Management - Canis Learning Systems

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Management
Course:
Health Care Administration
MBAHC−9
California College for Health Sciences
MBA Health Care Program
abc
McGraw-Hill/Irwin
McGraw−Hill Primis
ISBN: 0−390−55206−2
Text:
Effective Behavior in Organizations, Seventh
Edition
Cohen
Harvard Business Review Industry and
Competitive Strategy Articles
Harvard Business School POM Cases
Harvard Business Review Service
Management Articles
Contemporary Management, Fourth Edition
Jones−George
This book was printed on recycled paper.
Management
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Copyright ©2005 by The McGraw−Hill Companies, Inc. All rights
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111
MGMTGEN
ISBN: 0−390−55206−2
Management
Contents
Jones−George • Contemporary Management, Fourth Edition
I. Management
1
2. The Evolution of Management Thought
1
Cohen • Effective Behavior in Organizations, Seventh Edition
11. Leadership: Exerting Influence and Power
35
Text
35
Harvard Business Review Service Management Articles
Deregulation and Regulatory Backlash in Health Care
62
Article
62
Harvard Business Review Industry and Competitive Strategy Articles
Finding a Lasting Cure for U.S. Health Care
83
Article
83
Harvard Business School POM Cases
Deaconess−Glover Hospital (A)
99
Case
99
Harvard Business Review Industry and Competitive Strategy Articles
Making Competition in Health Care Work
123
Article
123
Will Disruptive Innovations Cure Health Care? (HBR)(OnPoint)(Enhanced)(Edition)
139
Article
139
iii
Jones−George:
Contemporary
Management, Fourth
Edition
I. Management
2. The Evolution of
Management Thought
© The McGraw−Hill
Companies, 2005
CHAPTER
2
The Evolution
of Management Thought
Learning Objectives
After studying this chapter, you should be able to:
• Describe how the need to
increase organizational
efficiency and effectiveness has
guided the evolution of
management theory.
• Explain the principle of job
specialization and division of
labor, and tell why the study of
person-task relationships is
central to the pursuit of
increased efficiency.
• Identify the principles of
administration and organization
that underlie effective
organizations.
• Trace the changes in theories
about how managers should
behave to motivate and control
employees.
• Explain the contributions of
management science to the
efficient use of organizational
resources.
• Explain why the study of the
external environment and its
impact on an organization has
become a central issue in
management thought.
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Contemporary
Management, Fourth
Edition
I. Management
Companies, 2005
2. The Evolution of
Management Thought
A Manager’s Challenge
Finding Better Ways to Make Cars
A Manager’s
Challenge
What is the best way to use people’s skills?
Car production has changed dramatically over
the years as managers have applied different
principles of management to organize and control work activities. Prior to 1900, small groups
What Kind of Personal
Computers Do Customers
modified to fit together. This system, a type of
Want?
small-batch production,
was very expensive;
of skilled workers cooperated to hand-build
cars with parts that often had to be altered and
assembling just one car took considerable time
and effort; and skilled workers could produce
only a few cars in a day. Although these cars
were of high quality, they were too expensive.
Managers of early car companies needed better techniques to increase efficiency, reduce
costs, and sell more cars.
Henry Ford revolutionized the car industry. In 1913, Ford opened the Highland Park
car plant in Detroit to produce the Model T
Ford, and his team of manufacturing managers pioneered the development of mass-
production manufacturing, a system that
made the small-batch system almost obsolete overnight. In mass production, moving
conveyor belts bring the cars to the workers.
Each worker performs a single assigned
(a) The photo on top, taken in 1904 inside a Daimler Motor Company factory,
is an example of the use of small-batch production, a production system in
which small groups of people work together and perform all the tasks
needed to assemble a product. (b) In 1913, Henry Ford revolutionized the
production process of a car by pioneering mass production manufacturing, a
production system in which a conveyor belt brings each car to the workers,
and each individual worker performs a single task along the production line.
Even today cars are still built using this system, as evidenced in the photo of
workers along a modern-day computerized automobile assembly line.
Jones−George:
Contemporary
Management, Fourth
Edition
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I. Management
2. The Evolution of
Management Thought
Companies, 2005
Chapter Two
task along a production line, and the speed
of the conveyor belt is the primary means of
controlling workers’ activities. Ford experimented to discover the most efficient way for
each worker to perform an assigned task.
The result was that each worker performed
one narrow, specialized task, such as bolting
on the door or attaching the door handle, and
jobs in the Ford car plant became very repetitive. They required little use of a worker’s
skills.1 Ford’s management approach increased efficiency and reduced costs by so
much that by 1920 he was able to reduce the
price of a car by two-thirds and to sell more
than 2 million cars a year.2 Ford became the
leading car company in the world, and competitors rushed to adopt the new mass-production techniques.
The next change in management thinking
about car assembly occurred in Japan when
Ohno Taiichi, a Toyota production engineer,
pioneered the development of lean manufacturing in the 1960s after touring the U.S. plants
of the Big Three car companies. The management philosophy behind lean manufacturing is
to continuously find methods to improve the
efficiency of the production process in order to
reduce costs, increase quality, and reduce car
assembly time. Lean production is based on
the idea that if workers have input and can participate continually in the decision-making
process, their skills and knowledge can be
used to increase efficiency.
In lean manufacturing, workers work on a
moving production line, but they are organized
into small teams, each of which is responsible
for a particular phase of car assembly, such as
installing the car’s transmission or electrical
wiring system. Each team member is expected
to learn the tasks of all members of that team,
and each work group is responsible not only for
assembling cars but also for continuously finding ways to increase quality and reduce costs.
By 1970, Japanese managers had applied the
new lean-production system so efficiently that
Overview
they were producing higher-quality cars at
lower prices than their U.S. counterparts. By
1980 Japanese companies dominated the
global car market.
To compete with the Japanese, managers
of U.S. carmakers visited Japan to learn the
new management principles of lean production. As a result, companies such as General
Motors (GM) established the Saturn plant to
experiment with this new way of involving
workers; GM also established a joint venture
with Toyota called New United Motor Manufacturing Inc. (NUMMI) to learn how to achieve
the benefits of lean production. Meanwhile,
Ford and Chrysler began to change their work
processes to take advantage of employees’
skills and knowledge.
In the 1990s global car companies increased the number of robots used on the
production line and began to use advanced
IT to build and track the quality of cars being
produced. Indeed, for a time it seemed that
robots rather than employees would be building cars in the future. However, Toyota discovered something interesting at its fully
roboticized car plant. When only robots build
cars, efficiency does not continually increase
because, unlike people, robots cannot provide input to improve the work process. The
crucial thing is to find the right balance
between using people, computers, and IT.
In the 2000s, global car companies are
continuing to compete fiercely to improve and
perfect better ways of making cars. Toyota is
constantly pioneering new ways to manage
its assembly lines to increase efficiency; however, other Japanese carmakers such as Nissan are catching up fast. U.S. carmakers are
catching up too: Ford, which made major
advances in the 1990s, has now been surpassed by both Chrysler and GM. Both
announced in 2004 that their productivity was
fast approaching that of Japanese companies
and that they expected to match the leaders,
Toyota and Nissan, within the next 10 years.
As this sketch of the evolution of management thinking in
global car manufacturing suggests, changes in management
practices occur as managers, theorists, researchers, and consultants seek new
ways to increase organizational efficiency and effectiveness. The driving force
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Contemporary
Management, Fourth
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I. Management
Companies, 2005
2. The Evolution of
Management Thought
43
The Evolution of Management Thought
Figure 2.1
The Evolution
of Management
Theory
Organizational Environment Theory
Management Science Theory
Behavioral Management Theory
Administrative Management Theory
Scientific Management Theory
1890
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
behind the evolution of management theory is the search for better ways to utilize organizational resources. Advances in management thought typically occur
as managers and researchers find better ways to perform the principal management tasks: planning, organizing, leading, and controlling human and other
organizational resources.
In this chapter, we examine how management thought has evolved in modern times and the central concerns that have guided ongoing advances in management theory. First, we examine the so-called classical management theories
that emerged around the turn of the 20th century. These include scientific management, which focuses on matching people and tasks to maximize efficiency,
and administrative management, which focuses on identifying the principles
that will lead to the creation of the most efficient system of organization and
management. Next, we consider behavioral management theories developed
both before and after World War II; these focus on how managers should lead
and control their workforces to increase performance. Then we discuss management science theory, which developed during World War II and has become
increasingly important as researchers have developed rigorous analytical and
quantitative techniques to help managers measure and control organizational
performance. Finally, we discuss business in the 1960s and 1970s and focus on
the theories developed to help explain how the external environment affects the
way organizations and managers operate.
By the end of this chapter you will understand the ways in which management
thought and theory have evolved over time. You will also understand how economic, political, and cultural forces have affected the development of these theories
and the ways in which managers and their organizations behave. In Figure 2.1 we
summarize the chronology of the management theories discussed in this chapter.
Scientific
Management
Theory
The evolution of modern management began in the closing decades of the 19th century, after the industrial revolution had swept through Europe and America. In the new
economic climate, managers of all types of organizations—
political, educational, and economic—were increasingly trying to find better ways to satisfy customers’ needs. Many
major economic, technical, and cultural changes were taking place at this time. The
introduction of steam power and the development of sophisticated machinery and
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Contemporary
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2. The Evolution of
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Companies, 2005
Chapter Two
equipment changed the way goods were produced, particularly in the weaving and
clothing industries. Small workshops run by skilled workers who produced handmanufactured products (a system called crafts production) were being replaced by
large factories in which sophisticated machines controlled by hundreds or even
thousands of unskilled or semiskilled workers made products. For example, raw
cotton and wool, which in the past had been spun into yarn by families or whole
villages working together, were now shipped to factories where workers operated
machines that spun and wove large quantities of yarn into cloth.
Owners and managers of the new factories found themselves unprepared for
the challenges accompanying the change from small-scale crafts production to
large-scale mechanized manufacturing. Moreover, many of the managers and
supervisors in these workshops and factories were engineers who had only a
technical orientation. They were unprepared for the social problems that occur
when people work together in large groups in a factory or shop system. Managers began to search for new techniques to manage their organizations’ resources, and soon they began to focus on ways to increase the efficiency of the
worker-task mix.
Job Specialization and the Division
of Labor
job specialization
The process by which a
division of labor occurs as
different workers specialize
in different tasks over time.
Initially, management theorists were interested in the subject of why the new
machine shops and factory system were more efficient and produced greater
quantities of goods and services than older, crafts-style production operations.
Nearly 200 years before, Adam Smith had been one of the first writers to investigate the advantages associated with producing goods and services in factories.
A famous economist, Smith journeyed around England in the 1700s studying
the effects of the industrial revolution.3 In a study of factories that produced various pins or nails, Smith identified two different manufacturing methods. The
first was similar to crafts-style production, in which each worker was responsible
for all of the 18 tasks involved in producing a pin. The other had each worker
performing only 1 or a few of the 18 tasks that go into making a complete pin.
In a comparison of the relative performance of these different ways of organizing production, Smith found that the performance of the factories in which
workers specialized in only one or a few tasks was much greater than the performance of the factory in which each worker performed all 18 pin-making tasks.
In fact, Smith found that 10 workers specializing in a particular task could make
48,000 pins a day, whereas those workers who performed all the tasks could
make only a few thousand at most.4 Smith reasoned that this difference in performance was due to the fact that the workers who specialized became much
more skilled at their specific tasks and as a group were thus able to produce a
product faster than the group of workers who each performed many tasks.
Smith concluded that increasing the level of job specialization—the process by
which a division of labor occurs as different workers specialize in specific tasks
over time—increases efficiency and leads to higher organizational performance.5
Armed with the insights gained from Adam Smith’s observations, other managers and researchers began to investigate how to improve job specialization to
increase performance. Management practitioners and theorists focused on how
managers should organize and control the work process to maximize the advantages of job specialization and the division of labor.
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I. Management
2. The Evolution of
Management Thought
Companies, 2005
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F. W. Taylor and Scientific
Management
Frederick W. Taylor, founder of Scientific
Management, and one of the first people
to study the behavior and performance of
people at work.
scientific
management The
systematic study of
relationships between
people and tasks for the
purpose of redesigning the
work process to increase
efficiency.
•
•
•
Frederick W. Taylor (1856–1915) is best known for defining the
techniques of scientific management, the systematic study of
relationships between people and tasks for the purpose of
redesigning the work process to increase efficiency. Taylor was
a manufacturing manager who eventually became a consultant
and taught other managers how to apply his scientific management techniques. Taylor believed that if the amount of time
and effort that each worker expends to produce a unit of output (a finished good or service) can be reduced by increasing
specialization and the division of labor, the production process
will become more efficient. According to Taylor, the way to create the most efficient division of labor could best be determined
by scientific management techniques, rather than intuitive or
informal rule-of-thumb knowledge. Based on his experiments
and observations as a manufacturing manager in a variety of
settings, he developed four principles to increase efficiency in
the workplace:
Principle 1: Study the way workers perform their tasks, gather all the informal job
knowledge that workers possess, and experiment with ways of improving how tasks
are performed.
To discover the most efficient method of performing specific tasks, Taylor
studied in great detail and measured the ways different workers went about
performing their tasks. One of the main tools he used was a time-and-motion
study, which involves the careful timing and recording of the actions taken to
perform a particular task. Once Taylor understood the existing method of
performing a task, he then experimented to increase specialization. He tried
different methods of dividing and coordinating the various tasks necessary
to produce a finished product. Usually this meant simplifying jobs and having each worker perform fewer, more routine tasks, as at the pin factory or
on Ford’s car assembly line. Taylor also sought to find ways to improve each
worker’s ability to perform a particular task—for example, by reducing the
number of motions workers made to complete the task, by changing the layout of the work area or the type of tools workers used, or by experimenting
with tools of different sizes.
Principle 2: Codify the new methods of performing tasks into written rules and standard operating procedures.
Once the best method of performing a particular task was determined, Taylor specified that it should be recorded so that this procedure could be
taught to all workers performing the same task. These new methods further
standardized and simplified jobs—essentially making jobs even more routine. In this way efficiency could be increased throughout an organization.
Principle 3: Carefully select workers who possess skills and abilities that match the
needs of the task, and train them to perform the task according to the established rules
and procedures.
To increase specialization, Taylor believed workers had to understand the
tasks that were required and be thoroughly trained to perform the tasks at
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•
the required level. Workers who could not be trained to this level were to be
transferred to a job where they were able to reach the minimum required
level of proficiency.6
Principle 4: Establish a fair or acceptable level of performance for a task, and then
develop a pay system that provides a reward for performance above the acceptable level.
To encourage workers to perform at a high level of efficiency, and to provide
them with an incentive to reveal the most efficient techniques for performing
a task, Taylor advocated that workers benefit from any gains in performance.
They should be paid a bonus and receive some percentage of the performance gains achieved through the more efficient work process.7
By 1910 Taylor’s system of scientific management had become nationally
known and in many instances was faithfully and fully practiced.8 However,
managers in many organizations chose to implement the new principles of scientific management selectively. This decision ultimately resulted in problems.
For example, some managers using scientific management obtained increases in
performance, but rather than sharing performance gains with workers through
bonuses as Taylor had advocated, they simply increased the amount of work
that each worker was expected to do. Many workers experiencing the reorganized work system found that as their performance increased, managers
required that they do more work for the same pay. Workers also learned that
increases in performance often meant fewer jobs and a greater threat of layoffs
because fewer workers were needed. In addition, the specialized, simplified jobs
were often monotonous and repetitive, and many workers became dissatisfied
with their jobs.
Scientific management brought many workers more hardship than gain and
a distrust of managers who did not seem to care about workers’ well-being.9
These dissatisfied workers resisted attempts to use the new scientific management techniques and at times even withheld their job knowledge from managers to protect their jobs and pay. It is not difficult for workers to conceal the
true potential efficiency of a work system to protect their interests. Experienced
machine operators, for example, can slow their machines in undetectable ways
by adjusting the tension in the belts or by misaligning the gears. Workers sometimes even develop informal work rules that discourage high performance and
encourage shirking as work groups attempt to identify an acceptable or fair performance level (a tactic discussed in the next section).
Unable to inspire workers to accept the new scientific management techniques for performing tasks, some organizations increased the mechanization
of the work process. For example, one reason why Henry Ford introduced
moving conveyor belts in his factory was the realization that when a conveyor
belt controls the pace of work (instead of workers setting their own pace),
workers can be pushed to perform at higher levels—levels that they may have
thought were beyond their reach. Charlie Chaplin captured this aspect of mass
production in one of the opening scenes of his famous movie Modern Times
(1936). In the film, Chaplin caricatured a new factory employee fighting to
work at the machine-imposed pace but losing the battle to the machine. Henry
Ford also used the principles of scientific management to identify the tasks that
each worker should perform on the production line and thus to determine the
most effective way to create a division of labor to suit the needs of a mechanized production system.
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Companies, 2005
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Charlie Chaplin tries to
extricate a fellow employee
from the machinery of
mass production in this
scene from Modern Times.
The complex machinery is
meant to represent the
power that machinery has
over the worker in the new
work system.
From a performance perspective, the combination of the two management
practices—(1) achieving the right mix of worker-task specialization and (2) linking people and tasks by the speed of the production line—makes sense. It produces the huge savings in cost and huge increases in output that occur in large,
organized work settings. For example, in 1908 managers at the Franklin Motor
Company using scientific management principles redesigned the work process,
and the output of cars increased from 100 cars a month to 45 cars a day; workers’ wages, however, increased by only 90 percent.10 From other perspectives,
however, scientific management practices raise many concerns. The definition
of workers’ rights, not by the workers themselves, but by the owners or managers as a result of the introduction of the new management practices, raised an
ethical issue, which we examine in the following “Ethics in Action.”
Fordism in Practice
Ethics
in Action
From 1908 to 1914, through trial and error, Henry Ford’s talented team of production managers pioneered the development of the moving conveyor belt and
thus changed manufacturing practices forever. Although the technical aspects of
the move to mass production were a dramatic financial success for Ford and for
the millions of Americans who could now afford cars, for the workers who actually produced the cars many human and social problems resulted.
With simplification of the work process, workers grew to hate the monotony of the moving conveyor belt. By 1914 Ford’s car plants were experiencing huge employee turnover—often reaching levels as high as 300 or 400 percent per year as workers left because they could not handle the work-induced
stress.11 Henry Ford recognized these problems and made an announcement:
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From that point on, to motivate his workforce, he would reduce the length of
the workday from nine hours to eight hours, and the company would double
the basic wage from $2.50 to $5.00 per day. This was a dramatic increase,
similar to an announcement today of an overnight doubling of the minimum
wage. Ford became an internationally famous figure, and the word Fordism
was coined for his new approach.12
Ford’s apparent generosity, however, was matched by an intense effort to
control the resources—both human and material—with which his empire was
built. He employed hundreds of inspectors to check up on employees, both
inside and outside his factories. In the factory supervision was close and confining. Employees were not allowed to leave their places at the production line,
and they were not permitted to talk to one another. Their job was to concentrate
fully on the task at hand. Few employees could adapt to this system, and they
developed ways of talking out of the sides of their mouths, like ventriloquists,
and invented a form of speech that became known as the “Ford Lisp.”13 Ford’s
obsession with control brought him into greater and greater conflict with managers, who often were fired when they disagreed with him. As a result, many talented people left Ford to join a growing number of rival car companies.
Outside the workplace, Ford went so far as to establish what he called the
“Sociological Department” to check up on how his employees lived and the
ways they spent their time. Inspectors from this department visited the homes
of employees and investigated their habits and problems. Employees who
exhibited behaviors contrary to Ford’s standards (for instance, if they drank
too much or were always in debt) were likely to be fired. Clearly, Ford’s efforts
to control his employees led him and his managers to behave in ways that
today would be considered unacceptable and unethical and in the long run
would impair an organization’s ability to prosper.
Despite the problems of worker turnover, absenteeism, and discontent at
Ford Motor Company, managers of the other car companies watched Ford
reap huge gains in efficiency from the application of the new management
principles. They believed that their companies would have to imitate Ford if
they were to survive. They followed Taylor and used many of his followers as
consultants to teach them how to adopt the techniques of scientific management. In addition, Taylor elaborated his principles in several books, including Shop Management (1903) and The Principles of Scientific Management (1911),
which explain in detail how to apply the principles of scientific management
to reorganize the work system.14
Taylor’s work has had an enduring effect on the management of production
systems. Managers in every organization, whether it produces goods or services,
now carefully analyze the basic tasks that must be performed and try to devise
the work systems that allow their organizations to operate most efficiently.
The Gilbreths
Two prominent followers of Taylor were Frank Gilbreth (1868–1924) and Lillian Gilbreth (1878–1972), who refined Taylor’s analysis of work movements
and made many contributions to time-and-motion study.15 Their aims were to
(1) break up and analyze every individual action necessary to perform a partic-
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Contemporary
Management, Fourth
Edition
I. Management
2. The Evolution of
Management Thought
Companies, 2005
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ular task into each of its component
actions, (2) find better ways to perform
each component action, and (3) reorganize each of the component actions
so that the action as a whole could be
performed more efficiently—at less cost
in time and effort.
The Gilbreths often filmed a worker
performing a particular task and then
separated the task actions, frame by
frame, into their component movements. Their goal was to maximize the
efficiency with which each individual
task was performed so that gains across
tasks would add up to enormous savings of time and effort. Their attempts
to develop improved management
principles were captured—at times quite
This scene from Cheaper by the Dozen illustrates how “efficient families,”
humorously—in the movie Cheaper by
such as the Gilbreths, use formal family courts to solve problems of assigning
the Dozen, a new version of which
chores to different family members and to solve disputes when they arise.
appeared in 2004, which depicts how
the Gilbreths (with their 12 children)
tried to live their own lives according to these efficiency principles and apply
them to daily actions such as shaving, cooking, and even raising a family.16
Eventually, the Gilbreths became increasingly interested in the study of
fatigue. They studied how the physical characteristics of the workplace contribute to job stress that often leads to fatigue and thus poor performance. They
isolated factors that result in worker fatigue, such as lighting, heating, the color
of walls, and the design of tools and machines. Their pioneering studies paved
the way for new advances in management theory.
In workshops and factories, the work of the Gilbreths, Taylor, and many others had a major effect on the practice of management. In comparison with the
old crafts system, jobs in the new system were more repetitive, boring, and
monotonous as a result of the application of scientific management principles,
and workers became increasingly dissatisfied. Frequently, the management of
work settings became a game between workers and managers: Managers tried
to initiate work practices to increase performance, and workers tried to hide the
true potential efficiency of the work setting to protect their own well-being.17
Administrative
Management
Theory
administrative
management The
study of how to create an
organizational structure
that leads to high efficiency
and effectiveness.
Side by side with scientific managers studying the person-task mix to increase efficiency, other researchers
were focusing on administrative management, the
study of how to create an organizational structure that
leads to high efficiency and effectiveness. Organizational
structure is the system of task and authority relationships
that control how employees use resources to achieve the organization’s goals.
Two of the most influential views regarding the creation of efficient systems
of organizational administration were developed in Europe: Max Weber, a
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German professor of sociology, developed one theory; Henri Fayol, the French
manager who developed the model of management introduced in Chapter 1,
developed the other.
The Theory of Bureaucracy
bureaucracy A formal
system of organization and
administration designed to
ensure efficiency and
effectiveness.
Max Weber (1864–1920), wrote at the turn of the 20th century, when Germany
was undergoing its industrial revolution.18 To help Germany manage its growing
industrial enterprises at a time when it was striving to become a world power,
Weber developed the principles of bureaucracy—a formal system of organization and administration designed to ensure efficiency and effectiveness. A
bureaucratic system of administration is based on the five principles summarized in Figure 2.2.
•
authority The power to
hold people accountable
for their actions and to
make decisions concerning
the use of organizational
resources.
•
•
•
•
Principle 1: In a bureaucracy, a manager’s formal authority derives from the position he or she holds in the organization.
Authority is the power to hold people accountable for their actions and to
make decisions concerning the use of organizational resources. Authority
gives managers the right to direct and control their subordinates’ behavior
to achieve organizational goals. In a bureaucratic system of administration,
obedience is owed to a manager, not because of any personal qualities—
such as personality, wealth, or social status—but because the manager occupies a position that is associated with a certain level of authority and
responsibility.19
Principle 2: In a bureaucracy, people should occupy positions because of their performance, not because of their social standing or personal contacts.
This principle was not always followed in Weber’s time and is often ignored
today. Some organizations and industries are still affected by social networks
in which personal contacts and relations, not job-related skills, influence hiring and promotional decisions.
Principle 3: The extent of each position’s formal authority and task responsibilities,
and its relationship to other positions in an organization, should be clearly specified.
When the tasks and authority associated with various positions in the organization are clearly specified, managers and workers know what is expected
of them and what to expect from each other. Moreover, an organization can
hold all its employees strictly accountable for their actions when they know
their exact responsibilities.
Principle 4: Authority can be exercised effectively in an organization when positions are
arranged hierarchically, so employees know whom to report to and who reports to them.20
Managers must create an organizational hierarchy of authority that makes it
clear who reports to whom and to whom managers and workers should go if
conflicts or problems arise. This principle is especially important in the
armed forces, FBI, CIA, and other organizations that deal with sensitive
issues involving possible major repercussions. It is vital that managers at
high levels of the hierarchy be able to hold subordinates accountable for
their actions.
Principle 5: Managers must create a well-defined system of rules, standard operating
procedures, and norms so that they can effectively control behavior within an organization.
11
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Figure 2.2
Weber’s Principles
of Bureaucracy
System of written
rules and standard
operating procedures
that specify how
employees should
behave.
Clearly specified
system of task and
role relationships.
A bureaucracy
should have a:
Clearly specified
hierarchy of
authority.
Selection and
evaluation system
that rewards
employees fairly
and equitably.
rules Formal written
instructions that specify
actions to be taken under
different circumstances to
achieve specific goals.
standard operating
procedures (SOPs)
Specific sets of written
instructions about how to
perform a certain aspect of
a task.
norms Unwritten, informal
codes of conduct that
prescribe how people
should act in particular
situations.
Rules are formal written instructions that specify actions to be taken under
different circumstances to achieve specific goals (for example, if A happens,
do B). Standard operating procedures (SOPs) are specific sets of written
instructions about how to perform a certain aspect of a task. A rule might
state that at the end of the workday employees are to leave their machines
in good order, and a set of SOPs would specify exactly how they should do
so, itemizing which machine parts must be oiled or replaced. Norms are
unwritten, informal codes of conduct that prescribe how people should act
in particular situations. For example, an organizational norm in a restaurant
might be that waiters should help each other if time permits.
Rules, SOPs, and norms provide behavioral guidelines that increase the
performance of a bureaucratic system because they specify the best ways to
accomplish organizational tasks. Companies such as McDonald’s and WalMart have developed extensive rules and procedures to specify the behaviors
required of their employees, such as “Always greet the customer with a smile.”
Weber believed that organizations that implement all five principles establish a
bureaucratic system that improves organizational performance. The specification
of positions and the use of rules and SOPs to regulate how tasks are performed
make it easier for managers to organize and control the work of subordinates.
Similarly, fair and equitable selection and promotion systems improve managers’
feelings of security, reduce stress, and encourage organizational members to act
ethically and further promote the interests of the organization.21
If bureaucracies are not managed well, however, many problems can result.
Sometimes, managers allow rules and SOPs, “bureaucratic red tape,” to become
so cumbersome that decision making is slow and inefficient and organizations
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are unable to change. When managers rely too much on rules to solve problems
and not enough on their own skills and judgment, their behavior becomes
inflexible. A key challenge for managers is to use bureaucratic principles to benefit, rather than harm, an organization.
Fayol’s Principles of Management
Henri Fayol (1841–1925), was the CEO of Comambault Mining. Working at the
same time as, but independently from, Weber, Fayol identified 14 principles
(summarized in Table 2.1) that he believed essential to increase the efficiency of
the management process.22 We discuss these principles in detail here because,
although they were developed at the turn of the 20th century, they remain the
bedrock on which much of recent management theory and research is based. In
fact, as the “Management Insight” following this discussion suggests, modern
writers such as well-known management guru Tom Peters continue to extol
these principles.
DIVISION OF LABOR A champion of job specialization and the division
of labor for reasons already mentioned, Fayol was nevertheless among the first
to point out the downside of too much specialization: boredom—a state of mind
likely to cause a fall in product quality, worker initiative, and flexibility. As a
result, Fayol advocated that workers be given more job duties to perform or be
encouraged to assume more responsibility for work outcomes, a principle
increasingly applied today in organizations that empower their workers.
AUTHORITY AND RESPONSIBILITY Like Weber, Fayol emphasized
the importance of authority and responsibility. Fayol, however, went beyond
Weber’s formal authority, which derives from a manager’s position in the hierarchy, to recognize the informal authority that derives from personal expertise,
technical knowledge, moral worth, and the ability to lead and to generate commitment from subordinates. (The study of authority is the subject of recent
research into leadership, discussed in Chapter 12.)
unity of command A
reporting relationship in
which an employee
receives orders from, and
reports to, only one
superior.
UNITY OF COMMAND The principle of unity of command specifies that
an employee should receive orders from, and report to, only one superior. Fayol
believed that dual command, the reporting relationship that exists when two
supervisors give orders to the same subordinate, should be avoided except in
exceptional circumstances. Dual command confuses subordinates, undermines
order and discipline, and creates havoc within the formal hierarchy of authority.
Assessing any manager’s authority and responsibility in a system of dual command is difficult, and the manager who is bypassed feels slighted and angry and
may be uncooperative in the future.
line of authority The
chain of command
extending from the top to
the bottom of an
organization.
LINE OF AUTHORITY The line of authority is the chain of command
extending from the top to the bottom of an organization. Fayol was one of the first
management theorists to point out the importance of limiting the length of the
chain of command by controlling the number of levels in the managerial hierarchy. The greater the number of levels in the hierarchy, the longer communication
between managers at the top and bottom takes and the slower the pace of planning and organizing. Restricting the number of hierarchical levels to lessen these
communication problems enables an organization to act quickly and flexibly; this
is one reason for the recent trend toward restructuring (discussed in Chapter 1).
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Table 2.1
Fayol’s 14 Principles of Management
Division of Labor Job specialization and the division of labor should increase
efficiency, especially if managers take steps to lessen workers’ boredom.
Authority and Responsibility Managers have the right to give orders and the
power to exhort subordinates for obedience.
Unity of Command An employee should receive orders from only one superior.
Line of Authority The length of the chain of command that extends from the
top to the bottom of an organization should be limited.
Centralization Authority should not be concentrated at the top of the chain of
command.
Unity of Direction The organization should have a single plan of action to
guide managers and workers.
Equity All organizational members are entitled to be treated with justice and
respect.
Order The arrangement of organizational positions should maximize
organizational efficiency and provide employees with satisfying career opportunities.
Initiative Managers should allow employees to be innovative and creative.
Discipline Managers need to create a workforce that strives to achieve
organizational goals.
Remuneration of Personnel The system that managers use to reward
employees should be equitable for both employees and the organization.
Stability of Tenure of Personnel Long-term employees develop skills that
can improve organizational efficiency.
Subordination of Individual Interests to the Common Interest Employees
should understand how their performance affects the performance of the whole
organization.
Esprit de Corps Managers should encourage the development of shared
feelings of comradeship, enthusiasm, or devotion to a common cause.
Fayol also pointed out that when organizations are split into different departments or functions, each with its own hierarchy, it is important to allow middle
and first-line managers in each department to interact with managers at similar
levels in other departments. This interaction helps to speed decision making,
because managers know each other and know whom to go to when problems
arise. For cross-departmental integration to work, Fayol noted the importance of
keeping one’s superiors informed about what is taking place so that lower-level
decisions do not harm activities taking place in other parts of the organization.
One alternative to cross-departmental integration is to create cross-departmental
teams controlled by a team leader (see Chapter 1).
centralization The
concentration of authority
at the top of the
managerial hierarchy.
CENTRALIZATION Fayol also was one of the first management writers to
focus on centralization, the concentration of authority at the top of the managerial
hierarchy. Fayol believed that authority should not be concentrated at the top of the
chain of command. One of the most significant issues that top managers face is how
much authority to centralize at the top of the organization and what authority to
decentralize to managers and workers at lower hierarchical levels. This is an important issue because it affects the behavior of people at all levels in the organization.
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If authority is very centralized, only managers at the top make important
decisions, and subordinates simply follow orders. This arrangement gives top
managers great control over organizational activities and helps ensure that
the organization is pursuing its strategy, but it makes it difficult for the people
who are closest to problems and issues to respond to them in a timely manner. It also can lower the motivation of middle and first-line managers and
make them less flexible and adaptable because they become reluctant to
make decisions on their own, even when doing so is necessary. They get used
to passing the buck. As we saw in Chapter 1, the pendulum is now swinging
toward decentralization, as organizations seek to empower middle managers
and create self-managed teams that monitor and control their own activities
both to increase organizational flexibility and to reduce operating costs and
increase efficiency.
unity of direction The
singleness of purpose that
makes possible the
creation of one plan of
action to guide managers
and workers as they use
organizational resources.
equity The justice,
impartiality, and fairness to
which all organizational
members are entitled.
order The methodical
arrangement of positions
to provide the organization
with the greatest benefit
and to provide employees
with career opportunities.
initiative The ability to
act on one’s own, without
direction from a superior.
UNITY OF DIRECTION Just as there is a need for unity of command,
there is also a need for unity of direction, the singleness of purpose that makes
possible the creation of one plan of action to guide managers and workers as
they use organizational resources. An organization without a single guiding plan
becomes inefficient and ineffective; its activities become unfocused, and individuals and groups work at cross-purposes. Successful planning starts with top
managers working as a team to craft the organization’s strategy, which they
communicate to middle managers, who decide how to use organizational
resources to implement the strategy.
EQUITY As Fayol wrote, “For personnel to be encouraged to carry out their
duties with all the devotion and loyalty of which they are capable, they must be
treated with respect for their own sense of integrity, and equity results from the
combination of respect and justice.”23 Equity—the justice, impartiality, and fairness to which all organizational members are entitled—is receiving much attention today; the desire to treat employees fairly is a primary concern for many
managers. (Equity theory is discussed in Chapter 12).
ORDER Like Taylor and the Gilbreths, Fayol was interested in analyzing jobs,
positions, and individuals to ensure that the organization was using resources as
efficiently as possible. To Fayol, order meant the methodical arrangement of
positions to provide the organization with the greatest benefit and to provide
employees with career opportunities that satisfy their needs. Thus, Fayol recommended the use of organizational charts to show the position and duties of each
employee and to indicate which positions an employee might move to or be promoted into in the future. He also advocated that managers engage in extensive
career planning to help ensure orderly career paths. Career planning is of primary interest today as organizations increase the resources they are willing to
devote to training and developing their workforces.
INITIATIVE Although order and equity are important means to fostering
commitment and loyalty among employees, Fayol believed that managers
must also encourage employees to exercise initiative, the ability to act on their
own, without direction from a superior. Used properly, initiative can be a
major source of strength for an organization because it leads to creativity and
innovation. Managers need skill and tact to achieve the difficult balance
between the organization’s need for order and employees’ desire for initiative.
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Fayol believed that the ability to strike this balance was a key indicator of a
superior manager.
discipline Obedience,
energy, application, and
other outward marks of
respect for a superior’s
authority.
DISCIPLINE In focusing on the importance of discipline—obedience,
energy, application, and other outward marks of respect for a superior’s
authority—Fayol was addressing the concern of many early managers: How
to create a workforce that was reliable and hardworking and would strive to
achieve organizational goals. According to Fayol, discipline results in respectful relations between organizational members and reflects the quality of an
organization’s leadership and a manager’s ability to act fairly and equitably.
REMUNERATION OF PERSONNEL Fayol proposed reward systems
including bonuses and profit-sharing plans, which are increasingly utilized
today as organizations seek improved ways to motivate employees. Convinced
from his own experience that an organization’s payment system has important
implications for organizational success, Fayol believed that effective reward systems should be equitable for both employees and the organization, encourage
productivity by rewarding well-directed effort, not be subject to abuse, and be
uniformly applied to employees.
STABILITY OF TENURE OF PERSONNEL Fayol also recognized the
importance of long-term employment, and the idea has been echoed by contemporary management gurus such as Tom Peters, Jeff Pfeffer, and William
Ouchi. When employees stay with an organization for extended periods
of time, they develop skills that improve the organization’s ability to utilize its
resources.
SUBORDINATION OF INDIVIDUAL INTERESTS TO THE COMMON
INTEREST The interests of the organization as a whole must take precedence over the interests of any one individual or group if the organization is to
survive. Equitable agreements must be established between the organization
and its members to ensure that employees are treated fairly and rewarded for
their performance and to maintain the disciplined organizational relationships
so vital to an efficient system of administration.
esprit de corps Shared
feelings of comradeship,
enthusiasm, or devotion to
a common cause among
members of a group.
ESPRIT DE CORPS As this discussion of Fayol’s ideas suggests, the appropriate design of an organization’s hierarchy of authority and the right mix of
order and discipline foster cooperation and commitment. Likewise, a key element in a successful organization is the development of esprit de corps, a
French expression that refers to shared feelings of comradeship, enthusiasm, or
devotion to a common cause among members of a group. Esprit de corps can
result when managers encourage personal, verbal contact between managers
and workers and encourage communication to solve problems and implement
solutions. (Today, the term organizational culture is used to refer to these shared
feelings; this concept is discussed at length in Chapter 3.)
Some of the principles that Fayol outlined have faded from contemporary
management practices, but most have endured. The characteristics of organizations that Tom Peters and Robert Waterman identified as being “excellently
managed” in their best-selling book In Search of Excellence (1982) are discussed in
the following “Management Insight.”24
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Peters and Waterman’s
Excellent Companies
Management
Insight
In the early 1980s, Tom Peters and Robert Waterman identified 62 organizations that they considered to be the best-performing organizations in the
United States. They asked the question: Why do these companies perform
better than their rivals? and discovered that successful organizations have
managers who manage according to three sets of related principles. Those
principles have a great deal in common with Fayol’s principles.
First, Peters and Waterman argued, top managers of successful companies
create principles and guidelines that emphasize managerial autonomy and
entrepreneurship and encourage risk taking and initiative. For example, they
allow middle managers to develop new products, even though there is no
assurance that these products will be winners. In high-performing organizations, top managers are closely involved in the day-to-day operations of the
company, provide unity of command and unity of direction, and do not simply
make decisions in an isolated ivory tower. Top managers decentralize authority
to lower-level managers and nonmanagerial employees and give them the
freedom to get involved and the motivation to get things done.
The second approach that managers of excellent organizations use to
increase performance is to create one central plan that puts organizational
goals at center stage. In high-performing organizations, managers focus attention on what the organization does best, and the emphasis is on continuously
improving the goods and services the organization provides to its customers.
Managers of top-performing companies resist the temptation to get sidetracked into pursuing ventures outside their area of expertise just because
they seem to promise a quick return. These managers also focus on customers and establish close relationships with them to learn their needs, for
responsiveness to customers increases competitive advantage.
The third set of management principles pertains to organizing and controlling the organization. Excellent companies establish a division of work and a
division of authority and responsibility that will motivate employees to subordinate
their individual interests to the common interest. Inherent in this approach is the
belief that high performance derives from individual skills and abilities and
that equity, order, initiative, and other indications of respect for the individual
create the esprit de corps that fosters productive behavior. An emphasis on
entrepreneurship and respect for every employee leads the best managers to
create a structure that gives employees room to exercise initiative and motivates them to succeed. Because a simple, streamlined managerial hierarchy is
best suited to achieve this outcome, top managers keep the line of authority as
short as possible. They also decentralize authority to permit employee participation, but they keep enough control to maintain unity of direction.
As this insight into contemporary management suggests, the basic concerns
that motivated Fayol continue to motivate management theorists.25 The principles that Fayol and Weber set forth still provide a clear and appropriate set of
guidelines that managers can use to create a work setting that makes efficient and
effective use of organizational resources. These principles remain the bedrock of
modern management theory; recent researchers have refined or developed them
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to suit modern conditions. For example, Weber’s and Fayol’s concerns for equity
and for establishing appropriate links between performance and reward are central themes in contemporary theories of motivation and leadership.
Behavioral
Management
Theory
behavioral
management The
study of how managers
should behave to motivate
employees and encourage
them to perform at high
levels and be committed
to the achievement of
Because the writings of Weber and Fayol were not translated into English and published in the United States until
the late 1940s, American management theorists in the first
half of the 20th century were unaware of the contributions
of these European pioneers. American management theorists began where Taylor and his followers left off. Although
their writings were all very different, these theorists all espoused a theme that
focused on behavioral management, the study of how managers should personally behave to motivate employees and encourage them to perform at high levels
and be committed to achieving organizational goals.
The Work of Mary Parker Follett
If F. W. Taylor is considered the father of management thought, Mary Parker Follett (1868–1933) serves as its mother.26 Much of her writing about management
and about the way managers should behave toward workers was a response to her
concern that Taylor was ignoring the human side of the organization. She pointed
out that management often overlooks the multitude of ways in which employees
can contribute to the organization when managers allow them to participate and
exercise initiative in their everyday work lives.27 Taylor, for example, never proposed that managers should involve workers in analyzing their jobs to identify
better ways to perform tasks or should even ask workers how they felt about their
jobs. Instead, he used time-and-motion experts to analyze workers’ jobs for them.
Follett, in contrast, argued that because workers know the most about their jobs,
they should be involved in job analysis and managers should allow
them to participate in the work development process.
Follett proposed that “authority should go with knowledge . . .
whether it is up the line or down.” In other words, if workers have
the relevant knowledge, then workers, rather than managers, should
be in control of the work process itself, and managers should behave
as coaches and facilitators—not as monitors and supervisors. In making this statement, Follett anticipated the current interest in self-managed teams and empowerment. She also recognized the importance
of having managers in different departments communicate directly
with each other to speed decision making. She advocated what she
called “cross-functioning”: members of different departments working together in cross-departmental teams to accomplish projects—an
approach that is increasingly utilized today.28
Fayol also mentioned expertise and knowledge as important
sources of managers’ authority, but Follett went further. She proposed that knowledge and expertise, and not managers’ formal
authority deriving from their position in the hierarchy, should
Mary Parker Follett, an early management
decide who will lead at any particular moment. She believed, as do
thinker who advocated that “Authority
many management theorists today, that power is fluid and should
should go with knowledge . . . whether it is
flow to the person who can best help the organization achieve its
up the line or down.”
goals. Follett took a horizontal view of power and authority, in
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contrast to Fayol, who saw the formal line of authority and vertical chain of
command as being most essential to effective management. Follett’s behavioral
approach to management was very radical for its time.
The Hawthorne Studies
and Human Relations
Probably because of its radical nature, Follett’s work was unappreciated by managers and researchers until quite recently. Most continued to follow in the footsteps of Taylor and the Gilbreths. To increase efficiency, they studied ways to
improve various characteristics of the work setting, such as job specialization or
the kinds of tools workers used. One series of studies was conducted from 1924 to
1932 at the Hawthorne Works of the Western Electric Company.29 This research,
now known as the Hawthorne studies, began as an attempt to investigate how characteristics of the work setting—specifically the level of lighting or illumination—
affect worker fatigue and performance. The researchers conducted an experiment
in which they systematically measured worker productivity at various levels of
illumination.
The experiment produced some unexpected results. The researchers found
that regardless of whether they raised or lowered the level of illumination, productivity increased. In fact, productivity began to fall only when the level of illumination dropped to the level of moonlight, a level at which, presumably, workers could no longer see well enough to do their work efficiently.
The researchers found these results puzzling and invited a noted Harvard psychologist, Elton Mayo, to help them. Mayo proposed another series of experiments to solve the mystery. These experiments, known as the relay assembly test
experiments, were designed to investigate the
effects of other aspects of the work context
on job performance, such as the effect of the
number and length of rest periods and hours
of work on fatigue and monotony.30 The
goal was to raise productivity.
During a two-year study of a small group
of female workers, the researchers again
observed that productivity increased over
time, but the increases could not be solely
attributed to the effects of changes in the
work setting. Gradually, the researchers
discovered that, to some degree, the results
they were obtaining were influenced by the
fact that the researchers themselves had
become part of the experiment. In other
words, the presence of the researchers was
affecting the results because the workers
Workers in a telephone manufacturing plant, in 1931. Around this time,
researchers at the Hawthorne Works of the Western Electric Company
enjoyed receiving attention and being the
began to study the effects of work setting characteristics—such as
subject of study and were willing to colighting and rest periods—on productivity. To their surprise, they
operate with the researchers to produce
discovered that workers’ productivity was affected more by the attention
the results they believed the researchers
they received from researchers than by the characteristics of the work
desired.
setting—a phenomenon that became known as the Hawthorne Effect.
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Hawthorne effect The
finding that a manager’s
behavior or leadership
approach can affect
workers’ level of
performance.
human relations
movement A
management approach
that advocates the idea
that supervisors should
receive behavioral training
to manage subordinates in
ways that elicit their
cooperation and increase
their productivity.
informal organization
The system of behavioral
rules and norms that
emerge in a group.
organizational
behavior The study of
the factors that have an
impact on how individuals
and groups respond to and
act in organizations.
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Subsequently, it was found that many other factors also influence worker
behavior, and it was not clear what was actually influencing the Hawthorne
workers’ behavior. However, this particular effect—which became known as the
Hawthorne effect—seemed to suggest that workers’ attitudes toward their
managers affect the level of workers’ performance. In particular, the significant
finding was that each manager’s personal behavior or leadership approach can
affect performance. This finding led many researchers to turn their attention to
managerial behavior and leadership. If supervisors could be trained to behave
in ways that would elicit cooperative behavior from their subordinates, then
productivity could be increased. From this view emerged the human relations
movement, which advocates that supervisors be behaviorally trained to
manage subordinates in ways that elicit their cooperation and increase their
productivity.
The importance of behavioral or human relations training became even
clearer to its supporters after another series of experiments—the bank wiring room
experiments. In a study of workers making telephone switching equipment,
researchers Elton Mayo and F. J. Roethlisberger discovered that the workers, as
a group, had deliberately adopted a norm of output restriction to protect their
jobs. Workers who violated this informal production norm were subjected to
sanctions by other group members. Those who violated group performance
norms and performed above the norm were called “ratebusters”; those who performed below the norm were called “chiselers.”
The experimenters concluded that both types of workers threatened the
group as a whole. Ratebusters threatened group members because they
revealed to managers how fast the work could be done. Chiselers were looked
down on because they were not doing their share of the work. Work-group
members disciplined both ratebusters and chiselers to create a pace of work that
the workers (not the managers) thought was fair. Thus, a work group’s influence
over output can be as great as the supervisors’ influence. Since the work group
can influence the behavior of its members, some management theorists argue
that supervisors should be trained to behave in ways that gain the goodwill and
cooperation of workers so that supervisors, not workers, control the level of
work-group performance.
One of the main implications of the Hawthorne studies was that the behavior
of managers and workers in the work setting is as important in explaining the
level of performance as the technical aspects of the task. Managers must understand the workings of the informal organization, the system of behavioral
rules and norms that emerge in a group, when they try to manage or change
behavior in organizations. Many studies have found that, as time passes, groups
often develop elaborate procedures and norms that bond members together,
allowing unified action either to cooperate with management to raise performance or to restrict output and thwart the attainment of organizational goals.31
The Hawthorne studies demonstrated the importance of understanding how the
feelings, thoughts, and behavior of work-group members and managers affect
performance. It was becoming increasingly clear to researchers that understanding behavior in organizations is a complex process that is critical to increasing
performance.32 Indeed, the increasing interest in the area of management
known as organizational behavior, the study of the factors that have an
impact on how individuals and groups respond to and act in organizations,
dates from these early studies.
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Theory X and Theory Y
Several studies after World War II revealed how assumptions about workers’ attitudes and behavior affect managers’ behavior. Perhaps the most influential
approach was developed by Douglas McGregor. He proposed two sets of assumptions about how work attitudes and behaviors not only dominate the way managers think but also affect how they behave in organizations. McGregor named
these two contrasting sets of assumptions Theory X and Theory Y (see Figure 2.3).33
Theory X A set of
negative assumptions
about workers that lead to
the conclusion that a
manager’s task is to
supervise workers closely
and control their behavior.
Theory Y A set of
positive assumptions
about workers that lead to
the conclusion that a
manager’s task is to create
a work setting that
encourages commitment
to organizational goals and
provides opportunities for
workers to be imaginative
and to exercise initiative
and self-direction.
Figure 2.3
Theory X versus
Theory Y
Source: D. McGregor, The
Human Side of Enterprise,
1960, McGraw-Hill, reproduced
with permission of the McGrawHill Companies, Inc.
THEORY X According to the assumptions of Theory X, the average worker is
lazy, dislikes work, and will try to do as little as possible. Moreover, workers have
little ambition and wish to avoid responsibility. Thus, the manager’s task is to counteract workers’ natural tendencies to avoid work. To keep workers’ performance at
a high level, the manager must supervise workers closely and control their behavior by means of “the carrot and stick”—rewards and punishments.
Managers who accept the assumptions of Theory X design and shape the work
setting to maximize their control over workers’ behaviors and minimize workers’
control over the pace of work. These managers believe that workers must be made
to do what is necessary for the success of the organization, and they focus on developing rules, SOPs, and a well-defined system of rewards and punishments to control behavior. They see little point in giving workers autonomy to solve their own
problems because they think that the workforce neither expects nor desires cooperation. Theory X managers see their role as closely monitoring workers to ensure
that they contribute to the production process and do not threaten product quality.
Henry Ford, who closely supervised and managed his workforce, fits McGregor’s
description of a manager who holds Theory X assumptions.
THEORY Y In contrast, Theory Y assumes that workers are not inherently
lazy, do not naturally dislike work, and, if given the opportunity, will do what is
good for the organization. According to Theory Y, the characteristics of the
work setting determine whether workers consider work to be a source of satisfaction or punishment, and managers do not need to closely control workers’
behavior to make them perform at a high level because workers exercise selfcontrol when they are committed to organizational goals. The implication of
Theory Y, according to McGregor, is that “the limits of collaboration in the
THEORY X
THEORY Y
The average employee is lazy, dislikes
work, and will try to do as little as possible.
Employees are not inherently lazy. Given
the chance, employees will do what is
good for the organization.
To ensure that employees work hard,
managers should closely supervise
employees.
To allow employees to work in the
organization's interest, managers must
create a work setting that provides
opportunities for workers to exercise
initiative and self-direction.
Managers should create strict work rules
and implement a well-defined system of
rewards and punishments to control
employees.
Managers should decentralize authority to
employees and make sure employees
have the resources necessary to achieve
21
22
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organizational setting are not limits of human nature but of management’s ingenuity in discovering how to realize the potential represented by its human
resources.”34 It is the manager’s task to create a work setting that encourages
commitment to organizational goals and provides opportunities for workers to
be imaginative and to exercise initiative and self-direction.
When managers design the organizational setting to reflect the assumptions
about attitudes and behavior suggested by Theory Y, the characteristics of the
organization are quite different from those of an organizational setting based on
Theory X. Managers who believe that workers are motivated to help the organization reach its goals can decentralize authority and give more control over the
job to workers, both as individuals and in groups. In this setting, individuals and
groups are still accountable for their activities, but the manager’s role is not to
control employees but to provide support and advice, to make sure employees
have the resources they need to perform their jobs, and to evaluate them on
their ability to help the organization meet its goals. Henri Fayol’s approach to
administration more closely reflects the assumptions of Theory Y, rather than
Theory X. One company that has always operated with the type of management philosophy inherent in Theory Y is Hewlett-Packard, the subject of the
next “Manager as a Person.”
The Hewlett-Packard Way
Manager as
a Person
Managers at the electronics company Hewlett-Packard (HP) consistently put
into practice principles derived from Theory Y. (Go to the company’s Web
site at www.hp.com for additional information.) Founders William Hewlett
and David Packard—Bill and Dave, as they are still known throughout the
organization—established a philosophy of management known as the “HP
Way” that is people-oriented, stresses the
importance of treating every person with
consideration and respect, and offers
recognition for achievements.35
HP’s philosophy rests on a few guiding principles. One is a policy of longterm employment. HP goes to great
lengths not to lay off workers. At times
when fewer people were needed, rather
than lay off workers management cut
pay and shortened the workday until
demand for HP products picked up.
This policy strengthened employees’
loyalty to the organization.
The HP Way is based on several
golden rules about how to treat members of the organization so that they feel
free to be innovative and creative. HP
managers believe that every employee
of the company is a member of the HP
Faced with questions about the company’s
team. They emphasize the need to
survival, HP CEO Carly Fiorina was forced
increase the level of communication
break with the tradition of “long-term
among employees, believing that horiemployment” and lay off over 40 percent of the
zontal communication between peers,
workforce.
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not just vertical communication up and down the hierarchy, is essential for
creating a positive climate for innovation.
To promote communication and cooperation between employees at different levels of the hierarchy, HP encourages informality. Managers and workers
are on a first-name basis with each other and with the founders, Bill and Dave.
In addition, Bill and Dave pioneered the technique known as “managing by
wandering around.” People are expected to wander around learning what others are doing so that they can tap into opportunities to develop new products
or find new avenues for cooperation. Bill and Dave also pioneered the principle that employees should spend 15 percent of their time working on projects
of their own choosing, and they encouraged employees to take equipment and
supplies home to experiment with them on their own time. HP’s product
design engineers leave their current work out in the open on their desks so
that anybody can see what they are doing, can learn from it, or can suggest
ways to improve it. Managers are selected and promoted because of their ability to engender excitement and enthusiasm for innovation in their subordinates. HP’s offices have low walls and shared laboratories to facilitate communication and cooperation between managers and workers. In all these ways,
HP managers seek to promote each employee’s desire to be innovative and
also to create a team and family atmosphere based on cooperation.36
The results of HP’s practices helped it become one of the leading electronics companies in the world. In 2001, however, HP, like most other high-tech
companies, was experiencing major problems because of the collapse of the
telecommunications industry, and the company announced that it was searching for ways to reduce costs. At first, its current CEO, Carly Fiorino, in keeping
with the management philosophy and values of the company’s founders,
announced that HP would not lay off employees but asked them to accept
lower salaries and unpaid leave to help the company through this rough spot.37
It soon became clear, however, that HP’s very survival was at stake as it battled
with efficient global competitors such as Dell and Canon. To fight back, HP
merged with Compaq, but by 2004 it had been forced to lay off over 40 percent of its employees and outsource thousands of jobs abroad in order to
remain competitive. Fiorino still believes, however, that HP’s values will survive its crisis and help it become the global leader in the next decade.38
Management
Science Theory
management science
theory An approach to
management that uses
rigorous quantitative
techniques to help
managers make maximum
use of organizational
resources.
Management science theory is a contemporary approach
to management that focuses on the use of rigorous quantitative techniques to help managers make maximum use of
organizational resources to produce goods and services. In
essence, management science theory is a contemporary extension of scientific
management, which, as developed by Taylor, also took a quantitative approach to
measuring the worker-task mix to raise efficiency. There are many branches of
management science, and once again, IT, which is having a significant impact on
all kinds of management practices, is affecting the tools managers use to make decisions.39 Each branch of management science deals with a specific set of concerns:
•
Quantitative management utilizes mathematical techniques—such as linear and
nonlinear programming, modeling, simulation, queuing theory, and chaos
theory—to help managers decide, for example, how much inventory to hold
at different times of the year, where to locate a new factory, and how best to
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•
•
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invest an organization’s financial capital. IT offers managers new and
improved ways of handling information so that they can make more accurate assessments of the situation and better decisions.
Operations management provides managers with a set of techniques that they
can use to analyze any aspect of an organization’s production system to
increase efficiency. IT, through the Internet and through growing B2B networks, is transforming the way managers handle the acquisition of inputs
and the disposal of finished products.
Total quality management (TQM) focuses on analyzing an organization’s input,
conversion, and output activities to increase product quality.40 Once again,
through sophisticated software packages and computer-controlled production, IT is changing the way managers and employees think about the work
process and ways of improving it.
Management information systems (MISs) help managers design systems that
provide information about events occurring inside the organization as well
as in its external environment—information that is vital for effective decision
making. Once again, IT gives managers access to more and better information and allows more managers at all levels to participate in the decisionmaking process.
All these subfields of management science, enhanced by sophisticated IT, provide tools and techniques that managers can use to help improve the quality of
their decision making and increase efficiency and effectiveness. We discuss many
of the important developments in management science theory thoroughly in Part 6
of this book. In particular, Chapter 17, “Managing Information Systems and Technologies,” describes the management of information systems and technologies,
and Chapter 18, “Operations Management: Managing Quality, Efficiency, and
Responsiveness to Customers,” focuses on IT, operations management, and TQM.
Organizational
Environment
Theory
organizational
environment The set of
forces and conditions that
operate beyond an
organization’s boundaries
but affect a manager’s
ability to acquire and utilize
resources.
An important milestone in the history of management
thought occurred when researchers went beyond the study
of how managers can influence behavior within organizations to consider how managers control the organization’s
relationship with its external environment, or organizational environment—the set of forces and conditions that
operate beyond an organization’s boundaries but affect a manager’s ability to
acquire and utilize resources. Resources in the organizational environment
include the raw materials and skilled people that an organization requires to produce goods and services, as well as the support of groups, including customers
who buy these goods and services and provide the organization with financial
resources. One way of determining the relative success of an organization is to
consider how effective its managers are at obtaining scarce and valuable
resources.41 The importance of studying the environment became clear after the
development of open-systems theory and contingency theory during the 1960s.
The Open-Systems View
One of the most influential views of how an organization is affected by its external environment was developed by Daniel Katz, Robert Kahn, and James
Thompson in the 1960s.42 These theorists viewed the organization as an
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Figure 2.4
The Organization
as an Open System
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ENVIRONMENT
Input
stage
Conversion
stage
Output
stage
• Raw materials
• Money and capital
• Human resources
• Machinery
• Computers
• Human skills
• Goods
• Services
Organization
obtains inputs
from its
environment
Organization
transforms inputs
and adds value
to them
Organization
releases
outputs to
its environment
Sales of outputs
allow organization
to obtain new
supplies of inputs
open system A system
that takes in resources
from its external
environment and converts
them into goods and
services that are then sent
back to that environment
for purchase by customers.
closed system A
system that is selfcontained and thus not
affected by changes
occurring in its external
environment.
entropy The tendency of
a closed system to lose its
ability to control itself and
thus to dissolve and
disintegrate.
open system—a system that takes in resources from its external environment
and converts or transforms them into goods and services that are sent back to
that environment, where they are bought by customers (see Figure 2.4).
At the input stage an organization acquires resources such as raw materials,
money, and skilled workers to produce goods and services. Once the organization has gathered the necessary resources, conversion begins. At the conversion
stage the organization’s workforce, using appropriate tools, techniques, and
machinery, transforms the inputs into outputs of finished goods and services
such as cars, hamburgers, or flights to Hawaii. At the output stage the organization releases finished goods and services to its external environment, where customers purchase and use them to satisfy their needs. The money the organization obtains from the sales of its outputs allows the organization to acquire more
resources so that the cycle can begin again.
The system just described is said to be open because the organization draws
from and interacts with the external environment in order to survive; in other
words, the organization is open to its environment. A closed system, in contrast, is a self-contained system that is not affected by changes in its external
environment. Organizations that operate as closed systems, that ignore the
external environment, and that fail to acquire inputs are likely to experience
entropy, the tendency of a closed system to lose its ability to control itself and
thus to dissolve and disintegrate.
Management theorists can model the activities of most organizations by
using the open-systems view. Manufacturing companies like Ford and General
Electric, for example, buy inputs such as component parts, skilled and semiskilled labor, and robots and computer-controlled manufacturing equipment;
then at the conversion stage they use their manufacturing skills to assemble
inputs into outputs of cars and appliances. As we discuss in later chapters, competition between organizations for resources is one of several major challenges
to managing the organizational environment.
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Figure 2.5
Contingency Theory
of Organizational
Design
Organizations in stable
environments choose a
mechanistic structure (centralized
authority, vertical communication
flows, control through strict rules
and procedures)
Characteristics of
the environment
Determine the design
of an organization's
structure and control
systems
There is no one best way to organize; organizational
structure depends on the environment in which an
organization operates.
synergy Performance
gains that result when
individuals and
departments coordinate
their actions.
Organizations in changing
environments choose an organic
structure (decentralized authority,
horizontal communication flows,
cross-departmental cooperation)
Researchers using the open-systems view are also interested in how the various parts of a system work together to promote efficiency and effectiveness. Systems theorists like to argue that the whole is greater than the sum of its parts;
they mean that an organization performs at a higher level when its departments
work together rather than separately. Synergy, the performance gains that
result from the combined actions of individuals and departments, is possible only
in an organized system. The recent interest in using teams combined or composed of people from different departments reflects systems theorists’ interest in
designing organizational systems to create synergy and thus increase efficiency
and effectiveness.
Contingency Theory
contingency theory
The idea that the
organizational structures
and control systems
managers choose depend
on—are contingent on—
characteristics of the
external environment in
which the organization
operates.
Another milestone in management theory was the development of contingency
theory in the 1960s by Tom Burns and G. M. Stalker in Britain and Paul
Lawrence and Jay Lorsch in the United States.43 The crucial message of contingency theory is that there is no one best way to organize: The organizational structures and the control systems that managers choose depend on—are contingent
on—characteristics of the external environment in which the organization operates. According to contingency theory, the characteristics of the environment
affect an organization’s ability to obtain resources; and to maximize the likelihood of gaining access to resources, managers must allow an organization’s
departments to organize and control their activities in ways most likely to allow
them to obtain resources, given the constraints of the particular environment
they face. In other words, how managers design the organizational hierarchy,
choose a control system, and lead and motivate their employees is contingent on
the characteristics of the organizational environment (see Figure 2.5).
An important characteristic of the external environment that affects an organization’s ability to obtain resources is the degree to which the environment is
changing. Changes in the organizational environment include changes in technology, which can lead to the creation of new products (such as compact discs)
and result in the obsolescence of existing products (eight-track tapes); the entry
of new competitors (such as foreign organizations that compete for available
resources); and unstable economic conditions. In general, the more quickly the
organizational environment is changing, the greater are the problems associated
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with gaining access to resources and the greater is managers’ need to find ways
to coordinate the activities of people in different departments to respond to the
environment quickly and effectively.
mechanistic structure
An organizational structure
in which authority is
centralized, tasks and rules
are clearly specified, and
employees are closely
supervised.
organic structure An
organizational structure in
which authority is
decentralized to middle
and first-line managers
and tasks and roles are
left ambiguous to
encourage employees to
cooperate and respond
quickly to the unexpected.
MECHANISTIC AND ORGANIC STRUCTURES Drawing on Weber’s
and Fayol’s principles of organization and management, Burns and Stalker proposed two basic ways in which managers can organize and control an organization’s activities to respond to characteristics of its external environment: They
can use a mechanistic structure or an organic structure.44 As you will see, a mechanistic structure typically rests on Theory X assumptions, and an organic structure typically rests on Theory Y assumptions.
When the environment surrounding an organization is stable, managers tend
to choose a mechanistic structure to organize and control activities and make
employee behavior predictable. In a mechanistic structure, authority is centralized at the top of the managerial hierarchy, and the vertical hierarchy of authority is the main means used to control subordinates’ behavior. Tasks and roles are
clearly specified, subordinates are closely supervised, and the emphasis is on
strict discipline and order. Everyone knows his or her place, and there is a place
for everyone. A mechanistic structure provides the most efficient way to operate
in a stable environment because it allows managers to obtain inputs at the lowest
cost, giving an organization the most control over its conversion processes and
enabling the most efficient production of goods and services with the smallest
expenditure of resources. McDonald’s restaurants operate with a mechanistic
structure. Supervisors make all important decisions; employees are closely supervised and follow well-defined rules and standard operating procedures.
In contrast, when the environment is changing rapidly, it is difficult to obtain
access to resources, and managers need to organize their activities in a way that
allows them to cooperate, to act quickly to acquire resources (such as new types of
inputs to produce new kinds of products), and to respond effectively to the unexpected. In an organic structure, authority is decentralized to middle and first-line
managers to encourage them to take responsibility and act quickly to pursue
scarce resources. Departments are encouraged to take a cross-departmental or
functional perspective, and, as in Mary Parker Follett’s model, authority rests with
the individuals and departments best positioned to control the current problems
the organization is facing. In an organic structure, control is much looser than it is
in a mechanistic structure, and reliance on shared norms to guide organizational
activities is greater. Managers in an organic structure can react more quickly to a
changing environment than can managers in a mechanistic structure. However,
an organic structure is generally more expensive to operate because it requires
that more managerial time, money, and effort be spent on coordination. So it is
used only when needed—when the organizational environment is unstable and
rapidly changing.
Summary and
Review
In this chapter we examined the evolution of management
theory and research over the last century. Much of the
material in the rest of this book stems from developments
and refinements of this work.
SCIENTIFIC MANAGEMENT THEORY The search for efficiency started
with the study of how managers could improve person-task relationships to
increase efficiency. The concept of job specialization and division of labor
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remains the basis for the design of work settings in modern organizations. New
developments such as lean production and total quality management are often
viewed as advances on the early scientific management principles developed by
Taylor and the Gilbreths.
ADMINISTRATIVE MANAGEMENT THEORY Max Weber and Henri
Fayol outlined principles of bureaucracy and administration that are as relevant
to managers today as they were when developed at the turn of the 20th century.
Much of modern management research refines these principles to suit contemporary conditions. For example, the increasing interest in the use of crossdepartmental teams and the empowerment of workers are issues that managers
also faced a century ago.
BEHAVIORAL MANAGEMENT THEORY Researchers have described
many different approaches to managerial behavior, including Theories X and Y.
Often, the managerial behavior that researchers suggest reflects the context of
their own historical era and culture. Mary Parker Follett advocated managerial
behaviors that did not reflect accepted modes of managerial behavior at the
time, and her work was largely ignored until conditions changed.
MANAGEMENT SCIENCE THEORY The various branches of management science theory provide rigorous quantitative techniques that give managers more control over each organization’s use of resources to produce goods
and services.
ORGANIZATIONAL ENVIRONMENT THEORY The importance of
studying the organization’s external environment became clear after the development of open-systems theory and contingency theory during the 1960s. A
main focus of contemporary management research is to find methods to help
managers improve the ways they utilize organizational resources and compete
successfully in the global environment. Strategic management and total quality
management are two important approaches intended to help managers make
better use of organizational resources.
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Management in Action
Topics for Discussion and Action
Discussion
1. Choose a fast-food restaurant,
a department store, or some
other organization with which
you are familiar, and describe
the division of labor and job
specialization it uses to
produce goods and services.
How might this division of
labor be improved?
2. Apply Taylor’s principles of
scientific management to
improve the performance of
the organization you chose in
item 1.
3. In what ways are Weber’s
and Fayol’s ideas about
bureaucracy and
administration similar?
In what ways do they differ?
4. Which of Weber’s and Fayol’s
principles seem most relevant
to the creation of an ethical
organization?
5. Why was the work of Mary
Parker Follett ahead of its
time? To what degree do you
think it is appropriate today?
7.
Why are mechanistic and
organic structures suited to
different organizational
environments?
Action
8. Question a manager about his
or her views of the relative
importance of Fayol’s 14
principles of management.
9.
6. What is contingency theory?
What kinds of organizations
familiar to you have been
successful or unsuccessful in
dealing with contingencies
from the external environment?
Visit at least two organizations
in your community, and
identify those that seem to
operate with a Theory X or
a Theory Y approach to
management.
Building Management Skills
Managing Your Own Business
Now that you understand the concerns addressed by management thinkers over the last
century, use this exercise to apply your knowledge to developing your management skills.
magine that you are the founding
entrepreneur of a software company that specializes in developing
games for home computers. Customer demand for your games has
increased so much that over the
last year your company has grown
from a busy 1-person operation to
one with 16 employees. In addition
to yourself, you employ six software developers to produce the
software, three graphic artists, two
computer technicians, two marketing and sales personnel, and two
secretaries. In the next year you
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expect to hire 30 new employees,
and you are wondering how best to
manage your growing company.
1. Use the principles of Weber
and Fayol to decide on the
system of organization and
management that you think
will be most effective for your
growing organization. How
many levels will the
managerial hierarchy of your
organization have? How much
authority will you decentralize
to your subordinates? How will
you establish the division of
labor between subordinates?
Will your subordinates work
alone and report to you or
work in teams?
2.
Which management approach
(for example, Theory X or Y)
do you propose to use to run
your organization? In 50
words or less write a
statement describing the
management approach you
believe will motivate and
coordinate your subordinates,
and tell why you think this
style will be best.
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Managing Ethically
Mr. Edens Profits from Watching His Workers’ Every Move
Read the case below, “Mr. Edens Profits from Watching His Workers’ Every Move,” and think
about the following issues.
C
ontrol is one of Ron Edens’s
favorite words. “This is a controlled environment,” he says of the
blank brick building that houses his
company, Electronic Banking System Inc.
Inside, long lines of women sit at
spartan desks, slitting envelopes,
sorting contents and filling out “control cards” that record how many
letters they have opened and how
long it has taken them. Workers
here, in “the cage,” must process
three envelopes a minute. Nearby,
other women tap keyboards, keeping pace with a quota that demands
8,500 strokes an hour.
The room is silent. Talking is forbidden. The windows are covered.
Coffee mugs, religious pictures and
other adornments are barred from
workers’ desks.
In his office upstairs, Mr. Edens
sits before a TV monitor that flashes
images from eight cameras posted
through the plant. “There’s a little bit
of Sneaky Pete to it,” he says, using
a remote control to zoom in on a
document atop a worker’s desk. “I
can basically read that and figure
out how someone’s day is going.”
This day, like most others, is
going smoothly, and Mr. Edens’s
business has boomed as a result.
“We maintain a lot of control,” he
says. “Order and control are everything in this business.”
Mr. Edens’s business belongs to
a small but expanding financial service known as “lockbox processing.”
Many companies and charities that
once did their paperwork in-house
now “out-source” clerical tasks to
firms like EBS, which processes
donations to groups such as Mothers Against Drunk Driving, the Doris
Day Animal League, Greenpeace
and the National Organization for
Women.
More broadly, EBS reflects the
explosive growth of jobs in which
workers perform low-wage and limited tasks in white-collar settings.
This has transformed towns like
Hagerstown—a blue-collar community hit hard by industrial layoffs in
the 1970s—into sites for thousands
of jobs in factory-sized offices.
Many of these jobs, though,
are part time and most pay far
less than the manufacturing occupations they replaced. Some
workers at EBS start at the minimum wage of $4.25 an hour and
most earn about $6 an hour. The
growth of such jobs—which often
cluster outside major cities—also
completes a curious historic circle.
During the Industrial Revolution,
farmers’ daughters went to work
in textile towns like Lowell, Mass.
In post-industrial America, many
women of modest means and skills
are entering clerical mills where
they process paper instead of cloth
(coincidentally, EBS occupies a former garment factory).
“The office of the future can look
a lot like the factory of the past,”
says Barbara Garson, author of
The Electronic Sweatshop and
other books on the modern workplace. “Modern tools are being used
to bring 19th-century working conditions into the white-collar world.”
The time-motion philosophies of
Frederick Taylor, for instance, have
found a 1990s correlate in the
phone, computer and camera, which
can be used to monitor workers
more closely than a foreman with a
stopwatch ever could. Also, the
nature of the work often justifies a
vigilant eye. In EBS workers handle
thousands of dollars in checks and
cash, and Mr. Edens says cameras
help deter would-be thieves. Tight
security also reassures visiting
clients. “If you’re disorderly, they’ll
think we’re out of control and that
things could get lost,” says Mr.
Edens, who worked as a financial
controller for the National Rifle Association before founding EBS in 1983.
But tight observation also helps
EBS monitor productivity and weed
out workers who don’t keep up.
“There’s multiple uses,” Mr. Edens
says of surveillance. His desk is
covered with computer printouts
recording the precise toll of keystrokes tapped by each data-entry
worker. He also keeps a day-to-day
tally of errors. The work floor itself
resembles an enormous classroom
in the throes of exam period. Desks
point toward the front, where a
manager keeps watch from a
raised platform that workers call
“the pedestal” or “the birdhouse.”
Other supervisors are positioned
toward the back of the room. “If you
want to watch someone,” Mr. Edens
explains, “it’s easier from behind
because they don’t know you’re
watching.” There also is a black
globe hanging from the ceiling, in
which cameras are positioned.
Mr. Edens sees nothing Orwellian
about this omniscience. “It’s not a
Big Brother attitude,” he says. “It’s
more of a calming attitude.”
But studies of workplace monitoring suggest otherwise. Experts
say that surveillance can create
a hostile environment in which
workers feel pressured, paranoid
and prone to stress-related illness. Surveillance also can be
used punitively, to intimidate workers or to justify their firing.
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Following a failed union drive at
EBS, the National Labor Relations
Board filed a series of complaints
against the company, including
charges that EBS threatened, interrogated, and spied on workers. As
part of an out-of-court settlement,
EBS reinstated a fired worker and
posted a notice that it would refrain
from illegal practices during a second union vote, which also failed.
“It’s all noise,” Mr. Edens says of
the unfair labor charges. As to the
pressure that surveillance creates,
Mr. Edens sees that simply as “the
nature of the beast.” He adds: “It’s
got to add stress when everyone
knows their production is being
monitored. I don’t apologize for that.”
Mr. Edens also is unapologetic
about the Draconian work rules he
maintains, including one that forbids all talk unrelated to the completion of each task. “I’m not paying
people to chat. I’m paying them to
open envelopes,” he says. Of the
blocked windows. Mr. Edens adds:
“I don’t want them looking out—it’s
distracting. They’ll make mistakes.”
This total focus boosts productivity but it makes many workers feel
lonely and trapped. Some try to circumvent the silence rule, like kids in
a school library. “If you don’t turn
your head and sort of mumble out of
the side of your mouth, supervisors
won’t hear you most of the time,”
Cindy Kesselring explains during
her lunch break. Even so, she feels
isolated and often longs for her former job as a waitress. “Work is your
social life, particularly if you’ve got
kids,” says the 27-year-old mother.
“Here it’s hard to get to know people
because you can’t talk.”
During lunch, workers crowd in
the parking lot outside, chatting
nonstop. “Some of us don’t eat
much because the more you chew
the less you can talk,” Ms. Kesselring says. There aren’t other breaks
and workers aren’t allowed to sip
coffee or eat at their desks during
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the long stretches before and after
lunch. Hard candy is the only permitted desk snack.
New technology, and the breaking down of labor into discrete,
repetitive tasks, also have effectively stripped jobs such as those
at EBS of whatever variety and
skills clerical work once possessed. Workers in the cage (an
antiquated banking term for a
money-handling area) only open
envelopes and sort contents; those
in the audit department compute
figures; and data-entry clerks
punch in the information that the
others have collected. If they make
a mistake, the computer buzzes
and a message such as “check
digit error” flashes on the screen.
“We don’t ask these people to
think—the machines think for them,”
Mr. Edens says. “They don’t have to
make any decisions.” This makes the
work simpler but also deepens its
monotony. In the cage, Carol Smith
says she looks forward to envelopes
that contain anything out of the ordinary, such as letters reporting that
the donor is deceased. Or she plays
mental games. “I think to myself, A
goes in this pile, B goes here and C
goes there—sort of like Bingo.” She
says she sometimes feels “like a
machine,” particularly when she fills
out the “control card” on which she
lists “time in” and “time out” for each
tray of envelopes. In a slot marked
“cage operator” Ms. Smith writes her
code number, 3173. “That’s me,” she
says.
Barbara Ann Wiles, a keyboard
operator, also plays mind games to
break up the boredom. Tapping in
the names and addresses of new
donors, she tries to imagine the
faces behind the names, particularly
the odd ones. “Like this one, Mrs. Fittizzi,” she chuckles. “I can picture her
as a very stout lady with a strong
accent, hollering on a street corner.”
She picks out another: “Doris Angelroth—she’s very sophisticated, a
monocle maybe, drinking tea on an
overstuffed mohair couch.”
It is a world remote from the one
Ms. Wiles inhabits. Like most EBS
employees, she must juggle her
low-paying job with child care. On
this Friday, for instance, Ms. Wiles
will finish her eight-hour shift at
about 4 P.M., go home for a few
hours, then return for a second
shift from midnight to 8 A.M. Otherwise, she would have to come in on
Saturday to finish the week’s work.
This way I can be home on the
weekend to look after my kids,”
she says.
Others find the work harder to
leave behind at the end of the day.
In the cage, Ms. Smith says her
husband used to complain because
she often woke him in the middle of
the night. “I’d be shuffling my hands
in my sleep,” she says, mimicking
the motion of opening envelopes.
Her cage colleague, Ms. Kesselring, says her fiancé has a different
gripe. “He dodges me for a couple
of hours after work because I don’t
shut up—I need to talk, talk, talk,”
she says. And there is one household task she can no longer abide.
“I won’t pay bills because I can’t
stand to open another envelope,”
she says. “I’ll leave letters sitting in
the mailbox for days.”
Questions
1.
Which of the management
theories described in the
chapter does Ron Edens
make most use of?
2.
What do you think are the
effects of this approach on (a)
workers and (b) supervisors?
3.
Do you regard Ron Eden’s
approach to management as
ethical and acceptable or
unethical and unacceptable in
the 2000s? Why?
Source: Tony Horwitz, “Mr. Edens Profits
from Watching His Workers’ Every Move,”
The Wall Street Journal, December 1, 1994.
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I. Management
Companies, 2005
2. The Evolution of
Management Thought
Small Group Breakout Exercise
Modeling an Open System
Form groups of three to five people, and appoint one group member as the spokesperson
who will communicate your findings to the class when called on by the instructor. Then
discuss the following scenario.
T
hink of an organization with
which you are all familiar, such
as a local restaurant, store, or bank.
After choosing an organization,
model it from an open-systems
perspective. Identify its input, conversion, and output processes;
and identify forces in the external
environment that help or hurt the
organization’s ability to obtain resources and dispose of its goods
or services.
Exploring the World Wide Web
R
esearch Ford’s Web site
(www.ford.com), and locate
and read the material on Ford’s history and evolution over time. What
have been the significant stages in
the company’s development? What
problems and issues confronted
managers at these stages? What
are the challenges facing Ford’s
managers now?
Be the Manager
How to Manage a Hotel
Y
ou have been called in to
advise the owners of an exclusive new luxury hotel. For the venture to succeed, hotel employees
must focus on providing customers
with the highest-quality customer
service possible. The challenge is
to devise a way of organizing and
controlling employees that will promote high-quality service, that will
encourage employees to be committed to the hotel, and that will
reduce the level of employee turnover and absenteeism—which are
typically high in the hotel business.
Questions
1. How do the various theories of
management discussed in this
chapter offer clues for
organizing and controlling
hotel employees?
2. Which parts would be the
most important for an effective
system to organize and
control employees?
Additional Activities on the Build Your
Management Skills DVD
•
Test Your Knowledge:
Management’s Historical
Figures
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Contemporary
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I. Management
2. The Evolution of
Management Thought
Companies, 2005
Case in the News
What You Don’t
Know About Dell
D
ell is the master at selling
direct, bypassing middlemen to
deliver PCs cheaper than any of its
rivals. And few would quarrel that it’s
the model of efficiency, with a farflung supply chain knitted together
so tightly that it’s like one electrical
wire, humming 24/7. Yet all this has
been true for more than a decade.
And although the entire computer
industry has tried to replicate Dell’s
tactics, none can hold a candle to
the company’s results.
As it turns out, it’s how Michael
Dell manages the company that
has elevated it far above its selldirect business model. What’s
Dell’s secret? At its heart is his
belief that the status quo is never
good enough, even if it means
painful changes for the man with
his name on the door. When success is achieved, it’s greeted with
five seconds of praise followed by
five hours of postmortem on what
could have been done better. Says
Michael Dell: “Celebrate for a
nanosecond. Then move on.” After
the outfit opened its first Asian factory, in Malaysia, the CEO sent the
manager heading the job one of
his old running shoes to congratulate him. The message: This is only
the first step in a marathon.
Just as crucial is Michael Dell’s
belief that once a problem is uncovered, it should be dealt with quickly
and directly, without excuses.
“There’s no ‘The dog ate my homework’ here,” says Dell. No, indeedy.
After Randall D. Groves, then head
of the server business, delivered 16
percent higher sales last year, he
was demoted. Never mind that none
of its rivals came close to that. It
72
could have been better, say two former Dell executives. Groves referred
calls to a Dell spokesman, who says
Groves’s job change was part of a
broader reorganization.
Above all, Michael Dell expects
everyone to watch each dime—
and turn it into at least a quarter.
Unlike most tech bosses, Dell
believes every product should be
profitable from Day One. To ensure
that, he expects his managers to
be walking databases, able to
cough up information on everything from top-line growth to the
average number of times a part
has to be replaced in the first 30
days after a computer is sold.
But there’s one number he cares
about most: operating margin. To
Dell, it’s not enough to rack up profits or grow fast. Execs must do both
to maximize long-term profitability.
That means products need to be
priced low enough to induce shoppers to buy, but not so low that they
cut unnecessarily into profits. When
Dell’s top managers in Europe lost
out on profits in 1999 because they
hadn’t cut costs far enough, they
were replaced. “There are some
organizations where people think
they’re a hero if they invent a new
thing,” says Rollins. “Being a hero at
Dell means saving money.”
It’s this combination—reaching
for the heights of perfection while
burrowing down into every last data
point—that no rival has been able
to imitate. “It’s like watching Michael
Jordan stuff the basketball,” says
Merrill Lynch & Co. technology
strategist Steven Milunovich. “I see
it. I understand it. But I can’t do it.”
How did this Mike come by his
management philosophy? It started
19 years ago, when he was ditching
classes to sell homemade PCs out
of his University of Texas dorm
room. Dell was the scrappy underdog, fighting for his company’s life
against the likes of IBM and Compaq Computer Corp. with a directsales model that people thought was
plain nuts. Now, Michael Dell is
worth $17 billion, while his 40,000employee company is about to top
$40 billion in sales. Yet he continues
to manage Dell with the urgency and
determination of a college kid with
his back to the wall. “I still think of us
as a challenger,” he says. “I still think
of us attacking.”
All this has kept Dell on track as
rivals have gone off the rails. Since
2000, the company has been
adding market share at a faster
pace than at any time in its history—
nearly three percentage points in
2002. A renewed effort to control
costs sliced overhead expenses to
just 9.6 percent of revenue in the
most recent quarter and boosted
productivity to nearly $1 million in
revenue per employee. That’s three
times the revenue per employee
at IBM and almost twice HewlettPackard Co.’s rate.
Still, for the restless Michael
Dell, that’s not nearly enough. He
wants to make sure the company
he has spent half his life building
can endure after he’s gone. So he
and Rollins have sketched out an
ambitious financial target: $60 billion in revenues by 2006. That’s
twice what the company did in 2001
and enough to put it in league with
the largest, most powerful companies in the world. Getting there will
require the same kind of success
that the company achieved in
PCs—but in altogether new markets. Already, Michael Dell is moving the company into printers, networking, handheld computers, and
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Contemporary
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I. Management
tech services. His latest foray: Dell
is entering the cutthroat $95 billion
consumer-electronics market with
a portable digital-music player, an
online music store, and a flat-panel
television set slated to go on sale in
October 2004.
Dell also faces an innovation
dilemma. Its penny-pinching ways
leave little room for investments in
product development and future
technologies, especially compared
with rivals. Even in the midst of the
recession, IBM spent $4.75 billion
or 5.9 percent of its revenues, on
research and development in 2002,
while HP ponied up $3.3 billion, or
4.8 percent of revenues. And Dell?
Just a paltry $455 million, or 1.3
percent. Rivals say that handicaps
Dell’s ability to move much beyond
PCs, particularly in such promising
markets as digital imaging and util-
2. The Evolution of
Management Thought
ity computing. “Dell is a great company, but they are a one-trick pony,”
says HP CEO Carleton S. Fiorina.
What’s more, Dell has shown little
patience for the costs of entering
new markets, killing off products—
like its high-end server—when they
didn’t produce quick profits, rather
than staying committed to a longterm investment. “They’re the best
in the world at what they do,” says
IBM server chief William M. Zeitler.
“The question is, will they be best
at the Next Big Thing?”
Dell’s track record suggests the
CEO will meet his $60 billion revenue goal by 2006. Already, Dell has
grabbed large chunks of the markets
for inexpensive servers and datastorage gear. After just two quarters,
its first handheld computer has captured 37 percent of the U.S. market
for such devices. And Rollins says
Companies, 2005
initial sales of Dell printers are double its internal targets. With the
potential growth in PCs and new
markets, few analysts doubt that Dell
can generate the 15 percent annual
growth needed to reach the mark.
Questions
1. What are the main principles
behind Michael Dell’s
approach to managing?
2. List these principles then
compare them to those
developed by Henry Fayol.
In what ways are they similar
or different?
Source: Andrew Park and Peter Burrows,
“What You Don’t Know About Dell.” Reprinted
from the November 3, 2003, issue of
BusinessWeek Online by special permission.
© 2003 McGraw-Hill Companies, Inc.
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Influence and Power
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Leadership
Exerting Influence and Power
MANAGERIAL BULLETIN
11
“The core
The Power of Personal Commitment and Vulnerability
problem for
So how do you motivate people? Not with techniques, but by risking yourself with a
personal, lifelong commitment to greatness—by demonstrating courage. You don’t
teach it so much as challenge it into existence.
leaders is
SOURCE: Peter Koestenbaum, Philosopher and Consultant to Top Executives, quoted in Polly Labarre, “Do You
Have the Will to Lead,” Fast Company, March 2000, p. 222.
getting others
to do what is
necessary to
accomplish the
organization’s
goals.”
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CHAPTER 11
The topic of leadership has fascinated people through the ages. After much discussion and research, the pursuit of a universal definition of effective leadership is still
intriguing but elusive. The world awaits definitive answers to such questions as:
What makes a good leader? Who can be a leader? Can anyone be a leader? Can
leadership skills be taught? What makes followers follow? What are the limits to
leadership?
Social science researchers for years pursued the notion that there must be some
common qualities shared by all leaders. Many long lists of sterling qualities (aggressiveness, wisdom, charisma, courage, and so forth) have been generated but have not
been found to apply to all leaders in all situations. To be effective a leader’s qualities
must relate somehow to the situation he or she is in and to the nature of the followers. This view is consistent with the situational approach taken throughout this
book, yet is barely widely accepted. The belief does not easily fade away that General Patton, Mahatma Gandhi, Vince Lombardi, Golda Meir, and Martin Luther
King—or the heads of AOL, GM, Microsoft, and John Hancock—must have had exactly the same qualities.
Throughout this and the next chapter, we will be using the terms manager and
leader interchangeably, even though customarily there is a distinction. A manager is
usually considered to be someone who makes sure that work is carried out properly,
while a leader is considered to be the person who decides on what the work ought
to be (i.e., the direction to be taken). The two roles are increasingly hard to separate,
since most managers today do have some responsibility for setting direction, and
few get to just carry out routine work.
As you might expect, insofar as there are common components to the manager’s
or leader’s job, a few traits appear to be consistent requirements. In Chapter 1 we induced from Mintzberg’s analysis of a manager’s job some of the skills required by a
manager. Recall that a manager needs interpersonal skills to acquire information
needed for decision making. Leaders need to have the ability to influence other people’s behavior, a readiness to absorb interpersonal stress, the capacity to structure social interactions to task needs, some self-confidence, and the drive to exercise
initiative in social situations, all of which are directly related to the nature of managerial work.
The role of the CEO is to produce poetry and plumbing.
James March
Effective leaders also have a strong drive for responsibility and task completion,
energy and persistence for accomplishing goals yet a willingness to tolerate frustration and delay (since working with and through others does not always result in immediate action!), some willingness to take risks and be original in solving problems,
and, perhaps most important, a willingness to accept the consequences of making
decisions and taking action.1
In general, you can see that these traits are closely related to the kinds of situations in which virtually all leaders find themselves, having to build relationships in
order to accomplish tasks and having to take responsibility for their system’s
performance.
The particular requirements for effective leadership in each situation, however,
may well outweigh all of these traits or make only certain ones critical in importance. As we will show in Chapter 12, different kinds of tasks, different kinds of subordinates, and differing leader characteristics all affect what leader behavior will be
effective. Thus, possession of the qualities listed does not guarantee that one will become a leader, nor does the absence of any one of them rule out the possibility of
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MANAGERIAL BULLETIN
In the Lead: Some Managers Are More than Bosses—They’re Leaders, Too
Managers “know how to write business plans, while
leaders get companies—and people—to change,” says
Carol Bartz, chief executive of Autodesk Inc. When she
was recruited six years ago to head the Silicon Valley
software company, profits were flat, and sales growth
was slowing dramatically. New software releases were
way behind schedule. The prior CEO had left amid
open rebellion by the company’s young and undisciplined programmers, who viewed top management as
an overbearing evil. Ms. Bartz didn’t hesitate to impose
her views. She rounded up employees she determined
were “opinion leaders” and persuaded them that no
matter how inventive they were at 3 A.M. dreaming up
new software, they wouldn’t get anywhere if they didn’t
deliver products on time. The new version of the company’s flagship product made it to market just four
days late.
Within six months, she dumped marginal businesses, made an acquisition and reassigned programmers, ignoring those who advise new CEOs to respect
the past. “That’s a mistake,” insists Ms. Bartz. “If you
just do what’s already been done, how do you show
your value? You have to make tough decisions.” She
also impressed employees with her personal courage.
On her second day at Autodesk, Ms. Bartz, a former
Sun Microsystems executive, was diagnosed with
breast cancer. Figuring that as a new CEO it wasn’t the
time to disappear, she refused to let her illness distract
her from her job. She had a stopgap lumpectomy, then
worked a month before getting the radical mastectomy
she needed.
Straightforward and unpretentious, with a hearty
laugh, Ms. Bartz links her leadership strength to knowing that “you constantly have to reinvent yourself.”
Since 1992, she has more than doubled Autodesk’s
revenue to more than $600 million. “Human nature
says cling to what you have, whether that’s an old coat,
a boyfriend, or a way of doing business,” she says. A
leader has to enjoy saying, “leave that behind.”
SOURCE: Carol Hymowitz, “In the Lead,” The Wall Street Journal, December 8, 1998, p. B1. (Copyright © 1998, Dow Jones & Company, Inc.)
MANAGERIAL BULLETIN
Leadership Practices and Attitudes (Competencies) Common to 62 Companies
The five core leadership attribute buckets:
“Tell” (Giving direction).
“IQ” (Mental horsepower).
“Sell” (Influencing others).
“EQ” (Emotional Intelligence).
“Initiate” (Making things happen).
“Know” (Business and technical acumen).
“Relate” (Building relationships).
“Grow” (personal development).
“Ego” (Strong sense of self).
SOURCE: George O. Klemp, “Leadership Practices and Attitudes (Competencies) Common to 62 Companies,” in Putting It Together (Cambria
Consulting, Inc., 1998).
Next, the four core leadership practice buckets:
becoming an effective leader. We, therefore, must emphasize that the potential for
leadership may be assumed to be widely distributed among the general population,
and a wide variety of leader behaviors may be effective in particular situations.2
What, then, must be taken into account by leaders who wish to be effective in
their particular organization? What behavior works best under what conditions?
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Can Leadership Be Taught?
Leadership is no longer seen as the exclusive preserve
of the inhabitants of executive row. The nurturing of
“corporate Gandhis” has given way to a focus on developing leadership abilities among employees at all
levels of our organizations. An executive, a manager, a
supervisor, an hourly worker—all can learn to develop a
vision for the future. All can learn to accept new
responsibilities, to take risks, to build consensus and
trust among subordinates and peers. Certainly not
everyone has the potential of a Lee Iacocca. But everyone possesses innate leadership abilities to some degree and those abilities can be improved.
SOURCE: Chris Lee, Training, July 1989.
That is what we explore in this and the next chapter. We begin in this chapter with
an analysis of leadership in general as the exercise of power and influence, then continue in Chapter 12 with the roles of formally appointed managers and their leadership choices.
Leadership as Influence
The core problem for leaders in organizations involves getting others to do what is
necessary to accomplish the organization’s goals. This is a complex process, because
the goals as well as the means for accomplishing them are often unclear, subject to
discussion or negotiation, and can change over time. A leader’s boss (or bosses),
peers, and subordinates all have ideas about what should be done and how to do it,
and they are likely to try to get their ideas heard. Furthermore, leaders are only human and unlikely to know everything, so they need to be able to alter their views
when others make good points.
Nevertheless, once goals are determined, leaders or managers must find a way to
create the conditions that will cause (or allow) subordinates to work hard and to direct that work toward organizational ends. This may call for many different kinds of
influence behavior aimed in many directions: negotiating a larger budget; getting
other departments to deliver accurate and timely information; providing vision, direction, or training to subordinates; simplifying or complicating work; obtaining a
deserved salary increase for someone, and so forth. All these activities—up, sideways,
and down—ultimately are aimed at getting others, especially subordinates, to do
what is necessary to accomplish successfully the work of the system being led.
Leadership is the ability to get men to do what they don’t want to do and like it.
Harry Truman
As countless leaders have discovered countless times, this is more easily said than
done. Subordinates don’t always know how to work well, don’t always work as hard
as is necessary, and don’t automatically care about the unit’s or organization’s success. The fact is, leaders are interdependent with many others, especially their followers. They have an effect on, and in turn are affected by, those with whom they
must work. The key element is the influence the leader has on others and the influence
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Training Bosses to Use Influence, Not Raw Aggression, Improves
Their Effectiveness
Coaching—as executive development has come to be
called—is not new. But corporate shrinkage and the
dawning era of flexible, decentralized management are
making obsolete the idea that executives can expect to
muscle their way to a career pinnacle and then coast
until retirement. Increasingly, they are expected to be, in
the words of the anthropologist Harvey Sarles, “autodidacts,” or self-teachers and lifelong learners, whose
performance will evolve and improve.
SOURCE: Barbara Presley Noble, “At Work: In Praise of Executive
Coaching,” New York Times, April 24, 1994, p. F23.
they have in return. For this reason we can think of leadership as a process in which
the involved parties influence one another in particular ways. Influence is any act or potential act that affects the behavior of another person(s). Let’s look at the implications of
using the concept.
First, influence cannot happen in isolation from others; it takes at least two to
“tangle,” just as with interpersonal relationships. The person who wants to influence
must find someone to influence. Second, if you think about it carefully, you will see
that only in the most extreme situations could one person in an influence transaction have all the influence—that is, affect the other’s behavior without being affected
in turn by the other’s reaction. The machinist who leaps to attention when the boss
gives an order, the secretary who bursts into tears when feeling that a request to work
late is unreasonable, the student who challenges an assignment due the day after vacation—all exert influence on the person trying to influence them.
Cooperating humbly, for example, affects the person who is asking for cooperation and “pulls” more of the same from him or her. As Gandhi showed so well in India, humble, passive noncooperation can have a profound influence on those giving
orders. Even the person who follows directions he or she knows are wrong out of
fear of being fired or punished has influence on the behavior of the tyrant, allowing
further exploitation and mistakes, because the directions were not resisted.
We must be careful then to remember that influence succeeds in moving others
in desired directions only when the net influence, the amount of A’s influence on B
compared with B’s influence on A, is greater. In the classroom or on the job, students and workers can be less or more influential than teachers and supervisors.
Leadership is net influence in a direction desired by the person possessing it.
To understand this process better, we need to look at various types of influence.
One important aspect of influence is whether or not it is formal or informal, part of
a job’s definition or acquired in some other way. Formal influence is influence prescribed
for the holder of an “office” or a position in a particular social system. It is influence assigned
to a position. The coach of a team has formal influence in initiating practice sessions, selecting starting players and substitutes, and so forth. Informal influence is influence not prescribed for the office holder but nevertheless affecting other members of the social
system. On the same team, for example, there may be several players whose advice
other players and even the coach seek on such matters as techniques and strategy
against opponents. Although by position the players have no special influence allotted or assigned to them, their knowledge or personal attractiveness, or both, give
them influence anyway. Influence based on special knowledge is expert influence,
while influence based on personal charm is called charisma.
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In addition to the distinction between formal and informal influence (i.e., assigned or unassigned), we need to add the concepts of legitimacy and illegitimacy.
Legitimate influence is exerted by a person who is seen as having the right to do so
by those influenced. In other words, legitimate influence is accepted as proper by the
person being influenced. Conversely, illegitimate influence is exerted by a person
not seen as having the right to do so by those being influenced. Illegitimate influence is not accepted as proper by the person being influenced. The basis for considering an influencer as legitimate may be (1) a positive assessment of his or her personal
qualities, such as competence, experience, and age and (2) the acceptance of the
process (such as election, appointment, or automatic succession) by which the person acquired a role calling for the exercise of influence. Legitimacy will usually
be limited to areas within the scope of the system and its goals. For example, most
people will believe that the boss may legitimately give orders about how to sell a
machine but not about where to go on vacation. But within the scope of the organization, orders, requests, and directions will be seen as proper when they come from
someone who has acquired an office by an approved process or has personal qualities considered appropriate.
To despise legitimate authority, no matter in whom it is invested, is unlawful;
it is rebellion against God’s will.
Leo XII
Immortale Dei
November 1, 1885
On the other hand, even in the army—where soldiers are taught to “salute the uniform, not the man,” suggesting that mere appointment to rank guarantees legitimacy—a soldier may refuse to follow direct orders under a variety of circumstances.
To illustrate, if the commanding officer has disruptive personality characteristics or
has acquired his office in objectionable ways, such as perceived favoritism, there
may be rebellion. Furthermore, when influence is not seen as acquired legitimately,
soldiers and other subordinates have many ways of subverting any orders from a person whose influence they do not accept, such as dragging their heels by following literally all rules in the books. Going passive is a common way of resisting what is seen
as illegitimate influence.
Because having formal influence does not ensure legitimacy nor does having informal influence ensure illegitimacy, it is useful to combine the two categories into
the four possible combinations, as shown in Figure 11–1.
By looking at the combinations, we can see the ways in which influence is exercised. Formal-legitimate influence is what is usually meant when people say “the boss
has the authority” to enforce particular behaviors. It is the influence both prescribed for
the holder of an office in a social system and seen as his or her right to exert by the other members of it. Many leadership activities in organizations involve formal-legitimate influence by someone who has been assigned a role with supervisory responsibilities and
who can use organizational means to reward or punish subordinates. The right to
hire, fire, promote, and adjust pay reinforces this kind of influence.
Because most people who accept jobs in an organization are reasonably willing to
accept directions from their “boss” on job-related matters, legitimacy is often taken
for granted and assumed to go with any formal role. During such times as the student strikes in the late 1960s and early 1970s or the rebellions of workers in France,
it becomes evident that the legitimacy of those with formal organizational positions
is precarious and rests upon the attitudes of the “followers.” Students challenged the
rights of professors to determine subject matter, give exams and grades, hire and fire
colleagues; and they exerted influence on other activities that had traditionally been
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Examples of Types of Influence
Legitimate (accepted as proper)
Illegitimate (not accepted as proper)
Formal (assigned)
Boss gives work-related orders to
subordinate: “Stop making widgets
and begin making frammisses.”
Informal (not assigned)
Respected colleague helps you solve a
problem by showing you the proper
order to make calculations.
Teacher assigns an analytical paper, based
on concepts in the text.
Basketball benchwarmer notices flaw in
opponent’s defense, convinces coach
to alter offense.
Co-worker threatens to beat you up if you
continue to produce so much.
Boss makes strong hints about
subordinate’s family life: “Send your
son to a private school.”
Student put in charge of class discussion
by instructor.
Fellow students ridicule you for asking
questions in class, despite instructor’s
request for questions.
seen as part of faculty prerogatives. More recently, students have challenged college
trustees about investments in companies using child labor, and challenged administrators about pay levels of building and grounds workers. Pressure from workers in
several European countries has led to change in what were traditionally considered
management’s prerogatives. In several countries, workers must even be consulted for
such decisions as plant location and new investments in equipment. Thus, the
boundaries of legitimacy for decisions is changing. Furthermore, legitimacy, even for
someone in a formal position, must be earned and may occasionally need renewal.
At different times a formal leader may find legitimacy slipping away because of questions about competence or about the way in which the person is leading. Similarly,
some subordinates may see the boss as legitimate while others don’t. It is often the
case that an appointed leader is perceived as legitimate by those with similar backgrounds and as illegitimate by those with backgrounds different from the leader’s. A
scientist might not, for example, accept the influence of an engineer as a project
leader as readily as would another engineer. Since legitimacy is an attitude about a
person by other persons, it can change just as do other attitudes. Nevertheless, much
of the work of organizations is done because there is a considerable amount of legitimacy granted to those in formal positions; but that is by no means the only kind
of leadership exerted.
A great deal of influence is based upon knowledge, expertise (whether perceived
or real), or personal charm rather than position.3 This informal-legitimate influence by a
member of a social system stands apart from the prescribed influence of his or her office but is
accepted as within one’s rights by the others in the system. It is not predictable from organization charts but is essential to organizational functioning. Some people know
things or behave in charismatic ways that others value, regardless of position, and
are given influence accordingly. The most expert auditor in an accounting office
may be consulted by other auditors and listened to even though he or she has no
formal assignment to help others. The rewards and punishments available to this
kind of influencer are more personal—that is, he or she can give or withhold important information or support in return for gratitude and respect.
Leadership in classroom groups is often of the “expert” kind, with the most
knowledgeable member(s) of the group gradually becoming respected and listened
to even when there is no formal leader. In fact, among many student groups there is
a widespread student norm that no peer should give orders or directions to another
student, so even those students put in leadership roles by a class exercise often hold
back from giving directions.
Conversely, a fellow student making a “grab for power” will usually be resisted by
other students. Sometimes such a person has quickly volunteered for a leadership role
before others dare to and is allowed to take it despite feelings that “it isn’t right”; in
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A Title Is No Guarantee of Power
And these considerations . . . hamstrung [Mayor] LaGuardia in his dealings with [Robert] Moses: Moses’
popularity; Moses’ immense influence with a governor
and a legislature from whom the mayor constantly
needed favors; Moses’ ability to ram through the great
public works that the mayor desperately wanted . . .
scandal-free and in time for the next election. With
good reason, he doubted whether anyone else could.
The powers that the mayor possessed over Moses’ authorities in theory he did not possess in practice. Political realities gave him no choice but to allow Moses to
remain at their head. And the mayor knew it.
Moses knew it, too. After reading the bond agreements and contracts, LaGuardia dropped all further
discussion of the authorities’ powers. Moses never
raised the matter again. But thereafter he treated LaGuardia not as his superior but as an equal. In the areas in which he was interested—transportation and
recreation—Robert Moses, who had never been elected
by the people of the city to any office, was thence forward to have at least as much voice in determining the
city’s future as any official the people had elected—including the mayor.
SOURCE: Robert A. Caro, The Power Broker: Robert Moses and The
Fall of New York (New York: Alfred A. Knopf, © 1974).
that case, the student has formal-illegitimate influence, which may not last long, unless
he or she is seen as helping the group reach its goals. Similarly, in organizations where
members are accustomed to having considerable say in matters affecting them, the
boss’s decision to create a new position located between him or her and the others
(“because the work load is too heavy for me”) can result in resentment toward whoever is put in that new job and lead only to grudging cooperation. If that person, however, has the formal authorization to administer some organizational rewards and
punishments, he or she may end up with considerable influence anyway.
Finally, the person who acquires influence over others by personal access to some valued rewards or feared punishments is using informal-illegitimate influence. Physical threats by a
fellow worker can coerce compliance that would otherwise be refused, as can special
relationships with higher-ups. In one New Hampshire school system, for example,
by maintaining a close relationship with several powerful school board members,
the music director forced principals to release students for weeklong band trips and
to arrange schedules to suit his convenience. He thus obtained more influence over
principals than was called for by his position or was seen as his right by them. Although he obtained compliance, he also created considerable resentment and was
constantly criticized behind his back by the principals.
I must admit my management style was too simple sometimes.
Chinese track coach Ma Junren, after confirming
that he occasionally beat up members of his worldclass squad, Newsweek, April 3, 1995
Taking Initiative as an Act of Leadership
Have you ever found yourself in a room that was so hot and stuffy that you and other
students were having trouble concentrating on the lecture or discussion? What do you
do? Wait and hope the instructor will recognize the problem and call a break; or raise
your hand, point out the difficulty, and suggest opening some windows and taking a
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break? Raising your hand could be an act of leadership. To wait for the designated
leader (instructor) to act could mean missing an opportunity to make it a better class.
Taking initiative might have the payoff of enhancing your influence (or status) but
also involves the risk of being “shot down” by the formal leader of the class.
In the next chapter we examine the obligations and choices of those who have
been formally appointed to managerial positions, that is, who are in a formal role.
In this chapter we have been discussing the exercise of influence by anyone and have
defined leadership as influence. We might also define leadership as those actions that
move a group toward its goals (such as opening a window when the room is stuffy). The
distinction between formal and informal leadership is a useful reminder that as
group members and as subordinates anyone can exert influence (leadership)—and often should. In small work groups, it is important for all members to take initiative.
Similarly, it can be important that a subordinate exert initiative in a staff meeting or
a committee meeting and not just wait for all leadership to come from the designated manager or chairperson.
How People Are Influenced
There are three processes (not mutually exclusive) by which people are influenced—
compliance, identification, and internalization.4 The very same behavior (namely, doing
what you are told to do by another person) can stem from any one or a combination
of these processes.
Compliance amounts to doing something because of the costs of not doing it. You
go along with the “order” on the outside, but inside you may feel resentment or resignation. Any leader’s influence can rest on compliance, particularly where there is
fear of punishment or a desire to gain some reward; this may be the only way in
which an informal-illegitimate leader can exert influence. Where compliance is operating, leaders will be successful only as long as they have control over whatever it
is followers need or want.
Identification occurs when you are influenced by someone because of the attractiveness of that person, because the person either is likable and has charisma or
represents something to which you aspire (e.g., an important position). Formal,
designated leaders or managers often exert influence because subordinates identify
with them. They may also be legitimized by their subordinates through the
same process.
Identification with a charismatic leader can dramatically affect behavior for people who want to believe in lofty goals that will somehow be ennobling. When such
people see a leader as having a grand vision of what is possible and offering specific
means for achieving their dreams, they identify with the leader and dedicate themselves to the cause. This can lead to extraordinary efforts by followers on behalf of
the leader and, thus, unusually high organizational performance. That is why effective high-level executives spend so much time creating a vision or “story” about
where they see their organization (or unit) going and then telling and retelling it to
colleagues, subordinates, and outsiders.5
Ironically, it has been claimed that charismatic leaders only succeed because they
make followers feel weak and dependent. But some charismatic leaders can make followers feel more powerful, more confident, and more capable, not less.6 Followers
come to see themselves as achieving their own goals through the leader, not as having the leader’s goals forced on them. When this happens, influence through identification with the leader can spread to another mode, internalization.
Internalization, the third kind of influence, happens when leaders have the necessary expertise and values to be credible to their followers; they come to believe that
what the leader suggests is in fact the best course of action for them. The leader’s
opinions are seen as valid and trustworthy. The effect is that followers internalize the
leader’s opinions, thus giving full legitimization to the leader—formally designated
or not.
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Managing Your Career: Silicon Valley Hybrid—A Boss Who Makes
Others’ Ideas Pay Off
At McKinsey, the emphasis was on getting the right answer, [Gregory Slayton, CEO of ClickAction, Inc.] says.
But “Silicon Valley is all about the strength of your network. If no one answers your call, you can’t get that answer implemented.” . . .
To succeed as a Silicon Valley CEO, he says, requires more than “intellectual firepower.” He considers
himself an “implementer,” whose successes have come
mostly from other people’s ideas. What is needed, he
says, is the ceaseless drive to make things happen, the
willingness to make a decision when you have only
10% of the information you would like to have, and the
ability to forge trusting relationships.
That ability is critical in motivating the workers of the
new economy, he says. “You have to get them interested in the greater cause you’re pursuing,” he explains. “If not, they’re out there playing video games
and trading on E*Trade.”
SOURCE: Hal Lancaster, “Silicon Valley Hybrid: A Boss Who Makes
Others’ Ideas Pay,” The Wall Street Journal, October 26, 1999.
. . . the ultimate paradox of social leadership and social power. To be an effective leader,
one must turn all of his so-called followers into leaders.
David C. McClelland
Power: The Inner Experience
Over the long run, the most successful managers are those whose influence is
based on credibility—that is, where the followers are convinced by the logic of the
leader’s ideas and requests and internalize the influence.
You can see how a combination of these factors can have different effects. Compliance may be necessary under certain conditions (e.g., an emergency or when the
task is minor and implementation is easily enforced) but is difficult for a manager to
sustain. Some people will do what you want strictly out of compliance and some because they identify with you or your position. To maximize your effectiveness as a
leader, however, it is best to build credibility and reach people through internalization, so that they will do what is necessary because they want to.
Generating Employee Commitment
The important outcome of both identification and internalization is commitment,
which is an attitude driven from within the person. You know when you are committed to something—a person, an activity, a belief—when your behavior is motivated by forces inside yourself and not from outside pressures, as with compliance.
In the past, organizations have depended heavily on compliance and control to accomplish their goals; today more and more organizations are attempting to build
employee commitment, which obviously has more long-lasting benefits. Leadership
efforts have been directed to three major areas: the work itself, the relations among
people, and the organization as a whole.
Approaches to building commitment to the work itself include both formal
methods, such as work redesign, and informal ones, such as permitting employees a
high degree of freedom to manage their own work procedures. Approaches to generating interpersonal commitment also have included formal and informal methods
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Winning Strategies of Corporate Stars
Headhunters Neff and Citrin found
America’s top business leaders share
these six principles:
1.
2.
3.
Live with integrity, lead by example. “Integrity
builds the trust in senior management that is . . .
critical for high-performing organizations.”
Develop a winning strategy or “big idea.” “A successful leader must go to the company’s roots
and build on the things the organization truly
does best.”
Build a great management team. Great leaders
hired managers “whose skills and experiences
complemented their own, but whose passion,
attitudes, and values were one and the same.”
4.
5.
6.
Inspire employees to greatness. “Communicate
continuously, listen carefully, genuinely tolerate
failure as a learning experience.”
Create a flexible, responsive organization. “The
best leaders have redesigned their organizations
to make sure decisions can be made fast.”
Use reinforcing management systems. “Compensation . . . must be consistent with and reinforce
the values and strategy of the organization.”
SOURCE: “In Search of Leadership: A Talk with Headhunters Turned Authors Citrin and Neff,” Business Week, November 15, 1999, p. 172.
(Copyright 1999 McGraw-Hill, Inc.)
such as planned team-building or informal encouragement of collaborative norms.
Similarly, organizational commitment is developed in both formal and informal
ways. The “transformational” leader, who inspires people to excel and articulates a
meaningful vision for the organization, uses both ways to build employee commitment.7 In Chapter 12 we introduce you to the concept of “developmental leadership,” which is similar to that of transformational leadership, but which goes beyond
it by spelling out practical applications in the workplace. It might interest you to
know that the traits of the transformational or developmental leader are claimed to
be more typically characteristic of women than of men. The implications of this for
future organizational needs and for personal learning and opportunity are extremely
important.8 However, recent survey evidence raises questions about whether there
are real differences between men and women managers:
. . . a 15-year survey of 41,000 executives—25% of them female—at 5,000 companies
shows that women are slightly more high-handed than the guys are when making
decisions . . . Discovery Learning . . . came to that conclusion by investigating
whether managers solve business problems autocratically—preferring to make unilateral decisions—or “inclusively . . .” [W]here an autocratic style was deemed appropriate, women chose “my-way-or-the-highway” 35% of the time, guys only 31.5%
. . . “Did [women managers] make it to these levels because they operate more like
men, or is there basically no difference?” . . . if your boss is a Ms., don’t automatically expect her decision-making to be warm and fuzzy.9
Finally, it is important to recognize that, while the three areas of commitment discussed above tend to be related, they also exist independently of each other. Many
workers are committed to their work and not to their colleagues or to the organization as a whole. And many employees are committed to their “team” and even to
the organization and feel a very low level of identification with the work they are doing. Because there are a variety of combinations of the three dimensions, it is important for a manager to develop a diagnostic profile of the three as they fit his
or her part of the organization. Such a diagnosis allows for a focused approach to
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Gaining Commitment from Your Employees: Some Key Points
For the individual, it depends on:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Involvement.
Choice.
Meeting positive expectations.
Feeling supported and valued.
Need fulfillment.
Feedback that facilitates improvement.
Intrinsic satisfactions.
Challenge and opportunities to grow.
Being treated fairly.
Affirmation of self-concept.
In interpersonal relationships, it depends on:
1. Mutual support, acceptance and reinforcement of self.
2. Openness where needed and appropriate.
3. Trust and confidence (mutual).
4. Compatible styles:
a. Similar or
b. Complementary.
5. Acceptance or appreciation of differences,
or both.
6. Opportunities to problem solve jointly.
7. Willingness to manage conflicts.
For a group, it depends on:
Norms that support organizational goals.
Cohesiveness around those norms.
Rewards at a group level.
Group being valued by organization.
Acceptance of individual differences in abilities, preferences, and values.
6. Ability to match member resources to any
given task.
1.
2.
3.
4.
5.
For the total system, it depends on:
1. The parts being aware of the whole.
2. Groups being willing to accept each other’s
legitimacy and importance.
3. Willingness of people to interact across
group boundaries.
4. Recognition of the importance of reciprocity.
5. Appreciating the importance of diversity with
respect to:
a. Ideas and
b. People.
SOURCE: Stephen L. Fink, High Commitment Workplaces, Quorum
Books, 1992.
actions that will address problems of commitment where they exist. In the Managerial Tools box above, we have listed some of the key issues that pertain to employee
commitment as they affect the individual, interpersonal relationships, group behavior, and the organization as a whole.
Power
The capacity to exert influence is power. (Often “power” and “influence” are used interchangeably.) People who have the ability to exert one or more of the four types of
influence have power, which can be used toward the organization’s ends or toward
subgroup or individual goals, including those in direct opposition to organizational
goals. As suggested earlier, no one is completely without influence, but some people
have more net influence than others and hence more power.
Power is often perceived to be a bit “dirty,” at least in the United States, something vulgar, but it is more than a set of sneaky tactics for grinding others into the
dirt; power in organizations is the ability to make things happen.10 Organizational work
cannot be done without that ability, and managers need to understand it in order to
bring together the people and resources to accomplish what must be done and to
avoid the negative consequences of power differentials.
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Tyrants Beware
Nobody minds being subjected to the power of somebody who’s genuinely interested in getting the job done
and making more money and extracting maximum performance. But nobody wants to be told that they have to
have their pencils sharpened and the erasers all facing
in the same direction before they leave the office at
night.
SOURCE: Michael Korda, “Psychodynamics of Power,” Mainliner, March
1977.
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Rep. Bolling Takes His Leave of Power
It took me 32 years to realize that it’s sometimes more
important to have the trappings of power than power itself. If you’ve got a good-looking room with a nice chandelier, your colleagues may think you’ve got power.
Actually, all you’ve got is a chandelier and room. Washington is full of illusions like that.
SOURCE: Dennis Farney, The Wall Street Journal, January 1, 1982.
Sources of Power in Organizations
How, then, is power obtained by individuals in organizations? In general, The more
legitimate one is perceived to be, the greater the likelihood of acceptance of one’s attempts to influence, and the less resentment at going along.11 Power goes to those
who are seen as having a right to it. Conversely, the less legitimate forms of influence breed resistance and resentment, although they will probably enhance the
power of someone who already possesses other kinds of legitimate influence.
Additionally, informal influence is often necessary for those with formal influence if they want more than drudging cooperation; when a formally designated
leader does not have some knowledge seen as helpful by subordinates, it will be difficult to secure more than token compliance. As organizations become more complex and technically demanding, more people in leadership positions do not have
the technical expertise necessary to gain influence beyond that of their own job description, making it hard for them to get full cooperation from those who know
more than they do about some other aspects of the job. They must then find ways
of gaining informal influence through their own personal attractiveness and their
ability to make friendly relationships—or they must settle for a low-power position
relative to their subordinates.
Perhaps the primary source of power is the ability to enhance the organization
positively in relation to its “environment” or key problems.12 Those who can help
the organization achieve its goals by overcoming the most difficult, pressing, and
dangerous problems are likely to acquire power. A marketing expert in a company
that can sell everything it can make but cannot solve its production problems is less
likely to gain power than the production engineer who can eliminate the bottlenecks. So it helps either to acquire skills that are (and will be) critical to the organization or to seek employment where the skills one has are most likely to be needed.
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Management: When Young Managers Deliver the Pink Slips
Many 20-somethings are managers, and holding onto
employees, not letting them go, is their main concern.
But when pink slips must be delivered, these young
bosses often have to deliver them. . . .
Managers have always had to dismiss underlings
when their performance lagged or the company’s profits sagged. Even Amazon.com and iVillage.com recently had to trim their staffs for economic reasons. . . .
But not so long ago, the bearer of bad tidings
was usually an old pro, or . . . old enough to know
how to cope with the emotions surrounding it. Today,
increasingly, the dirty work is done by people a few
years out of college for whom management has mostly
meant recruiting employees with stock options and
playing the host at happy hours. . . .
Aside from the legal implications, young executives
are often not equipped to handle the emotional side of
firings.
SOURCE: Charles Butler, “Management: When Young Managers Deliver
the Pink Slips,” New York Times, February 16, 2000, p. 10. ©2000 The
New York Times Company.
Furthermore, it helps to do things that are not routine, that are unusual or extraordinary in the organization. A person who performs critical tasks in a way that is
already established and routinized will receive less power than a person who develops new methods or procedures, starts a new unit or task, creates a new project or
product.13 That is why those who are organizationally ambitious do not like to be
the second or third person in a job; they would prefer to be the first to do a job, so
they can most easily leave their mark. And in any job they move into, they often
seek early changes in something, even office layout or decor, to show that they intend to do things differently.
That suggests a third important aspect of power acquisition: It is not enough to be
doing extraordinary, critical activities; one’s efforts must be visible and recognized.
Power goes not just to those who do well, but to those who are also seen to do well.14
(In fact, some cynics claim that appearance is all, though it is hard to sustain power
when one does not actually produce.) Those who want power must find ways to
achieve recognition. Among other things, it is a political process.
This can happen in many ways. A well-written and well-timed report can help
promote visibility, as can a well-presented oral report at a meeting. The opportunity
to make a presentation to higher-ups creates a natural chance for “showing one’s
stuff ” and for demonstrating the importance and relevance of the work done. Similarly, serving on committees, often seen as a nuisance, is a chance to show others besides one’s boss what one can do. “Doing one’s homework” before meetings often
helps both to make a good impression and to lead to more responsibility and thus
power within the committee. Those who want power look for responsibility, for
chances to demonstrate ability to get things done.
Through committee work or social contacts, power seekers make connections with
one or more people higher in the organization. A higher-up who thinks a person
shows promise might become a kind of “sponsor” who will look after the aspirant’s
career, help create opportunities, and build reputation. Also, when people are perceived as “having a friend or friends in high places,” then others may defer to them
or seek them out even without direct intervention on the powerful person’s part.
Because power is a social process of influencing others to act, it comes in part
from being able to do things for others that obligate them to be helpful in return by
fulfilling the norm of reciprocity.15 Thus, the person seeking power needs to find
ways to be helpful to others in the organization. Volunteering to handle unpleasant
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Are You More of a Street Fighter or a Jekyll and Hyde?
Most bosses think they do a pretty good job of keeping
their subordinates happy. Don Bibeault has no such illusions. “I’m not a jolly fellow who’s fun to be with,” . . .
“I’m extremely dedicated and determined, and I don’t
have time to sugarcoat problems. If that’s considered
abrasive behavior, so be it.”
[He claims] that being a street fighter is the only way
he could be effective. His harsh style helped him revive
or liquidate 11 companies . . . as a turnaround specialist. But it did lead to occasional confrontations.
SOURCE: Tony Lee, “Are You More of A Street Fighter or a Jekyll and
Hyde?” The Wall Street Journal, June 11, 1996, p. B1.
MANAGERIAL BULLETIN
Is Craig Weatherup Too Nice for PepsiCola’s Own Good?
The chief executive of PepsiCo Inc.’s global beverage
arm is widely regarded by employees as a benevolent
boss. . . .
One school of thought has it that Pepsi can never
beat an increasingly aggressive Coca-Cola Co. without
a certain ruthlessness in the executive suite. “What’s
needed at Pepsi is some basic brutality because when
you’re dealing with killers that’s the only thing that will
help you prevail. . . .
“It staggers me that for whatever reason being nice
is seen as being inconsistent with being tough,” says
[Weatherup]. [His] argument is this: If you’re a visionary
but you’re mean, employees won’t follow you.
SOURCE: Nikhil Deogun, “Pepsi’s Mr. Nice Guy Vows Not to Finish Last
in Battle with Coke,” The Wall Street Journal, March 19, 1997, p. B1.
tasks, finding ways to make others’ jobs easier, and doing favors whenever possible
are all ways of creating obligations, which can be collected on when needed. That is
exactly how politicians, who have to be interested in power, build it.
Another way of looking at this is in terms of control of key rewards and punishments in the organization. Power reflects the ability to give rewards or punishments
in order to get others to do what one believes needs to be done.16 The more a person has access to controlling rewards and punishments, the greater his or her
power.17 Thus, a person who can give the formal rewards or use the formal punishments of an organization—hiring, firing, promoting, adjusting salary, allocating
choice assignments or space, giving recommendations, and so forth—and give informal rewards or punishments, such as help, information, and liking, will have the
most power. Just what the rewards and punishments are depends on the organization and the perceptions of those in it; but whatever it is that people value or fear,
those who control it will have power to influence behavior. Attention to what the rewards are to those in the organization, who manages them, and which departments
or units currently get them in greatest proportion, can aid in determining how to get
control of them. At the very least, power seekers figure out what rewards they already control so that they can more wisely use them to create obligations or induce
cooperation when needed. One common accessible reward (even at lower levels of
the organization) is finishing, on time, work that someone else needs and is waiting
for. That builds gratitude—or, as it is called in some organizations, chits—which can
be “cashed in” when needed.
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“That Report Is on My Coffee Table”
Many of your readers . . . have aspirations of becoming
wealthy and powerful. If they succeed, however, I hope
their egos will not require offices with private saunas
and push-button controls. If one is important and powerful, the right people know it. If not, handpainted china
will not change it.
With the economy in a depression, dividends being
omitted, and millions unemployed, it is embarrassing to
read about the conspicuous consumption and crystalline egos of America’s top executives. What we need
are offices that look like offices, not living rooms.
SOURCE: From a letter to the editor of The Wall Street Journal by Sam
Bosch, January 28, 1982.
One interesting aspect of the kind of power that is associated with rewards is the
power obtained by helping to relieve people’s anxieties (reduce their tensions). “Got
a problem? Go see Joe. He’ll help you work it out.” In fact, when this kind of power
is carried to an extreme, unusually high expectations can be imposed on the holder
and may even put a strain on that person’s ability to retain that power.
Pfeffer18 points out the power one obtains by being seen as someone who can reduce uncertainty in an otherwise chaotic situation. Given the nature of organizations today, this source of power is undoubtedly on the increase. Most people have
a limited tolerance for uncertainty (or ambiguity); the person who can help to reduce that uncertainty is likely to attract a following. It is not unlike the following of
any person who is viewed as “having the answers.”
None of the methods described provide for easy access to power; in fact, sheer
willingness to work hard is almost always a requisite for acquiring power. As should
be clear by now, hard work alone may not be sufficient—it is necessary to work at
critical, unusual tasks with or for people who recognize what you are doing—but
without hard work it is extremely difficult to acquire power. Furthermore, A desire
for power with little genuine concern for the well-being of the organization and
for other members can be very destructive to the organization—and even to the
power seeker.
Consequences of Possessing Power
Regardless of the source of power, its possession tends to lead toward certain consequences, not all positive. These can be stated in the following propositions:19
1.
The more power attributed to a person, the more he or she is the recipient of:
a. Communication.
b. Solicitous behavior.
c. Deference by others seeking power.
This proposition suggests that those with power will be deferred to and that,
when those with less power are in the presence of powerful persons, they will address
comments to them more than to one another. Large discrepancies in power between
individuals, however, can interfere with successful work. If subordinates do not have
sufficient power, they often will not be able to get their work done, because they
can’t get the resources or responses they need. This in turn reduces the leader’s
power. Furthermore, large power gaps often lead to avoidance of the high-power person by the low-power person and to distorted communications—telling the powerful
person what one thinks that person wants to hear. Any powerful person will have to
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Bite Your Tongue When Evaluating Your Boss?
In a study at an insurance company, managers were
more positive about upward feedback when their employees signed their name to upward appraisals. But
the opposite was true for the employees. They rated
their manager’s leadership style more positively when
they were held accountable for their opinions. They
liked the process better and were more truthful only
when their views were kept anonymous.
SOURCE: Leo F. Brajkovich, “How Truthful Should You Be When Evaluating Your Boss,” (a research translation of a study by David Antonioni),
Academy of Management Executive 9, no. 4 (1995).
MANAGERIAL BULLETIN
CEO Disease: Egotism Can Breed Corporate Disaster—and the Malady
Is Spreading
Pampered, protected, and perked, the American CEO
can know every indulgence. The executive who finally
reaches the top of a major corporation enters an exclusive fraternity. The CEO’s judgment and presence are
eagerly sought by other captains of industry and policymakers. CEOs zip around the world in private jets
and cash the heftiest personal paychecks in industry.
They take home 85 times what the average blue-collar
worker makes, unlike their counterparts in Japan, where
the ratio is closer to 10 to 1.
It is a job that can easily go to one’s head—and
often does.
SOURCE: Business Week, April 1, 1991
be keenly aware of this problem and work hard to find ways to make less powerful
people feel comfortable enough to tell the truth. Without accurate communications
(and probably multiple sources), a powerful person will lose touch with actual feelings and is likely to make mistakes.
2.
The more a person is treated as though he or she has power, the greater will be
his or her self-esteem.
Feeling deferred to, powerful people have a tendency to begin to view themselves
as important, which enhances how they feel about themselves. Not surprisingly,
then, people who are powerful tend to seek one another out. Power breeds more
power. Thus,
3.
4.
The more power attributed to a person, the more that person will tend to identify with others who also have power.
Those with high-attributed power are attracted to and communicate more with
others with high-attributed power than with those who have low-attributed
power.
Many political leaders have been known to shift their attention and allegiance
from their constituencies to their fellow politicians. The same thing can happen in
an organization, especially as people climb increasingly higher in the hierarchy. Are
you familiar with instances in which an emergent social leader in a group was appointed formal leader by the system, thus enhancing his or her degree of influence?
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Charmed Forces: Army’s “Baby Generals” Take a Crash Course in
Sensitivity Training
“Each and every one of you has something that makes
you a jerk. Some of you have more than one. I know.
I’ve talked to you . . . work on losing that ugly part of
your personality.”
[Lt. Colonel Olsen] suggests that doubters ask their
spouses what he’s talking about: “They know, and
they’re dying to tell you.” . . .
Gen. Burnette warns that “The first deadly sin of the
general officer is arrogance. “Bask in the glow—and get
over it.” “You’ll find,” says another lecturer, “there aren’t
a whole lot of people who will tell you the truth anymore.”
SOURCE: Thomas E. Ricks, “Charmed Forces,” The Wall Street Journal,
January 19, 1998, p. A1.
Very often the individual is then seen to “change”; he or she is seen as less friendly
to “us mere workers” and as playing up to the big bosses. This frequently happens as
people find themselves in new leadership roles, having influence over people in
areas never before experienced.
In fact, one of the dangers of superiors having great power differentials over subordinates is that they begin to perceive any successes as due to their own skills and
to discount the capacities of the subordinates. Great power differentials lead to overestimates by the powerful of their own contributions and to blindness to the contributions of others.20
By examining these propositions, you can see why it is often said that power corrupts. The entire constellation of behavior and relationships that follow from the
possession of influence generates a cycle in which people with high power tend to
become more and more differentiated form those with low power, even though each
is dependent upon the other. The person with power has it only because it is given
by others; it ends the moment those who are doing the giving choose not to do so.
A leader is a leader only so long as there are followers. It certainly raises the question
of who really possesses the power, the one who leads or those being led.
There go my people. I must find out where they are going so I can lead them.
Anonymous
Another consequence of power for someone new to a position is the likelihood
of being closely observed by subordinates about where the leader’s loyalties and priorities will be, how open they can be, how friendly and close the leader will allow
them to be, and the like. Such early “testing” is often symbolic: The test is not direct, and the leader’s reactions are carefully scrutinized for favorable and unfavorable signs of what is to come. A leader who is unaware that such testing is inevitable
can make inadvertent mistakes that are hard to live down, sending messages that discourage future openness or cause resentment about assumed attitudes of superiority.
Consequences of Not Possessing Power
Although too much power can indeed be corrupting, so can too little. Because
power is needed to make things happen in organizations—being without it means
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The Bureaucrat Gets the Last Word
Ed Garvey was scheduled to make a business trip and
needed a cash advance. He went to the controller’s office to get the necessary signature on a form in order to
receive the cash. Mr. Pomeroy, an administrative assistant, was the person whose signature Ed needed. But
first Ed had to get past Mrs. Arnold, the secretary and
receptionist in the controller’s office. The Conversation
went like this:
Ed: I know, but I don’t have 24 hours before I have
to leave. I need the cash advance today.
Ed: I’d like to see Mr. Pomeroy for just one minute. I
need his signature for a cash advance.
Pomeroy: I know, but I do have a job to perform.
Mrs. Arnold: Mr. Pomeroy is very busy, so you’ll just
have to wait. Please sit over there.
Ed: Mrs. Arnold, I really have to get back to my office. Could you ask Mr. Pomeroy if he could take a
minute to sign this?
Mrs. Arnold: Well, I hate to interrupt him, but I’ll see
if he can take a moment. (Goes into Pomeroy’s office
and returns after about two minutes.) He’ll see you,
but you may have to leave the form here.
Ed goes into Pomeroy’s office and explains that this trip
was a last-minute thing and he was under time pressure. The conversation went like this:
Pomeroy: Well, I don’t know if I can take it upon
myself to sign this. If I break the rules for you, I could
end up with endless requests like this from others.
Ed: Look, this is an exceptional situation. The rules
don’t cover every situation.
Ed: Would you get into trouble if you signed it?
Pomeroy: No, but I believe in following proper procedure, Mr. Garvey.
Ed: I do too, but sometimes other things are more
important than rules. Is there someone over you I can
go to?
Pomeroy: I don’t think that will be necessary. I’ll
make the exception this time, Mr. Garvey, but please
try to give me the proper notice in the future.
Ed: That’s very nice of you, Mr. Pomeroy. Thank you.
When Ed walked out, he had the signature, but he felt
like he bought it with his soul.
Pomeroy: You know that at least 24 hours is required for approval of a cash advance.
insufficient resources, information, and support—managers who lack it have difficulty being effective. The manager who does not know what is going on, can’t get
the needed budget, and is not backed by higher-ups will inevitably be resisted by
subordinates. Why should they cooperate with someone who can’t deliver?
As a result, managers who are in positions that yield too little power (or who fill
their positions ineptly and lose what power they had) tend to:
1.
2.
3.
Overcontrol subordinates, try to make them cooperate.
Become petty tyrants, taking out their frustration on anyone they can
dominate.
Become turf-minded and rules-oriented, carving out a fiefdom where they can
reign supreme. 21
In this way, powerlessness also corrupts, since managers who become so dominating are seldom effective. Their attempts to find someone on whom to exercise
power only increase the resentment of their victims, causing even stronger attempts
at domination, more resistance, and so on. Without the proper tools, few managers
can be successful.
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MANAGERIAL TOOLS
Currencies Frequently Valued in Organizations
Inspiration-Related Currencies
Vision
Being involved in a task that has larger significance for unit, organization, customers, or society.
Excellence
Having a chance to do important things really well.
Moral/ethical correctness
Doing what is “right” by a higher standard than efficiency.
Task-Related Currencies
New resources
Obtaining money, budget increases, personnel, space, and so forth.
Challenge/learning
Doing tasks that increase skills and abilities.
Assistance
Getting help with existing projects or unwanted tasks.
Task support
Receiving overt or subtle backing or actual assistance with implementation.
Rapid response
Quicker response time.
Information
Access to organizational as well as technical knowledge.
Position-Related Currencies
Recognition
Acknowledgment of effort, accomplishment, or abilities.
Visibility
The chance to be known by higher-ups or significant others in the organization.
Reputation
Being seen as competent, committed.
Insiderness/importance
A sense of centrality, of “belonging.”
Contacts
Opportunities for linking with others.
Relationship-Related Currencies
Understanding
Having concerns and issues listened to.
Acceptance/inclusion
Closeness and friendship.
Personal support
Personal and emotional backing.
Personal-Related Currencies
Gratitude
Appreciation or expression of indebtedness.
Ownership/involvement
Ownership of and influence over important tasks.
Self-concept
Affirmation of one’s values, self-esteem, and identity.
Comfort
Avoidance of hassles.
SOURCE: A. R. Cohen and D. L. Bradford, Influence without Authority (New York: John Wiley & Sons, 1990).
Some Currencies of Influence
Often people see themselves as having little power, because they do not occupy
some formal position of power. But Cohen and Bradford22 point out that “people
also underestimate their power, because they aren’t creative in seeing connections
between what they have and what someone else wants.” These connections are like
“currencies,” which serve as a basis of exchange: “I give you my time, and you give
me appreciation.” “I generate ideas, and you feel empowered to act in ways that I, in
turn, value.” Managers have a vast array of currencies to influence their subordinates, their peers, and their bosses. Students don’t even begin to recognize the cur-
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MANAGERIAL TOOLS
Guide to Managing Your Boss—Or Anyone Else You Don’t Control
Understand your boss and the forces surrounding
him or her:
Boss’s goals and objectives.
How boss is rewarded.
Pressures on boss:
From his or her boss.
From the organization.
From the environment.
Boss’s power (capacity to mobilize resources).
Boss’s strengths, weaknesses, blind spots, and
hot buttons.
Boss’s managerial style—preferred degree of:
Control.
Information received and shared.
Formality.
Openness.
Work to make your boss’s life easier:
Aid in accomplishing boss’s goals.
Increase boss’s visibility and reputation.
Pick up tasks boss doesn’t like or isn’t good at.
Tie your requests/preferences to boss’s /organization’s goals; show how giving you what you want
will help achieve the goals.
Ask boss for evaluation of how you can perform
better:
If boss is uncomfortable, offer self-appraisal to
ease discussion.
Keep boss informed:
With frequency preferred by boss.
With level of detail preferred by boss.
In form preferred by boss:
Oral?
Brief reports?
Extensive reports?
Executive summary?
Work to demonstrate dependability; keep
your word.
Reward boss whenever he or she manages in way
you prefer:
Many bosses feel underappreciated.
Public praise increases boss’s reputation,
aiding obtaining of resources.
SOURCE: Based on J. J. Gabarro and J. P. Kotter, “Managing Your
Boss,” Harvard Business Review, January–February 1980; and Allan R.
Cohen, “How to Manage Your Boss,” Ms. Magazine, February 1981.
rencies they have to influence their instructors, ranging from nods of the head during a lecture to high levels of performance on papers or exams. The Managerial
Tools Chart above, shows a variety of currencies that are valued in organizations. Although many are not likely to fit your present circumstances, you might explore the
chart and possibly discover some influence currencies you do in fact possess and
never realized you have. Also, try using the Personal Application Exercise at the end
of the chapter.
Liking versus Respect
It is not uncommon for those who have power to be less well liked; as noted in the
group chapters, the group members who contribute most to getting tasks accomplished are usually most respected but seldom most liked. Informal task leaders often have to trade liking for respect; while occasionally someone can get both, most
often: The more a leader strives for popularity, the less effective he or she becomes
as task leader. Also, the more the leader strives to maintain task leadership, the more
he or she will lose popularity.23 Can you think of any conditions where these propositions would not be true? How important each factor is in comparison with the
other depends on the nature of the situation and the person involved in the leadership role. When a strong task leader brings a group through a very difficult situation,
popularity may soar, at least for awhile.
All leaders have to struggle with the question of how close they can be with their
followers. Can a leader also be a friend? If so, does this still allow him or her to push
them into working harder? Or, if the leader remains distant, will the followers still
feel the loyalty and commitment necessary to put forth sufficient effort?
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Falling Stars—Twilight of the Gods: CEO as American Icon Slips
into Down Cycle
“This whole drive toward empowerment,” says Pillsbury’s [CEO] Mr. Walsh, has meant that CEOs have to
cast off their big-shot image in order to communicate
with their troops. “You need to engage people on a
one-on-one basis and really work hard to make them
feel part of the enterprise,” he says. “Great ideas usually come from deep in the organization. They don’t
come from CEOs.”
SOURCE: Ellen Joan Pollock, The Wall Street Journal, January 5, 1999,
p. A1.
MANAGERIAL BULLETIN
Conflicting Demands on Politicians
It is a horrendously difficult mandate this—to remain in
the people’s eyes (1) a down-to-earth representative
who understands them because he is one of them and
(2) a leader to whom they can look up because he is
somehow well above the rest of the pack in knowledge,
mysteriously endowed with superior strengths and talents, a person who can be trusted to guard, to decide,
to lead . . . in short, I suppose, a parent.
SOURCE: Meg Greenfield, “The ‘Just Folks’ Pantomine,” Newsweek, October 10, 1994, p. 78.
For some situations and people, the task maintenance function must take priority over social maintenance; in other situations and for other individuals, the opposite might be true. The important thing to keep in mind is that there is more than
one option and that there may be some trade-offs in each.
But why does this dilemma occur? Why is it so difficult to mix these functions?
For one thing, not many people are really good at both; as a result, the task leader is
likely to be someone who has the best skills or abilities related to the task (as it
should be), and the social leader is often the most outgoing person in the group. If
that’s the case, then other group members tend to become dependent upon the task
leader and may even see him or her as superior to the rest of the group. While this
may generate respect for that individual, it also tends to breed resentment.
Furthermore, because people are social beings and usually have other interests in
addition to interest in working well—or will retreat into socializing when tasks become
unpleasant or might lead to conflict—task leaders occasionally have to refocus attention back to getting the task done. As a result, when the task leader pressures others
into working, they may feel grateful for the direction but also may feel resentful, annoyed, and resistant to the task.24 This sequence of events is not inevitable and may
be overcome when it leads to group success, but it occurs frequently enough to warrant particular attention. We have also found it to be characteristic of a great many
work groups in our classes. Does it apply to your own experience?
There is yet another problem. With a few exceptions, most people have the greatest difficulty being totally honest or giving directions to those to whom they feel
closest. When someone else is emotionally close, people feel the risk is great that the
relationship will be harmed by saying negative things or giving directions. Thus they
find themselves unable to ask much of close friends. A few people, however, find
that when they build close, supportive relationships, they can be both demanding
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MANAGERIAL BULLETIN
The Pentagon “Club” Closed Ranks to Shut Out Resor
Some defense officials sympathetic to Mr. Resor do
feel, however, that he contributed to his own troubles
by an unwillingness or inability to deal with the petty intrigues that are, after all, a cornerstone of any selfrespecting bureaucracy.
“There was no major conspiracy to undermine Stan;
it just happened, and he helped,” said one. “You
needed someone who could go to these little empires
that have been built up and say, ‘What are your priorities, what are the major issues, what are you doing?’
Stan just waited for people to come to him, and very
few did.”
A top defense official said in exasperation: “This is a
very tough place. There’s a lot of power; a lot of money
at stake. In comes Stanley Resor—a very decent gentleman, somewhat old-school, not a self-serving type in
any way.
“He was entirely wrong for the job.”
SOURCE: Bernard Weinraub, New York Times, March 18, 1979, copyright © 1979 by The New York Times Company. Reprinted by permission.
and caring—and be cared for and receive demands in return. This kind of openness
allows closeness with subordinates without harming productivity, but it requires
high skill and mutual commitment and probably only works where both boss and
subordinate have roughly equal expertise.
The Use and Abuse of Power
In general, it should be apparent by now that leadership can be an exciting opportunity to use power or influence for getting work done; but it can be abused. You
have undoubtedly known or heard about people in power primarily to serve their
own ends, and usually at the expense of others.
David McClelland distinguishes between personal power and socialized power, the
former referring to self-serving uses (or abuses) and the latter to uses that consider
the effects (usually benefits) on others.25 Sometimes it’s difficult to make a clear distinction between the two, especially when a leader claims to be acting for the benefit of others yet engages in behavior that reflects anything but the best of motives.
Any act by a person in power that pressures another person to behave in ways
that violate that person’s sense of personal worth is a form of manipulation. At best,
it’s insensitive; at worst, it’s a form of violence. Today’s organizations are paying increasing attention to these kinds of issues, including the specific problem of sexual
harassment in the workplace. Laws and policies are being developed, in part because
of pressures from the courts, that are designed to protect individuals from sexual harassment in their jobs. What was once looked on as harmless teasing has come to be
recognized as a humiliating abuse of power, unacceptable and unprofessional, as
well as illegal. How long it will take to educate organizational leaders and managers,
university professors, and the general public to understand such abuses and take action to prevent them remains to be seen. However, it is important for you—as a future manager and as someone who will possess power—to appreciate the ethical
burdens of your job and the kinds of actions you might be required to take in living
up to those ethics.
The Opportunity to Empower Others
In the coming years, the effectiveness of leaders/managers will be measured as much
by the performance of their subordinates as by their own performance. It will be
the job of the leader—of a team, a department, or a company—to empower others to
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Unmourned Departure
“[Departing chairman of Coopers & Lybrand, Eugene
Freedman] rubs a lot of people wrong,” . . . “He’s a very
aggressive person and very capable. But my guess is,
there’s no love for him.”
“He’s a legend in his own mind.”
According to partners and former partners, Mr.
Freedman gave himself big raises when profits flagged.
They say he lived in the grand manner befitting a movie
mogul, not the head of a public accounting firm, that he
sidelined rivals and surrounded himself with hordes of
minions. And they say Mr. Freedman used the power of
his office to suit his personal agenda and to punish
those who stood up to him.
SOURCE: Alison Leigh Cowan, “Unmourned Departure at Coopers,”
New York Times, January 17, 1994.
MANAGERIAL BULLETIN
Chainsaw!
He Anointed Himself America’s Best
CEO, but Al Dunlap Drove Sunbeam
into the Ground
Sunbeam investors knew that Dunlap’s arrival meant
that tough medicine would soon be administered. And
at precisely 9 A.M. on Monday, July 22, 1996, when
Dunlap marched into the penthouse boardroom at Sunbeam headquarters in Fort Lauderdale, the anxious
group of executives gathered around the table knew it,
too. Dunlap wasted no time on introductions. Like
George C. Scott in the movie Patton, he began by delivering a spellbinding, if sometimes disjointed monologue on himself and the company. “You guys are
responsible for the demise of Sunbeam!” Dunlap
roared, tossing his glasses onto the table. “I’m here to
tell you that things have changed. The old Sunbeam is
over today. It’s over!” . . .
The men gathered around the conference table
were stunned by Dunlap’s attack. “It was like a dog
barking at you for hours,” recalled Richard L. Boynton,
president of the household-products division. “He just
yelled, ranted, and raved. He was condescending, belligerent, and disrespectful.” . . .
Almost all his executives believed these goals were
impractical. Dunlap, however, refused to acknowledge
the near-impossibility of meeting them. Instead, he
began putting excruciating pressure on those who reported to him, who in turn passed that intimidation
down the line. People were told that either they met
their goals or another person would be found to do it
for them. Their livelihood hung on making numbers that
were not makeable.
In Dunlap’s presence, knees trembled and stomachs
churned. Underlings feared the torrential harangue that
Dunlap could unleash at any moment. At his worst, he
became viciously profane, even violent. Executives said
he would throw papers or furniture, bang his hands on
his desk, and shout so ferociously that a manager’s hair
would be blown back by the stream of air that rushed
from Dunlap’s mouth. “Hair spray day” became a code
phrase among execs, signifying a potential tantrum. . . .
“I have thousands of resumes from people who
would work here for free,” Dunlap would scream,
inches from his victim. “You are being paid to work
here, and you can become rich because I’ve given you
all these options. And you’re letting me down. I’m working hard for you on the Street, and you’re letting
me down.”
SOURCE: John A. Byrne, “Chainsaw!” Business Week, October 18,
1999, p. 128. (Copyright 1999 McGraw-Hill, Inc.)
perform at their best. Simple rewards and punishments won’t do the job, at least
over the long run; it will take efforts at employee involvement, shared purposes or
vision, and, in general, a spirit of collaboration heretofore known in few organizations. Even as you consider the situational options available to the leader, keep in
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mind that in most cases any choice that fails to empower others is likely to be a poor
one. Coercive approaches, while occasionally necessary and sometimes effective for
the short run, rarely sustain positive effects for the long run.
In the day of the knowledgeable workforce, when no single individual has a monopoly
on talent and answers, good subordinateship cannot consist only of constant agreement with the boss. Bosses cannot afford to send in the clones; they must create, value,
and work with strong individuals who have the knowledge the boss does not; and both
must learn to blend views rather than always fight to win or compromise away strength.
David Bradford and Allan Cohen
Power Up
KEY CONCEPTS FROM CHAPTER 11
1.
2.
3.
4.
5.
6.
Leadership is mostly situational, rather than determined by personality traits.
Leadership is an influence process with subordinates, peers, and colleagues. Even subordinates
are not totally without influence; thus, leadership is net influence.
Influence is an act or potential act that affects
the behavior of another person(s). Types of
influence:
a. Formal: prescribed by office or position.
b. Informal: based on expertise or charisma.
c. Legitimate: influencer seen by influenced as
having the right to do so.
d. Illegitimate: influencer seen by influenced
as not having the right to do so.
e. Types a and b can each combine with c or d
when examining influence.
People can be influenced through:
a. Compliance: fear of influencer.
b. Identification: attraction to influencer.
c. Internalization: belief in influencer’s beliefs.
Importance of employee commitment to:
a. The work itself.
b. The relationships with others.
c. The organization as a whole.
Power is the capacity to exert influence, to make
things happen.
7.
8.
9.
10.
11.
12.
13.
Power is based on:
a. Greater legitimacy.
b. Ability to enhance organization in relation
to key problems.
c. Doing new activities rather than routine.
d. Visibility, recognition.
e. Creating obligations through helpful acts.
f. Controlling rewards and punishments.
g. Reducing uncertainty.
The greater one’s power, the more one receives:
a. Communication.
b. Solicitous behavior.
c. Deference.
d. Self-esteem.
e. Close observation in new situations.
Powerlessness often leads to:
a. Overcontrol.
b. Petty tyranny.
c. Rule orientation and turf-mindedness.
Currencies of influence.
It is difficult for those with power to gain both
respect and liking:
a. Task orientation often breeds resentment.
b. Closeness to followers may constrain task
orientation.
The use and abuse of power.
Empowerment of others.
PERSONAL APPLICATION EXERCISE
Assessing Your Influence Currencies
As we pointed out in the chapter, you probably have more influence on others than
you realize. You may not fully appreciate the behavior—“currencies”—you can offer
that are valued by friends, family members, instructors, and others. The following
exercise is designed to help you assess your currencies and thereby develop a picture
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of the ways in which you influence others and how you might even increase that
influence.
We want you to start by identifying two people in each of three categories: (1)
friends, (2) family members, and (3) instructors. (Refer to the example below as a
guide.) Then list the currencies you can offer that are valued by both individuals in
each category and assign a value on a scale of 1 to 10 indicating the importance of
that currency to each person, with the higher numbers reflecting greater importance.
You should find similarities (closer numbers) and differences (numbers further
apart) between the individuals in a category, and you certainly should find some major differences in the currencies of the different categories. In the example, the numbers reflect a closer friendship with B than with A, because the currencies of “caring”
and “support” are more highly valued by B. In the family category, the currency that
counts more with the father than the mother is “success,” while the opposite is true
for the “dependency” currency. In the instructor example, “listening quietly” will
work better in accounting class than in organizational behavior (OB), while the opposite will be true for “offering opinions.”
If the example were you, can you see how your behavior could be different in the
different situations and in relation to the different individuals? This kind of diagnostic process could be a valuable way for you to strengthen your interpersonal
power. It could be especially useful in a work environment, where the career stakes
are high.
EXAMPLE
Friends
A
B
Family
Mother
Father
Instructors
Caring
Support
Feedback
Help
Knowledge of sports
Humor
5
5
6
8
2
10
8
10
6
6
9
7
Love
Pride
Dependency
Success
Doing chores
10
6
8
5
9
8
7
3
10
9
Listening
quietly
Asking
questions
Good work
Offering
opinions
Acctg.
OB
9
4
7
10
6
10
3
9
SUGGESTED READINGS
Agor, W. H. “The Logic of Intuition: How Top Executives
Make Important Decisions.” Organizational Dynamics,
Winter 1986, pp. 5–18.
Conger, J. A., and R. N. Kanungo. “The Empowerment
Process: Integrating Theory and Practice.” Academy of
Management Review, July 1988, p. 474.
Bass, B. M. Leadership and Performance Beyond Expectations. New York: Free Press, 1985.
Deaux, K. “Authority, Gender, Power, and Tokenism.”
Journal of Applied Behavioral Science, January–
February–March 1978, pp. 22–26.
Bateman, T. S., and S. Strasser. “A Longitudinal Analysis of
the Antecedents of Organizational Commitment.” Academy of Management Journal 27 (1984), pp. 95–112.
Bennis, W., and B. Nanus. Leaders: The Strategies for Taking Charge. New York: Harper & Row, 1985.
Caro, R. The Power Broker. New York: Alfred A. Knopf, 1974.
Cobb, A. T. “An Episodic Model of Power: Toward an Integration of Theory and Research.” Academy of Management Review, July 1984, pp. 482–93.
Conger, J. A. and R. N. Kanungo. “Toward a Behavioral
Theory of Charismatic Leadership in Organizational
Settings.” Academy of Management Review 12, no. 4
(1987), pp. 637–47.
Dobbins, G. H., and S. J. Platz. “Sex Differences in Leadership: How Real Are They?” Academy of Management
Review, January 1986, pp. 118–27.
Dumaine, Brian. “What the Leaders of Tomorrow See.” Fortune, July 3, 1989.
Farmer, Steven M.; John M. Maslyn; Donald B. Fedor; and
Jodi S. Goodman. “Putting Upward Influence Strategies
in Context.” Journal of Organizational Behavior, January
1997, pp. 17–42.
Fink, S. L. High Commitment Workplaces. Westport, CT:
Quorum Books, 1992.
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Gabarro, J. J., and J. P. Kotter. “Managing Your Boss.”
Harvard Business Review, January–February 1980,
pp. 97–100.
Pfeffer, J., and G. Salancik. “Who Gets Power and How
They Hold on to It.” Organizational Dynamics, Winter
1977.
Gault, Stanley; Linda J. Wachner; Mike H. Walsh; David W.
Johnson. “Leaders of Corporate Change.” Fortune, December 14, 1992.
Quinn, Robert E., and Gretchen M. Spreitzer. “The Road to
Empowerment: Seven Questions Every Leader Should
Consider.” Organizational Dynamics, Autumn 1997,
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Heller, T. “Changing Authority Patterns: A Cultural Perspective.” Academy of Management Review, July 1985,
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Howell, J. P., and P. W. Dorfman. “Leadership and Substitutes for Leadership among Professional and Nonprofessional Workers.” Journal of Applied Behavioral Science
22, no. 1 (1986), pp. 29–46.
Huey, John. “America’s Most Successful Merchant.” Fortune, September 23, 1991.
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Sayles, L. Leadership: What Effective Managers Do and
How They Do It. New York: McGraw-Hill, 1979.
. “Finding New Heroes for a New Era.” Fortune, January 25, 1993.
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the Manager: Muddle in the Middle.” Organizational Dynamics, Summer 1984, pp. 4–19.
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Stewart, Thomas. A. “Get with the New Power Game.” Fortune, January 13, 1997, pp. 58–62.
King, D., and B. Bass. Leadership, Power, and Influence.
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Liden, R. C., and T. R. Mitchell. “Ingratiatory Behaviors in Organizations Settings.” Academy of Management Review
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Malone, Thomas W. “Is Empowerment Just a Fad? Control,
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Deregulation and
Regulatory Backlash in
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Deregulation and
Regulatory Backlash
in Health Care
James C. Robinson
he traditional health care system, organized as a professional guild
and financed by indemnity insurance, has been irrevocably changed.
Once-complacent taxpayers and formerly paternalistic employers have
fought back against inflating costs and escalating premiums, choking
back the once massive flow of subsidies for inefficient physician practices, fragmented delivery systems, and cost-unconscious consumer demand. Communityrated insurance pools have fractured as self-interested and often self-insured
purchasers pursue better value for their health care dollar. Consumers are increasingly assertive as to their preferences and willingness to pay for particular
health benefits and medical interventions.
T
Three powerful and conflicting forces dominate the trajectory of the
health care system. The first and most fundamental is the continuing pressure
to adopt new technologies while moderating the economic burden on taxpayers,
employers, and consumers. New technologies derive from a broader accumulation of scientific and engineering knowledge, from advances in physics, pharmacology, and pathology that highlight opportunities for intervention in the
mechanisms of disease, trauma, recovery, and repair. These advances do not
remain under the exclusive purview of scientific or political elites but are communicated widely to the citizenry, generating strong demands for their immediate diffusion. However, this enthusiastic embrace of new clinical interventions
is not accompanied by a commensurate commitment on the part of the public to
pay for them. The increasing wealth of society permits ever-growing investments
in health care and it is to be assumed that expenditures will pace the overall
This article is based on my recently published book, The Corporate Practice of Medicine: Competition and
Innovation in Health Care. Research support for the book was obtained from the Robert Wood Johnson
Foundation and the Milbank Memorial Fund.
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growth in the economy. However, even the wealthiest of nations cannot continue on a trajectory that would devote 15, then 20, and then 25% of total
resources to health care. The limits on social willingness to pay manifest themselves in the taxpayer revolt, in labor market tradeoffs between wages and fringe
benefits, and in the tens of millions of citizens who lack even the most basic of
insurance coverage.
The second feature of the emerging health care system, which derives
from the first, is continued innovation in forms of organization, ownership,
contract, finance, and governance. Given the pressure to restrain inflation, large
rewards will accrue to those who pioneer cost-decreasing products and processes. Outpatient surgery, home health care, sub-acute facilities, nurse practitioners, inpatient hospitalist teams, practice profiling, drug formularies, case
managers for patients with chronic illness, and internet-enabled applications
of every description represent clinical innovations that attenuate rather than
accentuate the cost of health care (compared to what the traditional hospitalcentered, specialty-dominated, and indemnity-financed system would have
generated). Each product and process faces continued pressure towards evolution or extinction, but each exemplifies the process of organizational experimentation that has been unleashed by the transition to unmanaged competition
in health care.
The emerging corporate system of health care is better able to moderate cost
inflation than the traditional system of professional dominance and the only
partially implemented systems of utility regulation and managed competition.
The corporate health care system has adopted forms of organization, ownership,
and contracting from the most dynamic sectors of the larger economy and
applied them to the technology, culture, and institutions of medicine. Its foundations lie in the multi-specialty medical groups and health insurance plans that
redesign economic incentives and clinical practice at the grassroots level. Medical groups, IPAs, and physician-hospital organizations offer a balance of competition and cooperation that accommodates the social needs for efficiency,
adaptation, and innovation. Health plans have adjusted to the heterogeneity of
consumer demand by marketing multiple networks, methods of managing utilization, and benefit packages priced with multiple premiums, deductibles, and
coinsurance provisions. Product diversification is accompanied by geographic
expansion, as plans and providers reduce their dependence on any one region
and leverage skills gained in one local market into competitive advantages in
others. These multi-state, multi-product firms are consolidating through mergers
and acquisitions, leaving most metropolitan markets dominated by a small number of large organizations. Vertical disintegration also is the norm, permitting
health plans, medical groups and hospital systems to focus on those services they
perform best while coordinating with other services through contractual relationships. Innovation in organizational structures is accompanied by innovation
in contractual structures, as plans and providers experiment with new methods
of payment, medical management, and quality measurement.
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However, the long-term viability of an organizational system depends not
merely on its economic prowess, but on its compatibility with the social culture
and political institutions. In overturning so many traditional practices and expectations in such a short period, corporate health care has brought down upon
itself the wrath of the American populist heritage that distrusts big business
almost as much as it dislikes big government. The third fundamental feature of
the emerging system, therefore, is continued social discontent and political backlash. Legislatures, courts, attorneys general, and administrative agencies have
issued a flood of hostile legislation, litigation, and regulation. Some of these
impose beneficial supports for the corporate system, mandating grievance and
review, financial solvency, and quality monitoring mechanisms that enhance
accountability and legitimacy. Others, however, target the very engine of innovation, impeding or prohibiting new methods of payment, utilization management, benefit design, network contracting, capital financing, and organizational
affiliation.
Lessons of Utility Regulation and Deregulation
No nation has ever unleashed the forces of market competition and
corporate organization on its health care system. Insights are available from
the experiences of the transportation, communication, energy, and banking industries. For decades, these industries have been opened to competition and its
consequences. Despite differences in physical technology, geographic concentration, and consumer demand, the experiences of the utility industries under
partial and total deregulation have been broadly similar. There is now a substantial body of research from the airlines, trucking, railroad, banking, and
natural gas industries (as well as from telecommunications, electric power, and
cable television). While the experiences from these sectors do not precisely replicate that of health care, they can provide useful guideposts and standards of
comparison. Indeed, the utility industries are potentially more relevant to the
emerging health care system than the oft-cited experiences of health care in
other nations, which evolved in different cultural contexts and under different
political institutions.
The deregulation of the utility industries has been remarkable for the
breadth of the industries affected and the depth of the changes effected, but also
because it was so unanticipated. Scholars and industry observers have diverged
widely in their assessment of the economic desirability of regulation but converged in their assessment of its political durability. Liberals often interpreted
regulation as an efficiency-enhancing response to market failure and as an
equity-enhancing means of subsidizing the poor. Conservatives often denounced
utility commissions as captured by the regulated industries, and hence as conducive to inefficiency and inequity, but by this very token despaired of mobilizing a political constituency for change, since the beneficiaries of regulation
are concentrated and committed while the losers are dispersed and apathetic.
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However, over the course of the 1960s and 1970s, during the era of its apparent
invincibility, utility regulation was subjected to a sustained critique from both
the left and the right that created an intellectual quasi-consensus and prepared
the way for sweeping change in the following decades.
The new consensus, shared in diverse ways by consumer activists and
Nobel laureates, by Democrats and Republicans, is that utility regulation exacerbates rather than attenuates economic inefficiencies and social inequities.
The inefficiencies stem from incentive distortions induced by particular rules
and from the general climate of a protected, non-competitive industry. Regulatory pathologies were identified in the airline industry, where price floors stimulated cost-increasing competition through amenities and flight frequency;1 in the
electric power industry, where rate-of-return limits induced a substitution of
capital for labor and the construction of overly large generating facilities;2 in the
railroad industry, where restrictions on track abandonment led to excess capacity, under-maintenance, and demands for public subsidy;3 in the banking industry, where constraints on product and market diversification limited the number
and type of financial instruments and protected inefficient and poorly managed
firms;4 and in the natural gas industry, where uniform rates prevented conservation-enhancing seasonal and time-of-day pricing.5 Barriers to market entry,
product diversification, and corporate mergers protected incumbent firms
against the rigors of competition, fostered managerial slack, financed abovemarket wages, and discouraged innovation in methods of production, supply,
and marketing. The distributional impact of regulation derives from its attentiveness to mobilized political constituencies and its insulation from the larger but
less vocal majority. Simplistic theories of agency capture by regulated industries
failed to acknowledge the full complexity of regulatory politics, in which consumer groups, legislators, and litigators all play important roles, but did succeed
in dispelling even more simplistic interpretations of regulation as a means to tax
the rich and help the poor.6 The greatest defenders of continued regulation often
have been not the disenfranchised but the regulated firms themselves, backed by
their investors, bankers, labor unions, executives, and employees.
Deregulation is not a one-time event but a process that unfolds in different ways across industries and geographic markets. It generates instability and
stress, and it is threatened continually by political reaction and re-regulation.
Based on the industry experiences and research evidence to date, four basic
impacts can be identified.7 First, deregulation in the utility industries has stimulated productivity and performance, with significant reductions in cost and
improvements in service. Second, it has led to differentiation among product
features and prices depending on the purchaser, the geographic market, the season, and other characteristics of supply and demand. Third, the relaxation of
restrictions on new entry has led to dramatic changes in market structures, organizational forms, distribution networks, and methods of purchasing. Finally, deregulation has engendered countervailing pressures to slow the pace and reverse
the direction of change, to dampen the instability and impede the innovation, to
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cushion the blow to previously favored constituencies, and in some cases to
re-regulate in whole or in part the behavior of the industry.
Utility Deregulation: Cost and Quality
The most visible impact of deregulation has been to lower prices and
improve service to consumers.8 After adjusting for economy-wide inflation,
deregulation has reduced fares per mile traveled by 33% for airlines, 35% for
less-than-truckload freight, 75% for full-truckload shipping, and 50% for railroads. Natural gas prices have fallen 30% for both residential and industrial
users. Service frequency has increased substantially in air transportation, due
to lower fares and higher demand; service times have declined substantially for
less-than-truckload and full-truckload shipping; both the mean and standard
deviation of railroad transit times have fallen by approximately 20%; banking
is more convenient due to longer hours, automatic tellers, no restrictions on
branching; and natural gas service is more reliable as shortages have been
eliminated.
Higher value to the consumer has derived from improved industry productivity, capacity utilization, and network configurations and from a virtuous
cycle of lower costs, lower prices, increased demand, and further reductions in
costs. The hub-and-spoke route configuration developed by the deregulated
airline industry has raised rates of seat occupancy from 52% to 62% and thereby
lowered costs per mile flown by 25%. Price wars have driven down air fares,
dramatically increased business and leisure air travel, and permitted ever more
frequent flights.9 The trucking industry has increased the percentage of full
truckloads and reduced the number of empty return miles, thereby permitting
price reductions that have attracted additional business from non-trucking firms
that previously shipped on their own vehicles to avoid the costs of trucking regulation. Railroads have abandoned approximately one-third of their trackage,
reduced operating costs, improved profitability, and thereby escaped from the
regulation-induced death spiral of mandated excess capacity, high operating
costs, high prices, declining demand, and need for ever-greater subsidy. Banks
have lowered their operating costs through extended electronic and branch
banking, raised interest rates above regulatory ceilings, and developed new
financial products that better balance risk and return. Natural gas firms have
restructured their transmission and distribution networks and improved pipeline capacity utilization, reducing overall operating and maintenance expenses
by 35%.
Utility Deregulation: Price and Product Differentiation
A common characteristic of utility regulation was uniformity in products and prices in the face of great variability in consumer preferences and
the actual costs of providing service. This one-size-fits-all approach led to services that were of excessive cost for some consumers and insufficient quality for
others, impeded the use of price flexibility to enhance capacity utilization, and
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juxtaposed overcapacity and low load factors in some industries with undercapacity and shortages elsewhere. It generated cross-subsidies from consumers
for whom the cost of service was low to consumers for whom the cost of service
was high. Shippers on heavily traveled routes subsidized shippers on remote
routes and long distance telephone users subsidized local callers.
Deregulation has spurred an outpouring of new services that incur different costs and impose different prices, permitting a better match between supply
and demand. Air travelers can obtain substantial discounts if they purchase tickets in advance and stay for the weekend, but must pay the full cost of standby
capacity if they want to delay their decisions to the last minute. Shippers can
obtain low rates if they allow their freight to be combined with others’ and be
routed over less direct but more heavily traveled corridors, or they can choose to
pay the full cost of less-than-truckload delivery. The increased variability in price
and service results in part from the deregulation of contracting between buyers
and sellers. Rail and road regulation, for example, often prohibited shippers from
negotiating with transporters for volume discounts, flexibility factors, multimarket or multiyear agreements, or other variations from uniform price and
service standards. Now half of rail freight moves at specially contracted rates,
allowing better track utilization for the railroads and better coordination of production, inventory, and distribution for the shippers. Deregulation permits the
contractual flexibility that allows buyers and sellers to explore potential gains
from new electronic and Internet technologies, thereby accelerating the adoption and diffusion of innovation.
Utility Deregulation: Market and Organizational Structures
Deregulation stimulates competitive entry into previously protected
industries and local markets. Startups challenged the most prominent firms
in airlines, trucking, electric power, and telecommunications and even have
appeared in specialized niches of the railroad industry. After an initial turbulent
phase, however, deregulated industries undergo a process of concentration
through merger, acquisition, market exit, and bankruptcy. Airlines, railroad, and
banking firms are almost all larger now than prior to deregulation, and there has
been a similar wave of consolidation in the electric power and telecommunications sectors. Deregulation has spurred exit from particular product and geographic markets as firms have pulled out, sold out, or gone under in the face
of new entry. Much of this was overdue, since regulation protected incumbents
from more efficient and innovative outsiders. Large scale is not incompatible
with the most intense competition, as much growth has occurred through
product and market diversification.
Some firms have grown by developing broader networks that better fit
the needs and preferences of customers. Airlines have thickened their regional
nets by servicing more communities around their hubs and have developed joint
venture and contractual arrangements to service global demand. Railroads have
merged end-to-end to more efficiently link ports to mines to manufacturing
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centers, and have purchased or contracted with maritime shipping firms and
trucking companies to offer intermodal transport services. Many mergers and
acquisitions are designed to penetrate new geographic markets, as in branch
banking and local service telecommunications, or to penetrate new product
markets, as in linkages between commercial banks and investment banks. Substitution stimulates rivalry for traditional services and their producers. Mutual
funds, corporate lenders, life insurers, and other financial intermediaries now
compete with savings and loan institutions for deposits. Of course some consolidation is designed to reduce rather than increase competition. While end-to-end
mergers increase rivalry in the railroad industry, parallel mergers decrease it.
Airlines dominant at particular hubs can exploit the shortage in airport capacity
to exclude rivals and raise rates. All in all, however, the utility industries have
become increasingly competitive as the deregulatory process has unfolded, even
in what were formerly considered natural monopolies such as electric power
and telecommunications. The strategy of full service diversification—driven by
the heterogeneity of preferences, technology, and geography—leads to the creation of large firms competing fiercely across many products and many markets.
Utility Deregulation: Political Backlash
Deregulation has exerted a major impact on the political climate of the
utility industries, in some cases stimulating a backlash that finds sympathetic
ears in legislatures and the courts. Formerly subsidized consumers deplore market-level price and quality. Airline pilots, unionized teamsters, stock brokers
charging fixed commissions, employees of power companies with cost-plus rate
structures, and domestic crews on American flagships all have experienced the
reduction in industry costs as a reduction in personal incomes. Consumers as a
whole are winners, with more choices, better service, and lower prices, but significant subgroups find themselves to be losers. Everyone appreciates price
decreases and quality increases in services where regulation offered neither subsidy nor shelter. They lament, however, similar effects in industries where they
were protected and pampered.
The consumer and producer backlash against utility deregulation has
found sympathetic ears in Congress, state legislatures, and executive agencies
due to the structure of political incentives and institutions. Legislators look not
to the aggregate social impacts of deregulation but to the costs and benefits
accruing to their local constituents. They seek to slow, stop, and reverse adverse
impacts, such as the abandonment of little-used railroad trackage, competitive
threats to hometown truckers, and the transfer of jobs to distant communities.
Elected politicians and appointed administrators are concerned with short-run
rather than long-run effects and are uncomfortable with the instability created
as deregulation opens long-protected industries to entry and innovation. All
three branches of government are under continual pressure to do no direct
harm, to minimize adverse impacts on the visible and vocal at the expense of
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the invisible and inarticulate, thereby upholding perceived standards of due
process while rewarding politically powerful interests.
The process of deregulation has generated considerable friction, but
almost without exception it has not been reversed. Indeed, the deregulatory
process has spread to previously untouched industries and previously unconvinced nations, as local phone service sees the first glimmerings of competition,
global maritime and airline regulations are loosened, and European nations reexamine their telecommunications and transportation policies. Over time, moreover, deregulation creates a constituency in its own support, as producers,
consumers, and communities advantaged by the changes mobilize against reregulatory initiatives. Nevertheless, the process is fragile and always endangered.
Utility deregulation depends on the political as well as the economic marketplace, on the temporal and geographic incidence of costs and benefits, on the
comparative salience of winners and losers, and on the likelihood that political
entrepreneurs will find in the turbulence of change the opportunity to pursue
other agendas.
Comparing Health Care to the Utility Industries
No exact analogies can be drawn between the changes sweeping through
health care and the revolutionary transformations spurred by deregulation in
the transportation, communication, energy, and finance industries. Health care
was never subjected in such an explicit and comprehensive fashion to the dictates of a utility commission. However, the performance of the traditional health
care system so closely resembled a regulated utility, and health care competition
has affected performance in ways so similar to utility deregulation, that significant commonalities must be acknowledged and important lessons can be
learned. Many states experimented with price controls covering a subset of
insurers, and all imposed certificate-of-need entry barriers for at least some services and facilities and a few states imposed rate regulations affecting all hospital
patients. The Medicare program imposed a uniform administered pricing system
for its patients on the nation’s hospitals, and many states imposed Medicaid payment rates that were based on budgetary politics rather than an analysis of the
cost of care.
Economic theory looks to market failure and income redistribution to
explain the pattern of regulation and deregulation across industries. The most
commonly cited market failures include natural monopoly (which can lead to
excess profits and distortion of resource allocation) and imperfect information
(which can expose consumers to exploitation by better-informed producers).
Distributional motives include the efforts by producer or consumer groups to
convince legislators and regulators to impose taxes, rules, or other mechanisms
that generate special benefits for special interests. Health care includes rural
communities too small to support more than one hospital or a few physicians,
but the mainstream of the system is structurally so competitive and has so
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many providers that it is implausible that public policy can be an efficiencyenhancing response to natural monopoly. Imperfect information is a more
important feature of health care and one to which has been attributed most of
the system’s unusual organizational and normative characteristics.10 It is difficult
to believe, however, that the asymmetry of health care information between
consumers and producers has changed in an exogenous fashion over the past
three decades and thereby spurred the tumultuous changes in ownership,
finance, and payment mechanisms. The amount of health care information possessed by consumers is likely to be the result rather than the cause of changes in
the economic and political environment. It therefore is most enlightening to
examine distributional motives, cross-subsidies, and the creation of rents as the
underlying source of similarity between the processes of regulation and deregulation in health care and the utility industries.11
Many of the traditional institutional and normative features of health
care served to restrict entry, comparison-shopping, price competition, and other
features of a deregulated industry.12 Professional licensure, judicial acquiescence
in physician boycotts of prepaid group practice, and exemption from antitrust
statutes created economic rents for physicians that could be spent providing
charity care for the indigent or by enjoying a more generous personal lifestyle.
State “corporate practice of medicine” statutes outlawed the creation of vertically integrated delivery systems that would employ physicians to provide services on a salaried basis. “Any willing provider” statutes prevented insurance
companies from negotiating volume discounts with subsets of physicians, pharmacies, or other provider entities. Community-rating regulations limited the
ability of insurers to offer low premiums to healthy subscribers, thereby increasing revenues potentially available for subsidizing premiums for unhealthy subscribers. Hospital rate regulation programs directly imitated utility commission
pricing policies, imposing price floors as well as ceilings to generate the operating
surpluses necessary to subsidize charity patients. Certificate of need regulations
limited entry and dampened the non-price competition that would dissipate
operating surpluses. A particularly important feature of the health care industry,
less prevalent in the utility sector, is the moral hazard generated by widespread
insurance. Indemnity and Blue Cross insurance buffered consumers from the
cost consequences of the physicians’ decisions and thereby fueled an openended demand for quality-improving and service-enhancing new technologies
and process of care. Certificate of need and rate regulation in the hospital industry was consciously designed to moderate the inflationary aspects of this “medical arms race,” in a manner analogous to that of the Civil Aeronautics Board in
its campaign against amenity competition and low load factors in the airlines
industry. Some of the competition-limiting features of the health care system
were designed in part to effect the spreading of insurance risk and subsidy of
the ill through indirect means, as an alternative to creation of a national health
insurance system analogous to those in European nations. Here again the health
care system bears comparison to the utility and transportation industries, which
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were put under regulatory tutelage during the New Deal era in part to forestall
demands for nationalization on the then-prevalent European model.
Most economic discussions of the politics of deregulation focus on the
tendency for the cross-subsidies underlying utility regulation to grow over time
and to become ever more complex and unpredictable in incidence. These
changes gradually undermine the political support for the regulation, creating
new coalitions that eventually accumulate sufficient power to partially or completely remove the regulatory edifice.13 The accelerating medical care inflation
of the 1970s and 1980s spurred the principal purchasers of health care, including private employers, state Medicaid agencies, and the federal Medicare program, to attack the institutional barriers to competition in health care. The
removal of the antitrust exemption, abandonment of most Certificate of Need
and hospital rate-setting programs, and removal of limits on price-based negotiations between insurers and providers embody experiments in moving the
health care system towards a more competitive market. The phenomenon
known as managed care—comprising various combinations of volume purchasing (“selective contracting”), prepayment (“capitation”), monitoring and oversight (“utilization management”), creation of preferred provider panels, and
other mechanisms—attempts to limit moral hazard and stimulate cost-conscious
decision making.
Health Care: Cost and Quality
Market competition and corporate organization have demonstrated a
remarkable ability to moderate the inflationary trajectory.14 The development
of medical groups, health care systems, multi-product insurers, capitation contracting, and utilization management during the 1990s held the growth in
health care costs to the lowest levels in 50 years, confounding the skeptics and
contributing to the strong economic performance of the decade. It is difficult to
ascertain the influence of corporate organization on health care quality, due to
the inherent difficulties in measuring outcomes and to the lack of pre-existing
baselines for comparison. The overall quality of care is improving, but this is due
primarily to longer trends in laboratory research, physician training, and technology diffusion than to recent changes in markets and organization. The record
on customer service is decidedly mixed. Cost pressures have led to a shortening
of physician visits and oversight of utilization patterns that patients resent, while
the new emphasis on satisfaction surveys and enhancement has induced providers to offer longer office hours, 24-hour telephone advice, and other consumer
conveniences.
The short-term success against health care cost inflation does not imply
that the long-term battle for stable expenditures has been won. On the contrary,
America is poised to enjoy the clinical benefits but rues the budgetary implications of an outpouring of new drugs, devices, tests, and treatments that prevent
infection, dispel uncertainty, enhance functional ability, and generally contribute
to a healthier and more long-lived citizenry. This technological dynamic opens
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diagnostic and therapeutic opportunities that are hard to ignore, but it is less
important perhaps than the revolution of rising expectations. It is clear that as
the population gets healthier, it demands more—not less—from its medical care
system. We embrace treatments for old ailments that once were merely suffered,
from childhood viruses and rashes through migraine headaches and springtime
allergies to the impotence and arthritis of our golden years. We open our hearts
and our wallets to medical breakthroughs that benefit victims of the great
scourges of our time, from childhood cancer through AIDS to Alzheimer’s. We
take gains in longevity for granted, expect that full physical, social, and intellectual functioning will continue to the now more distant end, and insist that
these advances are for all to share.
The corporate system of health care does not seek to stop the development of quality-increasing technology or to quell the revolution of consumer
expectations, both of which inevitably accompany the growing wealth of society.
It does, however, create significant changes in economic incentives and organizational structures that will temper the rate of inflation and enhance the overall
value of health care services in a manner analogous to the gains in efficiency
and quality in the deregulated utility industries. Four dimensions are particularly
worthy of note.
The shift from the professional guild to integrated organization, from
indemnity insurance to managed care, and from non-price rivalry to price competition creates strong economic rewards for the diffusion of cost-decreasing
clinical innovations. The medical arms race rewarded the development of technologies that raised quality—real or perceived—but not ones that reduced costs.
Now firms and individuals at every point along the health care value chain—
from bench scientists to clinical researchers, pharmaceutical manufacturers,
hospital managers, multi-specialty medical groups, single-specialty networks,
and primary care physicians—can increase their status and income if they discover, develop, or adopt interventions that reduce the overall expense of care.
The corporate system is rapidly restoring the normal economic relationship between supply and demand, between market disequilibrium and price
changes in health care. The United States has inherited an excess supply of acute
care hospitals and physician specialists, analogous to the excess capacity generated by entry and exit regulation in many utility industries. In the now-passing
system of guild organization and indemnity insurance, excess capacity stimulated cost-increasing non-price competition analogous to that experienced by
the rate-regulated airline industry. Health services researchers delighted in discovering ever-new economic pathologies, from Roemer’s Law that a built bed is
a filled bed, to the medical arms race of duplicative clinical technology, to supplier-induced demand in response to physician fee reductions. Henceforth, facilities and services that are in excess supply will receive lower, rather than higher,
prices than otherwise comparable facilities and services that enjoy excess
demand. The painful recalibration of relative incomes within the profession
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and across the industry will continue, redirecting investments and career choices
towards areas of need rather than areas of excess.
The original demand placed on the corporate system by public and private
purchasers was to reduce the cost of care, not to improve quality and service,
and the system responded accordingly. The greatest emphasis in the early years
has been on methods of payment, network contracting, utilization management,
benefit design, and organizational structure that promise to restrain the inflationary spiral. Considerable success has been achieved in this endeavor. However, the distinctly American question remains: What have you done for me
lately? Patients are worried lest the emphasis on cost control reduce the quality
of the care they receive. Consumers are annoyed with every obstacle to obtaining what they want when they want it. The corporate system is shifting its
emphasis to developing methods for measuring and improving service, in a
manner analogous to the process pursued in the utility industries after deregulation. For the first time, the health care industry is being subjected to systematic
monitoring of quality and service levels, with the intent of promoting clinical
comparisons and quality-conscious consumer choice. The road to be traveled
in a difficult one, since almost all the monitoring tools need to be invented. A
salient feature of the professional guild was reliance on unmonitored trust and
opposition to quantitative, validated measures of performance. Purchasers,
plans, and provider organizations now experiment with satisfaction surveys,
indicators of preventive services utilization, tracers for appropriate clinical
processes, and risk-adjusted measures of patient outcomes. The new monitoring
mechanisms hold great potential to enhance as well as simply measure the quality of care, since statistical and epidemiological methods always outperform badapple approaches to quality improvement.
Deregulation has not universally improved quality and service in the utility industries. We all bemoan the paucity of empty seats on the airlines or the
ubiquity of small fees for banking services that once were offered free. Some
forms of regulation imposed a uniformly high-cost, high-quality style of service
by forbidding firms from developing economy options. Without the ability to
attract customers through lower prices, airlines added flights that they knew
would be half-empty and financial institutions offered white-glove service to
those customers who could come in during bankers’ hours. Deregulation in
these contexts led initially to a reduction in service as a byproduct of an even
greater reduction in price. However, the value offered to the customer, defined
as including both service and price, increased. Most of us are willing to put up
with strangers in adjacent seats in order to obtain economy fares and, for those
who are not, the airlines offer business class service. Similarly, the corporate
system of health care will experiment with different combinations of price and
service to find the mix that offers best value in the mind of the consumer. There
are tradeoffs to be made between broad and narrow provider networks, stringent and loose utilization management, thick and thin benefit coverage, high
deductible and first dollar cost sharing, and, of course, between connoisseur
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class and economy prices. The tradeoffs are more controversial in health care
than in the utility industries since the benefits of gold card service accrue to the
patient while the benefits of low cost often accrue to the employer or taxpayer.
Health Care: Price and Product Differentiation
Generations of reformers have sought to overcome the variability in
health care demand and supply through uniform benefits, premiums, and prices
that do not vary according to incomes, preferences, health, location, employment, or other characteristics of consumers and producers. In the absence of
strong governmental controls, however, the heterogeneity among consumers
(in what they are willing to buy) and among providers (in what they are willing
to sell) is driving price and product differentiation in health care. Benefit coverage and network design, premiums and prices, and method of marketing and
distribution now are highly variegated and promise to become ever more so.
The defeat of President Clinton’s Health Security Act spelled the demise
of the uniform benefit package as the foundation of health care policy in the
United States. Simply put, those who currently enjoy rich benefits and low premiums—due to good subsidies, good health, or good luck—are unwilling to sacrifice so that the less endowed, less healthy, or less fortunate can come up to
their level. A uniform benefit package sufficiently rich to be politically acceptable to the quality-conscious voter would be economically unacceptable to the
cost-conscious taxpayer. The unstandardized marketplace is responding to the
diversity in incomes and preferences though a wide variety of benefit packages,
cost-sharing provisions, network configurations, and methods of utilization
management. Self-employed individuals and small firms now can shop from a
menu of options—with inclusion, exclusion, or partial coverage for prescription
drugs, mental health services, rehabilitation therapy, and complementary medicine; with different levels of cost sharing; and with combinations of deductibles
and co-payments for particular services. Large public and private purchasers
demand idiosyncratic benefit configurations, reminding the health plans and
providers that he who pays the piper calls the tune. Network designs are proliferating at an equally astonishing rate, mixing and matching PPO and HMO
components, gatekeepers and self-referral, prior authorization and retrospective
profiling, out-of-network wraparounds and out-of-area expansions. The threeletter acronyms that once anchored our understanding of health insurance alternatives are rapidly becoming untethered as the industry crafts hybrid strains in
a dizzying display of product-engineering.
Premiums and prices have lost whatever uniformity they once possessed,
with community-rating and standard methods of capitation and fee-for-service
being swept aside by the market imperative to vary prices according to underlying variations in costs. Consumers choosing rich benefit packages, loose network
designs, and patrician physician practices find themselves paying substantially
more than those content with thinner benefits, more tightly managed access,
and community-based practitioners. Public and private sponsors are continuing
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their slow and painful transition from defined benefits to defined contributions,
paying a fixed dollar amount rather than encouraging costly choices through
higher subsidies. In a competitive market each product must be priced to be
self-supporting, since cross-subsidies invite new entry that appeals to the overcharged customers. The diverse options in benefit and network design are
reflected in actuarially sound, and hence diverse, price levels. Insurance premiums and provider payments will increasingly reflect the health status and cost
of care required by the individual enrollee and patient. Risk-adjusted prices are
desirable since they remove incentives to cherry-pick the healthy and avoid the
ill. They are essential for the continued economic viability of safety-net providers
who attract the sickest patients due to their geographic location or open-door
policy. In the absence of risk-adjusted subsidies, market competition will shift
the economic burden of illness onto the ill while allowing the healthy to pay for
only their modest medical needs. The United States currently maintains a tattered fabric of risk-adjusted subsidies, with employer-paid benefits, government
entitlement programs, and the health insurance tax deduction allocating greater
sums for sick than for healthy citizens. However, the system has many loopholes
and exceptions. Competitive markets and corporate organizations in health care
would benefit from a well-designed and well-financed system of risk subsidies,
since this would eliminate the pressure to deny coverage and would convert
charity cases into paying customers. However, steps in this direction are difficult
since they would violate the ban on new taxes, which is one manifestation of
the “do no direct harm” principle in contemporary politics.
The marketing of health care is increasingly differentiated and methods
of branding, distributing, and selling are becoming key competitive skills for
health plans and provider organizations. It is increasingly hard to imagine that
all Americans one day will pick up their health insurance at the local Social
Security office or be channeled through a uniform open enrollment process.
Consumers obtain their information and options through insurance brokers
and websites, private and public employers, state insurance pools and Medicaid
agencies, federal Medicare and military programs, and myriad other options. The
industry is pioneering ever-new ways of connecting buyers and sellers, including
print and electronic media, direct mail and the Internet, community organizations and consumer cooperatives. Through it all, the American consumer reigns
sovereign over a complete menu of choices, chaos of opportunities, and cacophony of salesmen promising a product as unique as the individual and as affordable as the alternative.
Health Care: Market and Organizational Structures
We are witnessing massive changes in the structure of health care
markets and organizations. Many of today’s most prominent organizational
forms, such as Independent Practice Associations and physician-hospital organizations, were difficult to find 20 years ago.15 Multi-specialty medical groups have
a long and illustrious history in some communities but have been thoroughly
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transformed by the marketplace shift towards managed care. Preferred provider
insurance has displaced indemnity and the network HMOs have displaced their
staff model progenitors only in the recent decade. Forms of contracting are in
a state of ferment, with payment methods that borrow from both capitation
and fee-for-service and methods of utilization management that compromise
between arm’s-length review and full delegation. Organizations are becoming
larger and more complex through merger, acquisition, and product diversification. However, increased scale is stimulating competition rather than cartels,
as local barriers fail to impede entry by multi-product, multi-market firms.
The most visible feature of the corporate system of health care is ceaseless
acquisition and divestiture, integration and outsourcing, and combination and
recombination. Medical groups, hospital systems, and health plans are coming
together and then coming apart, substituting contract for joint ownership, creating diversified conglomerates and refocused facilities, and experimenting with
ever new structures of ownership, finance, governance, and management. After
decades in which medicine was frozen into a cottage industry of solo physician
practices, freestanding community hospitals, and single-state Blue Cross insurers, incumbents and upstarts are pushing boundaries in ways once not merely
infeasible but unthinkable. They are exploring potential economies of scale, the
advantages offered by large size in insurance risk bearing, administrative efficiencies, and vendor contracting as well as the diseconomies that accompany the
attenuation of individual incentives and accentuation of influence politics. Firms
are exploring the economies and diseconomies of scope, the tradeoffs between
conglomerate versus staff-and-line organization, broad-spectrum versus niche
positioning, transfer versus market pricing, diversification versus product focus,
coordination versus clinical specialization. They seek some middle ground
between the extremes of vertical integration and spot contracting, some balance
of coordinated and autonomous adaptation in the face of ever-new challenges.
This process of trial and error is generating a diversity rather than uniformity of organizations and contracts. The heterogeneity of regional providers and
purchasers, technologies and transactions, economics and demographics, popular cultures and political institutions supports an enduring variety in the health
care marketplace. There are striking cross-market and within-market differences
in methods of payment, medical management, data reporting, and quality
accountability. Some physician communities are characterized by multi-specialty
medical groups, others by more loosely structured IPAs, and others by a continuing Diaspora of unaffiliated practices. For-profit hospital chains hold a strong
position in some communities, while others are dominated by large nonprofit
systems and the remainder cling to hometown facilities. Different regions favor
different mixes of HMO, PPO, and hybrid insurance products. This heterogeneity
stems both from enduring regional characteristics and from transient differences
in each community’s place on the health care learning curve, as experiments
that succeed in one locality are copied in others.
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Medical groups, hospital systems, and health plans want to avoid the
rigors of competition by acquiring or merging with their rivals, seeking oligopoly
and ultimately monopoly power to dictate prices and protect profits. However,
accomplishment seems ever to lag behind aspiration, as purchasers, suppliers,
substitute services, and entrepreneurial outsiders compete for their share of
those potential monopoly profits. The organizational diversification of health
plans and providers has created a ravenous crowd of well-financed and battlehardened competitors able to jump into new products and new markets when
revenue opportunities arise. Entry barriers are lower, not higher, than in the
bygone era when the professional guild boycotted group practices, fixed prices,
restricted advertising, enforced any-willing-provider laws, and banned the corporate practice of medicine. The cottage industry structure of yesteryear lent
itself well to the most thoroughgoing anti-competitive practices, while the large
corporate organizations, consolidated industry structures, and complex contractual relationships of today lend themselves to the most vigorous competition
ever observed in health care.
Health Care: Political Backlash
The political backlash against competitive markets and corporate organization in health care has far exceeded the reaction against deregulation in the
utility industries. The success against cost inflation has produced large savings
for employers and governmental programs but little visible benefit to individual
employees and taxpayers. Had the rate of inflation that prevailed in the five
years prior to the defeat the President Clinton’s Health Security Act continued
for the five years following that landmark event, health care costs and premiums
at the end of the decade would have been twice their actual levels, creating dire
personal hardships, acrimonious tax politics, and contentious labor relations.
However, the transition to a market-driven health care system coincided with
an acceleration of trends away from paternalistic employment policies and welfare state politics. Many employees experienced the decline in overall premiums
as an increase in their paycheck deductions and compared unfavorably the network restrictions and utilization oversight of managed care with the halcyon
days of first dollar indemnity insurance.
Consumer concerns have been accompanied and encouraged by a producer backlash against the changing market and organizational structures in
health care. Hospital employees and their labor unions are dismayed to note
the shift in jobs from unionized inpatient settings to often nonunion ambulatory,
sub-acute, and home health settings. Medical specialists resent the tilt in status
and income towards primary care. Physician earnings have continued to rise,
but at a slower pace and in a much more uneven pattern than in the era of costunconscious consumer demand. Medical groups and hospital systems impose a
degree of administrative oversight, peer review, and public accountability that
feels foreign and uncomfortable to clinical miracle-workers. Caregivers resent
the budgetary constraints necessary for financial solvency as unwarranted
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incursions on their clinical autonomy. Specialty societies, labor unions, device
manufacturers, and all the other constituents of the medical-industrial complex
have mobilized in defense of their economic self-interest, naturally explaining
their behavior as a defense of patient rights and the quality of care.
The number and variety of new laws and regulations concerning the
corporate health care system is remarkable. While debate over the federal legislation (including imposition of liability on insurance plans and exemption of
physicians from antitrust law) has gained the greatest attention, most of the
activity has been at the state level. In the 1999-2000 legislative session, over
10,000 pieces of health care legislation were introduced at the state level.16 For
example, 38 states imposed timelines on claims payment, 31 mandatory disclosure of pharmacy formularies, 27 banned various payment incentives for physicians, 21 required insurers to include “any willing provider” in their contractual
networks, 19 mandated “point of service” options on HMO products, 7 imposed
new tort liability on insurers, and one exempted physicians from state antitrust
statutes. The numbers rise rapidly when bills are counted that did not reach the
governor’s desk, including 21 state bills to exempt physicians from antitrust law
and 32 state bills to increase insurer tort liability. Needless to say, measures of
regulatory backlash that include regulations in addition to new statutes would
be substantially larger.
Social Benefits of Partial Re-Regulation
Market economies need well-conceived and well-implemented political
institutions just as much as democratic polities need vibrant economic markets.
Utility commissions and statutory compulsions were not replaced by laissez faire
in the transportation, communications, and finance industries but by a mix of
disclosure mandates, safety standards, financial reserve requirements, and other
safeguards that protect the public interest with a hand somewhat less visible
than before. By analogy, some mechanism of oversight and accountability are
beneficial and indeed essential for the corporate system of health care.
A salient characteristic of medicine is the clinical uncertainty of each individual’s diagnosis and appropriate treatment. It is essential that administratively
efficient and socially acceptable mechanisms be developed for reviewing, adjudicating, and appealing differences concerning benefit coverage, experimental
treatment, and medical necessity. These mechanisms must be not only sufficiently close to the clinical interface to produce informed and timely outcomes,
but sufficiently independent to claim a broader legitimacy. The system will need
to grope to some workable mix of mediation, arbitration, and litigation to
resolve differences in what is an inherently stressful and complex decisionmaking arena.
Health insurance involves the collecting of premiums and subsequent
paying of claims in a manner that invariably raises the possibility of overextension and insolvency. State insurance departments traditionally regulated
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indemnity, Blue Cross, and HMO carriers but have been outstripped by the geographic expansion, product diversification, and capitation contracting of the
industry. The locus of administrative control and the incidence of risk is no
longer clear in health plans that operate in multiple states, offer multiple network designs, and sell every form of insurance, partial insurance, and reinsurance. Private employers and public agencies with self-insured fringe benefits
programs escape state regulatory oversight altogether. Medical groups, practice
management firms, and physician-hospital systems cover capitated populations
larger than the enrollments in some insurance companies yet are often exempt
from formal insurance regulation. The emerging system needs to revisit the nuts
and bolts of tangible net equity, liquidity ratios, and other means for ensuring
that the money paid at the beginning of the year is still available to cover the
stream of claims that trickle in at the end.
The emerging health care system has pioneered new methods for the
collection, dissemination, and comparison of data on customer service and
clinical quality. The progress to date has been frustratingly slow but has laid
the foundation for more specific, severity-adjusted, and outcomes-oriented
measures in the future. This is an arena with important roles for public agencies
that can mandate participation, for nonprofit organizations that can develop the
instruments, and for health plans and providers who can cooperate on data collection and compete on quality results. The proliferation of print, television, and
internet avenues for the dissemination of quality and service data repeats the
experience of the deregulated utility industries, where the rise of choice and
competition created a new demand and thereby spurred a new supply of information to consumers.
The Corporate Practice of Medicine
The corporate system of health care has produced ever-larger organizations and ever more intense performance competition among them. However, its
sustainability has not thereby been assured. The very dynamism of the corporate
system disrupts established social norms and disadvantages powerful political
constituencies. American health care will never go back to professional dominance, which lost its political power as well as its organizational basis in the
transition to managed care. It will not proceed to the complete consolidation,
the full vertical and horizontal integration embodied in the principles of managed competition. However, corporate health care is threatened by a new form
of regulation. This will not be the entry barriers and rate setting of the utility
commission, but will come through myriad small rules, requirements, and judicial precedents designed to protect the purportedly helpless consumer against
the hazards of choice and competition. Individually, each new regulation will
limit only modestly the discretion of health care purchasers and providers.
Cumulatively, however, they could strap down the corporate Gulliver through
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a thousand small impediments on innovation, taxes on efficiency, and litigious
disputes over clinical uncertainties.
Despite the serious challenges facing the emerging health care system, it
is possible to conclude on a cautiously optimistic note.17 Political backlash followed the growth of large diversified firms in the American economy but did not
reverse its course, due to the remarkable gains in efficiency and quality generated by market competition and corporate organization. Capacity investment,
market entry, product price, and service specifications have been opened to
competition in the transportation, communication, energy, and finance industries after decades of utility regulation. The competitive corporate system has
been sustained because it proposes not incremental improvements in cost or
quality for the pre-existing set of goods and services but, rather, revolutionary
changes in the basic organizational and market structures of the economy. Similarly, the corporate system does not offer incremental reforms to the framework
of professional dominance in medicine but has swept it away completely, along
with fragmented physician practice, arm’s-length indemnity insurance, and costunconscious consumer demand. In the final analysis, it is not incremental
improvement in price and quality that counts, but rather the radical competition
from the entirely new product and service, the new technology, the new source
of supply, and the new type of organization—competition that strikes not at the
margins of the profits and the outputs of the existing organizations but at their
foundations and their very lives. This is the corporate practice of medicine.
Notes
1. D.W. Douglass and J.C. Miller, “Quality Competition, Industry Equilibrium, and
Efficiency in the Price-Constrained Airline Market,” American Economic Review,
64 (1974): 657-669; E.E. Bailey, D.R. Graham, and D.P. Kaplan, Deregulating the
Airlines (Cambridge, MA: The MIT Press, 1985); the classic paper on the costincreasing effects of competition in the presence of rate regulation is G.J. Stigler,
“Price and Non-Price Competition,” Journal of Political Economy, 76 (1968): 149154; R.H.K. Vietor, Contrived Competition: Regulation and Deregulation in America
(Cambridge, MA: Harvard University Press, 1994).
2. H. Averch and L. Johnson, “Behavior of the Firm under Regulatory Constraint,”
American Economic Review, 52 (1962): 1052-1069; P.L. Joskow and R. Schmalensee,
“Incentive Regulation for Electric Utilities,” Yale Journal on Regulation, 4/1 (1986):
1-49; P.L. Joskow, “Regulatory Failure, Regulatory Reform, and Structural
Change in the Electric Power Industry,” Brookings Papers: Microeconomics (1989),
pp. 125-199.
3. A.F. Friedlander and R.H. Spady, Freight Transport Regulation: Equity, Efficiency,
and Competition in the Rail and Trucking Industries (Cambridge, MA: The MIT Press,
1981); T.E. Keeler, Railroads, Freight, and Public Policy (Washington, D.C.: The
Brookings Institution, 1983); A.F. Friedlander, E.R. Berndt, and G. McCullough,
“Governance Structure, Managerial Characteristics, and Firm Performance in the
Deregulated Rail Industry,” Brookings Papers: Microeconomics (1992), pp. 95-183.
4. A.N. Berger, A.K. Sashyap, and J.M. Scalise, “The Transformation of the U.S.
Banking Industry: What a Long Strange Trip It’s Been,” Brookings Papers on Economic Activity, 2 (1995): 55-218.
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5. A. DeVany and W.D. Walls, “Natural Gas Industry Transformation, Competitive
Institutions, and the Role of Regulation,” Energy Policy, 22/9 (1994): 755-763;
K.W. Costello and D.J. Duann, “Turning Up the Heat in the Natural Gas Industry,”
Regulation, 1 (1996): 52-59; R.H.K. Vietor, Contrived Competition: Regulation and
Deregulation in America (Cambridge, MA: Harvard University Press, 1994).
6. G.J. Stigler, “The Theory of Economic Regulation,” Bell Journal of Economics and
Management Science, 2 (1971): 22-50; S. Pelzman, “Toward a More General Theory
of Regulation,” Journal of Law and Economics, 19 (1976): 211-240; G. Becker, “A
Theory of Competition among Pressure Groups for Political Influence,” Quarterly
Journal of Economics, 98 (1983): 371-400; S. Pelzman, “The Economic Theory of
Regulation after a Decade of Deregulation,” Brookings Papers: Microeconomics,
(1989), pp. 1-41; A.E. Kahn, The Economics of Regulation: Principles and Institutions
(New York, NY: John Wiley, 1971, second edition 1988); P.L. Joskow and R.C.
Noll, “Regulation in Theory and Practice: An Overview,” in G. Fromm, ed., Studies
in Public Regulation (Cambridge, MA: MIT Press, 1981); M.W. White, “Power
Struggles: Explaining Deregulatory Reforms in Electricity Markets,” Brookings
Papers: Microeconomics (1996), pp. 201-267.
7. A.E. Kahn, “Deregulation: Looking Backward and Looking Forward,” Yale Journal
on Regulation, 7 (1990): 325-354; C. Winston, “Economic Deregulation: Days of
Reckoning for Microeconomists,” Journal of Economic Literature, 31 (1993): 12631289; J.R. Meyer and W.B. Tye, “Toward Achieving Workable Competition in
Industries Undergoing a Transition to Deregulation: A Contractual Equilibrium
Approach,” Yale Journal on Regulation, 5 (1988): 273-297; R.H.K. Vietor, Contrived
Competition: Regulation and Deregulation in America (Cambridge, MA: Harvard University Press, 1994).
8. These quantitative estimates are derived from the literature survey in C. Winston,
“U.S. Industry Adjustment to Economic Deregulation,” Journal of Economic Perspectives, 12/3 (1998): 89-110.
9. Fare ceilings imposed by Civil Aeronautics Board had stimulated non-price competition through more frequent flights, reducing occupancy rates and raising
average costs per passenger mile, and it was anticipated that deregulation would
reduce frequency by stimulating price competition. However, the increase in
demand stimulated by the lower prices more than compensated for the
frequency-reducing impact of higher seat occupancy rates.
10. K.J. Arrow, “Uncertainty and the Welfare Economics of Medical Care,” American
Economic Review, 53/5 (1963): 941-973.
11. D.A. Banks, S.E. Foreman, and T.E. Keeler, “Cross-Subsidization in Hospital Care:
Some Lessons from the Law and Economics of Regulation,” Health Matrix Journal
of Law-Medicine, 9 (1999): 1-35.
12. For an overview of the economics of professional dominance, see J.C. Robinson,
The Corporate Practice of Medicine: Competition and Innovation in Health Care (Berkeley,
CA: University of California Press, 1999), Chapter 2.
13. R.G. Noll, “Economic Perspectives on the Politics of Regulation,” in R.
Schmalensee and R.D. Willig, eds., Handbook of Industrial Organization (Amsterdam:
Elsevier Science Publishers, 1989).
14. K. Levit, C. Cowan, B. Braden, et al., “National Health Expenditures in 1997:
More Slow Growth,” Health Affairs, 17/6 (1998): 99-110.
15. For an overview of organizational innovation in physician group practice, see J.C.
Robinson, op. cit., Chapters 5-8.
16. The BNA Health Plan and Provider Reporter provides a weekly summary of federal and state anti-managed care legislation and regulation. The figure on 10,000
bills was derived from analyses by the Health Insurance Association of America
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and National Conference of State Legislatures. Bureau of National Affairs, BNA
Health Plan and Provider Reporter, June 28, 2000): pp. 758-759.
17. The cognoscenti will recognize the debt of this paragraph to J.A. Schumpeter,
Capitalism, Socialism, and Democracy (New York, NY: Harper and Row, 1942).
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Industry and Competitive
Strategy Articles
Finding a Lasting Cure for
U.S. Health Care
Article
Companies, 2002
U.S. Health Care
Perspectives
Harvard Business Review
Reprint 94512
83
84
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Article
Companies, 2002
Strategy Articles
U.S. Health Care
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Companies, 2002
Article
HarvardBusinessReview
SEPTEMBER-OCTOBER 1994
Reprint Number
PETER F. DRUCKER
THE THEORY OF THE BUSINESS
94506
H. KENT BOWEN, KIM B. CLARK,
CHARLES A. HOLLOWAY,
DOROTHY LEONARD-BARTON,
STEVEN C. WHEELWRIGHT
SPECIAL SECTION:
REGAINING THE LEAD IN MANUFACTURING
DEVELOPMENT PROJECTS: THE ENGINE OF RENEWAL
HOW TO INTEGRATE WORK AND DEEPEN EXPERTISE
MAKE PROJECTS THE SCHOOL FOR LEADERS
94501
94502
94503
ARTEMIS MARCH
USABILITY: THE NEW DIMENSION OF PRODUCT DESIGN
94507
JOHN A. QUELCH, DAVID KENNY
EXTEND PROFITS, NOT PRODUCT LINES
94509
STAN DAVIS, JIM BOTKIN
THE COMING OF KNOWLEDGE-BASED BUSINESS
94505
REGINA FAZIO MARUCA
HBR CASE STUDY
CAN THIS BRAND BE SAVED?
94508
WILLIAM G. BOWEN
SOCIAL ENTERPRISE
WHEN A BUSINESS LEADER JOINS A NONPROFIT BOARD
94504
PERSPECTIVES
FINDING A LASTING CURE FOR U.S. HEALTH CARE
94512
RICK YAN
WORLD VIEW
TO REACH CHINA’S CONSUMERS, ADAPT TO GUO QING
94511
ALAN M. WEBBER
BOOKS IN REVIEW
SURVIVING IN THE NEW ECONOMY
94510
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Strategy Articles
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Article
P E R S P E C T I V E S
Can health care reform in the United States achieve longterm cost reductions and maintain quality of care?
Finding a Lasting Cure for U.S. Health Care
In “Making Competition in
Health Care Work” (July-August
1994), Elizabeth Olmsted Teisberg,
Michael E. Porter, and Gregory B.
Brown consider a question that has
been conspicuously absent from the
current national debate on health
care reform: How can the United
States achieve sustained cost reductions over time?
The authors find the answer in the
powerful lessons that business has
learned over the past two decades
about the imperatives of competition. In industry after industry, the
underlying dynamic is the same:
competition compels companies to
deliver constantly increasing value
to customers. The fundamental driver of this continuous quality improvement and cost reduction is
innovation. Without incentives to
sustain innovation in health care,
short-term cost savings will soon be
overwhelmed by the desire to widen
access, the growing health needs of
an aging population, and the unwillingness of Americans to settle for
HARVARD BUSINESS REVIEW
September-October 1994
anything less than the best treatments available.
The misguided assumption underlying much of the debate about
health care is that technology is the
enemy. By assuming that technology drives up costs, reformers neglect
the central importance of innovation or, worse yet, attempt to slow
its pace.
In fact, the authors argue, innovation driven by rigorous competition
is the key to successful reform. A
lasting cure for health care in the
United States should include four
basic elements: corrected incentives
to spur productive competition, universal insurance to secure economic
efficiency, relevant information to
ensure meaningful choice, and vigorous innovation to guarantee dynamic improvement.
Eleven experts examine the current state of the health care system
in the United States and offer their
views on the shape that reform
should take. Teisberg, Porter, and
Brown then provide a brief response.
Copyright © 1994 by the President and Fellows of Harvard College. All rights reserved.
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I. Steven Udvarhelyi
Vice President, Medical Services
The Prudential Insurance Company
of America
Executive Vice President
The Prudential Center for Health
Care Research
Philadelphia, Pennsylvania
As Elizabeth Teisberg, Michael
Porter, and Gregory Brown argue,
the failure of U.S. medicine to produce cost innovation has contributed significantly to the difficulty we
have in controlling health care costs.
And cost innovation is critical if we
want to succeed at reducing costs
and improving quality in a world of
fixed resources. However, the authors fail to emphasize some important issues and do not present others
in their full complexity.
The assertion that payers try to
deny payment on claims whenever
possible is just such an oversimplification. As the authors point out, The
Prudential Insurance Company of
America has demonstrated through
its Institutes of Quality Program
that incentives can be aligned to
produce cost savings and improve
quality. And our case is far from an
isolated one. Health maintenance
organizations cover and pay for more
comprehensive preventive care than
traditional fee-for-service plans do.
Some HMOs actually pay expectant
mothers on Medicaid to come in for
care. HMO managers understand
that an HMO is responsible for the
health of a defined population,
rather than for a series of individuals
with individual health problems. If
we are to solve the problems of the
health care system, we must start
thinking in these same terms.
Indeed, the use of new health care
technologies requires just such an
approach. The authors are correct to
say that we should not slow technological innovation in health care, especially innovation that can reduce
costs. But the diffusion of technologies into widespread medical practice prior to an adequate assessment
of their risks, benefits, and appropriate relative roles should be slowed.
The push for rapid dissemination of
new technologies is most prevalent
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Article
“On the road to
innovation, let
us not forget to
develop the
tools that allow
physicians,
payers, and
patients to
make better
decisions.”
I. Steven Udvarhelyi
where current therapies are limited
in their effectiveness. While it is
understandable that individuals may
wish to try new, unproven technologies in such situations, as a society
we must collect data that demonstrate the effectiveness of new technologies rather than submit a large
number of individuals to unknown
risks for unknown benefits. Gathering information on whether or not
a new technology produces better
health outcomes – or equal health
outcomes at a lower cost – is almost
impossible if the technology has become practice before data are collected and analyzed.
The argument that we will improve innovation by providing consumers, specifically individual patients and other purchasers, with
better information on health outcomes is true but again oversimpli-
fied. In the financial services markets, we have seen the development
of bond ratings as aggregate measures of performance, partly because
individual investors cannot make
use of detailed, individual financial
reports on bond stability and projected yields. Why should medicine be
different? Many individual consumers will have difficulty interpreting outcome data on complex
medical treatments and procedures
and weighing the risks and benefits
associated with different approaches
to treatment. We should anticipate
the equivalent of an aggregate “bond
rating” in medicine that allows the
lay public to evaluate competing
physicians, hospitals, and health
plans. In addition, we should expect
individuals to get better advice from
physicians who are better informed
than most physicians are today.
To that end, extensive research
that develops better outcome measures must be undertaken quickly;
however, that research should not
simply focus on measures that are
important to individual patients or
to group purchasers, such as employers. The information needs to be
useful to physicians, and the outcome data need to be coupled with
a better understanding of which
clinical processes produce the best
outcomes. It is critical that the foundation of clinical decision making
be improved. The health care system of the future will place less
emphasis on the decision-making
abilities of individual physicians and
more on the decision-making abilities of a team of individuals working
together – a team that should include
the patient. This new system of
health care delivery will require new
ways of supporting and making decisions in order to improve medical
outcomes. Information and outcome
data should be available to all decision makers so that better informed,
and better coordinated, recommendations can be made about treatment options. Such data should permit physicians to improve their own
performance, permit each decision
maker to understand the relationship of outcomes to the performance
of other team members, and provide patients with information that
Strategy Articles
U.S. Health Care
points out the pros and cons of different treatment options. On the
road to innovation, let us not forget
to develop the tools that allow
physicians, payers, and patients to
make better decisions.
Arnold S. Relman
Professor of Medicine and of
Social Medicine
Harvard Medical School
Editor-in-Chief Emeritus
The New England Journal
of Medicine
Boston, Massachusetts
The authors are largely correct in
their description of the inefficiencies and skewed incentives of the
present health care system in the
United States, but their suggested
remedy can’t work. They prescribe a
strong dose of “productive competition,” as if health care were simply
a business in which competition has
not been allowed to work its usual
magic. A lifetime of involvement in
the practice, teaching, and study of
medical care has convinced me that
this view, so commonly held by
businesspeople and economists, is
misguided. Health care is not a product or a simple service that can be
standardized, packaged, marketed,
or adequately judged by consumers
according to quality and price. The
authors correctly recognize that “informed purchasing decisions” have,
to date, had little influence on supply and demand in health care. But
they are wrong if they believe that
health care can be made to behave
like other parts of the U.S. economy
through the stimulation of competition and the use of “meaningful outcome measures.”
Medical care is a highly personal
and individualized service, the value
and success of which can be fully assessed only with respect to a particular individual in particular circumstances. Yes, it is true that narrowly
defined “outcomes” of certain procedures can be measured and reported in statistical, probabilistic terms,
but such data cannot capture the almost infinite variety of personal circumstances that determine the value of these procedures to a particular
patient. There is an enormous and
Article
“Health care is
not a product or
a simple service
that can be
standardized,
packaged,
marketed, or
adequately
judged by
consumers
according to
quality and
price.”
Arnold S. Relman
rapidly growing literature on the
probable effects of given procedures
in particular medical conditions, but
judgments on the quality of care in
a given patient rarely can be based on
such information.
Business managers don’t understand why they shouldn’t be able to
get reliable information about quality of care, which they can weigh
against the prices charged. The fact
is that the measurement of quality is
in a primitive state and will probably
remain so for the foreseeable future.
Here is the best definition of highquality medical care that I can come
up with: It is the care given to a particular patient under particular circumstances by a compassionate and
competent physician who has access
to consultants and the best current
information, who is not influenced
by economic incentives to do more
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or less than is medically appropriate,
and who is committed to serve the
patient’s best interests guided by
the latter’s wishes and medical needs.
This definition emphasizes the physician’s key role in allocating medical resources and preserving standards of quality.
Now, if what I have said about the
measurement of quality and the role
of physicians is correct, how likely
is it that market competition can
solve the present problems of our
health care system? What we need
instead is a reorganization of medical practice to emphasize community-based not-for-profit group practices, and the development of new
incentives for physicians and other
health care providers to act as prudent counselors for their patients.
Unlike ordinary markets, health care
needs some overall limitation of expenditures. A national health insurance system could provide a rational
and equitable basis for establishing
spending limits, subject to public
approval. However, the use of available resources within agreed-upon
national limits should be the responsibility of health care professionals
working with their patients.
The authors envision a competitive, market-driven health care system in which for-profit investorowned companies take responsibility
for providing care and expect financial rewards in exchange for risking
capital. What happens to the doctorpatient relationship in that kind of
market? If sick patients are not likely ever to function as independent
price-and-quality-sensitive consumers do in ordinary markets, how do
we ensure that the economic incentives of investors do not compromise the quality and availability of
care? Caveat emptor is the rule in
most markets. Who would want to
be cared for in a health system built
on that principle?
Gordon M. Binder
Chairman and CEO
Amgen
Thousand Oaks, California
The biotechnology industry offers
living proof of Teisberg, Porter, and
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Brown’s forceful argument: Decades
of basic research into the genetic
code are now paying off in effective
treatments and potential cures for
illnesses that have long eluded medical researchers. New drug therapies for heart disease, diabetes,
leukemia, cancer, and kidney disease are available to patients, and
biotech researchers are determined
to eradicate AIDS, Parkinson’s disease, and even cancer.
Biotechnology drugs offer patients
better and more cost-effective therapies, and they often help avoid
surgery and hospitalization. For example, a biotechnology drug we
developed at Amgen, Neupogen, is
given to patients undergoing chemotherapy to decrease their risk of
infection. In clinical trials at Duke
University Medical Center, Neupogen
has helped reduce the cost of bone
marrow transplantation for women
with breast cancer from $140,000
two years ago to $65,000 today.
Many women who had to receive
treatment as hospital inpatients
can now receive treatment virtually
on an outpatient basis. Yes, this
medical care is still expensive, but
lives are saved and extended, and
quality of life is improved.
This kind of progress can continue
only in an atmosphere of free and
competitive markets. Innovation
and investment are two sides of the
same coin. Before Amgen sold its
first product, more than $400 million had to be raised to fund research. The scientific discoveries
that will create today’s medical miracles can evolve only in an environment that rewards the enormous
risk that entrepreneurial companies
assume in conducting research.
The United States is on the brink
of stunting this progress. Under the
threat of price controls, investor interest in the health care industry is
drying up. The biotech industry
raised only $1.6 billion in the public
market in 1993, down from $3.7 billion in 1991, according to Montgomery Securities, an investment
bank based in San Francisco. Under
threats of the price controls and
added regulation that the Clinton
administration has proposed, the
number of new biotech companies
8
dropped from 120 in 1987 to 40 in
1993. Sixty percent of the companies
that planned to raise capital in 1993
either missed funding targets or canceled stock offerings. An astonishing
100% said that investor concern
about price controls has been harmful to their ability to raise funds.
Clearly, the threat of price controls
is already having a negative impact
on medical research.
Some members of Congress have
worried that if a cure for AIDS is developed, it may be too expensive.
But the most cost-effective health
care is a cure – or, better yet, a vaccine. For example, in 1952, more
children died of polio than of any
other infectious disease, and polio
was much feared as the great crippler
of children. After a concerted campaign to fund many millions of dollars of research, the Salk vaccine was
“The scientific
discoveries that
will create
today’s medical
miracles can
evolve only in
an environment
that rewards
the enormous
risk that
entrepreneurial
companies
assume in
conducting
research.”
Gordon M. Binder
developed, virtually eliminating polio as a threat. Who can estimate the
value of the lives saved and the children who were not crippled because
they received the vaccine in time?
While we have made dramatic
strides in medical research, the way
health care is financed and delivered
in the United States today needs to
be changed. Too many people go
without the medical treatment they
need, and too many others face
catastrophic medical expenses when
they have a major illness. But shortsighted efforts to control prices are
self-defeating and undermine scientific progress.
It is imperative that public-policymakers respect the vibrant connection between innovation and investment. The genius of medical
research goes hand in hand with the
genius of the competitive market.
The cure for the ailments of the U.S.
health care system is not increased
government regulation, price controls, and mandates but a healthy, vibrant market that offers ever more
effective and ever more cost-effective treatments and cures.
Rina K. Spence
President
RKS Health Ventures Corporation
Cambridge, Massachusetts
Former CEO
Emerson Hospital
Concord, Massachusetts
The authors have accurately identified many of the barriers to successful competition and therefore to
sustained cost savings. I would add
yet another barrier: the complexity
of medical culture and politics.
Innovation and competition may
appear to be stifled by regulators and
legislation, but in fact the conservative nature of much of the health
care industry itself – hospitals and
insurers included – contributes significantly to the problem. The medical community is fundamentally
risk-averse. While clinically sound,
this stance poses a real problem
when it comes to implementing
change in the structure of the health
care system. And the problem is only exacerbated by political forces
that generally promote the self-
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preservation of existing medical
practices and community institutions. Risk-averse behavior manifests itself in all areas of health care
delivery, and much of the payment
structure that exists today was put
into place precisely to limit the level
of risk undertaken by practitioners,
hospitals, and insurers alike.
Today’s innovative and cost-effective forms of service delivery will
necessarily involve taking risks, including acceptance of nonphysician
caregivers, nontraditional modes of
care, and less costly sites for service
delivery. Indeed, the new payment
scheme, capitation, is fundamentally risk based. Physicians, hospitals,
and other providers will receive a
fixed dollar amount per patient
based on an educated guess concerning the total cost of providing care
for their populations. Because of the
financial risk involved in serving a
population under capitation, these
entities will have to become more
efficient and find new ways of delivering high-quality care without exceeding their operating budgets.
Given these new dynamics, an industry that has been risk-averse will
have to change its culture to achieve
success. I believe that there is room
for successful niche approaches to
health care. After ten years as a hospital CEO, I changed paths in order
to see if one could create innovative
service delivery by stepping outside
the existing culture and politics of
a traditional institutional setting.
Could one build a more cost-effective staffing structure, purchasing
systems, and equipment based only
on cost and quality, and offer services based on consumer demand?
RKS Health Ventures, my answer to
that question, is a private outpatient
network of consumer-oriented women’s health facilities. These services
will be delivered cost-effectively
with an ability to incorporate riskbased reimbursement.
The private, for-profit sector is also seeking new business opportunities through different management
of old structures. Large hospital corporations are purchasing hospitals,
and those corporations may be better able to consolidate services and
regionalize care because they are not
party to the old politics and culture.
They are also rapidly developing
lower-cost alternatives for health
care delivery, such as subacute-care
and rehabilitation centers.
The health care industry can
achieve sustained cost-effectiveness. To that end, the system must
be reengineered, breaking down the
current paradigm of who, how, and
where health care is delivered.
Edward M. Kennedy
Senator, Massachusetts
Chairman, Committee on Labor
and Human Resources
Washington, D.C.
“Making Competition in Health
Care Work” is a powerful prescription for reform. The authors’ analysis is fundamentally compatible
with the Health Security Act pro-
“The medical
community is
fundamentally
risk-averse.
While clinically
sound, this
stance poses a
real problem
when it
comes to
implementing
change in the
structure of the
health care
system.”
Rina K. Spence
posed by President Clinton and recently approved in modified form by
the Committee on Labor and Human Resources. Everyone’s first priority in Congress is to unleash the
forces of competition in order to
achieve long-term cost reductions,
continuous quality improvements,
and innovation. But the real challenge is how to do it.
The Health Security Act addresses
the problems and will foster the innovation that Teisberg, Porter, and
Brown identify as the key to longterm cost control. A solution to the
cost problem, as the authors rightly
emphasize, requires universal coverage. The Health Security Act ensures that every citizen will have incentives to choose the highest-value
health plan from among a number of
different plans. Employees choosing
more expensive plans will pay more;
those choosing less expensive plans
will pay less. And they will receive
a cash rebate if they choose a plan
that costs less than the employer’s
contribution. Coverage will be comprehensive and standardized so that
people can compare plans on price
and quality without the subtle distortions introduced when benefits
vary among plans.
The program also improves the
negotiating power of citizens by reducing fragmentation. Employers
with fewer than 500 employees, as
well as the self-employed and the
unemployed, will purchase coverage
through community-rated pools,
and they will be able to exert considerable market power to curb costs.
Employers with more than 1,000
employees will purchase coverage
outside the pools. Companies with
500 to 1,000 employees will have a
choice: they can purchase coverage
directly or participate in pools. The
plan gives citizens still another
choice by making the Federal Employees Health Benefits Program
available to nonfederal employees.
The Health Security Act is also
consistent with a number of the other recommendations made by Teisberg, Porter, and Brown. It recognizes that good infor mation on
quality of care is an essential part of
making health care work. A consumer report card on each health
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plan must be developed and made
available, using the most up-to-date
and comprehensive information on
medical outcomes. A major additional investment must be made in
outcomes research and the development of practice guidelines.
The Health Security Act simplifies the content of health insurance
policies, outlawing balance billing
and providing for patient cost sharing in the standardized policies. By
substantially expanding funds for
medical research and academic
health centers, the act sends a message that cost savings should be
achieved by developing and disseminating new cures for diseases, rather
than by restricting the availability of
new products. Indeed, our proposal
carefully avoids the micromanagement and regulation of the price of
specific products and services, new
or old, which the authors rightly
caution could stifle innovation. Instead, each health plan will have
strong incentives to balance the value of a product or service against its
cost. In addition, each plan will allow subscribers to decide whether or
not that provider has struck the
right balance by deciding where to
take their business.
The main area in which our program differs from the authors’ recommendations is in its fallback
premium limits in areas where competition alone is not fully effective
or does not work fast enough. In my
view, these premium limits are not
incompatible with competition. Instead, they are a safety net to ensure that costs do not continue out
of control. Excessive inflation is so
deeply embedded in today’s system
that the availability of such limits
may be the “stick in the closet” that
is essential to let real competition
take hold. The experts we heard
from in our committee hearings generally felt that managed competition
alone might not be sufficient to restrain rising prices in the short run.
The goal is to find the best way to
manage competition. Just as antitrust laws are the wise restraints
that make competition free in other
sectors of the economy, so the right
kind of managed competition can
work well in health care.
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Article
“Just as
antitrust laws
are the wise
restraints that
make
competition
free in other
sectors of the
economy, so the
right kind of
managed
competition can
work well in
health care.”
Edward M. Kennedy
Jerome H. Grossman
Chairman and CEO
New England Medical Center
Boston, Massachusetts
We health care providers must
change the elements of practice that
are within our control if we are to realize the true benefits of new marketplace incentives.
Consider outcome measures. The
marketplace, the delivery system,
and patients are best served by attending to four categories of outcomes: clinical health (traditional
biomedical and physiological health
status); functional health (quality of
life and general well-being); satisfaction (the consumer’s attitudes and
responses to the experience of seeking and receiving care); and cost (the
costs of care to achieve the desired
level of health outcomes). Fortunately, we are making rapid strides
in our ability to measure all four categories. Developments in the field of
psychometrics are making it possible to utilize patient- and consumerbased survey instruments of great reliability and accuracy.
Essential to adopting outcome
measures in health care settings is
installing appropriate state-of-theart information systems. The health
care system has lagged behind other
industries in its use of computers
and information systems. Only recently have we begun looking in a
methodical way at the bigger picture
of how structure, process, and outcomes are intertwined and how operations can be adjusted to improve
results. Today we are creating a new
generation of decision-support systems to help clinicians and managers make the most efficient use of
resources while delivering the most
effective health care services. The
development of health-care-information systems may prove to be the
most significant innovation of all.
The health care system is already
changing dramatically because the
marketplace, led by powerful payers,
is transforming itself in ways that
the authors would endorse. This
evolution will continue, regardless
of the actions of Congress. Many of
us who are directly responsible for
providing health care see an opportunity to improve the health of the
population and at the same time enhance our own professional satisfaction. The fact is that we physicians
have grown increasingly frustrated
with a system that imposes micromanagement by payers, dictating
what we can and cannot do for our
patients. The alternative: pay us for
what we accomplish, not what we
do. Provide us with a predetermined
and appropriate capitation rate to
care for an enrolled population,
make us accountable for delivering
necessary care within the limits of
this budget, and help us measure and
monitor the outcomes to ensure that
we don’t sacrifice quality for profits.
If we succeed in improving outcomes at reduced costs, we stand to
gain by increasing our margins and
securing market share.
Strategy Articles
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Physicians and providers are responding to this evolving shift to a
health care system based on “covered lives” rather than “covered services” by building organized and integrated delivery systems, reviewing
and amending practice patterns, and
controlling expenditures. Under
capitation, providers will make
smart purchasing decisions, so that
innovations that make sense will be
rewarded. This, in turn, sets the context for pharmaceutical and medical
device companies to produce costeffective, labor-saving advances that
truly improve the outcomes of care.
In this way, we will structure an industry and a marketplace to achieve
our goals of high-quality and affordable health care.
Henri A. Termeer
Chairman, President, and CEO
Lisa J. Raines
Vice President for Government
Relations
Genzyme Corporation
Cambridge, Massachusetts
The pharmaceutical marketplace
provides a microcosm for Teisberg,
Porter, and Brown’s critique of the
U.S. health care system’s self-contradictory incentive system. Prescription drugs are usually the most
cost-effective way of treating a disease, but neither Medicare nor half
of all private insurance policies cover outpatient drugs. As a result, patients are sometimes tempted – or
forced by economic circumstance –
to forgo filling a $50-per-month prescription that significantly reduces
the probability of a more debilitating
and expensive heart attack or stroke.
And Medicare’s policy of covering
inpatient – but not outpatient – drugs
has led many oncologists to admit
cancer patients to the hospital at a
substantial cost to Medicare for the
purpose of qualifying the patient’s
chemotherapy for reimbursement.
The Clinton administration’s
health-care-reform plan recognizes
the foolishness of a system that will
pay for a $20,000 surgical procedure
but will not pay for a $2,000 drug
that eliminates the need for surgery.
The plan proposes to remedy this situation by requiring all public and
Article
“The fact
is that we
physicians have
grown
increasingly
frustrated with
a system that
imposes
micromanagement by payers,
dictating what
we can and
cannot do for
our patients.”
Jerome H. Grossman
private payers to cover outpatient
prescription drugs. Yet the details of
this proposal, particularly the Medicare portion, could be improved if
made more consistent with the authors’ suggestions. Under the Clinton plan, if two brand-name drugs
are therapeutically equivalent but
one drug costs twice as much as the
other, Medicare would pay for
whichever drug a physician prescribes. The plan has no meaningful
mechanism for encouraging the
physician to use the less expensive
but equally effective product. In contrast, HMOs and pharmacy-benefit
managers direct physicians to prescribe the least expensive therapeutically equivalent product. Furthermore, the administration’s proposal
would pay pharmacists a $5 dispensing fee for each Medicare prescription – almost twice the average fee
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negotiated by managed care organizations – and would prohibit some
of the types of discounting and product bundling arrangements that allow manufacturers to either cut the
cost or increase the value of their
products in ways dictated by an increasingly competitive marketplace.
Perhaps most ominously, the administration’s Medicare proposal
would authorize the secretary of
health and human services to “negotiate” a rebate for new drugs if she
“believes the manufacturer’s retail
price may be excessive.” It seems obvious that if Medicare can demand a
rebate of unlimited size, it has the
absolute right to set the product’s
price with respect to the Medicare
market. For drugs that are used
primarily or exclusively by elderly
patients – such as those for Alzheimer’s, arthritis, and many cancers – Medicare would control the
price for the entire U.S. market.
Diseases of the elderly account for
about half of all health care costs,
and that amount will increase as our
nation ages demographically. Our
only hope for a sustained reduction
of those costs is to create new methods of treatment that reduce the
need for hospitalization, surgery,
and nursing home care. The structure of the administration’s Medicare proposal undermines these incentives by imposing price controls
that would make drug development
unattractive to investors who have
a myriad of non-price-controlled investments from which to choose.
A better approach to a Medicare
drug benefit would be to allow pharmacy-benefit managers and HMOs
to administer the program. Such private-sector organizations have demonstrated success in containing prescription drug costs through the
use of generic substitution, therapeutic substitution, and price negotiations with drug manufacturers,
while avoiding the regulations, price
controls, paperwork, and inefficiency that would likely accompany a
government-run program. As the authors note, the federal government
can make an intellectual contribution to such a program through expanded outcomes research and technology-assessment studies that
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provide payers, providers, and patients with relevant information
about the relative merits of various
therapeutic approaches.
Beyond assessing the merits of individual products and services, however, we need to achieve a social
consensus that recognizes the value
of innovation. The debate about
whether innovation drives costs up
or down, whether it improves medical outcomes or not, will continue in
the absence of a meaningful evaluation of these issues.
Elizabeth Marincola
Executive Director
The American Society for
Cell Biology
Bethesda, Maryland
It is curious that innovation, and
in particular biomedical research,
has not figured more prominently in
the national health care debate. This
omission may be a function of the
contrast between the short-term
pressures of politics and the longterm ones of science. As the authors
point out, longer-term changes in
health care are needed, requiring
new insights at the most basic level.
In the current climate of perverse
economic incentives, those who are
most vocal in the health care debate – elected officials and advocacy groups representing people with
diseases – can be the unintentional
enemies of economic efficiency. According to these officials and advocates’ biased view of innovation,
federal appropriations for biomedical research are defined as being
for the social good. They are not
measured in terms of economic returns. Biomedical research should
be considered primarily an investment in the national economic wellbeing with additional humanitarian benefits. Like the Japanese, we
should consider federal funding of
biomedical research to be an investment in R&D for the health care industry, just as electronics research is
the R&D for the computer industry.
Resistance to investing in research also comes from the misleading but popular public claim that although technological innovation
increases the quality of health care,
12
it also always increases costs. In fact,
cost increases are often not caused
by the technology per se but are
rather artifacts of the suboptimal
use of diagnostic equipment, such as
the nonconsolidation of expensive
high-tech capital investments like
magnetic resonance imaging. As the
authors correctly claim, there must
be some regionalization of specialized services so that patients can
benefit from state-of-the-art technology free of incentives that encourage its overuse because too
many owners need to recoup their
investment in expensive machines.
The authors also make a good case
that the manipulation of incentives
for payers, consumers, and providers
should result in the actual reduction
of health care costs, not just in their
redistribution. Economic incentives
and regulatory reforms can and
“Biomedical
research should
be considered
primarily an
investment in
the national
economic wellbeing with
additional
humanitarian
benefits.”
Elizabeth Marincola
should be improved – but they can
only produce savings on the margin.
In an economic climate that seeks to
optimize value, we can expect that
fundamental research will lead to
better-quality treatments at less
cost. The only mechanism for significant change in the cost of treating
disease is basic biomedical research,
which presently consumes a very
small fraction (less than 2%) of the
health care budget.
Unfortunately, analysis of the economic impact of such research is
incomplete. Nevertheless, ample evidence exists demonstrating the dramatic returns of successful biomedical research. Hepatitis B vaccine is
estimated to save as much as $94.7
million per year by preventing acute
and chronic disease. The development of genetic screening techniques for neonatal hypothyroidism allows 97% of infants with
congenital hypothyroidism to be
identified early enough to avoid the
mental retardation that otherwise
results from this condition. Any single breakthrough of basic biomedical
research could alone produce more
savings in health care costs in one
year than the entire federal budget
for the National Institutes of Health,
which funds most biomedical research in the United States.
The emphasis on innovation driven by biomedical research, which
has been shamefully ignored so far,
must be a central element in the reformulated debate on health care reform. Although it is complicated to
measure accurately the cost savings
produced by biomedical research,
federal policy that uncouples such
research from the economics of
health care delivery undervalues
what will ultimately prove to be our
most direct avenue to both increasing the quality of health care and
lowering its costs.
Thomas O. Pyle
Managed Care Manager and
Policy Analyst
Metropolitan Life Insurance
Company
Westport, Connecticut
The authors have provided us
with a compelling description of the
Strategy Articles
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Article
95
Companies, 2002
problems in health care economics
and practices. Solutions, however,
are harder to find. The view that incentives are needed and that competition is good is repeatedly asserted.
But these icons of market-driven
systems, of which I am a firm advocate, are not easy to implement in
health care. Moreover, the authors
never tell us how they would do it.
The problems are myriad. For instance, since health care coverage is
a futures contract, it is inherently
speculative. The desire to participate in advantageous aggregations
by either buyer or seller is called adverse selection and skimming, respectively. It is the Achilles’ heel of
competition in health care. The inability to identify inherent risk in
population groups only compounds
the problem and prevents large employers in the United States from
comparing performance between
the various HMOs and indemnity
plans it offers; it stymies any simple
comparison of outcomes.
The problem of gaming extends
from health care insurance into the
delivery system. Gaming, of course,
is characteristic of all businesses,
but it’s rarely defended in other industries with the degree of sanctimony and professional weight that
is thrown around in health care. All
incentive systems have side effects
that must be monitored or offset.
Even a pure salary system, described
in the article as “volume neutral,”
is, in fact, not volume neutral. While
it will not stimulate the volume of
procedures, a pure salary system will
tend to reduce access and decrease
productivity.
The proposals for managed competition, largely the work of Alain
Enthoeven and Paul Ellwood, and
also known as the Jackson Hole proposals, have a good deal more merit
than the article suggests. (I admit to
bias, since I was chairman of the
Jackson Hole Group from 1991 to
1993.) The main purpose of the proposals is to create a workable market. The Jackson Hole proposals call
for the development of HMO-like
organizations called accountable
health plans (AHPs). These AHPs
would assume full responsibility for
cost and quality in any individual’s
care and would publish performance
data. They would compete on the
basis of the full array of service attributes, with consumers periodically selecting a new plan if they were
dissatisfied or felt a new plan offered
a more satisfactory package. For
smaller employers, a health store
would help the choice process.
These health stores would be nonregulatory entities that would facilitate the distribution of AHPs to promote availability and competition
and handle the accounting (admittedly primitive) for risk adjustment.
Each AHP would compete in a
medical market, roughly defined as
an area of variable size in which
a high percentage of the medical
transactions occur for both the population and the set of institutions
located within. Plans might be single-market, like the Harvard Com-
“While one can
envision a time
when medical
standards and
performance
data would
permit
competition on
individual types
of services, the
present state of
the art does not
allow
meaningful
competition.”
Thomas O. Pyle
munity Health Plan in Greater
Boston, or multimarket, like Kaiser
Permanente, serving markets nationwide. Each market, however,
would essentially be a stand-alone
business. These organizations would
have a strong incentive to improve
performance both individually and
by developing consortia with others
to sponsor research. While the possibility exists that a high-quality
provider might be excluded, market
incentives would encourage including the providers who offer the
best value. And the AHP would have
greater capabilities to distinguish
high-quality providers than would
any individual. The idea that all providers need to be included means
including many bad providers and
undermining cost-effectiveness.
While one can envision a time
when medical standards and performance data would permit competition on individual types of services,
the present state of the art does not
allow meaningful competition in
such a model. And who would the
decision maker be: the employer,
the patient, or the insurer? How
would we link payment responsibility with authority to choose? We buy
most of our products, such as automobiles, assembled with the named
manufacturer taking competitive responsibility for component quality
and cost. In the arcane world of
health care and health care financing, to do otherwise would perpetuate the gaming so well described in
the first part of the article.
Ben L. Holmes
Vice President
General Manager of Medical
Products Group
Hewlett-Packard Company
Andover, Massachusetts
It is true that innovation, best attained through healthy competition,
is critical to the success of comprehensive and sustained health care reform. The interests of the three primary links in the health care chain –
patients, providers, and payers – are
still largely conflicting, resulting in
inefficient, costly, and sometimes
ineffectual care. However, we are beginning to see their interests meld as
13
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Article
a result of health-care-industry
changes already under way.
Regardless of when a health care
bill is passed on Capitol Hill, market
dynamics have already begun to initiate changes to the system, as
shown by health-care-system consolidations and the movement to
managed care. Legislators and other
government agencies should resist
instituting unnecessary, and potentially damaging, policies that could
result in additional layers of bureaucracy, diluting competition and interfering with innovation.
The shifts occurring in our health
care system should not be ignored or
underestimated. Well before health
care reform became an important
topic in Washington, there were
signs that the health care industry
recognized the need to restructure
itself. One of the most dramatic changes – the movement from a
fee-for-service to a managed care
system – is causing ripple effects
throughout the entire industry. The
goal of the fee-for-service system
was to manage sick people – which
meant competing for patients, performing tests of perhaps unknown
effectiveness, or having uncertain
and unfair guidelines for compensation. In contrast, the goal of managed care is to keep patients healthy
within a certain budget. This goal
cannot be achieved without all parties assuming more responsibility
for health care than they have done
under the old system.
Indeed, we risk achieving the
goals of reform if we focus more on
cost – particularly if we implement
only short-term tactical measures.
Cost containment cannot be separated from quality of care and outcomes. Indeed, the three are inextricably linked and should be considered collectively.
The need to lower costs is already
well documented. With health care
running at 14% of the GNP even
while 38 million Americans are
uninsured, we’re spending too much
Elizabeth Teisberg, Michael Porter, and Gregory Brown Respond:
It is heartening that the respondents accept our diagnosis of the
problems with incentives in today’s health care system in the
United States, problems that
have driven up health care costs
substantially. Even more encouraging is their general endorsement of our argument that innovation, driven by rigorous
competition, is essential to successful reform – particularly given
that the principle of innovation
has been conspicuously absent
from the national debate on
health care reform. Rina Spence
underscores the importance of incentives for innovation in her critique of the medical culture and
the politics that have discouraged
new forms of and facilities for
health care delivery. Henri Termeer, Lisa Raines, Elizabeth Marincola, and Gordon Binder each
provide powerful examples of innovative therapies that not only
yield dramatic cost reductions
but also improve the quality of
life for patients. These commentators share our view of the innovation-stifling effects of price
controls and the need to support
both basic and applied research.
Of all the respondents, only
Ar nold Relman argues that
14
health care is a special case and
cannot rely on competition. Relman asserts, “Caveat emptor is
the rule in most markets. Who
would want to be cared for in a
health system built on that principle?” Actually, the current system in the United States is built
on that principle. Our argument
is that all “buyers” in the health
care system – patients, doctors,
payers, and employers–will make
better choices with a combination of more appropriate incentives and improved information.
The main debate raised by the
respondents centers on just how
to restructure incentives and
improve information. Two issues concerning how incentives
should be changed emerge. First,
Ben Holmes and Relman raise the
issue of spending caps. Holmes
holds that industry-initiated reforms should be sufficient. Relman, in contrast, asserts that
overall spending caps are necessary. In our view, health care reform should be implemented and
given a chance to work before instituting measures like overall
spending caps. Such measures are
apt to introduce new distortions
in incentives, like biases against
new treatments and procedures.
Second, Relman and Thomas
Pyle raise the issue of physicians’
incentives. Relman agrees with
us that salaries create incentives
that are preferable to either traditional fee-for-service reimbursement, which provides incentives
to overtreat, or the new capitation system, which provides incentives to undertreat. On the
other hand, Pyle argues that
salaries reduce access and decrease productivity, presumably
because salaried doctors will
work less or not perform all necessary procedures. Pyle’s argument seems to assume that
salaries must be low and fixed. Of
course, underpaying doctors
makes no sense. Incentives for
salaried physicians will stem not
only from their commitment to
patients but also from the possibility of bonuses, raises, and advancement. A doctor’s salary
should reflect the demand for his
or her services, which in turn will
reflect both the quality of care
and the quality of outcomes that
patients experience.
There is little disagreement
about the need for improved information. Holmes, for example,
underscores the dangers of reform
efforts that try to reduce costs
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and seeing too few results. Yet isolating expenditures also ignores how
better methods of care, from prevention to treatment, would not only
control costs but also contribute to
better health. Without understanding what treatments work and how
to achieve expected and desired
medical outcomes, it is virtually impossible to deliver efficient care. We
cannot, and should not, tackle the
system of cost without considering
a total solution involving quality of
care and better outcomes.
A key tenet of managed care requires all parties to make informed
decisions based on knowledge of basic treatments, costs, and expected
outcomes. Unfortunately, while
health care is one of the most information-rich industries, we are sorely
unprepared to aggregate patient data
and assess the most successful treatment methods. Technology can and
should play a stronger role in the
collection and utilization of clinical
and administrative data. Technology
manufacturers and providers are being charged with developing and utilizing technologies that provide
more information about patients,
leading to better outcomes. HewlettPackard, for one, is committed to
bringing to market products that
achieve those goals. Health care
providers are learning that in order
to survive, they need to operate
more as businesses, providing their
customers with the best medical service, competitively priced with
maximum efficiency.
By the time legislation is approved, industry-initiated reform
measures will have cured much of
what ails health care, resulting in
more reasonable costs while improving quality and enhancing outcomes.
But this success relies heavily on
developing concomitant interests
among those with the most to lose
or gain from a health care solution –
those who receive it, those who provide it, and those who pay for it.
Reprint 94512
“Bold reform that includes universal coverage is needed.”
without paying adequate attention to the effect of quality. The
questions center on how better
information will be used and by
whom. Steven Udvarhelyi agrees
that better information and improved outcome measures should
be developed rapidly but argues
that only physicians should have
access to specific information;
the lay public can understand
only aggregate ratings of providers. Relman goes a step further,
claiming that even physicians are
often unable to base judgments
on outcome data.
Improved, accessible data on
medical outcomes are first and
foremost needed for physicians.
Those data – in addition to knowledge about the individual patient
and professional expertise – will
allow doctors to make better professional judgments. In addition,
corrected physician incentives
will guard against the overuse
and underuse of treatments. Doctors’ judgments should not be replaced by practice guidelines developed by insurance managers or
government bureaucrats. Moreover, the benefits of medical outcome data will be amplified if
anyone who wants those data has
access to them.
Senator Edward Kennedy, a
central player in shaping health
care reform, comments that “everyone’s first priority in Congress
is to unleash the forces of competition.” We agree with the Senator that bold reform that includes
universal coverage is needed. (Indeed, in view of the current debate, it is notable and encouraging that none of the respondents
question our argument that universal coverage is necessary for
reasons of economic efficiency as
well as equity.) And we support
the Senator’s efforts, not mentioned in his response, to demonstrate more convincingly the value of research and innovation.
But three aspects of the Health
Security Act remain troubling.
First, as Kennedy points out,
“fallback premium limits” are a
form of price control. Price controls will distort incentives and
re-create health care inefficiency.
Second, the employer mandate
is expedient but inefficient and
unnecessary. Providing health
coverage at the employer level
creates an unnecessary level of
bureaucracy. A better long-term
solution is to require everyone to
have health insurance, mandate a
onetime salary adjustment to
cover the cost of forgone employer benefits, provide subsidies to
those who need them, and require age-adjusted community ratings by insurers. Coverage must
remain intact when someone
moves or changes jobs, and insurers and buying groups must be required to accept all comers to protect people with higher risks or
preexisting conditions.
Third, a consumer report card
is too narrow a vision of outcome measures. In addition to
“consumer” information, reform must encourage the rapid
development of sophisticated outcome measures that compare
specific treatments and specific
providers. As Jerome Grossman
and Holmes point out, outcome
measures and information-technology tools are already improving in anticipation of reform. The
fastest way to spur further advancement is via the widespread
dissemination of measures currently in use.
Hopefully, the consensus
among the respondents regarding
the importance of innovation can
begin to be reflected in the political debate about the direction of
health care and, ultimately, in the
plans for its reform.
15
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POM Cases
Deaconess−Glover
Hospital (A)
99
Companies, 2004
Case
9- 601-022
Rev. September 19, 2000
Deaconess-Glover Hospital (A)
Hospitals are filled with contradictions. You come to them because you’re sick and
need care, but hospitals are places where infections, uncertainty, and errors might
actually worsen your condition. Yet, miracles happen so routinely that we’ve come to
expect them. Broken bodies are fixed, illnesses are cured, and spirits are repaired
because of the hospitals’ caregivers. Unlike many business organizations, hospitals
don’t wrestle with the problem of an uncommitted workforce. You will never see a
more motivated group: nurses, doctors, technicians, and administrators. They are
infused with and exude a single-minded desire to comfort and heal, above all else.1
-- Paul O’Neill,
Chairman, Alcoa
Chairman, Working Together Healthcare Initiative of
Western Pennsylvania
Since August 1999, John Carter, a vascular surgeon, had been working with John Dalton,
President of Needham Massachusetts-based Deaconess-Glover Hospital (DGH); Julie
Bonenfant, Deaconess-Glover’s Vice President for Patient Services; and members of the
hospital’s staff (See Exhibit 1 for DGH’s organizational chart). They were seeking an
appropriate location within the hospital where they could test the applicability of the
Toyota Production System2 to the health care setting. The idea was that once a prototype
model line or learning unit was tested for functionality and its benefits were verified, lessons
from the learning unit could be taught throughout the rest of the hospital. The longer-term
hope was that once benefits were verified within Deaconess-Glover, lessons from DGH
could be applied within the CareGroup health care system of which DGH was part (See
Exhibit 2 for CareGroup’s organizational chart). Now, in November 1999, Carter was
sharing his initial recommendation for the model line. As he waited in Dalton’s office for
Bonenfant’s arrival, he mentally rehearsed his presentation of findings and supporting data
and anxiously anticipated Dalton and Bonenfant’s reaction.
The stakes were high for all concerned. Carter had a twenty-year career as a vascular
surgeon and as a surgical practice manager in Washington state. However, his experience as
a patient proved to be an epiphany. While vacationing with his family, he chased his son
up a tree, slipped on a branch, and fell, breaking the 2nd cervical vertebra in his neck. As a
practitioner, he had often wrestled with “the system” to ensure that his patients received
1
Quote taken from e-mail correspondence, January 1999.
2
For reference: “Decoding the DNA of the Toyota Production System” by S. Spear and K. Bowen,
Harvard Business Review, September/October, 1999.
Visiting Scholar John Kenagy, M.D. and Professor Steven J. Spear prepared this case as the basis for class discussion
rather than to illustrate either effective or ineffective handling of an administrative situation. Names and financial
numbers have been disguised.
Copyright © 2000 by the President and Fellows of Harvard College. To order copies or request permission to
reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to
http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used
in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or
otherwise—without the permission of Harvard Business School.
1
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the care they needed, when they needed it. As a patient, Carter found that the system was
filled with people who were as highly committed to patient care as he was, if not more so.
Time and again, nurses, doctors, aides, technicians, and administrators went to heroic
lengths to make sure that he was well treated. Yet, able to see his situation as a patient
from the perspective of a trained clinician, Carter knew he had experienced many,
uncomfortable close calls.
Carter returned from his hospitalization and recovery, looking for a better way to
manage health care. He spent the next five years -- now as an executive in a health care
delivery system -- pursuing better top-down management approaches such as incentive
alignment through integrated management systems and exploring public policy options for
oversight and regulation. Yet, for all his effort and that of those with whom he worked, he
saw no lasting changes. Finally, he decided to look outside of health care for proven
management methods, spending two years in a largely self-funded quest. The work at
Deaconess-Glover was his chance to demonstrate the opportunity generated by his two
previous years of intellectual prospecting.
Dalton and Bonenfant had significant stakes in this process too. Deaconess-Glover
was a 41-bed community hospital that had lost $2.7 million in the previous 12 months (See
Exhibit 3 for DGH’s summary statements of operations). CareGroup, the 1,500 bed system
of which DGH was part, had lost nearly $100 million in the same period (See Exhibit 4 for
CareGroup’s summary statements of operations). CareGroup’s CEO, James Reinertsen,
M.D., had enlisted Deaconess-Glover to be CareGroup’s test site, the first facility to learn
how to interpret Toyota Production System principles for the health care context.
Reinertsen and his senior management team had been persuaded that if CareGroup
mastered Toyota Production System principles, then it might provide higher quality care at
lower cost relative to its rivals, just as Toyota had demonstrated sustained and superior
quality, cost, and lead-time over several decades in automobile manufacturing. If
Deaconess-Glover met success, it would become both a showcase and the source of teachers
for the rest of the CareGroup system. There was an added imperative. After volunteering
Deaconess-Glover as the pilot, Dalton and Bonenfant agreed to have a portion of their
incentive compensation tied to the experiment’s outcome.
Reinertsen and Dalton invited Carter into CareGroup and Deaconess-Glover because he
brought two useful perspectives to the exercise. His many years of experience as a vascular
surgeon and as a health care manager meant that the Deaconess-Glover and CareGroup
environments were familiar to him. In addition, Carter had worked closely with TPS
experts over the previous year. They had helped him view the Toyota Production System as
more than a collection of specific production tools. Rather, he had begun to understand TPS
as an integrated approach to designing and improving the work of groups of people engaged
in collaborative effort. Carter could now test his understanding of the theory in actual
practice. It was time to see if Carter’s investment of time and Dalton and Bonenfant’s
willingness to take a significant professional risk were going to pay off.
Deaconess-Glover Hospital
Glover Memorial Hospital began serving the Needham community as a general-purpose,
town-owned facility in 1909. In the 1980s, Glover began to encounter financial difficulty, as
did much of the rest of the health care industry due to the switch from cost-plus payments
to “Diagnostic Related Groups” which put a cap on the amount hospitals would be
compensated per treatment. While medical science and technology had created many more,
increasingly complex, and ever more costly tests and treatments, and while demand on the
2
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Deaconess−Glover
Hospital (A)
Case
101
Companies, 2004
601-022
system had increased with a gradually aging, growing population, public and private
reimbursement rates weren’t keeping pace with rising costs.3
To control expenses, the Town hired the Hospital Corporation of America to provide
professional management. Despite pioneering efforts in Deming-inspired Continuous
Quality Improvement, Glover’s financial situation had not improved sufficiently, however.
Two weeks after joining Glover as its administrator in 1991, John Dalton learned that
the Town of Needham wanted to privatize the hospital. Since Glover lacked access to
needed capital, and because Glover retained strong support from its staff, its affiliated
physicians, and the surrounding community, a merger between Glover and a larger hospital
seemed most promising. This was especially true because the health care market in the
greater Boston area was consolidating.
In 1994, Deaconess Hospital, a large, Harvard-affiliated teaching and research
institution purchased Glover, agreeing to keep it open for at least five years as part of
Deaconess’s community-based, clinical network. Two years later, Deaconess merged its
system with that of the Beth Israel Medical Center, another large, Harvard-affiliated
teaching hospital. The combination, named CareGroup, was a 6-hospital network based in
Eastern Massachusetts, which employed 13,000 people, and had a 2,000 person medical
staff. Reinertsen, who became head of CareGroup in June 1998, and his senior management
team were working diligently to make CareGroup the premier system. Yet, it was caught in
a sea of external and internal problems that became more intense with almost daily
revelations in the media about the financial tribulations of the US health care system.
Finding A Model Line
In the first several weeks of his engagement, Carter’s primary objective was to identify a
site within Deaconess-Glover that had high potential for a model line. Just as DeaconessGlover was to be a test site within CareGroup, the model line would be a place where small
tests in applying TPS to health care could be performed. These tests would be the basis for
propagating these discoveries throughout Deaconess-Glover. Carter examined several areas
within the hospital including the Radiology and Emergency Departments, the Pharmacy,
and the Ambulatory Surgery, Gastrointestinal, and the “South Two” medical-surgical
inpatient units. In each, he spoke to members of the staff for a broad overview of what they
did individually and what their unit did overall before making detailed observations of how
work was done in practice.
Gastrointestinal Unit
In the Gastrointestinal unit (GI), Carter met with Dr. Greg Stoller, the gastroenterologist
who performed endoscopies and colonoscopies, Anita Hansen the unit’s senior nurse and
manager, Janice Gibb, a staff nurse, and Hannah Seltzer, an endoscopy nurse.
Beyond talking to the GI staff, Carter directly observed the work of the group by
following patients through a medical procedure. In one case, on August 24th, Carter met a
patient, Edward Bennett, in the admitting area at 8 AM. Mr. Bennett had been having
trouble swallowing food and Dr. Stoller was going to use an endoscope to investigate for
3
For reference: “The Structure of the Health Care Industry,” Harvard Business School Publishing,
9-196-049, by Ann Winslow and Regina Herzlinger, 1995 and “The Financing of the U.S. Health
Care Industry,” Harvard Business School Publishing, 9-196-095, by Winslow and Herzlinger, 1995.
3
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Companies, 2004
abnormalities in Mr. Bennett’s esophagus and stomach that might explain his symptoms.4
Carter followed Mr. Bennett in the prep room, stayed with him during the GI procedure in
the examination room, and joined him in the recovery area where Bennett rested until the
anesthesia wore off by 11 AM. Throughout, Carter noted who was doing what and when,
trying to record both the physical activities that were occurring and also the information
exchanges that were taking place among the different members of the GI staff and the
patient, on a minute-by-minute basis.
Carter saw that much of the information was situational. For example, some weeks
before, Mr. Bennett had had a similar procedure performed at a nearby, non-CareGroup
hospital. Due to the physical discomfort, uncertainty about the procedure, fear of the pain
he might experience, and concern about his condition, based on his previous experience with
the procedure, the 53-year old father of three was extremely anxious on the morning of his
Deaconess-Glover examination. Mr. Bennett’s anxiety caused the medical team to be
concerned with more than his physical condition. His emotional condition was an equally
pressing concern, affecting the amount of Valium-like sedative he would need and the
amount of agitation for which the team had to be prepared.
After Stoller completed Mr. Bennett’s procedure, Carter observed Hannah5 preparing
the examination room and equipment for the next patient and noted Anita’s procedures for
admitting, discharging, and record keeping. Carter generated a profile of the mix of
procedures that were performed in the unit and the frequency with which each had been
performed over the course of that day and that week. The purpose of this was to
understand better the actual needs of the unit’s patients and the demands these needs
placed on the work group.
This was one of several ways in which Carter’s process of making observations
reflected the professional norms of those with whom he was working. Within the hospital,
patient care was repeatedly held up as the primary priority. Similarly, Carter’s TPS
mentors routinely observed the work done in factories by starting at the shipping dock.
They started there to understand the mix, volume, and timing with which customers
expected to receive deliveries. Understanding customer expectations served as a prelude to
studying how and how well the processes within the plant met customers’ expectations.
South Two Medical/Surgical Inpatient Care Unit
During his initial study across several areas in the hospital, Carter familiarized himself
with the South Two inpatient care unit. Just as he had tried to understand the working of
the GI unit on a representative day, he approached South Two in the same way. South Two
patients were either being treated for an illness (medical patients) or were recovering from
an operation (surgical patients). The unit had 34 beds. By reviewing unit records, Carter
learned that over the previous month, the “census” had varied between 19 and 31 with an
average count of 24. Patients could be admitted by one of the more than 100 doctors who
had full staff privileges. Physicians with privileges were allowed to admit patients to the
hospital and to provide and to prescribe active care. Though some of the doctors who had
privileges were employed by the hospital directly, most were part of professional practices
independent of the hospital. A large portion of these doctors had privileges at more than
one hospital so could admit and treat patients where they saw most fit.
4
An endoscope is a long, narrow, rubber coated instrument with camera lenses on one end and
controls and video monitor connections on the other.
5
The narrative in this case follows the hospital’s convention by which nurses go by their first
names, doctors by their professional title and surname, and patients by their title and surname.
4
POM Cases
Deaconess−Glover
Hospital (A)
Case
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Companies, 2004
601-022
On August 24th, Carter arrived at Deaconess-Glover at 6:45 AM so that he could
observe the end of the night shift (11 PM - 7 AM) and the beginning of the day shift (7 AM 3 PM). He joined the nurses in their break room from 7 AM to 8 AM. There, the three nightnurses reported on patient conditions to the five day-shift nurses.
Carter learned from the nurses that while they were in the hospital, patients were
usually visited by their doctors twice in a day, during morning rounds and during evening
rounds. The bulk of the patients’ 7-day, 24-hour ongoing care was provided by South
Two’s nurses. Organized in three shifts, the nurses assessed patients’ conditions,
developed care plans, and administered medications and other treatments. They also
evaluated results, responded to emergencies, changed dressings, helped with meals, bathed
patients, and provided the support and information patients and their families needed
during what was a stressful experience. According to the unit’s staffing charts, the typical
day shift (7 AM to 3 PM) had five nurses, the evening shift (3 PM to 11 PM) had four, and
the night shift (11 PM to 7 AM) had three. Carter saw that staffing levels on each shift had
been adjusted based on the number of patients and the severity of each patient’s condition.
Because of days off, part time work loads, vacations, and sick days, the number of nurses
associated with South Two was actually double to triple the daily staffing level.
The day shift began when Arlene Wassel, the day-shift “charge nurse,” assigned each of
the 26 patients to one of the five day-nurses. (“Charge nurse” was not an official managerial
position. Rather, responsibility for making assignments was circulated among the more
senior nurses on an informal basis.) Working from a patient roster and from her own
knowledge of each patient’s condition, Arlene assigned patients to nurses based on each
nurse’s skill and interests and based on the acuity of each patient’s needs. For instance,
some nurses tended to be more comfortable with medical patients while others preferred to
work with surgical cases.6 Arlene explained that she knew many of the patients because
they had been on the unit the previous day (average stays were about 4 1/2 days).
However, before making assignments, she gathered information about those who had been
admitted during the evening and night shifts.
After Arlene made assignments, the night nurses began to exchange information with
the day nurses for the purposes of assessment and treatment. While the patients’ medical
charts contained quantitative information, there were unique anecdotal factors that were not
communicated on standardized forms. For example, two nurses discussed Mr. Howard’s
situation.
A veteran of World War II, Howard had run a family-owned hardware store in
Needham for thirty-seven years, raised a family, and was a long time Boy Scout leader.
Recently, suffering from progressive dementia, the nursing home resident had been having
trouble eating. This had left him weak, dehydrated, and in need of more active care than
the nursing home could provide. In addition to his medical issues, the night-nurse, Diane,
explained to her day-shift replacement that Mr. Howard kept misplacing his box of TicTacs®, and this caused him anxiety and mild distress. Furthermore, Diane had realized
that he only had one candy left. She tried the vending machine, but it didn’t sell the mints.
Diane called a day-shift colleague who bought a supply on her way to work. Diane
explained that she had put the Tic-Tacs® under Mr. Howard’s pillow so that he could find
them easily.
Carter saw that during the hour, nurses repeatedly left and returned to the room in
which report was being given. He followed several nurses and realized that even during
6
Before Dalton joined Glover Memorial, the surgical care unit and the medical care unit had been
separate entities.
5
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report, they continued to care for patients. In one instance, a day nurse, Cindy, responded
to an equipment buzzer. A pump that provided painkiller intravenously to a postoperative patient, Mrs. Gould, had stopped and needed to be reset.
After the night-shift finished its report, the day nurses reviewed the specific needs for
each patient in the KARDEX, a loose-leaf binder containing a sheet for each patient that
outlined treatment requirements such as dressing changes, special feeding instructions, etc.
Each nurse made notes on a “cheat sheet” that she carried as reference throughout the day.7
After the morning report, Carter spent 30 minutes observing the front desk nurses’
station. Here, doctors and nurses reviewed and modified patients’ charts, Denise -- the unit
secretary -- took calls, social workers reviewed records, and doctors phoned in instructions
that had not been communicated during rounds. For example, after making her own rounds,
a nurse had phoned the admitting-physician with questions about a patient’s treatment.
Carter watched as the receptionist received the return call from the physician and found the
nurse who had made the request.
On a second visit to South Two, Carter observed activity in the five-foot by seven-foot
Medication Room. Each patient had an individual drawer or cassette in which a day’s
worth of medication was kept. Each cassette was stored in one of two cabinets on wheels,
and with each cabinet was a loose-leaf binder that contained the Medication
Administration Record (MAR) for each patient. Carter saw that nurses would come to the
“med room,” transfer information from the MAR to their cheat sheets, and then stage
dosages of several medications that had to be administered at the same time in a disposable
paper cup. For instance, when asked what she was doing, one nurse explained that she was
putting together all the medications that had to be given at 9 AM in one cup, and all those
for 1 PM in another. While nurses were “pouring meds,” as this activity was called, other
nurses would look in, and if the room was crowded, they would move onto another activity
before returning to do their own medication staging.8
The Pharmacy
Carter also made observations in the pharmacy as he initially familiarized himself with
Deaconess-Glover. On September 8th, at 8 AM, he met Denise, the pharmacy technician,
Carol -- one of the registered pharmacists, and Dan Carpenter, also a registered pharmacist
and the unit’s manager. Carter started by watching Denise prepare intravenous medications
for patients in both South Two and also in the Intensive Care Unit.
Denise reviewed medication orders sent to the pharmacy on “Green Sheets.” She
explained that each Green Sheet was the 3rd copy of an order written by a doctor during
rounds or by a nurse after discussing a patient’s condition with a doctor on the phone. The
Green Sheet had information for a new or modified prescription. For those who had been at
Deaconess-Glover the day before, Denise modified the Pharmacy’s Patient’s Medication
Record (PMR) for intravenous medications. For those admitted during the evening or night
shift, Denise created a new PMR. Using each patient’s PMR for reference, Denise labeled
7
On a separate visit, Carter observed another shift-change activity, counting the narcotics locked
in South Two’s medication room. A nurse completing a shift and a nurse starting on the next shift
reviewed the entire narcotics inventory and compared that to the narcotics-use record. No nurse
could leave until all narcotics issues were reconciled and verified. Once the counts were reconciled,
a “White Sheet” was completed and sent to the pharmacy.
8 Carter noted variation in this activity. Some nurses staged medications for the entire day,
whereas others returned to the Medication Room every two hours for the next round of doses.
6
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the medications and staged them on a cart for delivery that day. As she took the IVs from
the freezer, refrigerator, or cabinet where they were stored, she noted those for which the
inventory was running low so that a replenishment order could be made later that day.
After watching Denise perform her work, Carter observed Carol do her work. She
started by updating a separate set of Patient Medication Records based on Green Sheets
that had been delivered to the pharmacy during the evening and night shifts. Then, at 10
AM she left the pharmacy and went to South Two’s medication room to reconcile her PMRs
with the Medication Administration Records kept there. After returning to the pharmacy,
she began withdrawing dosages for each patient from one of the 600 containers that were
kept on three shelves -- each fifteen feet long, and placed these blister-pack wrapped pills
and tablets in the patient’s cassette along with other prescribed medications such as eye
drops and syrups.
In several cases, Carol had to inform nurses that a particular medication needed special
attention. For example, in watching Carol do her work, Carter learned that the pharmacy
had 20 mg tablets of a certain drug, but the physician had prescribed a 10 mg dose. Carol
affixed a red adhesive label to the pill’s blister pack so that the nurse would know she had
to divide the tablet in half before giving half to the patient and disposing of the other half.
Carol said that she was trying to complete the filling of all the cassettes by 1:00 PM so that
she could wheel two cassette carts to the medication room in South Two and another to the
intensive care unit and collect the previous day’s carts.9
Medication Administration on South Two
After this overview of the hospital, Dalton, Bonenfant, and Carter decided to focus
their efforts. They chose not to concentrate on a particular department or unit -- Radiology
for instance -- but instead opted to test the application of the Toyota Production System to
a specific process, medication administration, in the South Two inpatient-care unit.
Medication administration was the process that delivered pharmaceuticals to patients
on a seven-day, 24-hour per day basis. Carter noted that on October 28 South Two’s 23
patients required as few as three and as many as 17 medications (See Exhibit 5 and Exhibit
6). The drugs varied by physical form (pills, tablets, intravenous solutions, topicals, etc.),
by administration timing (every 2, 4, 8, 12, 24, or 48 hours or on an as needed basis), and by
other criteria (i.e., with or without food). Carter had learned from his earlier observations
that several people were involved in the prescription, delivery, and administration of the
drugs, and in the pre-treatment and post-treatment evaluation of the patients. These
included nurses, doctors, pharmacists, and technicians with various specialties.
Though medication administration crossed the boundary of two areas of the hospital -the pharmacy and the medical/surgical recovery unit, it offered several advantages for the
purposes of the TPS implementation experiment. Medication administration directly
affected the quality and cost of patient care. Mis-medication could delay or compromise a
patient’s well being, yet the process didn’t automatically work well. National studies
estimated that getting the prescribed medication to patients in the correct form and
9
The pharmacy delivered several classes of medications. One group included those supplied on a
patient by patient basis, such as those just described. Second were narcotics delivered in response to
“White Sheet” orders. Other medications were supplied on a restock basis, and were ordered on
“Pink Sheets,” department by department. In South Two, for instance, certain saline solutions were
stocked in the medication room so they would be available immediately as needed.
7
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quantity, and at the right time, had error rates in the parts per hundred. 10 To reduce the
error problem, computerized prescription tracking and drug dispensing technologies were
being installed across the country, and CareGroup was an early adopter of these in some of
its facilities.
Material and Information Flows: Day-Shift
Once South Two had been picked as the site for the learning unit, Carter studied the
medication administration process more closely. His TPS mentors had emphasized
repeatedly that before he made any changes he had to understand the “current condition,”
how the process actually worked. As a first step, he had to know what goods and services
were provided to the patient, and how the organization produced and delivered each of
these goods and services. To gain this information, Carter waited at a patient’s room until
the patient’s nurse came to administer medication. After the patient received the various
doses, Carter asked the nurse how she had been supplied. He learned that the nurse had
taken two medications from the patient’s cassette which was stored in the medication cart
in the medication room. A third medication had been delivered directly to the nurse by the
pharmacist an hour earlier. Since he had already observed the pharmacy’s work during the
earlier portion of his study, Carter knew that the medication cart was delivered once per
day to South Two and that throughout the day, the pharmacy made additional deliveries
because of changes in patient medications created by new prescriptions.
Having made observations that established from whom to whom and from where to
where medication was transferred on its journey from the pharmacy to patient, Carter then
began a second step in grasping the current condition. He had determined the basic flows of
material characteristic of the medication administration process. Now Carter tried to
determine the basic information flows characteristic of the process, trying to determine how
people knew what to transfer, to whom, when. Therefore, as his second step in grasping the
current condition, Carter followed an order from when it was prescribed until when it was
delivered. He did this by following a doctor during rounds until the doctor revised a
patient’s prescription. This first occurred at 8:10 AM. Carter continued to follow the
doctor through the rest of her rounds and to the nurse’s station. There, she wrote the new
orders into the patient’s chart. 11
Next, Carter watched how that specific medication order was actually picked up and
delivered. The patient’s nurse saw the physician fill out the medication order sheet, so she
went immediately to the chart and separated the medication order into its three parts. The
10 According to the report To Err Is Human: Building a Safer Health System, medical errors k i l l
44,000 to 98,000 people in U.S. hospitals each year, a total greater than the deaths attributed to
highway accidents, breast cancer or AIDS. Medication errors specifically are responsible for 7,000
deaths per year, more than those due to workplace injuries. -- From the press Release for To Err Is
Human: Building a Safer Health System; L. Kohn, J. Corrigan, and M. Donaldson, Editors;
Committee on Quality of Health Care in America, Institute of Medicine; 2000
11
The patient “chart” was a large, maroon, three ringed binder and served as a primary medium
through which doctors and other health team members communicated. For example, if the doctor
examined a patient and decided the patient needed to get a particular medication every four hours,
the doctor would write that instruction in this three-ring binder and would then put the binder back
on the shelf.
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top copy remained in the chart, the middle copy was pasted into the MAR, and the third
copy, the Green Sheet, was sent to the pharmacy. 12
Carter observed that the Green Sheet for this particular order was placed in the nursing
station’s outbox, and a few minutes later, it was collected by Denise, the pharmacy
technician. At the same time, another nurse reminded Denise of a different patient who had
a change in medication requirements. Carter trailed Denise to the Intensive Care Unit, and
then back to the pharmacy where she gave the Green Sheet at 9 AM to Carol who was in the
midst of dispensing medications. Since the drug was needed before the filled medication
cart was to be delivered to South Two’s medication room, Carol placed the requested drug
dosage in a plastic bag that was labeled with the patient’s name and the drug’s names. She
gave this bag to a community volunteer who came to the pharmacy at 10:15 AM to take it
back to nursing station inbox at South Two. There, the nurse collected the medication from
the inbox at 10:30 AM and gave it to the patient at 10:35 AM.
Having followed one medication from when it was prescribed at the patient’s bedside
until it was administered to the patient, Carter followed a second prescription.
Mrs. Donaldson, one of Dr. Whestney’s patients, was complaining of gastrointestinal
symptoms, for which Whestney prescribed a 20 milligram dose of Prisolec. Whestney did
this by completing an order sheet and adding it to the chart. A few minutes later, Mrs.
Donaldson’s nurse, Arlene, read the new instructions and placed the Green Sheet copy in
the outbox and also started to add the order to the patient’s Medication Administration
Record. As she was recording this information in the MAR, she realized -- based on her
considerable experience -- that Prilosec was no longer part of the hospital’s formulary and
that it been replaced by Previcid, which was available in 15 milligram doses. 13
Though the Green Sheet had been collected, Arlene found Miriam, another pharmacist,
who had come to South Two to reconcile the pharmacy’s Patient Medication Record with
South Two’s Medication Administration Record. Miriam offered to return with two tablets
of Previcid so that if Dr. Whestney wanted either 15 mg or 30 mg given to Mrs. Donaldson,
Arlene would be prepared. In the meantime, Arlene called Dr. Whestney, confirmed that 15
mg was sufficient, and so was able to administer the drug to the patient at 9 AM when
Miriam returned to South Two.
Summary of Findings
After watching how the medication administration process occurred in actual practice,
Carter summarized his findings in a hand-drawn diagram (the version for South Two’s day
shift is replicated in Exhibit 7). He started by indicating the different participants in the
process: the patient, the doctor, the nurse, the pharmacist, and the volunteer. Then, he
indicated who communicated with whom and the way in which information was
communicated. For example, his diagram captured the observation that doctors learned
about patients’ conditions by direct examination during rounds or from information
12
Carter observed several ways in which nurses knew that something has been changed in t h e
chart. The doctor “flagged” the chart by flipping the color tag on its spine from green to red; t h e
doctor verbally told the patient’s nurse that a change had been made; or the nurse went to check i f
there was anything new in the book even if the flag-color had not been changed.
13
The medications kept in stock comprised the hospital’s “formulary.” Because identical drugs
existed with different brand names, and because different drugs might have had identical uses, i t
was possible for a doctor to prescribe a medication that was not in the formulary, and so was not
available in-house.
9
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Companies, 2004
gathered by nurses and communicated in medical charts, by face to face verbal
communication, or by phone. Carter included in his diagram his observations that
information about prescriptions was communicated from doctors to nurses through
information in the chart, in face to face conversation, or over the phone. He added the
different ways in which the pharmacy learned that a patient needed medication. These
included the various forms such as Green Sheets for specific prescriptions, White Sheets for
narcotics orders, and Pink Sheets for medications kept in stock in South Two. He added
the face-to-face and phone conversations that he had noted, and also the PMR/MAR
reconciliation done by Carol, the pharmacist, each morning and the calls the pharmacy
made to South Two for clarification of a hard-to-read Green Sheet entry.
Having indicated how requests were communicated between those who needed
something and those who would provide it, Carter then showed how suppliers responded.
His diagram showed that medications arrived to South Two from the pharmacy in the
medication cart, through the efforts of a volunteer, or when a pharmacist came to the floor,
as Miriam had done with Mrs. Donaldson’s Previcid. Carter’s illustration showed the
complete loop by indicating that it was the nurse who administered each medication.
Carter’s detailed description of South Two’s medication and information flows showed
who was involved in the medication administration process, what each person was
exchanging/communicating with the other, where these exchanges took place, and how they
were exchanging medications and communicating information. Because these information
flows contained instructions of what to do, the diagram suggested why people did certain
activities. The final element of the diagram indicated the time element, when events
occurred. Carter indicated when the doctor examined the patient, when the prescription
was entered in the chart, when the Green Sheet was detached and placed in the outbox,
when the sheet was picked up and delivered to the pharmacy, etc. on the drawings he made
for each specific medication administration observation.
Medication Administration: Evenings and Nights
For both the evening and night shifts, Carter repeated the process of following a
medication from when it was prescribed until when it was administered. He discovered
differences in the nature of orders made during these shifts and how orders were
communicated to the pharmacy and how a delivery was made back to South Two.
The nature of the orders differed in the following way. During the day, the pharmacy
prepared the patient-cassettes with a day’s worth of medication. During the evening and
night shifts prescriptions were for newly admitted patients or were adjustments in the
medication for a continuing patient. In both cases, medication delivery was for several
hours, not for an entire day. The form in which orders were handled differed because the
pharmacy was not staffed during evening and night shifts.
Therefore, it was the
responsibility of the shift’s nursing supervisor to bring Green Sheets to the pharmacy and
distribute the ordered medications to South Two. The Green Sheets were left until the next
day, at which point the information was transferred into the PMR. The medication was
carried back to South Two by the nursing supervisor so that it could be administered to the
patient. Beyond the description just given, these differences are not detailed further in this
case. However, as part of Carter’s effort to understand the medication administration
process, he generated a separate set of summary diagrams and analysis.
Observing the Work of a Nurse
In tracking medications from when and where they were prescribed to when and where
they were administered, Carter identified each person who had played a role. Therefore, he
10
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601-022
was able to document the particular pathway over which specific prescriptions traveled.
He was also able to observe how information and materials were exchanged among the
members of the health care team. In an additional set of observations, Carter sought to
learn about the work of the specific people who played a role in the process as part of his
larger effort to grasp the current condition of medication administration. He approached
this portion of the study by following an individual nurse for 60 minutes and recording -- on
a minute by minute basis -- where she was, what she was doing, with whom she was working,
and what was being said. (Exhibit 8 displays the table Carter generated from observing one
nurse on the day shift). To be sure that his observations were representative, Carter
repeated this activity with another day-shift nurse and with nurses on the evening and night
shifts. He then shared his findings with the nurses he observed and with other members of
the nursing staff to confirm the validity of his observations and the way he had represented
them.
Carter’s impression, which was confirmed when he reviewed his detailed records of his
observations, was that the nurses were blizzards of activity. For example, the nurse whose
work is documented in Exhibit 8, cared for five patients in three rooms during her shift. In
the hour that Carter observed her, Cindy worked in eight locations (patient rooms 237, 238,
and 239; the hall phone, the kitchen area, the nurses’ station, the medication room, and the
supply closet). In the hour, she moved among these 8 locations 22 times, and she spoke inperson or on the phone with 15 different people. For example, she spoke with the five
patients for whom she was caring, both to assess their condition and to provide information
and reassurance. Cindy discussed the condition of an elderly patient with the patient’s
daughter, explaining the follow up home care the mother would need after being discharged
from the hospital. Cindy traded information with five other South Two nurses, a hospice
nurse, and a nursing aide. She also spoke by phone with two doctors and their receptionists
in order to get clarity on the treatment two patients were to receive.
Carter asked the South Two nursing staff to define the function of a nurse and they
uniformly described it as “assessing a patient’s needs, developing a care plan, implementing
the care plans, administering treatments, evaluating the results, and otherwise attending to
the care of the patient.” In reviewing his minute by minute observations, Carter noted that
in the hour he had recorded, the nurse had spent two thirds of her total time locating
information and gathering the materials necessary to do the value-adding nursing work that
was described as a nurse’s job. Carter found that all the nurses he observed spent between
one-half and two-thirds of their time occupied by other activities that were necessary to do
value added nursing. To communicate these findings to other people, Carter summarized
his observations in hand-drawn diagrams that are reproduced in Exhibit 9.
Completing the Current Condition: Who Cares for Whom?
In his first step at understanding the current condition of the medication administration
in South Two, Carter had traced specific pathways over which prescriptions and
medications traveled, documenting flows of information and medication among those
making requests and those generating responses. That resulted in the diagram in Exhibit 7.
In his second step at understanding the current condition, Carter studied the work of
individuals who performed activities on the pathway over which prescriptions and
medications traveled.15 In the third and final step of understanding the current condition,
Carter tried to determine the number of distinct pathways over which prescription requests
and medications traveled. To do this, he obtained the sheet on which nursing assignments
were recorded. This document, reproduced in Exhibit 10, showed each patient (indicated
by room number), the patient’s doctor, and the nurse on each shift -- day, evening, and night
15
Activity studies were done in the pharmacy, though they are not reproduced in this case.
11
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-- who was assigned to that particular patient. Carter re-expressed that document
diagrammatically, as in Exhibit 11. He did this to show, pictorially, who had to speak with
whom about a patient’s condition, not only during a shift but across shifts as well.
Recommending a Next-Step
Carter had consolidated his findings on an 11x17 sheet of paper for the meeting with
Dalton and Bonenfant. He included background information about the underlying business
case for CareGroup, Deaconess-Glover, South Two, and the medication administration
process, and included the three summary diagrams he had developed. (See Exhibit 12)
Carter used this document to explain to Dalton and Bonenfant how he had studied
medication administration and what he and the front line team had observed. He explained
that he had confirmed his observations with members of the nursing and pharmacy staff.
Though the presentation was punctuated by questions, neither Dalton nor Bonenfant took
exception to Carter’s description of how this critical patient-care process actually occurred.
Carter was bolstered by their evident interest in what he had done and their obvious
agreement with his findings. After thirty minutes, Carter concluded the first portion of the
presentation. He then drew in his breath and began explaining the next step he and the TPS
experts had designed. Eager to learn Dalton and Bonenfant’s reaction, Carter presented the
diagram for the “target condition,” the first step for implementing the Toyota Production
System in South Two’s medication administration process.
12
Pharmacy
Emergency Department
Safety and Risk Mgt.
Medical Records
Volunteers
Clinical Education
Occupational Health
Intensive Care
Rehabilitation Services
Cardio-pulmonary services
Diagnostic Imaging
(Radiology)
Infection Control
Medical day care
Telecommunications
Materials Mgmt.
Facilities
Information Srv
Budget and
Reimbursement
Food Srv/Housekeeping
Managed Care Contracts
In-house MDs
Anesthesia
Patient Registration
Patient Acct.
Marketing/Planning
Community Development
General Acct.
Laboratoy
Accounts Payable
Treasurer/CFO
Case
Cont. Quality Imp.
Utilization Review/
Quality Assurance
Medical Library
Hospital Aid Association
Medical Staff Office
Social Service
Oper. Rm./
Post Anesthesia Care/
Same Day Surgery
Joint Committee on
Accreditation
Medical Staff
President and CEO
John Dalton
Deaconess−Glover
Hospital (A)
Ambulatory clinic
Medical/Surgical Unit
Vice President
Patient Services
Julie Bonenfant
Human resources
Vice President
Board of Trustees
President and CEO
John Dalton
Exhibit 1: Organizational Chart - Deaconess-Glover Hospital
601-022 -13-
POM Cases
Companies, 2004
111
Beth IsraelDeaconess
Medical Center
DeaconessGlover
Hospital
DeaconessWaltham
Hospital
General
Council
Chief
Financial Off.
Chief
Medical Off.
Chief Med.
Info. Off.
SVP-Development
SVP-System Development
and Communications
SVP-Human Resources
EVP-External Affairs
Deaconess−Glover
Hospital (A)
DeaconessNashoba
Hospital
New England
Baptist Hospital
CareGroup CEO
POM Cases
Mt. Auburn
Hospital
Exhibit 2: Organizational Chart - CareGroup
601-022 -14-
112
Case
Companies, 2004
Increase in unrestricted net assets
Transfers from (to) affiliates
Change in net unrealized gains on investment
$1,068
3,800
(4)
(2,728)
88
26,285
14,196
9,936
1,122
874
69
Deaconess−Glover
Hospital (A)
Deficiency of revenue over expenses
Expenses
Salaries and benefits
Supplies and other expenses
Uncompensated care
Depreciation
Interest
Restructuring expenses
Year 2000 Expenses
Twelve months ended: Sept 30, 1999
(in thousands)
Unrestricted revenue, gains and other support
Net patient service revenue
$22,416
Research Revenue
Contributions, investment income, gains
103
Other revenue
1,038
$23,557
Exhibit 3: Consolidated Statements of Operation: Deaconess-Glover Hospital
601-022 -15-
POM Cases
Case
Companies, 2004
113
($89,718)
($104,121)
(20,054)
403
(50,134)
(34,336)
Case
Decrease in unrestricted net assets
Transfers from restricted funds
5,354
2,129
Net assets released from restrictions used for
purchase and sale of property and equipment
Extraordinary loss on advance refunding of long-term debt
2,746
Change in net unrealized gains on investment
(99,947)
1,235,734
638,170
376,229
85,606
95,506
40,223
Deaconess−Glover
Hospital (A)
Deficiency of revenue over expenses
711,868
406,471
76,958
97,633
40,723
18,486
14,763
1,366,902
POM Cases
Expenses
Salaries and benefits
Supplies and other expenses
Uncompensated care
Depreciation
Interest
Restructuring expenses
Year 2000 Expenses
Twelve months ended: Sept 30, 1999
Sept 30, 1998
(in thousands)
Unrestricted revenue, gains and other support
Net patient service revenue
$987,871
$963,626
Research Revenue
105,114
88,169
Contributions, investment income, gains
63,188
69,447
Other revenue
110,782
80,156
$1,266,955
$1,201,398
Exhibit 4: Consolidated Statements of Operation: CareGroup
601-022 -16-
114
Companies, 2004
Patient
229 A
233 A
236 C
244 A
230 B
231 A
233 B
234 B
237 A
239 A
232 A
232 B
234 A
235 B
240 B
241 A
238
239 C
241
243
243 B
244 B
242 B
Nurse
RN A
RN A
RN A
RN A
RN B
RN B
RN B
RN B
RN B
RN B
RN C
RN C
RN C
RN D
RN D
RN D
RN E
RN E
RN E
RN E
RN E
RN E
RND
MD
MD 1
MD 5
MD 7
MD 13
MD 2
MD 3
MD 6
MD 4
MD 1
MD 9
MD 4
MD 7
MD 1
MD 2
MD 2
MD 12
MD 8
MD 10
MD 11
MD 1
MD 9
MD 5
MD 9
Med 1
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V
E1
WW
G
I
c2
AA
AA
f1
b1
s2
rr
g2
bb
xx
mm
Y
HH
W
hh
v1
e2
d1
p1
a2
o2
t2
e3
j2
I
nn
b3
H
T
LL
mm
a3
G
S
aa
ww
d
X
GG
XX
gg
u1
P
c1
o1
z1
n2
d1
M
i2
Med 5
Med 4
AA
Z
JJ
RR
e1
r1
q2
v2
f3
p1
HH
w1
X
q1
p2
u2
p1
h1
r2
w2
f1
x2
g1
BB
L
PP
rr
Med 9
f1
h1
CC
M
QQ
RR
Med 10
AA
j1
DD
N
G
ss
Med 11
y2
O
RR
gg
Med 12
p1
VV
SS
5 others
Med 13
TT
Med 14
Deaconess−Glover
Hospital (A)
x1
ee
a1
K
J
dd
zz
OO
qq
Med 8
NN
pp
Med 7
cc
yy.
AA
B
II
MM
oo
c3
I
Med 6
Exhibit 5: Medications prescribed for each patient in South Two on October 28th, 1999
601-022 -17-
POM Cases
Case
Companies, 2004
115
a2 trimacinalone cream
b2 Zestril 5
c2 Glyburide 2.5
d2 Toprol XL 200
e2 Diltiazem CD 300
f2 Gentamycin 240 IV
g2 Cosyn 3.375 IV
h2 Demerol 50 IM
I2 Vistaril 25 IM
j2 Ventolin 1 puff
l2 Acuolate 20
m2 Solumedrol 60
j1 Compazine 5 IM
k1 Vasotec 15
l1 Levoxyl 0.112
m1 Cardizem 120
n1 Lopressor 25
o1 Darvocet
p1 APAP 650
q1 Motrin 450
r1 Nitroglycerine SL
s1 Thiamine
t1 Effexor 37.5
u1 Nadolol 20
v1 Casopt ophth
w1 Aphagan ophth
x1 Dexicidin ophth
y1 Kefzol 500 IV
z1 Clotriamzole cream
a1 Vanceril 2 puffs
b1 Zoloft 25
c1 Lanoxin 0.125
d1 Metoprol 25
e1 Quinine SO4
f1 KCL 20 mEq
g1 Hydralazine 10
h1 Ambien 5
a3 Gentamycin 120 IV
b3 Kefzol 1 gm IV
c3 Metronidazole 500
d3 Gentamycin 160 IV
e3 Clindamycin 600 IV
f3 Dakins solution
n2 Humabid 1200
o2 Zithromax 250
p2 Heparin 5000 SQ
q2 Albuterol nebulizer
r2 Xanac 1
s2 Vitamin C 500
t2 Capoten 37.5
u2 Hydralazine 25
v2 Prednisone 30
w2 Ampicillin 1 gm IV
x2 Erthromycin ophth
y2 KCL 40-80 mEq
z2 ZnSO4 220
Deaconess−Glover
Hospital (A)
ll Zinc 50
mm FeSO4 325
nn Colace 100
oo Lactulose 300
pp Folate 1 mg
qq Vancomycin 750
rr Zosyn 2.25 IV
ss Percocet
tt Prinivil 40
uu Gylburide 10
vv Lasix 80
ww Synthroid .075
xx Lipitor 10
yy Reglan 5
zz Coumadin 5 & 7.5
aa Flagyl 250
bb Zyprexia 5
cc Naprosyn bid
dd Valium 5
ee Xyprexia 25
ff Compazine 10 IM
gg MgSO4
hh Tylenol #3
ii Epogen 12,000 u IM
jj Nephrocaps
NN Nuerantin 500 mg
OO Vit C 500 mg
PP Megace 40
QQ Clindamycin 600
RR Ativan .5 mg PO
SS Chlorazepam .5
TT Gentamycin 300
UU Morphine IV drip
VV Atenolol 25
WW Dilantin 200
XX Folic acid 1 gm
YY Corgard 20
ZZ Plavix 75
POM Cases
AA Lasix 20 mg
BB Ducolax supp
CC Timoptic .5 ophth
DD Robitussen AC 5cc
EE Zestril 20 mg
FF Hydrochlorthiazide 12.5 mg
GG NS flush IV
HH Darvocet
II Phenobarbital
JJ Ativan O.5 IM
KK Zoloft 50
LL ZnSO4 220 mg
MM Nuerantin 400 mg
A Prednisone 20
B Prednisone 10
C Prednisone 15
D Destin oint
E Zantac 150
F Lopressor 50
G APAP 650
H Heparin 5000 SQ
I MVI IV
J Flagyl 500
K Risperdol .5 mg
L Risperdol 1.0 mg
M Zantac 50 mg IV
N Cephazalam 1 gm
O Zosyn 3.375 mg
P Imdur 30 mg
Q KDUR 20 mg
R Lasix 40 mg
S MOM
T Percolace
U Amiodarone 200
V Tamoxyphen 10 mg
W ELASA 8 mg
X Coumadin variable
Y Prevacid 15 mg
Z Bisonprolol 5 mg
Exhibit 6: Medications prescribed in South Two: Identification Key
601-022 -18-
116
Case
Companies, 2004
Med
Cart
Doctor
2x/day
physician
exam
24hr/7day
nursing
care
Medication
deliveries
Information:
Requests, clarifications
Patient
10:35 AM
10:30 AM
Medication given
Nurse takes
medication from to patient
in-box
Drug given
according to
prescription
Chart
Elapsed time for responses
10:15 AM
Medication left in
South Two in-box
South
Two
Nurse
Verbal
Phone
Verbal
Chart
Phone
Phone
Receptionist
8:10 AM
Prescription
written
Case
10:00 AM Volunteer
Volunteer receives
medication
Medication
Special
Delivery
Verbal
Phone
Verbal
Phone
Green
Sheet
White
Sheet
Pink
Sheet
Patient Medication Record/
Medication Administration Record
Reconciliation
Elapsed time for requests
Deaconess−Glover
Hospital (A)
Pharmacy
Information
9:00 AM
Green sheet
delivered to
pharmacist
Exhibit 7: Medication Administration - South Two - Day Shift: Flows of Medication and Information -
601-022 -19-
POM Cases
Companies, 2004
117
Nurse’s Station
9:40
Call another office
Talk to MD
Call MD
help rolling patient
Washes hands
Starts referral forms and process
Answers phone
observe site for bleeding
wash hands, get MAR sheets
for transfer, hunt for chart
MD
receptionist 1 MD at other
office
Aide
Hospice RN
Aide
Aide
with patient in 237
receptionist 2 find MD
explain hospice concerns
phone call
concerns about patient’s status
and meds, Family has worries
gets suggestion for new med
Where’s chart?
Help rolling patient
NA finds out it is not Cindy’s
patient, apologizes
Explains flu shot, and IV
removal, answer questions
about discharge
Case
9:45
Supply & Med Room
Nurse’s Station
Room 239
9:35
Wash hands, get flu shot and
supplies, give flu shot, remove
patient’s IV
Deaconess−Glover
Hospital (A)
Supply & Med Room
Room 237
Many questions from patient.
isolation precautions?,
going home, meds, bath when, etc.
“Did you use your inhaler?”
Using MAR?
Greeting, give med, receive request
Saying what
Is this vaccine ok?
Is this vaccine ok?
POM Cases
9:30
Exhibit 8: Example: Day-Shift Nursing Activities - November 3, 1999, 9:15 - 10:15
Time Where
What
Who
9:15 Hallway phone
Phonecall Pharm, hunt med
Medication Room
look for syringe, draw label vaccine
Arlene, Rosie
Room 239
look for patient
Nurse’s Station
label syringe
Medication Room
put syringe in fridge. Find 10 meds
9:20
pull MAR Sheets for discharge
RN 1
Room 238
give med
with patient in 238
kitchen
get juice
Room 238
deliver juice
with patient in 238
leaves med, finish bath, change
9:25
bed, straighten room, etc
Asks questions of patient
601-022 -20-
118
Companies, 2004
Remembers something on discharge
form
Check chart
Gives med
Room 237
Nurse’s Station
10:15 Room 237
10:10
Get above med from floor stock
Give above med
Find chart, review order, check
lab to see if dose appropriate,
check discharge order
Discovers new med order on the
transfering patient, change form,
sign off order, records med “given”
phone call
Medication Room
Room 237
Nurse’s Station
Nurse’s Station
Medication Room
Find’s patient’s chart, starts write
orders, intercom again, finish
order, replace chart
Post new order
observe “wastes” narcotic
Back to transfer chart form
Excuse me, asks about new
med, waste narcotic?
apologize for keeping her waiting
Where’s chart?
does intercom work?
get new med order by phone
with patient in 237
with patient in 237
with patient in 237
Answers many questions,
convinces patient that it is ok to take
med
Reasure
Many questions about this med
patient believes dosage incorrect
Aide
“You have phone call”
Pt’s daughter - concerns from
hospice,
clarification, reassurance
Pharmacist
RN 2
RN 3
Intecom - call another RN to
the phone
Aide
Aide
Deaconess−Glover
Hospital (A)
10:05
10:00
9:55
9:50
Answers phone
601-022 -21-
POM Cases
Case
Companies, 2004
119
Patient
Rm 237
Rm 238
Rm 239
Hall
Phone
In one hour . . .
• 8 locations
• 22 location changes
• 15 conversation partners
• 25 topics
• 5 patients in 3 rooms
Med
Room
Nurses’
Station
Storage
Room
Kitchen
Deaconess−Glover
Hospital (A)
South
Two
Nurse
• Assess Condition • Searching for
• Plan Care
and transmitting
• Treat
information and
• Evaluate
material
• Other care
100%
Exhibit 9: Summary of one-hour of nursing activity
601-022 -22-
POM Cases
Activity Assessment
120
Case
Companies, 2004
Exhibit10: Patient/Nurse/Doctor Assignments in South
Two
Bed #
MD
Day RN Evening RN Night RN
229A
Duane
Cindy
Susan
Bob
230B
Guzman
Joan
Susan
Bob
231B
Duane
Joan
Susan
Bob
232A
Weiss
Diane
Susan
Bob
232B
Hayden
Diane
Susan
Bob
233A
Whestney
Cindy
Susan
Bob
233B
Whestney
Joan
Meg
Bob
234A
Peters
Diane
Meg
Alice
234B
Weiss
Diane
Meg
Alice
235A
Guzman
Arlene
Meg
Alice
236C
Michaels
Cindy
Sarah
Alice
237A
Peters
Diane
Sarah
Alice
238
McAndrews Amy
Sarah
Alice
239A
Frick
Joan
Sarah
Alice
239C
Larenzo
Amy
Sarah
Alice
240B
Hayden
Arlene
Sarah
Fran
241A
Larenzo
Amy
Meg
Fran
242A
Bose
Amy
Chris
Fran
242B
Ferber
Amy
Chris
Fran
243A
Peters
Arlene
Chris
Fran
243B
Frick
Cindy
Chris
Fran
244A
Brooks
Joan
Chris
Fran
244B
Whestney
Arlene
Chris
Fran
Arlene
Alice
Bob
Fran
Night RN
Meg
Sarah
Susan
Chris
Evening RN
Arlene
Diane
Cindy
Joan
Amy
Day RN
233A
233B
244B
234B
232A
Whestney
Weiss
Peters
238
234A
237A
243A
241A
239C
236C
239A
230B
235A
232B
240B
The Patient
in Room:
242A
244A
229A
231B
242B
243B
McAndrews
Michaels
Larenzo
Hayden
Guzman
Frick
Ferber
MD
Bose
Brooks
Duane
Deaconess−Glover
Hospital (A)
Diane
Cindy
Joan
Amy
Day RN
For simplicity, (MD-EveningRN, MD-NightRN, & Pharmacy links not shown)
Exhibit 11: Who communicates with whom
601-022 -23-
POM Cases
Case
Companies, 2004
121
Medication
Pharmacy
•
Patient
Searching for and
transmitting
information and
material
Rm 237
Rm 238
Rm 239
Hall Phone
In one hour . . .
• 8 locations
• 22 location changes
• 15 conversation partners
• 25 topics
• 5 patients in 3 rooms
Med
Room
Nurses’
Station
Volunteer
Med
Cart
Special
Delivery
Verbal
Phone
Phone
Verbal
Green
Sheet
Pink
Sheet
White
Sheet
Doctor
2x/day
physician
exam
24hr/7day
nursing care
Drug given
according to
prescription
Chart
Elapsed time for responses
South
Two
Nurse
Verbal
Phone
Verbal
Chart
Phone
Phone
Receptionist
Elapsed time for requests
Patient Medication Record/
Medication Administration Record
Reconciliation
Alice
Bob
Fran
Night RN
Meg
Sarah
Susan
Chris
Evening RN
Arlene
Diane
Cindy
Joan
Amy
Day RN
Rationale:
Michaels
Larenzo
Hayden
Guzman
Ferber
Frick
MD
Bose
Brooks
Duane
Weiss
Whestney
McAndrews
Peters
Recommended Next Step:
Arlene
Diane
Cindy
Joan
Amy
Day RN
234B
232A
233A
233B
244B
243A
241A
239C
236C
238
234A
237A
242A
244A
229A
231B
242B
243B
239A
230B
235A
232B
240B
The Patient
in Room:
Around the clock Pathway: Who works with whom
Case
Medication
deliveries
Storage
Room
Kitchen
Information:
Requests, clarifications
Patient
Medication and Information Flows
Nurse
• Assess Condition
• Plan care
• Treat
• Evaluate
• Other care
100%
•Med Administration
• South Two
Nursing Activity
• Glover
• CareGroup
Deaconess−Glover
Hospital (A)
Information
Background:
Medicine Administration Process - South Two Medical/Surgical Ward - Current Condition as of November ‘99
Exhibit 12: Current Condition - 11 x 17 single page presentation
601-022 -24-
POM Cases
Activity Assessment
122
Companies, 2004
Strategy Articles
Making Competition in
Health Care Work
Article
Companies, 2002
Health Care Work
by Elizabeth Olmsted Teisberg, Michael E. Porter, and Gregory B. Brown
Reprint 94408
123
124
Strategy Articles
Health Care Work
Article
Companies, 2002
Strategy Articles
Health Care Work
125
Companies, 2002
Article
HarvardBusinessReview
JULY-AUGUST 1994
Reprint Number
CHRIS ARGYRIS
GOOD COMMUNICATION THAT BLOCKS LEARNING
94401
ROBERT H. WATERMAN, JR.,
JUDITH A. WATERMAN, AND
BETSY A. COLLARD
TOWARD A CAREER-RESILIENT WORKFORCE
94409
ROSABETH MOSS KANTER
COLLABORATIVE ADVANTAGE: THE ART OF ALLIANCES
94405
PAUL KRUGMAN
DOES THIRD WORLD GROWTH HURT
FIRST WORLD PROSPERITY?
94406
GARY HAMEL, C.K. PRAHALAD
COMPETING FOR THE FUTURE
94403
ELIZABETH O. TEISBERG,
MICHAEL E. PORTER, AND
GREGORY B. BROWN
MAKING COMPETITION IN HEALTH CARE WORK
94408
HBR CASE STUDY
MEDIA POLICY – WHAT MEDIA POLICY?
94407
PERSPECTIVES
THE CHALLENGE OF GOING GREEN
94410
SOCIAL ENTERPRISE
EFFECTIVE OVERSIGHT: A GUIDE FOR
NONPROFIT DIRECTORS
94404
SANDI SONNENFELD
REGINA HERZLINGER
BENJAMIN GOMES-CASSERES
WORLD VIEW
GROUP VERSUS GROUP:
HOW ALLIANCE NETWORKS COMPETE
94402
126
Strategy Articles
Health Care Work
Article
Companies, 2002
Strategy Articles
Health Care Work
Companies, 2002
Article
Incentives throughout the health care system are so skewed that
the normal rules of competition do not apply.
Making
Competition in
Health Care
Work
by Elizabeth Olmsted Teisberg, Michael E. Porter, and Gregory B. Brown
Health care reform in the United States is on a
collision course with economic reality. Most proposals focus on measures that will produce onetime cost savings by eliminating waste and inefficiency. The question at the heart of the current
political debate is whether these savings will be
large enough to pay for the added costs of universal
coverage. But this is the wrong question to ask if reformers are serious about achieving a lasting cure
for U.S. health care.
The right question, and one that is conspicuously
missing from the health care debate, is how to
achieve dramatic and sustained cost reductions
over time. What will it take to foster entirely new
approaches to disease prevention and treatment,
new ways to deliver services, and more cost-effective facilities?
The answer lies in the powerful lessons business
has learned over the past two decades about the imperatives of competition. In industry after industry,
the underlying dynamic is the same: competition
July-August 1994
compels companies to deliver increasing value to
customers. The fundamental driver of this continuous quality improvement and cost reduction is innovation. Without incentives to sustain innovation
in health care, short-term cost savings will soon be
overwhelmed by the desire to widen access, the
growing health needs of an aging population, and
the unwillingness of Americans to settle for anything less than the best treatments available. Inevitably, the failure to promote innovation will
lead to lower quality or more rationing of care – two
equally undesirable results.
Elizabeth Olmsted Teisberg and Michael E. Porter are
associate professor and professor, respectively, at the
Harvard Business School in Boston, Massachusetts.
Gregory B. Brown, a former surgeon, is a vice president
of Vector Securities International in Chicago, Illinois.
The three have recently completed a three-year study
that examines the competitive dynamics of health care,
Innovation, Information, and Competition: A Lasting
Cure for U.S. Health Care.
Copyright © 1994 by the President and Fellows of Harvard College. All rights reserved.
127
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Article
HEALTH CARE COMPETITION
The misguided assumption underlying much of
the debate about health care reform is that technology is the enemy. By assuming that technology
drives up costs, reformers neglect the central importance of innovation or, worse yet, attempt to
slow its pace. In fact, innovation driven by rigorous
competition is the key to successful reform. Although health care is unique in some ways, in this
respect, it is no different than any other industry.
The United States can achieve universal access and
lower costs without sacrificing quality, but only by
allowing competition to work at all levels of the
health care system.
What’s Wrong with Competition in
Health Care?
More health care competition exists in the United States than in any other industrial nation. The
puzzle confounding reformers is that while competition has been enormously successful at producing
quality-enhancing innovation, it appears to have
failed on the crucial dimension of
cost. A closer look suggests not that
competition is failing, but that incentives throughout the system have
been so skewed that the normal
rules of competition simply do not
apply. Prices remain high even when
there is excess capacity. Technologies remain expensive even when
they are widely used. Hospitals and
physicians remain in business even
when they charge higher prices for equal quality or
fail to provide high-quality service. Until recently,
incentives existed only for innovations that raised
costs or increased quality regardless of cost.
Successful reform must begin with a clear understanding of how the current system creates incentives for unproductive competition.
services; and doctors, who determine or advise on
the tests and treatments for patients.
These customers have different interests. The
employer is concerned with paying the lowest premiums while providing enough insurance to retain
employees or meet contractual obligations. The
third-party payer is concerned with spending less
on patient care than was received in premiums. The
insured patient is concerned with finding the best
quality care regardless of cost. And the advising
doctor often has incentives to order more services.
Since payers do not have the final legal responsibility for insured patients’ bills, patients are the
payers of last resort. The conflict of interest between payers and patients creates incentives for
payers to compete on the basis of creative and complicated methods of denying coverage to people
who might need expensive care. The payer becomes
the patient’s adversary, rather than advocate, denying payment on claims whenever possible. The incentives not to pay claims also set the payer in opposition to the provider by requiring the provider to
Until recently, incentives existed
only for innovations
that raised costs or increased
quality regardless of cost.
Payers’ Incentives Make Payers
Adversaries of Patients and Providers
In most industries, the consumer makes the purchasing decision and pays for the product or service.
In health care, the purchasing decision, payment,
and receipt of services are separated. As a result,
there are multiple tiers of customers: employers,
who purchase health care coverage for their employees; third-party payers, such as insurance companies and health maintenance organizations
(HMOs), which collect premiums and then pay
providers for services rendered to their subscribers;
patients, who ultimately receive the health care
132
assume the costs that neither payer nor patient has
paid. As a result, providers expend scarce resources
on bill collection and avoid patients whose insurance companies may deny claims. These skewed
incentives lead to behaviors that get in the way of
genuine cost reduction.
However, the conflict among payers, patients,
and providers is unnecessary. Payers should be able
to profit only from actually improving the quality
of medical outcomes and reducing costs, not from
shifting payment responsibility onto patients or
providers. They should concentrate on identifying
high-quality providers with good medical outcomes and negotiate lower prices for their services.
Studies show that better quality care is often lower
in cost due to the efficiency of experienced medical
teams, fewer complications, and better long-term
results.1 For example, The Prudential Insurance
Company of America estimates that it saves more
than 20% in costs with its Institutes of Quality Program by directing bone-marrow transplant patients
to high-quality providers, which are screened on
July-August 1994
Strategy Articles
Health Care Work
Article
the basis of the limited available data on facilities,
staff, credentials, processes, and past outcomes.
Recent programs like this one are productive responses to new pressures to find ways to reduce
costs, not just avoid paying claims.
Patients’ Incentives Discourage
Cost Sensitivity
In life-threatening or urgent situations, patients
and their families are rarely price sensitive. But
even when it comes to receiving routine and discretionary services or choosing a health plan, most patients have had little incentive to consider cost.
Patients rarely have access to relative price information; they rarely comparison shop; and they often feel uncomfortable asking about prices for fear
of offending the physician on whom they rely.
In fact, most employees choose insurance plans
without considering price. Sometimes employees
do not pay at all for their health benefits. Other
times the prices of competing plans are equalized
by the employer, who pockets the difference, removing the incentive for employees to choose a
lower priced plan. More efficient health plans or insurers have little incentive to reduce prices if lower
prices do not help them gain market share. And
once a person has insurance, the current system
makes patients insensitive to price even for decisions such as where to undergo elective surgery, fill
a prescription, or obtain diagnostic tests. Copayments and deductibles can compensate only to the
extent that the patient can make choices about
which provider to use.
Even under the current system, the patient has
no choice when it comes to many types of decisions. Usually, once a patient chooses a doctor,
health plan, or hospital, decisions such as which
laboratory, imaging facility, or specialist to use are
predetermined. This is especially true in managed
care organizations and provider networks.
One choice all patients make is the frequency of
visits for routine concerns. Copayments help make
price a factor in these decisions. One of the results
of the greater attention to health care costs in recent years has been increasing the use of copayments to reduce premiums and to discourage the
overuse of primary care visits.
Fragmented Customers Have Little
Negotiating Power
Well-functioning competition is characterized by
demanding customers with enough clout to push
providers to improve quality while at the same
July-August 1994
129
Companies, 2002
time reducing costs. But when customers are fragmented, as they are in health care, their power is
greatly diminished.
The United States has 1,500 different third-party
payers, such as insurance companies and HMOs,
with roughly 200 serving a given region. Typically,
3 to 12 payers – the number varies by region – represent significant purchase volumes to a given hospital, doctor, or other provider, while the rest of the
payers and individual patients have little bargaining power. Moreover, under the current system, patients have little bargaining power with their insurance companies or other payers.
This fragmentation of patients and payers not only limits competitive pressure but also drives up
transaction costs since many of the payers have different policies, procedures, and forms for provider
reimbursement. The long, customized forms, different reporting requirements, and bureaucracies
developed to handle the forms and requirements
contribute to high administrative costs, which account for nearly 25% of health care expenditures.2
Providers, Patients, and Payers
Lack Information
Health care customers also lack access to information that would improve decisions and in turn
pressure providers to ameliorate medical outcomes
and reduce costs. In most industries, customers can
compare product performance and price with competing products. Buyers of automobiles, for example, can go on test drives, compare prices at different dealers, draw on their own and friends’ past
experiences, and consult publications that provide
information on costs, margins, ratings of quality
and reliability, and used-car values.
Health care could hardly be more different. Patients, payers, and referring physicians do not have
readily available measures of quality or of the relationship between price and quality for a given
physician, procedure, course of treatment, or hospital. Data from the Pennsylvania Health Care Cost
Containment Council reveal that both referring
physicians and patients continue to recommend
and use the services of providers that have poorer
outcomes and higher costs than nearby rivals. 3
Since many health care purchases are onetime
events, patients cannot draw on past personal experiences. They usually receive only the expert opinion of one doctor (or sometimes two if the patient
obtains a second opinion), and they frequently have
difficulty judging the quality of that advice.
Even under managed care, in which a gatekeeper
physician makes supposedly informed choices
133
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Article
about how a patient is treated, good information
about the best type of care and provider for a given
patient is lacking. Worse still, physicians must often refer patients within a network of approved
providers, which are selected by administrators.
These administrators base their selection primarily
on price negotiations because they have little information about quality of care or outcomes. Without
adequate quality measures and information, the
dangers are that the network may either exclude
high-priced providers that deliver better quality
care or include substandard providers in spite of the
good intentions of administrators and physicians.
This lack of relevant, comparative information
based on meaningful medical outcome measures –
not the complexity of medicine itself – prevents informed purchasing decisions. Customers in other
complex, highly technical fields, such as aerospace
and computer software, require competitive bidding on products or services and delineate precise
criteria against which products are evaluated. In
contrast, the poor comparative information and
lack of meaningful outcome measures in health
care create incentives for hospitals and physicians
to compete based on what is observed: the hospital’s pleasing physical environment, high-tech
equipment, or wide array of services; the physician’s comforting bedside manner; even high prices.
Measures of customers’ satisfaction are inadequate quality measures. The right information concerns short- and long-term outcomes of treatments
As health care moves increasingly toward provider capitation (a fixed dollar amount per patient
in the plan per period of time), the need for meaningful information is more crucial than ever. Historically, the attitude of the U.S. health care system
was, “If it might work, try it.” Today the equally
risky bias is, “If we’re not sure, don’t do it.” This
kind of thinking can only stifle innovation and
erode quality. Better information is the antidote to
either bias, allowing decisions to be based on expected outcomes.
Providers’ Incentives Increase Costs
In a well-functioning competitive market, producers’ desires to raise prices or create more demand are counterbalanced by buyers who purchase
only what they need and can afford. Demand rises
when prices fall or when quality at a given price increases. These simple economic laws do not apply
to health care providers in the United States because the health care system skews their incentives
in a number of ways.
Hospitals and Outpatient Facilities: Incentives
to Maximize Reimbursement. Beginning in the
post-World War II period, hospitals were reimbursed on a cost-plus basis, which in turn produced
rapidly escalating hospital costs. The Medicare
Prospective Payment System, implemented in
1983, granted hospitals a fixed fee based on the diagnosis that resulted in the patient’s admission to
the hospital. (Changes in Medicare
carry particular significance because
other players tend to follow Medicare and implement the same rules.)
This diagnosis-related group (DRG)
reimbursement created incentives to
reduce hospital stays and treatment
costs. In the decade following its
introduction, DRG reimbursement
rules reduced the average length of
stay for an inpatient by half a
day, and the number of inpatient hospital stays
dropped by 20%.
Corrections needed to be made to the cost-plus
system, which created incentives for providers to
overtreat. But fixed-price reimbursement skews
incentives in the opposite direction, pressuring
providers to undertreat and to discharge patients
prematurely. These incentives create the risk that
undertreatment or early discharge will raise overall
costs by increasing the rate of recurrent or prolonged health problems. They also encourage hospitals to admit some patients unnecessarily and
then quickly discharge them.
Health care incentives will
dramatically improve when
customers can base decisions
on relevant outcome measures.
for particular diseases by specific providers, taking
into consideration the patient’s general health.
Health care is not a monolithic service, but a myriad of types of services. Reformers must develop information and outcome measures at the level of
specific conditions and treatments instead of relying on aggregate comparisons of provider networks
or payment plans. Buying treatment for cancer will
never be like buying a car. But incentives in the
U.S. health care system will dramatically improve
when payers, patients, providers, and referring doctors can base decisions on comparisons of relevant
outcome measures and prices.
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Outpatient reimbursement has not yet changed
to a DRG-like system. The cost-plus reimbursement combined with incentives for the earlier discharge of hospital patients has led hospitals and
other providers to open many new outpatient facilities. Some of the resulting changes were productive. Effective outpatient treatment and surgeries
are helping to reduce costs. However, there have
also been unproductive results. For example,
providers manipulated the DRG rules when they
were first implemented by delaying admission of
some patients and instead administering expensive
drugs or treatments in the emergency room. While
this specific practice has been forbidden, incentives
for the overtreatment of outpatients remain.
Physicians: Incentives to Increase Services.
While the DRG rules encourage hospitals to undertreat, physicians currently have incentives to increase the volume of services they perform, even if
those additional services do not lower costs or improve medical outcomes. Although physician capitation (a fixed dollar amount per primary care patient per period of time) aims to correct incentives,
it may lead to undertreatment because physicians
earn more by limiting care, including tests and referrals. Salary is also becoming more common, and
its incentives are volume neutral. But most physicians still face an incentive structure in which they
earn more by performing more tests or expensive
procedures because they are paid for each service
performed. The recently implemented ResourceBased Relative Value System (RBRVS) does lower
reimbursement for technical procedures like
surgery relative to cognitive services like office visits. But lower pay per procedure actually creates incentives for physicians to perform more procedures
in order to maintain their incomes.
We are not arguing that doctors unscrupulously
take advantage of patients and payers. Medical
practice is complex and requires professional judgment. Furthermore, many legitimate efforts to care
for the patient increase the use of medical services.
Physicians cannot in good conscience do less for
a patient or pursue less costly treatments without
evidence that these decisions improve outcomes or
quality of life.
But the complexity of medicine cannot explain
why demand for physicians’ services is higher in areas where there are more physicians. Doctors with
the time and facilities can increase demand by performing more tests and procedures, seeing patients
more frequently, or operating on less severely ill patients. For example, the rate of open heart surgery
on residents of Manchester, New Hampshire, doubled the year a local hospital opened an open-heartPHOTO BY BRUCE T. MARTIN
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surgery service.4 Before the local service opened,
90% of bypass operations on patients from the community involved three or more arteries. Three years
after the local center opened, over 50% of the bypasses involved only one or two arteries. But an appreciable improvement in coronary-heart-disease
mortality did not accompany this surgical treatment of less severe coronary disease, and it is not
clear whether other measures of health outcomes
were improved. Cardiologists can debate the medical merits of operating on patients with less severe
coronary disease. We simply use this example to il-
Similarly, a University of Arizona study showed
that physicians with diagnostic imaging equipment
in their offices ordered four times as many imaging exams as physicians who referred patients for
imaging tests.
Congress passed the Stark bill, which became effective in 1992, forbidding physicians from billing
Medicare patients for services performed in clinical
labs in which the doctor has an equity interest. And
other legislation has passed or is pending to limit
self-referral further. But the more fundamental underlying problem, physicians’ incentives, remains
unaddressed. If physician-owned
labs are more efficient, then prohibiting their existence would be a
mistake. Ideally, physicians should
have incentives to promote and improve health rather than to increase
the use of health care services.
Physicians: Incentives to Increase
Fees. As health care technologies
evolved in the United States, high
prices were placed on novel procedures, such as gastrointestinal endoscopy, because
these procedures carried higher risk and were offered by relatively few, highly skilled physicians. In
a competitive market, the diffusion of technology
and increase in the supply of such services would
drive down their prices over time. In health care,
however, the fees did not decline because patients
were not price sensitive and insurance payments to
physicians were based on customary charges rather
than on costs.
In most industries, market forces determine how
much a company can charge; prices need to be high
enough to cover costs but low enough to attract
customers. Companies can charge higher prices only for products or services that are differentiated,
that is, products and services that provide more
benefit to the customer. In health care, however,
the normal rules do not apply. High prices have
their roots in the “usual, customary, and reasonable
charges” on which insurance companies traditionally based their payments to physicians. This structure made sense in the infancy of the health insurance industry in the United States, when most
patients did not have insurance, paid for their own
health care, and were price sensitive. At that time,
doctors faced powerful constraints in setting their
customary charges.
As health insurance became more widespread,
payers retained the “usual, customary, and reasonable” structure, even though a competitive market
ceased to exist in physician services. With insurance the norm, doctors no longer attracted patients
Physicians should have
incentives to improve health
rather than to increase the use
of health care services.
lustrate the point that doctors can increase demand
for medical services without clear evidence of improving outcomes.
This tendency for supply to create demand is part
of the reason that the United States has a general
shortage of primary care physicians compared with
the number of specialists. In a competitive system,
the income potential for specialists, now higher
than that of primary care physicians, would fall
with oversupply. But since the availability of specialists generates demand for specialized care, the
oversupply perpetuates itself. The increasing debt
burden of medical school graduates, which leads
them to high-paying specialties, only serves to accentuate this tendency.
Physicians: Incentives to Make Expensive Referrals. In addition to providing care, physicians also
act as purchasing agents on behalf of their patients
by ordering tests or making referrals. Referring
physicians have traditionally had no incentive to
choose a less expensive lab, ancillary service, or
other provider since patients’ insurance paid the
bills. Instead, convenience, established relationships, perceived quality, or direct financial rewards
from equity interests in labs or facilities have determined referral patterns for independent physicians.
The incentive to perform more tests and procedures is strongest when the physician has a financial interest in the facility or equipment. For example, a Florida State University study found that
physician-owned laboratories in Florida performed
twice as many tests per patient as independent labs.
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by setting lower prices. Indeed, patients with insurance came to view low prices as a signal of lower
quality. Since any fee could become “usual, customary, and reasonable” as long as enough doctors
charged it, physicians were able to boost their incomes by regularly increasing their fees so that future reimbursement calculations would be based
on higher charges.
Over the past decade, changes in physician reimbursement have limited the ability of physicians to
increase fees. But piecemeal regulations can be circumvented. For example, when Medicare implemented a fee freeze in 1984 that lasted for two
years, physician group practices responded by setting artificially high rates for new physicians in the
group. Similarly, some payers have imposed fixedfee structures on physicians, but physicians have
circumvented them with so-called balance billing:
physicians simply bill patients for the difference
between their “list charges” and the approved
“fixed fee.” This strategy reduces the payers’ price
sensitivity and their incentive to work for price reductions since they are no longer responsible for
the entire bill. While balance billing may make patients more price sensitive, they often do not know
in advance whether the bill will be significant. And
when the balance is small, patients are often inclined to pay. Fortunately, an increasing number of
insurance contracts now restricts doctors from balance billing patients.
Physicians: Incentives to Practice Defensive
Medicine. The threat of malpractice or the insistence of patients pushes even doctors paid by salary
or capitation to practice defensive medicine by or-
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problem and help retain good physicians in fields
such as obstetrics. However, malpractice reform
alone will not produce the dramatic changes that
U.S. health care needs.
Providers’ Incentives Encourage
Overinvestment
The U.S. health care system still supplies incentives for excessive capital investment by providers.
Companies in a competitive market invest to enhance differentiation or to lower costs. Because
they bear the costs and risks of investment, they invest only when they anticipate a reasonable return.
Those that make inappropriate investments face
declining profits and eventually go out of business.
This has not been the case for capital expenditures in the U.S. health care industry. Until 1992,
reimbursement by Medicare for capital investments was cost-plus. Thus, providers profited by
building facilities and adding new equipment without the usual market constraint of needing to be
sure that the capital investments would pay off.
Regulators became aware of the resulting incentive
to overinvest and tried to handle it by creating review boards to determine community needs. They
did not attempt to correct the incentive itself.
What’s more, the excess capacity of beds or
equipment, such as imaging machines or medical
helicopters, did not produce lower prices. Health
care defied the usual laws of gravity for three reasons. First, reimbursement was not dependent on
how fully a facility was used. Second, providers
were protected from failure not only by cost-plus
reimbursement but also by community interests in maintaining local
health care facilities. Third, once facilities existed, there was a strong
tendency to create demand to fill
them. Ultimately, hospitals and outpatient treatment centers had incentives to overinvest in equipment and
facilities because these investments
attracted both doctors and patients.
Without real measures of outcomes,
state-of-the-art facilities became the focus of health
care competition.
In 1992, the Medicare capital reimbursement
rules changed, limiting the rate at which major capital investments could be amortized. This change,
coupled with increasing national attention to
health care costs, substantially enhances incentives for improving the productivity of capital
equipment. Cost-saving innovations in investment
productivity will begin to emerge after a time lag.
Companies in a competitive
market invest only when they
anticipate a reasonable return –
not so in health care.
dering more tests and procedures than are often
necessary. The most widely cited study estimates
the direct cost of defensive medicine to be about
1% of total health care expenditures.5 But such
measures understate the problem because the
threat of malpractice may also indirectly affect
costs by coloring physicians’ judgments. Still, the
popular notion that the threat of malpractice is the
crux of the health care problem is oversimplified.
Legal reform is essential to address the malpractice
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But the benefits of this change are unnecessarily diluted by too many loopholes allowed in the new
Medicare rules. These rules include significant adjustments, such as those for geographic location
(regional, as well as urban versus rural), patient
population (severity of illness, or “case-mix”), and
reimbursement features (percentage of uninsured
or indigent patients). Together, the adjustments
make the system still effectively cost-plus.
Exit Barriers Protect Substandard
Payers and Providers
Incentives for cost reduction will be fully effective only if lower quality, inefficient providers and
insurance companies are allowed to fail. Any
healthy competitive market forces the exit of substandard players, which are displaced by efficient
ones. The net result is lower costs without compromising quality.
The past two decades have witnessed dramatic
reductions in the demand for hospital facilities, but
relatively little capacity has been eliminated. The
cost and quality penalty to the nation of too many
facilities is high. Low volumes drive up costs, as
fixed overhead must be spread over few patients.
At the same time, quality suffers. For example,
providers that perform fewer than 150 open heart
procedures per year have higher death and complication rates. As a result, the American College of
Surgeons has recommended that each cardiac
surgery team perform at least 150 operations per
year. Other studies show that hospitals that perform a higher volume of a given procedure have
lower mortality rates and shorter inpatient stays.6
It is not beneficial to have reimbursement rules
that guarantee any provider the ability to offer any
service even if their quality and utilization rates are
low. But in U.S. health care, there has been a surprising reluctance to force substandard providers to
exit either by closing entire facilities or by dropping
specific services.
The idea that the closure of some hospitals and
some services within hospitals would be good public policy is radical given the history of providing
public incentives to open hospitals in every U.S.
community. The U.S. hospital system developed at
a time when the full range of medical care could be
reasonably provided at a community hospital.
Communities still benefit today from the ready
availability of services like routine emergency care,
routine obstetric care, and care for common disorders requiring hospitalization. However, for complex care such as high-risk obstetrics, trauma care,
and organ transplantation, regionalization and ra138
tionalization could significantly enhance both
quality and efficiency.
While traveling to a preeminent regional facility
may sound expensive and inconvenient, the savings in costs and the promise of better short- and
long-term medical results can easily make it worthwhile for both patients and payers. Higher volumes
of specialized treatments lead to better outcomes
and lower costs, not only because physicians become more skilled with more practice but also because whole teams of medical professionals learn
effective routines and develop expertise in protocols and problem spotting. As a result, facilities
that have high volume in a specialized service also
tend to have lower costs in that service.
The current trends of consolidation into provider
networks, however, could have detrimental effects
on the cost and quality of specialized services. A
managed care network is fine for primary care and
relatively simple specialized care. However, the
risks are that either high-quality providers will be
excluded because they cannot conclusively prove
cost-effectiveness or substandard providers of complex and highly specialized care will be hidden and
protected within the networks. Although managers
will not intentionally maintain clearly substandard
services, measuring outcomes is difficult, and networks will be reluctant to lose their full-service status based on uncertain evidence of substandard
care. The guaranteed patient flow to in-network
providers, then, creates new exit barriers.
Public policy should play a critical role in fostering competition. Although some consolidation is
desirable to reduce excess capacity, it is important
not to relax antitrust rules to the point of undermining competition. Excessive consolidation will
risk creating very powerful providers with less need
to respond to their customers. It will also limit the
experimentation that is critical to stimulating new
procedures and treatments.
Piecemeal Solutions Treat Only
the Symptoms
The skewed incentives of the U.S. health care
system are not the result of inattention. A great
deal of regulatory effort has focused on fixing the
problems. Unfortunately, much of this effort has
aimed at treating symptoms rather than the underlying causes. In fact, new regulations make the system less efficient, while failing to improve quality.
For example, when DRG reimbursement shortened hospital stays by encouraging earlier discharge, concerns surfaced that hospitals’ efforts to
reduce costs might diminish the quality of care. So
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the government added new regulations and expanded the bureaucracy to address the issues of quality
and utilization. Hospitals responded to these quality regulations by creating parallel utilization review staffs. The net result was health care reduction, not cost reduction. Money previously spent
on patient care was shifted to administration.
Another result of such piecemeal solutions has
been a complex collection of sometimes inconsistent rules that provide rewards to those who
can figure out how to manipulate the system. Billing consultants have taught doctors and hospital
administrators to maximize reimbursement. For
example, when fixed fees were established for a
given procedure, doctors learned the practice of
unbundling: billing separately for the component
parts of a procedure to increase fees. The rise of
fixed-fee third-party payers and the increasing burden of the uninsured encouraged cost shifting –
those patients with less restrictive payment plans
absorbed the costs of caring for others. Only
changes in incentives can close these loopholes.
Additional layers of regulation will be circumvented and will create new administrative cost burdens.
The failure to look at the health care system
comprehensively and to focus on the long term has
also raised systemwide costs. For example, many
U.S. mothers receive little prenatal care, but the
cost of universal prenatal care is almost negligible
compared with the cost of intensive care for prema-
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healthful behavior by making smoking expensive.
But subsidizing tobacco and then taxing it is yet
another example of complicated, piecemeal regulation that could be simplified if we looked at the
systemwide costs and benefits of specific policies.
Recent Progress on Cost Reduction Is
Not Enough
In response to national attention to rising costs
and the DRG reimbursement system, a number of
cost-reducing advances began to emerge by the late
1980s. Indeed, the results of the new, albeit incomplete, incentives for cost reduction have become
noticeable at the national level. Although the medical component of the consumer price index is still
rising faster than inflation, the rate of increase has
dropped enough to shave $15 billion off expected
U.S. health care expenditures in a single year.
Specific examples of cost-reducing innovations
span a wide range of treatments and procedures.
Consider the antibiotic ceftriaxone. Until the mid1980s, advances in antibiotic development tended
to deliver broader spectrum antibiotics. The 1988
introduction of ceftriaxone offered a drug with essentially the same spectrum as existing drugs of the
same class, but at a lower cost due to the need for
only one intravenous dose every 24 hours instead of
every 3 or 4. Less frequent dosing means less nursing time and lower aggregate treatment costs,
while providing equally good results;
it also allows some patients to be
discharged from the hospital and receive the injection on a daily outpatient basis. Because of these pharmacoeconomic advantages, ceftriaxone
quickly became the top selling pharmaceutical product in hospitals. Other examples include new therapies
and surgical techniques. Laparoscopy reduces the cost and recovery time
from procedures such as cholecystectomies and
appendectomies. Gene therapy is creating the potential for dramatic cost reduction by restoring
normal function in congenital diseases like cystic
fibrosis and ADA deficiency. Most pharmaceutical
and biopharmaceutical companies are now consciously analyzing both the clinical and the economic advances of potential new products to decide
which products to pursue and which research-anddevelopment investments to make.
There are still other indications of the power of
improved incentives to restore health to the U.S.
health care system. Numerous private-sector initiatives have begun to ratchet down the rate of
Some consolidation is desirable.
Too much will risk creating
powerful providers with little
need to respond to customers.
ture babies and the cost of long-term care for children with considerable health problems as a result
of poor prenatal care. As improved outcome measures are developed, it is important to determine
when apparently expensive care at one stage in an
illness actually reduces overall costs or improves
outcomes at subsequent stages.
In addition, seemingly unrelated government
policies contribute to rising health care costs. The
most obvious example is the subsidization of tobacco. Given the demonstrated health risks of tobacco,
the subsidies drive up health care costs. The Clinton administration’s suggested tax increase on tobacco products does strengthen incentives for
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health care growth. Large employers are beginning
to ask employees to pay more when choosing more
expensive health care plans. Small-business coalitions are demanding and receiving greater value
from insurers and providers. Employers are ferreting out information to empower their health benefit choices, and providers and insurers are learning
to respond more effectively to informed buyers.
These are positive signs, but they are not enough.
The current trends should not be used as an excuse
to avoid the real reform of incentives. Indeed, the
anticipation of reform is itself driving cost reduction. And if weak and uncoordinated incentives can
encourage such innovation, a systematic introduction of clear, competitive market incentives should
be able to achieve dramatic results. Innovation in
response to competitive forces will bring health
care costs under control without rationing care or
retarding the search for cures for currently untreatable diseases.
Reform Can Cure Competition in
Health Care
Competition in U.S. health care has produced a
breathtaking rate of advance in state-of-the-art
treatments for a wide range of diseases and injuries.
People come from all over the world for treatment
by U.S. doctors in U.S. hospitals with U.S.-developed technologies. Reform should preserve this excellence and expand the scope of innovation. A lasting cure for U.S. health care should incorporate four
basic elements: corrected incentives to spur productive competition, universal insurance to secure
economic efficiency, relevant information to ensure meaningful choice, and vigorous innovation to
guarantee dynamic improvement.
Incentives for Productive Competition. Much of
the health care debate is based on the premise that
because competition has failed to control costs in
the past, it will not be able to do so in the future.
Paradoxically, competition, usually a powerful
force for both quality enhancement and cost reduction, appears to be driving health care costs through
the ceiling. But the problem, as we have seen, lies in
the skewed incentives that allow providers, payers,
and suppliers of drugs and equipment to prosper
while costs escalate.
“Managed competition” has been offered up as a
solution. It encourages patients and employers to
join large purchasing cooperatives, which will contract for health plans with large payers and organize
providers and physicians into integrated delivery
networks. But the pooling of customers and providers could create bilateral monopolies with lit140
tle incentive to innovate. More powerful payers
could slow innovation by refusing to pay for new
treatments in the effort to contain costs. More
equal groups of customers and payers, without restructured incentives, could increase the mountains of paperwork generated by battles over who
should pay the bills. Indeed, without restructured
incentives, managed competition will only increase the power of the parties engaged in dysfunctional competition.
Reform must eliminate the incentives that create
dysfunctional competition. Rather than managed
competition, reform must foster rigorous competition among providers and among payers to deliver
value to customers. Providers and their suppliers
should earn higher profits only when they make
cost-effective advances in medical outcomes.
Four conditions will help foster productive competition in health care:
䡺 Avoid overconsolidation. Providers must be
forced to compete with one another on the basis of
quality and price for specific services.
䡺 Maintain antitrust laws in order to ensure
healthy rivalry.
䡺 Allow exit of substandard providers when regional competition is not restricted. The opportunity to
prosper must be coupled with the risk of failure. In
addition, a safety net must be set up to protect subscribers if their insurance plan fails.
䡺 Reject price caps because they will have devastating effects on innovation in new drugs and devices.
Instead, competition among established products
should be encouraged to push down their prices.
Payers’ and patients’ incentives must also be
aligned. Payers should profit when they negotiate
good value for their subscribers. Patients should
benefit when they seek good values. It is not
enough to pool patients into purchasing groups or
create streamlined provider networks. Unless incentives are changed, payers will continue in their
attempts to shift costs rather than identify good
values, and providers will continue to manipulate
the reimbursement rules without necessarily improving quality.
Four steps will help align patients’ and payers’ incentives and avoid the fruitless cost shifting that
takes place today:
䡺 Align interests. Payers must have the legal responsibility for paying their subscribers’ bills.
䡺 Simplify the content of health insurance to reduce disputes over claims.
䡺 Outlaw balance billing.
䡺 Increase patient responsibility. Patients should
bear some portion of costs through a noticeable copayment up to an income-graduated cap.
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Insurance Coverage for Economic Efficiency.
Universal coverage is essential for economic efficiency as well as for equity. Many of the skewed incentives and inefficiencies stem from problems created by uncompensated care.
The best way to eliminate costly practices like
cost shifting and patient dumping is not by creating
more reviews, audits, or penalties. Reform should
make everyone a paying customer. The cost of
universal coverage will not be as high as some fear
because the expense of the uninsured is already
largely borne by the health care system through uncompensated care assessments that providers recoup by raising average prices. Moreover, the costs
now borne to serve the uninsured will be reduced
because patients who lack access to primary care
currently use expensive emergency-room care as a
substitute.
Universal coverage is also important to ensure
that competition will work in the interests of all
patients. Otherwise, many providers that currently
serve the poor will be forced to exit. The solution is
to make the poor into paying customers who decide
which providers will best serve them.
Information for Meaningful Choice. Effective
competition requires free choice, but choice without good information is useless. Competition will
work only when decisions by providers, referring
doctors, payers, and patients are based on relevant,
comparable information about price and medical
outcomes. That information must be at the level of
specific treatments by specific providers and must
include long-term outcomes and immediate results. There has been much discussion about providing consumers with information about insurance plans to help them in their purchasing
decisions. It is far more critical to provide all parties
with specific information about treatment outcomes and prices.
Without this kind of information, reform risks
sacrificing quality to the goals of access and cost
containment. Hospitals may discharge patients before they are ready for outpatient care, and physicians may skimp when ordering tests or making referrals. Medical outcome information also guards
against the perils of overconsolidation. Substandard providers should not be protected from
healthy competition because customers are captive
within consolidated health networks.
The development of germane and accessible outcome measures should be one of the nation’s highest research priorities. Admittedly, this will be no
easy task. But rapid progress is already being made,
and nothing will speed the development of better
measures faster than the widespread dissemination
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of the data and measures already in use. With good
information available to all parties, informed
choice – not restricted choice – will promote productive competition that raises quality and drives
down costs.
Innovation for Dynamic Improvement. The national debate defines technology as the enemy and
focuses on how to cut fat and eliminate waste in the
current system with reforms like health plan buying alliances, consolidated networks, and price caps
on drugs and devices. But these reforms are essentially ways to deliver today’s health care more efficiently and will not reduce costs enough. In fact,
overconsolidation of networks and price restraints
on or biases against new drugs and devices will undermine incentives for innovation. A real solution
to our health care cost problem requires a dynamic
view, one that fosters the kind of innovation that
pushes down costs and enhances quality.
Pharmaceutical, biotechnological, and medical
device companies are beginning to deliver cost-reducing innovations. Private companies are beginning to develop quality comparisons and outcome
measures. Small businesses are beginning to form
buying groups to negotiate with payers for quality
care at competitive prices. As a result, the rate of
health care cost increases is slowing.
Health care reform must build on this progress by
creating still stronger incentives for both medical
and managerial innovation. Reformers must not
confuse onetime efficiencies with sustained cost
improvement. Innovation, the missing principle in
all the contending reform proposals, is the only
true, long-term solution for high-quality, affordable
health care.
Notes
1. See, for example, J. Showstack, et al., “Association of Volume with
Outcome of Coronary Artery Bypass Graft Surgery,” Journal of the American
Medical Association, vol. 257 (1987), pp. 785-89; Charles Marwick, “Using High-Quality Providers to Cope with Today’s Rising Health Care
Costs,” JAMA, vol. 268 (1992), pp. 2142-45; and James W. Winkelman, et
al., “Cost Savings in a Hospital Clinical Laboratory with a Pay-for-Performance Incentive Program for Supervisors,” Archives of Pathology and
Laboratory Medicine, vol. 115 (1991), pp. 38-41.
2. Steffie Woolhandler and David U. Himmelstein, “The Deteriorating
Administrative Efficiency of the U.S. Health Care System,” New England Journal of Medicine, vol. 324, no. 18 (1991), pp. 1253-58.
3. See David Wessel and Walt Bogdanich, “Closed Market: Laws of Economics Often Don’t Apply in Health-Care Field,” Wall Street Journal,
January 22, 1992, p. A1.
4. Philip Caper, “Database Strategies for the Management of Clinical Decision Making,” New Perspectives in Health Care Economics (London:
Mediq Ltd., 1991), p. 65.
5. Roger A. Reynolds, John A. Rizzo, and Martin L. Gonzalez, “The Cost
of Medical Professional Liability,” JAMA, vol. 257 (1987), pp. 2776-81.
6. See V.E. Stone, et al., “The Relation Between Hospital Experience and
Mortality Rates for Patients with AIDS,” JAMA, vol. 268 (1992), pp. 265561; and H.S. Luft, et al., “Should Operations Be Regionalized?” New
England Journal of Medicine, vol. 301 (1979), pp. 1364-69.
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Will Disruptive
Innovations Cure
Health Care?
by Clayton M. Christensen, Richard Bohmer, and
John Kenagy
Included with this full-text Harvard Business Review article:
1 Article Summary
The Idea in Brief—the core idea
The Idea in Practice—putting the idea to work
3 Will Disruptive Innovations Cure Health Care?
13 Further Reading
A list of related materials, with annotations to guide further
exploration of the article’s ideas and applications
Product 6972
Will Disruptive Innovations Cure Health Care?
The Idea in Brief
The Idea in Practice
The U.S. health care industry is ailing. The
symptoms? Expensive, inconvenient delivery systems that leave more and more consumers dissatisfied. Why? Major health care
institutions have “overshot” the level of care
most patients need. Researchers and practitioners focus on the most complicated diseases, while paying insufficient attention to
the needs of patients with more common
ailments.
Disruptive innovations in other industries offer
lessons for transforming health care:
COPYRIGHT © 2004 HARVARD BUSINESS SCHOOL PUBLISHING CORPORATION. ALL RIGHTS RESERVED.
The cure? All health care industry players
must embrace disruptive innovations:
cheaper, simpler, more convenient products or services that ultimately let less expensive professionals provide sophisticated service in affordable settings.
Consider angioplasty, used by cardiologists
with patients who not long ago would
have needed invasive, costly surgery by
open-heart specialists. Or the latest blood
glucose meters, which allow diabetic patients to monitor their own health—accurately, conveniently, and inexpensively.
We need many more of these disruptive innovations to revitalize the health care industry. Companies that develop them will
grow profitably with less investment. Hospitals and managed-care institutions will
stem their financial hemorrhaging. When
industry players and consumers join forces
to promote affordable, high-quality medical services, everyone will win.
Create a system that matches clinicians’
skill levels to the level of medical difficulty.
Use technology to channel simple problems
(e.g., strep throat) to clinicians who can follow
predictable rules for diagnosis and treatment.
For example, expand nurse practitioners’ role
as primary care providers and provide tools
that allow them to accurately refer more complicated conditions to physicians with more
sophisticated diagnostic abilities.
cost savings. Regulators could support the
new technology and address any concerns
about possible risks. How? Require that
all images interpreted by nonradiologists
be transmitted via Internet to a secondopinion center. There, skilled radiologists
could check or confirm initial diagnoses.
Invest more money in technologies that
simplify complex problems, and less in
high-end technologies.
Today most R&D dollars go to complex solutions for complex problems. But more venture
capital must flow to projects focused on technologies that simplify diagnosis and treatment—especially of common diseases. By
launching a series of such disruptive business
ventures, major health care companies
(Johnson & Johnson, Baxter, Merck) could spur
significant growth—with less investment.
Don’t be afraid to invent the institution
that could put you out of business.
We’ll always need some general hospitals for
critical care (just as we still need mainframe
computers after PCs transformed that industry). But most health care needs can be better
met through specialized institutions that provide state-of-the-art care for a single category
of disorders, such as cardiac or renal illnesses.
Overcome the inertia of regulation.
Instead of working to preserve the existing
system at all costs, regulators should be asking, “How can we enable disruptive innovations to emerge?”
Example:
An entrepreneur creates a portable X-ray
machine for use in medical offices rather
than in hospitals—promising significant
page 1
Health care may be the most entrenched, change-averse industry in the
United States. The innovations that will eventually turn it around are
ready, in some cases—but they can’t find backers.
Will Disruptive
Innovations Cure
Health Care?
by Clayton M. Christensen, Richard Bohmer, and
COPYRIGHT © 2000 HARVARD BUSINESS SCHOOL PUBLISHING CORPORATION. ALL RIGHTS RESERVED.
John Kenagy
Imagine a portable, low-intensity X-ray machine that can be wheeled between offices on a
small cart. It creates images of such clarity that
pediatricians, internists, and nurses can detect
cracks in bones or lumps in tissue in their offices, not in a hospital. It works through a patented “nanocrystal” process, which uses nightvision technology borrowed from the military.
At 10% of the cost of a conventional X-ray machine, it could save patients, their employers,
and insurance companies hundreds of thousands of dollars every year. Great innovation,
right? Guess again. When the entrepreneur
who developed the machine tried to license the
technology to established health care companies, he couldn’t even get his foot in the door.
Large-scale X-ray equipment suppliers wanted
no part of it. Why? Because it threatened their
business models.
What happened to the X-ray entrepreneur is
all too common in the health care industry.
Powerful institutional forces fight simpler alternatives to expensive care because those alternatives threaten their livelihoods. And those oppo-
harvard business review • september–october 2000
nents to low-cost change are usually lined up
three or four deep. Imagine for a moment that
our entrepreneur was able to license the technology. Even then, he would probably face insuperable barriers. Regulators, afraid of putting
patients at risk, would withhold approvals. Radiologists, who establish the licensing standards
that regulators enforce, don’t want to lose their
jobs, so they’d fight it, too. Insurance companies, which approve only established licensed
procedures, would refuse to reimburse for it.
And hospitals, with their large investments in
radiology and emergency departments, want injuries to flow to them—so they, too, would join
the forces holding back change.
This resistance to low-cost alternatives is understandable, but it’s not in the best interests
of the industry or of the patients it serves.
Quite the reverse—the health care industry
desperately needs to open its doors to market
forces. Health care professionals often shudder when they hear that phrase “market
forces.” But when we use it, we’re not talking
about letting insurance companies microman-
page 3
age doctors as they practice medicine or about
putting profits above patient care. Rather,
we’re talking about being open to disruptive
technologies and business models that may
threaten the status quo but will ultimately
raise the quality of health care for everyone.
Make no mistake: the U.S. health care industry is in crisis. Prestigious teaching hospitals lose millions of dollars every year. Health
care delivery is convoluted, expensive, and
often deeply dissatisfying to consumers. Managed care, which evolved to address some of
these problems, seems increasingly to contribute to them—and some of the best managedcare agencies are on the brink of insolvency.
We believe that a whole host of disruptive innovations, small and large, could end the crisis—but only if the entrenched powers get out
of the way and let market forces play out. If
the natural process of disruption is allowed to
proceed, we’ll be able to build a new system
that’s characterized by lower costs, higher
quality, and greater convenience than could
ever be achieved under the old system.
What’s Wrong with Health Care
Clayton M. Christensen is a professor
of business administration at Harvard
Business School in Boston. Richard
Bohmer is a physician and also a senior lecturer at Harvard Business
School. John Kenagy is a physician, a
visiting scholar at Harvard Business
School, and a clinical associate professor of surgery at the University of Washington in Seattle.
page 4
In any industry, a disruptive innovation sneaks
in from below. While the dominant players are
focused on improving their products or services to the point where the average consumer
doesn’t even know what she’s using (think
overengineered computers), they miss simpler, more convenient, and less costly offerings initially designed to appeal to the low end
of the market. Over time, the simpler offerings
get better—so much better that they meet the
needs of the vast majority of users. We’ve seen
this happen recently in the telecommunications industry, where routers—initially dismissed by leading makers of the faster, more
reliable circuit switches—came to take over
the market.
The graph “The Progress of Disruptive Innovation” illustrates this dynamic. The top solid
line depicts the pace of technological innovation—the improvement an industry creates as
it introduces new and more-advanced products
to serve the more-sophisticated customers at
the high end of the market. We call these sustaining innovations. The shaded area outlines
the rate of improvement consumers can absorb
over the same time. The pace of sustaining innovation nearly always outstrips the ability of
customers to absorb it. That creates the poten-
tial for upstart companies to introduce disruptive innovations—cheaper, simpler, more convenient products or services that start by
meeting the needs of less-demanding customers. The progress of these disruptive innovations is shown by the bottom solid line. Disruptive technologies have caused many of
history’s best companies to plunge into crisis
and ultimately fail.1
This phenomenon of overshooting the needs
of average customers and creating the potential for disruption quite accurately describes
the health care industry. If we were to draw a
graph to illustrate health care specifically, we
would measure the complexity of diagnosing
and treating various disorders on the vertical
axis. The least-demanding tiers of the market
are patients with disorders such as simple infectious diseases. The most-demanding tiers include patients with complex, interactive problems such as an elderly man with a broken hip
complicated by poor health from long-standing diabetes, hypertension, and heart disease—situations in which multiple systems of
the body are involved, and cause and effect are
difficult to disentangle.
Our major health care institutions—medical
schools, groups of specialist physicians, general
hospitals, research organizations—have together overshot the level of care actually
needed or used by the vast majority of patients. Indeed, most players in today’s health
care system are in a lockstep march toward the
most scientifically demanding challenges. Between 1960 and now, for example, our medical
schools and residency programs have churned
out specialists and subspecialists with extraordinary capabilities. But most of the things that
afflict us are relatively straightforward disorders whose diagnoses and treatments tap but a
small fraction of what our medical schools
have prepared physicians to do. Similarly, the
vast majority of research funding from the National Institutes of Health is aimed at learning
to cure diseases that historically have been incurable. Much less is being spent on learning
how to provide the health care that most of us
need most of the time in a way that is simpler,
more convenient, and less costly.
General hospitals—especially teaching hospitals—have likewise overshot the needs of
most patients. Their impressive technological
ability to deliver care enables them to address
the needs of a relatively small population of
very sick patients. But in the process of adding
and incurring the costs of such capabilities, they
have come to overserve the needs of the much
larger population of patients with less serious
disorders. Most types of patients that occupied
hospital beds 20 years ago are not there today;
they’re being treated in lower cost, morefocused settings. As the stand-alone cardiac care
centers, outpatient surgery centers, and other
focused institutions get better and better, they
become the price setters. As a consequence, the
old high-cost institutions can’t compete financially; nor are there enough really sick people to
sustain them. Last year not a single teaching
hospital in Massachusetts made money.
As a group, the medical schools, specialist
physicians, hospitals, and equipment suppliers
have done an exceptional job of learning to
treat and resolve difficult, intractable problems
at the high end. We stand in awe of what they
have accomplished. But precisely because of
their achievements, health care is now ripe for
disruption.
How Disruptive Innovations Work
To get a sense of what those disruptions might
be, let’s look briefly at what has happened in
other industries. Many of the most powerful
innovations that disrupted other industries
did so by enabling a larger population of lessskilled people to do in a more convenient, less
expensive setting things that historically could
be performed only by expensive specialists in
centralized, inconvenient locations.
The Progress of
Disruptive Innovation
For example, in the 1960s when people
needed computing help, they had to take their
punched cards to the corporate mainframe
computer center and wait in line for the dataprocessing specialists to run the job for them.
Minicomputers and then personal computers
were disruptive technologies to the mainframe
makers. At the outset, they weren’t nearly as capable as mainframes, and as a consequence the
professionals who operated the sophisticated
computers, and the companies that supplied
them, discounted their value. But minicomputers enabled engineers to solve problems for
themselves that had required centralized computing facilities. And personal computers enabled the unwashed masses—less-skilled people
like the rest of us—to compute in the convenience of their offices and homes.
Nearly every disruptive innovation in history has had the same impact. George Eastman’s camera made amateur photography
widespread. Bell’s telephone let people communicate without the need for professional
telegraph operators. Photocopying enabled office workers to do things that historically only
professional printers could do. Online brokerages have made investing so inexpensive and
convenient that even college students now actively manage their own portfolios. Indeed,
disruptive technologies have been one of the
fundamental mechanisms through which the
quality of our lives has improved. In each of
these cases, the disruption left consumers far
better off than they had been—we don’t yearn
Performance
Dominant players in most markets focus on
sustaining innovations—on improving
their products and services to meet the
needs of the profitable high-end customers.
Soon, those improvements overshoot the
needs of the vast majority of customers.
That makes a market ripe for upstart companies seeking to introduce disruptive innovations—cheaper, simpler, more convenient products or services aimed at the
lower end of the market. Over time, those
products improve to meet the needs of
most of the market, a phenomenon that has
caused many of history’s best companies to
plunge into crisis.
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page 5
content on an expensive piece of laboratory
equipment. Today, patients pack miniature
blood glucose meters with them wherever they
go; they themselves now manage most aspects
of a disease that previously had required much
more professional involvement. They get far
higher quality care far more conveniently. No
patient or professional pines for the good old
days—even though the companies that made
the large laboratory blood-glucose testers were
all driven from the market, and endocrinologists now face significantly reduced demand
for their services.
Angioplasty is another example. Before the
early 1980s, patients with coronary artery disease were treated through bypass surgery. It required a complex, technologically sophisticated surgical team, as well as multiple
specialists in several disciplines, complicated
equipment, days in the hospital, and weeks in
recovery. The far simpler angioplasty uses a
balloon to dilate narrowed arteries, causing
less pain and disability. It enables less expensive or specialized practitioners to treat more
people with coronary artery disease in lower
cost settings. Initially, angioplasty was used in
only the easiest cases and was much less effective than surgery. Experts viewed the procedure with skepticism because of all the things
it and its practitioners couldn’t do. But over
time the disruptive innovation improved. Increasing skill and experience, together with
sustaining technological innovations such as
stents, have allowed angioplasty to supplant
surgery in many cases. Angioplasty can now be
to return to the days of the corporate mainframe center, for example.
Our health care system needs to be transformed in the same way. Rather than ask complex, high-cost institutions and expensive, specialized professionals to move down-market,
we need to look at the problem in a very different way. Managers and technologies need to
focus instead on enabling less expensive professionals to do progressively more sophisticated things in less expensive settings.
We need diagnostic and therapeutic advances that allow nurse practitioners to treat
diseases that used to require a physician’s care,
for example, or primary care physicians to
treat conditions that used to require specialists.
Similarly, we need innovations that enable procedures to be done in less expensive, more convenient settings—for doctors to provide services in their offices that used to be done
during a hospital stay, for example. The graphs
“Disruptions of Health Care Professions” and
“Disruptions of Health Care Institutions” suggest the patterns by which these disruptive innovations might transform health care.
Some innovations of exactly this sort have
transformed pockets of the health care system,
and where they have happened, higher quality,
greater convenience, and lower cost actually
have been achieved. Before 1980, for example,
patients with diabetes could only know
whether they had abnormal levels of glucose in
their blood indirectly; they used an often inaccurate urine test or visited a doctor who drew a
blood sample and then measured its glucose
Disruptions of Health
Care Professions
As specialist physicians continue to concentrate on curing the most incurable of illnesses for the sickest of patients, less-skilled
practitioners could take on more complex
roles than they are currently being allowed
to do. Already, a host of over-the-counter
drugs allow patients to administer care that
used to require a doctor’s prescription.
Nurse practitioners are capable of treating
many ailments that used to require a physician’s care. And new procedures like angioplasty are allowing cardiologists to treat patients that in the past would have needed
the services of open-heart surgeons.
page 6
Complexity of
diagnosis and
treatment
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reliably performed in stand-alone cardiac care
centers, which aren’t burdened with the tremendous overhead costs of hospitals.
By enabling less expensive practitioners to
treat diabetes and coronary artery disease in
less costly locations, these disruptive innovations have made health care more efficient.
But more important, no compromises in quality were made. On the contrary, more patients
get more care. When care is complex, expensive, and inconvenient, many afflictions simply
go untreated. Before the disruption of angioplasty, for example, many people with coronary artery disease were not treated. Patients
had to be disabled with chest pain or at risk of
heart attack to justify the expense and inconvenience of open-heart surgery.
We need many more such disruptions—and
today we have them within our reach. Unfortunately, the people and institutions whose
livelihoods they threaten often resist them. We
saw such resistance in the story of the portable
X-ray machine. Here’s another example. An English entrepreneur has developed a system for
customizing eyeglasses quickly and efficiently.
The patient puts on a pair of eyeglasses with
seemingly flat lenses and an odd-looking rubber bulb attached to each stem. Looking at a
vision-test chart and covering one eye, she
squeezes the bulb on the right stem until she
can read the fine print on the chart. A monomer in the bulb shapes the lens until that eye
can see perfectly. She repeats the process for
the other eye. Within two minutes, she has perfectly tailored eyeglasses—at a cost of about
Disruptions of Health
Care Institutions
$5. This is a disruptive technology. It lets patients do for themselves something that historically required the skill of professionals.
Predictably, the established professions
quickly mobilized to discredit the entrepreneur’s technology, asserting that dangers such
as glaucoma might go undetected if patients
corrected their own vision and that for the
long-term well-being of patients, care of the
eyes must be left in the hands of professionals.
Of course this is a reasonable concern. But it
frames the problem incorrectly. The problem
should be, instead, let’s find a way to allow patients to correct vision for themselves while
finding new ways for professionals to catch potentially serious disorders at an early stage.
Such resistance affects not only technology
but people as well. Take nurse practitioners
and physicians’ assistants. Because of advances
in diagnostic and therapeutic technologies,
these clinicians can now competently, reliably
diagnose and treat simple disorders that would
have required the training and judgment of a
physician only a few years ago. Accurate new
tests, for example, allow physicians’ assistants
to diagnose diseases as simple as strep infections and as serious as diabetes. In addition,
studies have shown that nurse practitioners
typically devote more time to patients during
consultations than physicians do and emphasize prevention and health maintenance to a
greater degree.2 But many states have regulations that prevent nurse practitioners from diagnosing diseases or from prescribing treatment that they are fully capable of handling.
Complexity of
diagnosis and
treatment
Teaching hospitals incur great costs to develop the ability to treat difficult, intractable illnesses at the high end. In the process, they have come to overserve the
needs of the much larger population of patients whose disorders are becoming more
and more routine. Most types of patients
that occupied hospital beds 20 years ago
are now being treated in more-focused
care centers and outpatient clinics, doctors’ offices, and even at home.
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page 7
The flawed rationale behind such policies is
that because nurse practitioners are not as
highly trained as physicians, they are not capable of providing care of comparable quality.
This is the same logic that minicomputer makers used to discredit the personal computer.
When a physician diagnoses a simple infectious disease, the patient uses only that fraction of the physician’s training that relates to
simple infectious diseases. Studies have shown
that nurse practitioners with comparable training in simple infectious diseases can provide
care of comparable quality in that tier of the
market—even though they lack training in
more complex disorders.3
Some nearsighted advocates of patients’
Patient Welfare in Disruptive Times
How might patients fare amidst health
care disruptions? The answer depends
on whether competitive markets are allowed to work efficiently. If clinicians or
patients are forced to use less expensive
technologies, disaster will result. But if
consumers and providers are given
choices, the use of disruptive technologies will migrate to those applications
where they create real value.
Consider Sonosite, a Seattle-area
company that makes a small, highly portable, inexpensive ultrasound machine.
The machine is good, but it is disruptive—it lacks the analytical features and
the degree of resolution found in more
expensive ultrasound equipment. If a
managed care organization forced
echocardiologists and OB-GYN physicians to use these less expensive devices
for situations in which they previously
have used traditional equipment, a
specialist could risk missing something
important, and the patient’s well-being
could be compromised. But suppose instead that because Sonosite’s technology now makes ultrasound accessible
and affordable to generalist clinicians,
they could begin to provide better, more
accurate care within the low-cost and
more convenient context of their offices.
Instead of conducting exams in which
they hypothesize about what’s going on
inside a patient’s body by listening
page 8
through a stethoscope or by using their
fingers to probe for irregularities, they
could use this simple ultrasound device
that would let them see inside the
body. By enabling generalists to diagnose more quickly and with greater
precision, disruptive technologies such
as Sonosite’s can improve, not compromise, the cost, quality, and convenience
of care.
Ultimately, we would expect that the
disruptive portable machines will improve to the point that they will supplant the more expensive traditional
ultrasound equipment in established
applications as well. But the true transformative impact of such technologies
in health care will come as they allow
less expensive professionals to provide
better care.
If history is any guide, the established
high-end providers of products and services are likely to be articulate and assertive about preserving existing systems in
order to ensure patient well-being. Very
often, however, their eloquence reflects
concerns about their own well-being.
Customers have almost always emerged
from disruptive transitions better off—
as long as the disruptions are not forced
into an old mode, but instead enable
better service to be delivered in a lesscostly, more convenient context.
rights assert that nurse practitioners might not
have the judgment to recognize when a disorder is beyond their expertise. But family practice doctors recognize when they can treat a
disorder and when it merits referral to a specialist. Surely nurse practitioners, working at
even simpler tiers of the market, can be
equipped to do the same thing. The real reason
for blocking such disruption, we suspect, is the
predictable desire of physicians to preserve
their traditional market hegemony.
Instead of working to enable the natural upmarket migration that is an intrinsic part of
economic progress, today’s managed care organizations, insurers, and regulators have done
just the opposite. They have forced highly
trained physicians down-market to diagnose
ear infections and bronchitis and have prevented nurse practitioners from doing things
that technology enables them to do perfectly
well. The result of this policy is perverse. To
maintain their incomes, primary care physicians are forced to churn patients at an alarming rate—frequently spending only a few minutes with each patient. That reduces the
quality and convenience of care.
This practice, which has become pervasive in
most managed care organizations, is akin to
what would have happened if some regulatory
body in the early 1980s had decreed that because microprocessors were inferior in computing power to wired logic circuits, all personal
computers had to be equipped with wired logic
boards, not microprocessors. Such a regulation
would have halted the industry’s progress. The
fact that we were able to use microprocessorbased computers for the jobs they were capable
of handling, and wired-logic-based machines
for the jobs for which microprocessors weren’t
suited, has been a key to the creation of highquality, convenient, cost-effective computing
for all of us. Enabling less expensive people to
do things that were previously unimaginable
has been one of the fundamental engines of
economic progress—and the established health
care institutions have fought that engine tooth
and nail.
Solutions to the Crisis
The crisis in health care is deep, to be sure. But
the history of other disruptive revolutions offers a number of suggestions for how a systemic transformation might be managed. We
describe some of these here:
Create—then embrace—a system where
the clinician’s skill level is matched to the difficulty of the medical problem. Medical problems range from the very simple to the very
complex, as we’ve said. Let’s look more closely
at that range for a moment. In the simplest
tiers, diagnosis and treatment can be rulebased: accurate data yield an unambiguous diagnosis, indicating a proven therapeutic strategy. Many infectious diseases fall into this category. In the middle tiers, diagnosis and
treatment occur through pattern recognition—no single piece of data yields an answer,
but multiple data points lead to a definitive diagnosis. The onset of Type I diabetes, for example, is diagnosed when a pattern is observed—blurry vision, incessant thirst, weight
loss, and frequent urination. Once a diagnosis
is confirmed, relatively standardized treatment protocols often exist. In the most complex disorders, diagnosis and treatment occur
in a problem-solving mode. These problems
require the collective experience and judgment of a team of clinical investigators and
often involve cycles of testing, hypotheses,
and experimentation.
By now it’s clear that the simplest tiers can
be reliably treated and diagnosed by less
highly skilled clinicians—and also that institutional forces will fight that reality. We cannot
allow such opposition to arrest reform. Instead, we must invent processes that can channel complex problems, which can’t be solved in
a rule-based mode, to clinicians whose skills
are appropriate to a pattern-recognition or a
problem-solving mode.
Scientific progress moves disorders that
used to be dealt with in a problem-solving
mode toward a pattern-recognition mode and
those that had to be addressed through pattern
recognition toward a rule-based regime. Mapping the human genome will accelerate this
process. Not long ago, for example, leukemia
was thought to be a single disease. Diagnosing
and treating it was complex—no two patients
responded identically to the same therapy, and
treatment required the experience, intuition,
and problem-solving skills of the best oncologists. Our improved understanding of the
human genetic code, however, has helped researchers see that what we previously called
leukemia is really at least six different diseases.
Each is characterized by a specific genetic pattern, and patients can be precisely diagnosed
by matching their patterns to a template.
Where once therapy used to be applied experimentally, such precise definition of the disease will allow for precise treatment protocols.
Disruptive technologies such as this are precisely what are needed to reform health care.
They will continue to enable less-experienced
caregivers to make more precise diagnoses and
provide higher quality care than they could
have in problem-solving mode.
It’s in physicians’ interest to embrace this
change. Rather than fight the nurse practitioners who are invading their turf, primary care
physicians should move upmarket themselves,
using advances in diagnostic and therapeutic
technologies to perform many of the services
they now refer to costly hospitals and specialists. They should, in other words, disrupt those
above them rather than fight a reactionary and
ultimately futile battle with disrupters from
below.4 Let us be clear. Many managed care organizations today give primary care physicians
a financial incentive not to refer patients to
specialists—to continue treating patients they
are not competent to care for. Inviting them to
move incompetently upmarket is a recipe for
disaster. Disruptive technologies such as those
we have described will enable these caregivers
to move competently upward. These innovations are the sort that will reform health care.
This strategy—unlike the one that pushes
these physicians down-market or encourages
them upward without enabling technology—is
consistent with the way technological progress
and customer needs interact.
Invest less money in high-end, complex
technologies and more in technologies that
simplify complex problems. Equity markets
have not been generous to companies making
health care products and equipment in recent
years. Other sectors of the economy are perceived to exhibit greater growth and profit potential. One reason for this, we believe, is that
much of the energy and capital spent in the
development of new health care products and
services have been targeted at the high end—
at sustaining technologies that enable the
most skilled practitioners to solve problems
that could not be solved before. We do not
contest the value of these innovations—but
they will not transform health care. The great
growth opportunities exist in the simpler tiers
of the market. History tells us that major new
growth markets coalesce when products, pro-
When care is complex,
expensive, and
inconvenient, many
afflictions simply go
untreated.
page 9
cesses, and information technologies let less
highly paid groups of people do things in more
convenient settings. To truly disrupt the
health care system, venture capital, entrepreneurial energy, and technology development
need to flow toward these enabling initiatives.
Rather than focus on complex solutions for
complex problems, research and development
need to focus on simplification.
It’s not entirely clear why more venture capital hasn’t flowed in this direction. One possible reason is that individual entrepreneurial
companies don’t get to pick fights with individual Goliaths—more often, they face an army of
giants. Because regulators, litigators, insurers,
physicians, hospitals, and medical schools have
such powerful interlocking interests in the status quo, disruption might require the concerted strategic focus of major health care
companies such as Johnson & Johnson, Baxter,
Medtronic, or Merck. Over time, they could
overcome the inertia of entrenched institutions. A series of disruptive business ventures
launched by these companies would create far
greater growth for them, with less investment,
than would continued pursuit of sustaining
technologies that enable specialists to push
further into high-end complexities.
Create new organizations to do the disrupting. The health care industry today is trying to preserve outmoded institutions. Yet the
history of disruptive innovations tells us that
those institutions will be replaced, soon
enough, with new institutions whose business
models are appropriate to the new technologies and markets.
When disruptive innovations have invaded
the mainstream markets of other industries, a
difficult period typically has preceded the arrival of truly convenient, lower cost, higher
quality products and services. Between 1988 and
1993, for example, as networked personal computers became the dominant information technology architecture, the former industry leaders
fell into disarray. Together, the mainframe and
minicomputer makers logged $20 billion in operating losses during that period. None of these
companies was able to adapt its business model
to compete in the personal computer world. Instead, they seemed able only to tighten the
thumbscrews on their existing processes, attacking costs through mergers and layoffs, as they
withered away. During this period, it wasn’t the
computer industry that was in crisis—only its
page 10
traditional institutions were. Disruptive innovators such as Intel, Sun, Microsoft, and Dell were
creating extraordinary value.
The massive financial losses that hospitals
and managed care institutions are suffering
today mirror exactly what happened to the
dominant players in other disrupted industries.
And they are responding in the same way—by
tightening controls on their existing business
models. They are merging, closing facilities, laying off workers, forming buying groups, delaying payments, adding layers of control-oriented
overhead workers, and hiring consultants—
while going about their work in a fundamentally unchanged way. In fact, the billions of dollars large general hospitals are spending to build
information technology systems and to create
integrated feeder systems of physicians’ group
practices and primary-, secondary-, and tertiarycare hospitals are designed to preserve, rather
than displace, the existing institutions.
We will always need some general hospitals
to provide intensive and critical care to the
sickest patients, just as we still need IBM and
Hitachi to make mainframe computers for the
most complex computing applications. But it is
very likely that the care of disorders that primarily involve one system in the body—from
earaches to cardiac and renal illnesses—will
migrate to focused institutions whose scope
enables them to provide better care with less
complexity-driven overhead. If history is any
guide, the health care system can be transformed only by creating new institutions that
can capably deliver the vast majority of such
care, rather than attempting a tortuous transformation of existing institutions that were designed for other purposes.
Leaders of today’s hospital and managed
care companies might profit from comparing
the approaches that S.S. Kresge and F.W. Woolworth took toward disruptive discount retailing, beginning in the early 1960s, as recounted
in Clayton Christensen’s The Innovator’s Dilemma. Kresge addressed the disruption by systematically closing 10% of its variety stores
every year and funneling all its cash into its disruptive start-up, Kmart. Woolworth, by contrast, tried to maintain its pace of investment
in its traditional stores while building its discount-retailing arm, Woolco. Despite the fact
that Woolworth was far larger and had much
deeper pockets, Woolco—and ultimately all of
Woolworth’s variety stores—folded. The les-
sons for today’s medical institutions: don’t be
scared to invent the institution that could put
you out of business, and stop investing in dying
business models.
Overcome the inertia of regulation. Attempts to use regulation to stave off disruptive
attacks are quite common. The U.S. automakers, for example, relied on import quotas as
long as they could to keep disruptive Toyota
and Honda at bay. Unfortunately, regulators
are inclined to be even more protective of the
entrenched professions and institutions in
health care than they were of the U.S. automakers. The links between those institutions, federal and state regulators, and insurance companies are strong; they are wielded to preserve the
status quo. (Nothing else could explain why
nurse practitioners are forbidden from diagnosing simple illnesses in so many states.)
Instead of working to preserve the existing
system, regulators need to frame their jobs differently. They need to ask how they can enable
disruptive innovations to emerge. Let’s return
to the example we began with—the low-cost Xray machine. Suppose the regulators wanted to
see this disruptive innovation work in doctors’
offices but were concerned about potential
risks. They might require that all images interpreted in a physician’s office by a nonradiologist be transmitted via the Internet to a secondopinion center, where skilled radiologists could
confirm those initial diagnoses. Admittedly,
that would require a massive change in the
way regulators do their work.
The Need for Leadership
Once an industry is in crisis, individual leaders
often become paralyzed. They’re incapable of embracing disruptive approaches because the profitability of the institutions they lead has been so
eroded. Typically, not only do they ignore the potential disruptions, they actively work to discredit
and oppose them. Thus far, this pattern has held
true in the health care industry as well.
Successful disruptive revolution of this system will unfold more quickly, and far less painfully for everyone, if leaders at regional and national levels work together—not to regulate the
existing system but to coordinate the removal of
the barriers that have prevented disruptions
from happening. Unfortunately, in this presidential election year, the proposals from both
leading parties for dealing with the crisis in
health care have been molded within the estab-
lished system. These proposals can be divided
into three categories of solutions: control costs
by consuming less health care; impose reimbursement controls that force high-end providers to become more efficient; and use government money to subsidize the high costs of
health care for targeted segments of the population. None of these proposals addresses the fundamental causes of the dilemmas that the
health care system faces.
Government and health care industry leaders need to step forward—to help insurers, regulators, managed care organizations, hospitals,
and health professionals work together to facilitate disruption instead of uniting to prevent it.
If they do, some of the established institutions
will fail. But many more health care providers
will realize the opportunities for growth that
come with disruption—because disruption is
the fundamental mechanism through which we
will build a higher quality, more convenient,
and lower cost health care system. If leaders
with such vision do indeed step forward, we will
all have access to more health care, not less.
The authors express appreciation to Jeff Elton
and his staff at Integral, Incorporated for their
contributions to this article.
1. Clayton M. Christensen, The Innovator’s Dilemma: When
New Technologies Cause Great Firms to Fail (Harvard Business School Press, 1997).
2. See James Lardner, “For Nurses, a Barrier Is Broken,” U.S.
News & World Report, July 1998.
Instead of working to
preserve the existing
system, health care
regulators need to ask
how they can enable
disruptive innovations to
emerge.
3. Richard A. Cooper, MD, et al. “Roles of Non-physician
Clinicians as Autonomous Providers of Patient Care,” JAMA,
September 2, 1998. These market forces are already at
work. It is estimated that by the year 2005, the number of
nurse practitioners in clinical practice will equal the number of family physicians. Between 1992 and 1997, the number of schools offering qualification programs for NPs more
than doubled, from less than 100 to approximately 250.
During that same time, the number of students pursuing
NP degrees quintupled, from 4,000 to over 20,000.
4. Evidence that specialists are already being disrupted in
this manner can be found in a 1995 report by the Council of
Graduate Medical Education, which predicted an excess of
115,000 specialists by the year 2000. See Stephen M. Shortell et al., Remaking Health Care in America: Building Organized Delivery Systems (Jossey-Bass Publishers, 1996), p. 298.
Reprint R00501
Harvard Business Review OnPoint 6972
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page 11
Further Reading
ARTICLES
Disruptive Technologies:
Catching the Wave
by Joseph L. Bower and
Clayton M. Christensen
January–February 1995
Product no. 3510
The authors examine more closely what can
happen to companies that ignore disruptive
innovations—and offer guidelines for avoiding that fate. Established firms often reject
disruptive technologies. Why? Their most
profitable, high-end customers want more
sophisticated technologies. And, the new
technologies’ projected profit margins won’t
cover their big-company cost structures.
While they’re ignoring the disruptive innovations, upstart companies step in to bring
these cheaper, simpler, more convenient
products to less-demanding markets. Over
time, these products improve to meet the
needs of high-end customers as well. By the
time established firms recognize disruptive
threats, their competitive opportunities have
been lost.
To Order
For reprints, Harvard Business Review
OnPoint orders, and subscriptions
to Harvard Business Review:
Call 800-988-0886 or 617-783-7500.
Go to www.hbr.org
To prevent disruptive technologies from slipping through their fingers, established corporations must identify and nurture innovations
on a more modest scale—so small orders are
meaningful, ill-defined markets have time to
mature, and overhead is low enough to permit early profits.
Transforming Life, Transforming
Business: The Life-Science Revolution
by Juan Enriquez and Ray A. Goldberg
March–April 2000
Product no. R00203
Where will the next disruptive innovations in
health care come from? Enriquez and Goldberg argue that genetic engineering will not
only revolutionize the practice of medicine,
benefiting individuals and societies everywhere—it will also reshape vast sectors of the
world economy. Ultimately, it will subsume
health care (and other industries such as agribusiness, chemicals, and pharmaceuticals)
into what promises to become the largest
industry in the world: life sciences.
As genetic advances continue to accelerate,
more and more businesses will be drawn—
by choice or by necessity—into the lifescience industry. Firms must rethink their
business, financial, and M&A strategies, as
well as make vast R&D investments with distant and uncertain payoffs. The actions companies take now will go a long way toward
determining the ultimate role they play in this
emerging industry.
For customized and quantity orders
of reprints and Harvard Business
Review OnPoint products:
Call Frank Tamoshunas at
617-783-7626,
or e-mail him at
[email protected]
page 13
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800-988-0886
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617-783-7555 fax

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