Tag: Vertical integration

Vertical Integration Doesn’t Work in Healthcare: Time to Move On

Aug 14, 2023• 1

So in this week of THCB’s 20th birthday it’s a little ironic that we are running what is almost a mea culpa article from Jeff Goldsmith. I first heard Jeff speak in 1995 (I think!) at the now defunct UMGA meeting, where he explained how he felt virtual ~~vertical~~ integration was the best future for health care. Nearly 30 years on he has some reflections. If you want to read a longer version of this piece, it’s here—Matthew Holt

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.

A Closer Look at Physician-Hospital Alignment

May 12, 2014• 1

By Paul Keckley

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.’

What We’ve Learned from Horizontal and Vertical Integration of Physicians

Apr 25, 2014• 10

By Lawton R. Burns & Aditi Sen

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.”

The Summer of Sequels

Jun 2, 2011• 32

By DAVID DRANOVE

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.Continue reading…