By JEFF GOLDSMITH

The concept of vertical integration has recently resurfaced in healthcare both as a solution to maturing demand for healthcare organizations’ traditional products and as a vehicle for ambitious outsiders to “disrupt” care delivery.    Vertical integration is a strategy which emerged in US in the 19th Century industrial economy.  It relied upon achieving economies of scale and co-ordination through managing the industrial value chain.    We are now in a post-industrial age, where economies of scale are in scarce supply.  Health enterprises that are pursuing vertical integration need to change course. If you look and feel like Sears or General Motors, you may well end up like them.  This essay outlines reasons for believing that vertical integration is a strategic dead end and what actions healthcare leaders need to take.

Where Did Vertical Integration Come From?

The strategy of vertical integration was a creature of the US industrial Revolution. The concept was elucidated by the late Alfred DuPont Chandler, Jr. of the Harvard Business School. Chandler found a common pattern of growth and adaptation of 70 large US industrial firms. He looked in detail at four firms that came to dominate markedly different sectors of the US economy:  DuPont, General Motors, Sears Roebuck and Standard Oil of New Jersey. They all followed a common pattern: after growing horizontally through merging with like firms, they vertically integrated by acquiring firms that supplied them raw materials or intermediate products or who distributed the finished products to final customers. Vertical integration enabled firms to own and co-ordinate the entire value chain, squeezing out middlemens’ profits.

The most famous example of vertical integration was the famed 1200 acre River Rouge complex at Ford in Detroit, where literally iron ore to make steel, copper to make wiring and sand to make windshields went in one end of the plant and finished automobiles rolled out the other end. Only the tires, made in nearby Akron Ohio, were manufactured elsewhere. Ford owned 700 thousand acres of forest, iron and limestone mines in the Mesabi range, and built a fleet of ore boats to bring the ore and other raw materials down to Detroit to be made into cars. 

Subsequent stages of industrial evolution required two cycles of re-organization to achieve greater cost discipline and control, as well as diversification into related products and geographical markets. Industrial firms that did not follow this pattern either failed or were acquired. But Chandler also showed that the benefits of each stage of evolution were fleeting; specifically, the benefits conferred by controlling the entire value chain did not last unless companies took other actions. Those interested in this process should read Chandler’s pathbreaking book: Strategy and Structure: Chapters in the History of the US Industrial Enterprise (1962).   

By the late 1960’s, the sun was setting on the firms Chandler wrote about. Chandler’s writing coincided with an historic transition in the US economy from a manufacturing dominated industrial economy to a post-industrial economy dominated by technology and services. Supply chains re-oriented around relocating and coordinating the value-added process where it could be most efficient and profitable.  Owning the entire value chain no longer made economic sense. River Rouge was designated a SuperFund site and part of it has been repurposed as a factory for Ford’s new electric F-150 Lightning truck. 

Why Vertical Integration Arose in Healthcare

I met Alfred Chandler in 1976 when I was being recruited to the Harvard Business School faculty. As a result of this meeting and reading Chandler’s writing, I wrote about the relevance to healthcare of Chandler’s framework in the Harvard Business Review in 1980 and then in a 1981 book Can Hospitals Survive: The New Competitive Healthcare Market, which was, to my knowledge, the first serious discussion of vertical integration in health services.

Can Hospitals Survive correctly predicted a significant decline in inpatient hospital use (inpatient days fell 20% in the next decade!). It also argued that Chandler’s pattern of market evolution would prevail in hospital care as the market for its core product matured. However, some of the strategic advice in this book did not age well, because it focused on defending the hospital’s inpatient franchise rather than evolving toward a more agile and less costly business model. Ambulatory services, which are today almost half of hospital revenues, were viewed as precursors to hospitalization rather than the emerging care template.

Policymakers Fell in Love with Vertical Integration:  Cost Containment by HMOs

At the time of my writing, vertical integration was a hot topic in health policy.  Federal policymakers’ attention was fixated on Kaiser Permanente, the largest vertically integrated actor in healthcare (then and now). Dr Paul Ellwood, a health reform advocate, persuaded the Nixon Administration to sponsor the HMO Act of 1973, designed to foster health plans modelled on Kaiser as a “pro-competitive” alternative to a government run national health insurance plan. 

Nixon’s 1973 HMO Act provided federal grants to foster HMOs as a vehicle for containing soaring health spending through market mechanisms. Many multi-hospital systems-Intermountain in Utah, Henry Ford in Detroit, Sentara in Virginia,  Geisinger in Pennsylvania, Humana, Lutheran Hospital Society of Southern California, Michael Reese and Rush Presbyterian Hospitals in Chicago-created their own HMOs during the 1970’s and early 80’s. As a result of these federal investments, HMOs covered 31% of the privately insured population by 1990.  

However, Kaiser-style health plans did not prosper in communities with strong traditions of independent (e.g. solo and partnership) medical practice. HMOs contracting with private physicians individually or through physician sponsored Independent Practice Associations (IPAs) dominated the space. IPAs enabled physicians to participate in HMOs without being employed by them or by hospitals, and to earn extra income through shared profits. 

The abortive Clinton health reforms during 1993-1995 provided a further push toward vertical integration. The almost inexplicably complex Clinton plan would have required the entire care system to be re-organized into competing Kaiser-like regional health enterprises that would receive a global payment for caring for all citizens in its region. The Clinton reforms foundered over concerns about restricting consumer choice of physicians and hospitals (and because no-one could understand exactly what they were trying to do). Nonetheless, hospitals launched a frenzy of physician practice acquisition and regional mergers to prepare for a ClintonCare which never came. 

Shortly thereafter, HMOs suffered an angry consumer and employer backlash (fanned by organized medicine and hospitals). Commercial insurers including Blue Cross plans, United Healthcare, Aetna, Humana and CIGNA displaced HMOs in the commercial market using broad network Preferred Provider Organizations (PPOs) that contracted with hospitals and doctors through, mainly, discounted fee-for-service payment. Today, HMOs represent only about 12% of private insurance enrollment, of which Kaiser’s members represent well more than half.  

The Obama Administration’s 2010 health reforms attempted to revive enthusiasm for vertically integrated healthcare by fostering “value based care”, a fluffy term intended to describe a raft new payment models that shifted risk onto provider organizations-hospitals, physician groups and others. The policy intent was that “value-based care” would serve as  a bridge to full risk/delegated risk capitation. Thirteen years on, “value-based” care remains largely unproven as a cost containment strategy, and the evolution to full-risk capitation has not occurred. 

Why Vertical Integration Hasn’t Worked in Healthcare:  What the Literature Shows

We now have had five full decades of broad experimentation with vertical integration strategies in healthcare. With the benefit of hindsight, Chandler’s pattern has not worked well in this field. There has been a lot of “consolidation” but no measurable efficiency gains. Costs have soared. Something about healthcare has fiercely resisted “industrialization”.

Healthcare mergers-horizontal or vertical- have not only not reduced cost, but may actually have added cost through high transaction costs and new and expensive layers of supervision. Vertical integration of physician practice into hospitals has increased costs, not reduced them. And  vertically “integrated delivery systems” that combined hospital, physicians and health plans in a single organization are neither cheaper nor of demonstrably higher quality than less integrated competitors in the same markets. As health systems diversified into non-hospital businesses, their returns on capital declined. The greater the investment, the greater the decline.  (For a comprehensive review of this literature, see my 2015 piece in integrated delivery networks).

Kaiser and Geisinger

The vertical exemplar, Kaiser, has grown to $95 billion in revenues in 2022.  However, it has remained largely a creature of the markets in which it originated (e.g the Pacific Coast) where over 80% of its members live.  It has taken nearly eighty years to grow to 12.7 million members (and about 2% of total US health spending), despite the bursts of federal enthusiasm. Kaiser suffered several years of major financial losses by attempting to become a “national brand” in the late 1990’s. Kaiser’s success was likely attributable to the market conditions in their original markets rather than its vertical strategy.

An ominous development for the vertical strategy was the recent failure of Geisinger, a 110 year old exceptionally high quality multi-specialty physician group-based health system with a significant health plan and ten hospitals in central Pennsylvania. Geisinger lost $842 million in 2022, and was losing $20 million a month on operations when it announced a complex, non-merger style affiliation with Kaiser through a new enterprise unpromisingly named Risant. At almost $7 billion revenues, it is difficult to argue that Geisinger had insufficient scale to prosper. Rather, Geisinger’s demise as a freestanding enterprise raises serious questions about the viability of the vertically integrated model.

The Heart of the Matter: The Structure of the Value Chain in Healthcare

The main problem with the vertical integration strategy in healthcare: professional judgment and the personalized care guided by it does not scale very well. People, not raw materials, energy or capital, are the vast majority of health costs. Healthcare’s value chain is fundamentally different and more complex than that in manufacturing or retailing. There is also greater variability and uncertainty at the point of service, as well as greater personal risk to the “consumer” than just about anywhere else in the economy.  Chandler’s pattern has also not held for the other professional services that dominate the American economy: education, law, accounting, consulting, etc.

Action is Needed

Vertical integration is a relic of the industrial age. It neither guarantees market dominance nor profitability in healthcare. Actors in the health system should adjust their strategies accordingly.

Keep What You Do Well or Which Would Be Missed If you Did Not Do It.  Lose the Rest.

Health care enterprises’ earnings and financial positions have been damaged by the pandemic, and restoring a positive return on the organization’s assets and people is essential. Health systems that have been adjusting to this new environment with layoffs rather than examining their portfolio of businesses. It is time to ask Peter Drucker’s famous question:  if we were starting fresh today, would we own all the assets and programs we have now? Do we do a good job of running them (e.g. generate both happy customers and black ink), and would anyone miss them if someone else did?  

Don’t just guess what you do best. Rely on empirical sources if available, whether federal HCAHPS patient survey results or Medicare STAR ratings, Leapfrog ratings, independently gathered Net Promoter Scores or internal surveys of clinicians and managers working in each service area, as well as a searching and fearless analysis of where positive cash flow is being generated.

Community needs are an important consideration. If your community would suffer if you stopped doing something, you can count the losses you incur by continuing to do it as part of your community benefit.   An important exception might be for teaching institutions, for whom the breadth of clinical experience required to train new physicians might dictate a breadth of service that does not make sense otherwise.  Those losses are covered in part by Medicare’s direct and indirect medical education supplemental payments.

Services that do not sustainably return your capital or generate a positive work experience for clinicians should be flagged for divestiture, unless you need to continue doing them for teaching purposes or are meeting a significant and demonstrable unmet community need. It makes no sense to own the tenth home care agency or the sixth chain of convenience clinics just to “feed” your clinicians referrals or to field a complete “continuum of care”.

Health Plans in Hospital Systems:  A Bridge to Nowhere?

The future of population-level risk in healthcare delivery enterprises is cloudy. It is true that some health systems saw windfall profits in their captive health plans from declining healthcare use during COVID provide a significant offset to their care delivery losses. But this was a once-in-a-century health emergency, not a “use case” for continuing to invest scarce capital (in a capital intensive business) in a business most care enterprises have struggled with.

Being a “payvider” is not vertical integration, nor is it an efficient vehicle for growing healthcare volumes. Health insurance and healthcare delivery are very different businesses, with dramatically different critical success factors. For care delivery entities, health insurance is unrelated and risky diversification with a high probability of negative investment returns. Unlike inside Kaiser, where the sole access point is enrollment in their health plan, there is “dysergy”, not synergy, between care delivery and health insurance. Success in the health plan business requires reducing both unit cost and utilization in care systems, as well as angering physicians, as Humana realized on its way to divesting its hospitals in the early 1990s.    

Overall, health plan revenues in a few health systems (UPMC, Sentara, Spectrum/CoreWell, Geisinger, InterMountain, Aultman, Providence/Oregon) are such a significant piece of overall revenues and so significant in key local markets that the plans are integral to the future of the enterprise. How many of these systems prop up their health plans’ profitability with “below market” payment rates and pay their physician groups on an RVU basis that incents them to do “more” not “less”  are interesting research questions.  

For organizations with a smaller footprint in health insurance or sputtering “risk models”, it is time for an agonizing re-appraisal of these investments. Those with successful managed care infrastructure may discover that accepting delegated risk capitation, (If, and a large if indeed, it is available in their market) is a better strategy than “owning the whole premium dollar”.

Stop Relying on Market Anomalies to Justify Physician Employment

Physicians are complex professionals, not pawns on a three-dimensional chess board. Aggrandizing the market for physician care is not a cost-effective means of leveraging other healthcare businesses, be it hospitals, health insurance or pharmacies. Subsidizing physician care as a “loss leader” is not vertical integration;  vertical integration was about capturing margins and leveraging economies of scale, not frantically grabbing market share. 

The rush to dominate the physician marketplace has created substandard working conditions for busy professionals and conveyed the impression that physicians’ services are a means to an end, not a valuable end in itself. It also fosters the toxic illusion that those physicians’ patients belong somehow to the “owner”, not the clinicians who are responsible for them. The push by major retailers like Amazon, CVS and WalMart into the physician business is likely to end in tears, both for the companies and the professionals they employ.   

Hospitals will likely lose the Medicare subsidies for employed physicians as federal budgetary conditions worsen.  It is also likely the FTC will also outlaw non-compete clauses in physicians’ contracts (though non-profit hospitals and systems may be exempt). Relying on coercive measures like non-competes clauses that compel physicians to leave your community if they resign (and laying claim to their patients as if they were your property) is a sad confession of a bankrupt corporate culture. Outlawing non-competes as FTC intends will probably damage the big retail “disrupters”, the contract physician providers like Envision and Team Health and the vast enterprise that is Optum Health more than it will damage hospitals and systems.       

Conclusion

Healthcare providers of all stripes must leave the industrial world behind. The value chains in health services are not physical, but rather comprised of human relationships, sustained by trust. Virtual care, the advent of AI in healthcare and consumer demand will require a flexible, 24/7 and care anywhere business model. Those who build the best modern clinical mousetrap will end up with a committed clinical staff and loyal patients. Healthcare isn’t about the building, or the brand, or scale. Surviving and thriving in the future will require engaged clinicians who foster trust on the part of their patients and the community.

Jeff Goldsmith is President of Health Futures, Inc. and a long time THCB Contributor. Jeff wants to thank the following individuals for comments on this writing: Tom Priselac, Andy Mueller, Stephen Jones, Steve Motew, Troy Wells, Kerry Shannon, Trevor Goldsmith, Nate Kaufman and Rebecca Harrington.

A study by Stanford researchers in the current issue of Health Affairs is likely to intensify growing tension between health insurers and hospitals.

At issue: the impact of physician-hospital consolidation, or vertical integration as some academics prefer to call the trend.

The researchers analyzed 2 million claims submitted to insurers by hospitals from 2001 to 2007, evaluating the impact on hospital prices, volumes (admissions), and spending for privately insured, non-elderly patients. Using data from Truven Analytics MarketScan.

They constructed county-level indices of prices, volumes, and spending and adjusted for enrollees’ age and sex. “We measured hospital-physician integration using information from the American Hospital Association on the types of relationships hospitals have with physicians.”

What they found is not surprising: vertical integration involving physician-hospital consolidation results in better care and higher costs. They found hospital prices increased 2%-3% each time physician-employing hospitals’ market share increased by one standard deviation. And overall spending on services at the hospitals that employed physicians increased while the utilization of services (volume) at those hospitals didn’t change.

They  concluded the following:

“We found that an increase in the market share of hospitals with the tightest vertically integrated relationship with physicians—ownership of physician practices—was associated with higher hospital prices and spending.

We found that an increase in contractual integration reduced the frequency of hospital admissions, but this effect was relatively small. Taken together, our results provide a mixed, although somewhat negative, picture of vertical integration from the perspective of the privately insured.”

What’s the significance of the study?

1-Hospitals and physicians will bolster their position that vertical integration is necessary to improved outcomes. The shift from volume to value via accountable care organizations, bundled payments, medical homes, and value based purchasing require closer collaboration between physicians and hospitals.

“Clinical integration” is central to each, and payers– Medicare and private insurers– are promoting these risk-based contracting efforts energetically while cutting reimbursement rates for services aggressively. So the provider position is this: ‘We get better results. We built what you said you wanted.

It’s costly to make the change, especially while since Medicare and Medicaid don’t cover our costs, demand is soaring and our bad debt from the uninsured increasing. You told us to build it, but you don’t want to cover our costs.’

2-Payers now have proof that vertical integration is increasing costs. Timing is everything, and concern about health cost is growing. Last month, the Bureau of Economic Analysis reported that overall health spending in the first quarter, 2014 increased 9.9%, the highest quarterly increase since the 1980s, and following the 4thQ increase of 5.6%. The Stanford study’s finding supports a vexing concern shared by most private insurers: consolidation among providers increases their leverage in negotiating.

Insurance companies think providers are inefficient and wasteful, so adding bargaining leverage to their already suboptimal cost-management proficiency makes matters worse…for everyone.Ultimately these costs are passed through in higher premiums.

So insurers reason: ‘providers are vertically integrating to protect their financial interests at our expense’.

So what’s it mean?

1-Physician-hospital consolidation will continue, but payers will increase incentives for cost-efficiency as models mature. Efficiency measures linked to supply chain costs, staffing and productivity, workflow and lean operating models will find their way into contracts with payers for accountable care organizations and bundled payments—the two most prominent levers payers are likely to pull.

The relative weight of cost containment measures in calculating bonuses and savings will increase relative to other measures. These risk sharing models will not go away, but how payers measure their performance, structure incentives, and monitor consolidation efforts will change.

2-Regulators will pay closer attention to vertical integration and provider consolidation. the US Federal trade Commission and the US Department of Justice are alert to the potential for provider cartels that discourage competition and produce imbalance between private payers and providers. Recent rulings in Idaho, Georgia and others point to heightened scrutiny.

3-New models of provider-payer collaboration and gain sharing will emerge, especially around targeted high cost populations. combining the financing and delivering of care to better align incentives between payers and providers seems inevitable, but a pluralistic payment system makes it problematic in most communities.

In most industries, customers pay a price for a service and a provider (seller) delivers based on an expectation of quality, service and price.

In healthcare, the separation between payer and provider, and the lack of transparency about prices, costs and anticipated outcomes (results) lends to the mess we’ve created. Might vertical integration of financing and delivery be a solution? Might the pursuit of value in healthcare be enhanced if in each community where two or more entities that finance (sell insurance) and deliver (providers) compete?

In most communities, providers grapple with multiple private payers while responding to the mandates of Medicare. Could it be simpler? Might employers that provide employee health insurance coverage find it easier to contract if they dealt with entities that could produce and manage the full array of services based on a predictable cost structure linked to results?

And might carve-outs for specific high cost populations contracted by high performing, fully integrated systems be an answer for managing costs while improving outcomes? Time will tell, but something’s got to give.

In Section 2718e of the Patient Protection and Affordable Care Act, a 56 word mandate for hospitals is set to take effect this October: it requires hospitals to post prices for a list of products and services annually. Big deal.  Hospital prices mean little since most health insurers negotiate discounts, and consumers without insurance coverage end up paying only a fraction of the posted price.

Publishing prices from the charge-master will not fix the mess.

So as health costs take center stage in the market, physician-hospital vertical integration is likely to increase as will criticism by payers that these are contracting cartels, not platforms that improve health and reduce cost synchronously. At the end of the day, based on the Stanford study, both are right. But being right doesn’t fix the problem.

Righteous indignation never results in a solution; rather, innovative, bold, fresh ways to clean up the mess is needed. That’s where we are.

Paul Keckley, PhD  (@paulkeckley) is an independent health care industry analyst, policy expert and entrepreneur. Keckley most recently served as Executive Director of the Deloitte Center for Health Solutions and currently serves on the boards of the Ohio State University Medical Center, Healthcare Financial Management Leadership Council, and Lipscomb University College of Pharmacy. He is member of the Health Executive Network and advisor to the Bipartisan Policy Center in Washington DC.  Keckley writes a weekly health reform newsletter, The Keckley Report, where an earlier version of this post appeared.

As health care reform rolls out, there is a growing focus on restructuring the health service delivery system in the hope of improving health care quality and “bending the cost curve.”

A key part of this focus has been on physician organization and, in particular, moving toward large, multispecialty physician groups or hospital-physician systems that can provide integrated, coordinated patient care (e.g., through “Accountable Care Organizations”).

In a recent chapter in Advances in Health Care Management’s Annual Review of Health Care Management, however, we and our co-author Jeff Goldsmith find that there is little evidence for the superiority of these integrated models in terms of patient care quality or cost-savings, and that the trends toward physician consolidation has been much less dramatic than is often thought.

Using data from a variety of sources, we find there are two separate phenomena at work in physician organization. At one end of the spectrum (bottom tail of the size distribution of physician groups), the majority of physicians continue to practice in small groups, although there has been some movement from really small practices (one to three or four physicians) to slightly larger groups (five to nine physicians).

Still, nearly two-thirds of office-based physicians continue to practice in solo settings, two-person partnerships, and small (usually single specialty) groups with five or fewer physicians.

At the other end of the spectrum (upper tail of the distribution), however, is a smaller number of very large and rapidly growing multispecialty physician groups, which are often owned by hospitals, health plans, private equity firms, or other non-physician sponsors.

These two stories of what is happening in the distribution of physician group size are described as “a tale of two tails.”

Despite the relative stability in the distribution of practice sizes, the upper tail accounts for an increasing percentage of practicing physicians and the most rapid growth in total physicians and physician visit volumes.

Key integration forms
There are two key forms of integration in physician markets. Horizontal integration occurs when individual physicians join group
practices or existing groups merge with each other. There are numerous theoretical reasons to expect that this type of integration might lead to improved quality and cost savings, including enhanced operating efficiency and economies of scale.

When groups consist of physicians across multiple specialties, there also may be gains from economies of scope, including improved coordination and quality of patient care, in-house or within network referrals, and capture of high-revenue services such as outpatient surgeries and imaging services.

We find some evidence that group practices are more productive than solo practices in terms of number of patient visits or gross revenues per physician, though scale economies appear to be reached quickly — at around 10 or so physicians in a group.

Beyond this, monitoring, coordination, and creating a cohesive culture become challenging. Scope economies do not appear to exist or are, at best, weak. The authors also consider the evidence supporting vertical integration, when physicians align with non-physician partners such as hospitals, universities/medical schools, and health plans.

Again, there are many theoretical rationales underpinning these relationships, including lowered transaction costs and improved efforts to monitor, manage, and coordinate patient care, increased network size and geographic coverage to handle risk contracting, and market power over buyers and suppliers.

In addition, these relationships may help physicians stabilize their incomes, manage malpractice, and improve the predictability of their caseload. Because of the supposed advantages, and based on numerous media reports of physician hiring, many analysts assert that physician employment levels have reached as high as 50-60 percent of all doctors.

Questions about effectiveness
The data show that hospital-physician integration is on the rise, but not as fast and nowhere near the levels that analysts propose. The percentage of physicians employed by hospitals has increased from 11% in 2000 to nearly 15% in 2008.

There are also major questions about the effectiveness of the physician employment model, as it has led to financial losses approaching $200,000 per year per physician, double the losses incurred during the early period of integration in the 1990s.

There is similarly no evidence of improved quality following integration. Finally, there is evidence that economic integration between physicians and hospitals does not automatically lead to functioning clinical integration and that, even after integration, a lack of alignment between physicians and hospitals threatens the success of these models.

Another form of vertical integration is between providers and health insurance plans. There are several well-known examples of these systems, including Kaiser Health Plan and other major integrated systems (e.g., Mayo Clinic, Cleveland Clinic).

The success of these integrated systems can be attributed to a number of features, in particular a notably physician-driven system, unified clinical and administrative cultures, a long history with sufficient time to develop this culture, and strong economic interdependence among their three arms (the physicians, the hospital, and the health plan).

Despite the success of these models, they have had difficulty expanding beyond their core markets due to physician resistance, difficulty ramping up enrollment, and employers’ preference to contract with one plan rather than offer a menu of options.

Areas of renewed focus
With the implementation of the Affordable Care Act, there is a renewed focus on horizontal and vertical integration of physicians. Insurers have purchased medical groups in efforts to cut costs by managing patient care and physician networks more tightly.

There is also a movement towards “virtual integration” which allows a physician to remain independent but exploit some of the advantages of group practice, including centralized administration, risk spreading, and leverage with health plans.

Though the mass of physicians remain organized into small, independent, and fragmented group practices, there is clearly flux in the physician market with growth in the number of large groups and increasing physician employment by hospitals.

There is no evidence to suggest how each tail will fare competitively going forward, but past experience suggests that achieving widespread cost savings and quality improvements through restructuring the delivery system alone will be challenging.

To be most effective going forward, policymakers ought to revisit the evidence on integrated systems and consider how they may be implemented and targeted (e.g., to populations who really benefit from coordinated care, such as those with chronic diseases).

Lawton R. Burns, PhD is professor and chair of the health care management department at The Wharton School of Business at the University of Pennsylvania.  He is also a senior fellow of Penn’s Leonard Davis Institute of Health Economics.  

Aditi Sen is a doctoral student in health care management at the University of Pennsylvania. 

This post originally appeared in the Penn LDI Voices Blog. 

I have seen this film before. Folks get all excited about the potential for vertical integration to save our healthcare system, and then the facts emerge.

The results of the first major ACO demonstration project are in and unless there is some hidden meaning behind all the data, it looks like ACOs may not be the magic bullet that the Obama administration had hoped. The demonstration began under President Bush and the specific payment structure and quality incentive differ somewhat from the ACO rules under the Affordable Care Act, but the main features are the same – give an integrated provider organization a share of the savings if it can hold down Medicare spending while also offering some quality bonuses.

Despite the fact that the participants included ten of the nation’s best known physician-led integrated organizations, less than half were able to lower Medicare costs by the final year of the project and only two demonstrated consistent cost savings. And the methods used to achieve savings – nurse call centers and telephone health checkups – are the sorts of thing that don’t exactly require vertical integration.

There are going to be excuses – the ACOs need to be run by hospitals, they need more time to develop their information technologies, the performance incentives need to be strengthened. But that is the kind of ex post rationalizing one hears any time an experiment fails to support a theory. Maybe the theory (that vertical integration is the panacea for our ailing system) is wrong.

There remains a deep divide in both academia and amongst practitioners about the merits of vertical integration. Supporters of the ACA will continue to pin their hopes for Medicare savings on ACOs, the new evidence be damned. I have blogged that we need less top down direction about how to organize care delivery and I am sorry in a way to see the data bear me out. (Sorry because I am fresh out of magic bullets.) If the government is to play a role in the future of the health system, then it should either go all in on regulation (i.e., single payer) or fix the problems that are limiting the effectiveness of the free market (e.g., subsidize and standardize integrated health information systems; double down on antitrust enforcement.) Will these ideas work? I don’t know. But at least there isn’t a strong theoretical case to be made that they will fail.

Let’s stop this love affair with vertical integration. How many times do we have to keep seeing this bad movie?

P.S. I am currently reading The Quantum Story which is about the evolution of quantum physics. I barely understand much of it. But this much I do understand. When physicists perform experiments and the results do not confirm their theory, they reject the theory.

David Dranove, PhD, is the Walter McNerney Distinguished Professor of Health Industry Management at Northwestern University’s Kellogg Graduate School of Management, where he is also Professor of Management and Strategy and Director of the Health Enterprise Management Program. He has published over 80 research articles and book chapters and written five books, including “The Economic Evolution of American Healthcare and Code Red.”