Vertical Integration and Organizational Networks in Health Care

Prologue: Many private and public entrepreneurs are busily building large corporate systems to compete in the rapidly evolving world of managed care. By contrast, California, which has a health insurance market that is dominated by for-profit health maintenance organizations (HMOs), reflects a wide variety of organizational approaches along a continuum that stretches from contractual networks to fully integrated systems. If a trend is emerging, it seems to favor less “vertical integration” and more reliance on “virtual integration” among physician groups, hospitals, and health plans. In this paper Jamie Robinson and Larry Casalino discuss how primary care physicians, specialists, and hospitals in California are reorganizing to become more effective competitors. They place a particular emphasis on capitated medical groups and their marketplace relationships. Unlike more conventional academic methods of literature searches and analyses of past performance, Robinson and Casalino combine information gleaned from extensive interviews (what Robinson has characterized as “shoe-leather social science”) with the principles of institutional economic theory to arrive at their conclusions, Robinson is an associate professor of health economics at the University of California (UC), Berkeley, and also obtained his doctorate there. He conducted his work with support from an Investigator Award in Health Policy Research from The Robert Wood Johnson Foundation, Casalino is a clinical assistant professor of family medicine at Stanford University and a community-based family practitioner. He received his medical degree from the University of California, San Francisco, and holds a master's degree in public health from UC Berkeley, where he is completing a doctorate in organizational sociology and health policy. His doctoral dissertation describes the transformation of California's health care market and the growth of large medical groups within it. Abstract: This paper documents the growing linkages between primary care-centered medical groups and specialists and between physicians and hospitals under managed care. We evaluate the two alternative forms of organizational coordination: “vertical integration,” based on unified ownership, and “virtual integration,” based on contractual networks. Excess capacity and the need for investment capital are major short-term determinants of these vertical versus virtual integration decisions in health care. In the longer term, the principal determinants are economies of scale, risk-bearing ability, transaction costs, and the capacity for innovation in methods of managing care.