A Hostage Situation in Pittsburgh?

29 December 2008 at 10:26 pm 1 comment

| David Gerard |

upmc4I would like to thank Peter for inviting me to guest blog, as I have been a fan of Organizations & Markets for some time. I spent the better part of the past year developing courses that emphasized organizations, entrepreneurship, and innovation. O&M has been an invaluable resource, whether to “borrow” slides from Richard Langlois,  or to get ideas for classroom topics.

I am writing from the “Steel City” of Pittsburgh, though the steel industry has largely fled the region. For evidence of that we need to look no further than our skyline (which we can now see because there is less smog), where the University of Pittsburgh Medical Center’s UPMC logo is now emblazoned atop the US Steel Tower. Health care accounts for about 15% of the region’s workforce.

Aside from being a case-study in post-industrialization, UPMC is also an interesting point of departure for exploration of some fundamental organizational questions.  One that leaps to mind: Are non-profits where the real money is? Last year, UPMC generated $6 billion in revenue and cleared more than $600 million in “non-profit.”

A more traditional organizations question is the question of organization boundaries, and the tortured negotiations between UPMC and Highmark illustrate concepts such as transaction costs (hint for the exam: if it takes 3+ years to strike a deal, transaction costs may be high), vertical integration versus arm’s-length contracting, market power, bilateral dependency, credible commitment, and the hostage model. Indeed, the linchpin of the deal was Highmark kicking in for the construction of the new Children’s Hospital:

Highmark and UPMC have had a good working relationship since 2002, when the two companies signed a landmark 10-year deal. UPMC won a contract with its best customer, and hundreds of millions in loans and grants from Highmark so UPMC could build a new Children’s Hospital in Lawrenceville. Highmark, meanwhile, was guaranteed access to the wide UPMC network for a decade.

Having students explain why Highmark built a hospital rather than simply writing a check turned out to be a pretty good exam question.

The Pittsburgh Post Gazette ran a nice five-part series on the growth of UPMC growth and its phenomenal role in medical innovation. Despite the is long-term agreement, UPMC and Highmark are at odds over a proposed merger between Highmark and Independence Blue Cross. The federal authorities granted antitrust clearance, but Pennsylvania regulators won’t rule on the matter until next month. The state’s hesitation to give the green light gave Senator Specter and federal regulators time to reexamine the matter, and this might be a case to follow to see how the new Administration exercises its antitrust authority.

Entry filed under: Former Guest Bloggers, Teaching, Theory of the Firm.

Introducing Guest Blogger David Gerard Krugman’s Got the Disease

1 Comment Add your own

  • 1. John Kitzmiller  |  31 December 2008 at 5:15 pm

    Interesting that Dr. Detre had to fight for state funding in the early 70’s because the state Legislature didn’t see the benefit of WPIC, but WPIC became the model and foundation for such phenomenal growth as reflected in UPMC. The regional impact is staggering, $200 million annual construction, and 80k +jobs up and over direct employment. That is state funding well spent. Or not well spent as may or may not be the case.

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