-5 ([i.e., full model] columns 4 and
5) . 12 The acquired coefficient in the no PS regressions can be interpreted as the effect of
chain acquisition on outcomes as if chain acquisition was an exogenous event.
Therefore, comparing the value of the acquired covariate in the no PS regressions against
the full model regressions will facilitate a better understanding of why is necessary to
control for the ex ante characteristics that may influence outcomes.
Regardless of the PS tertiles statistical significance in the full models, including
the PS tertiles reduces the significance of the acquired covariate in nearly all of the
regressions. For example, in all follow-up periods for percent of skilled labor (Table 37), including PS tertiles in the full model consistently reduces the effect and significance
12 Interactions between acquisition and propensity score tertiles were originally included in the regressions
for all seven outcomes to examine if the effect o f acquisition differed by facilities prior likelihood of
being chain-acquired (not shown). The interaction terms were insignificant for the almost all of the
outcomes o f interest (regardless of follow-up period), though, and were subsequently dropped from the
analyses.
78
of the acquired covariate (i.e., for the first year post-acquisition, -1.50, p=0.005 versus
-1.22, p=0.025 for no PS versus full model, respectively).
In some cases, including the PS tertile eliminates significant findings of the
acquired variable entirely. For example, for logged(stat/pt) two years post-acquisition
(Table 3-9), chain acquisition is associated with a significant increase (6.2%, p=0.024)
with no PS.
However, the coefficient drops to 4.1% and becomes statistically
insignificant in the full model (p=0.141).

As expected, controlling for observed differences in the likelihood of acquisition
yields important differences regarding the effect of chain acquisition for most of the
outcomes. Accordingly, the remaining discussion focuses on the full model that includes
PS tertiles (i.e., columns 4 and 5 of Tables 3-5 through 3-13).
Financial performance
As Table 3-5 shows, chain-acquired facilities had slight declines in their CR
cost/tx in the first and second years post-acquisition (i.e., -0.3% and -0.2%, respectively)
followed by worse financial performance (as reflected by the positive coefficients)
compared to independent units for the remaining years.
However, none of these
differences were statistically significant.

Facilities that had a medium propensity to be acquired consistently experienced
the largest percentage drop in CR cost/tx relative to facilities in low and high PS tertiles
(e.g., for the first year post-acquisition, medium PS = -2.3%, versus high PS= -1.2%; for
the second year post-acquisition, medium PS = -2.3%, versus high PS= -1.9%; etc.). As
79
the likelihood ratio test results show, the difference across PS tertiles was significant at
the p=0.05 level in the first, third, and fourth year post-acquisition.
Clinical/qualitv performance
Unlike financial performance, chain acquisition appears to have a positive and
significant effect on the clinical performance:
even after controlling for a facilitys
propensity to be acquired, chain facilities have a higher percentage of patients achieving

target hematocrit levels compared to independents for all five years of follow-up (Table
3-6). The difference is greatest immediately after acquisition and slowly tapers off as the
length of follow-up increases (i.e., 3.93, p<0.0001 one year post-acquisition vs. 1.41,
p=0.07 four years post-acquisition), with the exception of a slight increase from the
fourth to fifth year of follow-up.
Labor treatment patterns

The percent of skilled labor at chain-acquired facilities is consistently lower than
independent facilities throughout the follow-up period (Table 3-7). The difference is
significant immediately following acquisition (-1.22, p=0.025) as well as in the fourth
and fifth years post-acquisition (-1.49, p=0.016 and -2.27, p=0.005, respectively).
Facilities differed on their staffing practices based on their likelihood of being acquired.
Specifically, facilities with a high PS consistently had the lowest percent of skilled labor,
and this difference was significant at the p=0.05 for all but the fourth year of follow-up.
In fact, the coefficient for the high PS tertile is larger in absolute magnitude than that of
the acquired variables coefficient for all five years of follow-up.
Taking the two
80
extremes, an acquired facility with a high likelihood of acquisition had 2.48% (-1.221.26) less of their workforce as skilled labor in the first year post-acquisition compared to
a non-acquired facility with a low likelihood of acquisition facility, ceteris paribus. In
contrast, neither chain acquisition nor prior likelihood of acquisition appears to have an
effect on the RN-pt ratio for the first five years post-acquisition (Table 3-8).
Non-labor treatment patterns

Chain acquisition has no discemable effect on stations per patient within the first
five years of acquisition (Table 3-9). However, there were significant differences across
PS tertiles for the fourth and fifth year post-acquisition (p=0.043 and p=0.008,
respectively). Specifically, facilities with a high PS had more stat/pt relative to facilities
with a low PS, ceteris paribus.
The results for the two binary outcomes (dialysis modality and dialyzer reuse) are
presented in Tables 3-10 through 3-13. Odds ratios are presented in lieu of parameter
estimates for ease of interpretation.
The estimates for the three propensity score
categories are not displayed since they are not significant in any of the models (i.e.,
likelihood ratio test not significant at the p=0.05 level).
Among facilities that offered only hemodialysis (i.e., HDonly=l) at baseline,
chain acquisition was not a significant predictor of a facility offering additional
modalities during the first five years after acquisition (Table 3-10). Among facilities that
offered multiple dialysis modalities (i.e., HDonly=0) at baseline, chain-acquired facilities
were more likely to restrict treatment to HD only compared to independent facilities
(OR=1.79, p=0.034) in the first year after being acquired (Table 3-11), as hypothesized.
81
However, there was no significant differences in the second through fifth year of follow-
up. This could reflect centralization of non-HD treatments from other chain-affiliated
facilities.
Table 3-12 shows that among facilities that reused dialyzers (i.e., reuse=l) at
baseline, chain-acquired facilities were more likely than independent facilities to stop
reusing dialyzers in the second and third year of follow-up (OR=2.58, p<0.0001 and
OR=1.51, p=0.018, respectively).
Meanwhile, among facilities that did not reuse
dialyzers (i.e., reuse=0) at baseline, Table 3-13 shows that chain-acquired facilities were
more likely than independent facilities to begin reusing dialyzers in the third year of
follow-up (OR=2.39; p=0.008). There was no significant difference between acquired
and independent facilities for the other years of follow-up, however.
Discussion
This study offers several important implications for health services researchers as
well as policy-makers. Unlike the findings from the nursing home and hospital industry
discussed earlier (Mark 1999; Sloan 2003; Shen 2003; Dranove and Lindrooth 2003),
financial outcomes did not significantly improve among dialysis facilities that underwent
an organizational change compared to facilities which remained independent (however,
we cannot directly observe profitability). Although CR costs/tx were lower at chainacquired facilities than independent facilities for the first two years after acquisition, the
difference between provider types was not significant nor did the lower costs persist past
the second year. Therefore, the results do not lend support for HI.
82
However, as hypothesized in H2, quality outcomes were significantly better at

dialysis facilities that experienced a change in organization (i.e., chain acquisition) versus
independent dialysis facilities, ceteris paribus. The difference in the percent of patients
achieving quality benchmarks was most pronounced in the first year after acquisition and
declined in the second and third years after acquisition but remained significant. This
result suggests that chain acquisition has the most impact on improvement in %HCT>33
immediately after acquisition. As hypothesized, the findings regarding an organizational
changes effect on quality outcomes were dissimilar to those found in the nursing home
and hospital literature.
In addition to the characteristics unique to the dialysis industry already
mentioned, the difference in findings may also be due to the outcome measure itself. For
example, unlike reducing heart attack and stroke 90-day readmission rates, the process
involved with increasing HCT among dialysis patients is relatively straightforward and
more easily measured (e.g., EPO dose, the primary treatment for low HCT, is reported on
Medicare claims for each dialysis treatment as a simple number rather than one of several
DRG codes). It is also noteworthy that year was highly significant in all of the follow-up
periods for %HCT>33 as well as most of the other outcomes, suggesting year-specific
industry wide trends. Future research that compared outcomes for facilities acquired in,
say, 1997, against those acquired in 2000 would provide further insight into time-specific
effects.
Unlike the research that found significant reductions on labor ratios after
organizational changes in other industries (Currie et al. 2005; Mark 1999; Shen 2003),
chain acquisition had no significant effect on RN-pt ratios, and was not even in the
83
hypothesized direction (i.e., lower RN-pt ratio) for two of the five years of follow-up. A
broader measure of labor that included other personnel in addition to (or instead of)
registered nurses may reveal staffing ratio differences.
However, as hypothesized in H3a, chain acquisition was associated with a
reduction in the other labor measure (i.e., percent of skilled labor).
Chain-acquired
facilities had a lower percent of skilled labor compared to independent facilities for the
first five years after acquisition (and significant in the first, fourth, and fifth years),
suggesting labor changes enacted by chains are relatively permanent. Future analyses
that includes nurses aides, LPNs, and other less skilled (and less expensive) labor
components may reveal substitution trends.
Overall, chain acquisition did not have a consistent effect on stations/patient. As
hypothesized in H3b, though, chains did restrict treatment to HD only immediately after
acquiring a facility. However, this trend did not persist in the subsequent years. One
explanation for the non-significant modality results is that there might not be any non-HD
patients at the facility.
Facilities are defined as HDonly if there are no non-HD
treatments reported on the cost report.
Therefore, facilities not offering multiple
modalities might be due to the lack of patients eligible for non-HD treatments opposed to
a conscious decision on the part of the facility.
The finding that chain-acquired facilities that reused dialyzers before acquisition
were more likely to discontinue their reuse practice two and three years after being
acquired was unexpected since it is inconsistent with the cost-reducing findings found in
other healthcare industries (Mark 1999; Sloan 2003; Shen 2003; Dranove and Lindrooth
2003) and as hypothesized in H3b. However, this measure (as well as the modalities
84
offered variable) is complicated by the fact that facilities can switch reuse treatment
patterns yearly. That is, a facility may reuse dialyzers in 1997 and 1998, then not reuse
them in 1999, and the begin reusing again in 2000. Further refinement of the two binary
variables (i.e., time to switch modalities offered or reuse practice) may provide better
insight into the effect of chain acquisition on these amenities.
In addition to offering insight into how outcomes change after chain acquisition in
the dialysis industry, this research also demonstrates the use of propensity scores to
control for observed heterogeneity between event and non-event groups in an
observational study.
Comparison between the no PS and full model in Tables 3-5
through 3-13 underscores the importance of controlling for pre-existing factors that also
affect performance (i.e., omission of PS generally led to biased estimates and erroneous
conclusions regarding significance of chain acquisition on outcomes).
Although propensity scores reduce the selection bias inherent with observational
studies and secondary data sources, they do not control for unobserved factors that affect
treatment. 13
Concerns of omitted variable bias are not unique to propensity score
methods, though (e.g., it is also a concern with ordinary least squares regressions), and
propensity scores have been used successfully in a wide variety of other healthcare
studies (D'Agostino 1998). For example, propensity scores have been used in estimating
cost-effectiveness of medical therapies and substance disorders (Indurkhya et al. 2006;
Mitra and Indurkhya 2005; Mojtabai and Graff Zivin 2003), examining differences in
mortality among patients with bacterial infections (Kim et al. 2006), and comparing
patient outcomes, utilization, and spending in hospital-based versus freestanding skilled
13 An instrumental variable (IV) approach would mitigate the omitted variable bias, but identifying a good
IV is often difficult and also has its own weaknesses (Bound et al. 1995; Stearns et al. forthcoming).
85
nursing facilities (Steams et al. forthcoming; White and Seagrave 2005). Other studies
that examine outcomes after organizational changes in the healthcare industry also have
employed propensity scores (e.g., Danzon et al., 2004; Dranove and Lindrooth 2003;
Shen 2002; Shen 2003) and also noted the disparate findings with and without the
measure.
In addition to the above caveat regarding unobserved factors, there are other
limitations to this analysis. The results may not be generalizable to the effect of chain
acquisitions on outcomes outside of the time period studied (1997-2003) or to hospitalbased dialysis facilities since they were excluded from the analysis. However, hospitalbased facilities make up a relatively small proportion of the entire industry, and to the
extent that their financial performance, clinical outcomes, and treatment patterns are
similar to freestanding facilities, hospital-based providers may still be able to glean
information from these findings.
As with any study that uses CMS Cost Reports, there also are concerns on the
incompleteness of the data (Bednar 1992; Magnus and Smith 2000; Medicare Payment
Advisory Commission 2004). However, as the only available source of dialysis cost data
and historical chain affiliation for freestanding providers, cost reports have been used in
other studies and also to monitor and modify Medicares ESRD payment policy. 14
Furthermore, the number of dialysis treatments reported on the cost report is highly
correlated with the number of dialysis treatments reported on Medicare claims,
strengthening the credibility of the cost report data. 15 CMS has recently made efforts not
14 For example, see KECCs Methodology for Developing a Basic Case-mix Adjustment for the Medicare
ESRD Prospective Payment System: http://www.sph.umich.edu/keec/pps/Case Mix Methods Report
Final appdx 040105.pdf accessed August 12, 2005.
15 Personal communication with Marc Turenne, KECC.
86
only to refine the minimum file requirements but also to increase the number of flags that
alert providers to Potential Rejection Errors; for example, zero or negative values for
number of dialysis treatments, implausible dates, etc. 16
Nonetheless, this research provides the first examination of how chain acquisition
affects outcomes in the dialysis industry.
The results suggest important benefits
associated with chain acquisition over independent ownership:

quality without significantly higher CR costs.
consistently higher
However, these benefits have to be
weighed against monopolistic behavior and other concerns regarding dialysis chains
outlined in the previous Chapter.
16 http://www.cms.hhs.gov/manuals/publ52/P152 34.zip. accessed July 12, 2005.
87
Table 3-1. Frequency of dialysis facility acquisition, by year.
Independent not acquired by chain

Independent acquired by chain
% independent facilities acquired
1997 1998 1999 2 0 0 0

383 387 392 444
92
78
71
19
19% 17% 15% 4%
2 0 0 1
457
51
1 0 %
88
2 0 0 2
459
46
9%
Figure 3-1: Distribution by Tertile and Acquisition

1200
not acquired acquired
1000
Observations
800
600
4 00
200
0
1
Tertiles (Predicted probability of chain

acquisition)
89
Table 3-2. Regressions for follow-up analyses.
Year post-acauisition
1
2
3
4
5
N (facilitv-vears)
2,779
2,231
1,714
1,260
826
90
Table 3-3. Variable definitions for propensity score analysis.
Dependent Variables
Definition
CR cost/tx
log(Composite Rate cost/treatment $2003) in year t
%HCT>33%
% of patients with hematocrit (HCT) of > 33 in year t
Labor
%skilled
% skilled labor measured by (MD+RN)/(all staff) in year t
RN-pt ratio
log(FTE registered nurse (RN) relative to number of patients at
the facility) in year t
Non-labor
stat/pt
Modalities (HDonly)
log(Number of dialysis stations per patient) in year t
Multiple modalities
offered at baseline
Among facilities that offered multiple modalities at baseline:

=1 if facility offers only HD in year t, 0 otherwise
Single modality
offered at baseline
Dialyzer reuse (reuse)
Among facilities that offered HD only at baseline:

= 1 if facility offered multiple modalities in year t, 0 otherwise
Did not reuse dialzyers Among facilities that did not reuse dialzyers at baseline:
at baseline
= 1 if facility reports reusing dialyzer, 0 otherwise
Did reuse dialzyers at Among facilities that did reuse dialzyers at baseline:
baseline
= 1 if facility reports reusing dialyzer, 0 otherwise
Was facility
Propensity to be
acquired by chain at
baseline
Definition
0=not acquired
1 =acquired
1=low propensity to be acquired by chain
2 =medium propensity to be acquired by chain
3=high propensity to be acquired by chain
Censored
=1 if facility is censored in year t, 0 otherwise
Baseline
Value of dependent variable at baseline
Year_______________ year dummy variable (1997-2003)_____________________
91
Table 3-4. Odds ratios and 95% confidence intervals (Cl) with binary chain outcome and
covariate means, by propensity score tertiles.______________________________________
Means
Odds
Propensity Score Tertiles
Variable
Ratio
95% Cl
low
medium
high
Intercept
0.08 0.03 0.21 ***
1.30 1.10 1.54 **
58%
60%
65%
CR cost/treatment
1.24 1.05 1.48 *
$166
$163
$180
Facility age
0.85 0.73 0.98 *
8.18
6.12
4.26
% Mcare treatments
0.92 0.80 1.07
73%
73%
76%
Facility size
1.16 0.99 1.36
9.99
10.44
10.19
% skilled labor
0.97 0.84 1.12
35%
31%
30%
RN-to-patient ratio
1.05 0.93 1.19
0.11
0.09
0.10
0.83 0.69 0.98 *
0.29
0.30
0.30
For Profit (ref=N)
Rural (ref=N)
CON (ref=N)
0.81
1.11
1.38
1.17
1.11
0.62
0.82
0.88
0.83
0.57
1.06
1.51
2.16
1.66
2.19
Market measures:
HHI
market size (tx in 1,000s)
0.89
1.44
1.03
0.73
1.10
0.84
1.11
1.22
1.02
0.92
0.89
MV+
PVD
pericarditis
drug dependence
MI
Patients aged:
< 18 yrs old
18-44 years
45-59 years
60-69 years (ref)
70-79 years
80+ years
% female
% pts BMI< 18.5 kg/m2
BSA
Likelihood ratio test of categorical
Year
Network
51%
69%
79%
22%
72%
56%
78%
94%
23%
69%
48%
80%
95%
23%
64%
1.08
1.89 **
1.25
2859
532.02
16%
2163
755.52
16%
2055
523.37
13%
1.00
1.05
0.91
0.79
0.76
1.22 *
1.43 *
1.15
1.06
1.04
1%
39%
2%
2%
16%
1%
40%
2%
2%
14%
2%
43%
2%
2%
13%
0.93
0.83
0.80
0.79
0.69
0.66
1.10
1.01
0.97 *
0.89
0.96
1.13
1.04
1.05
0.73
0.81
0.96
0.89
0.91
1.08
1.14
1.33
1.21
1.21
1%
17%
26%
23%
24%
10%
20%
46%
5%
0%
16%
26%
24%
24%
10%
32%
48%
6%
0%
17%
25%
25%
24%
10%
35%
48%
6%
1.08
1.04
0.90
0.88
1.29
1.21
1.82
30%
1.82
31%
1.83
34%
***
***
All continuous variables are standardized, so a one-unit change in a covariate corresponds to

its respective standard deviation with other covariates held at their mean.
92
Table 3-5. CR cost/treatment (logged) 1-5 years post acquisition, excluding and including
propensity score (PS) tertiles.
1 year post acquisition (t+1)

N=2725
Intercept
Acquired in year t (ref=N)
Propensity to merge in year t (ref=Low):
Medium
High
Final year (censored) in t+1 (ref=N)
Baseline value of outcome (year t)
Tertile
Year
No PS
Estimate
P-Value
0.991
< .0 0 0 1
-0.007
0.489
-0.060
0.003
< .0 0 0 1
0.817
years post acquisition (t+2 )

N=2189
Intercept
Medium
High
Tertile
Year
No PS
P-Value
Estimate
2.238
< .0 0 0 1
-0.005
0.699
0.015
0.056
0.563
< .0 0 0 1
3 years post acquisition (t+3)

N=1684
Intercept
Medium
High
Tertile
Year
No PS
P-Value
Estimate
< .0 0 0 1
2.991
0 .0 0 2
0.890
-0.005
0.080
0.419
< .0 0 0 1
Full Model
Estimate
P-Value
1 .0 0 1
-0.003
--0.023
-0 . 0 1 2
0.051
0.815
< .0 0 0 1
0.781
N/A
0 .0 0 2
0.098
0.013
< .0 0 0 1
0.007
< .0 0 0 1
< .0 0 0 1
Full Model
Estimate
P-Value
2.213
< .0 0 0 1
-0 . 0 0 2
0.880
N/A
-0.023
0.040
-0.019
0 .1 2 1
0.054
0.024
0.570
< .0 0 0 1
0.106
0 .0 0 0
0 .0 0 0 1
Full Model
Estimate
P-Value
2.966
< .0 0 0 1
0.009
0.553
N/A
-0.033
0.014
-0.018
0.217
0.082
0.005
0.428
< .0 0 0 1
0 .0 0 1
0.047
0 .0 0 2
Table 3-5. CR cost/treatment (logged) 1-5 years post acquisition, excluding and including
propensity score (PS) tertiles, continued.

N=1238
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
< .0 0 0 1
3.449
0.013
0.367
0.023
0.491
0.312
< .0 0 0 1

N=812
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
3.920
< .0 0 0 1
0 .0 1 0
0.529
N/A
0.226
< .0 0 0 1
Full Model
Estimate
P-Value
3.429
< .0 0 0 1
0 .0 2 0
0.197
N/A
-0.045
0.004
-0.038
0.033
0 .0 2 0
0.567
0.321
< .0 0 0 1
0.013
0 .0 0 1
0 .0 0 1
Full Model
Estimate
P-Value
3.952
< .0 0 0 1
0 .0 1 2
0.464
-N/A
-0.040
0 .0 2 2
-0.033
0.104
-N/A
0.224
< .0 0 0 1
0.000
All models control for within provider variance.
94
0.069
0 .0 0 0 1
Table 3-6. Percent of patients with adequate HCT 1-5 years post acquisition, excluding and
including propensity score (PS) tertiles.
year post acquisition (t+1 )

N=2725
Intercept
Medium
High
Tertile
Year
No PS
P-Value
Estimate
< .0 0 0 1
24.91
3.70
< .0 0 0 1
---

N=2189
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
57.11
< .0 0 0 1
2.94
0 .0 0 0 2

N=1684
Intercept
Medium
High
Tertile
Year
No PS
P-Value
Estimate
68.65
< .0 0 0 1
2.76
0 .0 0 1
---1 . 2 1
0.425
0.14
< .0 0 0 1
-2.60
0.54
0.046
< .0 0 0 1
Full Model
Estimate
P-Value
22.98
< .0 0 0 1
3.93
< .0 0 0 1
N/A
1.54
0.007
-0.15
0.794
-3.30
0.013
0.56
< .0 0 0 1
0.004
< .0 0 0 1
-0.81
0.23
0.590
< .0 0 0 1
< .0 0 0 1
Full Model
Estimate
P-Value
57.37
< .0 0 0 1
2.71
0 .0 0 1
-N/A
0.31
0.655
1.33
0.091
0.05
0.975
0.24
< .0 0 0 1
0.196
< .0 0 0 1
< .0 0 0 1
Full Model
Estimate
P-Value
67.86
< .0 0 0 1
2.73
0 .0 0 1
N/A
1.44
0.059
1.17
0.178
-0.93
0.549
0.15
< .0 0 0 1
< .0 0 0 1
0.161
< .0 0 0 1
Table 3-6. Percent of patients with adequate HCT 1-5 years post acquisition, excluding and
including propensity score (PS) tertiles, continued.

N=1238
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
73.39
< .0 0 0 1
1.49
0.048
-
-4.07
0.013
0.09
< .0 0 0 1

N=812
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
78.67
< .0 0 0 1
Full Model
Estimate
P-Value
72.56
< .0 0 0 1
1.41
0.070
N/A
0.34
0.669
0.34
0.710
-4.41
0 .0 1 0
0.09
< .0 0 0 1
-
0.902
< .0 0 0 1
2 .0 0
0 .0 2 2
-0 .1 2
< .0 0 0 1
Full Model
Estimate
P-Value
77.80
< .0 0 0 1
1.79
0.048
N/A
0.25
0.795
1.28
0.215
N/A
-
N/A
< .0 0 0 1
0 .1 2
0 .0 0 0 2
96
< .0 0 0 1
0.406
0 .0 0 0 1
T able 3-7. Percent o f skilled labor 1-5 years post acquisition, excluding and including propensity
score (PS) tertiles.

N=2689
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
8.38
< .0 0 0 1
-1.50
0.005
---0.50
0.579
0.74
< .0 0 0 1

N=2162
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
18.46
< .0 0 0 1
0.190
-0.79
----0.27
0.787
0.36
< .0 0 0 1

N=1662
Intercept
Medium
High
Tertile
Year
No PS
P-Value
Estimate
23.34
< .0 0 0 1
-0.42
0.509
----
Full Model
Estimate
P-Value
9.20
< .0 0 0 1
-1 . 2 2
0.025
N/A
-0.61
0.127
-1.26
0 .0 0 2
0.39
0.670
0.74
< .0 0 0 1
0.009
0.041
0.136
Full Model
Estimate
P-Value
19.47
< .0 0 0 1
-0.34
0.583
N/A
-1 . 0 1
0.058
-2.42
0.000
-0.39
0.710
0.36
< .0 0 0 1
0 .0 0 1
0.007
0 .0 1 1
Full Model
Estimate
P-Value
23.56
< .0 0 0 1
-0.17
0.794
-N/A
-0.80
0.193
-2.34
0 .0 0 2
0 .3 8
0.733
-0.08
0 .9 4 4
0 .2 0
< .0 0 0 1
0 .2 2
< .0 0 0 1
0.043
0.005
0.067
Table 3-7. Percent of skilled labor 1-5 years post acquisition, excluding and including propensity
score (PS) tertiles, continued.

N=1221
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
22.33
< .0 0 0 1
-1.77
0.003
-1.40
0.247
0.24
< .0 0 0 1

N=802
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
19.18
< .0 0 0 1
0 .0 0 1
-2.67
---N/A
-0.28
< .0 0 0 1
Full Model
Estimate
P-Value
22.91
< .0 0 0 1
-1.49
0.016
-N/A
-0.65
0.320
-1.54
0.047
1.24
0.318
0.24
< .0 0 0 1
0.135
0.042
0.061
Full Model
Estimate
P-Value
20.23
< .0 0 0 1
-2.27
0.005
-N/A
-1.34
0.106
-2.56
0.005
-N/A
0.29
< .0 0 0 1
0.013
98
0 .0 2 0
0.007
T able 3-8 . RN-to-patient ratio (logged) 1-5 years post acquisition, excluding and including

N=2625
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
-0.764
< .0 0 0 1
-0.008
0.803

N=2110
Intercept
Medium
High
Tertile
Year
No PS
P-Value
Estimate
-2.105
< .0 0 0 1
-0.040
0.238
--

N=1621
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
-1.980
< .0 0 0 1
0.005
0.882
0.080
0.687
0.187
< .0 0 0 1
0 .1 0 0
0.172
0.173
--
0.036
0.214
Full Model
Estimate
P-Value
-0.745
< .0 0 0 1
0 .0 1 0
0.758
N/A
-0.040
0.079
-0.044
0.053
0.073
0.231
0.687
< .0 0 0 1
0.602
< .0 0 0 1
Full Model
Estimate
P-Value
-2.079
< .0 0 0 1
-0.043
0.209
N/A
-0.016
0.623
-0.035
0.346
0.047
0.498
0 .2 1 1
0.638
0.186
0.159
--0 .0 7 6
0.260
< .0 0 0 1
Full Model
Estimate
P-Value
-1.971
< .0 0 0 1
0.034
0.336
-N/A
-0.041
0.230
-0.104
0.008
0 .3 1 5
0 .0 6 3
0.401
< .0 0 0 1
0.254
< .0 0 0 1
0 .8 6 6
99
0.025
0.828
Table 3-8. RN-to-patient ratio (logged) 1-5 years post acquisition, excluding and including

N=1198
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
-1.945
< .0 0 0 1
-0.064
0.107
-0.130
0.128
0.246
< .0 0 0 1

N=787
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
-2.096
< .0 0 0 1
-0.064
0 .2 1 1
N/A
0.256
< .0 0 0 1
Full Model
Estimate
P-Value
-1 . 8 8 8
< .0 0 0 1
-0.048
0.243
N/A
-0.058
0.172
-0.055
0.243
0.123
0.155
0.255
< .0 0 0 1
-
0.352
0.297
0.329
Full Model
Estimate
P-Value
-2.007
< .0 0 0 1
-0.047
0.370
-N/A
-0.060
0.262
-0.078
0.183
-N/A
0.272
< .0 0 0 1
0.667
100
0.370
0.619
Table 3-9. Stations/patient (logged) 1-5 years post acquisition, excluding and including

N=2725
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
-0.188
0.000
0.016
0.506
--

N=2189
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
-0.737
< .0 0 0 1
0.062
0.024
-

N=1684
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
-0.694
< .0 0 0 1
0.752
0 .0 1 0
-
0.006
0.887
0.885
< .0 0 0 1
Full Model
Estimate
P-Value
-0 . 2 0 2
< .0 0 0 1
-0.005
0.819
N/A
-0.005
0.778
0.044
0.007
0.028
0.479
0.870
< .0 0 0 1
-
0.005
0.243
0.129
-0 . 0 0 1
0.510
0.992
< .0 0 0 1
Full Model
Estimate
P-Value
-0.682
< .0 0 0 1
0.041
0.141
N/A
0.024
0.326
0.054
0.062
-0 . 0 0 2
0.972
0.561
< .0 0 0 1
0.173
0.482
0.328
0.004
0.543
0.950
< .0 0 0 1
Full Model
Estimate
P-Value
-0.758
< .0 0 0 1
0 .0 1 1
0.738
-N/A
0.048
0.125
0.037
0.306
0.015
0.805
0.515
< .0 0 0 1
0.871
0.304
0.731
Table 3-9. Stations/patient (logged) 1-5 years post acquisition, excluding and including

N=1238
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
-0.618
< .0 0 0 1
0.024
0.486
-
-0.077
0.303
< .0 0 0 1
0.545

N=812
Intercept
Medium
High
Tertile
Year
No PS
Estimate
P-Value
-0.845
< .0 0 0 1
0.045
0.313
-N/A
-0.437
< .0 0 0 1
Full Model
Estimate
P-Value
-0.621
< .0 0 0 1
0.009
0.786
N/A
0.044
0.224
0 .1 0 0
0.013
0.103
0.185
0.555
< .0 0 0 1
0.043
0.466
0.420
Full Model
Estimate
P-Value
-0.939
< .0 0 0 1
0.019
0.678
N/A
0.090
0.061
0.164
0 .0 0 2
N/A
0.425
< .0 0 0 1
-
0.463
102
0.008
0.541
Table 3-10. 1-5 years post-acquisition for facilities that did not offer multiple modalities
(HDonly=l) at baseline.
N=1373_____________________Odds Ratio Pr > ChiSq
Intercept
0.07
0.000
0.663
1.16
Final year (censored) in t+1
(ref=N)
-1.10
0.891
Tertile
Year
0.730
Including PS Tertiles
Odds Ratio Pr > ChiSq
0.04
<.0001
1.09
0.801

N=1068
Intercept
0.10
<.0001
0.880
0.96
(ref=N)
0.814
-1.12
Tertile
Year
0.434
0.09
<.0001
0.95
0.852

N=790
Intercept
0.000
0.10
1.31
0.306
(ref=N)
0.427
-1.63
Tertile
Year
0.219
0.08
<.0001
1.26
0.375

N=548
Intercept
0.11
0.002
0.215
1.43
0.796
(ref=N)
-1.19
Tertile
Year
0.468
0.10
0.002
1.43
0.221
-1.08
0.919
0.721
0.709
-1.12
0.812
0.926
0.425
0.64
0.474
0.627
0.219
-1.20
103
0.791
0.848
0.463
Table 3-10. 1-5 years post-acquisition for facilities that did not offer multiple modalities
(HDonly=l) at baseline, continued.
N=335
0.14
<.0001
Intercept
1.17
0.615
(ref=N)
Tertile
Year
0.388
0.13
<.0001
1.24
0.492
104
0.404
0.390
Table 3-11. 1-5 years post-acquisition for facilities that offered multiple modalities
(HDonly=0) at baseline.
N=1352
<.0001
Intercept
0.07
1.78
0.032
(ref=N)
0.813
-0.87
Tertile
Year
0.302
0.07
<.0001
1.79
0.034

N=1121
Intercept
0.07
<.0001
0.244
1.28
0.182
(ref=N)
-1.69
Tertile
Year
0.138
0.07
<.0001
1.30
0.222

N=894
<.0001
Intercept
0.07
1.10
0.582
0.090
(ref=N)
-2.08
Tertile
Year
0.078
0.07
<.0001
1.11
0.571
N=690
Intercept
0.21
<.0001
0.95
0.786
0.902
(ref=N)
-0.97
Tertile
Year
0.043
0.24
<.0001
0.98
0.894
-0.88
0.821
0.943
0.295
-1.74
0.158
0.865
0.137
-2.06
0.094
0.970
0.080
-0.94
105
0.791
0.678
0.043
Table 3-11. 1-5 years post-acquisition for facilities that offered multiple modalities
(HDonly=0) at baseline, continued.
N=477
<.0001
Intercept
0.23
0.898
1.03
(ref=N)
Tertile
Year
0.121
0.25
<.0001
1.09
0.711
106
0.312
0.125
Table 3-12. 1-5 years post-acquisition for facilities that reused dialyzers (reuse=l) at
baseline.
N=2076_____________________Odds Ratio Pr > ChiSq
0.05
<.0001
Intercept
0.417
1.19
0.664
(ref=N)
-0.84
Tertile
Year
<.0001
0.05
<.0001
1.29
0.235
N=1730
0.02
<.0001
Intercept
<.0001
2.47
(ref=N)
0.314
-1.78
Tertile
Year
<.0001
0.03
<.0001
2.58
<.0001
N=1351
0.14
<.0001
Intercept
0.008
1.58
(ref=N)
-1.03
0.947
Tertile
Year
<.0001
0.14
<.0001
1.51
0.018
N=1005
Intercept
0.28
0.005
1.02
0.909
0.454
(ref=N)
-0.72
Tertile
Year
<.0001
0.28
0.007
0.96
0.804
-0.88
0.750
0.120
<.0001
-1.83
0.289
0.441
<.0001
-0.98
0.955
0.322
<.0001
-0.67
107
0.374
0.290
<.0001
Table 3-12. 1-5 years post-acquisition for facilities that reused dialyzers (reuse=l) at
baseline, continued.
N=652
<.0001
Intercept
0.25
0.888
1.03
-(ref=N)
Tertile
Year
<.0001
Odds Ratio Pr> ChiSq
0.24
<.0001
0.976
0.99
-
108
0.646
<.0001
Table 3-13. 1-5 years post-acquisition for facilities that did not reuse dialyzers (reuse=0) at
baseline.
N=649
Intercept
0.56
0.033
1.41
0.300
(ref=N)
0.794
-0.95
Tertile
Year
0.243
0.42
0.061
1.14
0.830

N=459
Intercept
0.53
0.089
1.44
0.114
(ref=N)
-1.06
0.860
Tertile
Year
0.121
0.51
0.076
0.150
1.39

N=333
Intercept
0.68
0.539
2.39
0.007
(ref=N)
0.695
-0.78
Tertile
Year
0.002
0.66
0.511
2.39
0.008

N=233
0.352
Intercept
0.49
1.85
0.097
(ref=N)
-1.08
0.923
Tertile
Year
<.0001
0.361
0.49
1.87
0.092
-0.79
0.568
0.300
0.615
-1.00
0.991
0.375
0.139
-0.72
0.615
0.540
0.003
-1.04
0.962
0.878
<.0001
Table 3-13. 1-5 years post-acquisition for facilities that did not reuse dialyzers (reuse=0) at
baseline, continued.
N=160
0.52
0.0043
Intercept
0.136
1.80
(ref=N)
-Likelihood ratio test of categorical variables
Tertile
Year
0.020
0.41
0.006
0.144
1.79
110
0.377
0.016
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Rosenbaum, P.R. and Rubin, D.B. 1983. The Central Role of the Propensity Score in
Observational Studies for Causal Effects. Biometrika 70(l):41-55.
Rubin, D.B. 1997. Estimating Causal Effects from Large Data Sets using Propensity
Scores. Annals o f Internal Medicine 127(8_Part_2):757-763.
113
Rubin, D.B. and Thomas, N. 1996. Matching using Estimated Propensity Scores:
Relating Theory to Practice. Biometrics 52(l):249-264.
Shen, Y.C. 2003. Changes in Hospital Performance After Ownership Conversions.
Inquiry 40(3):217-234.
Shen, Y. 2002. The Effect of Hospital Ownership Choice on Patient Outcomes After
Treatment for Acute Myocardial Infarction. Journal o f Health Economics 21(5):901-922.
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Chapter IV
Chapter IV. Change for Chains? Franchising as an Organizational Structure in

the Healthcare Industry
Abstract
There are varying organizational forms among healthcare providers, ranging from
arms length contracting to full integration. Between these two affiliation extremes is
franchising, a well-established and successful business model used in many industries
with diverse products and services. Some healthcare sectors have experimented with
franchising but, overall, it has largely been absent as a business model. This article
presents the economic theory behind franchising and a description of the healthcare
sectors that have experimented with it. Although franchising had limited success in
dentistry, it has flourished in the optometry industry and is increasingly used by home
healthcare services companies. Several factors affect the likelihood of further franchising
in other healthcare sectors, including the increased popularity of consumer-driven health
plans, the prevalence of health insurance, and the costs of compliance with healthcare
fraud and abuse laws. The article concludes with recommendations for future research to
understand better the role and potential of franchising in healthcare.
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Introduction
In simple terms, franchising is:
a contractual arrangement between two legally independent firms,
whereby the franchisee pays the franchisor for the right to sell the
franchisors product or the right to use his trademarks in a given location
for a specified time period p. 1,042 (Lafontaine and Shaw 1999).
Franchising is the prevailing organizational form in a number of diverse industries,
including fast food restaurants, hotels, and tax preparation. Although franchising has
been attempted and even thrives in several healthcare sectors, it has received little
attention from health service researchers and policy-makers.1
The paucity of research examining healthcare franchising is largely attributable to
how uncommon the organizational form is in most healthcare sectors. However, there
are also many misconceptions about what differentiates a franchise from other integrated
organizations, and, more generally, what exactly franchising is.
For instance, some
health researchers have use the term franchise to describe any healthcare chain
organization, regardless of the principal-agent relationship (Gessner and Morisseau 1980;
Guncheon 1983; Johnson 1968; McDonald 1984; Schuweiler 1996).
The term
franchise has also been used by researchers as a synonym for exclusive territories
and branding (Allen 1999; Narad 1997; Partridge 1996). Although these are two
common characteristics associated with franchising, they are not exclusive to the
organizational form nor encompass all of a franchises attributes. As will be explored
more fully below, the Federal Trade Commission (FTC) has outlined specific
requirements that need to be met before an organization is considered a franchise.
1 For example, franchising does not appear in Bazzoli et al.s (2004) extensive review o f organizational
changes among healthcare providers over the last twenty years.
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As new trends emerge in the healthcare industry that focus on patient-centered

care and pay-for-performance incentives, franchising may be considered as an
organizational form that provides the appropriate incentives to consumers and providers
(e.g., reduces search costs and provides a means to standardize care to achieve qualityimprovement protocols, respectively). No research has yet examined the factors that
might contribute to the success or failure of healthcare franchising, though, which may
impede implementation of the organizational form. Although the economics literature
has extensive research on this area, asymmetric information, presence of insurance, and
other factors unique to healthcare also need to be considered.
New Contribution
The purpose of this article is to educate researchers and policy-makers about
franchising as it relates to and occurs within the healthcare system.
I first define
franchising and present economic theory explaining why firms and agents choose
franchising over other organizational forms. Second, I present examples of franchising,
both successful and not, within different healthcare sectors. Third, I explore the issues
that are likely to hinder or encourage further franchising of healthcare services. Finally, I
conclude with recommendations for further research to understand better the role
franchising can play in todays changing healthcare sectors.
Franchising Defined
Franchising has existed in the US since 1851 when the Singer Sewing Machine
Company first sold distribution rights to traveling salesmen (Shane 2005).
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As
franchising became an increasingly legitimate and popular business format in the 1950s
and 1960s, so too did the number of illegitimate companies that did little more than
deplete would-be franchisees investments. Because of the increase in fraud, the North
American Securities Administration provided guidelines for information to be included in
franchise offerings in 1975 that eventually became the now standard Uniform Franchise
Offering Circular (UFOC). The FTC began regulating franchises in 1979, four years
after its first franchise fraud investigations; it defines a franchise as any business
relationship where the following three requirements are met (FTC 16 C.F.R. 436.2):
1. One company (which need not call itself a franchisor) provides, or
has the power to provide, significant control and assistance to another
company (i.e., the franchisee).
2. The franchisee operates and distributes goods or services under the
franchisors licensed trademark or trade name.
3. The franchisee must pay at least $500 to the franchisor during the first
6 months of operation.
In addition to the federal regulations, fifteen states also have regulations pertaining to
franchises2 (Fuss 1984; Shane 2005).
There are two types of franchising: the product (or trade name) franchise; and
the business-format franchise. Both product and business-format franchisors develop a
brand name for their product and then license it to their franchisees, who in turn deliver
the product or service to consumers for a specified period of time in a defined
geographical location.
However, the business-format franchisor also develops an
operating system for the franchisee to use. By requiring franchisees to adhere to their
operating systems, business-format franchisors emphasize uniformity more than product
franchisors do; this uniformity is one of the major distinguishing features between the
two types of franchising (Blair and Lafontaine 2005; Shane 2005).
2 http://www.ftc. gov/bcp/franchise/netdiscl .him accessed February 22, 2006.
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Business-format and product franchisors also differ in terms of where the

production occurs and how they gamer compensation from their franchisees. Product
franchisors manufacture their product and then distribute it to their franchisees to sell, but
production usually occurs at the franchised unit among business-format franchises (Blair
and Lafontaine 2005). The business-format franchisor makes money from royalties on
sales, whereas a product franchisor profits from the direct sale of his products to the
franchisee. However, because some business-format franchisors also earn profits based
on the direct sale of their products to the franchisee, this distinction between the two
types of franchising is not as salient (Ibid.). Examples of product franchises include soft
drink bottling companies, gas stations, and automobile dealerships, while fast food
restaurants are business-format franchises (Ibid.).
More casually, franchising has been characterized as an intermediate form of
organization ...somewhere between the firm and the market, retaining features of both
p.l (Lafontaine and Masten 1995), or simply as a means to allow
...transactors to achieve whatever benefits of large scale may be
available in, for example, brand name development and organizational
design, while harnessing the profit incentive and retailing efforts of local
owners. p. 10 (Klein 1995).
Alternatively, some researchers use a dictionary definition of a franchise:
the right or license granted to an individual or group to market a
companys goods or services in a particular territory, or the territory
granted in such an arrangement p.8 (Rothenberg 1993).
These characteristics also are found in firms that do not m eet all o f the F T C s
definitions for a franchise. For instance, Hallmark Gold Crown Stores share many of the
same characteristics as franchises. The stores are:
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privately (usually locally) ow ned and operated...ow ners have licensing

agreem ents to sell H allm ark-branded products and to display the H allm ark
name...the Hallmark brand [is featured] on 60 percent of products,

including H allm ark G old Crow n exclusive item s .3
However, none o f the H allm ark stores is a franchise. B y avoiding the official franchise
label (i.e., not meeting the three specific FTC requirements), the parent company does not
need to comply with the FTC and state regulations governing franchises, nor does it need
to disclose a UFOC to prospective store buyers. This concept of pseudo franchises,
also found in the healthcare industry, is explored more fully below.
Why Firms and Individuals Choose to Franchise

When a firm decides to sell its units as franchises, it is making an implicit
assumption that a franchisee is just as good as if not better than a manager; otherwise, the
firm would use only employee managers. A local entrepreneur who knows local market
conditions and opportunities, but who may not have the know-how to start a business
from scratch, is an attractive potential franchisee candidate from the franchisors
perspective (Dnes 1996; Minkler 1992). Likewise, the franchisee must also see a benefit
in a franchise over a non-chain business opportunity. As Mazzeo points out,
...any franchising arrangement is inherently two-sided: a vertically
disintegrated governance structure must be preferred over company
ownership, and individual entrepreneurs must find it more attractive to
become a franchisee than to operate an unaffiliated, independently owned
business p.613 (Mazzeo 2004).
There is considerable variation in franchising rates w ithin industries.
For
example, within the broad Donuts/Cookies/Bagels Industry listed in the annual Bonds
Franchise Guide, all 5,000 Dunkin Donuts outlets and 66% of Panera Bread Companys
3 http://pressroom.hallmark.coin/gold crown fact sheet.html. accessed March 9, 2006.
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540 units are franchised (Bond 2004), while Starbucks and Au Bon Pain own all of their
outlets (Lutz 1995; Shane 2005). Given this variation, there is extensive research in the
economics literature that examines why a firm chooses to franchise their units rather than
keep them as company-owned, and why an entrepreneur chooses to purchase a franchise
rather than an independent business. Caves and Murphy present one of the earliest and
most persistent arguments for franchising in their 1976 seminal article. The authors
argue that franchising is a way for capital-constrained firms to raise funds necessary for
expansion, with the implicit assumption that the firm-cum-franchisor is more averse to
risk than would-be franchisees.
However, Caves and Murphys capital-market argument is not supported
empirically (Brickley et al. 1991; Lafontaine and Bhattacharyya 1995; Lafontaine and
Masten 1995; Norton 1995; Rubin 1978; Scott 1995).
For example, one of the
implications of this argument is that firms would buy back their franchises once the firms
mature and acquire capital. However, this has not been found to occur with older firms
(Lafontaine and Shaw 1999), nor do only small, young companies choose to franchise
(Brickley et al. 1991). Other researchers argue against the unlikely assumption that the
franchisor, with varied and diversified risk, is more risk averse than the franchisee, who
often sinks a large share of her personal assets into a single investment (i.e., the
franchise) (Brickley and Dark 1987; Dnes 1996; Rubin 1978).
Rather than the capital-market
argument,
some researchers emphasize
franchisings ability to better monitor and control potential shirking over companyownership (Mathewson and Winter 1985; Rubin 1978). Under franchising, the manager
(i.e., the franchisee) has a financial stake in the outlets (and companys) success, making
121
her less likely to shirk on her work responsibilities than a salaried employee. This is
especially important when the outlets are geographically dispersed, making monitoring
expensive and difficult (Brickley and Dark 1987; Dnes 1996). However, franchising also
introduces an incentive for the franchisee to free-ride on the brand name, and the
opportunity for the franchisor to behave opportunistically towards the franchisee
(Brickley and Dark 1987; Minkler 1992).
Other researchers cite franchising as a more effective means to address the
incomplete contracting issues inherent between a firm and its managers-cum-franchisees
(Maness 1996; Rubin 1978; Windsperger 2002). For example, royalty fees in most
franchise contracts are based on the franchised units revenue or sales, rather than on
profits.
Not only are sales easier to monitor than profits, but it also provides the
franchisor with the correct incentives (i.e., prevents the franchisor from under-investing
in policing quality at the franchised units) (Lafontaine 1992; Rubin 1978).
Franchising in Healthcare Industries

The history of franchising in healthcare is relatively young compared to other
industries. In addition to franchisings growth and acceptance in other industries, a 1977
Supreme Court ruling that allowed advertising by professionals under the First
Amendment also helped franchising take hold in healthcare (Bates et al. v. State Bar of
Arizona 1977). In response, dental, optical, home health, and other healthcare sectors
began experimenting with franchising over the next twenty years. Each is explored
below.
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Dentistry
A Sears store in California opened the first retail dental center shortly after the
1977 Supreme Court ruling, and drugstore chains soon began offering dental services at
their stores, too (Gondela 1984; Rupert 1979; Yablon et al. 1986). Like most franchises,
dentists were required to pay an initial fee to join the system, a monthly service charge,
and additional funds specifically earmarked for a collective advertising fund.
Some
ventures also offered turn-key systems in which a dentist purchased a complete

operation, down to the office design and construction (Anderson 1984). In exchange, the
dentist would, in theory, benefit from the lower costs associated with centralized
purchasing of office materials and equipment, managerial assistance from the franchisor,
and an increased number of patients via brand name recognition (Corby 1979). In some
instances, the lower costs to dentists translated to lower prices for the consumer, too,
thereby providing dental care to consumers who previously could not afford it (Bush and
Nitse 1992; Rupert 1979). Some consumers also benefited from greater accessibility to
dental services via extended hours at franchises compared to traditional dental offices,
and more time with the dentist since less of the dentists time was spent on administrative
chores (Bush and Nitse 1992; Corby 1979).
Retail and franchise dentistrys potential was especially promising, since, at the
time, the dental industry was experiencing a steady increase in supply - 5% annual
increase in dentists - coupled with stagnant (if not decreasing) demand due to near-zero
population growth and the recently discovered benefits of fluoride (Eagan 1984; Gondela
1984; Hankin 1987). Not surprisingly, some industry observers were soon heralding
123
franchising as the future of dentistry (Anderson 1984; Corby 1979; Gondela 1984; Moran
1983; Wood and Scher 1984).
However, the enthusiasm was premature and short-lived. Although the Supreme
Courts ruling approved a dentists right to advertise, other legal concerns remained. For
instance, advertisements needed to reflect the subtle distinction of dentistry being
practiced by professionals versus business corporations, making dentists walk a fine line
between highlighting their affiliation with the brand name while simultaneously exerting
that they were not employees or under the control of the franchisor (Wood and Scher
1984).
How the franchisor collected his fees was complicated, too. Whereas many non
health related franchises simply based monthly franchise fees on a franchisees sales
volume (e.g., McDonalds and Best Western), franchise fees for dentists practicing in
New York could ...not be tied to the dentists revenues from patients p.677 (Ibid.).
Other states had similar restrictions on fee-splitting, regulations on the number of
practices a dentist could own, and restrictions on dentists working for non-dentists
(Anderson 1984; Rupert 1979).
In addition to state-specific laws that added to the legal complexity of expanding
a dental franchise, there was also the issue of dentists-cum-franchisees gaining their
peers acceptance (Eagan 1984; Rupert 1979). Some dentists worried about the adverse
effect that advertising would have on the profession as a whole (Anderson 1984;
Waldman 1980) or that quality of care would be compromised (Gondela 1984; Rupert
1979; Yablon et al. 1986). Meanwhile, the American Dental Associations (ADA) stance
was lukewarm at best: The ADA does not have an official policy on franchise dentistry
124
although its reaffirmation of ownership of a dental practice solely by dentists is clear

p.518 (Anonymous 1983).
These concerns led some dentists and industry observers to forecast the imminent
demise of franchise dentistry just ten years after its arrival. Hankin (1987) theorized that
franchise dentistry would not survive since advertising cooperatives could yield the same
results as pooled money from a franchisor. He also argued that dentistry could not be
standardized, yielding the brand names association with a set level of quality impossible,
and dental franchisors ineffective: .. .knowledge of how to produce or sell real estate or
doughnuts does not provide much insight into dental care p.22 (Ibid.). Yavner et al.
(1988) cited management problems as a contributing reason to dental franchisings
decline, stressing an inherent contradiction between the franchisors and franchisees
respective goals:
the franchisor will emphasize product standardization and cost
minimization, while the dentist-cum-franchisee will focus on providing quality care

which may not be the same for each patient. Consequently, many dental franchisors took
on the role as consultant rather than franchisor, resulting in far less control over their
franchisees than franchisors in other industries.
The incentives that some novice franchisors provided to their franchisees also
caused a misalignment of objectives. Because incentives based on sales or profits made
some consumers uneasy, several franchisees were rewarded based on services performed
rather than collections received, encouraging the franchisees to provide dental care to
customers who could not necessarily pay for their care (Yavner 1989). Other incentives
were based on the productivity of the entire practice, in which case an individual
franchisees effort would be muted by other dentists performance.
125
This, in turn,
encouraged free-riding on the brands name, and the larger the franchise operation, the
greater the threat. Despite these issues, franchisors were eager to gain market presence
and take advantage of the economies of scale associated with larger firms. Therefore,
some inexperienced franchisors agreed to leases without having secured any franchisees,
which eventually led to bankruptcy and poor management of their franchisees who were
still in business (Yavner et al. 1988).
Yavner et al. also found the high costs imposed on the dental franchisees by the
franchisors to be an issue. The authors calculated that the start-up costs were over three
times that of a traditional dental office, and a dental franchisee would have to attract
almost fifteen new patients a week just to cover their franchise fees {Ibid.). These
franchise-related financial pressures may have prompted some dentists to over-treat their
patients which, in turn, contributed to quality and image concerns of dental franchising
overall.
Despite the initial set-backs, dental franchising is still present today, although its
long-term viability is questionable. For example, in 2004, Enhance Dental Care was
actively seeking dentists for new franchise locations in the Kansas City area and planned
to have 1,000 locations within the next five years (Butcher 2004).4 But by the beginning
of 2006, Enhance Dental had gone out of business and their websites no longer existed.
Other dental franchises that are still in operation (e.g., Comfort Dental Partners and
European-based Vital Dent) are relatively small, regional companies.5 Rather than dental
care, dental franchising might shift towards dental-related services, such as dental
personnel (e.g., Edso Dental Training Centers) and dental supplies (e.g., Shamrock
4 http://enhancedentalcare.net/franchisel.html accessed February 13, 2004 and
http://www.smilekansascitv.com/ accessed July 18, 2005.
5 http://www.comfortdentalpartners.com/ and http://www.vitaldent.com/. accessed March 10, 2006.
126
Dental and Dentists Choice),6 although the long-term viability of these firms also
remains to be seen.
Optometry
Unlike the dental industry, there is virtually no empirical research on franchising
in the optometry industry, despite (or perhaps, because of) its prevalence and success.
Begun in 1961, Pearle Vision has become the worlds largest network of optical retail
outlets, with 333 company-owned and 502 franchised stores in 2005 (Anonymous 2006).7
Sterling Optical is also a heavily franchised optometry chain with 90% of its 243 offices
franchised.8 Pearle Vision and other optical franchises are almost always stand alone
operations, located in malls or other convenient-to-consumer locations.
However,
retailers - including Wal-mart, Sears and upscale department stores - offer on-site
optometry services, too, with a mix of franchising and company ownership. Phoenixbased Optical Franchises Inc. offers Macys shoppers seven-day-a-week optical care
through its franchised Macys Vision Express chain (Smith 2003).
Meanwhile, US
Vision operates retail optical stores in J.C. Penney, Sears, and regional department
stores.9 Founded in 1991, US Vision currently owns all of its outlets, but it will be
interesting to observe if the young company follows in the footsteps of the industry
leaders and eventually turns to franchising.
6 http://www.dent-tempcareers.com/franchise.htm. http://www.shamrockdental.com/shamrock-dentalfranchise-information.html. and http://www.thedentistschoice.com/. accessed March 10, 2006.

7 http://www.pearlevision.com/ accessed March 10, 2006.
8 http://www.sterlingoptical.com/ accessed March 10, 2006.
9 httn://www. usvi sion.com/ accessed March 10, 2006.
127
Pharmacies
Although CVS, Rite-Aid and other large national chains own all of their outlets,
some smaller retail pharmacies do franchise.
The Medicine Shoppe and Medicap
Pharmacies began franchising in 1971 and 1973, respectively.10 Like optical franchises,
though, little empirical research has focused on pharmacy franchises. One notable (albeit
dated) exception is a 1977 article examining the advantages and disadvantages associated
with owning a pharmacy franchise (Christensen and Curtiss 1977). The authors found no
correlation between franchisee satisfaction and type of franchise and also report mixed
results on how satisfied franchisees were with the franchisor-provided services. Because
the authors only solicited responses from three Midwestern companies (translating to
forty-three responses), though, it is difficult to extrapolate their findings to other
healthcare sectors, let alone the pharmacy industry.
Home healthcare
Despite initial claims in the 1980s by researchers and industry pundits that the
industry was ripe for franchising due to a new acceptability of advertising and
underdevelopment of brand recognition, franchising in home healthcare had a rocky
beginning (Habsburg 1995; Kelly 1987). In 1984, a non-medical home health specialist
began Doctors to Your Door (DTYD) in Louisville, Kentucky - a service that provided
non-emergency care to homebound patients - and began franchising the idea four years
later (Whittemore 1989; Willen 1992). In exchange for an initial franchising fee and 6%
of sales, DTYD provided franchisees with a software program, training, and referrals.
10 http://www.medicineshoppe.com/ and https://www.medicaprx.com/asp/ourcompanv/ourcompanv.asp.

accessed March 15, 2006.
128
The companys growth plan included diversification by offering insurance exams,

employment physicals, and other occupational health services (Willen 1992). Two years
after it began franchising, though, DTYD was out of business, citing low Medicaid and
Medicare reimbursement rates and slow-to-process claims.
Not all home healthcare franchises have failed, however. In fact, one of the oldest
home healthcare providers, Tender Loving Care Healthcare Services (previously called
Staff Builders), began franchising its units in 1987 and presently franchises 20% of its
104 outlets in twenty-one states." Interim Healthcare, the largest provider of home
healthcare and supplemental healthcare staffing, also franchises. Its website states that it
has no plans to develop corporate owned businesses and currently franchises
approximately 90% of its 300 units.12 In addition to an in-home care franchise, the
company also offers a medical staffing franchise that provides temporary healthcare
personnel to healthcare institutions, as well as a non-medical care assistance franchise.
These non-medical homecare franchises have become increasingly popular: in 2006,
Entrepreneur magazine listed 13 such senior care franchises in their annual ranking of
franchises (Anonymous 2006).13 Although billed as non-medical, many of the companies
highlight the nurse-led training that workers receive, Medicare and Medicaid eligibility
concerns, and their services as a supplement to home health agencies.
11 Personal communication with David Frank o f Tender Loving Care, March 17, 2006.
12 http://www.interimhealthcare.com/franchise.asp. accessed March 8, 2006.
13 Home Helpers/Direct Link www.homehelpers.ee. Home Instead Senior Care www.homeinstead.com.
Comfort Keepers www.comfortkeepers.com. Visiting Angels www.livingassistance.com. Right at Home
Inc. www.ri ghtathome.net. Homewatch CareGivers www.homewatch-intl.com. ComForcare Senior
Services Inc. www.comforcare.com/ffanchise. Griswold Special Care www.griswoldspecialcare.com.
Aristocare Home Health Services http://www.aristocare.net/. AtWork Helping Hands Services
www.atworkhelpinghands.com. Choose Home www.choosehome.biz. Home Care Assistance Franchise
Corp.www.hcafranchise.com. Spectrum Home Services www.spectrumhomeservice.com
129
Provider groups
Started in 1985, Physical Therapy Provider Network (PTPN) promotes itself as

the oldest and largest specialty preferred provider organization (PPO) in the US
(Rothenberg 1993). In exchange for a one-time franchise fee as well as a continuing
annual fee, PTPN franchisees receive proprietary software that helps expedite claims
processing, national name recognition, standardization of services, and ongoing
consulting and training.
Like other healthcare-related franchises, PTPN stresses the
benefit of a quicker start-up time over non-franchised PPOs.
PTPN presently has
members in twenty-three states with over 1,000 offices and 3,000 therapists providing
outpatient rehabilitation services.14
Individual physicians also have experimented with franchising.
After being
overwhelmed by administrative and managerial tasks at his own practice, an Illinois

physician created American Family Doctor in 1988 to provide business techniques and
advice to other doctors practices with the dual appeal of autonomy and ownership p.
65 (Willen 1992). In exchange for a $35,000 start-up fee and monthly royalty fees, the
franchisor filed medical-insurance claims, billed the patients, and performed other
administrative tasks, thus allowing the physician franchisees to focus on the their
patients. The physician who founded American Family Doctor created a business-tobusiness software program in 1998 that encourages self-care of the corporate customers
insured population,15but no trace of his original franchise remains.
14 http://www.DtDn.com/aboutus 1.htm accessed March 17, 2006.

15 http://www.ecaresolutionsinc.cotn/about.html accessed March 17, 2006.
130
Hospital-related services
As early as 1984, researchers were considering how hospital specialty programs such as freestanding imaging centers, physical therapy, alcoholism recovery, and surgicenters - could be successfully franchised (Fuss 1984). St. James Hospital in Chicago
Heights franchised its Industrial Medical Technician Program to other hospitals,
including detailed instruction manuals and marketing techniques for the trainers
(Anonymous 1984). Meanwhile, Medical Networks Inc. began marketing freestanding
ambulatory care centers to hospitals in the Midwest, and similar operations were
underway in California through Sutter Medical Management and US Medical Enterprises
(Anderson 1985). Medical doctors provided primary care and other services - including
industrial medicine and employee physical exams - in a convenience clinic setting (i.e.,
appointments were not required). In addition to advertising and promoting the MedStop
brand name, Medical Networks boasted a quick entry time to the market, quality
assurance via computerized patient record reviews, and managerial expertise.
More recently, Serviscope Corporation began offering a turnkey package of
refurbished cardiac catheterization equipment in 1993 to hospitals seeking to expand their
cardiology department but unable to afford the newest equipment (Freiherr 1994;
Southard 1994). Serviscope shared the financial risk with the hospitals that used its labs,
but, unlike MedCath and other specialty hospitals, the cardiologists involved had no stake
in ownership to protect themselves against self-referral restrictions. Issues concerning
chains compliance with fraud and abuse laws are explored more fully below.
131
International healthcare
Regardless of the industry, franchising is much more common in the United
States than in other countries. Not surprisingly, then, healthcare franchising outside of
the US is a rarity. Several studies have focused on social franchises that are used for
delivering family planning and reproductive health services in developing countries
(Fiedler and Wight 2003; Kumaranayake et al. 2000; Montagu 2002; Peters et al. 2004;
Prata et al. 2005; Stephenson et al. 2004). However, these programs are perhaps better
described as pseudo franchises for the purpose of this research since social franchises
are often characterized as a public-private partnership where profitable outlets subsidize
the money-losing outlets. As one of the authors explains, [Bolivias] PROSALUD
probably does not meet all of the technical requirements for being a franchise
operation p. 183 (Fiedler and Wight 2003).
There are several examples of healthcare franchising in the United Kingdom but,
like the social franchise misnomer, it is not clear that these are actual franchises. For
instance, any hospital that received zero out of three stars on the National Health System
Performance (Star) Rating System had three months to improve its performance, or else
the management of the hospital will be put out to franchise p.22 (Appleby and Harrison
2002). Meanwhile, Hiffe (1996) characterized the modernization of Britains National
Health System as a franchisor and franchisee relationship between the National Health
System and general practitioners, respectively. But as Campion (1996) argued, it is
doubtful that this relationship holds in the traditional sense of the franchisor and
franchisee relationship.
132
Feasibility of Franchising in Healthcare

Because of the pervasiveness of chain organizations in many healthcare sectors for example, over half of all kidney dialysis centers, nursing homes, and hospitals are
chain-affiliated - the lack of healthcare franchises is not likely to be due to issues with
healthcare chain organizations per se, but rather with the ownership of the chain outlets.
The fundamental difference between a company-owned and a franchised outlet is how the
principal-agent relationship is managed and the incentives each arrangement creates for
the two parties. Therefore, the discussion that follows focuses mostly on franchises
versus company-owned chains, rather than franchises versus independent firms.
Given the number of successful health-related chain organizations currently in
business, it is reasonable to assume that many consumers not only accept but patronize
chains for their healthcare needs. Provided that a consumer would use a healthcare chain,
the distinction between franchised and company-owned outlets is unlikely to matter since
it is doubtful that she is aware of her particular chains outlet ownership structure. Even
if the ownership type is known, the consumer would presumably be indifferent between a
company-owned and franchised outlet since one of the hallmarks of franchising is
consistent quality and product throughout the firms outlets, regardless of outlet
ownership.16
This view is supported empirically by McIntyre and Gilbert (1999) in their study
of consumer receptiveness to healthcare franchises. The authors classified respondents
into two groups - receptive and unreceptive to healthcare franchising - and compared
their differences on five constructs: competence, access, interactions, ownership, and
16 Consumers may prefer an independently-owned healthcare business over a chain-affiliated firm,
regardless of whether the chains unit is owned by the company or a franchisee. In this case, the owner of
the chains outlet is irrelevant.
133
price. Compared to non-receptive consumers, those receptive to healthcare franchising

(79% of the 548 respondents) placed significantly greater emphasis on all of the
constructs except ownership. In fact, both groups regarded unit ownership as the least
important attribute.
On the opposite end of the spectrum, McIntyre and Gilbert found that competence
was the most important aspect for consumers, regardless of their receptiveness to
franchising.
The competence construct was comprised of several quality-related
questions, including facility has strict quality control standards and the same quality
service is provided each time you visit p.51 (Ibid.). Because consumers cannot as easily
judge quality within healthcare as they can with non-healthcare industries, quality
indicators can be very valuable and effective search tools for healthcare consumers,
whether provided by the government or privately (e.g., the National Committee for
Quality Assurances Health Plan Employer Data and Information Set and Medicares
hospital, nursing home, and dialysis facility compare websites).17 As consumer-driven
health plans grow in popularity and consumers become increasingly responsible for their
healthcare decisions, it is likely that the brand-quality link will become even more
important to them.
Revolution Health Group, a health company launched in February of 2005, is
anticipating what will be important once consumers are in the drivers seat. In addition to
healthcare information websites and software dedicated to helping consumers manage
their healthcare spending, Revolution Health Group also has a controlling interest in a
consumer-directed healthcare platform for companies and provided the capital for a
17 http://www.ncQa.org/programs/hedis/. http://www.hospitalcompare.hhs.gov/,
www.medicare.gov/NHCompare/home.asp. www.medicare.gov/Dialvsis/Home.asp. accessed March 31,
2006.
134
retail-based medical care chain. Although different products, all of the services reflect
the companys patient-centered focus and, consequently, the importance of branding:
We believe in brands. We seek to build the leading brands in each sector
we target, so we can achieve broad, mainstream appeal. We often will
embrace an existing brand when it is on its way to recognition, but
sometimes we will use our own Revolution brand to jumpstart market
acceptance...we intend to build Revolution into a global consumer brand
that stands for ushering in revolutionary change by giving consumers more
choice, control and convenience.18
As important as a brand names association with a recognized level of quality is
for consumers, the quality-brand link cannot be understated for the chain organization,
either. Indeed, one of the main reasons that franchisees are willing to pay the initial
franchise fee and a continuing percentage of their sales to the franchisor is for the use of
the brand name and the benefits it offers, including quicker entry into the market and
instant name recognition from consumers. However, the benefits of branding only hold
for established franchises with reputable brand names.
Therefore, because of the
uncharted territory, a new chain offering its outlets as franchises will have a harder sell to
potential franchisees than an established chain, regardless of the industry.
Although the process of becoming established is unavoidable for any company after all, even McDonalds and Coca-Cola were once fledgling companies with uncertain
futures - the prominence and instant name recognition of these and many other franchises
today proves that establishing a brand name is not impossible for healthcare or non-health
service companies (e.g., Pearle Vision has been in business for over forty years and
Fantastic Sams has franchised its hair care salons since 197619). That said, the time it
takes a firm (regardless of franchising) to establish its brand name varies greatly. For
18 http://www.revolution.com/revolutionis/default.asp accessed February 22, 2006.

19 http://www.fantasticsams.com/ accessed March 17, 2006.
135
example, within 20 years, Starbucks has grown tremendously (17 stores in 1987 versus
11,225 stores in the beginning of 2006)20 and become ubiquitous throughout the US.
Meanwhile, its competitor, Seattles Best Coffee, which began around the same time and
was also based out of Seattle, was never able to establish its brand to the same extent and
was eventually acquired by Starbucks in 2003.21
To become an established chain with a well-known brand-quality link, a firm
must standardize its service, a charge that may be more difficult in healthcare than in
other industries due, in part, to the autonomous nature of medical professionals (i.e., the
would-be franchisees who need to follow the franchisors detailed business protocol).
For example, Anderson posited that franchising flies in the face of the entrepreneurial
streak in most physicians p.60 (Anderson 1985) and Stem claimed that ...clinicians
had difficulty relinquishing control of everyday operations so that the operations business
manager could effectively do his/her job p.7 (Stem 1993). Although standardization is
inherent to both business-format and product franchising, it may be more of a concern for
the former given its heightened emphasis on uniformity.
Provider autonomy concerns are valid when contrasting an independent contractor
with a franchisee, but are less so when comparing a provider who works for a companyowned chain against a provider-cum-franchisee, since providers resistance to
standardization will be an issue for any chain organization.
Furthermore, being a
franchisee also may be attractive to the characteristically independent medical

professional since it would offer more autonomy than working as a manager in a chainowned unit. And from the franchisors perspective, franchising takes advantage of the
20 http://www.starbucks.com/aboutus/Companv Timeline Feb06.pdf accessed June 5, 2006.

21 http://www.seattlesbest.com/About/release.aspx?ID=l accessed June 5, 2006.
136
motivated entrepreneurial spirit - an often described trait of physicians - of the

franchisee compared to a salaried employee at a chain-owned unit (Anderson 1985).
In addition to personnel, the diverse products and services that comprise
healthcare must be standardized, too. Shane specifically singles out healthcare as an
industry not amenable to franchising in his chapter entitled, Is Franchising Right for
Your Industry?:
This preference for franchising in industries in which products or services
are standardized is why we tend to see franchising in services such as tax
preparation but not in medical care...The process for doing heart surgery
cannot be standardized, and the failure to customize when necessary can
have very severe adverse results. As a result, contracting how to do heart
surgery is difficult, and monitoring the behavior of heart surgeons is too
difficult to make franchising of much value. p. 13 (Shane 2005).
While it is persuasive to argue that it is impossible to codify heart surgery, not all
healthcare services are so complex that they cannot be standardized.
For example,
several companies have begun offering routine medical care, including medical tests,
diagnostic procedures, and vaccinations, through in-store clinics housed in large national
pharmacies and retailers.22 The leading companies in the nascent retail-based medical
care industry - including Minute Clinic, RediClinic, and Take Care Health systems currently own all of their outlets.23 It is not immediately evident why these companies
chose not to franchise, given the importance of the managers effort, high cost of
monitoring employees, and ease (relative to, say, heart surgery) of standardizing their
services. Further speculation on the companies decisions to own rather than franchise is
22 http://www.cnn.com/2006/HEALTH/02/03/clinics.instores.ap/, accessed February 8, 2006.

23 http://www.minuteclinic.com/. http://www.rediclinic.com/. and http://www.takecarehealth.com/.
accessed February 21, 2006.
137
beyond the scope of this paper,24 but it will be interesting to observe if any of the
companies do eventually franchise their outlets.
In addition to standardization concerns, healthcare chains also need to comply
with state-level certificate of need regulations as well as federal laws regarding healthcare
fraud and abuse. Although these laws are an issue regardless of chain or franchise status,
the Ethics in Patient Referral Act (more commonly known as the Stark laws) and the
federal Anti-Kickback statute (U.S.C. 1998a; U.S.C. 1998b) may complicate the
principal-agent relationship more for healthcare chains that franchise than those that do
not.
The Stark laws prohibit physicians from referring patients to health service
entities with which the physicians (or any member of their immediate family) have a
financial relationship. Although an important restriction on self-referral, it is important to
note that with respect to franchising, the Stark laws do not affect all healthcare providers
or services; rather, the law only pertains to physicians and eleven designated health
service entities.25 In fact, some of the providers who do fall under the Stark laws
jurisdictions (e.g., home health service providers) have been able to successfully
franchise. Also, just as a chef does not need to own a McDonalds franchise, it also is not
necessary for a medical professional to own a healthcare franchise. Therefore, having a
24 There is extensive research on this subject in the economic literature for the interested reader (e.g.,
Brickley and Dark 1987, Klein 1995, and Maness 1996).
25 The 11 designated health service entities defined by the Stark laws are: clinical lab services; physical
therapy, occupational therapy and speech-language pathology services; radiology and other imaging
services not including nuclear medicine; radiation therapy not including nuclear medicine; durable
medical equipment and supplies; prosthetics, orthotics and prosthetic devices and supplies; home health
services; outpatient prescription drugs; inpatient hospital services; outpatient hospital services; and
parental and enteral nutrients and associated equipment and supplies. http://www.aafp.org/x37609.xml.
accessed March 31, 2006.
138
medical provider without self-referral concerns or a non-medical personnel as a

healthcare franchisee may simplify the issues related to the Stark laws.
Still, legal issues that may impede healthcare franchising remain. For example,
there is a whole hospital exception to the Stark laws that has recently received
increased scrutiny regarding its applicability to specialty hospitals (specifically, cardiac,
orthopedic, and surgical hospitals) where a physician is part-owner (Guterman 2006;
Kahn 2006). Although physician-owned hospitals do not meet the FTC definition of a
franchise, the physicians face similar incentives that a franchisee would since both have a
financial stake in the business.
As the number of physician-owned specialty hospitals has grown - from 29 in
1990 to 92 in 2003 - so too have concerns of potential conflicts of interest between the
patients needs and the physicians financial incentive (Stensland and Winter 2006).
Accordingly, the Medicare Prescription Drug, Improvement, and Modernization Act
(MMA) of 2003 placed an eighteen month moratorium on the development of new
physician-owned hospitals and also restricted growth in existing facilities until more was
known about differences of referral patterns and patient care between specialty hospitals
and community hospitals (Greenwald et al. 2006; Stensland and Winter 2006). After
reviewing reports by the Medicare Payment Advisory Commission (MedPAC) and the
Department of Health and Human Services, the Center for Medicaid and Medicare
Services (CMS) extended the moratorium through 2006 as the government continues to
examine how specialty hospitals should be paid and if they even meet the definition of a
hospital (Guterman 2006). This continuing debate on how best to deal with physicians
with ownership or investment interests in specialty hospitals may serve as an impediment
139
for other healthcare providers considering franchising or other contractual agreements

that include a financial incentive to the provider.
Unlike the physician-specific Stark laws, the Anti-Kickback statute prohibits any
person or corporation from accepting financial inducements that influence the referral of
a patient or the purchase of a health-related product or service that will ultimately be paid
for by the government (Kalb 1999). This may be more of a concern for a franchisee than
for a salaried manager since the former has a financial incentive that the latter does not.
However, both the principal and agent have an incentive to stay in business, regardless of
the contractual arrangement between them, so it is hard to argue that either would
intentionally receive illegal remuneration. The penalties and collateral consequences
imposed on guilty providers are also quite severe, including imprisonment, hefty fines,
loss of license, and restriction from participating in Medicare and other federal programs
(Kalb 1999; Sage 1999). Indeed, as a franchisor of diagnostic cardiac catheterization labs
states, ...it is in the best interests of everyone that only the patients who need to be
diagnosed are indeed diagnosed p.25 (Freiherr 1994).
And as evident from the
previously discussed healthcare franchises currently in operation, these legal restrictions

may be complex but are not insurmountable.
While the Anti-Kickback statute, Stark laws, and other healthcare-related
legislation help to deter fraud and abuse, one of their other consequences is that many
economically rational transactions that would be encouraged in other industries could be
deemed illegal when applied to healthcare (e.g., a price reduction considered to be a
rebate) (Kalb 1999). Similarly, supplier-induced demand is a potential liability in many
healthcare organizational structures whereas it is selling point and encouraged in other
140
industries, especially among chains that emphasize their brand names ability to gamer
more business than non-chains. The providers ethical standards and desire to avoid
malpractice claims will limit them somewhat from inducing demand, but the threat of
providing unnecessary care can never be completely avoided due to the inherent
asymmetry of information between consumers and healthcare providers (Stensland and
Winter 2006). Although supplier-induced demand is not unique to chain organizations, it
is arguably more of a concern with a franchisee than with an independent healthcare
provider since the franchisee has a financial incentive to provide care. As one author
observes, physician-owners...react to financial incentives. It would, in fact, be odd if
they did not p. 103 (Guterman 2006).
However, to the extent that franchises can provide necessary healthcare services
to consumers who previously could not afford or access them, generating new demand
is not inevitably detrimental to the healthcare system. As discussed above, researchers
found that some customers benefited from the extended hours and walk-in appointments
offered by franchised dental services that were absent in private dental practices (Bush
and Nitse 1992). The same study also found that some consumers who were previously
unable to afford care at private dental practices were able to afford care at retail dental
practices (Ibid.). McIntyre and Gilbert (1999) also found that the price of the service was
important to all respondents in their study, but especially for those consumers receptive to
franchising.
Even when newly generated demand is for previously unmet need, though, the
inelastic demand for most healthcare products restricts the amount of new business. In
addition to the inelastic demand for healthcare, the presence of insurance also restricts a
141
firms ability to increase demand. Because insured consumers only take into account
their subsidized cost rather than the actual cost of care, their observed demand is less
price-sensitive (i.e., more inelastic) than that of uninsured consumers. Therefore, it will
be more difficult for a provider to increase demand through lower prices in healthcare
markets with a high incidence of insurance than in markets with limited or incomplete
insurance. As insurance companies increase co-pays and deductibles and consumerdriven health plans grow in popularity, though, it is expected that even insured consumers
will become more price-sensitive
about their healthcare spending decisions.
Furthermore, the statistic of forty-five million uninsured Americans in 200326 suggests

there is unmet need that could be remedied by providing lower cost services.
Recommendations for Future Research

Given the 7.9% growth in healthcare expenditures in 2004 and the industrys
steadily increasing share of the gross domestic product (GDP) (Smith et al. 2006), it is
critical to understand the myriad of organizational forms, including franchising, that
could be employed to help reduce costs while also providing high quality care. For
instance, it may be easier for franchises to provide lower cost services through improved
resource allocation, increased market power, and other operational efficiencies that are
largely absent with independent firms (Pautler 2003). Franchised-chains also may have
advantages over non-franchised chains because of franchisings greater emphasis on the
entrepreneurial traits and local market expertise of healthcare providers.
These
speculations are derived from economic theory, but it is unknown if they hold empirically
26 http://www.census.gov/Press-Release/www/re1eases/archives/income wealth/002484.html. accessed

April 7, 2006.
142
since, as shown by this review, little research has been done on healthcare franchising.
Therefore, to understand better franchisings role in healthcare, future research should
focus on three of the major stakeholders acceptance of and response to the
organizational form:
healthcare chain organizations (i.e., potential franchisors);
healthcare providers (i.e., potential franchisees); and healthcare consumers.

Since a chain must first offer its outlets as franchises in order for franchising to
exist, more research is needed on how healthcare chains determine the optimal
management method. In healthcare industries that have experimented with or currently
employ franchising, like dental and optical, comparing firms that franchise with nonfranchised chains and independent providers will help define the different incentives each
organization form creates. In industries with no franchising, research may need to be
more qualitative in nature, such as structured interviews with managers and owners
regarding their management choices. In particular, talking to the CEOs of the new retailbased medical care companies and their decision to own rather than franchise their outlets
may provide useful insight into why franchising is relatively rare among healthcare
companies.
Research also is needed on how healthcare providers view franchising. To date,
there is only anecdotal (and dated) evidence on what provider characteristics are
associated with healthcare franchising. For example, Yavner et. al (1988) found dental
franchising to be more attractive to younger professionals (the average age of dentists at
one franchise was just twenty-nine years), and the franchisor of the physician-oriented
American Family Doctor also found his franchises to be most popular with young
physicians right out of medical school (Willen 1992). However, no empirical studies
143
have examined why healthcare providers chose franchising over other options, or why
they do not chose franchising at all.
Therefore, quantifiable research that explores
provider characteristics and how healthcare professionals organize their practice, as well
as whether payment form influences providers reactions to franchising, will help in
understanding the organizational form from the healthcare agents perspective.
Considering the varied financial incentives and pay structures employed by
different healthcare sectors, provider-focused research should begin with comparisons
within healthcare sectors before trying to make cross-sector comparisons. Although a
study comparing dental franchisees against private practice or retail dentists may not
inform research outside of the dental industry, it will help dental consumers and dental
chains better understand the specific providers perspective. Sector-specific research will
also allow researchers to understand the type of healthcare products and services that are
most amenable to franchising. For instance, the Stark laws and Anti-Kickback statute
affect providers differently, so it is to be expected that organizational structures across
industries will also differ to establish the correct incentives while complying with
relevant regulations.
Finally, consumer receptiveness to and experience with healthcare franchising
also should be addressed. Although it is posited that ownership form is largely invisible
to consumers, it should be confirmed with empirical results. Thus far, this area has been
largely ignored, with just two studies exploring healthcare franchising from the
consumers perspective (Bush and Nitse 1992; McIntyre and Gilbert 1999). In McIntyre
and Gilberts study that examined differences in consumers receptive versus not receptive
to healthcare franchising, no differences were found between the two groups with respect
144
to marital status, education, or income (McIntyre and Gilbert 1999). However, receptive
consumers were significantly more likely to be young and male than non-receptive
consumers. Bush and Nitses 1992 analysis comparing patients at retail (comprised of
franchised and company-owned chains) and private dental practices suggests important
demographic differences between dental patients, too. The authors found patients at
retail dental practices were more likely to be younger, single, and earning a lower income
compared to patients at private dental practices. Although both analyses are useful, more
recent studies that examines demographics, insurance status, and healthcare consumption
differences are needed.
In addition to demographics, both studies also examined what criteria or
constructs were most important to consumers in their healthcare decisions. As mentioned
earlier, McIntyre and Gilbert (1999) found competence of the healthcare provider to be
most important for both groups of consumers, but it was significantly more important to
franchising-receptive consumers than those unreceptive.
Similarly, dental patients at
both retail and private dental practices ranked quality of care as the most important
motivation behind their choice of dentist in Bush and Nitses study (1992). However, the
authors also found retail dental customers placed more value on the cost of care,
convenient hours, and whether or not an appointment was required, whereas private
dental customers were more concerned with the reputation and courteousness of the
employees at the practice. It would be useful to know whether this market segmentation
within the dental industry - retail practices satisfying lower price, convenience-oriented
consumers and private practices appealing to quality-oriented consumers - would likely
occur in other healthcare sectors.
145
Because of the importance consumers place on quality, regardless of their

healthcare provider, research also is needed to understand how consumers perceive
advertising and other brand promotion activities commonly employed by franchising.
With the continued growth in popularity of consumer-driven health plans - a recent
survey by the Federation of American Hospitals and the American Hospital Association
estimates that 70% of employers will likely offer a consumer-driven plan to their
employees by 2006, and estimates of people with such plans range from one to four
million (Wilensky 2006) - a better understanding of consumers acceptance of the brandquality link will become increasingly important to firms and consumers alike. To best
address franchisings potential to provide services that are currently unmet, consumeroriented research also should consider differences between insurance status and other
price sensitive indicators.
146
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151
Chapter V
Chapter V. Conclusion
Summary of Findings
This research offers several important implications to policy-makers and other
researchers. To the extent that dialysis chains are acquiring high cost facilities that might
have otherwise gone out of business, the findings presented in Chapter II regarding chain
acquisition of independent facilities could result in more efficient management, improved
treatment patterns, and better clinical outcomes.
Any cost-saving implications are
especially salient for the dialysis patient population due to the high cost associated with
treating them.1 However, as the ESRD industry continues to consolidate through chain
conversions and acquisitions, the decrease in competition may eventually outweigh costreducing benefits. Private insurers will feel the brunt of any chain monopolistic pricing
behavior, and chains with significant market power may also be detrimental for patients
since they will face less choice in dialysis facilities. In the absence of competition,
quality of care - ranging from amenities to clinical indicators - also may decline since a
dominant chain would not need to compete with other units for patients or nephrologist
referrals in its market (Held and Pauly 1983).
1 Although only one-half of one percent of Medicare patients is enrolled in the ESRD program, they
account for 6.6% o f the Medicare budget, translating to $18.13 billion in 2003 (U.S. Renal Data System
2005).
152
The empirical research on dialysis chains suggests a mixed logic motivating

dialysis chain acquisitions that differs slightly from the turn around hypothesis
supported in other healthcare sectors. That is, although dialysis chains are more likely to
acquire facilities that had better quality outcomes, concerns of cream skimming are
mitigated by the fact that higher cost facilities are also more likely to be acquired.
Furthermore, as Chapter HI illustrates, chains are able to maintain higher levels of quality
at their units compared to independent providers. This further lends empirical support to
the theoretical benefits associated with chain affiliation. However, there are still reasons
to be concerned with the consistent growth in chain-affiliated dialysis units. In addition
to monopoly concerns and decreased patient choice, it is not clear if the benefits are
short-lived (i.e., less than five years) or more permanent.
The research presented in Chapter IV offers an alternative to the traditional
healthcare chain: franchising. Although some healthcare sectors have experimented with
this organizational form, it has largely been absent as a business model. Collaboration
between healthcare providers and leaders from other industries that have successfully
franchised their products and services may offer further insight into how this
organizational form could be more widely used in healthcare.
Study Limitations
There are a number of limitations to the findings. The empirical research
presented in Chapters II and IH only looks at acquisition of independent facilities from
1997-2003, so results may not be applicable to other time periods. The results also may
not be generalizable to hospital-based dialysis facilities since they were excluded from
the analysis. However, hospital-based facilities make up a relatively small proportion of
153
the entire industry, and to the extent that their financial characteristics and treatment
patterns are similar to freestanding facilities, providers may still be able to glean
information from these findings.
As mentioned in the Discussion section of Chapter III, the propensity score
methodology employed does not control for unobserved factors that affect treatment.
Therefore, there may be meaningful predictors of chain acquisition that also affect
outcomes that are not controlled for. Although the potential for omitted variable bias is
not unique to propensity scores, it is a limitation nonetheless.
Some researchers have criticized the incompleteness of the cost report data
(Bednar 1992; Magnus and Smith 2000; Medicare Payment Advisory Commission 2004).
However, as the only available source of dialysis cost data, cost reports have been used in
other studies and also to monitor and modify Medicares ESRD payment policy.2
Furthermore, the number of dialysis treatments reported on the cost report is highly
correlated with the number of dialysis treatments reported on Medicare claims,
strengthening the credibility of the cost report data.3 Additionally, CMS has recently
made efforts not only to refine the minimum file requirements but also to increase the
number of flags that alert providers to Potential Rejection Errors; for example, zero or
negative values for number of dialysis treatments, implausible dates, etc.4
2 For example, see KECCs Methodology for Developing a Basic Case-mix Adjustment for the Medicare
ESRD Prospective Payment System: http://www.SDh.umich.edu/kecc/pps/Case Mix Methods Report
Final appdx 040105.pdf accessed August 12, 2005.
3 Personal communication with Marc Turenne, KECC.
4 http://www.cms.hhs.gov/manuals/publ52/P152 34.zip. accessed July 12, 2005.
154
Future Research
Future analyses that include longer follow up time of outcomes will help address
the permanency of the empirical findings regarding the effect of dialysis chain acquisition
on outcomes. Additionally, just as small versus large chains were examined separately
with regard to acquisition strategy, future research that applies a similar refinement of
chain status should be applied to outcomes of interest since different chains may focus on
different components post-acquisition.
Given the consistent and significant findings regarding dialysis chains effect on
quality, future research that incorporates other quality indicators, such as urea reduction
ratio (a measure of how much waste is removed from the body during dialysis) and
hospitalization would contribute to a better understanding of how chain acquisition
affects different quality measures. Because EPO is the most common method employed
for treating low HCT in dialysis patients, examining how EPO costs and use change after
chain acquisition could also reveal important findings regarding the cost/quality trade-off
made by dialysis providers.
Research also is needed on how healthcare chains determine the optimal
management method to better understand the role of franchising in this industry. In
healthcare sectors that have experimented with or currently employ franchising,
comparing firms that franchise with non-franchised chains and independent providers
will help define the different incentives each organization form creates. In industries
with no franchising, research may need to be more qualitative in nature, such as
structured interviews with managers and owners regarding their management choices.
155
Furthermore, no empirical studies have examined why healthcare providers chose

franchising over other options, or why they do not chose franchising at all. Therefore,
quantifiable research that explores provider characteristics and how healthcare
professionals organize their practice will help in understanding franchising from the
healthcare agents perspective.
Finally, consumer receptiveness to and experience with healthcare franchising
also should be addressed. Thus far, this area has been largely ignored, and studies that
examine consumer demographics, insurance status, and healthcare consumption
differences are needed to better understand what constructs are most important to
consumers in their healthcare decisions.
156
References for Chapter V

Bednar, B. 1992. The Value of the Medicare Cost Report. ANNA Journal /American
Nephrology Nurses' Association 19(3):235.
Held, P.J. and Pauly, M.V. 1983. Competition and Efficiency in the End Stage Renal
Disease Program. Journal o f Health Economics 2(2):95-118.
25(4):65.
Medicare Payment Advisory Commission, 2004. Report to the Congress: Sources of
157

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AN EXAMINATION OF ORGANIZATIONAL CHANGE AND

STRUCTURE IN THE HEALTHCARE INDUSTRY

Alyssa Suzanne Pozniak

A dissertation submitted in partial fulfillment

UMI Number: 3238062

ProQuest Information and Learning Company

Alyssa Suzanne Pozniak

Many thanks to my committee for their assistance and support throughout my

Finally, this acknowledgement would not be complete without a huge

Methods and Data.

Given the rapid growth in US healthcare expenditures, it is critical to understand

More broadly, it is critical to understand the myriad of organizational forms that

Some healthcare sectors have

This thesis examines the characteristics of independent (i.e., non-chain affiliated)

Chapter II. Modeling the Likelihood of Chain Acquisition Among Independent

Although chain affiliation may yield

of acquisition by a small chain but was not a significant predictor of acquisition by a

Rationale for Acquisition in the ESRD Industry

Pc reflects the NPV of the facilitys profit under the chains

ownership, discounted at interest rate rc over time i:

Regardless of the owners involvement and

The CMS payment system for ESRD services

Concerns about chain growth in the ESRD industry

The usual concerns of underproduction and overcharging by

Prior studies have found no evidence of

This may be a result of the mixed findings on the importance and

dichotomous independent variable. The potential under-specification caused by using a

Schlesinger et al. (1989) found significant

Banaszak-Holl et al. (2002) employed three levels of chain size to investigate

Determinants of chain acquisition

Using hospital financial conditions to predict their likelihood of

hospitals that converted and then by hospitals that merged.

Although perhaps less

New contribution to the literature

To better understand the motivation behind chain growth among dialysis

facility performance (financial,

treatment patterns, and clinical); market factors; and payer mix.

Hypothesis 1: Facility performance

9 Provider Reimbursement Manual Part II - http://www.cms.hhs.gov/manuals/publ52/PUB 15 2.asp.

At some cost, dialysis facilities with a low

Poor performing facilities may seek chain

12 www.medicare.gov/Dialvsis/Home.asp. accessed August 15, 2005.

From Hlc, it is expected that facilities with a lower percentage of patients

Hypothesis 2: Facility market factors

It follows, then, that dialysis chains would be more interested in acquiring

facilities in markets where there is relatively low competition, ceteris paribus.

The m easure ranges from nearly zero, reflecting nearly perfect

competition, to 10,000, indicating a pure monopoly. To capture the concentration of

Hypothesis 3: Facility paver mix

As previously discussed, unlike Medicare treatments, there is no

regulation concerning the price charged by dialysis facilities to private insurers.

Data and Methods

Several false positive chain

were considered to be chains.

Additionally, misspellings of chain affiliation were

corrected so that an accurate tally of affiliated facilities could be calculated.

Other facility characteristics

14 http://www.esrdnetworks.org/. accessed July 12, 2005.

17 http://www.cms.hhs. gov/data/download/hcris rnl/default.aso accessed on December 22, 2004.

Medical Evidence Forms

CMS physician supplier and institutional claims

AARPs State Profiles

Annual Facility Surveys

log [P(</(l-P)] = a, + Pixi + ... + Px,f + e