Virtual corporation: A collection of companies organized to behave as if it were a larger, multifaceted organization.
A new, cyber-sounding word is creeping into the healthcare lexicon. It's trickling down from the nation's business schools and consulting firms where pundits tout the virtues of being "virtual" in today's fast-paced, global marketplace.
In B-school vernacular, a virtual corporation is a network of companies strategically aligned to develop and market a product. Companies link up through information systems and contractual relationships, rather than common ownership or control. And each partner shares the costs and risks.
Healthcare professionals are beginning to use the term to describe healthcare integration initiatives that don't require a merger of assets.
To competitiveness experts Steven L. Goldman, Roger N. Nagel and Kenneth Preiss, "virtual organizations are the business equivalent of all-star teams." Their book, Agile Competitors and Virtual Organizations, uses the metaphor to show how a "world-class team" may be formed by integrating several companies' core competencies and resources.
Business Week's Feb. 8, 1993, cover story, "The Virtual Corporation," traces the term back to the early days of computer technology when "virtual memory" was used to describe "a way of making a computer act as if it had more storage capacity than it really possessed."
A virtual corporation, then, is a collection of companies organized to behave as if it were a larger, multifaceted organization. "The idea of virtual integration isn't new at all; it's just not a hospital concept," said Jeff C. Goldsmith, a healthcare futurist who is president of Bannockburn, Ill.-based Health Futures and a national adviser for Ernst & Young.
But it seems to be catching on. "Virtual integration," "virtual network" and "virtual organization" are the latest additions to healthcare industry jargon.
The phrase "virtual hospital" also has been coined to describe coordinated, electronically linked healthcare services often provided outside hospital walls (See related story, p. 46).
Searching MODERN HEALTHCARE's back issues through 1992, the word "virtual" didn't appear in either context until 1994, when "virtual hospital" turned up in an article on the challenges facing the healthcare system in Ontario, Canada (Feb. 14, 1994, p. 78). Last year five references to virtual integration appeared, and there were three this January alone. For example:
In describing a Twin Cities joint venture between Allina Health System and HealthEast, Allina Vice President John Grotting said the Minnesota experiment would test "virtual integration"(Nov. 20, 1995, p. 30).
Legacy Health System President John King talked about the creation of "a virtual organization" linking the Portland, Ore.-based system with primary-care physician groups and Blue Cross and Blue Shield of Oregon (June 19, 1995, p. 122).
And, in the wake of a big supply company split and the merger of three hospital alliances, industry analysts pondered the value of "virtual" linkages of healthcare providers and medical supply companies (Jan. 8, p. 26).
Already in the works. If the concept sounds familiar, that's because HMO companies such as United HealthCare Corp. and PacifiCare already have invested in virtual integration, Goldsmith said. Neither organization has assets tied up in the ownership of physicians or hospitals.
One of the great attractions of virtual integration is that a healthcare delivery system can be created without investing huge amounts of capital to acquire the pieces.
On the other hand, some healthcare executives believe that owning some or all of the system's assets helps weed out excess costs, increase control and manage risks.
Ziegler Securities has estimated that some $20 billion in capital is currently required by the nation's "emerging healthcare organizations." The Chicago-based investment banking firm based the estimate on the results of its 1995 survey of healthcare organizations' capital requirements (April 10, 1995, p. 44). By the survey's definition, emerging healthcare organizations consist of hospitals, physicians and payers that have consolidated, merged, integrated or affiliated in response to managed-care pressures and healthcare reform.
Virtual integration avoids potential barriers such as unwilling sellers and long delays.
Using a baseball analogy, let's pretend you're starting a new major league franchise. Imagine what it would cost to acquire all the best players. At today's inflated salaries? As an old Brooklyn Dodgers fan would say, fugeddaboudit! And, no matter what you offered, some players couldn't be bought. By the time you've assembled an entire team, you'd be up to your neck in debt.
In the Portland, Ore., market, a healthcare system, an insurer and a group of physicians have created a virtual organization that they believe will enable them to function as if a single parent company were in charge. Yet the arrangement allows each player-Legacy Health System, Blue Cross and Blue Shield of Oregon and the Northwest Group Practice Association-to maintain control of its own operations.
The partners "have not wanted to give up their own particular business lines," said Robert Pallari, president of the new partnership, called Northwest Physician Alliance, and Legacy's senior vice president of marketing and health plans.
When Legacy first formed a strategic alliance with the Oregon Blues in October 1993, the Portland-based system didn't see room for another new health plan. With about 50% of the commercial population and nearly all Medicaid beneficiaries enrolled in HMOs, Portland is one of the nation's most mature managed-care markets.
"The ability to bring in another health plan to break into this market is exceedingly difficult, in our estimation," Pallari said. "And the experiences gained by competitors who own a health plan*.*.*.*proved that we would never be able to get the market share we needed."
Last May, after studying ways to add physician services to the mix, Legacy and the Blues entered an agreement with Cascade Medical Group, Mullikin Medical Enterprises and Metropolitan Clinic, collectively called the Northwest Group Practice Association.
"As a hospital-based system, we did review the option of physician employment and decided that wasn't the approach we wanted," Pallari said. "Our ability to manage physicians wasn't all that great, and the ability to be productive was probably going to be best achieved through collaboration."
Northwest Physician Alliance, the partners' new jointly owned for-profit corporation, will collectively plan and manage services. Pallari declined to reveal how much equity the three partners have invested in the new venture. He did say the dollar amounts vary, although each of the three has an equal share of stock for voting purposes.
"This was done purposefully so that there was an egalitarian feel around the issues of governance," Pallari said. "It really was to promote the sense that one large organization like a hospital system or an insurance system was not going to dominate the effort."
Making it "virtual." According to Goldsmith, what separates virtual organizations from run-of-the-mill contractual relationships are the agreements and protocols governing patient care, the information systems that monitor the process and the incentives governing how hospitals and physicians are paid.
Portland's virtual network is just beginning to tackle some of these issues, Pallari admitted. In the area of information systems, the partners are looking at what information is needed and who will produce it. Patient-care protocols are being reviewed to reduce duplicative services, shed excess costs and improve care.
"There's no question under contractual relationships between managed healthcare plans and providers that there is incredible duplication of overhead," Pallari said. The Portland partners have spent quite a bit of time building trust and identifying common goals. "When you overcome the trust issue, you can begin to say, `Why do all three of us have nurse case managers?'*"
Despite such examples, many hospitals continue to invest capital in physician and insurance operations. Experts say it's too soon to measure the eventual payoff of such investments. But the upfront costs of asset-based integration are painfully clear.
Last year, Moody's Investors Service reported that losses on physician practice acquisitions may negatively affect hospitals' and healthcare systems' credit ratings (Nov. 13, 1995, p. 16). Diana Lee, head of the New York-based credit-rating agency's healthcare group, said hospitals, on average, are losing up to 5% of total revenues annually on those acquisitions. The report said healthcare institutions are spending $50,000 to $200,000 in some competitive markets to acquire a single physician practice.
Meanwhile, the Healthcare Financial Management Association and Sterling Physician Services of America, a Louisville, Ky.-based consulting, physician recruiting and publishing company, found most organizations have yet to make money on physician practice investments (Sept. 25, 1995, p. 64). Only 17% of senior healthcare finance executives reported "always" or "usually" achieving a positive return.
Investing in an HMO or other managed-care organization can be pricey as well. According to the Ziegler survey, the median amount of capital needed by independent practice association model managed-care networks is $1 million.
In Goldsmith's view, "the integration movement in healthcare has been a costly mistake." His 1994 Healthcare Forum Journal article, "The Illusive Logic of Integration," explores the difficulties of owning or employing all the pieces of the healthcare system, not the least of which are inflexibility and cost. He argues in the article that the "asset-based model" of integration is obsolete, suggesting healthcare organizations must pick the organizational structure that creates the best value for buyers of healthcare.
"Merely having a large asset base, owning a lot of beds or health-related businesses, or employing a lot of physicians does not, by itself, create value," Goldsmith wrote.
For example, he generally views physician-hospital organizations and physician practice acquisitions as "no more than exceptionally risky efforts to prop up excess capacity and fixed costs by buying utilization or market share wholesale."
Purchasing physicians, many of whom may be "contemplating retirement" anyway, also doesn't make sense to him. "It's clearly not a risk-bearing structure. When you purchase physicians, the risk shifts to you," Goldsmith said. In a virtual relationship with physicians, there's more "dynamic tension," and everybody does what he or she does best.
Remember Humana? In 1984, the for-profit hospital chain entered the insurance business, a move that eventually alienated physicians who didn't participate in Humana's insurance plan. Many felt they were being treated as second-class citizens and began boycotting Humana hospitals.
Patients were admitted elsewhere, and the company's profits suffered.
Less than a decade later, the Louisville, Ky.-based healthcare giant split its hospital and insurance operations into
two unrelated companies. Humana's experience remains a textbook example of the pitfalls of a vertical integration strategy in which the parent company owns or controls all the system's parts.
More recently, FHP, a Fountain Valley, Calif.-based HMO, sold its Fountain Valley hospital, agreed to sell its South Salt Lake, Utah, hospital, and spun off its clinics and healthcare staff into a new management company called Talbert Medical Management Corp. The company's restructuring, expected to save $65 million a year, is viewed positively by Wall Street. Recently, Salomon Brothers said the company "should enjoy better enrollment growth, an improved cost structure and stabilizing operating margins."
Pundits like John Mitchell, a principal in the Minneapolis office of KPMG Peat Marwick's national healthcare strategy practice, and E. Preston Gee, senior vice president of marketing and business development for St. David's Health Care System in Austin, Texas, think the devolution of FHP's vertically integrated network may be a harbinger for the industry.
"There is a move on the frontier...toward more of an expansive network," Gee said. Even Oakland, Calif.-based Kaiser Health Plans, the granddaddy among group-practice-model HMOs, is loosening its network, allowing enrollees to see non-Kaiser physicians.
In the classic manufacturing sense, vertical integration links all the related pieces of the product supply and development chain through common ownership or control, Mitchell explained. He contends the benefits of vertical integration can be achieved through contractual relationships that create what can appear as a seamless delivery system.
"I think we're going to see more and more folks recognize that they don't have to be vertically integrated to make their strategies work," he said.
Vertical integration "is absolutely the right strategy" but not necessarily the right "organizational structure" for healthcare, Mitchell said. What's more important is how the organization behaves, not how it's legally linked, he added.
In Remaking Health Care in America: Building Organized Delivery Systems, a book scheduled to go to press March 22, researchers from KPMG Peat Marwick and Northwestern University conclude that virtual, or "behavioral," integration may be a more appropriate strategy for creating healthcare delivery systems. The book is based on findings from the Health Systems Integration Study, a four-year project sponsored by 11 of the nation's largest healthcare systems.
While most of the systems in the study have common ownership of hospitals, physicians and health plans or health plan products, they all have a number of virtual relationships as well, Mitchell said. For example, Fairview in the Twin Cities maintains a relationship with Blue Cross and Blue Shield to develop new managed-care products.
The study doesn't suggest that one model of integration is superior or financially sounder than another. "It's really the upfront costs that are dramatically different," Mitchell said. The advantage of virtual integration is a healthcare organization may share, rather than buy, expertise.
It's not for everyone. Virtual integration isn't a universal solution, analysts warn. Hospitals that support high-cost teaching programs, for example, could be forced to buy primary-care physicians because looser arrangements aren't feasible. "The hospital at the bottom of the food chain doesn't always have the leverage to get into a network," said William B. Hanlon III, a principal in the Atlanta office of Shattuck Hammond Partners. Many healthcare strategists favor some level of consolidation to drive out inefficiencies and duplication.
"Alliances do not produce the kinds of economies of scale, the kind of radical restructuring that is needed to compete," said Gee of St. David's Health Care.
Gee recommends virtual integration as a way for healthcare organizations to align with insurers. Many healthcare providers have learned that when you become your own HMO, you may lose volume from competing insurers. "That's skating on real thin ice," he said.
And, in Goldsmith's view, few providers are positioned to contract directly with payers. "Middlemen exist for a reason," he said. They provide a cushion against the underwriting risks.
In Harvard Business Review's January-February cover story, Henry W. Chesbrough and David J. Teece argue against going totally virtual. They say companies need to strike the right balance between contracting out and making in-house investments.
"Few virtual companies that have survived and prospered have outsourced everything," the authors said. "Rather, the virtuous virtuals have carefully nurtured and guarded the internal capabilities that provide the essential underpinnings of competitive advantage."
Virtual integration works as long as patients and employers believe they're getting maximum value, observed Saad Allawi, a senior principal with Mercer Management Consulting's Health Care Provider Practice in New York. If per-member-per-month costs are competitive and outcomes are good, "they don't care if it's virtual or not," he said.
Allawi, who describes himself as an "anti-strategist," doesn't favor one integration strategy over another. "It's not the best-designed model that makes the most sense," he said. "It's literally the best-executed one."
With the proliferation of investment and consulting firms in the business of capitalizing and deploying healthcare integration strategies, "there are a lot of folks who are just trying to get organizations to the altar," Mitchell warned.
Healthcare organizations need to focus on their long-term goals to determine the right organizational structure, he said. "Concentrate on what you want the marriage to be like instead of just getting the wedding done."