No easy cure: what the U.S. health care system needs are entirely new forms of competition, says Michael Porter.

Rising health care costs are a major concern for chief executives. Michael E. Porter, a professor at the Harvard Business School and a leading expert on competitive strategy, argues that the heart of the problem is a flawed health care system. Following are excerpts from a conversation with Editor-in-Chief William J. Holstein, an abridged version of which first appeared in The New York Times.

[ILLUSTRATION OMITTED]

Is there a crisis?

We certainly think so. Costs are going up at double-digit rates. Yet the consumer feels that quality is suffering. People are having to pay a bigger piece of their health plan costs. And then all the data on quality and defects and errors are really quite alarming. Yes, we have a system producing results that are deeply disturbing.

You say we have the wrong kinds of competition. What does that mean?

The health care system is a great paradox. We have the most competition of any health care system in the world. That should be a powerful force for improving things. Yet we also have results that aren't the worst results but certainly not the most desirable.

What kind of competition did you find?

For purposes of driving value and improvements in quality versus costs, the relevant place where you want to have competition is diagnosing and treating particular diseases or conditions. We want people to compete to do that better and better.

But as we looked at the U.S. system, we found that there's actually almost no competition at that level. Instead, we see a lot of competition among provider networks, whether they consist of hospitals or doctors or both, to assemble bargaining power so they can strike a better deal for themselves. But that kind of cost-shifting or bargaining-power competition doesn't create health care value. In many ways, it destroys value because it injects massive administrative costs and complexity. The kind of competition that drives value creation isn't really occurring.

Is there a particular villain?

We don't think there is any one entity that has made the fatal decisions that have caused the system to be the way it is. Indeed, there was a set of incentives created partly by government regulation and partly by history. They have led each actor in the system to behave in ways that were rational for them but were not aligned with creating health care value.

For example, if hospitals have to bargain with health plans and health plans are pushing them really hard to drive down their prices and offer greater discounts in return for a flow of patients, you can see why hospitals would naturally want to form larger groups so that they have more bargaining power. That's natural reaction. It's not evil. But that has exacerbated the problem of lack of competition.

Has consolidation affected the quality of care?

One of the things we find over and over again is that hospital groups don't want leakage, which is the word they use, of patients going outside their provider group. When primary care physicians are going to refer a patient to a specialist, they often get penalized for referring that patient to a provider who is not part of the group.

I thought it was the insurers that made decisions about where you receive a medical service.

In the early stages of managed care, the health plans were often the gatekeepers. But there's been so much outcry against that that many of those restrictions have lapsed. Now, the more important restriction is on the provider side. They're trying to capture a patient and keep them in their network. That's rational for them. But it's ultimately not creating health care value because it tends to bias who you get treated by, and it eliminates the providers' incentive to get better and better at whatever they do.

Employers seem to be shifting some of the cost burden to their employees, right?

Right, Employers, because of our tax system, have been the principal funding mechanism for health insurance. We believe very strongly that employers for the foreseeable future are going to be big players. So our focus is on how we can make employers do a better job as the purchasers of health care services.

What should employers be doing differently?

Employers have made a lot of fundamental mistakes. They buy health care services as a commodity, by and large ignoring the issues of quality and value. They insist on signing up the health plan that gives them the best deal and then kind of holding their hands over their eyes and not paying any attention to what happens next. Now, they're beginning to understand that that created zero-sum competition. They may get a lower price this year from the health plan but next year their premiums are going to rise dramatically.

Will shifting costs to employees solve the problem?

It used to be that employees might pay 5 percent of their health care costs. Now they're being asked in some cases to pay 25 to 30 percent. But that is not improving value. That is not driving improvements in efficiency or quality. That's just cost-shifting--and no amount of cost-shifting is going to make a single bit of impact.

Can anything be done to fix the system?

We've got to break out of this zero-sum, cost-shifting competition into a positive-sum, value-creating competition. To do that, every actor in the system is going to have to behave differently and understand what their true long-term interest is.

So the system isn't delivering enough quality?

It's not built around quality. It also doesn't really care about costs. The system is not designed to reward the most efficient providers. All providers get the same price. The health plans don't even know what the true costs are. They don't even care.

I've had some stunning discussions with provider groups and physician groups and various kinds of specialized teams at hospitals. Ironically, even the providers don't know their costs. They might sorta, kinda know, but they don't look at costs in the right way, which is to look at total life-cycle costs. How much does it cost to have the initial diagnosis? How much does the presurgical visit cost, assuming we're talking about surgery? How much does it cost to be in a hospital? How much does it cost to do the rehab? How much does it cost to have the repeat visit? That's the total life cycle.

How would it help if we knew all of those costs?

For example, I was recently with a group of physicians who practiced in the spine area. They said they'd learned that doubling the amount of time they spend with each patient on physical therapy has a dramatic payoff. That's an example of how you spend more on one category of cost to dramatically lower other categories of cost.

That kind of thinking doesn't typically occur in the health sector. Indeed, there is a shocking sense that people don't know what their outcomes are. They don't measure them. As a result, the providers are trying to cure people and do good things, but nobody is behaving in a way that would reflect a deep concern with either cost or quality.

You also think the system ought to be geared more toward preventing disease than treating illness?

That's absolutely true. Right now, there is little true focus on that. There's a bit of lip service to it, and there's a lot of talk about anti-smoking and fitness and keeping your weight down.

Is it a problem that insurance companies don't want to pay for diagnostic tests?

The problem is that we've not set up diagnosis as a business. I'd love to know who is the best at diagnosing in a particular field. And I'd like to know whether the doctors ordering more tests are better at getting the diagnosis right than the ones who order fewer tests.

Can that data be obtained?

It absolutely can be had, but not without some changes in perspective and perhaps in government regulation. Right now, the assumption is that all doctors are equally good in diagnosis. But they aren't. We also don't know whether the tests are value-creating. So individual practitioners are making their own choices about what to do. There's no measurement of their success, or lack of success. The system is essentially flying blind.

Do the reform proposals by either President Bush or Sen. John Kerry address the heart of the problem?

No, the proposals have to do almost exclusively with who pays. It's an issue of cost-shifting and how much government resources we're willing to pour into the system. There is very little I see that gets at value and driving improvements in value.

No one is really in charge of the total system. How can all the various players be forced to change?

Most of the participants in the system can voluntarily move in the direction we advocate. They don't need to be forced. I've been stunned by how many of these entities write to me say, "We're starting to move in this direction. Let's talk about how we might work with you to do that." This is a good moment, in a sense, because most of the entities in the system are quite convinced that something significant needs to change.

So you're actually optimistic?

I find myself--and this is probably a disease I have--quite optimistic. Things have gotten bad enough and people have tried all the simple things, and they haven't worked. I think most people are now stepping back and saying, "My God, we've got to rethink this whole system."