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Strategic_Healthcare_Management_Planning_and_Execu..._----_Chapter_3_-Business_Models_and_Common_Strategies_.pdf

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CHAPTER

BUSINESS MODELS AND COMMON STRATEGIES

Learning Objectives

After reading this chapter, you will

• understand the concept and use of business models; • be able to describe how business models vary in healthcare and how

business models may provide a competitive advantage; • comprehend generic strategies and their application to healthcare; • be familiar with strategies for differentiation in healthcare, including

focused factories; and • recognize the advantages and disadvantages of first-mover strategy.

3 Five years from now,” said a hospital CEO to his peers at a recent conference, “our organizations will look very different. They will operate with different incentives, different business models and different footprints.” What does the future look like for community hospitals and health systems—and what are their marching orders?

The hospital business model is under pressure. The costs of physi- cians, nurses, technology, compliance, and marketing are rising, while payments from all payer types are shrinking, as is inpatient utilization. We anticipate a 12 to 28 percent revenue decline over the next few years.

Many community hospitals, already operating at razor-thin margins, soon may find themselves deep in the red. Although most hospital leaders realize this possibility, their responses to these pressures often betray a lack of focus. They react with across-the-board cuts, a race to acquire physicians, a superficial rebranding, or a search for elusive mergers and acquisitions. These incremental actions are unlikely to move the needle. What’s needed is a new way of thinking about form and function.

—Gary Ahlquist, “New Approaches for Community Hospitals and Health Systems,” 2013

Walston, Stephen L.. Strategic Healthcare Management : Planning and Execution, Health Administration Press, 2018. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/westernkentucky/detail.action?docID=5517312. Created from westernkentucky on 2021-09-17 02:00:02.

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O rganizations, even direct competitors, may form and pursue strategies in vastly different ways. This chapter discusses how organizations pro- duce value for customers and how their structure, processes, and strate-

gies influence their success. As discussed in chapter 6, success is relative to the values, mission, and vision of an organization. For for-profit organizations, sustained profits may signify competitive advantage and success. Not-for-profit organizations, however, may recognize other achievements as success. There- fore, the desired business outcome must dictate the business model of an organization.

Business Models

Whatever their definition of success, organizations constantly face the challenge of devising strategies that will enable them to enhance the value they provide to their key stakeholders. As stated in the introduction to the chapter, experts expect that healthcare and hospital business models will experience pressure to change. Business models, the underlying structure and function of orga- nizations, build on the idea of value chains and value creation (Morris et al. 2006; Porter 1985). Although a common definition of business model has not been established, Walston and Chou (2012) define it as the core elements of an organization and how it is structured to deliver value to its customers and generate revenues. Business models encompass all aspects of organizations, including their economic, operational, and strategic domains, and successful organizations design their business models around their internal competencies (Morris et al. 2006). Appropriate, competitive business models often succeed when matched against organizations that have better ideas and better technol- ogy but a poor business model (Chesbrough 2007).

Most established organizations in the same industry do not have distinct business models. Organizations that compete for the same set of customers frequently copy each other’s structures and strategies. Over time, many orga- nizations may come to offer similar sets of products and services. As discussed in chapter 7, barriers commonly restrict entry into an industry, and mobility barriers limit competition in strategic groups. With limited entry of new organi- zations and similar environmental conditions, incumbents become isomorphic over time, adopting homogenous forms and practices (DiMaggio and Powell 1983). As a result, pronounced differences in business models often emerge only when environmental shifts alter customer preferences, technology, and barriers to entry, thereby allowing new organizations to enter the industry.

New business models do not guarantee success and are often fraught with peril. For example, the US government has encouraged new organizations to experiment with distinct business models. Some experiments, like the Pioneer

Business model The underlying structure of an organization; the means through which an organization creates and delivers value to its customers and earns revenues.

Isomorphic The tendency of organizations in a market to become similar in form and structure, offer similar products, and adopt similar practices over time.

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Accountable Care Organization (ACO) Model program, created accountable care organizations that would provide savings (see exhibit 3.1). However, while many healthcare organizations initially welcomed the new approaches, most seemingly failed and abandoned the program.

Scholars often discuss business models as four interrelated components: value to customers, organizational inputs, organizational processes, and means of generating and obtaining revenues (see exhibit 3.2). The content and structure of these components should result from strategic decisions; their functions and interactions substantially contribute to the success or failure of an organization. As shown in exhibit 3.1, healthcare organizations moving to a new payment and business model may greatly struggle, and many may fail.

Customer Value Organizations seek to produce what customers value. This perceived value consists of a range of products and services, a degree of customization, ease of availability and access, and the trade-off between cost and quality. Dissimi- lar business models may provide a different type of value to customers (e.g., Amazon vs. Walmart). Customers have differing desires and needs. Some may value ease of access and availability, others want low cost, yet others seek high quality. An innovative business model aims to address the needs and desires of

In December 2011, the Centers for Medicare & Medicaid Services (CMS) signed agreements with 32 organizations to participate in its Pioneer ACO Model. According to CMS, the model was “designed for health care organi- zations and providers that are already experienced in coordinating care for patients across care settings. It will allow these provider groups to move more rapidly from a shared savings payment model to a population-based payment model on a track consistent with, but separate from, the Medicare Shared Savings Program. And it is designed to work in coordination with private payers by aligning provider incentives, which will improve quality and health outcomes for patients across the ACO, and achieve cost savings for Medicare, employers and patients.”

Moving to a new business model remains challenging. Five years later, only 9 of the 32 continued with the model program. The inability to accrue savings and increasing financial risk, coupled with the model’s strategic, operational, and information technology challenges, were huge departures from these organizations’ original business models, and few could success- fully adapt. ACOs are much more complex and require significantly greater cooperation and coordination among healthcare facilities and professionals. CMS also required the health systems to track too many quality metrics, and organizations also found it difficult to attract and retain patients.

EXHIBIT 3.1 The Challenge of Business Model Change: ACOs

Source: CMS (2017a), Advisory Board (2014), Evans (2015), Leventhal (2015).

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all consumers or just a segment. The value provided by successful organizations reflects their mission and vision and differentiates them from competitors.

The following questions can be used to explore the customer value an organization provides:

• What value is provided to the customer segments served? • What customer problems does the organization’s product or service

solve? • What customer needs does the product or service satisfy? What needs

are not satisfied? • Does the value created by the organization support its mission and

vision? • How does this value distinguish the organization from competitors?

Inputs The type and mix of resources organizations use to provide a product or ser- vice make up the inputs component of the business model. Resources include personnel, materials, and equipment. Organizations choose a mix of automated equipment and personal interaction and select types and quantities of materi- als and supplies according to the value they wish to deliver. Some businesses choose to hire personnel to answer phones and greet customers, while others automate customer interactions. Other inputs include organizational core competencies—a critical source of competitive advantage—and strategic assets, such as facilities, equipment, location, patents, networks, and partnerships. For

Customer value The perceived benefits of a product or service. Consumers may find value in many aspects of products and services, including range and type, degree of customization, ease of availability and access, and the trade-off between quality and cost.

Inputs The combination, type, and mix of resources an organization uses to provide a product or service, such as personnel; materials; and strategic assets such as facilities, equipment, location, patents, networks, and partnerships.

Value to Customers

Revenue Generation What financial mechanism is used to generate revenues to sustain the provision of the product or service?

Processes

Inputs What inputs distinguish the organization in terms of the combination of resources it uses to produce the product or service?

What value is created for customers in terms of product quality, cost, or access and availability?

What processes are used to create and provide the product or service?

EXHIBIT 3.2 The Four

Components of Business

Models

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instance, many hospitals have begun using hospitalists and intensivists as an input. An organization may change its inputs over time; for example, innova- tions in technology often trigger a change of inputs.

An organization can use the following questions to examine its inputs:

• What key inputs directly contribute to the value of the product or service?

• Are any inputs inconsequential? Could the organization lower costs or increase value if it changed any of its inputs?

• Are there new technologies that the organization should consider adding as new inputs?

Processes A process is a series of steps that ultimately transforms inputs into customer- valued products and services. In addition to creating value, processes simplify decision making, increase efficiency, complete tasks, organize functions, and enable an organization to interface with external entities. A process sits between every input and resultant output. Processes are often formalized into policies and procedures and may be categorized as primary, support, or management processes (Rummler and Brache 1995). Each step in a process should add value. Organizations vary widely in their use of processes in their business models.

The following questions can be used to examine processes:

• How do the organization’s processes differ from those of its competitors?

• Which processes add value, and which do not? • Could processes be redesigned to eliminate unneeded steps? • Do processes unnecessarily delay final outputs? • Can processes be automated? • Is there new technology that could streamline existing processes?

Revenue Generation All organizations must generate sufficient revenues to operate. To survive and prosper, even not-for-profit organizations must produce “profits” or take in more money than they expend. The ways in which funds are generated vary significantly. Organizations may obtain monies directly from consumers or through third parties. Payments for products and services can be made directly (e.g., fee-for-service), through bartering exchanges, via rebates from manufacturers, in advance (e.g., prepayments for a scope of services), and in other ways. Organizations can generate additional revenues indirectly from donations, grants, and taxation. To remain in business, however, its total direct and indirect income must exceed its expenses over time.

Process A series of steps that transforms inputs into products or services (outputs). Processes usually are established to organize functions and interface with external entities.

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Use the following questions to assess the profitability of a business model:

• In what ways does the organization generate revenues? • If the organization generates revenues in multiple ways, which are the

most important? Which will be the most important in the future? • Could new technology significantly affect the ways the organization

generates revenues? • Does the organization generate enough revenues to achieve its mission?

If not, what needs to occur?

Business Model Innovation and Adaptation

The four components of a business model constantly interact to execute an organization’s strategies. To be successful, organizations must be willing to modify their business models as conditions change. However, organizations with established business models find them difficult to change because the four components are interlinked.

The innovative business models of new market entrants are often dif- ficult for incumbents to imitate. For example, many of the major airlines have sought but failed to imitate Southwest’s low-cost business model. The inability to copy new organizations’ business models lies in the interconnectedness of the model components. Older organizations commonly try to compete with new organizations by changing only part of their business model, but this approach has consistently proved to be ineffective. For example, Continental Airlines established a no-frills, low-cost service in 1993, only to shut it down in 1995 after expending $140 million. Continental Lite mixed its business model by using its existing reservation system and employees, and even though it charged very low prices, few people flew with the airline (Bryant 1995; Hensel 2004). Recently, legacy airlines such as Delta and United have instituted lower-cost services, called basic economy. Passengers are not given frequent flier mileage points, they are not given the opportunity to select their seats, and small carry- on bags are only allowed under their seats. Many wonder if these changes can be sustained and successfully compete against low-cost airlines (Reed 2016).

Nonetheless, business models must change when the external environ- ment substantially shifts and organizations must seek different ways to compete and survive. For example, most consider the traditional pharmaceutical business model unsustainable. It consists of large, vertically integrated organizations with large sales forces promoting drugs created from small-molecule compounds (Miller 2008; Tyson 2015). As detailed in exhibit 3.3, experts predict that by 2020, the business model of successful pharmaceutical companies will evolve

Profitability The degree to which the revenues generated by a product or service exceed the costs of producing that product or service.

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into a collaborative network of firms that help manage patient outcomes through a so-called medicine-plus approach.

Some large pharmaceutical companies, such as Eli Lilly, are changing their business models and taking a more collaborative approach. For more than 130 years, Eli Lilly has functioned as a traditional, fully integrated pharma- ceutical company. However, in response to skyrocketing discovery costs and other pressures, Eli Lilly instituted Chorus, a virtual network with nonowned companies that manage many discovery programs at a fraction of the in-house cost while significantly reducing the time of clinical trials (Pricewaterhouse- Coopers 2009).

The following excerpt from a company brochure further explains this new model (Chorus 2009, 3, 9, 10):

Chorus is a small group of experienced drug developers focused on establishing

clinical proof-of-concept (PoC) as quickly and inexpensively as possible. Chorus

designs and manages drug development plans on new chemical entities. . . .

Component Traditional Pharmaceutical

Business Model Suggested 2020

Pharmaceutical Business Model

Value Vendor of medicines to physi- cians and patients

Managing patient outcomes through pharmaceuticals

Inputs Large, vertically integrated organizations, including research, clinical trials, marketing, and manufacturing based in Western countries

Nonownership agreements with universities, hospitals, technol- ogy providers, and organizations offering such services as compli- ance programs, stress manage- ment, nutrition, physiotherapy, exercise, and health screenings; more research to migrate to Asia

Processes Discovery of small-molecule compounds, few of which are approved for sale; sales direct to primary care physicians and patients focused on primary care

Collaboration with many firms to provide offerings of medicine-plus packages; sale through insurance and regulated mechanisms

Profits Profits generated for and by individual organizations; most profits obtained from sale of blockbuster drugs to pharma- cies and physicians

Profits generated by joint com- pany efforts to achieve health outcomes from sales through governmental payers, which will determine which medicines are prescribed

Source: Data from PricewaterhouseCoopers (2009).

EXHIBIT 3.3 The Changing Pharmaceutical Business Model

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The Chorus approach alters the balance of risk across the portfolio and

enables clinical study of many more candidates at a fraction of the time and cost

typically associated with traditional drug development. . . .

Chorus teamed up with an external IT solutions partner to develop a cus-

tom, web-based enterprise management system called Voice. Voice enables small,

virtual, global drug development teams to securely collaborate on all aspects of a

project—including broad planning, detailed implementation, document develop-

ment and approvals—and provides administrative solutions to numerous internal

portfolio challenges. . . .

The Chorus business model is built on the foundation of flexible outsource

staffing through TPPs [third-party providers], offsetting fixed internal costs. Tactical

outsourcing such as staff augmentation, functional outsourcing, and full-service

outsourcing is an increasingly common method used by most pharmaceutical and

biotech companies to reduce R&D fixed costs. Rather than dealing with inefficient

outsource models, such as relying on a small exclusive group of providers, Chorus

recognizes the need to leverage a wider group of external global implementation

expertise to deliver multifaceted services. This external network provides Chorus

with the flexibility to match each project’s unique needs and strategic integration

requirements to a wider array of global and niche TPPs. To support this more inclusive

model, Chorus developed and maintains a large and growing network of providers to

support each function. The Chorus external network continues to grow and currently

consists of more than 200 global providers.

Since its inception, Chorus has demonstrated substantial productivity improvements in both time and cost compared to traditional pharmaceutical research and development (R&D). Lilly claims that Chorus helped it make decisions about 12 months earlier at around half the cost of comparable indus- try research. As a result of Chorus’s successful track record and the increased demand for capacity, Lilly has expanded in Indianapolis, the United Kingdom, and India (Grogan 2011; Owens et al. 2015).

The principles and components of business models also can be used to examine macro business relationships, and they likewise apply to larger markets and industries. For example, many are calling for fundamental changes to the business model of the US healthcare system (Crean 2010; Lin 2008; Perkins 2010; Porter and Lee 2013).

US Healthcare Business Model

As illustrated in exhibit 3.4, healthcare in the United States conventionally has offered fragmented treatment of illness focused on acute care at the expense of primary and preventive care (Marvasti and Stafford 2012; Shih et al. 2008). Physicians and hospitals have been primarily engaged in curing disease on an

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individual basis. Little coordination has occurred among healthcare providers, instigating the delivery of duplicate services and driving up costs. American hospitals have become some of the most costly structures ever built and, as the hubs of healthcare provision, have promoted high-cost acute care medicine (Perkins 2010). Yet duplication and the high cost structure have increased hospitals’ profits (Trinh, Begun, and Luke 2008). Insurance companies have taken the role of middleman, receiving monies from businesses and negotiating contracts with providers for healthcare services. The more services providers deliver, the more money they make.

From a public and consumer perspective, this business model has not produced consistent value. Despite spending more than double per capita on healthcare than any other system in the world, the US healthcare system per- forms relatively poorly in terms of mortality and morbidity outcomes. Despite the high spending, Americans had relatively poor health outcomes, with shorter life expectancy and more chronic disease. Consistently, the US healthcare

Component Traditional Healthcare

Business Model Changing Healthcare

Business Model

Value Treatment of acute care problems; focus on curative outcomes

Improving population health; focus on preventive medicine and reduction of disease

Inputs Fragmented system in which many different providers often compete with each other; sepa- rate ownership of physicians, insurance companies, and hospitals

Greater integration and com- munication among delivery systems focused on the health of a population; information systems needed to capture and manage key data

Processes Insurance companies contract with businesses and individuals for healthcare services. Insur- ance companies negotiate with hospitals and physicians for services. Public health ser- vices are not integrated with traditional acute care. Focus on referrals to specialist physi- cians. Physicians obtain privi- leges to practice at indepen- dently owned hospitals.

Businesses and governments contract with systems to pro- vide a wide scope of healthcare services. Public health services are integrated with acute care services. Focus is on treatment by primary care physicians.

Profits Profits generated by fee-for- service: the more services provided, the more revenue produced

Profits generated by reduc- ing disease and controlling expenses

EXHIBIT 3.4 The Changing Healthcare Business Model

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system ranked last or next to last on quality, access, efficiency, equity, and health measures. Relative to global averages, the US government also invests little in social services that could potentially stem the tide of healthcare costs (Davis, Schoen, and Stremikis 2010; Squires and Anderson 2015).

The weaknesses inherent in the current US healthcare business model have created a fragmented, inefficient system (Shih et al. 2008, ix):

• Unassisted navigation by patients and families across different providers and care settings fosters frustrating, dangerous experiences.

• Poor communication and a lack of clear accountability for patients among providers lead to medical errors, waste, and duplication of services.

• The absence of peer accountability, a quality improvement infrastructure, and clinical information systems creates poor overall quality of care.

In addition, primary care practices’ common structure consists of seven- minute visits in which the provider rapidly determines whether to prescribe a pill or refer the patient for a procedure or to another specialist. Little wonder primary care physicians are the most dissatisfied among physician specialties (Chase 2013). Some believe that various stakeholders will demand that the US healthcare business model be revised, moving to patient-centered, value-based, or population-based focus and requiring greater coordination of care and a greater attention to preventive and primary care (American Hospital Association 2017; CMS 2016; Friedman et al. 2016). As shown in exhibit 3.5, the largest payer of hospital services, CMS, has moved to a partially value-based payment system by setting aside 2 percent of overall monies for incentive awards based on clinical and service quality indicators. Improving the quality and value of healthcare has become an imperative for all.

To coordinate, manage, and control care more effectively, US healthcare delivery systems—whether owned companies or virtual networks—will need to implement comprehensive information systems capable of capturing both clinical and administrative data. In addition, methods of provider payment must change. Payers may contract directly with systems to establish a fixed rate covering the health of their discrete populations—for example, a fee per person per month or a global payment for a segment of the population. The new business model may leave out many insurance intermediaries. Finally, profits (called surpluses by not-for-profit organizations) will be generated by improving health outcomes, preventing disease, and controlling overall expenses more effectively rather than by providing more services.

One example of a health system that has transitioned to a new model is Western Maryland Health System in Cumberland, Maryland. In 2010, as

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part of the state of Maryland’s Total Patient Revenue System demonstration, this system moved to a fully value-based payment that resulted in inpatient admissions declining by 32 percent in four years. Yet the system is enjoying greater financial success. Changes included moving from a “a traditional deliv- ery model, with the hospital and emergency department at the center” to “a continuum of care that elevates the importance of pre-acute services such as retail pharmacies and urgent care centers, and post-acute services, including rehabilitation and skilled nursing facilities, hospice, and palliative care” (Butcher 2014). Western Maryland Health System modified care delivery with resources set aside to manage patients with chronic diseases and high utilizers of services more effectively (Butcher 2014).

The Threat of Disruptive Innovation

Popularized by Harvard professor Clayton Christensen, the concept of dis- ruptive innovations suggests that disruption occurs when organizations suc- cessfully combine technological enablers and business model innovation (see exhibit 3.6) (Christensen 1997; Christensen and Mangelsdorf 2009). These factors can destroy existing organizational competencies and spur the rise of new, dominant organizations.

Disruptive innovations Innovations that create new markets by discovering new categories of customers. They do this partly by harnessing new technologies but also by developing new business models and exploiting old technologies in new ways. (A. W. 2015)

In September 2015, CMS published a document explaining its value-based purchasing, which provided incentive payments for more than 3,000 US acute care hospitals for the achievement of quality indicators related to their treatment of Medicare patients. The incentives are based on the following three primary factors:

1. The quality of care provided to Medicare patients 2. How closely best clinical practices are followed 3. How well hospitals enhance patients’ experiences of care during hospital

stays

Awards for 2018 are broken into four domains, with each receiving a quarter of the possible incentive payments. These areas are (1) patient- and caregiver-centered experience of care/care coordination, (2) safety, (3) clinical care, and (4) efficiency and cost reduction. Twenty-three indicators are tracked and performance is assessed by giving a hospital points for both achievement and improvement for each indicator against baselines and benchmarks. Hospi- tals must score in three out of the four domains to receive an incentive award. Incentives are funded by withholding 2 percent of hospital DRG payments.

EXHIBIT 3.5 CMS Hospital Value-Based Purchasing

Source: CMS (2015).

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Technological enablers that have prompted radical innovation include the microprocessor, which helped personal computers overwhelm mainframes; the Internet, which gave rise to online news and the development of online retail stockbrokers, such as E*TRADE and Charles Schwab; and advancements in electronics, such as digital photography. As the quality of these new technolo- gies improved, they overtook entrenched incumbents by offering better service and lower prices. Companies that previously controlled these markets, such as the Los Angeles Times, Merrill Lynch, and Kodak, are struggling to survive.

Novel business models that use disruptive technology enable organiza- tions to better compete in the market and radically diminish incumbents’ ability to generate profits. As a result, few dominant businesses ever survive disrup- tive innovation to remain the leading organizations in the new environment. For example, today’s movie entertainment outlets used online technology and different business models to dominate the previous rental market king, Blockbuster. In the early 2000s, Blockbuster lost vast amounts of business to Netflix, Hulu, and Redbox and ultimately filed for bankruptcy in 2010 (Sher- man 2010). For decades, Kodak produced excellent film for cameras and had expert competencies in chemical engineering. The advance to digital imaging destroyed the value and relative competence of the thousands of chemical engineers employed by Kodak. Electrical engineering skills were needed in the new world of digital imaging, and companies without these competencies failed to adapt to the new reality.

Type of Innovation

Radical Sustaining

B us

in es

s M

od el

C h

an g

N on

e N

High potential for disruptive innovation; incumbents threatened

Low potential for disruptive innovation; innovation benefits incumbents

Low potential for disruptive innovation; new innovations change market relationships

No potential for disruptive innovation; incumbents strengthened

EXHIBIT 3.6 Components of Disruptive

Innovation

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Healthcare has not generated many radical innovations—mostly sustain- ing discoveries that have benefited incumbents. However, many predict that future innovation, whether driven by legislative dictum (e.g., the Affordable Care Act) or scientific discovery, may disrupt existing healthcare relationships and the ways in which care is provided. It may also reconfigure service offer- ings to meet customer demand at lower prices (Nam 2016; Walsteijn 2012). Others suggest that the use of new midlevel providers (e.g., dental therapists) or retail clinics as alternatives for physician care might constitute disruptive innovation (Edelstein 2011; Pauly 2011). Advances in genomics, which plays a role in nine of the ten leading causes of disease in the United States, pres- ent great potential for disruptive innovation in the diagnoses, treatment, and prevention of disease (CDC 2017b). Clinical molecular testing, pharmacoge- nomics, and other medical genomics discoveries are rapidly expanding and helping physicians provide personalized medicine and make better prescribing and dosing decisions.

According to Hwang and Christensen (2008), healthcare is prone to fragmentation of care, coordination of care is difficult, consumers lack the proper incentives to shop for care, and many regulatory barriers exist. For these reasons, disruptive innovation does not easily take root in healthcare. Neverthe- less, with steadily increasing costs and rampant inefficiencies, healthcare needs radical surgery, and strategists must recognize the possibility that new business models will emerge and bring about major change. “By coupling technological advances with appropriately matched business models, disruptive innovation has brought affordability 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 desperately needed and long overdue” (Hwang and Christensen 2008, 1335).

Healthcare’s unique structure, with intermediaries and ubiquitous gov- ernmental regulation, makes disruptive innovation more difficult. However, to be disruptive the innovation must do the following:

• Cure disease. Most innovations treat symptoms of disease. Disruptive innovation cures and resolves disease. For example, the introduction of the drug Sovaldi (and its successor Harvoni) was disruptive, as it cures 80 to 90 percent of those infected with hepatitis C.

• Transform how medicine is practiced. Disruptive innovation changes the practice of medicine. Examples include drug-eluting stents that made heart surgery less invasive and vaccines for polio and smallpox.

• Take root deeply. The effect (disruptive or sustaining) of a technology depends on how it is applied—many technologies, such as big data, sensors, and other tools have the potential to be disruptive, but only if applied to change radically the practice and cost of care (Nam 2016).

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Generic Strategies

Decades ago, Michael Porter (1980), professor of business administration at the Harvard Business School, proposed three generic strategies from which organizations may select. Others have since increased the number of generic categories to five (Bourgeois, Duhaime, and Stimpert 1999; Hill and Jones 1998; Thompson et. al 2016). Most authors define the generic types of strat- egy as combinations of a target market (a small, focused customer base vs. a large, general customer base) and the type of competitive advantage sought (low cost vs. differentiation). Exhibit 3.7 lists the possible combinations and provides examples of organizations that have adopted each type of strategy.

Broad Low-Cost Strategy An organization with a broad low-cost strategy targets a wide customer seg- ment and seeks to achieve competitive advantage in the market by maintaining low costs and underpricing its competitors to earn higher profits. Low-cost positions can be gained by economies of scale; experience curves; efficient value chain management; effective bargaining; elimination of unnecessary features; and rock-bottom product costs through appropriate outsourcing, vertical integration, and information systems.

Use of the term cost frequently causes confusion because authors at times refer to cost as both the expense of producing a product or a service and the price charged for a product or a service. Although low-cost and low-price strategies ideally go together, organizations may adopt one but not the other. Low-cost strategies may be pursued concurrently with some aspect of differen- tiation to offer reasonable prices, coupled with some unique characteristic (e.g.,

Generic strategies Commonly used strategies that combine a target market (e.g., a small segment of a population) and a type of differentiation (e.g., low cost).

Broad low-cost strategy A type of strategy aimed at providing low-cost products to a broad customer segment.

Target Market Type of

Competitive Advantage Example

Broad segment

Low costs Walmart, Dell

Broad segment

Differentiation Pepsi, Ford

Moderate segment

Moderate costs and differentiation

Grocery stores, community hospitals

Middle strategy

Focused segment

Low costs ALDI

Focused segment

Differentiation Rolls-Royce, Rolex, con- cierge medicine

]

EXHIBIT 3.7 Different

Generic Strategies

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quality, service, access), while a true low-price strategy may need to offer the lowest price in the market (Yip and Johnson 2007). Although low production costs often do have a relationship with low prices, in this book low cost refers to the cost of production.

Broad low-cost strategies are most effective in markets where cost is more important than reputation or product characteristics or where large economies of scale exist. Firms producing commodities, such as wheat, oil, gold, and sugar, may more easily use a low-cost strategy. Likewise, companies that can exploit large economies of scale, such as manufacturers of computer chips, can compete on the basis of cost. As a result, organizations using a broad low-cost strategy strive to maximize their market share. However, low-cost products and services still must maintain a certain level of quality and differentiation. Consumers must perceive the lowest cost for the value received. Organizations often take one of the following approaches to create this perception:

• Product line narrowed to standardized, no-frills goods. Organizations pursuing a broad low-cost strategy may eliminate low-volume products and services from their offerings and retain only those that generate the greatest sales and profitability. They keep production costs low by using standard components, limiting the number of product models, and minimizing overhead and indirect costs. Noncore components may be outsourced. For example, specialty hospitals narrow the wide product line of general hospitals, standardize products and processes, and eliminate some services, thereby lowering their costs.

• High asset turnover. Organizations make optimal use of their assets and resources by managing large volumes efficiently and operating their facilities at full capacity. Examples include table turnover in restaurants, airlines’ maximization of the time its planes are in flight, and maximization of actual surgical time in operating rooms.

• Control of purchases and procurement. Organizations seeking to keep costs low generally exercise control over their supply chain and purchases to minimize expenditures. Purchasing in bulk, consigning products (vendor-managed inventory), negotiating high discounts, and using just- in-time purchasing can significantly lower costs. Hospitals have often used consignment, especially for surgical implants (Crans 2009).

• Low-cost distribution systems. The logistics of the supply chain, including distribution, inventory management, sterilization, transportation, and so on are now the focus in the effort to lower costs in healthcare. Some systems, such as the University of Pittsburgh Medical Center, have established centralized, system-owned warehouses to limit costs, while others are working with medical and surgical distributors to distribute and store inventory more cost-effectively (Rubenfire 2016).

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The costs of distribution are significant for many products and services. Low-cost strategies call for a wide distribution system at a minimal cost. Instead of using personal contact, organizations may use online sales and marketing tools to reach customers. Sophisticated software systems promote efficient distribution, and some organizations bypass distributors and sell directly to the consumer to reduce costs—for example, Dell and Apple. Customers order computers from low-cost-focused Dell via the Internet or phone. While Apple’s customers may order computers these same ways, they also can visit one of Apple’s many local stores and consult with service representatives. Likewise, manufacturers of generic drugs may market only to wholesalers, while brand- name drug companies have large, owned sales forces and market directly to consumers and physicians.

Focused Low-Cost Strategy An organization adopting a focused low-cost strategy competes on the basis of costs but targets only a subset of the mass market. This strategy refines the broad low-cost approach by narrowing its customer base and—possibly— undercutting the pricing of generalists. In highly competitive markets, smaller, low-cost organizations may find a niche in which the larger rivals cannot com- pete. For example, ALDI and Walmart are both large, international chains. Walmart employs a broad low-cost strategy, while ALDI employs a focused low-cost strategy. Yet their business models are similar in that both focus on cost and reasonable quality. ALDI, however, offers only a limited assortment of groceries and related items targeted to customers with low to moderate incomes and can often price these products almost 20 percent lower than Walmart (Pettypiece 2016). On ALDI’s website, the company states that it “has been named the Low-Price Grocery Leader for the second straight year! . . . As a two-time low-price leader, we know that everything you buy should be of the highest quality. That’s why all our products are backed by our Double Guarantee” (ALDI 2013).

As shown in exhibit 3.8, ALDI’s strategy differs from Walmart’s strat- egy mostly with regard to inputs and processes. Both offer low-cost grocer- ies. However, Walmart sells dramatically more products and multiple brands, while ALDI sells relatively few products and only one brand of each product. ALDI also greatly minimizes personnel costs by having customers bag their own groceries and displaying products in cartons, among other techniques.

Low-Cost Strategies in Healthcare Low-cost strategies succeed better in some segments of healthcare. The difficulty with a low-cost strategy in healthcare is the perception that low cost equates to low quality. Consumers want more than low cost in healthcare, especially if their health or the health of their family is in jeopardy. In such situations,

Focused low-cost strategy A type of strategy aimed at providing low-cost products to a limited subset of the broad mass market.

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quality almost always trumps cost. As Porter and Teisberg (2006, 98) state, “Minimizing costs is simply the wrong goal, and will lead to counterproduc- tive results.” Few would desire to have their loved ones undergo surgery in a hospital that promotes itself as the low-cost option. Likewise, patients generally prefer cutting-edge technology, even if the costs are higher.

Nevertheless, many ambulatory surgery centers (ASCs) and specialty hospitals and clinics promise to provide services at a unit cost lower than that charged by general hospitals. The lower costs have been attributed to reorgani- zation into integrated practice units, breaking down silos with multidisciplinary teams that focus on patient outcomes and value (Porter and Lee 2013)

In segments where consumers are more price sensitive, low cost may help organizations achieve competitive advantage. For example, in obstetrics, plastic surgery, and the health insurance business, prices (costs) may have a greater influence on consumers’ choices. Consumers with high out-of-pocket costs more often compare prices, choose lower-cost healthcare services, and select less expensive drugs and healthcare services (Buchmueller 2006; Penn Medicine News 2016; Ungar and O’Donnell 2015).

Component ALDI Walmart

Value Low-cost groceries Low-cost groceries

Inputs Stores carry about 700 mostly private-label products bought from independent producers and offer only one brand of each product. Products include a cluster of essential items and about 30 seasonal items. Store size is small, about one-tenth of the average Walmart, and use of information technology is mini- mal. Stores may function with only 4 or 5 employees.

Stores carry about 15,000 prod- ucts, of which about 55% are food items. Only 15% of products are private label. The rest are national brands.

Processes Customers pay 25 cents to use shopping carts. Stores do not accept checks and do not pro- vide shopping bags. Goods are sold out of cartons. Customers bag their own groceries.

Food section looks like a normal grocery store. Checkout stands often are congested. A greeter welcomes customers at the door in many stores, and personnel help bag groceries.

Profits Privately owned; expansion funded with cash; payment for products

Publicly owned; expansion funded with debt and stock; payment for products

Sources: Gerhard and Hahn (2005) and Pettypiece (2016).

EXHIBIT 3.8 A Comparison of Focused Low-Cost and Broad Low-Cost Generic Grocery Store Strategies

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Broad Differentiation Strategy Organizations using broad differentiation strategies offer products and services that have unique features and appeal to a wide segment of a market. Consumers purchase products and services that have singular characteristics or features they value, and they often will pay more for those valued features. Broad differentiation strategies tend to be most effective in large markets where

• buyer preferences and values are diverse, • many organizations offer common products, and • product innovation is rapid (Hitt, Ireland, and Hoskisson 2016).

Nearly all products and services can be effectively differentiated. Com- panies spend millions of dollars annually to differentiate both basic products, such as salt and soft drinks, and complex merchandise, such as microprocessors and automobiles. Differentiation can be based on characteristics of a product or service or on the attributes of an organization’s personnel, distribution channels, and image.

Exhibit 3.9 lists many ways an organization may choose to differentiate its products and services. A pharmaceutical company might alter the size, texture, reliability, and duration of its medications; accelerate ordering and delivery; or improve the responsiveness and friendliness of its sales personnel. A radiological equipment manufacturer may elect to focus on ease of installation, customer training, maintenance and repair, and its personnel’s credibility and reliability.

“Overall, a firm using the differentiation strategy seeks to be different from its competitors on as many dimensions as possible” (Hitt, Ireland, and Hoskisson 2016, 123). Porter (1980) suggests that an organization must have strong marketing capabilities and a perceived reputation for quality or another unique characteristic for a broad differentiation strategy to be effective. Orga- nizations must understand and offer what buyers need and value to succeed through differentiation. Competitive advantage often is short lived and must be constantly renewed, so innovation and an ability to change are critical fac- tors. An organization is using differentiation successfully if

• it can charge premium prices, • sales are increasing, and • customers become loyal to its brand (Thompson et al. 2016).

Certain hospitals have achieved a strong, broadly differentiated position and are able to use it to their competitive advantage. They have carved out “must-have” market positions that enable them to extract higher payments. A must-have hospital is one that insurance companies must have in their network;

Broad differentiation strategies Strategies aimed at offering products that consumers perceive to be distinct from competitors’ products and that appeal to a wide segment of a market.

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else, they face the possibility of losing customers. These hospitals, such as Cedars-Sinai Medical Center in Los Angeles, have established excellent reputa- tions and most often provide unique, specialized services. In negotiations with insurance companies, the must-have hospitals demand and frequently receive premium reimbursement rates (Berenson et al. 2012; Berenson, Ginsburg, and Kemper 2010).

Products

• Form: size, shape, and structure • Features: bundling or customization • Conformance/quality: consistency

with specifications • Durability: expected useful life

• Reliability: probability of failure • Reparability: ease of fixing • Style: feel and look • Design: ease of operation and use

Services

• Ordering: rapidity and ease of purchasing

• Delivery: speed, accuracy, and attention to order

• Installation: ease and cost of setup

• Customer training: quality and quantity of instruction

• Customer assistance: level of responsiveness, quality of service

• Maintenance/repair: speed and quality of problem solving

Personnel

• Competence: knowledge and skill level

• Courtesy: degree of respect and consideration shown

• Credibility: promises and commit- ments kept

• Reliability: consistent, accurate performance

• Responsiveness: rapidity of response to customers’ needs

• Communication: degree of interac- tion and clarity

Distribution

• Coverage: extent of geographic area • Expertise: specialized knowledge

• Performance: efficiency and effec- tiveness of distribution

Image

• Symbols: attractiveness • Prestige: Perceived status of users • Colors: desirability and variety • Slogans: meaningfulness • Atmosphere: attractiveness of the

organization’s environment and ambience

• Events: number of activities and events meaningful to customers (e.g., open houses, sales events, health screenings, grand openings)

EXHIBIT 3.9 Ways to Differentiate Products, Services, Personnel, Distribution, and Image

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On the other hand, there is some value to adopting strategies similar to those of competitors and not appearing different. Conformity sometimes enhances performance and promotes long-term survival. Customers see that the conforming organization’s product is consistent with those of its competi- tors and may be more willing to try the new product. In fact, competitors quickly copy and imitate successful differentiation strategies to conform. An organization seeking to sustain a differentiation strategy must develop strong creativity and innovation by integrating its marketing and production and by hiring and retaining creative personnel (Shenkar 2012).

Focused Differentiation Strategy Focused differentiation strategy targets a narrow industry niche or cus- tomer segment. Companies can differentiate their product and services via the means listed in exhibit 3.8, but the differences are perceived as unique to a narrow group or population. For example, Rolls-Royce, Rolex, Saks Fifth Avenue, Harrods, Chanel, and Tiffany & Co. focus their products on the luxury market segment. They offer high-quality, prestigious products at high prices. Such organizations refrain from expanding into unrelated businesses and offer specialized products.

Some have long suggested that healthcare should be organized in a more specialized, focused way and should move away from its broad, unfocused strategies, which have led to quality and cost problems (Herzlinger 1997). A potential solution, focused factories, is a term that dates back to the 1970s and initially described a manufacturing strategy that concentrated on core (often single) products and a defined set of technologies and customers. Some scholars have suggested that this strategy was a major factor in the past revitalization of US business fortunes (Herzlinger 2000; Pesch 1996).

The creation of healthcare focused factories in the United States has been limited to separating common services, such as cardiology and surgery, from general hospitals and placing each service in its own facility. Examples include ASCs and specialty hospitals, both of which have rapidly increased in number. These focused healthcare organizations are often owned by physicians (in contrast to public ownership of most general hospitals), offer a relatively narrow line of services, and may attend to only one type of disease. For exam- ple, David Cook and colleagues found that the “focused factory model was appropriate for 67 percent of cardiac surgical patients.” If implemented more widely, this system would reduce “resource use, length-of-stay, and cost,” as well as variation (Cook et al. 2014, 746). Other possible focused factories may include diabetes clinics, cancer clinics, asthma clinics, and orthopedic surgery.

Focused differentiation has emerged in healthcare in other forms as well. As shown in exhibit 3.10, some physicians have devised a means of narrowing their customer focus and increasing their incomes by offering differentiated

Focused differentiation strategy A type of strategy aimed at offering products that consumers perceive to be distinct from competitors’ products and that appeal to a limited industry niche or customer segment.

Focused factories A manufacturing strategy that concentrates on core (often single) products and a defined set of technologies and customers.

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primary care. In this arrangement, patients pay an annual fee in addition to regular clinic charges to obtain greater access to their physician and more personalized care. Similarly, various health systems and hospitals have sought to highlight their differentiation and specialties by establishing luxury ser- vices to attract wealthy domestic and foreign patients. Differentiating services include uniformed valets, professional greeters, 24-hour room service, and spas (Pourat 2016).

Although critics have raised ethical concerns about physician aban- donment of patients who cannot pay the additional fee and the creation of a two-tiered system of care in which the more affluent receive better healthcare, the number of physicians entering concierge medicine has rapidly grown. By 2016, there were about 12,000 physicians practicing concierge medicine in the United States. Companies have been established to provide turnkey and franchise services for physicians desiring to convert to this practice style (Col- well 2016). Two journals, Concierge Medicine Today and Concierge Medicine Journal, have also been organized to promote the concept.

Middle Strategy Middle strategy is also called best-cost strategy or integrated cost leadership/ differentiation strategy because it intends to offer customers the optimal mix of distinctive value and attractive costs simultaneously. Middle strategies are more successful in markets where buyers desire a degree of product differentiation but at the same time are price sensitive (Hitt, Ireland, and Hoskisson 2016). A perennial example of a firm employing a middle strategy is Southwest Airlines, which combines low costs with measured differentiation. Porter (1980) initially

Middle strategy A strategy that seeks to deliver low cost and differentiation simultaneously.

Primary care physicians often have a patient panel: a group of 2,000 to 3,000 patients they have seen in the past and would agree to see in the future. Under a fee-for-service payment model, physicians are reimbursed for each patient they see, creating an incentive to see many patients per day and minimize the amount of time spent with each patient, sometimes to less than ten minutes.

To increase their incomes and change their practice style, some phy- sicians have adopted a focused differentiation strategy called concierge medicine. Under this arrangement, the physician restricts his patient panel to as few as 500 patients who are willing to pay an annual fee of, on average, $1,800 though it may be as high as $5,000—in addition to regular insurance payments for clinical services. For this additional fee, the patient receives longer, more immediate physician visits and house calls and greater coor- dination of care, along with other premium services. Typical patients tend to come from upper-middle-class families and earn between $125,000 and $250,000 per year.

Concierge medicine Also known as retainer medicine, a relationship between a patient and a primary care physician in which the patient pays an annual fee or a retainer for enhanced services.

EXHIBIT 3.10 Concierge Medicine

Source: Chen (2010).

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cautioned against this strategic position, believing efforts to achieve one facet would contradict the other and the organization would get “caught in the middle.” He reasoned that efforts to lower costs would make differentiation more difficult and that greater differentiation would increase costs; as a result, businesses would alienate both high-volume customers demanding low prices and high-margin consumers desiring distinct products. Others have since noted that in some markets, a middle strategy may be effective, and recently, many large corporations have been employing it (Baroto, Madi Bin Abdullah, and Wan 2012; Luke, Walston, and Plummer 2004; Parnell and Lester 2008).

Middle strategy may in fact be the strongest position for many consumer product markets, including groceries, apparel, and hardware, and for many hospitals. Traditionally low margins—just 1.8 percent in 2008—force grocery stores to reduce costs. Yet they also seek to differentiate their services and products through coupons, unique ethnic products, in-store babysitters, fresh vegetables, cleanliness, and other features (Hiiemaa 2016). Many community hospitals selectively invest in sophisticated technology and offer “good enough” quality at generally lower prices than those charged by high-quality academic medical centers and tertiary referral hospitals (Luke, Walston, and Plummer 2004). Of course, the challenge for organizations with middle strategies lies in the difficulty of distinguishing themselves from competitors. Middle positions are copied more easily by competitors, and differences in cost and quality are often difficult to define to consumers clearly. For example, patients normally see little quality and cost differences among community hospitals.

The Dynamics of Competitive Strategies

Intense competitive and environmental pressures often encourage organizations to shift their competitive strategies. An organization with a low-cost strategy may add new features and products to increase its differentiation, while an organization with a middle strategy might provide a low-cost alternative.

For example, the ALDI grocery chain, which employs a low-cost strategy, now owns Trader Joe’s. While Trader Joe’s employs a more focused differen- tiation strategy, it also integrates many of ALDI’s low-cost strategies. Trader Joe’s offers specialty foods that have been described as “yuppie-friendly,” exotic, affordable luxuries, such as Belgian butter waffle cookies and Thai lime- and-chili cashews (Farfan 2016; Kowitt 2010). As another example, high-cost academic medical centers may seek to develop low-cost clinics in large retail stores, such as Walmart.

As illustrated in exhibit 3.11, strategic positions may shift among the dimensions of cost and differentiation. Few organizations implement strategies

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at the extremes, and most organizations, even those with low-cost strategies, proffer a degree of differentiation. Although any strategy may be diffi cult to achieve, some are much more diffi cult to develop and maintain. For example, sustaining a high-cost, low-differentiation position may be problematic. A successful fi rm must constantly be willing to examine and alter its position as required by competitive pressures (Luke, Walston, and Plummer 2004, 155): “In a competitive and turbulent environment . . . the requirements for occupy- ing one or another position will change. . . . Therefore, organizations need to be vigilant about sustaining established positions and, in competitive market environments, work to improve those positions. Positioning threats can come from similarly positioned rivals; from rivals located in other, stronger positions . . . or from rivals that need to improve on weak positions.”

Organizations usually shift their position only marginally, trying new products, pricing, and features to improve their business. Those that try to move from one extreme to another may not have the appropriate internal resources and competencies to transition successfully. For example, Tesla has faced immense challenges while shifting its cars from high-priced luxury vehi- cles to a more mass-produced, midrange, $35,000 product (DeBord 2016). Likewise, organizations moving from one strategic position to another must be careful not to abandon their mission. For instance, intense competitive pressures are moving many academic medical centers to develop integrated

Low Cost and High Differentiation

High Cost and High Differentiation

Low Cost and Low Differentiation

High Cost and Low Differentiation

Cost Position

Low

D if

fe re

n ti

at io

Lo w

ed iu

ig h

Middle Position

Medium High

Source: Adapted from Luke, Walston, and Plummer (2004).

EXHIBIT 3.11 Shifting Strategies

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networks and reduce their costs to compete on price more effectively, which may distract them from their teaching and research missions.

Organizations desiring to try a radically different strategy may con- sider creating a separate organization (subunit) or a distinct brand name and managing it differently, external to the operations of the parent organization. The new organization can then build the competencies and resources neces- sary to provide the different product or service. Toyota created Lexus to offer high-end products. As mentioned earlier, Chorus, consisting of only a small number of employees, exists as an autonomous division of Eli Lilly to advance drug research more rapidly from discovery through clinical proof of concept (Chorus 2017). Rigid business strategies will not survive in today’s volatile, turbulent market. Long-term success depends on agility and responsiveness to market and environmental conditions. If an organization’s existing business strategy does not meet environmental and market pressures, it must be adept enough to change. Exploring new strategic positions with a view to exploit- ing opportunities and avoiding threats created by market conditions may be a pragmatic, realistic approach.

When an organization moves into a product market early, it is using a first-mover strategy. The speed with which organizations enter new markets greatly varies. First movers (also called early entrants) consistently search for innovation opportunities and attempt to gain first-mover advantages by being among the first to enter a new market. Others wait, watch, and analyze competitors’ actions and move later into new markets.

Although the first-mover advantage is a well-known strategy concept, authors have mixed opinions of its long-term benefits (Lieberman and Mont- gomery 1998; Suarez and Lanzolla 2005). Organizations seeking first-mover advantage move quickly into an unoccupied or uncrowded market segment or product space. First movers may enjoy durable advantages for many years, or the advantages may quickly fade as later entrants take over a market. One factor critical to the success of a first mover is its ability to establish barriers to entry by other organizations. First movers often can create entry barriers and sustainable advantage from

• technological advantage, • acquisition and control of scarce assets, and • reputation.

First, an early entrant can develop competitive advantages from having superior technologies. The technological advantage can come from patents, improved distribution channels, and learning. First movers may create inno- vative competencies that produce technical knowledge superior to that of

First movers Organizations that are the earliest to enter a market or an industry.

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competitors. Organizations learn by doing and not only develop innovation but also advance along a learning curve to better produce a product. When an organization first offers a new product or service, the unit price is generally high, especially in a new market where the processes for creating the product or service and necessary features are not well understood and the customer base is small. Over time, the organization can lower its unit price by develop- ing more efficient processes and standardizing its products or services. Thus, first-mover organizations may gain technological and cost advantages over potential later entrants and discourage market entry.

A historical example of technological advantage is Richard Arkwright’s invention of the modern factory system for spinning cotton. He developed original patents for spinning cotton in 1768, quickly built factories across England, and licensed his technology. By 1774, he employed 600 workers in 15 mills in England. Although he eventually lost control of his patents in 1785, he used the time before his patents expired to improve and position his mills, and competitors never caught up to him during his lifetime (Musson and Robinson 1960). Likewise, Xerox, Coca-Cola, and Nike leveraged their first-mover strategies into global leading companies.

Second, first movers may tie up critical, scarce resources, such as location, employees, and crucial partners, making it more difficult for new organizations to enter the market. Thus, speed alone is not sufficient to be successful as a first mover; such organizations must add the correct critical resources. The great Confederate general Nathan Bedford Forrest recognized the need to connect speed and resources when he responded to the question of what was key to his military success: The essence of his strategy was simply to “git thar first with the most men” (Catton 1971, 160).

Third, first movers often cultivate a base of loyal customers. One approach to retaining customers is to make it inconvenient or expensive to switch to later entrants’ products. First movers should seek to gain a positive organizational image and reputation with customers and establish their product as the market standard. By raising the bar in terms of features and quality, first movers set a precedent that other organizations must surpass to enter the market successfully. All of these tactics, if executed appropriately, discourage other organizations from entering the market, which strengthens the first mover’s advantage.

First movers often receive extensive free publicity and gain public name recognition and visibility. Sometimes the first mover becomes so prominent that the name of its product or service becomes the name used to describe all other products or services of the same type. For example, Twitter became the standard for micromessaging. It rapidly developed a large following and established the norm for this social networking medium. It has become so popular that tweeting is the term used to describe the action of sending a micromessage, regardless

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of the networking site used. As stated in 2011, “[Twitter was] among the most recognized brands on the Internet and a bona fide cultural phenomenon, with as many as 400 million monthly users” (Colorado Springs Gazette 2011).

On the other hand, as stated earlier, first movers may gain only tempo- rary advantage or fail completely. Those that hurry to be the first in a market may not test their product designs and sell defective products or products with limited customer appeal as a result. Alternatively, some first-mover products may raise tremendous demand and overwhelm the organization’s capacities. For example, although Twitter was initially highly successful, innovations from Facebook, Instagram, WhatsApp, Snapchat, and WeChat caused Twitter’s growth to slow, and, given its executive turnover and financial struggles, many question its long-term viability (Topolsky 2016).

Some claim that subsequent entrants, or fast followers, succeed more often than do first movers because a level of demand already exists and consumers understand the benefits of the product (Shankar and Carpenter 2013). Sec- ondary entrants may be able to imitate or “freeload” on first movers’ research and initial investments. Later entrants also do not sustain the risk involved in creating a new customer base and are able to follow existing industry standards.

The success of the CT (computed tomography) scanner, a widely used radiological diagnostic tool, is a good example of how fast followers can succeed at the expense of a first mover. The sales and service of CT scanners generate huge profits. In 2007, healthcare organizations performed an estimated 72 million CT scans in the United States alone (Gonzalez et al. 2009). In the early 1970s, a British company, EMI, was the first to successfully develop and market a CT scanner. Primarily a music company, EMI had little experience in the medical equipment market. It estimated that it would sell up to 50 scan- ners in the product’s first year and have three to four years to establish itself in that market before competitors arose. By 1977, the organization had achieved phenomenal success and had an order backlog of more than 300 units. How- ever, rapid technological advances ensued and benefited later entrants, such as industry giants GE, Toshiba, and Siemens. In the early 1980s, EMI abandoned its investments in scanning technology and returned to its core music business (Alexander and Gunderman 2010).

Suarez and Lanzolla (2005) suggest that the relative short- and long- term success of a first mover may depend on two factors: the speed of tech- nological advancement and the rate of market demand. As depicted in exhibit 3.12, first-mover advantage is sustained only in markets characterized by slow technological change. Rapid technological change poses serious challenges to first movers and enables new entrants to leap ahead of the quality and features of first movers’ initial products.

In summary, being the first in a market does not necessarily translate into first-mover advantage. Sustained advantage depends on a combination of speed of entry, resources, speed of technological change, and market growth.

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Chapter Summary

This chapter examines the different ways organizations can strategize to achieve their missions. The underlying structures of an organization make up its busi- ness model. A business model includes the value produced for customers, the types and combinations of inputs, the processes used to create products, and the means for revenue generation. Changing business models may increase an organization’s competitive advantage and enable it to distinguish itself from its rivals. An organization also must change its business model to compete effectively when its environment shifts.

Organizations use a variety of strategies to position themselves in differ- ent ways. Generic strategies include dimensions of either a focused or general market (customer base) and a dimension of cost (low vs. high) or quality (degree of differentiation). Low-cost strategies may succeed in some segments of healthcare. Differentiation strategies seek to provide unique features for which the consumer is willing to pay more. Differences may include product characteristics, service, distribution channels, reputation, and image. Concierge

Speed of Technological Change

Slow Rapid

S p

ee d

o f

M ar

ke t

C h

an g

R ap

id S

lo w

Unlikely short- term advantage

Likely long-term advantage

Likely short-term advantage

Very unlikely long-term advantage

Very likely short- term advantage

Likely long-term advantage

Very unlikely short-term advantage

Unlikely long- term advantage

Key: brand

awareness

Key: marketing,

distribution,

production, and R&D

Key: strong R&D

and finance

Key: marketing,

distribution,

and production

EXHIBIT 3.12 The Effect of Technology and Market Growth on First Movers’ Success

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medicine is an example of focused differentiation in healthcare. Some organiza- tions employ middle strategies, which offer a desired mix of distinctive value and attractive costs. Many general hospitals seem to use this type of strategy.

Many organizations seek to gain advantage by being the first to enter a market. Being a first mover may be a durable advantage or become a liability as later entrants learn from the first mover’s mistakes. First-mover advantage may be gained from technology, acquisition and control of scarce assets, or superior customer reputation. The rate of technological advancement and market growth significantly affect first movers’ ability to sustain their advantage. Markets charac- terized by slow technological change are positive environments for first movers.

Chapter Questions

1. How do the four components of a business model affect each other? For example, how can the depth of value to customers influence the means of revenue generation?

2. What difficulties does an organization face when seeking to change its business model? In your opinion, why have Barnes & Noble and Kodak struggled to shift their business models?

3. How can a new business model become a competitive advantage for an organization?

4. What changes could hospitals, physicians, pharmaceutical companies, and insurance companies make to their business models to position them more advantageously for the future?

5. Generic strategies’ dimensions include type of competitive advantage and target market. In your opinion, how would a focused strategy differ from a broad strategy?

6. Are middle strategies most commonly used? Why or why not? 7. What actions can an organization take to offer a product at the lowest

cost? 8. When is low cost a viable strategy in healthcare? When would it not be

viable? 9. Which shift in strategy would be most difficult in your opinion:

moving from low cost and high differentiation to high cost and high differentiation, or moving from high cost and high differentiation to low cost and high differentiation? Why?

10. A first mover can sustain its market advantage through technology, control of scarce resources, and reputation. Look at the first movers you are familiar with. Which of these approaches have they taken?

11. How does technological change affect a first mover?

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Chapter Cases

Case Studies “Move to a Concierge Model or a Direct Primary Care–Medicine Business Model?” “The Case of Humana and Vertical Integration,” and “An Orthopedic Group Decides to Construct a Specialty Hospital” may be used to explore material in this chapter. They are found in the case studies section at the back of the book.

Integral Healthcare System and Proton Therapy Integral Healthcare System (IHS), a not-for-profit organization with a strong, service-oriented mission, is one of the largest care systems in its region. Although highly profitable, it has seen its market share in certain special- ties slip. The decline has been most prominent in oncology and cardiology because of the establishment of specialty hospitals and care centers by competitors. IHS’s executives have attempted to differentiate the system and recoup its market share by setting up centers of excellence, recruiting physician specialists in these areas, and using extensive media advertis- ing, but to date none of these strategies has reversed the market decline.

Recently IHS was approached by National For-profit Company (NFC) proposing a joint venture proton therapy center. In 2010, proton therapy became eligible for reimbursement by most insurance companies and Medi- care. This service involves sending a beam of protons to irradiate diseased tissue, mostly cancers. The protons appear to effectively kill cancer cells and cause less collateral damage to normal tissue. However, medical profes- sionals question whether it is any more effective than traditional radiation therapy. For this reason, only six proton therapy units exist in the United States, none of which are located in IHS’s greater service area. The joint venture would be the first proton therapy unit in the region.

The problem with proton therapy is the facility cost; construction of a proton therapy unit could exceed $200 million. As a result, the cost per treatment often exceeds $100,000 per patient—two to three times the cost of traditional radiation therapy. Although state-of-the-art, the facility’s massive cyclotron could be supplanted in the future by superconducting synchrocyclotrons, a newer technology that might cost less than half the proposed construction cost. Local insurance companies have also expressed concerns about paying for this service.

IHS has to decide whether it wants to pursue the partnership. By add- ing proton therapy, it may achieve the differentiation it desires. It might be able to distinguish itself in oncology and regain much of the market volume

(continued)

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Chapter Assignments

1. Identify an innovation that is in the emerging stage of market development. Write a one-page paper describing how product standards and quality are established. Address how the rate of technological and

it has lost to competitors. Nevertheless, there are risks. The large capital cost would need to be financed or taken from IHS’s limited capital reserves. NFC also has hinted that it may take its offer to one of IHS’s competitors if IHS does not agree to the partnership. Moreover, the local university hospital has established oncology as one of its key competencies and has been seeking tax support to establish a proton therapy research and treatment center.

Questions 1. For IHS, what are the advantages and disadvantages of being the

first mover into the proton therapy market? 2. How might IHS minimize the risk posed by the joint venture? 3. What additional actions would you propose IHS take to improve its

chances for a successful partnership with NFC? 4. Would you recommend that IHS accept or decline the offer?

Deciding Between Innovative Options A donor gave Major Boston Academic Medical Center (MBAMC) a large bequest to further its mission. Stakeholders were asked to come up with innovative proposals, which were narrowed down to two that were submit- ted to MBAMC’s board. One proposed to use the funds to expand the exist- ing tertiary services into more highly specialized quaternary services that would extend the “boundaries of its clinical excellence.” The other created a unique nursing fellowship that would train nurses to provide services cur- rently given by physicians, but at a much lower cost. After due deliberation the board chose the first option and all the donation was applied toward increasing the sophistication of MBAMC’s services (Christensen et al. 2006).

Questions 1. Which proposal was a sustaining and which a disruptive innovation? 2. Why would an organization choose a sustaining innovation over a

disruptive innovation? 3. Read the article the case comes from and discuss the impact

disruptive innovation has on the social structure.

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market change affects the product’s potential for success during the emerging stage of market development.

2. How can a middle strategy be successful in healthcare? Write a one- page paper on what a healthcare organization must do to make this strategy successful. What problems might creating this type of strategy in healthcare present?

3. The MedCottage—sometimes called a granny pod or, more properly, an auxiliary dwelling unit (ADU)—is a portable hospital room that can be placed next to a private residence. The units are designed as a substitute for nursing homes and can keep elderly persons out of institutionalized care. The units are equipped with the latest biometric and communications technology, enabling physicians and nurses to monitor the occupant’s vital signs directly, be alerted to emergencies, and even change the unit’s temperature. ADUs run from $100,000 to $125,000. Read more about this innovation in the November 25, 2012, Washington Post article by Fredrick Kunkle titled “The Ultimate Care Package? ‘Granny Pods’ Help Keep Loved Ones Close.” Write a one-page paper about how ADUs are disruptive innovation as described in this chapter and whether they present a first-mover opportunity.

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