MANAGED CARE May 1998. ©1998 Stezzi Communications
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'FOCUSED FACTORIES' WILL PROVIDE CARE
Harvard's Regina E. Herzlinger says entrepreneurial geniuses will give restless baby
boomers what they want: a delivery system in which consumers can choose coverage the same
way they shop for cars.
A CONVERSATION WITH
REGINA E. HERZLINGER
Regina E. Herzlinger, Ph.D., is the first holder of the Nancy R. McPherson Professor of
Business Administration Chair at the Harvard Business School. An expert in management
control and health care, Herzlinger argues that health care delivery in America is ripe
for a consumer-driven transformation. In her most recent book, Market-Driven Health Care
(Addison-Wesley, 1997), she details how that transformation might unfold. Impatient and
demanding baby boomers will lead the charge. To meet the needs of these customers, health
care organizations will draw on lessons that other American industries learned over the
last 20 years. Integrated delivery systems will give way to "focused factories"
that offer all the care needed to treat a particular disease. Third-party purchase of
health insurance by employers and government will yield to direct purchase of health
insurance by users. Herzlinger received her bachelor's degree from the Massachusetts
Institute of Technology and her doctorate from the Harvard Business School. She spoke
recently with Senior Contributing Editor Patrick Mullen.
MANAGED CARE: You've written that market forces will fix the health care system
just as they fixed other parts of the economy. What leads you to that belief?
REGINA HERZLINGER: The driving force is a generation of consumers who are
empowered, pragmatic, narcissistic and manipulative. They're the ones who have changed the
rest of the economy and they're very interested in health care. There's no reason for any
rational person to believe that they're going to say, "Oh no, leave health care in
the hands of these people who are going to tell me what to do." Today's consumers
simply won't accept that. The second driving force is technology, which has already vastly
increased the quality and lowered the cost of health care.
MC: What technologies will lead the way?
HERZLINGER: This is the age of biotechnology and there will be fabulous changes
in that area. Already there's evidence of the efficacy of gene therapy and biomaterials.
In the scene in The Graduate where the executive tells Dustin Hoffman the future is in
plastics, he should have said the future is in plastic catheters. They've revolutionized
surgery and they'll make possible more and more minimally invasive surgery where you don't
have to cut people apart in order to fix what is wrong inside.
MC: Surgeons will no longer have to heal with steel.
HERZLINGER: Exactly. I just saw a brain surgery on a tumor, where the surgeon
went in through the nose and they didn't have to do a craniotomy. Any time you have to
drill through the brain, the recuperative process is lengthy and traumatic. If you can
reach the brain through the nose with this instrumentation, it's obviously a great boon.
The patient left the hospital in two days and I'm sure had a sore nose but otherwise felt
fine. Normally the procedure would take six weeks of hospital recuperation and who knows
how much time outside the hospital. Then there's the whole miniaturization of chips that
enables monitors and devices that replicate the functioning of organs. I'm sure that
implantable pancreata and other organs will be feasible because of the increasing power of
MC: You argue that industry has learned that big isn't necessarily beautiful,
although a number of large banks lately seem to disagree. What went wrong with vertical
HERZLINGER: Well, the jury is still out on these recent deals. A lot of the
old-fashioned, vertically integrated companies like Ford used to make everything that went
into their end products themselves. Those companies learned to sharply focus on what they
do very well and not try to do everything for everybody. That lesson is inescapable in
health care. The health care system is organized nowadays to meet the needs of providers
rather than consumers. You have physicians, hospitals, nursing homes and home-infusion
centers, but if you're sick, you want an integrated system to care for your cancer or your
AIDS or your asthma. You don't want to integrate the system yourself. Increasingly, health
care is organized by these vertically integrated delivery systems that fly in the face of
economic reality. Other American firms have gotten more focused, not more integrated. They
learned that that doesn't work, and I think this trend about how companies are organized
will change the face of health care. It is an irresistible trend.
MC: Can you give an example of this trend in action?
HERZLINGER: A number of companies that manage diseases integrate the health care
system around the needs of consumers. Those companies are the focused factories of health
care. They're going to compete against these integrated-delivery systems and there's no
way that the integrated-delivery systems can compete with them because these
disease-management companies are very focused. They're high quality because they do only
one thing, and when you do one thing you do it very well and can do it very efficiently
too. They're much more efficient than the everything-for-everybody kind of health care
MC: Why do you use the term "focused factory" to describe your vision
for health care delivery when that name metaphorically puts physicians in the role of
factory workers and is sure to annoy people?
HERZLINGER: Yes, I use the term "factory" purposefully to be
provocative. The people in the factories made the changes. They figured out, and
continually figure out, how to improve the production process. It's not a top-down
process, it's an organic process that's led by the people who actually do the work. An HMO
is a top-down process. That's not the lesson from the American economy. The lesson is it's
bottom-up. It's the people who actually deliver the services who will re-create the
services. My general theme is that focus leads to excellence, and excellence leads to
lower costs. Some genius entrepreneurs will figure out how to make that happen.
MC: You talk in your book about Salick Health Care, which runs cancer-treatment
centers. How close does it come to your concept of the focused factory?
HERZLINGER: Pretty close but not totally. People think focused factory means
specialists; I don't mean that at all. What I mean is quite the contrary. I mean an
integrated team, where the focus is not on the providers, because that's yesterday's way
of thinking. The focus is on what consumers need. The interesting thing about Salick is
it's focused on cancer. It has a total team of providers, not just oncologists. It has
oncologists, infusionists and even psychologists, family therapists and financial
counselors--anything that the person with cancer may need. Salick Health Care is not a
focused factory to the degree that it's limited to one geographic platform, the outpatient
site. A true focused factory will deliver health care wherever consumers need it: in the
home, in the neighborhood pharmacy, in a community center, in a shopping mall, in a
community hospital and in a specialist hospital.
MC: Walk us through a prototypical focused factory.
HERZLINGER: For example in diabetes, ideally you would have somebody who
interacts with patients daily to help them monitor and manage their insulin glucose
levels. You'd have dialysis centers in convenient community locations because a big
co-morbidity of diabetes is kidney disease. You'd have pharmacists who would enable
diabetics to monitor their disease status and who would know the patients and give them
information and encourage them in dealing with this terrible disease. You'd have specialty
hospitals that did things like kidney or pancreas transplants or eye surgery.
Unfortunately, all too many diabetics find that their feet or some part of their leg may
become gangrenous because of impairment in circulation. You'd have people who do
amputations. What characterizes the system is that it exists in many geographic sites,
wherever customers need help.
MC: In your book, you call this type of organization a diabetes-focused factory.
Would two or more of these compete in a given market?
HERZLINGER: Absolutely, and I'll give you the numbers to show how real this idea
is. Roughly $100 billion is spent on diabetes a year, so in the average state,
expenditures for diabetes would be $2 billion a year. What can you buy for $2 billion in
the average state? You could buy up to ten 300-bed hospitals devoted solely to diabetics
plus hundreds of community facilities. So in an average state you could easily have three
or more competing diabetes-focused factories.
MC: Let's take a look at where managed care finds itself these days. Do you
still belong to an HMO, a staff model?
HERZLINGER: I do. Always will. It's no longer a staff model because they took it
away from me. I didn't want to leave it but they stopped offering it.
MC: A lot of people have rejected the staff model because they didn't think they
had enough choice, and so plans offered various open-ended options and point-of-service
plans. In doing so, did the pendulum swing so far away from the classic HMO model that the
types of plans that predominate today are not able to effectively manage care?
HERZLINGER: I think that is correct. The older, larger staff- and group-model
plans have a very rich culture that providers and customers believe in. The culture is
widely inculcated, which is an effective way of controlling costs. Customers like it and
believe in it themselves. But now you have more and more open-ended HMOs without this
cultural buy-in to the HMO philosophy. In this model, where are the economies going to
come from? Where is the quality going to come from.
MC: Some would argue that economies come from what appears to be rationing of
HERZLINGER: Rationing of care or avoidance of sick enrollees--they've got to be
the ways to do it. But the best way to make health care more cost-effective is not to deny
health care to the American public. It won't stand for it, first of all, and second, it's
a lousy way to do anything. The way to do it is to permit entrepreneurial health care
ventures and to encourage them to re-create how health care is delivered. That's what
these health-care-focused factories are. They don't say "no" to their customers;
they deliver health care in a new way. HMOs are not going to do that; they're not the
right vehicle for that kind of revolution.
MC: It would appear that a number of large insurance companies at least agree
with you that insurance companies are not the vehicle for delivering health care.
Prudential is only the latest of many large insurers to say it is getting out of the
health insurance business. Aetna for a time thought it should be in the business of owning
primary care clinics but fairly quickly changed its mind.
HERZLINGER: The correct insurance response is not to get out of the health
insurance business; it's to focus on what they do well. In most industries, if you said
that insurers are going to re-create the way the industry does its stuff, you would be
laughed out of the room. If you said the automobile insurance people are going to
re-create the way automobiles are manufactured, it would be ludicrous. So I don't think
it's going to happen to health care either. Insurers are the right people to do
underwriting, marketing, putting together various packages and selling them to consumers
in a way that consumers understand. Oxford Specialty Management is an example of what
might happen. This is a sister company to Oxford Health Plans, the HMO. Oxford Specialty
Management contracts with various care groups that do, let's say GI or ophthalmology or
orthopedics. The care groups offer their services at a fixed price. Oxford then markets
them to its enrollees, but it doesn't just market them. Both the enrollee and the primary
care provider get the credentials of every practitioner in that group. They get measures
of customer satisfaction with that group. For each group, Oxford employs a group of
experts who develop clinical benchmarks about what is the appropriate level of care for
whatever the disease is, and they measure clinicians in the group against those
benchmarks. So Oxford is now out of the business of micromanaging health care but it's in
the business of marketing focused factories to consumers, doing the actuarial analysis and
underwriting and collecting information that makes a market possible. Humana is another
MC: What needs to happen to employee health benefits?
HERZLINGER: I think employers are going to switch to defined-contribution health
care plans rather than defined-benefit plans. They're going to have to make it clear to
consumers that it's not a take-away or a way of cutting health care costs. Employers
thought they found the magic bullet for controlling health care costs with HMOs, but the
bullet lost its magic. Health care costs are starting to increase again, consumers don't
like HMOs and, with 4 percent unemployment, if your employees don't like their health
care, that's a big problem. You want to keep those employees happy. Employers are saying,
"Look, I've got a business to run here, I can't run the health care business and my
own business." On the other hand, you have these empowered consumers who are saying,
"I buy my own stocks out of the 401(k) plan. I do a lot of serious shopping for
difficult-to-buy things like computers and cars. Let me buy my own health care." So
you have employers moving to defined-contribution plans and employees who want to buy
health care for themselves. Combined, this will enable consumers to make their own
MC: So you want to get benefit managers out of the middle of choosing plans
because they're not focusing on the things that need to be focused on.
HERZLINGER: They're very good people. We're all God's creatures. But the benefit
mentality is on benefits and not on cost-effectiveness. The consumer mentality is always
on benefit versus cost, and really only consumers can make that judgment. I wouldn't want
you buying my car and you wouldn't want me buying your car. The benefits people could
still vet the plans that are offered and make sure that they're solvent and provide the
right kind of information to consumers. They could also make sure that consumers are
honest and they don't misrepresent their conditions to insurers.
MC: Who do you see performing that oversight function?
HERZLINGER: I see the SEC model as a very interesting one. Now, whether it's the
feds or the states, that's very complicated. I don't want my answer to read federal
government, I want it to read government. The role of the government is to ensure
solvency, to penalize any kind of fraud and make sure that there's good information. In
the capital markets, the SEC has these powers and it's given these powers over to private,
nonprofit organizations. For example, the group that decides what information ought to be
disseminated about publicly traded organizations is FASB, a private nonprofit, but the SEC
is the iron hand in the velvet glove. Anybody who screws up is going to have to deal with
the SEC, which is very vigilant in its oversight. But the actual promulgation of rules is
done by a private-sector organization and I think that's a very good model.
MC: What's your sense of the political appetite for the kind of change here?
HERZLINGER: Very serious. Centrist Democrats at the Progressive Policy Institute
have recommended that insurers adopt the Federal Employees Health Benefits Program model,
essentially a defined-contribution, multiple-choice model of the sort that I just
described. Republicans will soon propose a kind of health care supermarket that medium and
small employers can buy into. The supermarket would enable employees to shop among a large
variety of health insurers just like people who invest can buy all kinds of mutual funds.
So centrists in both parties are essentially espousing variations on the same theme.
MC: Are you optimistic that something can pass this year?
HERZLINGER: I am optimistic. The main force agent in back of all of this is the
baby boomers. The baby boomer generation is the most manipulative, self-seeking and
effective generation that this country has seen.
MC: I'm sure you say that with the greatest respect and affection.
HERZLINGER: Absolutely. I'm a member of that group. While they were still in
college, they got rid of Presidents Johnson and Nixon. In my book, I talk about the 20/80
rule; that 20 percent of patients use 80 percent of health care resources. That rule also
works by age, and so most health care resources are consumed by people 55 and older. The
baby boomers are heading toward that point. Now, if anybody is going to mount a credible
public campaign to make sure that they're in charge of their health care expenditures,
it's that particular cohort, so that will nail it.
MC: I thank you for your time.
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