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At the Intersection of Health, Health Care and Policy

doi: 10.1377/hlthaff.27.5.1329 27, no.5 (2008):1329-1335Health Affairs Innovation

Disruptive Innovation In Health Care Delivery: A Framework For Business-Model Jason Hwang and Clayton M. Christensen

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P e r s p e c t i v e

Disruptive Innovation In Health Care Delivery: A Framework For Business-Model Innovation Coupling technological advances with appropriately matched business models is the right prescription for our ailing health system.

by Jason Hwang and Clayton M. Christensen

ABSTRACT: Disruptive innovation has brought affordability and convenience to customers in a variety of industries. However, health care remains expensive and inaccessible to many because of the lack of business-model innovation. This paper explains the theory of disrup- tive innovation and describes how disruptive technologies must be matched with innova- tive business models. The authors present a framework for categorizing and developing business models in health care, followed by a discussion of some of the reasons why dis- ruptive innovation in health care delivery has been slow. [Health Affairs 27, no. 5 (2007): 1329–1335; 10.1377/hlthaff.27.5.1329]

I t i s a l m o s t r e q u i s i t e that any dis- cussion about the future of health care be- gin with a reference to the unsustainable

growth rate of U.S. medical spending. Charts and graphs expound on health care’s acceler- ating share of gross domestic product (GDP), depicting a voracious beast that threatens to swallow what little money remains for other vital services. And yet, although deliberations about how to curb this dramatic increase in spend ing are imperative, a related , but equally important, question is often lost amid these debates.

In this paper we attempt to address this other side of the coin. Instead of asking how we can afford health care, we instead ask how we can make health care more affordable. We present a conceptual framework from the world of business administration that explains how other industries have coupled cost- reducing technologies with innovative busi-

ness models to deliver increasingly affordable and accessible products and services. We call the process that drives these advances “disrup- tive innovation,” and we believe that it is a nec- essary component to creating a high-perform- ing health care system that is available to all.

Defining “Disruptive Innovation” The theory of disruptive innovation helps

explain how complicated, expensive products and services are eventually converted into sim- pler, affordable ones.1 Exhibit 1 portrays the performance of a product or service, which gradually improves over time. However, there are actually two different trajectories of per- formance improvement in every market, de- picted in the graph by the solid and dotted lines.

The solid lines depict the continual im- provement of a product or service that is intro- duced by companies over time. Although these

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DOI 10.1377/hlthaff.27.5.1329 ©2008 Project HOPE–The People-to-People Health Foundation, Inc.

Jason Hwang ([email protected]) is executive director of the Healthcare Practice at the Innosight Institute in Watertown, Massachusetts. Clayton Christensen is the Robert and Jane Cizik Professor of Business Administration at the Harvard Business School in Boston.

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innovations can be either small and incremen- tal or dramatic breakthroughs, we have chosen to call them all “sustaining innovations” be- cause they sustain the existing trajectory of performance improvement. Sustaining innova- tions result in better products that can be sold for higher profits to the best customers—a prevailing mantra of the business world that can offer prudent guidance for businesses and entire industries for many years.

However, the dotted lines in Exhibit 1 re- flect a different trajectory: customers’ demand for and usage of ever-improving products and services. The spectrum of customers’ desire for increased performance is represented by the multiple dotted lines, but what is interesting is that these lines, beginning with the least- demanding tier of customers, eventually inter- sect with the trajectory of product improve- ment. These points of intersection are the graphic representation of the fact that compa- nies upgrade their products with features much more quickly than most customers can use them. And when products begin to pack in more functionality than customers need or de- sire, a different type of innovation occasionally emerges—a disruptive innovation.

In contrast with sustaining innovations, a disruptive product is actually not as good as what existing customers are already using, and hence it does not appeal to many customers in the existing market. However, because the

new product is usually simpler, more conve- nient, and more affordable, it enables the par- ticipation of a new set of customers who were previously ignored by the market or shut out completely. As shown in the exhibit, not only does this type of innovation take root in a por- tion of the market that is least demanding or not consuming at all, but it also targets cus- tomers who are least attractive to the market leaders. Successful incumbent firms will al- most always choose instead to focus on offer- ing sustaining products to their higher-paying, performance-hungry tiers of customers.

Because disruptive products do not appeal to the best customers paying the highest prices, they are almost always introduced by new entrants rather than the dominant in- cumbents of an industry. Yet once the disrup- tive product establishes a foothold in the mar- ket, it too begins to improve over time, and, one by one, customers of the sustaining com- pany find that their needs can be met by the disruptive innovation. Before long, the leaders find themselves bereft of customers.

Impact Of Disruptive Innovation On Value

Disruptive innovation explains how up- start companies, in an effort to deliver more- affordable and -accessible solutions, are able to sweep away once-dominant firms with alarm- ing regularity, often before the incumbents

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and their leaders realize that their days are numbered. Canon did it to Xerox by bringing slower but less costly tabletop photocopiers to the market. Toyota did it to General Motors by introducing less stylish but cheaper models, and now Korean, Chinese, and Indian automo- bile manufacturers are disrupting Toyota by doing the same thing.

One of our favorite examples was the dis- ruption of the mainframe and minicomputer by the less powerful but more affordable per- sonal computer (PC). Only a few decades ago, access to computing power was very expen- sive, and computers were complicated to use. To compute, one had to bring a stack of punch cards to a corporate mainframe center or to a university, where highly skilled computer sci- entists and technicians could help process the jobs. With the introduction of the PC, how- ever, many more people could afford to com- pute in their own offices and homes without the intervention of specially trained experts. As PCs became more powerful themselves, fewer individuals and businesses needed the expensive computing power of a mainframe. And although we spend far more today on computers than we did in the past, hardly any of us ever questions the fact that we are all better off.

The widespread belief that increased spending in health care, particularly on new technologies, is something that must be

quelled shows how long we have tried to an- swer the wrong question. When embedded within disruptive business models that capi- talize on increased convenience and afford- ability, new technologies can deliver tremen- dous value. We next address the critical step of business-model innovation that must be paired with these technologies.

Disruptive Technologies And Business-Model Innovations

We are often asked why, with so many so- phisticated medical technologies introduced every year, health care has not been disrupted to a significant degree already. The reason is that technology has almost always been imple- mented in a sustaining manner in health care—primarily to help hospitals and doctors solve the most complex problems. There is nothing wrong with this, of course, but it does little to make health care more affordable and accessible. To understand why this happens, we must start by analyzing what constitutes a business model.

The starting point of a successful business model is its value proposition: a product or service that helps customers get a job done more effectively, conveniently, and affordably (Exhibit 2). Managers then bring together a set of resources—including people, supplies, intellectual property (IP), equipment, and cash—required to deliver the value proposi-

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EXHIBIT 2 The Four Components Of A Business Model

SOURCE: Authors’ analysis (with Mark Johnson).

Profit formula: Assets and fixed cost structure, and the

margins and velocity required to cover them

Processes: Ways of working together to address

recurrent tasks in a consistent way: training, development, manufacturing, budgeting,

planning, etc.

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tion. As employees and other resources repeat- edly work together to generate the product, processes emerge and become ingrained in the business model. Finally, a profit formula mate- rializes, which defines the pricing, mark-ups, gross and net profit margins, asset turns, and volumes necessary to profitably cover the costs of the resources and processes that are required to deliver the value proposition.

Over time, an established business model begins to determine the types of value proposi- tions an organization can and c a n n o t d e l i v e r . I n o t h e r words, once the pieces of a b u s i n e s s m o d e l h av e c o- alesced to deliver a particular value proposition, the causal- ity of events begins to work in reverse—only value proposi- tions that fit the existing re- sources, processes, and profit formula of the organization can be successfully taken to market. In our re- search on disruptive innovation, the only in- stances when an original market leader suc- cessfully transitioned to becoming a leader in the new disruptive plane of competition oc- curred when the incumbent established an en- tirely autonomous business unit organized around the disruptive value proposition. This independent business was therefore allowed to create its own profit formula, making money on lower margins than the parent com- pany could, while processes and resources were also markedly different because they were adopted under the new profit formula.

Many companies actually had disruptive technologies within their grasp but failed to link those technologies with disruptive busi- ness models. For example, as the PC market was heating up, Digital Equipment Corpora- tion (DEC), the leading manufacturer of mini- computers, indeed had access to microproces- sors. In fact, given the company’s industry expertise and experience, it made some of the best ones. But DEC’s business model could not profitably make and sell computers for less than $50,000, and internal business plans that featured microprocessor-based computers

languished in favor of proposals that offered higher-end products for the company’s best customers. In contrast, IBM created a very dif- ferent business model in Florida, allowing it to grow autonomously despite the threat of can- nibalizing sales of more-profitable products. DEC was disrupted away, along with all of the other minicomputer manufacturers, while IBM’s new business model, with the micro- processor at its core, revolutionized the world.

In health care, most technological enablers have failed to bring about lower costs, higher quality, and greater accessibility. We believe that the primary rea- son is a lack of business- model innovation, for a vari- ety of reasons that we postu- late at the close of this paper.

A Typology Of Business Models

Before describing what can and needs to be done in health care, we present a construct for classifying and analyzing business-model in- novation. In general, business models can be categorized into three types: solution shops, value-adding process businesses, and facili- tated user networks.2

� Solution shops. Solution shops are in- stitutions built to diagnose and solve unstruc- tured problems. Consulting firms, advertising agencies, research and development organiza- tions, and many law firms employ this type of business model. These solution shops deliver value primarily through the people they em- ploy—experts who draw upon their intuition and problem-solving skills to diagnose the cause of complicated problems and recom- mend solutions—and successful firms are those that can attract the best talent. Solution- shop work tends to be unique for each cus- tomer, who is often quite willing to pay very high prices in return.

� Value-adding process businesses. These businesses transform inputs of re- sources, such as people, equipment, raw mate- rials, energy, and capital, into outputs of greater value. The business model is built to do

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“In health care, most technological

enablers have failed to bring about lower costs, higher quality,

and greater accessibility.”

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this in repetitive ways so that the organiza- tion’s capabilities are embedded more in its processes than in its resources. Although some value-adding process businesses may be more efficient than others, as a whole they focus their attention on process excellence that can deliver high-quality services and products consistently at a lower cost, and they are less affected than other types of businesses are by the variability that occurs when outcomes de- pend on people’s intuition. Often, results can be guaranteed or redone free of charge. Retailing, restau- rants, automobile manufac- turing, and petroleum refin- ing are examples of this type of business model.

� Facilitated user net- works. User networks are en- terprises in which the same people buy and sell and de- liver and receive things to and from each other. In these types of businesses, the companies that deliver value and make money are those that facilitate the effective op- eration of the network and its user transac- tions. Mutual insurance companies are user- network businesses—customers deposit their insurance premiums into a collective pool, and they take claims out of it. Telecommunications companies, which facilitate calls and data transfers among their customers, as well as the online auction site eBay, stock exchanges, and many activities of banks are also user-network businesses.

Finding The Right Business Models For Health Care

The two dominant business models in health care—those of general hospitals and physician practices—are solution shops that emerged in an era when nearly all medical care relied on the intuition of highly skilled profes- sionals. But over time, these institutions have subsumed under their organizational umbrel- las many activities that are perhaps better suited to businesses based on value-adding processes or user-network models. The legacy institutions of health care delivery are jumbled

mixtures of multiple business models strug- gling to delivery value out of chaos, incorporat- ing indecipherable systems of cost accounting, excessive overhead, pervasive cross-subsidiza- tion, and an unacceptable amount of variability and medical error.

Nevertheless, there are already examples of business models in health care whose re- sources, processes, and profit formulae appro- priately match the nature of their value propo- sitions. Many medical procedures, ranging

from having a nurse use a rules-based diagnostic test to verify the presence of Group A streptococcal pharyngitis and then writing and filling a prescription to cure it, to her- niorrhaphy and angioplasty, are value-adding process ac- tivities. This type of work is possible only after a definitive diagnosis is made first, often

by a solution shop. But when the value-adding procedures are organizationally separated from the work of solution shops, the overhead costs of the value-adding activities drop so dramatically that focused value-adding proc- ess hospitals and clinics can deliver care at prices that are 60 percent lower than those at hospitals and physician practices in which the business models of value-adding process busi- nesses and solution shops are conflated. Insti- tutions such as MinuteClinic, Shouldice Hospi- tal in Ontario, and certain focused cardiology hospitals are examples of value-adding process businesses in health care.3

Meanwhile, although facilitated user net- works remain underdeveloped and underused in health care, they are an ideal business model for the care of many chronic diseases. Familiar examples include Weight Watchers and Alco- holics Anonymous; dLife, which created a net- work for diabetics and their families, is an- other example of a user-network business that facilitates the exchange of information and care advice among its customers. Using a vast array of patient and insurance carrier data, Revolution Health is building a network that will allow users to find matched cohorts, share

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“Legacy institutions of health care

delivery are jumbled mixtures of multiple

business models struggling to delivery value out of chaos.”

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data, and learn from one another. User net- works will help shift much of the care of chronic diseases out of the intuitive-based practice of hospitals and physician practices, whose business models are poorly equipped to meet the needs of these people. Similar to value-adding process hospitals that can per- form procedures with higher quality and at dramatically lower cost than traditional hos- pitals, user-network businesses will also im- prove the quality and reduce the cost of care for many behavior-dependent chronic dis- eases.

These disruptive business models attempt to deliver value propositions that are distinct from those of hospitals and physician prac- tices. By embedding into their business models the technologies that have simplified the once- complex work performed in solution shops, the disruptive entrants fit together their re- sources, processes, and profit formulae in ways that hospitals and physician practices cannot match—nor should they be expected to. Be- cause these disruptive businesses focus on specific, rules-based portions of health care, they can deliver care at lower cost and with higher quality than could the models of old. This is because the processes have such pre- dictable variation that work can be transferred from specialists to generalists, from generalists to nurses and other physician extenders, and ultimately to patients themselves.

Pairing technological enablers with disrup- tive business models is what leads to greater affordability and accessibility, and this is where health care entrepreneurs and policy- makers must focus their energy if the same de- gree of innovation is to be brought to health care that has already transformed numerous other industries.

Challenges To New Business Models In Health Care

� Fragmentation of care. Carving fo- cused facilities and user networks out of to- day’s mixed models of health care delivery might indeed capture unrealized efficiencies and cost savings, but they also might fragment the delivery of care. Coordination of care in

such a system is critical, and the importance of interoperable health information technology (IT) cannot be stressed enough. Health IT sys- tems must serve as the connective tissue join- ing the various pieces of health care delivery into a coherent system that delivers continuity through safe, satisfying relationships. The role of care coordination can also be performed to varying degrees by a patient-centered medical home (PCMH), telephonic services such as Revolution Health’s Nightingale service, Web- based decision-making software, and personal health records (PHRs).

� Lack of a retail market. Disruptive in- novation requires that a market of consumers carry proper incentives to shop for products and services that best meet their needs. This has long been the criticism of the third-party payer system, and dizzying combinations of deductibles, coinsurance, copayments, and limits have failed to create the true retail mar- ket necessary to generate shopping behavior. Health savings accounts (HSAs), in combina- tion with high-deductible health plans, are perhaps the best vehicle available today to en- courage rational health care purchasing deci- sions.

However, it is important to recognize that the health care system comprises highly inter- dependent business models, and one cannot simply plug in a new component and expect it to work. HSAs do create proper incentives for healthy behavior, but as long as the health care delivery system remains costly and inconve- nient, customers rationally avoid spending their money on those services. In other words, until we see business-model innovation in health care delivery in conjunction with HSAs, we will continue to see individuals paradoxi- cally avoiding the healthy behavior that these vehicles were meant to encourage.

� Regulatory barriers. Well-known bat- tles over federal moratoria on focused spe- cialty hospitals, state certificate-of-need (CON) policies, and restrictions on physi- cians’ ownership of medical facilities have all involved impassioned claims by proponents of the status quo that disruptive change could jeopardize public safety for the sake of higher

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profits. Interestingly, every company and in- dustry that was eventually disrupted has had supporters who at one time lobbied against change and argued that disruptive enterprises could never offer more than substandard per- formance and unacceptable quality.

The firms that grew to become successful under specific regulatory conditions subse- quently worked very hard to make sure that those conditions remained in their favor. It wasn’t very long ago that General Motors lob- bied for increased tariffs and quotas on Japa- nese imports, arg uing before Cong ress, “What’s good for General Motors is good for America.”

However, although often written with good intentions, these regulations unintentionally trap health care in high-cost models of care. For example, many states do not allow nurses to interpret simple test results or write basic prescriptions, leaving care delivery to be per- formed by physician-staffed solution shops. This makes sense for complex illnesses that re- quire the intuition of experts, but such regula- tions leave no room for value-added process businesses such as nurse-staffed retail clinics that can deliver better and more cost-effective care for a growing list of conditions. Health care policymakers must recognize the hidden cost of supporting and renewing regulations that inhibit innovation over the long run.

� Reimbursement. Finally, returning to our original premise that it is a mistake to fo- cus only on cutting costs when trying to fix the health care system, regulators and payers often direct their attention to cutting reim- bursement rates as the primary solution. How- ever, cutting reimbursement in an attempt to force the solution-shop business models of hospitals and physician practices to somehow figure out a way to become more efficient does little to improve health care delivery. With lower reimbursement, hospitals and physi- cians struggle even more to fulfill their value propositions of providing complex, inherently expensive medical care, and they become even less inclined to hand off work to value-added process businesses.

A s w e h av e t r i e d to emphasize in this paper, the appropriate solution is to encourage the development of dis-

ruptive business models that can assume a greater share of the workload—not to force the old models of solution-shop medicine, successful in their own right, to twist and conform. By coupling technological advances with appropriately matched business models, disruptive innovation has brought afford- ability and accessibility to industries ranging from steel making to personal finance, and it is the right prescription for the ailing U.S. health care system—a treatment that is des- perately needed and long overdue.

This work was supported in part by a grant from the California HealthCare Foundation.

NOTES 1. For details about the research that underlies the

theory of disr uptive innovation, see C.M. Christensen, The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail (Boston: Har- vard Business School Press, 1997).

2. C.B. Stabell and Ø.D. Fjeldstad, “Configuring Value for Competitive Advantage: On Chains, Shops, and Networks,” Strategic Management Jour- nal 19, no. 5 (1998): 413–437.

3. For further discussion about the value of focus, see R.E. Herzlinger, Market-Driven Health Care: Who Wins, Who Loses in the Transformation of America’s Largest Service Industry (Reading, Mass.: Addison- Wesley, 1997), 157–199.

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