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Written by Lawton R. Burns and a panel of expert contributors, fromthe prestigious Wharton School, The Health Care Value Chainanalyzes the key developments and future trends in the UnitedStates' health care supply chain. Based on a groundbreakingresearch initiative underwritten by the industry/universityconsortium— the Center for Health Management Research—this important book offers an in-depth examination of how thehealth care supply chain helps create value and competitiveadvantage.
The Health Care Value Chain offers a thorough examination of thetrading relationships among the manufacturers of health careproducts, the distributors, the group purchasing organizations, andthe hospital customers and end users of those products. And theauthors show how health care professionals and manufacturers canwork together to form beneficial strategic alliances. The HealthCare Value Chain
Lawton R. Burns, Robert A. DeGraaff, Patricia M. Danzon, John R. Kimberly, William L. Kissick, and Mark V. Pauly
Focus of This Book
This book analyzes developments in the U.S. health care value chain over the past decade. Wharton School researchers spent three and one-half years (January 1998-June 2001) studying three major players at various stages of the value chain: producers (product manufacturers), purchasers (group purchasing organizations, or GPOs, and wholesalers/distributors), and health care providers (hospital systems and integrated delivery networks, or IDNs) (see Exhibit 1.1). Manufacturers make the products, GPOs purchase them in bulk on behalf of hospitals, distributors take title to them and deliver them, and providers consume them in the course of rendering patient care.
In conducting this study, the Wharton School research team had five broad aims:
1. To profile the major segments in the health care value chain and some of the key players within them, their resources and capabilities, and their recent history;
2. To document how the value chain currently operates;
3. To identify and analyze the strategic and competitive issues facing the three major players;
4. To assess the impact of e-commerce on the valuechain; and
5. To assess future prospects for partnerships and improved efficiencies between value chain players.
We believe that an understanding of the first two topics is essential for addressing the latter three.
Our analysis is more strategic than operational. We do not provide comparative benchmarking data or measures or standards of supply chain performance, nor do we identify specific time-and cost-saving opportunities for improvements in work-flow processes. Instead, we seek to understand the bases of cooperation and competition along the value chain, the sources of efficiency in contracting between suppliers and providers, and the emerging best practices and strategic alliances along the value chain. Our overall aim is to determine whether "extended enterprise" models of supply chain collaboration found in other industries can develop in health care.
The book is addressed to both academic researchers and industry executives. We hope academics will find it a useful and comprehensive introduction to a huge segment of the health care industry that is rarely studied, as well as an analysis of the multiple problems in strategic alliance formation in health care. We hope executives will find it helpful for better understanding the motivations of their trading partners and the opportunities for working with them in cooperative endeavors.
Why Study the Health Care Value Chain?
Several major developments in the health care industry during the 1990s prompted interest in the health care value chain. These developments encompassed vertical integration, horizontal integration, managed care pressures, changes in federal reimbursement, the rise of e-commerce, and the passage of the Health Insurance Portability and Accountability Act (HIPAA) in 1996.
First, provider organizations (hospitals and hospital systems) vertically integrated into the health insurance business (for example, starting up HMOs) and the ambulatory care business (for example, acquiring physician practices), and in the process developed integrated delivery networks, or IDNs. Such efforts represented attempts to integrate downstream toward the patient, capture a greater portion of patient flows and insurance premiums, and develop some countervailing power vis-à-vis health maintenance organizations (HMOs). With a few notable exceptions, such efforts were spectacularly unsuccessful. Providers instead began to realize there may be opportunities to improve their financial position by partnering with upstream value chain players and, in some cases (for example wholesalers/ distributors), integrating with them.
Second, every major player along the value chain horizontally consolidated. Hospitals merged with one another or joined systems; their group purchasing organizations (GPOs) merged to form super GPOs; distributors merged to build mega warehouses and achieve economies of scale; and product manufacturers merged to gain market share, pool capital and sales forces, and deal with the other consolidated players just mentioned. By the start of the new millennium, it was unclear what were the resulting contracting dynamics within the new, consolidated chain. Was it more competitive or less competitive?
Third, provider organizations were rocked by reimbursement pressures emanating from large HMOs, which had merged to develop greater bargaining leverage with employers and to squeeze providers on payments. Providers were also rocked by reductions in both inpatient and outpatient Medicare payments resulting from the Balanced Budget Act (BBA, 1997) and the Balanced Budget Relief Act (BBRA, 1999), which included the Ambulatory Payment Classification (APC) system.
Fourth, the rise of e-commerce promised a "sea change" and "paradigm shift" in how trading partners were to transact business. Business-to-business (B2B) models using Web technology were sold as the solution to all of the industry's problems and inefficiencies. The new technology would speed up transactions; provide visibility of products and information along the entire chain; and eliminate duplication, paperwork, and processing errors.
Finally, HIPAA developed standards for providers to follow with regard to the format, use, and security of electronically stored and transmitted health care information. These standards had enormous implications for reducing overhead and administrative costs, for the development of electronic commerce, for transacting business with trading partners, and for improving the information available for decision making.
Whereas before the value chain was an unimportant side issue, the events just mentioned collectively propelled value chain issues to the forefront. The increasing importance is reflected in recent consulting firm studies of value chain improvements and efficiencies using e-commerce, and funding for this investigation by a consortium of large IDNs known as the Center for Health Management Research (CHMR).
In addition to these developments in health care, the 1990s witnessed the formation of strategic trading alliances in the U.S. auto industry. These alliances, also known as extended enterprise supplier networks, brought together suppliers of component parts with large auto manufacturers to collaboratively improve quality, reduce costs, and develop competitive advantage. Such strategic alliances have been held out as examples for the health care industry to follow.
What Is a Value Chain?
Michael Porter, an economist at the Harvard Business School, has popularized the term value chain among academic circles to mean the entire production chain from the input of raw materials to the output of final product consumed by the end user. This chain is called a value chain because each link in the chain adds some value to the original inputs. There are really two value chains here. The first concerns the stream of productive activities within a given firm that allows it to manufacture a product or render a service (see Exhibit 1.2). Thus, a firm acquires inputs (for example, raw materials, labor, capital, and so on), integrates and processes them in a throughput stage, and then produces its outputs. The second value chain includes the stream of activities across firms, where the outputs of one set of firms become the inputs for another set of firms. Thus, a firm has input suppliers, industry competitors, distributors, and end customers. An analysis of the value created within a given firm helps to identify its contribution to the value created along the interfirm supply chain.
What Is a Supply Chain?
In industry, the term supply chain tends to be used more frequently than value chain. A supply chain is a virtual (as opposed to vertically owned) network "that facilitates the movement of a product from its earliest point of production, through packaging and distribution, and ultimately to the point of consumption." The supply chain is thus the path traveled by the product; each stop along that path defines a link in the supply chain.
Supply chain networks may operate to both (1) "push" manufactured products through the chain using sales forces and promotional campaigns, and (2) "pull" products through the chain to continually replenish retailers' inventories and meet customer demand. In the former model, manufacturers promote and sell as much product as they can to customers. In the latter model, customers demand products from the preceding link in the chain; those vendors then become responsible to manage the customer's inventories.
Why Do Value and Supply Chains Exist?
Why do value and supply chains exist? There are at least two explanations, derived from industrial organization theory and organizational theory. First, supply chains exist because there is little vertical integration of manufacturers into the distribution and delivery of their products to the end customer. Vertical integration is low because manufacturers believe that the costs of transacting with the marketplace for distribution and delivery are much less than the costs of attempting to take distribution in-house and coordinating all of these exchanges using hierarchical means. That is, manufacturers believe that it is cheaper for them to "buy" distribution services from product wholesalers in the marketplace rather than "make" distribution services in-house. Consequently, manufacturers have elected not to enter the distribution business but rather let specialist firms produce these services for them.
Second, because manufacturers have left the provision of distribution services to others, they are now interdependent with external firms over whom they exercise no hierarchical or managerial control. Consequently, they need to develop contractual or strategic alliance relationships with these specialist firms in order to get their products to the end customer. Supply chains thus exist to coordinate and manage the exchanges of firms that are interdependent.
What Are the Objectives of a Value Chain?
Across firms engaged in trading relationships, a value chain is concerned with several theorized objectives:
Optimizing the overall activities of firms working together to create bundles of goods and services
Managing and coordinating the whole chain from raw material suppliers to end customers, rather than focusing on maximizing the interests of one player
Developing highly competitive chains and positive outcomes for all firms involved
Establishing a portfolio approach to working with suppliers and customers; that is, deciding which players to work with most closely and establishing the processes and information technology (IT) infrastructure to support the relationships
That is, value chains are supposed to be collaborative partnerships between adjacent players engaged in economic exchange. Such collaborative activity includes coordinated planning of production and distribution to meet the customer's needs on a just-in-time basis that reduces inventory levels and delays in product availability. It is also designed to create a lowest-total-cost solution for the end customer and the manufacturer. Lowest total cost is achieved using demand planning, which relies on information gathered from the customer that "pulls products." Demand planning works backward from the customer toward the manufacturers and their suppliers and original equipment manufacturers (OEMs). This is all in contrast to traditional supply chain management, which starts with the manufacturer that "pushes product" (for example, using marketing and advertising campaigns) and works forward toward the customer. Here the manufacturer's aim is not achieving lowest total cost but increasing product sales, greatest product differentiation, and lowest delivered cost.
Value Chains and Extended Enterprises
Value chains are also supposed to develop as strategies of competitive advantage in which one set of trading partners (input supplier-product manufacturer-distributor) seeks to create more value (for example, higher quality and/or lower-cost products and services) than a rival set of trading partners. Recent research on value chain alliances in the auto industry suggests some of the essential ingredients for success.
One key ingredient is dedicated asset investments in one's supply chain partners in order to increase productivity. These can include dedicated managers and account representatives who accumulate substantial understanding and know-how through longstanding relationships with trading partners. Another type of asset investment is the development of capital investments tailored and customized to a specific trading partner.
A second key ingredient is effective management of knowledge and knowledge flows among trading partners. This requires sharing of information (both explicit and tacit knowledge) rather than secrecy. This is accomplished through supplier associations, learning teams, on-site consultation, joint-study groups, problem-solving teams, and interfirm employee transfers. In this manner, suppliers provide input to product development and process improvement initiatives.
A third key ingredient is trust among trading partners. The presence of trust lowers the necessity for contract enforcement and surveillance and thus reduces transaction costs. Specific means to foster trust include selection of suppliers based on their capabilities and track record for performance (rather than competitive bidding) and previous contracting relationships, establishment of long-term contracts, stability of employment of managers involved in contracting, extensive two-way communication, financial investments in one another, and evaluation of the relationship on a broader scale than just unit price of inputs.
Research on the auto industry suggests that the presence of these three ingredients allows the formation of extended enterprises that span manufacturers and their suppliers. Such enterprises achieve competitive advantage over other manufacturers (that lack such alliances) in terms of the speed of product development, product development costs, transaction costs in procurement, product costs, quality, market share, and profitability.
Do Value Chains Exist in the U.S.
Excerpted from The Health Care Value Chain by Lawton R. Burns Excerpted by permission.
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About the Author.
Part I: Value Chain Basics.
1. The Wharton School Study of the HealthCare Value Chain (LawtonR. Burns, Robert A. DeGraaff, Patricia M. Danzon,John R. Kimberly,William L. Kissick, and Mark V. Pauly).
2. Importance of the Health Care Value Chain (Lawton R. Burns andRobert A. DeGraaff).
3. How the Health Care Value Chain Operates (Lawton R.Burns).
Part II: The Intermediaries.
4. Role of Group Purchasing Organizations (GPOs) (Lawton R.Burns).
5. Role of Wholesalers and Distributors (Lawton R. Burns and RobertA. DeGraaff).
6. Threats of Disintermediation Facing Distributors (Robert A.DeGraaff and Lawton R. Burns).
Part III: The Manufacturers.
7. Pharmaceutical Manufacturers (Lawton R. Burns and Patricia M.Danzon).
8. Medical Device Manufacturers (Robert A. DeGraaff and Mark V.Pauly).
9. Medical-Surgical Manufacturers (Lawton R. Burns).
Part IV: E-Commerce.
10. E-Commerce in Health Care Manufacturers,Distributors, and GPOs(Lawton R. Burns and Robert A. DeGraaff ).
11. E-Commerce and Integrated DeliveryNetworks (IDNs) (Lawton R.Burns).
Part V: Conclusion.
12. Conclusion (Lawton R. Burns and John R. Kimberly).