Although managed care is an established force in the private sector, there is growing interest and experimentation with this concept in the public sector. This interest has been generated by the increased demand for services, the shrinking resource base due to cutbacks in state budgets, and the fragmentation of care that has accompanied the shift from a centralized, hospital-based model to a decentralized, community-based model for treating individuals with serious mental illness. But despite this interest, no consensus exists about the form or functions of managed care in the public arena. Simply importing private-sector versions of managed care is inadequate given the substantial differences in the patient population and service delivery mechanisms. The authors present a functional analysis of managed care in the public sector. Drawing on their conceptualization of managed care, they outline a functional approach to evaluating the strengths and weaknesses of treatment systems, innovations such as privatization and capitation, and recent health care reform proposals.