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Stakeholder participation helps direct the creative inquiry toward better questions, which lead, in turn, to more sharply defined problems. That reduces the level of innovation risk while producing superior—often breakthrough—solutions. Chris McCarthy shows up for an early-morning interview wearing raspberry-colored scrubs. McCarthy, a KP innovation specialist, is just beginning a project aimed at optimizing the time nurses spend with their patients.

In KP hired IDEO to help it develop better, more-efficient ways of performing certain high-value activities, and gained a distinctive innovation methodology in the process. What McCarthy will do all day is watch people, take notes, snap pictures, and make sketches. Some of what matters to him will be physical or logistical: Who stands where, does what, communicates most or least or best?

What tools are used? Are they used easily, effectively, gracefully? How are they carried? But McCarthy is also interested in subjective evidence. He will try to get some sense of the atmosphere—color, light, energy, mood. He knows that information that may at first seem unimportant can later mean a lot.

Or anyone. After a day spent watching other people work, McCarthy tries to capture experiences from the points of view of everyone involved. The goal is to find hidden clues to the nature of the problem at hand and some line of inquiry for progressing toward possible solutions. The Innovation Consultancy takes on carefully chosen projects throughout Kaiser Permanente, which is based in Oakland, California, and serves the health needs of more than 8.

McCarthy and his colleagues pursue an expansive, service-focused version of innovation, not the conventional one that by definition excludes everything but new technologies or tangible products. Surprisingly little attention has yet been paid to this version. But, as Kaiser is discovering, the bucks are relatively few and the bang can be disproportionately big. Compared with costly, long-horizon, research-driven innovation, service-focused innovation can be done both rapidly and economically.

Its work is still in a relatively early stage—one in which there may be an abundance of low-hanging fruit. And given the depth and breadth of the problem, widespread improvements may be slow in coming. It remains to be seen whether his goals will be achieved. Consider, for example, the return on investment from a project called KP MedRite , an effort to reduce medication errors in KP hospitals. The process has also produced intangible, hard-to-measure benefits such as greater employee satisfaction and patient peace of mind.

Worse, nurses compiled and exchanged patient information in idiosyncratic and unreliable ways some even scrawled notes on their scrubs. Important details were often left out, or care that had already been provided was needlessly repeated. What came to be called Nurse Knowledge Exchange created a process for passing on higher-quality information more quickly and reliably. Patients are encouraged to participate, making it less likely that anything important relating to their care will fall through the cracks.

New software helps nurses compile information in a standard format throughout their shifts. As the relationship between KP and IDEO progressed, what had been conceived as a three-month immersion turned into an eighteen-month apprenticeship.

Three different versions of the package target business leaders, project managers, and frontline staff members.

No matter how brilliantly conceived, projects often go awry through neglect of the back-end work. They not only provide sensible instructions for getting on with the program but also reinforce the cultural imperative that change is an important part of work life and innovation ultimately touches every corner of the enterprise.

He now admits that assumption was naive. And, of course, not everyone has the temperament or wants to be an innovator. In too many enterprises, innovation is treated as a sideshow. It may get its due in lip service without being appropriately supported or well understood. Potential breakthrough ideas struggle to survive amid entrenched systems and values. Kaiser Permanente is among a minority of enterprises that take innovative approaches to innovation itself. Within its industry, Kaiser enjoys some advantages:.

In this context the Innovation Consultancy flourishes. I need help during the process. Dispensing meds correctly means giving the right prescribed drug in the right dose to the right patient at the right time.

The observation phase of the MedRite project strongly suggested that interruptions and distractions were the leading cause of errors. For nurses, interruptions are a regular feature of hospital life. Important information is constantly being asked for and given out. This typically occurs at the Sidney R. For two days a group of 70 deputized codesigners tackled the problem of medication errors. They produced about ideas, ranging from incremental to outlandish.

It had a microwave built in. I mean, it was a pretty crazy bed. Cohesive physician organizations can find ways to inhibit the entry and growth of prepaid group practices. This can include informal means, such as the public characterization of PGPs as dispensing low-quality medicine. Physicians and hospitals in the traditional medical community in North Carolina were quite hostile to prepaid group practice. KP—Carolina did not adequately anticipate the magnitude of this resistance and so was slow to counter it.

The North Carolina Medical Society also was generally opposed to KP—Carolina, and in fact, some specialist medical societies organized against prepaid health plans. The nature of the market itself may have contributed to KP's failure to expand in this new region. PGPs require sufficient population density so that they can enroll a critical mass of members within a referral area sufficient to support a multispecialty group practice that represents most of the secondary care specialists.

The Research Triangle had the smallest and least dense population base of any market in which KP operated. The market analysis on which KP based its decision to enter the state suggested that KP—Carolina would have had to enroll 40, members in order to achieve financial viability, a figure that, in retrospect, looks astonishingly low.

As it turned out, KP—Carolina needed a much higher enrollment, perhaps as many as , members in the Triangle alone, to reap the economies of scale on which its business model depended. Although it exceeded that number in the state, it never gained that market share in the Triangle. Two important marketing and financial assumptions proved difficult to meet: 1 people would join KP because it was KP even though its provider network was tiny and a closed-group practice was an unfamiliar arrangement , and 2 membership would grow because their premiums would be 20 to 25 percent below those of their competitors.

For KP to market its comparative advantage, employers would need to be willing to offer choices among plans and also be willing to structure the choice so that employees could share the savings if they selected a less expensive plan.

As is the case with any new health plan, KP—Carolina faced a two-tiered marketing challenge. First, it had to convince employers to offer its product. Then, if employers offered several different options to their employees, KP had to convince the employees to choose its product over other health plans.

Most employees worked in firms in which multiple choices would be very costly to administer, such as national firms with a small concentration of employees in many regional markets. And not until , facing the rising costs of employee health benefits, did the Research Triangle's largest employers, like IBM and Cisco Systems, become members of the newly formed Triangle now North Carolina Business Group on Health personal communication from Jack Rodman, May 20, Unfortunately for KP—Carolina, many employers especially small firms preferred contracting with a single carrier or insurer that could offer a menu of health plan options to contracting with multiple carriers.

Major commercial carriers and insurers have capitalized on the administrative convenience of single-plan replacement and have developed employee-choice products for small employers.

Because of adverse selection and other concerns, carriers often refuse to offer a comprehensive plan alongside a different carrier's plan that has a markedly different level of coverage. For example, a KP manager noted that many of the large banks in Charlotte claimed that commercial insurance carriers offered better deals, broader geographic coverage, and greater physician choice than KP—Carolina could.

In addition, some large employers were national firms with centralized buying offices that negotiated only with those health plans that had a presence in several states, including those where KP did not have a presence. KP—Carolina faced two other challenges in marketing its product to private-sector enrollees.

First, employers that contracted with KP—Carolina often continued a historical practice of paying all or a high fixed percentage of the monthly premiums. KP's initial market analysis signaled the pervasiveness of this practice when it noted that only 35 percent of the employers it surveyed required employees to pay all or part of the monthly premium KPAS That is, two-thirds of the surveyed firms dampened one of KP—Carolina's key selling points to prospective enrollees: comprehensive coverage at a low cost.

In addition, KP's premiums were higher than those of some of its competitors. Consequently, KP—Carolina attempted to enroll recent arrivals to the state, the majority of whom relocated to the Charlotte and Triangle markets. In addition to meeting the two-tiered marketing challenge, KP's success depended heavily on efficiently providing medical care through the group-practice model.

Here, too, the Carolina Permanente Medical Group encountered difficulty. As one interview participant noted:. In those markets where [KP] had created a favorable cost structure, the local medical group has essentially taken and executed the responsibility for making that happen.

They have found ways to perform more effectively than community physicians, often requiring some sacrifices on the part of the physicians to achieve that level of performance either in how hard they work or in how much they get paid or in how they utilize resources. The medical groups have themselves created those efficiencies. Whether it's will or skill or circumstances, the medical group in Raleigh was never able to achieve the level of efficiency that would afford that kind of cost structure.

The CPMG also faced the dilemma of having to operate many small clinics in order to maintain convenient access for its geographically dispersed enrollees, even though the high fixed costs of doing so undercut its ability to achieve and sustain the scale efficiencies necessary to support its cost-leadership strategy.

Those clinics were filled. However, not all of KP—Carolina's nine medical offices had such a high volume of patients. KP—Carolina and the CPMG could not achieve the economies of scale necessary to generate and maintain market share by offering lower premiums, lower out-of-pocket expenses, and more comprehensive benefits to prospective enrollees. PGPs require a supply of high-quality providers hospitals and specialists willing to contract on terms similar to those granted to other carriers.

The CPMG did not employ its own specialists or own its own hospitals, as KP and its medical groups did in other parts of the country. Even obstetric and gynecological services, often considered primary care specialties elsewhere, were not provided by the CPMG until the early s, perhaps because KP—Carolina lacked the volume necessary to support the fixed costs of internalizing these services.

This meant that the CPMG exerted less control over utilization and costs than it might have. And many interview participants suggested that the CPMG compounded the problem by contracting with specialists and hospitals at unfavorable fee-for-service rates.

The high fixed costs of maintaining a PGP infrastructure became an increasing liability as new market entrants increased the level of price competition.

Prospective enrollees did not see a significant enough price difference to offset the restricted choice and geographic inconvenience of KP—Carolina physicians and facilities.

People were looking to the health plan where they could maintain their provider relations. Like other organizations with multidivisional structures, KP's corporate headquarters struggled to find the right balance between giving new regions the flexibility and autonomy they needed to respond to local market conditions and advancing KP's corporate goals and maintaining consistent policies.

Some of KP's corporate decisions benefited the organization as a whole but constrained the region's ability to respond to start-up demands in a challenging market. For example, the company required the region to repay its start-up debt with interest, at rates that some former KP—Carolina managers described as above market. From the KP corporate point of view, the decision made sense given its experience in Texas, where the West Coast medical groups had been incensed about having to subsidize an operation that lost money for 15 years.

Moreover, it needed its investment repaid quickly, as its West Coast regions were clamoring for funds for information technology and facility upgrades. In our interviews, current and former KP corporate executives downplayed the significance of the debt service requirement in KP—Carolina's performance problems, but former KP—Carolina regional managers expressed a different point of view.

Similarly, in the early s, KP's corporate headquarters urged KP—Carolina and other regions to develop business plans for achieving and sustaining a 15 to 20 percent price differential from competitors. Faced with heated competition from network-model managed care plans, KP corporate headquarters jointly conducted a study with a major consulting firm and affirmed its commitment to the cost-leadership strategy. The consulting firm encouraged KP to think about market share as an important success factor.

The conventional wisdom was that with a good economic base, marketplace presence was a key factor. At the time, KP—Carolina had just reported its first profitable year and had priced its product above the average for the market in order to reflect its true costs of operation including service on the start-up debt.

Again, the opinions on the wisdom of this corporate decision differed. As one CPMG leader stated:. We were encouraged, to use a mild word, to reduce our operating infrastructures enough to support a 15 to 20 percent lower price point. But we were unable to cover the cost of what we were doing. The solution was applied uniformly across the organization, which I think in retrospect everybody believes was a problem.

Current and former KP national executives disagreed, arguing that the problem was not the wisdom of the strategy but, rather, its poor execution by the medical group.

Corporate executives cited the inability or unwillingness of regional leaders—especially in the CPMG—to build a sustainable business model based on tight cost control. These constraints were said to include limits on plan and benefit design as well as on advertising, sales, and marketing.

Interview participants disagreed about whether the failure to achieve the requisite operating efficiencies to sustain this corporate objective resulted from problems of ability, willingness, or circumstances. The general business literature indicates, however, that simultaneously achieving revenue growth and cost control in a start-up is daunting even under ideal market circumstances e.

Like many organizations, KP routinely transferred personnel laterally in order to shift needed expertise from one region to another and to enhance career development. Several interview participants reported, however, that this did not work well in the case of KP—Carolina.

Not surprisingly, senior KP—Carolina managers disagreed, contending that the lack of entrepreneurship stemmed not from inexperienced management but from national corporate constraints on innovation. As one said:. The original leadership brought in to start this region was supposed to replicate, not innovate. The job was to replicate the KP model in North Carolina. There was no room for entrepreneurship, nor would it have been welcomed.

We were given binders of material that we were supposed to use—staffing ratios, financial reporting formats, marketing materials, benefit plans, graphic standards, staff training tools, even floor plans. They wanted us to stick to the recipe. It was the Oakland way—or no way. As the competition from less restrictive managed care products intensified, KP—Carolina tried to complement its group-model HMO with a point-of-service product and an IPA-model product.

Two problems immediately arose. First, KP—Carolina did not have the organizational capability to effectively manage an extensive network of contracted providers. Its business systems could not track members as they moved through a more open, networked delivery system, pay claims in a timely and accurate manner, or monitor utilization across loosely affiliated physicians and hospitals.

As one former CPMG employee noted:. We didn't know how to pay a claim. We hadn't had to pay very many claims. We had a lot of capitated and prepaid specialty arrangements and all of a sudden we started getting claims in, and I remember when 50,, you know, six months of claims went unpaid.

It was outrageous. KP—Carolina managers and medical directors found it hard enough to build the familiar group-model delivery system from scratch under less than hospitable market conditions.

Simultaneously creating and managing a network model so far removed from KP's core competence proved impossible. Moreover, by trying to straddle the gap between staff-model and network-model product markets, KP—Carolina diverted precious resources from its core product and its core constituencies.

The original group-health model concept did not get the attention that it needed and started to deteriorate. This seemed a good way to build enrollment, increase volume, and counter the growth of competing products.

Reflecting on KP's flirtation with network models in North Carolina and other regions, several interview participants commented that the flawed strategy nearly cost the company its soul.

Perhaps this is the most important internal lesson that KP as an organization could learn from its North Carolina experience. It is easy for outside observers to be critical of a business strategy and outcome after the fact. However, reflecting on our analysis of the North Carolina experience, David Lawrence, KP's CEO at the time, concluded that the regional failure was due to an internal corporate failure to understand how to expand:.

KP expanded with a missionary zeal that substituted for careful, thoughtful planning and development of the core modules required to incrementally build a viable business.

We did not learn from other industries, follow established pathways for successful expansion that have occurred in other industries, etc. It is an important lesson for us. We operated with a California bias and had no real understanding of what was required to accomplish, execute a start-up, and to build a successful business.

I do not think the model was wrong; rather, it was in the execution. Stated differently, I do not believe we have tested whether or not the model can be successful yet.

We thus conclude that the KP experience in North Carolina illustrates in microcosm the complex interdependencies that determined the fate of a KP expansion effort, not to mention similar efforts by other PGPs around the country. The demise of several KP regional expansions reinforces the importance of the numerous interlocking pieces that are necessary to foster a market in which a prepaid group practice can exercise its competitive advantage.

It is clear that in North Carolina none of the important factors was pointing in the right direction. However, while KP used to be able to charge less for more comprehensive benefits than others were charging for less comprehensive benefits, KP now has a smaller price advantage.

KP's historical business model attempts to build efficient-scale operations and vigorously pursue cost control while maintaining acceptable levels of quality and service. Achieving low overall costs requires enough enrollees to support the internalization of most specialties into the medical group as well as access to production inputs e.

By achieving low overall costs through efficient, high-volume operations, KP can offer low premiums and low out-of-pocket expenses as well as more comprehensive benefits. Furthermore, in its fully perfected version, the Kaiser model would offer more coordinated care delivery through a group-practice culture and internal coordination among medical and hospital service providers in exchange for a more restricted choice and, sometimes, less convenient access. The historical business model clearly did not succeed in North Carolina.

Where KP has been successful in entering markets, an important factor has been strong backing from influential local organizations e. Local sponsors such as unions have provided an enrollee base and lent important political support. On the West Coast and in Colorado, Kaiser had strong backing from the AFL-CIO, which liked its emphasis on comprehensive benefits and preventive medicine and demanded that employers offer Kaiser as an alternative to traditional insurance.

Regional expansions have also been successful in Georgia with more than , members and in the Washington, D. While there were widespread losses in the competitive Atlanta market, KP's ability to consolidate allowed it to reach a critical mass of enrollees. Kaiser has also continued to grow steadily in Colorado, Hawaii, and on the West Coast. It was able to build on the West Coast from the s through the s, when the managed care industry was young, and independent competing medical groups were scarce.

It achieved a network scale and scope that would be difficult to replicate today, when the industry is mature and competitors abound. When Kaiser expanded outside its core markets in the s, as was the case in North Carolina, the industry was maturing, and sophisticated competitors were plentiful. The North Carolina case illustrates the difficulties of replicating the vertically integrated model in new geographic markets under these circumstances.

Kaiser Permanente maintains a dominant position on the West Coast, and hybrid entities that embody some but not all the elements of prepaid group practice can be found in many metropolitan areas.

In its most recent report, Kaiser Permanente's national membership in nine states and the District of Columbia remained flat at 8. But the trend in the health care marketplace generally is toward broad-network insurance products divorced from provider systems, retrospective rather than prospective payment, a purchasing framework that emphasizes copayments at the time of service rather than a cost-conscious choice at the time of insurance enrollment, and an institutional framework hostile to the principles and practices of managed competition.

In six of the eight geographic regions that Kaiser Permanente serves, the two largest customer groups are state and federal employees. In the other two, the largest enrollee groups are federal employees and a public school system.

In the FEHBP, the benefits are not as standardized, but the Office of Personnel Management has required that the benefit packages offered be fairly comprehensive. However, not all is perfect even in the ideal purchasing environment. In the CalPERS program, Kaiser is concentrated in urban areas in California, where health plan competition still works, which means that with a statewide premium, the PGPs enjoy the luxury of not having to operate in rural areas that are costly because of local provider monopolies but where the self-funded PPOs do operate.

It is likely that certain markets, such as most rural or commuter areas, may not have the geographic conditions to sustain a profitable private-sector PGP, even when these conditions are met.

What can private employer and public policymakers do to make market environments more hospitable to the PGP model of care delivery? The essential insight of managed competition, as a reform, is to divide the provider community into competing economic units and then to offer employees a responsible choice with premiums that reflect the differences in per capita cost, in order to give them an incentive to choose the efficient providers Enthoven If a critical mass of employers were able to do this in any market area, managed competition advocates still claim, they would create the environmental conditions in which efficient delivery systems could enter, market their superior value for the money, and achieve economies of scale.

The following elements must be present if a PGP is to have access to the employee not just employer market: a broad choice of health plans; risk adjustment to mitigate adverse selection; an employer contribution that allows employees to retain any savings resulting from an economical choice; a level regulatory playing field among HMOs, insurers, and self-insured plans; and reliable, comparable information about the quality of care and consumer satisfaction. Recent research has shown wide variations among providers in the resources used to treat the same conditions and produce the same outcomes Fisher et al.

Employers might offer employees a price-sensitive choice among existing HMOs and encourage HMOs to develop selective networks to improve their performance. The all-inclusive network favored by employers in the single-source model is sure to be ineffective. Alternatively, under the protection of the Employee Retirement Income Security Act, employers might develop several selective PPOs, each of which would offer the preferred services of a different network of providers.

If there are effective IPAs in a market, employers might build their choices on them or even share the gains created by the most efficient providers by offering them bonuses for achieving performance goals.

The focal points for these networks would likely be different hospitals and their staffs. The idea is to be sure that those employees who choose efficient providers realize the savings generated by their choices. Despite the high expectations, PGPs have fared poorly in the market in recent decades. Group- and staff-model HMOs have survived only where they constitute a large portion of the local market, offer an adequate choice of physicians, and gain from economies of scale similar to those of nonintegrated competitors Hurley et al.

PGPs have had a great impact on the American health care system and continue to offer high-quality, cost-effective care to millions of patients in particular regions and communities. Yet their future remains unclear. KP was not the only HMO to have faced competitive challenges.

Nationally, no group- and staff-model HMOs have performed well over the past two decades. In June , the group and staff models had 7. By July , with In July , group and staff models served 7. Membership in staff models actually declined, while membership in group models mainly Kaiser Permanente grew slowly and lost market share to faster-growing models, such as IPAs and mixed models.

The models that rely on established providers and facilities can grow much faster than group and staff models that must recruit and develop their own doctors and facilities.

By the early s, some group- and staff-model HMOs, seeking to attract employers that wanted a single source of health insurance, sought innovations and merged with or acquired wide networks of traditional providers to offer alongside their groups. After experiencing three years of no growth, it brought another group into its network and created a wide network of fee-for-service, solo-practice doctors. In these cases, market conditions created by the employer single-source and employee contribution policies that did not highlight cost differences forced health plans to abandon the pure staff model InterStudy Some health plans have tried to combine the virtues of organizational integration with the attractions of contractual promiscuity by wrapping a network of independent physicians around a core of an integrated group practice.

In Washington and Idaho, however, the Group Health Cooperative has combined a core prepaid group practice with a contracted network of solo and small-group practices, thereby preserving its market share. But it has not been able to leverage the distinct virtues of integrated efficiency and broad choice into a comparative advantage and so remains a niche player in a market increasingly dominated by broad network-insurance products and fee-for-service payment Robinson As a vertically integrated organization that combines an insurance entity with multispecialty group practices and, in some regions, hospitals, KP possesses particular strengths and weaknesses.

A PGP cannot be built overnight. For decades, KP and the Group Health Cooperative have been working out the kinks and links in the financing and delivery systems. Hence, the most general lesson of our analysis is that the successful introduction and proliferation of prepaid group practice into markets with little or no experience with the model depend on the conjuncture of several supportive conditions.

These include employers willing to offer a choice of carriers because PGPs cannot succeed as a single source ; employers willing to structure the offering to employees so that the employee making the choice gets most, if not all, of the savings; a framework that mitigates adverse selection; a regulatory framework that imposes equal burdens on PGPs and their competitors; a supply of high-quality providers hospitals and specialists willing to contract with PGPs on terms similar to those granted to others; and a high enough population density to permit the enrollment of a critical mass of members within a referral area sufficient to support the multispecialty group practice with most of the secondary care specialists represented.

All this suggests that while PGPs can play an important role in market-driven reform, without the right mix of supporting factors, a variety of other, more flexible and robust models will also be needed. We gratefully acknowledge the numerous interview participants who gave generously of their time and insights, especially Dr.

The Kaiser Permanente Institute for Health Policy provided grant support and information, but the analysis and conclusions are solely our own.

James Bernstein, M. William Brandon, Ph. Christopher Conover, Ph. Ray Coppedge, M. June 20, Allen Feezor, M. Claudia Ghianni, M. Bill Gillespie, M. Nancy Henley, M. Eugenie Komives, M. May 6, Anna Lore, B. Don Madison, M.

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