Using value innovation to create competitive advantage

Physician Executive, May-June, 2005 by David P. Tarantino

A hospital known and respected for its cardiac and orthopedic surgery programs realizes it cannot rely on only two successful programs to continue to be profitable in the long term. A loss of either of its major surgical groups to a competitor would spell disaster.

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A consultant hired to evaluate their situation determines that morbid obesity is growing in prevalence and the market for bariatric surgery is still in its growth phase. Nationally, reimbursement for bariatric surgery without major complications exceeds costs. Several other hospitals in the area are offering bariatric surgery and have been profitable.

Based on these findings, the senior executive team decides to expand its surgical service line by offering bariatric surgery. The hospital retrofits a ward to accommodate morbidly obese patients, acquires the necessary equipment and recruits two new surgeons to lead the program. Their competitors launch major advertising campaigns against them, focusing on their program's lack of experience.

The hospital counters with its own campaign focusing on the quality rather than quantity of what they do. A prolonged battle ensues between the competing hospitals for these patients. The result is the hospital's new bariatric program gains some patients, but is not realizing the profits that were projected. The hospital board demands to know what is going to be done.

How to compete

If this scenario sounds familiar, it's because hospitals and medical practices often build strategy around trying to understand the competition, with the focus being to match and beat rivals.

This conventional approach, however, may not produce optimal results. All too often competitors tend to emulate each other with strategies that produce incremental improvements in cost or quality. Competitors end up fighting for an increase share of an shrinking market rather than creating new market space.

Is there a different way to compete?

Before leaders of a hospital or practice answer this question, they first must understand their industry. This process begins with what Michael Porter of the Harvard School of Business has described as analysis of the "five basic forces of competition."

These competitive forces include:

1. Present competitors

2. Potential competitors

3. Bargaining power of suppliers

4. Bargaining power of buyers

5. Threat of substitute products (1)

When taken together, these five forces determine an industry's long-term attractiveness. The mix of forces explains why some industries are consistently more profitable than others and provides insights into which resources are required and which strategies should be adopted to be successful.

The strength of the individual forces varies from industry to industry and, over time, within the same industry. In health care, the key forces are rivalry among present competitors (e.g., community hospitals, tertiary care hospitals, surgical centers), bargaining power of suppliers (e.g., shortages of nurses), and the bargaining power of buyers (third-party payers, individual consumers).

How attractive is the industry for bariatric surgery? What are the trends for future attractiveness and profitability?

Rivalry occurs among health care providers whose services are close substitutes for each other, especially when one provider acts to improve its standing or protect its position.

Rivalry is greatest when there is high investment intensity, there are many small providers, there is little service differentiation and it is easy for customers to switch from one provider to another. These conditions describe the environment for bariatric surgery. They suggest that rivalry is an unfavorable competitive force.

New competitors add capacity to the industry and bring with them the need to gain market share, making competition more intense. Entry is more difficult when economies of scale are present, high capital investment is required at the outset, strong service differentiation exists among current providers and gaining patient volume is particularly difficult.

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For bariatric surgery, assessing the threat of new entrants requires answering the basic question: How easy is it for a laparoscopic surgeon and hospital to start a bariatric service? In general, the higher the barriers to entry, the greater the potential for profits since you can exclude new individuals or hospitals from becoming competitors.

Finding a substitute

Substitutes are alternative services that perform essentially the same function. Substitute offerings put a ceiling on the profitability of an industry by limiting the price that can be charged. The greater the substitutes the more difficult it is to generate and sustain profits.

One only needs to think of the number and types of books, print, television ads, and Web sites dealing with obesity and weight loss programs to understand the concept of substitute services.

Patients can choose from diet programs, fitness facilities and cosmetic surgery in lieu of bariatric surgery. So the availability of substitute service offerings is relatively high, though it has been argued that there are few alternatives for the morbidly obese patient.