OBJECTIVES: The adaption of technological advances in the past decades underscores the importance of measuring how efficiently hospitals are utilizing the growing labor force to provide health services. Our study aimed to assess California hospital productivity growth through addressing the severity of patient’s illness and outcomes of care. METHODS: We examined hospital productivity growth by analyzing patient discharge data from California for the period 2005 to 2011, among patient stays with a principal diagnosis of heart attack, pneumonia or heart failure. Productivity was defined by the ratio of the number of stays to total costs in each hospital-year. RESULTS: The study cohorts included 171,250 patient stays at 358 hospitals with a primary diagnosis of heart attack, 336,111 stays at 387 hospitals with pneumonia, and 389,413 stays at 383 hospitals  with heart attack.  Average costs per stay showed a slightly increasing trend from 2005 to 2011 (from $22,965 to $23,669 in heart-attack stays, from $10,956 to $12,238 in pneumonia stays, and from $13,279 to $14,144 in heart-failure stays, all in 2011 dollars). The average number of patient comorbidities increased by 37% for heart attack, 28% for pneumonia, and 87% for heart failure. A decreasing trend was observed in inpatient mortality rate, ranging from 26% for heart attack to 19% for pneumonia.  Unadjusted annual productivity growth rates were significantly negative (-0.7% per year for heart-attack stays, -2.4% for pneumonia stays, and -1.5% for heart-failure stays).  In contrast, after adjustment for patient severity of illness and inpatient survival, annual productivity growth rates became +0.4% per year for heart attack and +0.2% for heart failure; growth for pneumonia was no longer significantly negative. CONCLUSIONS: Accounting for patient severity and quality of care, as is appropriate, results in substantially more favorable trends in productivity growth at California hospitals.