Many health care services are available in both hospital and freestanding settings. Hospital-based providers are usually much more expensive than freestanding providers. According to Medicare data, costs in hospital-based skilled nursing facilities (SNFs) are twice those of freestanding facilities. While critics charge that this is the result of inefficiency, hospitals counter that higher costs are caused by treatment of sicker patients and provision of higher-quality care. This paper analyzes the research on the case-mix differences between hospitalbased and freestanding SNFs. On the basis of this analysis, it appears that hospital-based facilities tend to serve more severely ill patients (i.e., have a more difficult case mix) than do freestanding facilities. Case-mix differences, however, appear to explain less than half of the cost differential between the two types of facilities.