Cost versus control: Understanding ownership through outsourcing in hospitals

•For-profit hospitals in California outsource much more intensely than nonprofits.•Outsourcing can be modeled as trade-off of income vs. control over production.•Differences are exaggerated in services where control is important.•Differences are minimized when faced with fixed cost shocks.•Public and private nonprofits show distinct patterns of control over services. For-profit hospitals in California contract out services much more intensely than either private nonprofit or public hospitals. To explain why, we build a model in which the outsourcing decision is a trade-off between cost and control. Since nonprofit firms are more restricted in how they consume net revenues, they experience more rapidly diminishing value of a dollar saved, and they are less attracted to a low-cost but low-control outsourcing opportunity than a for-profit firm is. This difference is exaggerated in services where the benefits of controlling the details of production are particularly important but minimized when a fixed-cost shock raises the marginal value of a dollar of cost savings. We test these predictions in a panel of California hospitals, finding evidence for each and that the set of services that private non-profits are particularly interested in controlling (physician-intensive services) is very different from those than public hospitals are particularly interested in (labor-intensive services). These results suggest that a model of public or nonprofit make-or-buy decisions should be more than a simple relabeling of a model derived in the for-profit context.