Structure Follows Strategy: What’s the Best Organizational Model for Capitated Healthcare Systems?

“Structure follows strategy” is an old business motto coined by the business historian Alfred Chandler. The adage refers to Chandler’s observation that organizational structures should change to reflect an organization’s evolving corporate strategy. As strategy evolves, so too should the organizational structure. 

I’ve been giving this concept a lot of thought. It seems to me that many healthcare systems are integrating and taking on ever-increasing amounts of financial risk without giving much thought to their internal structures. I’m very interested in looking outside healthcare because I’m not sure that any of the dominant organizational models in healthcare today work well in a risk-bearing environment.

First—some background, and why we’re taking about General Motors.

It’s generally recognized that there are three main ways to organize large organizations: These are the U-Form, the H-Form and the M-Form models.

The U-Form (Unitary Form) is a traditional hierarchy, where central management, divided into functional departments, oversees the production of a few products. Most small medical groups and small hospitals are U-Form. These aren’t complex businesses and being hierarchical allows them to provide a consistent and well-managed product– though at the cost of being unable to easily migrate into adjacent businesses. U-Form companies become unwieldy when they grow too big, and their structure often allows poor performance to hide within the guts of the business.

At the other extreme of the organizational continuum are H-Form (Holding Form) companies. These are loose agglomerations of diverse businesses all under a relatively weak corporate superstructure that makes limited policy and capital decisions. The various businesses all compete independently, with all of the risks and benefits that entails.

Somewhere in between the two is the M-Form (Multidivisional Form) company. A M-Form company has a more empowered corporate body while allowing semi-independent divisions (led by a divisional president) to make routine decisions.   Most large international businesses are now M-Form: it has been argued that migration to the M-Form model was what led to the financial success of US companies in the 1920’s to 1960’s.  I’ve heard the multidivisional form of corporate organization described as: “American capitalism’s most important single innovation of the twentieth century.”

General Motor’s CEO, Alfred Sloan, was the first to reorganize GM into separate divisions that were self-contained with their own functional hierarchy. I recently read a terrific synopsis of this migration; the author argued that Sloan was compelled develop the M-Form partly because GM was growing and becoming vertically integrated. The car company was moving into auto finance and frame body construction. And, as the company began moving into affiliated businesses, it’s U-Form management model came under strain. The new M-form system allowed GM’s leadership to focus on long-term strategy versus operational minutia.

Today, in healthcare, M-Form seems to have won out as the dominant model of for organizing large integrated healthcare systems for many of the same reasons that GM evolved into a M-Form structure.

A random org chart from an Ohio health system, almost certainly run as a M-Form healthcare system

A random 2010 org chart from an Ohio health system that is almost certainly run as a M-Form healthcare system.

But, M-Form companies aren’t without problems. There is a tendency for divisions to compete for resources and the ensuring coordination between relatively autonomous divisions can be a problem.

These inherent limitations haven’t caught up with healthcare yet because, to my mind, the Fee for Service payment system shields the industry from the need to coordinate the activities in various divisions of a larger company.

For example, if an integrated system hospital is too small to support the number of patients seem in it’s FFS integrated physician group, the overflow goes elsewhere and the only cost is missed opportunity.  Similarly, FFS systems can encourage wild growth of cardiology, neurosurgery and other profitable service lines far in excess of a primary care base because these independently generate both revenue and cost. In other words, there is no dependency between divisions under FFS.

Global capitation, in contrast, requires a hyper-vigilant focus on integrating all parts of the system. In capitation, management’s task is to match revenue (imprecisely, growth in covered lives) with expense (almost all service lines). Capitated systems don’t have the luxury of allowing divisions to develop and grow autonomously because as the proportion of capitation increases, these divisions transform from revenue centers to cost centers.

Thus, as capitation grows, managers need to grow each division to match the rate of growth in covered lives. If there is excess or inadequate capacity in any division, the costs can be significant. Covered lives will leave for uncoordinated outside care (that the system needs to pay for). Or, internal capacity sits unused, or generates marginal FFS revenue. The role of executive management is to tightly regulate the capacity and cost of each division. The second major task is figuring out the internal transfer rate for divisional services.

In light of all of these challenges, I’m increasingly wondering whether capitated healthcare organizations, due to their massive internal interdependencies, may find themselves ill-suited for M-Form structures. I’m not sure what the right structure is, but suspect that we will need to find ourselves in systems with greater levels of central oversight than most M-Form companies, if not quite U-Form structures.

(Interestingly, an academic paper a few years ago noted that while most industries migrated to M-Form decades ago, aluminum smelters were unable to migrate from their U-Form structures because they too had too many internal production interdependencies).

Structure follows strategy… and I’m still watching to see which structures are best for this new era or risk in healthcare payment.  We may be migrating to more centralized models of management.  The fallout could be the need for integrated systems to get smaller and more focused.

Photo: Chad Kainz via cc

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