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CAN THIS RELATIONSHIP BE SAVED? by Rhonda Engleman and Jisun Yu under the supervision of Professor Andrew H. Van de Ven. Reproduced with permission of Professor Andrew H. Van de Ven in the format post in a course management system.

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UNIVERSITY OF MINNESOTA

Carlson School of Management Strategic Management Research Center Voice: 612-624-1864 321 – 19th Avenue South Minnesota Healthcare Organizations Study FAX: 612-625-6822 Minneapolis, MN 55455

CAN THIS RELATIONSHIP BE SAVED?

THE MIDWESTERN MEDICAL GROUP’S1 INTEGRATION JOURNEY

Forthcoming in P. Ginter, L. Swayne, and J. Duncan, The Strategic Management of Health Care Organizations, Fifth Edition, New York: Blackwell Business, 2005. (Current draft 10-7-04)

INTRODUCTION On a snowy January evening, the MMG management team held a retirement party for Judith Olsen, president of Midwestern Medical Group (MMG). During the evening, Olsen reflected back on the years she had worked for the MMG with mixed feelings about her experience. During their eight-year integration journey within the Midwestern Health System (Midwestern), the MMG management team experienced many encouraging moments, achievements, and successes as well as many struggles, disappointments, and conflicts. She was scheduled to meet with the board chair the next day to talk about the major issues her successor would need to address as president of the MMG. Knowing this might be her last contribution to the MMG before she retired, Olsen wanted to provide the board chair with helpful advice to pass on to her successor. This case focuses on the historical events in the MMG’s integration journey that Olsen pondered as she thought about what to say in that meeting. BACKGROUND Midwestern Health System (Midwestern) was established in July 1994 through the merger of Health Systems Corporation and Midwest Health Plan, making it the largest healthcare organization in its region. Health Systems contributed hospitals, clinics, nursing homes, a home health agency, and other healthcare services while Midwest Health Plan contributed health insurance products and relationships with physician groups. The vision guiding Midwestern’s development was to “offer an integrated healthcare system to affordably enhance the health of

1 This case was written by Rhonda Engleman and Jisun Yu under the supervision of Professor Andrew H. Van de Ven of the Carlson School of Management at the University of Minnesota. We also appreciate the editorial assistance of Julie Trupke and useful comments of Gyewan Moon and Margaret Schomaker. We gratefully acknowledge Stuart Bunderson, Shawn Lofstrom, Russel Rogers, Frank Schultz, and Jeffery Thompson who assisted in collecting data during this eight-year longitudinal study of MMG's integration journey. The case was prepared to promote class discussion and learning. It was not designed to illustrate either effective or ineffective management.

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people living and working in communities we serve.” This vision implied two priorities: the commitment to build an integrated healthcare system and the goal to improve community health. The MMG was founded in 1994 with an initial network of 340 employed physicians working in 20 clinics previously owned by Health Systems Corporation hospitals at the time of the merger with Midwest Health Plan. Hal Patrick was selected as the first MMG president. Under Patrick’s leadership, the MMG grew rapidly during its first two years, acquiring 30 additional primary care clinics in strategic locations across Midwestern’s geographic market. By mid-1996, MMG’s management attention shifted from growth by acquisition to management and organizational development of its now 50 clinics with 450 physicians and over 3000 employees. The MMG experienced many challenges during these formation and establishment periods within the Midwestern system. Managing the multi-faceted nature of the MMG-system integration process proved complex, involving many interdependent change initiatives. The initiatives included: 1) creating a large integrated group medical practice from formerly small independent physician clinics, 2) transitioning the identities and roles of physicians from being principals of private clinical practices to becoming agents and employees of healthcare companies, 3) building an organizational culture that aligned incentives and motivated commitments of clinicians with the MMG and Midwestern system while maintaining their commitment to the medical profession, and 4) developing an integrated system of healthcare for patients by linking the MMG’s clinical and business services across with other Midwestern units including the hospitals and the Midwestern Health Plan. In July 1997, Patrick was promoted to system vice president of clinical services for Midwestern. Midwestern leaders appointed Lief Erickson as the new MMG president. Erickson represented a strong voice for MMG physicians and patient care and had worked as an MMG manager since its formation. Despite continuous hardships in both financials and operations, Erickson led the MMG as the group rebounded from a record loss of $41 million in 1996, decreasing losses to $22 million in 1997 and $20 million in 1998. The MMG was on track to improve its financial performance in 1999 by decreasing its losses to $17 million, still far from ideal but improvement in the right direction. Under Erickson’s leadership, the MMG developed a solid management team of administrative and physician leaders as the MMG moved from a culture of survival to a culture of performance. The MMG had faced many challenges since its formation in 1994, but Erickson and his management team weathered the storm to establish the MMG as an integral part of the Midwestern Health System. The MMG management team still faced many tensions in their relationships with others in the Midwestern system, but Erickson was confident that his team had demonstrated the MMG’s value to Midwestern and would continue their journey to lead the MMG to even better results in the future. ARRANGED MARRIAGE OF EQUALS The Midwestern Health System experienced escalating financial pressures in 1998 and 1999. Since Midwestern’s formation, the system had not achieved its overall financial performance goals. Johanson, CEO of Midwestern, anticipated that the system would experience reductions of $50 million in Medicare reimbursement over the next five years due to changes in the program made in the Balanced Budget Act of 1997. Reimbursement rates from other commercial payors

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were also declining. Johanson feared that Midwestern could not survive without major system- wide changes to improve the organization’s financial performance in patient care services. Meanwhile, Midwest Health Plan had achieved stellar results with the Market Business Segments (MBS) business model. In 1997, Midwest Health Plan was experiencing significant financial losses. Midwest Health Plan adopted the MBS business model, moving from a structure with staff organized by major functions such as marketing, member relations, and product development to a structure with staff organized around Midwest Health Plan’s major customer segments such as government payors, small business, and other commercial payor groups. The move to the MBS business model allowed Midwest Health Plan leaders to streamline the health plan’s organization structure and develop products and pricing systems tailored to customer needs in each business segment. As a result, Midwest Health Plan improved its financial performance, moving from a significant financial loss before the MBS to a sound financial gain after its implementation. Johanson decided to extend the MBS business model to the rest of the Midwestern system, anticipating that the hospitals and the MMG could achieve financial results similar to Midwest Health Plan’s and allow Midwestern to improve the performance of all its individual units. In February 1999, Johanson officially unveiled the plan to implement the MBS business model in the Midwestern hospitals and MMG. Johanson announced that in the MBS business model, Midwestern would move from three divisions–Hospitals, MMG, and Health Plan–and reorganize as two divisions–the Health Plan division, and the Hospitals & Clinics division. Midwest Health Plan would continue with the MBS business model as previously defined and implemented. The Hospitals & Clinics division, including the Midwestern hospitals and the MMG, would define and organize around its own market business segments. These two divisions would be assigned accountability and responsibility to become the leader in their chosen market business segments. Johanson stated that the MBS model signaled a short-term move away from system-wide integration. The old Midwestern business model assumed that individual units shared one customer and attempted to provide a single “Midwestern experience.” The MBS model acknowledged that the old view was inadequate because each division served unique customer groups. Midwest Health Plan’s customers were health plan members, corporations, other purchasers, and insurance brokers. The MMG’s primary customers were patients. The Midwestern hospitals’ primary customers were physician specialists. While the mission and vision of Midwestern would remain the same, the system would back off from tight integration and pursue high impact integration in a few selected areas to meet the unique customer needs of each division. Johanson charged each division to maximize its financial and patient care performance within certain “rules of the game” including open communication between divisions and “no tolerance for badmouthing other parts of the organization.” Johanson declared 1999 as the year of "freedom to act." He expected the units within each division to coordinate their activities, but each division would be free to define and manage its own unique set of market business segments. Johanson purposely designed the MBS business model to force the hospitals and the MMG to resolve their tensions and conflicts by combining them into a single division. According Johanson, “We're learning more about integration. We used to assume that if we put them all

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together, they'd see the need to talk and automatically coordinate. They don't, it's not natural. Our new model acknowledges that and encourages integration more directly.” Johanson expected and looked forward to watching these tensions unfold and play out between the hospitals and MMG in the move to the MBS model. WE DON’T KNOW HOW THIS WILL GO, BUT LET’S HOPE FOR THE BEST After the announced restructuring, Erickson expressed mixed feelings about the MBS model when he discussed the change with his MMG management team. Erickson expected that the MMG would have an equal voice in the MBS implementation process with representation on a new board established to govern the Hospital & MMG division. He welcomed the freedom to act that Johanson had given the hospitals and the MMG to establish their own business market segments. Johanson promised that if the MMG decided that improving patient care was one of their most important goals, then his expectation would be that the MMG will outperform their competitors in that area. Erickson reported, “Then he will go away, and wait for me to come back and tell him how the MMG did. That's different, isn't it! They're not going to tell us how to do it.” Erickson hoped that the MBS model would help to improve relationships between the MMG and the Midwestern hospitals. He felt that this would be the first time that the hospitals and the MMG had a chance to test integration. The hospitals and the MMG had not yet been able to work together to prove what they could achieve together to improve patient care. Erickson reassured his MMG management team, “There is a lot of instability and uncertainty. I’m convinced, though, that the strategy is right to focus more on customers and relationships.” At the same time, Erickson wondered if the MMG and the hospitals could resolve the differences in their customer groups and approaches to healthcare delivery. “The structure by itself will not do away with those fundamental market activities that make us see the world differently and to be different. When they think of a customer, they look out the window and see the specialist building; my customer is this region because sometime those people will eventually wind up in the hospital. For the MMG, the customer is across the table. They simply have a different customer set. It's funny how you won't face what you have to face. Hospitals say they have patients and referring doctors, as on an equal plane. When you really look at it, though, the referring doctor is on the top of the priority list. . . . In the MMG, the patient is center, and it's relationship based. We see customers and markets differently. And now you say you've got to get together in a ‘market-based segment?’ Hang on! It will be OK, but it will be another game; all those market dynamics are still in place. If we can survive it, it will be good. No matter how good a new model is if you make a change like this, the bridge in between is tough. I don't think we've got many more shots at this thing.” Erickson went on to note, “If you're the CEO and you say, ‘I expect you to outperform your competition at all costs –which is a part of this market segment idea–but then I put you in a box with these other groups who have the ability to impede you, you're sending them a very complex message. Every day the clinics are compounded by the hospital's needs. . . . They have a good theory, but if it's not carried out well, it's not a good theory. But, anyway, we're going to try.” Erickson urged his MMG management team to send a positive message about the new MBS business model to the staff and physicians working in their clinics, “No matter which way we go,

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we’re partners with the hospitals; we’ve got to coordinate, and the future’s about relationships. . . As we sell this to our clinics and our partners, we want to make it positive and build hope.” THE CHILDREN GET SEPARATE ROOMS Johanson appointed Frank Henry as Senior Vice President of the Hospitals & Clinics division. Henry formed a division management team of representatives from each unit to review options for selecting market business segments. The team explored three options. First, the group considered the status quo option with the MMG as one business segment and each of the three hospitals as a separate business segment. Second, the group explored the implications of establishing two business segments, hospital services and ambulatory care services. Finally, the group considered creating a regional model with each metro hospital forming the anchor of three separate MBSs and the clinics organized geographically around these hospitals. After discussing the pros and cons of each option, the team decided to maintain the status quo with a few additions by selecting six market business segments for the Hospitals & Clinics Division: three metropolitan hospitals, regional hospitals, the MMG, and home care. THE MMG AS THE PROBLEM CHILD In early 1999, Johanson asked the Midwestern financial management staff to compare the MMG’s performance to a best practice model developed by a national consulting group. In a study of seven health system-sponsored primary care groups, the consulting group concluded that financial losses were inevitable in such groups due to costs associated with system membership including high practice acquisition costs, additional system overhead, increased employee benefit costs, new information systems expenses, and loss of ancillary revenues to hospital affiliates. The consulting group developed a model of realistic performance expectations for health system-sponsored primary care groups given such limitations. The finance staff found that MMG gross revenues were lower than the benchmark, but the MMG compared favorably in net revenue, expenses, and loss per RVU2 when compared to the best practice standards. The MMG also compared favorably in productivity, producing 6,428 RVUs per physician in 1998 compared to best practice benchmarks of only 6,100. Erickson summarized the significance of these findings, “What's important is that it should eliminate the notion that the MMG can gradually move to a zero loss.” Erickson presented the MMG’s favorable benchmark comparisons to the Midwestern board. The board expressed a new appreciation of the MMG, its performance, and its value to the larger Midwestern system. They reported that this study gave them a better understanding of how to measure the MMG’s financial and operational performance, how to set benchmarks for its performance, and the need to recognize the value that the MMG contributed to the Midwestern system.

2 RVU stands for relative value unit. An RVU is a physician productivity measure calculated using a multi-level factor system to assign a set value to each clinical service based on the complexity of the patient visit. More complex services are assigned higher RVU values than less complex services to reflect the additional work performed in providing these services.

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Despite the board’s affirmation of the MMG’s value to Midwestern and recognition that its financial performance exceeded expectations, MMG leaders heard repeated comments by other Midwestern leaders that there must be something wrong with the management team of a unit that consistently loses money. For example, when an MMG vice president presented an analysis of MMG’s financial losses to a group of other Midwestern leaders, one of the hospital vice presidents in the audience taunted her saying, “It pretty much sucks to be you, doesn't it?” When she made the same presentation to the MMG’s own physician advisory group members, many of whom had sold their practices to the MMG, “They went off the deep end on it. Their mindset was, ‘No, we used to at least break even.’ Something's wrong if we lose $17 million!” One Midwestern hospital administrator summarized the hospital leaders’ views on the “MMG problem” this way, “Looking at the MMG’s bottom line losses, the hospital leaders started thinking that they must not be very good managers and resented having to subsidize the MMG. . . . They were making money before they became part of Midwestern and now they were getting fat and lazy. . . . The move to the MBS only reinforced that ‘what’s your problem’ mentality regardless of the data that showed the MMG being set up to lose money. The data became almost irrelevant. There was no view that we were in this together.” These negative reactions affected MMG management team morale. The perception by other Midwestern leaders that the MMG was a financial drain on the system was clearly felt by MMG leaders. The MMG financial manager acknowledged the view that, “The MMG’s been looked down on – if it weren't for us, the hospitals would have more capital to spend.” In one MMG leadership meeting when the group reviewed a report showing that the MMG’s losses were far lower than budget, one MMG manager lamented, “If we’re doing so great, how come we are not feeling better?” Another manager replied, “It's because we're in a lousy business. No matter what we do, we lose money.” In another meeting, one MMG physician manager urged, “We need to stop presenting that awful $20 million loss figure. That turns us into the no-joy club. We should be talking instead about how we compare to best practice clinic groups.” Searching to bolster his team’s morale, Erickson asserted that, “The MMG is a very important piece of the Midwestern Health System, and we are not underperformers.” In addition to concerns about the MMG’s financial losses, some Midwestern hospital administrators expressed concern that the MMG failed to honor its responsibility to other system members by inappropriately referring patients to non-Midwestern hospitals. In Spring 2000, the Midwestern board commissioned another study to quantify the value and appropriateness of MMG referrals to Midwestern hospitals. Erickson felt that this new study was another example of, “. . . some guys in the board room occasionally waking up and wondering, ‘why do we have this clinic, again?’” This MMG valuation study provided evidence that the MMG stabilized and increased referrals to Midwestern owned facilities and affiliated specialists, and provided a large and geographically well located clinic group to strengthen Midwestern’s position in contract negotiations with payors. This study also showed that the MMG clinics contributed more than $500 million in net revenue and about $250 million in contribution margin to the Midwestern hospitals annually. Overall, the MMG valuation study once again affirmed the MMG’s value to the larger Midwestern system despite its individual unit losses.

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The Midwestern system and hospital leaders weren’t entirely impressed by the results of the MMG valuation study. When the MMG leaders presented the MMG valuation study findings to the Midwestern executive committee, members initially responded that the results “couldn’t be this good.” They sent the MMG back to check their numbers and review their findings with Midwestern’s chief financial officer. This additional review confirmed the original results. The MMG leadership team found the hospital administrators’ interpretations of the MMG valuation study results interesting. While the study showed that the MMG contributed $250 million to the hospitals, Olsen summarized the hospital leaders’ attitudes toward this news as, "We would have gotten those referrals anyway, so sit down and shut up." FAMILY SQUABBLES IN THE HOSPITALS & CLINICS DIVISION Midwestern held the individual market business segments accountable for their individual revenue and expense statements. As its own MBS within the Hospitals & Clinics division, the MMG continued to experience significant financial losses. The MMG attempted several strategies to improve its financial performance. One promising strategy was to expand MMG services to the community by hiring specialists because their services are typically reimbursed at a higher rate than primary care services. The MMG leaders engaged in their “freedom to act” within the general guidelines set out for them by Johanson in the MBS rollout. They committed to hire outside specialists only if Midwestern hospital-affiliated specialists could not meet their needs. However, the MMG’s efforts to hire specialists led to several squabbles with other members of the Hospital & Clinics division. In late 1998, the MMG decided to hire an ophthalmologist to provide outpatient laser surgery in an MMG clinic near one of Midwestern’s hospitals. The ophthalmologists practicing at that hospital perceived this MMG decision as promoting unfair competition within their service area. According to the hospital administrator, the MMG made the decision to hire an ophthalmologist unilaterally without consulting with him or his ophthalmologist group. The ophthalmologists affiliated with this Midwestern hospital said, “To heck with that. We’ve been taking ER calls in the middle of the night and the MMG doesn’t do that.” This group of ophthalmologists resigned and established a new independent practice. The Midwestern hospital lost patient volume to this new competitor and had to find another group to provide emergency room coverage for ophthalmology services. According to the hospital administrator, “It was a good business decision for the MMG, but it was a dumb decision for Midwestern.” In early 1999, the MMG learned that Midwestern had developed a formal specialty strategy. In a strategy presentation to a management group, a Midwestern leader cited the MMG’s plan to recruit an independent spine surgeon as a prime example of this strategy in practice. The MMG leaders were excited to see their strategy moving forward and receiving acceptance and support from the Midwestern leadership group. A week later, the MMG learned that Midwestern system leaders had made a commitment to a group practicing at one of the Midwestern hospitals and decided that all Midwestern business related to spine surgery should go to them. The MMG was forced to comply with this new contract by working with the Midwestern hospital group to provide spine surgery services and had to retract their previous employment offer to the independent surgeon.

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Later in 1999, the MMG hired a general surgeon to practice at another of its clinics. According to Erickson, “It's got the whole damn city up in arms. The official policy, though, is that we, when we can, should work with existing specialists. If they can't meet your needs to out- compete the market, then you can get your own. In this clinic, there's a stodgy old surgeon group who won't meet our needs in our new great facility, so we're going outside to hire.” Once again, Midwestern system leaders had other ideas. They demanded that the MMG leaders retract their plan to hire the general surgeon originally selected and instead work with the local Midwestern hospital’s surgeon group. Johanson blamed Erickson for these conflicts with Midwestern hospital-affiliated specialists. According to Johanson, “It was so painfully obvious to me that Erickson needed to get key players together to hash out issues, but he simply wasn’t getting to the issues.” Johanson went on to note that, “Erickson falls into the trap of seeing our need for information and coordination as questioning respect; he refuses at times to admit he needs help and discussion. . . . On this specialty issue, he didn't get the big picture about implications for the whole organization and the ripple effects he might be creating. There's a ‘lack of learning’ problem.” Erickson viewed these conflicts as evidence to support his suspicion that the Midwestern hospitals wanted to regionalize the MMG. His management team tried to follow the expectation that the MMG would work with Midwestern hospital-affiliated specialists and only go outside the system when they could not meet the MMG’s needs. Even so, the MMG leaders were handcuffed in their attempts to improve MMG financials and expand services by hiring specialists. Erickson and the MMG management group were discouraged by the lack of a coherent specialty strategy at the Midwestern system level. One MMG manager expressed frustration “because you start going down a path, and then it gets pulled out from under you. And then you find out that there was never really a strategy to begin with.” MMG MOVES ALONG WITH ITS WORK Despite difficulties implementing the MBS business model in the Hospitals & Clinics division, the MMG continued to move on with its work in 1999. The MMG management team focused on fine-tuning their systems, structures, and working procedures across clinics as well as developing patient-focused quality improvement initiatives. A 1998 billing practices audit report showed that MMG billing practices were often inaccurate and patient care documentation was sometimes incomplete. MMG leaders worked hard in 1999 to implement standardized patient care documentation and billing practices to assure that the MMG was in compliance with the government’s billing and documentation standards. Improving these systems also provided an excellent opportunity to increase revenues by collecting payments for previously unbilled and underbilled services. While they were trying to improve such administrative issues, the MMG management team also initiated several programs to enhance their patient care quality. One program of focus was the Clinical Care Improvement (CCI) initiative. The MMG management team believed that MMG could produce measurable improvement in clinical care and transfer successful experience from one clinic to another. Thus, the MMG managers established a CCI cross-functional team to lead the MMG on clinical care improvement initiatives. The CCI cross-functional team set out to

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prioritize healthcare services where the MMG could have a strong impact on community health improvement such as diabetes care, elderly care, and smoking cessation. The team identified methods that MMG clinics could use to improve their services in these areas and established incentives to motivate clinics to improve their patient care outcomes in these areas. The MMG leaders hoped that their work would provide an example to other Midwestern system units by demonstrating the benefits of continuous care improvement in action. These continuous efforts paid off. Early in 1999 at an executive leadership re

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