Understanding the nature of hospitals and their raison d'étre in an environment of increasing efficiency requirements is crucial for both the administrators of hospitals and health policy makers alike. This paper critically reviews traditional profit/utility maximising models of hospital behaviour and highlights their limitations in explaining this behaviour, especially with respect to nonprofit and public hospitals. Subsequently, the Yang-Ng (1993) new classical model of the firm is applied to the Australian hospital setting and, by referring to the trade-off between transaction costs and economies of specialisation, provides increased insight as to why particular hospitals even exist and the mix of their ownership structure. The low pricing efficiency of ‘intangible’ medical services necessitates the need to allocate such services within the hospital. However, the co-existence of larger publicly-funded state owned hospitals and non-profit private hospitals is also justified on the grounds that economies of specialisation can be more readily reaped by larger organisations and may be traded-off against transaction costs associated with markets representing intangible services.