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This is the first entry in a new series from Duke Strategy Professor Will Mitchell.

Most criticism of the US health care system focuses on its high costs, variable quality, and limited access. These criticisms are often apt, but they miss an increasingly important issue – which is that the US healthcare system creates disadvantages for established US businesses compared to younger firms and to foreign competitors. This two part series outlines the problem and suggests a starting point for solutions.

PART 1 – PROBLEMS

US health care – high costs, variable quality, limited access: The US health care system regularly faces attacks for having high costs and variable quality, while offering only limited access when compared to health care systems in most other developed countries. The usual criticisms focus on the large number of people in the country who have little or no health care insurance, while common measures of health quality, such as mortality rates, lag many countries in Europe, Asia, and elsewhere, despite the fact that the costs of health care have grown to more than 15% of Gross National Product (the OECD reports that the US spent about $6,700 per capita on health care in 2006, more than 1.5 times the next highest country, Norway). Analysts regularly question whether even the current cost level is sustainable, an issue that has come to the fore again during the current recession.

Brief aside: In anticipation of criticisms from my colleagues in outstanding US hospitals and other health care providers – I am deeply aware of the incredible strengths in innovation and care that are available in many parts of the US health system. And a large part of the population enjoys access to outstanding care, even if the costs are high. There are powerful parts of the system that we need to cherish and preserve. But there are fundamental flaws in cost, quality, and access that we need to address, or they will pull down the towers of strength.

Depending on employment-based health care is unhealthy for business: While most of the attention focuses on costs and access to health care for individuals, there is a hidden problem that may slow our recovery from the recession by inhibiting the ability of established firms to lead a recovery.  The core problem is that health insurance for most of the working population in the US is tied to employment. Employers – particularly large and established employers – provide medical insurance as an employment benefit and, in many cases, as a continuing benefit to retired employees. While this approach has several attractions, partly based on the ability to reduce rates by generating large pools of insured lives and partly based on the tax-free status of the benefit, employment-based insurance creates competitive problems for established firms. (Employment-based insurance also creates problems for employees who lose their jobs – an issue that is highly salient in the current economic climate – but let’s focus on the competitive disadvantages for businesses, which receive less attention and often lead to lost jobs).

Established firms pay more for health insurance: The competitive problem is simple. Established firms tend to have older workforces and more retirees than newer firms. Older workers cost more to insure (we get sick more often and more expensively) and retirees often continue to be a cost at least until they qualify for Medicare coverage (and often beyond, if Medicare covers only part of their medical costs).

Two disadvantages: As a result, established companies have disadvantages relative to two classes of competitors.

Disadvantage 1 – Old firms pay more for health insurance than young firms: Older firms have higher health insurance costs than newer companies in the US. The Big Three auto companies, especially GM and Ford, are prototypical examples of this problem. Their medical benefit costs are substantially higher than more recently established plants in the US, such as Toyota and Honda’s American facilities. The New York Times recently reported estimates that more than half of the wage disadvantage of the Big Three versus Honda and Toyota plants in the US is made up of the difference in pension and health care costs to retirees, owing to the fact that the new plants had not been in the country long enough to have a large group of retirees. And even part of the remaining differences arises because Honda and Toyota have a younger workforce in the US, which is cheaper to insure, so that equivalent benefits cost less.

Disadvantage 2 – US firms pay more for health insurance than foreign competitors: Most firms that provide employee health insurance in the US –  which is predominantly established firms – have a disadvantage relative to companies in countries that offer a broad base of national health insurance, rather than tie insurance to employment. Again picking up on the auto example, Japan is an obvious case in point, in which Detroit’s vehicles need to cover costs that plants in Toyota City and Nagoya do not, because the health costs are covered through income taxes and general funds, rather than coming directly out of corporate bottom lines. Of course, this issue is exacerbated by the fact that the Japanese medical system is much more efficient than the US system, producing at least as good quality of care for much less money on average, but even ignoring the efficiency difference, US firms have a disadvantage.

Implication – Established firms are more likely to fail than younger firms and foreign competitors, even if they are strategically equivalent: This is a bad set of results. In the extreme, the first disadvantage means that established firms may be more likely to go out of business when they face younger competitors. The second disadvantage means that established firms may fail when they face effective foreign competition. In both cases, the failures cause substantial hardship for employees, communities, supply chains, and shareholders.

Is this relevant today? The Big Three auto makers are a case in point. Most of the criticism of their pleas for a public bailout has focused on claims of high wages and managerial incompetence. But the underlying problems stem much more from structural disadvantages, with health care costs being a major contributor (supply chain and dealer network rigidities are two other structural problems, but those are beyond the scope of this discussion), rather than from greedy line workers or inept managers.

This has been a quick overview of the competitive problems. Tomorrow, let’s look at some solutions.