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Chicago Fed Letter

The Value Chain Case for Health Care Reform—
A conference summary
by Sam Kahan, senior economist, and William A. Testa, vice president and director of regional programs

On April 24–25, 2007, the Federal Reserve Bank of Chicago and the Detroit Regional
Chamber sponsored a two-day forum examining a “value chain” perspective of health care
delivery in the U.S. The program discussed how a value chain evaluation might lead to
improvement in health care quality, reduction in costs, and increased user accessibility.

Health care costs in the U.S. are high and challenges in Michigan and across the
rising rapidly. The U.S. spent approxi- nation—the “value chain.”
mately $2 trillion on health care in 2005,
Michael Porter has popularized the
nearly 15% of real gross domestic prod-
term value chain to mean the entire
uct (GDP)—up from 5.9% in 1965 and
production process from the input of
currently among the highest in the world.
raw materials to the output of the final
More importantly, costs are rising rapidly
product consumed by the end-user.1 It
with no hint of any slowing. Since 1990,
is called a value chain because each link
medical care costs as measured by the
Materials presented at the in the process adds some value before
Consumer Price Index (CPI) have risen
the product or service is delivered to the
conference are available at at a compound annual rate of 4.6%,
ultimate customer. Along the way, the nearly 2 percentage points faster than
particular actors involved—which may
the overall CPI. Without effective reforms
and_conferences/conferences_ in the health care system, such trends are
include government agencies, nonprofit
and_events/2007_detroit_ organizations, and other agents—and
likely to continue as the U.S. population
the arrangements and incentives under
healthcare_agenda.cfm. ages and the scope of medical technology
which the process takes place help to
continues to broaden.
determine the cost and quality features
In Michigan, providing more cost-effec- of the final product or service. For value
tive and customer-attuned health care is chains involving public sector inputs,
especially important as the automotive such as health care, there are myriad
industry—the state’s primary industry— policy options, cooperative agreements,
bears the hefty legacy health care costs regulatory regimes, and institutional
of its retirees. This also implies that effi- arrangements available at various stages
ciency improvements in health care may of the value chain. Such arrangements
have profound effects on Michigan’s characterize the quality, cost, and vari-
competitiveness. Currently, the state is ety of the final product or service. In
burdened with both a slowly growing contrast, for many goods and services
economy and an aging population. At supplied by private firms, the value
the conference, academics, health care chain process, while complex, has its
providers, insurers, employers, labor elements chiefly fashioned within or
union representatives, and representa- between private firms, operating with
tives of various governmental authori- relatively fewer constraints than public
ties gathered to discuss one particular sector entities.
approach to addressing the health care
In the private sector, the value chain of party payer” arrangement may mean over the whole process from individual
today’s automotive industry is often held that consumers are motivated to over- payer to service provider.
up as an ideal. Today, the automotive purchase some types of health care ser-
Burns also suggested that better technol-
value chain is a segmented string of auto- vices or to avoid price shopping that they
ogy should be used in many parts of the
motive assembly firms and autonomous might otherwise engage in if they were
health care value chain to create greater
parts suppliers, with each being highly paying directly. Physicians and hospitals
efficiencies. He said that approximately
specialized and focused on particular often act as informed agents for consum-
$554 billion, or 28%, of the nearly
core competencies. Competition among ers of sophisticated health care services,
$2 trillion spent on health care is cur-
firms at each stage imposes cost-effective and they too may not be strongly moti-
rently technology-related; and this area
production and product innovation. vated to ration services on the basis of
of spending is growing rapidly.
According to Burns, currently, physicians
Two alternatives were presented as to who should be the have the central role in the health care
value chain. They are the decision-makers
ultimate decision-maker in health care: the consumer
for many products, such as medical de-
(patient) or the provider (hospital/physician). vices and drugs, as well as for services at
hospital-based programs and alternative
Despite this specialization and compe- cost in third party payer systems or to sites, such as outpatient clinics. As a re-
tition, greater overall cost-effectiveness tightly control the cost-efficiency of their sult, physicians’ preferences are the focus
of the final automobile is also brought own operations. Also, a significant part of attention by medical equipment and
about by particular cooperative relations of health care responsibilities may fall drug producers, and they are probably
among firms along the value chain. on the consumers so that their behaviors the key determinant of value. But Burns
Given the level of cooperation in this in prevention, self-medication, and life- sees an increasing role for the payer in
system, quality and competitive price style must often be considered in achiev- the value chain. Through an expanded
information are communicated quickly ing desired outcomes. So, too, in the U.S., collection of data on cost, utilization, and
upstream in the value chain. Consumers governments and nonprofit agencies product and service performance, he
downstream also have ready information commonly serve as direct health care argued that efficiencies and cost savings
on the final product’s quality and price. providers or as insurers and regulators. can be discerned and the information
This availability of information along Private sector employers often include dispersed to the health care providers
the value chain imposes market disci- health care insurance as part of their and producers—and ultimately, to con-
pline on many competing automakers, employee compensation package. Such sumers. While there has been a very re-
which must in turn exert discipline on arrangements thereby introduce yet cent movement to gather data on the
their suppliers, while also acting coop- more actors into health care transac- quality and cost of medical services, es-
eratively on specific preassembly activi- tions and payments. pecially those of hospitals, there is still a
ties, such as automotive design and dearth of comparative information on
production planning. Value chain overview health care. Burns stated that the patient
To open the proceedings, Robert Burns, needs to be more active in the value chain
In contrast to today’s automotive market, process, particularly as an informed
Wharton School of the University of
the partnerships in the markets for health purchaser of goods and services.
Pennsylvania, gave an overview of the
care services have not given rise to cost-
value chain approach, noting that this
efficiencies and delivery innovation. Pros and cons of value chain
approach has not been effective in the
Fundamentally, many health care ser- Uwe E. Reinhardt, Princeton University,
health care arena. Some of the reasons
vices are complex and only purchased questioned whether the value chain con-
include an inability to create and coor-
intermittently, if at all. This means that, cept can be very helpful to the health
dinate strategic alliances, a lack of in-
often, consumers are not well informed care industry until society decides who
formation regarding value/cost at each
in their purchase decisions. Even if the should determine value. The concept of
link, and an insufficient sharing of
consumer understands what to shop for, the value chain can be a highly useful
knowledge in health care. Attempts at
information on cost and quality among analytical tool in many contexts, but it
vertical integration, whether initiated
providers is often sparse. Many needs for runs into a host of conceptual and meth-
by providers, insurers, or employers,
health care services are associated with odological problems if applied to health
have largely proved ineffective, proba-
costly and unpredictable episodes of care. The driving force for change in well-
bly because the coordination costs ex-
illness, so that the services are often functioning value chains is competition
ceeded the gains from agglomeration.
paid for under insurance arrangements to provide the best value to the ultimate
The only partial success at vertical inte-
rather than with direct fees for services. customer. For health care in the U.S.,
gration has been at the U.S. Department
But insurance often gives rise to especial- two important questions in applying this
of Veterans Affairs’ Veterans Health
ly difficult “moral hazard” issues in the framework are: Who should set the “val-
Administration—an organization that
health care arena. That is, this “third ue” in the value chain; and how should
by its very nature has greater control
the value of services be determined (that little or maybe even receive a refund. contain costs and maintain access. She
is, by market forces or by some other pro- Smith noted that the University of noted that a government agency is not
cess)? These are open questions because Michigan, in its role as an employer, is merely a purchaser of health services and
health care is often viewed by some as experimenting with funding similar pre- products; rather, it is also a provider, reg-
a social good to be distributed to all who ventive actions, which in the short run can ulator, convener (bringing interested
need it regardless of ability to pay, but be expensive but which in the long run parties together), and occupier of a
by others as a private good. Under our may actually result in lower costs because “bully pulpit” for policy and process re-
current system, there are several poten- the client base will be healthier. form. One effort at cost containment
tial candidates to be the ultimate cus- involved the pooling of Michigan’s
Wyszewianski observed that in the cur-
tomer, Reinhardt said, including the Medicaid purchases with those of other
rent system the physician has a near
individual patient, the insured person, states. This enabled Michigan to slow
monopoly in decision-making that is
the insurance company, the taxpayer, and the trend growth of expenditures and
difficult to change in several important
the employer. Since they all have varying to experience an absolute drop in
ways. His experience has been that phy-
motivations and requirements, there will pharmaceutical expenditures of 5.2%
sicians are not fully aware of the array of
not necessarily be an alignment of values in 2006. Health plan contracting was
alternative approaches or procedures
along the value chain. He buttressed his another area of success. The health plans
available; are not always fully apprised
argument by noting that current spend- were rated on their performance in
of the effectiveness of procedures; and
ing on health care varies across regions areas such as children’s care and chronic
are sometimes reluctant to implement
and procedures by a wide margin. For ex- illnesses (e.g., diabetes) and awarded
different methods. He pointed to the
ample, U.S. personal health care spend- bonuses for outstanding performance.
Greater Detroit Area Health Council’s
ing per capita in 1998 averaged $3,759, Olszewski cited three keys to the success
Save Lives Save Dollars program that has
but it ranged from a low of $2,731 in Utah of health care in the future—namely,
adopted performance metrics and issued
to a high of $4,810 in Massachusetts. ensuring access to health care, especially
evidence-based guidelines as one way of
to the uninsured; increasing the usage of
Dean G. Smith and Leon Wyszewianski, lessening physicians’ reluctance to change.
health care information technology; and
both of the University of Michigan School
Taylor reported that a shift from a paper emphasizing beneficial lifestyle practices.
of Public Health, and Jeffrey R. Taylor,
to an electronic form of recordkeeping
Michigan Public Health Institute (MPHI), Vernice Davis Anthony, Greater Detroit
by fiscal intermediaries, such as Michigan
discussed the merits of the health care Area Health Council, reported on her
County Health Plans, to MPHI has re-
value chain approach. Smith noted that organization’s efforts to improve quality,
duced costs from $15 to about $6 per
the purpose of the health care system is accessibility, and cost-effectiveness in
processing in the past two years. Electron-
“not to minimize overall or total expen- the health care arena under the rubric,
ic recordkeeping enhances the search
ditures but to deliver value to patients, Save Lives Save Dollars, which was
for Medicare eligibility, thereby reducing
that is, better health per dollar spent.”
labor costs, errors, and time-to-service.
He argued that greater attention should
Taylor estimated that this enhancement
be paid to the patient, particularly the Charles L. Evans, President; Daniel G. Sullivan,
represents 1.3 million transactions per Senior Vice President and Director of Research; Douglas
financial incentives needed to influence Evanoff, Vice President, financial studies; Jonas Fisher,
month and reflects an annual cost saving
patient behavior. As an example, he not- Economic Advisor and Team Leader, macroeconomic
of about $7.7 million. policy research; Richard Porter, Vice President, payment
ed that, while lower co-payments tend to
studies; Daniel Aaronson, Economic Advisor and
increase usage of drugs (statins in his Perspectives from the value chain Team Leader, microeconomic policy research; William
example), there is a marked decline in Testa, Vice President, regional programs, and Economics
Scott P. Serota, Blue Cross Blue Shield Editor; Helen O’D. Koshy, Kathryn Moran, and
usage by individual patients over time; Han Y. Choi, Editors; Rita Molloy and Julia Baker,
Association, argued that the future health
by year three, only 10% of patients con- Production Editors.
care model should be much more con-
tinue using statins (as directed by their Chicago Fed Letter is published monthly by the
sumer centric and information driven. Research Department of the Federal Reserve
physicians) if the co-payment is greater
The insurer’s role in such a world would Bank of Chicago. The views expressed are the
than $20, but slightly more than half con- authors’ and are not necessarily those of the
be to provide consumers with informa-
tinue when payments are less than $10. Federal Reserve Bank of Chicago or the Federal
tion on the comparative quality of care Reserve System.
In this instance, there is apparently a
by provider, institution, and even indi- © 2008 Federal Reserve Bank of Chicago
need to provide patients with an incen- Chicago Fed Letter articles may be reproduced in
vidual physician; to assess the various
tive to continue using medication. More whole or in part, provided the articles are not
procedures; and to provide the costs of reproduced or distributed for commercial gain
generally, medication charges should be
alternatives. At the center of all this would and provided the source is appropriately credited.
better aligned with potential future costs. Prior written permission must be obtained for
be personal health records of consumers
An implication of this approach, to mini- any other reproduction, distribution, republica-
that would be electronically portable. tion, or creation of derivative works of Chicago Fed
mize total costs over a patient’s lifetime, Letter articles. To request permission, please contact
is that someone who is at low risk might Janet Olszewski, Michigan Department Helen Koshy, senior editor, at 312-322-5830 or
have a high co-payment for treatment, of Community Health, described how email Chicago Fed
Letter and other Bank publications are available
while someone at high risk should pay the state of Michigan is attempting to on the Bank’s website at
ISSN 0895-0164
mentioned earlier. She attributed the care outcome divided by cost. He argued and quality. Insurers, nonprofits, and
program’s success to the creation of a that physicians should take the lead in governments also may play important
broad-based coalition consisting of busi- making decisions on health care prod- roles in assisting consumers to obtain
ness, labor, health care, government, and ucts and processes because they are aware comparative information.
consumer groups, which provided a crit- of the best ways to safely cut waste, are
Determination (and delivery) of the ap-
ical mass of support for change. Rather best equipped to evaluate new technol-
propriate health care services has always
than tackling all health care issues, this ogy, and can implement change. He
entailed trust between physician and
multistakeholder group selected specific acknowledged that, under most current
patient. Physicians have the advantages
target issues, such as diabetes, heart arrangements, costs, procedures, and
of relevant and educated information to
attack/heart failure, and surgical site the whole care cycle are largely hidden
inform health care decisions, although
infections. The targets were selected be- from physicians—a shortcoming that
they are often isolated from background
cause of the potential for improvement, needs correction.
administrative processes that generate
opportunity to reduce costs, and avail-
Conclusion significant costs. Thus, like others in the
ability of measurable metrics. A major
chain, physicians would also benefit from
achievement was the agreement by the The value chain approach offers some
a broader understanding of the total
major participating health plans to focus merit as a framework for understanding
health care cycle.
on a common set of metrics and to pro- decision-making in health care provi-
vide physicians with financial incentives sion. In business sectors like advanced The health care market is generally
for performance. Save Lives Save Dollars manufacturing, where value chains are characterized by a lack of transparency
has created a website ( observed to work well, conditions are and a shortage of information among
save.asp) that reports on hospital quality often controlled by one or more prin- all the agents along the value chain.
as well as the performance metrics. With- cipal agents—such as competing auto Market participants need information
in a year, data on health plans and the assembly companies—which can man- on costs; quality of care; and availability
performance of individual physicians age the entire value chain so as to de- of procedures, techniques, and equip-
will also become available. liver final products of high value at low ment. Many of the presenters described
cost. At the conference, two alternatives ways in which they were trying to increase
Peter W. Carmel, American Medical
were presented as to who should be the the quantity and quality of information.
Association and New Jersey Medical
ultimate decision-maker in health care: Such efforts will be useful in stimulating
School, presented the physician’s per-
the consumer (patient) or the provider competition and innovation where it is
spective. Carmel said that value criteria
(hospital/physician). To be an effective most needed.
should be focused on the patient, the
principal agent, the consumer (patient)
ultimate receiver of benefits, and orga- 1
Michael E. Porter, 1998, Competitive Advantage:
and the enabling agencies will need con-
nized around medical conditions and Creating and Sustaining Superior Performance,
siderable time and effort to build up the
care cycles rather than specific proce- New York: Free Press.
knowledge base and skills to access and
dures or incidents. Further, the metric
assimilate information concerning price
should be the value of improved health