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Managing a Business/Strategic Management


1. Porters model helps with the structural analysis of the environment. How does this model work? Explain.

2. Take any 02 operational areas and discuss the main elements of their strategies in manufacturing organisation.

3. Discuss the sources of power within the organisation and explain the method used for the selection of strategic options.

4. Enumerate the main characteristics of strategic decisions. What measures can use for assessing resource utilization strategy?


2. Take any 02 operational areas and discuss the main elements of their strategies in manufacturing organization
Labor flexibility. Until very recently, U.S. auto manufacturers hadn’t done much to modernize their manufacturing techniques because of resistance from the United Auto Workers (UAW). Deere has a different sort of relationship with the union. In exchange for greater flexibility in work practices, Deere offers its UAW employees profit-sharing schemes based on SVA and productivity. That kind of collegiality has built a relationship that can handle even tough calls, like closing down production, as the company did with engines in Dubuque. “When we can’t compete, we lay it out,” Lane explains. “We showed them that we wouldn’t be able to build these diesel engines, and we closed down our engine manufacuring in Dubuque. But in other places, we’ve reinvested in our UAW factories. We work very cooperatively with them.”
Lean production. The company has embraced lean production with the Deere Production System (DPS), which is adapted to its unique needs. “We are not an auto company with huge volumes,” Lane says. “What you have is lots of different products — planters, sprayers, combines, tractors — all of them quite different. So our Deere Production System is tailored to low-volume, high-quality production.” The system has been implemented at virtually all of Deere’s factories over the past four years.
One critical element of DPS is its “pull system.” In the old days, Deere aimed for a steady, even pace of production. But now Deere bases its manufacturing on customer demand, and products are made only after a customer has ordered them. This approach lets Deere adapt to cyclical and seasonal factors much better than in the past.
Another element of DPS is a constant push to update machine tools, eliminate waste, and enhance flow-through. The advances have been dramatic. “We’re ending up with significant productivity gains — close to double digits every year,” Lane says. In any form of manufacturing, productivity gains of 8 to 9 percent a year are huge.
Deere’s rigorously analytical approach has given it the market muscle to discourage the emergence of a competitor that can challenge Deere’s agricultural products on a global basis. Even in India, where a giant like Mahindra & Mahindra is posing a challenge to so many automotive and related companies, Deere has prospered. Thus far, at least, Deere’s strategy has yielded global dominance and stands as an example of how U.S. manufacturing is proving remarkably resilient in an increasingly competitive global economy.

1.Porters model helps with the structural analysis of the environment. How does this model wor k? Explain.

Porter's five forces - Michael Porter 5 forcesMichael Porter’s Five Forces is a model used to explore the environment in which a product or company operates to generate competitive advantage.

Porter’s Five Forces analysis looks at five key areas mainly:

The threat of entry
The power of buyers
The power of suppliers
The threat of substitutes, and
Competitive rivalry (advantage).

Michael Porter’s Five Forces:

New Entrants   

Industry competitors and extent of rivalry & advantage



Introduction to The Five Forces

Michael Porter’s five forces model is based on the insight that a corporate strategy should meet the opportunities and threats in the organizations external environment. Especially, competitive strategy should based on an understanding of industry structures and the way they change.

Porter has identified five competitive forces that shape every industry and every market. These forces determine the intensity of competition and hence the profitability and attractiveness of an industry. The objective of corporate strategy should be to modify these competitive forces in a way that improves the position of the organization. Porters model supports analysis of the driving forces in an industry. Based on the information derived from Porter’s Five Forces Analysis, management can decide how to influence or to exploit particular characteristics of their industry.

Porter’s Forces model is an “outside looking in” business unit strategy tool that is used to make an analysis of the attractiveness or value of an industry structure.

The Competitive Forces analysis is made by the identification of 5 fundamental competitive forces:

The entry of competitors (how easy or difficult is it for new entrants to start to compete, which barriers do exist)
The threat of substitutes (how easy can our product or service be substituted, especially cheaper)
The bargaining power of buyers (how strong is the position of buyers, can they work together to order large volumes)
The bargaining power of suppliers (how strong is the position of sellers, are there many or only few potential suppliers, is there a monopoly)
The rivalry among the existing players (is there a strong competition between the existing players, is one player very dominant or all all equal in strength/size)
Some academics believe that a sixth force could be included – government.

Michael Porter’s Factor 1) Threat of New Entrants –

The easier it is for new companies to enter the industry, the more cut-throat competition there will be. Factors that can limit the threat of new entrants are known as barriers to entry. Some examples include:

Existing loyalty to major brands
Incentives for using a particular buyer (such as frequent shopper programs)
High fixed costs
Scarcity of resources
Government restrictions or legislation
Entry protection (patents, rights, etc.)
Economies of product differences
Brand equity
Switching costs or sunk costs
Capital requirements
Access to distribution
Absolute cost advantages
Learning curve advantages
Expected retaliation by incumbents

Michael Porter’s Factor 2) Power of Suppliers

This is how much pressure suppliers can place on a business. If one supplier has a large enough impact to affect a company’s margins and volumes, then they hold substantial power. Here are a few reasons that suppliers might have power:

There are very few suppliers of a particular product
There are no substitutes
The product is extremely important to the buyer, they cannot do without it
The supplying industry has a higher profitability than the buying industry
Supplier switching costs relative to firm switching costs
Degree of differentiation of inputs
Presence of substitute inputs
Supplier concentration to firm concentration ratio
Threat of forward integration by suppliers relative to the threat of backward integration by firms
Cost of inputs relative to selling price of the product

Michael Porter’s Factor 3) Power of Buyers/ Customers

This is how much pressure customers can place on a business. If one customer has a large enough impact to affect a company’s margins and volumes, then they hold substantial power. Here are a few reasons that customers might have power

Small number of buyers
Purchases of large volumes
Switching to another (competitive) product is simple
The product is not extremely important to the buyer, they can do without it for a period of time.
Customers are price sensitive
Buyer concentration to firm concentration ratio
Bargaining leverage
Buyer volume
Buyer switching costs relative to firm switching costs
Buyer information availability
Ability to backward integrate
Availability of existing substitute products
Buyer price sensitivity
Price of total purchase

Michael Porter’s Factor 4) Availability of Substitutes

What is the likelihood that someone will switch to a competitive product or service? If the cost of switching is low, then this poses to be a serious threat. Here are a few factors that can affect the threat of substitutes:

Buyer propensity to substitute
Relative price performance of substitutes
Buyer switching costs
Perceived level of product differentiation
Fad and fashion
Technology change and product innovation
The main issue is the similarity of substitutes. For example, if the price of coffee rises substantially, a coffee drinker is likely to switch over to a beverage like tea because the products are so similar.

If substitutes are similar, then it can be viewed in the same light as a new entrant.
Consider technology substitutes (who would have thought that MP3 technology would replace tape & CD’s?)

Michael Porter’s Factor 5) Competitive Rivalry

And last but not least, this describes the intensity of competition between existing firms in an industry. Highly competitive industries generally earn low returns because the cost of competition is high. A highly competitive market might result from:

Many players of about the same size, no dominant firm.
Little differentiation between competitors products and services.
A mature industry with very little growth.
Companies can only grow by stealing customers away from competitors.
For many industries, this is the major determinant of the competitiveness of the industry. Sometimes rivals compete aggressively and sometimes rivals compete in non-price dimensions such as innovation, marketing, etc.

Number of competitors
Rate of industry growth
Intermittent industry overcapacity
Exit barriers
Diversity of competitors
Informational complexity and asymmetry
Fixed cost allocation per value added
Level of advertising expense

Use of the Information from Michael Porter’s Analysis Tool:

Five Forces Analysis can provide valuable information for three aspects of corporate planning:

Statistical Analysis:
The Porter’s Five Forces Analysis allows determining the attractiveness of an industry. It provides insights on profitability. Thus, it supports decisions about entry to or exit from and industry or a market segment. Moreover, the model can be used to compare the impact of competitive forces on the own organization with their impact on competitors. Competitors may have different options to react to changes in competitive forces from their different resources and competence’s. This may influence the structure of the whole industry.
Dynamical Analysis:
In combination with a PESTLE Analysis, which reveals drivers for change in an industry, Porter’s Five Forces Analysis can reveal insights about the potential future attractiveness of the industry. Expected Political, Economical, Socio-demo-graphical, Technological, Legal and Environmental changes can influence the five competitive forces and thus have impact on industry structures.
Useful tools to determine potential changes of competitive forces are scenarios.
Analysis of Options:
With the knowledge about intensity and power of competitive forces, organizations can develop options to influence them in a way that improves their own competitive position. The result could be a new strategic direction, e.g. a new positioning, differentiation for competitive products of strategic partnerships .
Porter’s model of Five Competitive Forces allows a structured and systematic analysis of market structure and competitive situation. The model can be applied to particular companies, market segments, industries or regions. Therefore, it is necessary to determine the scope of the market to be analysed in a first step. Following, all relevant forces for this market are identified and analysed Hence, it is not necessary to analyzer all elements of all competitive forces with the same depth.

The Porter’s Five Forces Model is based on microeconomics. It takes into account supply and demand, complementary products and substitutes, the relationship between volume of production and cost of production, and market structures like monopoly, oligopoly or perfect competition.
Influencing the Power of Five Forces

After the analysis of current and potential future state of the five competitive forces, managers can search for options to influence these forces in their organization’s interest. Although industry-specific business models will limit options, the own strategy can change the impact of competitive forces on the organisation. The objective is to reduce the power of competitive forces. The following figure provides some examples. They are of general nature. Hence, they have to be adjusted to each organization’s specific situation. The options of an organization are determined not only by the external market environment, but also by its own internal resources, competence’s and objectives.

Michael Porter’s Five Forces

Reducing the Treat of New EntrantsIncrease minimum efficient scales of operationsCreate a marketing / brand image (loyalty as a barrier)Patents, protection of intellectual propertyAlliances with linked products / services Tie up with suppliers Tie up with distributors Retaliation tacticsReducing the Competitive Rivalry between Existing PlayersAvoid price competition – Differentiate your productBuy out competitionReduce industry over-capacity Focus on different segments Communicate with competitorsReducing the Bargaining Power of CustomersPartnering Supply chain managementIncrease loyaltyIncrease incentives and value added Move purchase decision away from price Cut put powerful intermediaries (go directly to customer)Reducing the Threat of SubstitutesLegal actions – Increase switching costsAlliancesCustomer surveys to learn about their preferences Enter substitute market and influence from within Accentuate differences (real or perceived)

Reducing the Bargaining Power of Suppliers
Partnering Supply chain management Supply chain training Increase dependency Build knowledge of supplier costs and methods Take over a supplier

Generic Strategies to help counter the Five Forces

To counter the Porter’s five forces, Strategy can be formulated on three levels:

Corporate level
Business unit level
Functional or departmental level.
The business unit level is the primary context of industry rivalry. Michael Porter identified three generic strategies (cost leadership, differentiation, and focus) that can be implemented at the business unit level to create a competitive advantage. The proper generic strategy will position the firm to leverage its strengths and defend against the adverse effects of Porter’s five forces.

Assumptions made about the Porter’s model:

That buyers, competitors, and suppliers are unrelated and do not interact and collude
That the source of value is structural advantage (creating barriers to entry)
That uncertainty is low, allowing participants in a market to plan for and respond to competitive behaviour.
Use of the Porter’s Five Forces model

The Porter’s Five Forces tool is a simple but powerful tool for understanding where power lies in a given business situation. This is important, as it helps you understand both the strength of your current competitive position, and the strength of a position you’re looking to move into.

With a clear understanding of where power lies, using the Five Forces) you can take fair advantage of a situation of strength, improve a situation of weakness, and avoid taking wrong steps. This makes it an important part of your business planning toolkit.

Supplier Power
Supplier concentration
Importance of volume to supplier
Differentiation of inputs
Impact of inputs on cost or differentiation
Switching costs of firms in the industry
Presence of substitute inputs
Threat of forward integration
Cost relative to total purchases in industry   
Barriers to Entry
Absolute cost advantages
Proprietary learning curve
Access to inputs
Government policy
Economies of scale
Capital requirements
Brand identity
Switching costs
Access to distribution
Expected retaliation
Proprietary products   Degree of Rivalry
Exit barriers
Industry concentration
Fixed costs/Value added
Industry growth
Intermittent overcapacity
Product differences
Switching costs
Brand identity
Diversity of rivals
Corporate stakes   Threat of Substitutes
Switching costs
Buyer inclination to
trade-off of substitutes
Buyer Power
Bargaining leverage
Buyer volume
Buyer information
Brand identity
Price sensitivity
Threat of backward integration
Product differentiation
Buyer concentration vs. industry
Substitutes available
Buyers’ incentives   

Application with other tools

Porter’s five forces model works well in association with  a SWOT analysis and a PESTLE analysis

A SWOT analysis is a valuable diagnostic tool, but it is only as good as the data and context considered. Remember, keep the analysis real, in context and focussed on the goal you are seeking. When using a SWOT analysis, always use the PRIMO-F & PEST or PESTLE analysis profiles to ensure all factors are covered.Need to know more about SWOT analysis? then check out Mike Morrison's Book - Strategic Business Diagnostic Tools on Amazon or on KindleFor more on SWOT analysis read our other articles.
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Filed Under: SWOT Analysis
Tagged With: competitive advantage, competitor analysis, five forces, michael porter, Porter, porter 5 forces, porter five forces, porter's five forces
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September 19, 2011 at 00:26
Michael Porter's Five Forces – Competitor Analysis – competitive advantage | RapidBI – Rapid Business Improvemen…

Vera Woodhead says:
January 23, 2012 at 07:27
Worth using + easy to understand > Porter's 5 Forces for competitor analysis & competitive advantage via@247tweet

Apara says:
March 16, 2012 at 07:13
Very Informative article. Thanks

Lorna Tyrtania says:
March 19, 2012 at 15:40
A great refresher…“@247tweet: Michael Porter's Five Forces for competitor analysis & competitive advantage”

rekha says:
April 21, 2012 at 09:44
This article is very informative.but i want to know that how IT will impact on each of these five forces and also what are the implications for organization’s future strategies?

Admin-Mike says:
April 21, 2012 at 10:12
You cannot look at IT in isolation, for IT could make or break any internal changes.

Often the problem with IT is that it is implemented in isolation
the sooner organizations implement strategically and hiolistically according to the PRIMO-F framework the better – Note there is no IT in PRIMO-F – as IT is a part of resources!

strategic management

3.discuss the sources of power within the organization and explain the method used for the selection of strategic options.

sources of power within the organization

5 Sources of Power in Organizations

Power refers to the possession of authority and influence over others. Power is a tool that, depending on how it's used, can lead to either positive or negative outcomes in an organization.
"The Bases of Power," that's regarded as the basis for classifying power in organizations. They identified five sources of power, namely: coercive, referent, legitimate, expert and reward power.
Legitimate Power
Legitimate power is also known as positional power. It's derived from the position a person holds in an organization's hierarchy. Job descriptions, for example, require junior workers to report to managers and give managers the power to assign duties to their juniors. For positional power to be exercised effectively, the person wielding it must be deemed to have earned it legitimately. An example of legitimate power is that held by a company's CEO.
Expert power
Knowledge is power. Expert power is derived from possessing knowledge or expertise in a particular area. Such people are highly valued by organizations for their problem solving skills. People who have expert power perform critical tasks and are therefore deemed indispensable. The opinions, ideas and decisions of people with expert power are held in high regard by other employees and hence greatly influence their actions. Possession of expert power is normally a stepping stone to other sources of power such as legitimate power. For example, a person who holds expert power can be promoted to senior management, thereby giving him legitimate power.
Referent Power
Referent power is derived from the interpersonal relationships that a person cultivates with other people in the organization. People possess reference power when others respect and like them. Referent power arises from charisma, as the charismatic person influences others via the admiration, respect and trust others have for her. Referent power is also derived from personal connections that a person has with key people in the organization's hierarchy, such as the CEO. It's the perception of the personal relationships that she has that generates her power over others.
Coercive Power
Coercive power is derived from a person's ability to influence others via threats, punishments or sanctions. A junior staff member may work late to meet a deadline to avoid disciplinary action from his boss. Coercive power is, therefore, a person's ability to punish, fire or reprimand another employee. Coercive power helps control the behavior of employees by ensuring that they adhere to the organization's policies and norms.
Reward Power
Reward power arises from the ability of a person to influence the allocation of incentives in an organization. These incentives include salary increments, positive appraisals and promotions. In an organization, people who wield reward power tend to influence the actions of other employees. Reward power, if used well, greatly motivates employees. But if it's applied through favoritism, reward power can greatly demoralize employees and diminish their output.

2.enumerate the main characteristics of strategic decisions.what measures can be used for assessing resource utilization strategy?
main characteristics of strategic decisions

Strategic decisions are the decisions that are concerned with whole environment in which the firm operates, the entire resources and the people who form the company and the interface between the two.
Characteristics/Features of Strategic Decisions
a.   Strategic decisions have major resource propositions for an organization. These decisions may be concerned with possessing new resources, organizing others or reallocating others.
b.   Strategic decisions deal with harmonizing organizational resource capabilities with the threats and opportunities.
c.   Strategic decisions deal with the range of organizational activities. It is all about what they want the organization to be like and to be about.
d.   Strategic decisions involve a change of major kind since an organization operates in ever-changing environment.
e.   Strategic decisions are complex in nature.
f.   Strategic decisions are at the top most level, are uncertain as they deal with the future, and involve a lot of risk.
g.   Strategic decisions are different from administrative and operational decisions. Administrative decisions are routine decisions which help or rather facilitate strategic decisions or operational decisions. Operational decisions are technical decisions which help execution of strategic decisions. To reduce cost is a strategic decision which is achieved through operational decision of reducing the number of employees and how we carry out these reductions will be administrative decision.
The differences between Strategic, Administrative and Operational decisions can be summarized as follows-
Strategic Decisions   Administrative Decisions   Operational Decisions
Strategic decisions are long-term decisions.   Administrative decisions are taken daily.   Operational decisions are not frequently taken.
These are considered where The future planning is concerned.   These are short-term based Decisions.   These are medium-period based decisions.
Strategic decisions are taken in Accordance with organizational mission and vision.   These are taken according to strategic and operational Decisions.   These are taken in accordance with strategic and administrative decision.
These are related to overall Counter planning of all Organization.   These are related to working of employees in an Organization.   These are related to production.
These deal with organizational Growth.   These are in welfare of employees working in an organization.   These are related to production and factory growth.

what measures can be used for assessing resource utilization strategy?
Resource use measurement is in the early stages of development. Although public and private payers express considerable interest in calculating the value of health care services, it remains a challenge to develop and implement nationally accepted measures

What are the main types of resource use measures?
The term “resource use measures” is intended to broadly capture indicators of the cost and efficiency of health care provision. Health care resource use measures reflect the amount or cost of resources used to create a specific product of the health care system. The specific product could be a visit or procedure, all services related to a health condition, all services during a period of time, or a health outcome. “Efficiency” measures are a subset of resource use measures that compare the production of products of a specified level of quality.1, 106 Most resource use measures in use are not efficiency measures by this definition because they do not explicitly incorporate a measurement of the quality of the product.
Three main groups of resource use measures have been developed:
1.   Relatively simple measures of the resources used to produce health care, such as mean length of stay, mean charges or estimated costs, and readmission rates for hospitals; and consultation or test ordering rates for outpatients with common complaints such as low back pain.
2.   More complex measures of health care resource use, including both inpatient and outpatient services, using econometric or mathematical programming techniques to account for multiple outputs.
3.   Measures of the resources used in an episode of care for a patient, or to treat a patient with a specified burden of comorbidity for a specified period of time.
Relatively Simple Measures
The first group of measures includes relatively straightforward measures long used in hospital management. The most common measure of this type is the average length of hospital stay, adjusted for case mix. This provides an estimate of the resources used to care for a hospitalized patient with a particular diagnosis. Other measures focus on whether the hospitalization itself was a necessary use of resources; potentially avoidable readmissions following hospital stays are a commonly used measure of this type. Finally, charges or estimated costs associated with specific services are sometimes presented as resource use measures, although these measures may be distorted by cost shifting, anticompetitive behavior, differences in quality, and a variety of other manifestations of market failure.
More Complex Measures
The second group of measures, typically published in the peer-reviewed literature,107 reflects the amount and type of various resources used to produce a mix of hospital services, such as hospital discharges, outpatient visits, and procedures. These measures use complex methods to account for different mixes of resources used and services produced. The complexity of these methods may have inhibited the broad use of these measures beyond academic research, because measurement results can be sensitive to many specification choices and difficult to interpret.
Episode- and Population-Based Measures
The third group includes two main approaches to resource measurement: (1) “episode-based” measures of resources used for an “episode of care,” including all services related to a particular medical condition or acute event; or (2)“population-based” measures of resources used in providing all care to an individual with one or more chronic conditions for a period of time. Of the two approaches, episode-based measures have been used most widely by commercial payers and have been recommended for use in Medicare by the Congressional Budget Office and the Medicare Payment Advisory Commission, among others.
Episodes are defined using “grouper” tools, such as the Episode Treatment Groups (ETGs) developed by Symmetry Health Data Systems and Medstat Episode Groups (MEGs) developed by Thomson Medstat. These tools group related services into episodes primarily using diagnosis codes; episodes include services furnished by different providers in different care settings. The cost or resources used to produce each episode are then tallied across providers.
A population-based approach to efficiency measurement, such as Diagnostic Cost Groups (DCGs), classifies a patient population according to morbidity burden in a given period (e.g., one year). The cost or resources used for all health care for that patient over the time period are then measured.

What types of data are used to construct resource use measures? How is “cost” measured?
Resource use measures are typically constructed using administrative data. Hospital-focused measures can use administrative data sets such as those collected and disseminated by statewide health data organizations.109 Measures that cover a broader range of services and care settings may require the use of insurance claims for medical, ancillary, and pharmacy services. While administrative data do not include much clinical information, they have the advantage of being readily available and reasonably standardized. Some measures append additional data from other sources on provider characteristics, such as the American Hospital Association Annual Survey.
One of the main challenges in using administrative data is that each insurer's data include only a portion of all care provided by each provider. Data from one insurer may not be sufficient to allow for stable measurement or may not be representative of a provider's entire practice. For this reason, some initiatives have aggregated data across multiple sources. For example, statewide health data organizations collect all-payer hospital data, and six communities have aggregated data from multiple sources for the Centers for Medicare & Medicaid Services (CMS) Better Quality Information project, described under Question 13.44 However, aggregation of cost data can be both technically and politically challenging, because insurers and providers are reluctant to share sensitive information, such as pricing arrangements.
Alternative Sources for Capturing Cost
For a profit-maximizing firm in a perfectly competitive market with symmetric information, the marginal cost of producing a service equals the marginal revenue or transacted price of that service. However, health care markets are not perfectly competitive, and transacted prices in the commercial market are generally unknown. Therefore, there are two easy alternatives to using actual prices (payments) in measuring hospital costs. One option is to use the amounts that providers charge payers, which are more readily available than either prices (payments) or hospital costs. However, prices (payments) often differ significantly from charges due to negotiated discounts, bundling of claims, and shared risk or capitated payment. For hospitals, charges can be used to estimate hospital resource costs by applying cost-to-charge ratios calculated from Medicare hospital cost reports or similar all-payer systems established by several States (e.g., California, Florida, Massachusetts, New Jersey). Although the accuracy of these estimates at the service level has been questioned, they appear to have reasonable validity at the hospital level.110-111
Another alternative, most commonly applied to ambulatory care, is to use standardized units to assign the relative resource use of different services. For example, relative value units (RVUs), which are used by Medicare and other payers to determine relative payment rates for various procedures, could be used instead of the price paid for services. One group that has followed this approach is the Washington-Puget Sound Health Alliance. The Alliance has constructed a regional all-payer database that is being used for quality and resource use measurement, but the data suppliers do not submit any financial information. Instead, The Alliance uses a system of RVUs developed by Milliman to score different services (including not only physician services but also other types of services without Medicare RVUs) using a common metric for relative resource use.112
Different questions are answered by using standardized prices, which are the same for all providers and payers, than by using charges or actual prices, which differ across providers and payers. Standardized prices address whether a health care service could be produced faster, with fewer people, fewer labor hours, or fewer supplies (i.e., fewer inputs).Charges or actual prices address whether the output could be produced less expensively (i.e., reducing the total cost of labor, supplies, and capital, either by using fewer inputs or by procuring those inputs at lower cost).
Consumers and purchasers may favor using actual prices, which reflect what they actually pay. For example, the price of an imaging study is likely to be higher at a teaching hospital than at a community hospital, even though the same real resources may be used in each setting.113 In this hypothetical example, a measure based on actual prices would reflect the fact that consumers and payers pay more for the imaging study at a teaching hospital than at a community hospital. By comparison, a measure based on standardized prices might show that the same quantity of resources was used for the imaging study in both settings.

What is known about the validity of available resource use measures, including their advantages and disadvantages?
The state of the art in health care resource use measurement contrasts sharply with that of the measurement of health care quality. Little is known about the validity of resource use measures or the advantages and disadvantages of different measures. Only a few resource use measures (length of stay and readmission measures) have been endorsed by the National Quality Forum (NQF). Unlike the evolution of most quality measures, current resource use measures are not typically derived from practice standards in the research literature, professional medical associations, or expert panels. Unlike most quality measures, resource use measures have been subjected to few rigorous evaluations of their reliability and validity.
Differences Among Resource Use Measures
Several differences among resource use measures could guide a community collaborative's choice of measures. Many resource use measures focus on hospitals, including simple measures such as mean length of stay and more complex multiple-output measures using econometric or mathematical programming techniques. Hospitals account for a high proportion of total health spending, and so may be of particular interest for resource use measurement. However, a focus on hospital care omits many types of services and does not capture coordination of care across settings, where many inefficiencies in delivery occur.
Commercial measures, both episode based and population based, reflect care provided in multiple settings. Population-based measures, although typically adjusted for patients' risk of higher resource use, reflect the “probability risk” that patients will acquire a condition that requires higher than expected resources during the data collection period. Episode-based measures, in contrast, reflect only the resources used in treatment of a particular condition, beginning at the onset of the episode of care for that condition.
After weighing these considerations, several national groups, including NQF and CMS, have expressed a preference for episode-based measures over population-based or hospital-focused measures. CMS lists the following advantages of episode-based measures114:
•   “Compare more similar patients than per capita calculations, as they are defined by similar procedures or conditions;
•   Capture the multiple ways in which services can be combined and substituted to produce the best outcome at the lowest cost;
•   Reflect patients' view of care as they move between and across settings and managers of their care, rather than simply measuring resources used for just a part of their care in one setting, and
•   Encourage improved coordination across settings included in the episode.”
Many hospital-focused measures, such as average length of stay and readmission rates, are widely used and relatively simple to construct. For example, United Health Group sponsors an NQF-endorsed measure described as “overall inpatient 30-day hospital readmission rate.” However, “single output” measures of this type may be misleading, because the services needed to avert readmissions (e.g., longer inpatient stays) may actually consume more resources than the “preventable service” itself. Readmission may be an undesirable outcome for some patients in some settings, but a desirable outcome for other patients in other settings.
More complex multiple-output hospital measures are published in the peer-reviewed literature. However, they are generally published in one-off studies and use complex methodology, so that community quality collaboratives would need to reconstruct such measures at considerable cost. Commercial episode-based and population-based measures are proprietary and are available to be licensed for application to existing data sets. Many commercial insurers are using these measures, although there is little evidence about the relative merits of competing products from different vendors. Because of concerns over the proprietary nature of these measures, some collaboratives, such as the Washington-Puget Sound Health Alliance, have elected instead to use public domain episode-based measures that are currently under development.
Further Methodological Questions
Several methodological questions that are important to establishing credible resource use measurement remain. These questions apply to most types of measures.
1.   Reliability: Reliability is an analysis of whether the variation seen in resource use is due to measurement error or to true differences in performance. The reliability of various resource use measures is largely unknown. The sample size of observations required to produce stable resource use estimates is uncertain. Health plans currently use arbitrary cutoffs, such as 30 episodes per physician, and therefore are often unable to profile as many as one-third of the eligible physicians in their networks.
2.   Provider Attribution: A key issue for resource measurement for care provided by more than one provider, such as episodes of care, is how to attribute primary accountability for the resources used. Various algorithms, mainly based on visit counts and payment amounts, have been used. Different algorithms lead to different assignments, and every algorithm needs to be adjusted based on market characteristics such as the availability of subspecialists and geographic or cultural isolation. No national consensus guidelines for provider attribution are available.
3.   Risk adjustment: Variation in resource use may be driven largely by differences in patient risk. While several risk-adjustment methods are used in various applications, most notably by vendors such as 3M Health Information Systems (distributor of Severity of Illness scores for All Patient Refined DRGs), limited testing has been done in some resource measurement applications, such as episodes of care.
4.   Treatment of outliers: The distribution of resource use across individuals is highly skewed, with some people having no encounters or prescriptions and others having hundreds of encounters per year. Some users exclude outliers, but a preferable approach is probably to truncate (also known as Winsorizing) outliers to reduce their influence on subsequent analyses.
Question 17. Which national groups are developing or endorsing resource use measures?
The Agency for Healthcare Research and Quality (AHRQ) includes a chapter on “efficiency” in its annual National Healthcare Quality Report.115 The chapter includes several “potential” measures of efficiency that AHRQ believes “should be viewed as preliminary and designed to stimulate productive ongoing discussions about health care efficiency.” These measures include trends in potentially avoidable hospitalizations and related costs, rehospitalization for heart failure, and an application of stochastic frontier analysis, which is an econometric technique that models provider-level inefficiency as a departure from an estimated best-practice frontier.108, 116 A set of resource use and efficiency measures is currently being developed for broader application, under AHRQ's Quality Indicators program.
The Centers for Medicare & Medicaid Services (CMS) is developing reporting of physician resource use using episode-based measures.117 CMS has been evaluating two commercial episode groupers, Episode Treatment Groups (ETGs) and Medstat Episode Groups (MEGs). It also has funded a study developing alternative approaches to the commercial groupers. It is continuing to explore ways to improve on the commercial measures and is considering funding the development of new groupers for use with Medicare claims. CMS's publicly reported, National Quality Forum (NQF)-endorsed measures of 30-day readmissions after hospitalization for heart failure, pneumonia, or heart attack may also be interpreted as hospital-level resource use measures.
The National Committee for Quality Assurance (NCQA) has developed Relative Resource Use (RRU) measures. The RRUs are population-based measures that are used to compare health plans on resources used to care for beneficiaries with six conditions: asthma, diabetes, low back pain, cardiovascular disease, hypertension, and chronic obstructive pulmonary disease. Published tables allow organizations to match severity-adjusted resource use within service categories (Inpatient Facility, Surgery and Procedure, Evaluation and Management (E&M), and Pharmacy) to a standardized allowed payment in order to calculate total standard costs for their eligible members across different areas of clinical care.
The Leapfrog Group is a purchaser coalition that publishes information on hospital quality and resource use for coronary artery bypass graft surgery, percutaneous coronary intervention, heart attack, and pneumonia. Efficiency of care for each procedure and condition is a blend of a hospital's quality score for that procedure or condition (based on statewide outcome data, process-of-care measures, and volume) with their resource utilization score for that procedure or condition (Table 5). The resource utilization score for each procedure or condition is based on a hospital's standardized, risk-adjusted, geometric mean length of stay for that procedure or condition, inflated by the hospital's 14-day all-cause readmission rate for that condition.
The Quality Alliance Steering Committee (QASC) is a collaborative effort among government agencies, physicians, nurses, pharmacists, hospitals, health insurers, employers, consumers, and others.117 To support the generation of effective health care performance information, the QASC is working to foster coordinated episode- and patient-level measures across the care continuum. It is aggregating data from different national health plans and Medicare to enable measurement of physicians' care for their entire practice panels. The QASC is also developing resource use measures for 20 high-cost/priority conditions, which will include both episode-based and per capita resource use measures.
The National Quality Forum (NQF) has developed a draft measurement framework for efficiency. A draft report,Measurement Framework: Evaluating Efficiency Across Patient-Focused Episodes of Care, has been endorsed by the NQF.106 This episode-based framework will be used to develop a comprehensive set of performance measures, including resource use and quality measures, for selected clinical conditions.
The Consumer-Purchaser Disclosure Project (CPDP) is a multistakeholder collaboration involving consumer, employer, and labor organizations. It has published a “Patient Charter for Physician Performance Measurement, Reporting and Tiering Programs.” This charter lays out a set of principles to guide physician performance measurement, which community quality collaboratives might consider as they develop reporting programs about resource use. The principles are118:
1.   Measures should be meaningful to consumers and reflect a diverse array of physician clinical activities.
2.   Those being measured should be actively involved.
3.   Measures and methodology should be transparent and valid.
4.   Measures should be based on national standards to the greatest extent possible.
Question 18. How have resource use measures been used to compare providers to benchmarks?
Provider resource use is typically compared to benchmarks of “peer” providers. A common approach is to calculate a resource use score by dividing a provider's observed resource use by the “expected” resource use derived from a benchmark population. This approach allows for aggregation of resource use measurements across multiple episodes (or other units of service). The resource use score is then used to identify outliers that have significantly higher or lower resource use than peers.
Slightly different methods are used in these calculations, which could have a significant effect on the results.119 For example, Medstat Episode Group (MEG) can be used to calculate a Risk-Adjusted Cost Index (RACI), which is a ratio of the total allowed costs of qualified episodes for which the provider is attributed responsibility divided by the total expected costs. The expected cost is based on the average cost of similar episodes based on MEGs, severity of illness (classified from 0 to 3), comorbidity burden (defined by the Diagnostic Cost Group [DCG] Relative Risk Score), provider specialty, and geographic region. With Symmetry Episode Treatment Groups (ETGs), the estimated ratio is somewhat different: a physician's normalized, actual resource use for a given set of ETGs serves as the numerator, and his or her specialty's normalized, average resource use for the same set of ETGs serves as the denominator.
Arbitrary thresholds are typically used to determine which providers are categorized as “high resource use” or “low resource use.” These thresholds are often set at percentiles in the distribution of resource use scores (e.g., the providers in the top decile of resource use scores are labeled “high resource use”). The Washington-Puget Sound Health Allianceprovides another example of how resource use is compared. Following the format of their quality reports, the Alliance plans to report provider resource use for episodes of care as “above the regional average,” “at the regional average,” or “below the regional average.”
Choosing Benchmarks
Different peer groups have been used in resource use comparisons. One decision is whether to use a benchmark of providers from the same geographic area or a national benchmark. Practice patterns vary widely between regions. For example, the cost per episode and the number of episodes per beneficiary were found to differ widely between Minneapolis and Miami.120 A regional benchmark would control for these differences, while a national benchmark would compare providers to national practice standards.
A second decision is whether to use a benchmark of providers of the same type (e.g., specialty) or providers of all types (e.g., multiple specialties). Many conditions are treated by multiple specialties, and practice patterns often differ widely by specialty. For example, endocrinologists and primary care physicians both provide care for diabetes. A measure of resource use for diabetes treatment could compare endocrinologists to other endocrinologists, as well as to primary care physicians.
A single-specialty benchmark holds providers accountable for the standards of their specialty, while a multiple-specialty benchmark compares resource use across specialties. Similarly, hospital comparisons could be limited to hospitals of the same teaching status or safety-net status. Comparing providers only to similar providers has the advantage of reducing variation that is beyond the provider's control, but the disadvantage is that providers are not held accountable to the level of performance achieved by other types of providers caring for similar patients.  

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