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Responses to prospective payment by rural New Mexico hospitals.

A cross-sectional study is used to determine how rural New Mexico hospitals altered service diversification, inpatient service emphasis, and service promotion during Medicare's prospective payment system (PPS) transition and posttransition phases. Results suggest that the hospitals implemented distinct strategies in response to PPS. The posttransition strategies were examined for their association with improved revenue and utilization indicators. Few of the service diversification and promotional strategies were consistent predictors of performance. Emphasis on fine-tuning inpatient services was the most promising predictor of higher utilization and revenue measures. The implications for other rural hospitals are discussed.

Rural hospitals face an inauspicious environment not only from the perspective of economic (Cordes 1989) and demographic (Norton and McManus 1989) trends, but also due to pressures from an evolving health care system (Moscovice 1989). The convergence of these forces has led to an increasing number of rural hospital closures potentially affecting access to health services (Mullner et al. 1989; Mullner and McNeil 1986; Mullner, Byre, and Kubal 1980). The economic viability of rural communities may also be threatened by hospital closures (Christianson and Faulkner 1981). Despite these problems, few definitive resolutions have surfaced in health services research (Moscovice and Rosenblatt 1985a, 1985b). This has stimulated a call for more research on predictors of rural hospital economic viability, prospective payment's fiscal impact on rural hospitals, and financially promising diversification strategies that can be used by rural hospitals (Hirsh and Van Hook 1989).

The implementation of prospective payment policies by third-party reimbursers presents a distinct impediment to rural hospitals' financial viability. A complex mixture of unique cost structures, service delivery features, and low utilization rates exacerbates rural hospitals' inability to overcome prospective payment constraints (Finch and Christianson 1981; Hatten and Connerton 1986). Additionally, sole community hospitals confront local expectations, thereby complicating the situation (Freiman and Cromwell 1987). Consequently, rural and sole community hospitals are more likely to possess low or negative operating margins (Guterman, Eggers, Riley, et al. 1988; Guterman and Dobson 1986). Many rural hospitals are also experiencing lower utilization, which threatens fiscal solvency (Farley 1988; Smith and Pickard 1986). These forces have led to an increasing prevalence of hospital closures (Ermann 1990; Nemes 1988). In sum, rural hospitals are at risk fiscally due to prospective reimbursement.

The article examines the responses of rural New Mexico hospitals to prospective payment pressures and the association of these responses with revenue and utilization. The primary objectives are (1) to ascertain whether rural hospitals reconfigured their service delivery strategies during Medicare's prospective payment system (PPS) posttransition (since early 1988) compared to the transition phase (1983-1987), and (2) to examine the association of the posttransition strategies with revenue and utilization indicators normally linked to fiscal viability.


A growing body of theoretical and empirical research has explored hospital responses to significant environmental shifts (e.g., Medicare PPS). However, the literature primarily centers on urban hospitals with limited attention given to rural hospitals. A theoretical framework similar to that studied by Friedman and Shortell (1988) was adopted for this article. Drawing on the strategic adaptation (Chakravarthy 1982) and health services literature (Kimberly and Zajac 1985; Shortell, Morrison, and Robbins 1985; Weiner, Maxwell, Sapolsky et al. 1987), it is theorized that rural hospitals implement adaptive strategies in addressing the constraints of PPS. Previous models suggest that regulatory policy changes such as PPS provide incentives for hospitals to adjust operations in order to reach desired goals (Cook et al. 1983; Gay et al. 1989; Smith and Mick 1985).

Strategic adaptation theory has been examined extensively in the private sector from the perspective of ascertaining how organizations alter strategy to improve performance (Hambrick 1980; Hambrick and Lei 1985; Hitt, Ireland, and Stadter 1982; Prescott 1986). Recent analogs can be found addressing health care organizations and their adaptive strategies (Friedman and Shortell 1988; Luke and Begun 1988; Zajac and Shortell 1989). Furthermore, related analysis has been made of rural hospital responses to environmental factors (Amundson and Rosenblatt 1988; Berry et al. 1988; Berry, Tucker, and Seavey 1987; Seavey and Berry 1986). However, limited attention had been given to PPS-induced strategy changes by rural hospitals and the relationship of such changes with financial or utilization variables.

Theory suggests that fiscally viable rural hospitals will actively respond to PPS through specific strategy changes (Guterman, Eggers, Riley, et al. 1988; Melnick and Zwanziger 1987). Rural hospitals are challenged to formulate and implement strategies addressing PPS constraints and the threats to fiscal viability. This process of strategic adaptation is not expected to vary extensively for rural hospitals compared to other organizations (Hatten 1982; Ring and Perry 1985). The common denominator is devising optimal strategies (Mintzberg 1978; Porter 1980, 1985; Hofer and Schendel 1978). Nonetheless, formation of effective strategies is very difficult for rural hospitals to undertake. Previous research suggests that rural hospitals are less able to adapt to PPS pressures than urban hospitals (Gay et al. 1989).



PPS provides incentives for hospitals to expand their revenue base and to improve utilization (Ermann 1990; Moscovice 1989). To achieve higher revenues and utilization, hospitals must first alter their service delivery strategies. A wide range of options is available. Service diversification involving outpatient and other health-related services (e.g., long-term care, swing beds, ambulatory surgery, outpatient rehabilitation, urgent care, outpatient substance abuse treatment, etc.) has received considerable attention as a favorable approach for enhancing revenues and utilization (Friedman 1986; Golda 1981). However, it should be noted that service diversification does not always guarantee improved performance (Clement 1987, 1988). Despite mixed support from the initial research available, rural hospitals are hypothesized to respond to PPS by pursuing service diversification.

Inpatient services represent another way to influence revenues and utilization in rural hospitals (Moscovice and Rosenblatt 1985b). Rural hospitals can fine-tune inpatient services (e.g., inpatient surgery, obstetrics, pediatrics, general medical services, rehabilitation, etc.) to meet community needs and optimize resource use. Rural hospitals are hypothesized to respond to PPS by intensifying their emphasis on key inpatient services. Promotional strategies (e.g., advertising, guest relations, market research, improving access to care, changing facility appearance, cultivating physician relations, etc.) communicate the availability of hospital services to a community or service area (Clark and Shyavitz 1987; McCarthy 1987; McDevitt 1987). Greater visibility improves the opportunities for service utilization and the prospects for higher revenue (MacStravic 1988). Rural hospitals are hypothesized to respond to PPS by more intensely promoting their services.

The staged introduction of PPS provided a convenient opportunity for assessing strategy changes between transition and posttransition periods. Prior research in hospitals (Zajac and Shortell 1989) and non-health care organizations (Kim and Lim 1988; Smith and Grimm 1987) indicates that major environmental shifts such as PPS motivate nonrandom strategy changes. In effect, hospitals adopt generic strategies as responses to PPS. The magnitude of strategy change varies within each hospital's unique situation.

Medicare PPS was gradually phased in during the transition period 1983-1987. The rates took effect in federal Fiscal Year 1984 (in some cases, hospitals began their fiscal years after October 1, 1983). Full implementation of PPS began in FY 1988. For example, a hospital's Medicare reimbursement might have fluctuated in the manner shown: [TABULAR DATA OMITTED]

To interpret the preceding figures, the federal rates represent a blending of regional and national rates. The hospital-specific rate is based on historical costs for a particular hospital and derived from prior Medicare cost reports. Thus, in FY 1987, 25 percent of the Medicare reimbursement rate is based on the hospital-specific cost experience (adjusted for inflation), and 75 percent of the rate is based on the federal cost experience. Given these rate policy variations, hospitals faced a significant challenge in determining the strategy implications.

The transition period was a time of uncertainty about how reimbursement policy would evolve. There were mixed messages and results for hospitals as they attempted to understand and react to the new policies. Many hospitals undoubtedly experienced false starts in the strategic adaptation process. Strategies were reformulated as hospitals acquired more information on PPS implications, monitored industry trends, and obtained direct feedback on their unique strategy adaptations. Due to the vagaries of the transition period (1983-1987) and subsequent stability in reimbursement policy beginning in FY 1988, this study bifurcated the PPS period into the transition period (1983-1987) and posttransition period (1988 to the present).

According to the first three hypotheses investigated in this study, rural hospitals are more likely to emphasize service diversification, inpatient services, and promotional strategies in the posttransition period than in the transition period. The transition period was intended to moderate the impact of PPS. It was a time in which hospitals could carefully formulate or craft strategies as the constraints and direction of PPS became more apparent (Mintzberg 1987). By 1988, it was predicted, hospitals would have a better understanding of PPS and a well-defined set of strategic adaptations that would be receiving emphasis (Hamermesh 1986; Quinn 1980). Therefore, the transition and posttransition periods provide a convenient point of bifurcation for strategy emphasis.



Revenue and utilization are benchmark performance indicators and a primary reason for altering strategy. They form the primary dependent variables in this study. It is hypothesized that hospital revenues and utilization will vary positively with hospital strategy changes designed to diversify services, intensify emphasis on inpatient services, and increase service promotion. Specifically, it is predicted that posttransition strategies are associated with higher revenues and utilization in rural hospitals.

It is necessary to control for various market variables potentially affecting the strategy-performance relationship (Griffith 1988). This is particularly true for rural hospitals located in communities with relatively poor economies. Since this study is limited to one state with inherently congruent market and economic characteristics among rural communities, fewer variables required control during the analysis. Two control variables were selected.

The percentage of population over 65 years old is predicted to be an indicator of patient demand. Although prior studies have reported mixed results, older people are expected to utilize more hospital services (Berry, Tucker, and Seavey 1987; Friedman and Shortell 1988). The level of family income may also influence patient demand (e.g., in the ability to afford health insurance). Higher income levels in rural communities are thought to improve access to primary and acute care services (Rowland and Lyons 1989). It is hypothesized that rural hospitals have higher revenues and utilization when located in communities with a high percentage of people over 65 years old and with a high median family income.



Economic models have traditionally been used in explaining why hospital costs vary. Prior research has examined variations in efficiency and cost levels relative to inputs, outputs, and contextual factors (Cromwell et al. 1987; Feldstein 1979, 1981; Finch and Christianson 1981; Friedman and Pauly 1983; Lave and Lave 1978; Lave and Leinhardt 1976; Salkever, Steinwachs, and Rupp 1986). Although economic research on hospital costs provides a foundation for studying financial performance variations in rural hospitals (Davis 1974; Sloan and Steinwald 1980), a more comprehensive model is applicable in the area of strategy formulation (Chakravarthy 1982; Shortell, Morrison, and Robbins 1985; Weiner, Maxwell, Sapolsky, et al. 1987). Such a model proposes that financial performance can be influenced by strategic adaptations to exogenous factors such as environmental pressures (e.g., reimbursement policy revisions), regulation, public expectations, external factions or constituents, and other variables (Gay et al. 1989).

Hospital revenues (i.e., gross revenue per patient day and net income per patient day) and utilization (i.e., occupancy rates and discharges) from the dependent variables in this study. Independent variables include hospital strategic activity (i.e., outpatient service diversification, inpatient service development, and expanded promotion) and moderating variables (i.e., county population and family income). The causal links between independent and dependent variables have been defined in the health economics literature. Two reviews of the literature as it pertains to rural hospitals have been presented by Moscovice (1989) and Moscovice and Rosenblatt (1982). Presented next are the explicit causal relationships and prior studies upon which the predicted relationships are based.

Outpatient service diversification and inpatient service development are expected to lead to higher gross revenues per patient day, because additional services (beyond the traditional service component) are provided for which charges can be levied (Clement 1987; Golda 1981; Moscovice and Rosenblatt 1985b). Expanded promotion is anticipated to enchance a hospital's visibility in a community and surrounding area/region (MacStravic 1988; McDevitt 1987). Higher gross revenues result from patients and physicians who are attracted to the hospital and subsequently use outpatient or inpatient services, or who refer other potential users (Ermann 1990).

Outpatient services normally offer higher profit margins (Ermann 1988; Hospitals 1988). Consequently, outpatient service diversification should lead to higher net income levels per patient day (Shortell 1988). Inpatient service development and promotional emphasis are expected to produce high net income levels due to economies of operation (Francisco 1970; Lave and Lave 1970). As fixed costs are spread over a larger revenue base (due to a larger patient component attracted by promotion and the availability of more diverse inpatient services), rural hospitals have a better opportunity to derive net income (Berry 1974; Mullner et al. 1989).

Outpatient service diversification is expected to raise both occupancy levels and discharges due to inpatient referral (i.e., a percentage of the patients using new outpatient services will need more intensive acute care) (Ermann 1988; Ermann and Gabel 1985). Promotion will raise occupancy and discharges because physicians and patients will become more aware of hospital services and more likely to use the services when needed (MacStravic 1988). Inpatient service development will generate a higher number of admissions and inpatient days (thereby raising occupancy), and a corresponding higher number of discharges due to the service delivery effort (Finch and Christianson 1981).

County population and family income should be positively associated with hospital revenues and utilization (Brecher and Nesbitt 1985; Friedman and Shortell 1988). Higher population densities offer the potential for higher demand (due to a larger patient base) that raises both revenues and utilization (Morrisey, Sloan, and Valvona 1989). A higher percentage of the population on Medicare is expected to improve the financial prospects for rural hospitals (Friedman and Shortell 1988). Higher median family income levels are more likely to improve revenues and utilization because patients can afford health insurance or can personally pay for the cost of care (Rowland and Lyons 1989).



The sample population included all rural (i.e., outside of an MSA - Metropolitan Statistical Area) nonfederal hospitals in New Mexico - a total of 24 hospitals (one facility was deleted from the sample population because it had recently undergone a change of administrators). Data were collected using survey questionnaires (copies are available from the senior author) and from audited 1988 Medicare cost reports. A total of 22 hospitals (92 percent compliance rate) returned the survey questionnaires completed by each hospital's top administrator. The questionnaire was formulated with the advice of a rural hospital administrator advisory panel and pretested in several rural hospitals (not included in the final sample).

A single-state sample has several advantages. First, it facilitates examining hypothesized relationships under fairly consistent regulatory, epidemiologic, market, and reimbursement conditions. Second, the hospitals experience similar economic, cultural, ethnic, and demographic environments, yet with sufficient differences to ensure variability in strategic responses. Third, New Mexico is a predominantly rural state. It possesses one major metropolitan area. The rural hospitals serve a decidedly rural population where there is little room for contamination from adjoining or nearby urban centers (either in-state or out-of-state).

How do New Mexico's numbers compare with national statistics on rural hospitals? According to several sources (American Hospital Association 1988; Hatten and Connerton 1986), New Mexico has fewer Medicare discharges per hospital than U.S. rural hospitals (585 compared to 945). It serves a slightly more severe case mix (1.0381

This research was supported by grants from the Lovelace Medical Foundation and the Research Allocations Committee of the University of New Mexico.

Address correspondence and requests for reprints of Howard L. Smith, Ph.D., Professor and Associate Dean, Anderson School of Management, University of New Mexico, Albuquerque, New Mexico 87131. Neill F. Piland, Dr. P.H. is Director of the Center for Health and Population Research, Lovelace Medical Foundation, Albuquerque, New Mexico; and Annette M. Philipp, M. P. H. is Research Associate in the Center for Health and Population Research, Lovelace Medical Foundation. This article, submitted to Health Services Research on April 16, 1990, was revised and accepted for publication on October 29, 1990. compared to 1.0229) and provides a shorter average length of stay (6.8 compared to 7.4). Total costs per discharge are higher in New Mexico ($3,471 compared to $3,007) ostensibly due to higher ancillary charges ($2,146 compared to $1,782). The average bed size (60) for rural New Mexico hospitals is approximately 25 percent lower than the average U.S. rural hospital. These statistics seem to suggest that New Mexico hospitals are fairly comparable to the average rural hospital in the United States.


A data base was established around survey questionnaires, census records, and Medicare cost reports. Strategic responses to PPS were measured by a survey questionnaire that was formulated from previous research (Friedman and Shortell 1988). Hospital administrators indicated the extent to which their hospitals emphasized specific diversified services, inpatient services, and promotional strategies on a seven-point scale (1 = no emphasis; 7 = much emphasis). The use of executive perceptions to assess strategy emphasis is a prevalent research methodology (Bourgeois 1980; Luke and Begun 1988; Zajac and Shortell 1989).

The administrators distinguished the extent of strategy emphasis during the PPS transition period (1983-1987) and posttransition period (after 1987). Because the hospital administrators were expressing retrospective views on strategy emphasis in the transition period while simultaneously indicating their strategy emphasis in the post-transition period, it is essential to underscore the cross-sectional nature of these perceptions. Tests for reliability using Cronbach's coefficient alpha suggest very acceptable scores for administrator responses on diversified services (transition strategy alpha = .683, posttransition strategy alpha = .827), inpatient services (transition strategy alpha = .850, posttransition strategy alpha = .755), and promotional strategies (transitional strategy alpha = .872, posttransition strategy alpha = .857).

Financial and utilization data were acquired from audited 1988 Medicare cost reports collected from the Medicare intermediary. Two revenue indicators were calculated: gross revenue per patient day (i.e., gross revenue [divided by] total patient days provided) and net income per patient day (i.e., net income [divided by] total patient days provided). Two utilization indicators were also calculated from the Medicare cost reports: percent occupancy (i.e., total patient days provided) [divided by] total patient days possible) and discharges (i.e., total number of patient discharges). Descriptive statistics and intercorrelations for these variables are shown in Table 1.


As the seminal literature on rural hospitals suggests (Ermann 1990; Moscovice 1989; Moscovice and Rosenblatt 1985b), rural hospitals can expand revenues and improve utilization when responding to PPS. The two revenue and two utilization measures adopted in this study are: (1) commonly examined in health services research, (2) illustrative of target end results used by hospital executives when assessing performance, and (3) indicative of rates or ratios (i.e., per patient-day calculations) as well as volume (e.g., discharges). The use of per day figures as the dependent variable means that the models tested attempted to explain case, service, and payer mix, but not volume. However, the discharges variable is used as an indicator of volume. Rural hospitals are interested in simultaneously increasing the volume of services provided (to cover overhead costs) and achieving efficiency in service delivery (represented by the ratio measures).

Finally, data on the control variables (Berry et al. 1988) were obtained from updated census projections. The percentage of population greater than 65 years old was measured for each hospital's home county (mean = 12.6; s.d. = 6.4). The median family income was also identified for each hospital's county (mean = ($9,280; s.d. = $2,735). During the analysis many other control variables were examined, including ownership status, chain membership or multi-institutional affiliation, sole community hospital status, case-mix index, and number of practicing physicians in each hospital's home county. None of these variables surfaced consistently in statistically significant results. They were dropped from the analysis to conserve degrees of freedom. Median family income was also deleted because it seldom became a statistically significant predictor of the dependent variables. Its exclusion did not measurably alter the results.


The analytical approach used t-tests to ascertain differences in strategy emphasis between transition and posttransition periods. This phase of the analysis addressed the first three hypotheses. Next, each strategy was correlated with the revenue and utilization indicators to identify associations. This phase explored the second set of hypotheses. Finally, in controlling for moderating variables, ordinary least-squares regressions examined the association of strategies and control variables on the dependent variables (i.e., revenue and utilization). Interest in proceeding conservatively relative to statistical tests ultimately led to regressions with only two independent variables (i.e., strategy and percent population greater than 65 years old). Regressions using backward elimination were also examined, but the results were little different from those reported.


Rural New Mexico hospital administrators reported their PPS transition strategy emphasis and posttransition strategy emphasis for 18 service diversification alternatives. Although the services are primarily outpatient service oriented, also included are other health-related programs (e.g., managed care plan involvement) adopted by hospitals since the implementation of PPS. Table 2 presents descriptive statistics for the strategies and t-test results.


Only three diversified strategies were identified as receiving more than moderate (i.e., X = 4.0) emphasis during the PPS transition period. Ambulatory surgery (X = 4.68), emergency medical care (X = 4.50), and outpatient diagnostic services (X = 4.23) were the typical strategies used in New Mexico rural hospitals during the transition period to diversify services. In contrast, the remaining 83.3 percent (N = 15) of the service diversification strategies received very limited emphasis according to the administrators.

Additional insight into rural hospital service diversification practices is obtained from the PPS posttransition period. After 1987, the New Mexico rural hospitals report a broader spectrum of strategy emphasis including ambulatory surgery (X = 5.59), outpatient diagnostic services (X = 4.95), emergency medical care (X = 4.86), addition of specialty care (X = 4.45), and outpatient rehabilitation (X = 4.00). The remaining 72.2 percent (N = 13) of the diversification services are not highly emphasized according to the hospital administrators. However, it should be noted that every posttransition service strategy (mean score) is higher than its corresponding transition strategy. For 50 percent (N = 8) of the strategies the emphasis difference is statistically significant (p < .05). Another 16.7 percent (N = 8) of the service diversification strategies have marginally significant (p < .10) differences.

The correlations of service diversification strategies with gross revenue and net income are reported in Table 3. Outpatient psychiatric care and outpatient substance abuse treatment are correlated (p < .05) with gross revenue. Long-term care and emergency medical care have marginally significant (p < .10) correlations with gross revenue. However, the strategy-revenue association changes considerably in the regressions. Outpatient psychiatric care, adult day care, outpatient substance abuse treatment, and hospice are statistically significant (p < .05) predictors of gross revenue. Long-term care, emergency medical care, and outpatient rehabilitation attain marginal significance (p < .10). Neither ambulatory surgery nor outpatient diagnostic services (strategies that the New Mexico hospitals reported emphasizing in Table 2) have statistically significant regressions.

The percentage of population greater than 65 years old in a hospital's home county is a consistent statistically significant predictor of gross revenue. The beta weights suggest a negative association. Thus, a rural Mexico hospital is more likely to achieve high gross revenue per patient day when only a small percentage of people in its home county is older than 65 years.

Table 3 also reports the correlations and regressions for net income. Emergency medical care is the only service strategy significantly correlated (p < .05) with net income. Furthermore, emergency medical care has the only statistically significant regression relative to net income. Twenty-eight percent of the variance in net income is explained by the independent variables - emergency medical care emphasis and population. The statistically significant beta coefficient (p < .05) for emergency medical care indicates that higher net income per patient day is associated with a greater emphasis on emergency care services.


Correlations of the service diversification strategies with occupancy and discharges are shown in Table 4. Outpatient diagnosis (p < .10), emergency medical care (p < .05), and professional offices for providers (p < .10) are correlated with occupancy. None of the regressions for occupancy are statistically significant.


Emergency medical care, professional offices for providers, and home health care services are positively correlated (p < .05) with discharges. The correlation of outpatient diagnosis and discharges is marginally significant (p < .10). The results suggest that more emphasis on these strategies is associated with a higher number of discharges. The negative correlation of swing beds and discharges implies that greater emphasis on swing beds is associated with fewer discharges. Finally, only the regressions for swing beds and home health care are statistically significant. Both regressions explain approximately 32 percent of the variance in discharges. The respective strategy variables have statistically significant (p < .01) beta coefficients.


Rural New Mexico hospital administrators reported their PPS transition strategy emphasis and posttransition strategy emphasis for eight inpatient services. Table 5 presents descriptive statistics for the strategies and t-tests examining differences in strategy emphasis. The data suggest that surgery (X = 5.09), general medical services (X = 5.00), obstetrics (X = 4.82) and the intensive and cardiac care units (ICU/CCU) (X = 4.36) are the main inpatient services emphasized during the PPS transition phase. After the transition, obstetrics (X = became the most emphasized inpatient service strategy. It was followed closely by surgery (X = 5.14), general medical services (X = 5.09), and ICU/CCU (X = 4.59).


Only one marginally significant (p < .10) difference was observed between the transition and posttransition strategies. Rural New Mexico hospitals report placing greater emphasis on obstetrics after the PPS transition. All of the posttransition strategy scores indicate slightly more emphasis relative to the transition period. Nonetheless, the differences are not statistically significant.

The correlation for inpatient service strategies with gross revenue and net income are shown in Table 6. Inpatient psychiatric care is the only strategy highly correlated (p < .05) with gross revenue. Additional strategy-revenue relationships surface in the multiple regressions. Inpatient psychiatric care (p < .05) and inpatient substance abuse treatment (p < .10) are statistically significant predictors of gross revenue. The variance in gross revenue explained in these two regressions is 35 percent and 29 percent, respectively. Percentage of population greater than 65 years old is a significant (p < .05) predictor of gross revenue in both regression. The negative beta coefficient implies that rural hospitals have higher gross revenue in communities where there are fewer people 65 years of age and older. Finally, the regressions for inpatient pediatrics and rehabilitation services are marginally significant (p < .10). For both of these regressions the percentage of population greater than 65 years old is the statistically significant predictor.

Inpatient surgery (p < .10), generally medical services (p < .10), obstetrics (p < .05), psychiatric care (p < .05), and rehabilitation (p < .10) are all positively correlated with net income. Higher emphasis on these service strategies is associated with higher net income. When net income is regressed on the obstetric strategy and population control variables, 29 percent of the variance in net income is explained. The statistically significant (p < .05) beta coefficient suggests that obstetric emphasis is associated with higher net income. The same results occur when net income is regressed on psychiatric care and the population variable. Twenty-seven percent of the variance in net income is explained by the independent variables. However, the psychiatric care strategy is the only significant (p < .05) predictor of net income. Similar results surface for the rehabilitation strategy, but to a lesser degree due to the marginally significant (p < .10) regressions.

Only the inpatient obstetric strategy is significantly (p < .05) correlated with occupancy, as shown in Table 7. Twenty-six percent of the variance is explained in the corresponding regression involving obstetric, population, and net income. In contrast, the inpatient service strategies are highly correlated with discharges. Inpatient surgery (p < .01), general medical services (p < .01), obstetrics (p < .01), psychiatric care (p < .10), and ICU/CCU (p < .01) are positively correlated with discharges. With the exception of psychiatric care, the hospitals reported emphasizing these strategies during and after the PPS transition (see Table 5).


The regression involving the inpatient surgery, general medical services, obstetric, and ICU/CCU strategies are all statistically significant at the .05 level. The regression explain about 30-33 percent of the variance in discharges. In all of the regressions only the strategy variables have statistically significant (p < .01) beta coefficients. These beta weights imply that greater emphasis on inpatient service strategies is associated with a higher number of discharges. Parallel results are found for the psychiatric care strategy, but with a lower threshold of statistical significance (p < .10) and variance explained (18 percent).


Rural hospitals are predicted to intensity their marketing efforts as Medicare PPS is fully implemented. Table 8 displays descriptive statistics and t-test comparing PPS transition and posttransition strategies. The data suggest that during the PPS transition rural hospitals did not emphasize many promotional strategies. According to the administrators, steps were taken to change hospital facility appearance/ attractiveness (X = 4.32) and to improve night and weekend access to care (X = 4.14). The remaining 83 percent (N = 10) of the promotional strategies were not extensively emphasized. However, after the transition phase, the rural hospitals substantially intensified their promotional efforts.

In rank order of emphasis, newspaper advertising (X = 4.77), facility appearance changes (X = 4.64), guest relations (X = 4.50), staff training in interpersonal skills (X = 4.45), market research (X = 4.23), radio advertising (X = 4.23), improved care access (X = 4.14), and cultivating physician relations (X = 4.09) are the strategies receiving most emphasis after the PPS transition. These posttransition promotional strategies received significant ( p < .05) more emphasis (than in the transition phase) according to the t-tests. It should be noted that the facility appearance and access strategies had already been emphasized during the transition period. Hence, their posttransition scores are not significantly different. Only 33 percent (N = 4) of the promotional strategies are receiving less than a moderate degree of emphasis in the posttransition phase. Despite the statistical differences rural New Mexico hospitals are only moderately emphasizing promotion.

The value of promotional strategies becomes apparently when considering gross revenues (see Table 9). Television advertising (p < .01), radio advertising (p < .05), billboard advertising (p < .10), and staff appearance changes (p < .10) are all positively correlated with gross revenue per patient day. These results improve further when considering the regressions. Half of the regressions are statistically significant (p < .05). The beta coefficients for promotional strategy are significant (p < .10) in these regressions. The positive beta weights suggest that a higher level of promotional emphasis is associated with higher gross revenues. An additional 25 percent (N = 3) of the regressions are statistically (p < .10) where the population beta weight (but not the strategy beta coefficient) is significant. The negative beta coefficient suggests that hospitals with high gross revenues per patient day are located in countries with a low percentage of people beyond age 65.


Approximately 28-30 percent of the variance in gross revenue is explained in regressions where a statistically significant strategy beta coefficient is observed (i.e., radio advertising, newspaper advertising, cultivating physician relations, billboard advertising, and staff appearance changes). The regression for TV advertising indicates that 52 percent of the variance in gross revenue is explained by the two independent variables. However, the rural hospitals do not report extensive emphasis of this strategy (see Table 8).

Finally, Table 9 displays the correlations for promotional strategies with net income. Retaining outside consultants and facility appearance changes were the only strategies positively correlated (p < .10) with net income. Retention of outside consultants was the only regressions with statistical significant (p < .10). The positive beta weight suggests that greater use of outside consultants leads to higher net income. Together, the independent variables explain 25 percent of the variance in net income.

The promotional strategies were correlated with occupancy and discharges. However, none of the correlations or regressions for the promotional strategies and occupancy were statistically noteworthy. Only two promotional strategies achieved statistically significant correlations with discharges-retaining outside consultants or expert (p < .01) and changing facility appearance (p < .10). The regression for use of outside experts was also significant (p < .05). This strategy explained 34 percent of the variance in discharges. The significant (p < .01) strategy beta coefficient suggests that greater use of outside consultants in promotion is associated with a higher number of discharges.


Rural New Mexico hospitals have been predicted to respond to Medicare PPS through several strategy changes designed to enhance revenue and utilization. As hypothesized, service diversification strategies are emphasized more extensively in the posttransition (compared to the transition) phase, according to the t-tests in Table 2. However, the transition base levels for diversification activity were very minimal in most instance, which may explain the statistically significant differences. In actuality, the rural hospitals report only moderate emphasis on ambulatory surgery, emergency care, and outpatient diagnosis since the PPS transition. Specialty care and outpatient rehabilitation are also being emphasized in the posttransition phase. The profile that emerges is one of relatively limited service diversification.

The rural hospitals also report major changes in their promotional strategies (see Table 8), as hypothesized. In the posttransition period, rural hospitals are improving facility appearance, staff interpersonal skills, newspaper and radio advertising, guest relations, and market studies. Similar to the findings for diversified services, the extent of change must be interpreted conservatively due to low base levels in the transition period. During the PPS transition, rural New Mexico hospitals attempted few promotion efforts according to the data. After the transition the threshold of emphasis increased substantially across more than half of the strategies. Nonetheless, it would be inappropriate to conclude that New Mexico's rural hospitals of today are intensely and comprehensively involved in service promotion.

The rural New Mexico hospitals do not indicate widesweeping changes in inpatient services. The transition and posttransition inpatient service strategy differences were not statistically significant except in the case of obstetric (see Table 5). On this basis, the hypothesis is rejected. Nevertheless, it should be noted that the transition strategy emphases on surgery, general medical services, obstetrics, and ICU/CCU were high. Since the transition, the rural New Mexico hospitals additionally have been emphasizing obstetrics and (to a lesser extent) pediatrics. These strategy changes support the spirit of the hypothesis (Moscovice and Rosenblatt 1985b) even though desired levels of statistical significance are not attained.

It is hypothesized that revenue and utilization vary positively with posttransition service diversification, inpatient service enhancement, and promotion. Using correlational and regression analyses, it appears that rural New Mexico hospitals' gross revenues per patient day are not positively correlated with service diversification (see Table 3). However, as predicted, posttransition emphasis on inpatient services (see Table 6) and promotion strategies (see Table 9) is positively correlated with gross revenue. Not every inpatient service or promotional strategy is necessarily associated with higher gross revenue. And the associations are moderately by the percentage of the population older than 65 years.

Mixed support for the hypothesis is also evident when considering net income. The only diversified service correlated with net income is emergency medical care (see Table 3). Similarly, the only promotional strategy associated with net income is the use of outside consultants or experts (see Table 9). Much stronger support for the hypothesis is evident when considering inpatient service strategies. Again, surgery, general medical services, and obstetrics are linked with higher net income (see Table 6). There is also an indication that inpatient psychiatric care and rehabilitation may lead to higher net income. However, the rural hospitals do not report extensive emphasis (see Table 5) on these last two strategies.

In sum, emphasis on inpatient services is the most consistent predictors of gross revenue and net income in New Mexico's rural hospitals. Promotional strategies are linked with higher gross revenue, but not net income. Diversified services do not appear to be positively associated with gross revenue or net income, except for emergency care. Considering these trends among the data, there is only mixed support for the hypothesized relationships.

Turning to utilization, the service diversification strategies are not extensively associated with either occupancy or discharges (see Table 4). Outpatient diagnosis and emergency care are the most consistent diversified services leading to higher occupancy and discharges. Providing professional offices for physicians and home health care are also correlated with more discharges. Overall there is limited consistent support indicating that a board scope of service diversification leads to better utilization. The same conclusion holds for the promotional strategies. Retaining outside consultants (to facilitate promotion) is the only promotional strategy associated with discharges. None of the promotional strategies are correlated with occupancy.

The result are improved somewhat when considering emphasis on inpatient services (see Table 7). Obstetric is the only inpatient service strategy positively correlated with occupancy. However, emphasis on surgery, and emphasis on general medical services, obstetrics, phychiatric care, and ICU/CCU services are statistically significant predictors of discharges. Consequently, some evidence does surface to indicate, as hypothesized, that emphasizing inpatient service strategies is associated with higher utilization.

Considering all of the data, a prudent interpretation suggests mixed evidence for the hypothesized relationships between strategies and performance indicators. The strongest case appears to be inpatient services. Emphasis on inpatient services is a strategy most often associated with gross revenue, net income, and discharges. Occupancy is associated with only a few of the strategies. Promotion contributes to gross revenue, but few significant relationships surface for net income, occupancy, or discharges. Service diversification is not consistently associated with gross revenue, net income, occupancy, or discharges. However, outpatient diagnosis and emergency care are exceptions.


Bearing in mind the cross-sectional nature of this study and the use of a sample from one state with distinct economic, demographic, and epidemiologic environments, what implications are there for other rural hospitals? First, the evidence suggests that rural New Mexico hospitals are attempting to emphasize more intense service diversification, inpatient service, and promotional strategies since the PPS transition. This finding lends further confirmation to research and theory proposing that hospitals initiate adaptive responses to major environmental shifts (Friedman and Shortell 1988; Zajac and Shortell 1989). Rural New Mexico hospitals appear to be emphasizing distinctive strategies in an effort to address PPS constraints. Other rural hospitals may have emphasized similar adaptive response as well (Gay et al. 1989).

Second, the results imply that strategies may vary in their effectiveness for raising revenues or utilization. The posttransition service diversification and promotional strategies were only occasionally associated with higher revenue or utilization. This finding is somewhat consistent with prior research (Clement 1987, 1988). The diversification strategies in outpatient diagnosis and emergency care (and ambulatory surgery, to a lesser extent), and the promotional strategy of retaining outside consultants (to develop marketing strategy) were the notable exceptions. These results seem to imply that rural hospitals should emphasize a few specific diversification and promotional strategies.

A conservative interpretation of the data is warranted. The results may be due to shortcomings inherent in the strategies, improper strategy selection for a given set of circumstances, weak implementation of the strategies, or other confounding factors not readily ascertained in the analysis. The cross-sectional nature of the study also affects the ability to clarify cause and effect. For example, the hospitals adopting promotional strategies may be the already higher performers, rather than performers improved by promotional strategies.

Inpatient services surface as the best (strategy) predictors of higher revenue, net income, and discharges (but not higher occupancy). Especially relevant for the New Mexico hospitals are inpatient services such as surgery, general medical services, and ICU/CCU. The analysis also suggests that obstetrics and psychiatric care may carry promise for improving revenue and utilization. Whether these results will hold true for other rural hospitals is open to speculation. Nonetheless, this study represents yet one more piece of evidence to corroborate previous recommendations that rural hospitals fine-tune their existing inpatient services (Moscovice and Rosenblatt 1985b).

Third, the results of this study imply that rural hospitals should "stick to their knitting"; that is, they should emphasize strategies consonant with rural environments (Peters and Waterman 1982). The health services literature has underscored innovation as a key for addressing PPS (Goldsmith 1981). However, New Mexico hospitals do not appear to be attempting significant departures from fundamental practices. Precisely why not is not immediately apparent. Among other factors, however, it is possible that the constraints of rural settings are formidable and difficult to overcome. Rural hospitals may discover that their local economy, population (i.e., epidemiology, etc.), and other contextual factors are insufficient to support strategies reportedly fruitful in urban locations.

Clearly, caution should be used in interpreting the results of this study. It should not be inferred that a cross-sectional study of rural hospitals in one state is generalizable to all other rural hospitals. The findings should be assessed in light of the extremely limited information available to pinpoint those strategies that can assist rural hospitals in attaining viability. Building on previous hospital research, this study provides additional insight into ways that rural hospitals respond to PPS constraints through deliberate strategies. Research incorporating a broader range of rural hospitals would tend further confidence to the generalizability of this study's findings. This presents an opportunity and underscores the need for more extensive health services research on rural hospitals.


The authors wish to acknowledge the assistance of Mr. Charlies Alfero, New Mexico Hospital Association; Mr. Michael J. Funk, Southwest Community Health Services; and Dr. Richard A. Reid, Anderson School of Management, University of New Nexico, for their assistance at critical points of this study.


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