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Vertical Integration Strategies Read the overview below and complete the activities that follow. Concepts & Connections 6.3 describes how Kaiser Permanente, a health insurance company, uses a vertical integration strategy to deliver high-quality patient care while controlling costs.

Decisions concerning the scope of a company's operationswhich activities a firm will perform internally and which it will notcan also affect the strength of a company's market position. The scope of the firm refers to the range of its activities, the breadth of its product and service offerings, the extent of its geographic market presence, and its mix of businesses. Companies can expand their scope horizontally (more broadly within their focal market) or vertically (up or down the chain of value-adding activities that start with raw-material production and end with sales and service to the end consumer). Horizontal mergers and acquisitions (combinations of market rivals) provide a means for a company to expand its horizontal scope. Vertical integration expands a firm's vertical scope. Vertical integration, forward or backward, makes strategic sense only if it strengthens a company's position via either cost reduction or creation of a differentiation-based advantage. Otherwise, the drawbacks of vertical integration (increased investment, greater business risk, increased vulnerability to technological changes, less flexibility in making product changes, and the potential for channel conflict) are likely to outweigh any advantages.

In this exercise, please read the mini-case and answer the questions that follow.

Kaiser Permanentes unique business model features a vertical integration strategy that enables it to deliver higher-quality care to patients at a lower cost. Kaiser Permanente is the largest vertically integrated health care delivery system in the United States, with $64.6 billion in revenues and $3.1 billion in net income in 2016. It functions as a health insurance company with over 11 million members and a provider of health care services with 38 hospitals, 673 medical offices, and more than 21,000 physicians. As a result of its vertical integration, Kaiser Permanente is better able to efficiently match demand for services by health plan members to capacity of its delivery infrastructure, including physicians and hospitals. Moreover, its prepaid financial model helps to incentivize the appropriate delivery of health care services.

Unlike Kaiser Permanente, the majority of physicians and hospitals in the United States provide care on a fee-for-service revenue model or per-procedure basis. Consequently, most physicians and hospitals earn higher revenues by providing more services, which limits investments in preventive care. In contrast, Kaiser Permanente providers are incentivized to focus on health promotion, disease prevention, and chronic disease management. Kaiser Permanente pays primary care physicians more than local averages to attract top talent, and surgeons are salaried rather than paid by procedure to encourage the optimal level of care. Physicians from multiple specialties work collaboratively to coordinate care and treat the overall health of patients rather than individual health issues.

One result of this strategy is enhanced efficiency, enabling Kaiser Permanente to provide health insurance that is, on average, 10 percent cheaper than that of its competitors. Further, the care provided is of higher quality based on national standards of care. For the sixth year in a row, Kaiser Permanente health plans received the highest overall quality-of-care rating of any health plan in California, which accounts for 7 million of its 11 million members. Kaiser Permanente is also consistently praised for member satisfaction. Four of Kaisers health plan regions, accounting for 90 percent of its membership, were ranked highest in member satisfaction by J.D. Power and Associates. The success of Kaiser Permanentes vertical integration strategy is the primary reason why many health care organizations are seeking to replicate its model as they transition from a fee-for-service revenue model to an accountable care model.

Note: Developed with Christopher C. Sukenik.

Sources: Kaiser Foundation Health Plan Report and Hospitals Annual Financial Results for 2016, PRNewswire, February 13, 2017, www.prnewswire.com; Kaiser Permanente website and 2012 annual report; and J. ODonnell, Kaiser Permanente CEO on Saving Lives, Money, USA Today, October 23, 2012.

How has vertical integration aided the organization in building competitive advantage?

Multiple Choice

a.)It has helped contribute to its receiving the highest overall quality-of-care rating in the state of California.

b.)It has resulted in enhanced efficiency, allowing Kaiser Permanente to offer health insurance that is 10 percent cheaper than competitors.

c.)It has helped contribute to high member satisfaction ratings.

d.)All of these choices are correct.