Futurist Predicts Less Margin, More Consolidation in Market

Healthcare CEOS preparing for three big trends

CEO SUMMARY: Based on interviews with 40 CEOs of major healthcare companies, one expert says that the next three years will bring major changes to healthcare. In his presentation at the Executive War College, Ted Schwab noted that these changes include a swift adoption of budgeted care (and not value-based care), more consolidation that creates behemoth health systems, and a shift from a vertical business model to a horizontal business model. For labs, he predicts that this consolidation will reduce the number of customers.

PREDICTING HEALTHCARE’S FUTURE is what Ted Schwab does for a living. He’s a partner with Strategy& (formerly Booz and Company), a global consulting firm now associated with PwC.

Schwab recently interviewed 40 CEOs of big hospital corporations, physician groups, and delivery systems. His goal was to find out what these CEOs expected to happen in healthcare over the next three years.

What Schwab learned from these interviews was radically different from the expectations he had about future events. “During my interviews with these 40 senior executives, I learned that these individuals see the future in ways that are quite different than the assumptions most of us hold today,” he said. “This alone was significant, because these executives are my clients and I already knew much about their businesses!”

 Predicting Coming Changes

Schwab made that comment during his presentation in April at THE DARK REPORT’S Executive War College in New Orleans. He provided lab executives and pathologists in the audience with an intriguing range of insights about how these 40 healthcare CEOs are preparing to deal with the changes unfolding today in the American healthcare system.

There were 10 key predictions that emerged from these interviews. Schwab chose to emphasize three predictions as the most important. “First, like most of you, I’ve been talking about value-based care for a long time,” he explained. “That’s no longer true for these CEOs. They have moved beyond value-based care and are now preparing their healthcare organizations to deal with budgeted care.

“The second really important change is consolidation,” continued Schwab. “During my interviews with the CEOs, they talked about the massive consolidation that’s coming in the next three years. You think HCA is big? You think Tenet is big? Wait until you see what’s about to happen in the next three years as not-for-profit health systems come together. That development has major implications for your laboratories, since your customers just went from many to one.

“The third significant change is the shift from a healthcare organization organized around a vertical business model to a business model that is horizontal,” he continued. “Today, these CEO’s are in a vertical business: the hospital business, the insurance business, the doctor business. And how do you run a vertical business? You optimize. You build a bureaucracy, you have redundancy. It is command and control.

“That all changes in the next few years,” stated Schwab. “The business they will be in—the business to which they are migrating—is a horizontal business. It is about partnerships. It is about joint ventures. I look at some of my clients, and they have no idea how to do this.

Horizontal Business Structure

“We all know that a horizontal business has a radically different management structure,” he added. “Plus, this business model requires very different strategies and governance. Moreover, this is a system that won’t be designed by government or commercial health insurers. It is a system that is designed by consumers.”

Schwab encouraged the audience to see these three big changes in terms of: 1) economic transformation (budget-based care); 2) clinical transformation (“where clinical labs play every day,” noted Schwab); and, 3) the transformation of the organization into one anchored by partnerships, joint ventures, and network management.

The next bombshell that Schwab dropped on the audience was the prediction, that, as of January 1, 2017, the profit margin in healthcare disappears.

Affordable Care Act

“On that day, health insurance incentives in the Affordable Care Act will lead small businesses to flip into the public exchanges,” he said. “Remember all the hubbub that resulted last December from the cancellation of individual policies that forced these individuals to move to the public exchanges? On January 1, 2017, a much greater number of people with coverage from small businesses will be shifted into the public exchanges.

“This single development is huge because, when it happens in 2017, all the money—all the profit margin for providers—disappears!” stated Schwab. “Let me share an example with you.

“Recently I did a study for a client,” he said. “This big delivery system wanted to know where its operating profit margin comes from.

“Does it come from Medicare? Does it come from Medicaid? Does it come from the individual market? Does it come from the large market?” he asked. “The answer was unexpected and a surprise to everyone.

“For this client, more than 250% of their margin came from the small group business market!” stated Schwab. “That’s because, at best, Medicare, Medicaid, large group commercial, and individual lines of business generate no margin or negative margin.

“It is the excessive profitability of small group business that generates margin,” he said. “Yet, this margin disappears January 1, 2017, when small business health benefits shift to the public exchanges.”

Schwab related this expected loss of margin to the change in reimbursement. “What this means for my clients—and for clinical labs—is that we are entering the era of budgeted care.

“The 40 CEOs I interviewed no longer talk about value-based care; now they speak of budgeted care,” he noted. “This means healthcare systems are beginning to internalize all the workings of financial and clinical risk.

“So, if you don’t think that your piece of the pie will become budgeted, think again—and that includes lab testing services,” stated Schwab. “The risk element means, as one executive I interviewed put it, ‘Everybody’s an insurance company now.’”

The transition to budgeted care and the need to assume and manage risk are factors fueling the coming surge of consolidations among hospitals, physicians, and other providers. “This is also what fuels the creation of accountable care organizations,” noted Schwab.

Coming Soon: 1,000 ACOs

“Today, more than 50% of the population lives in a geography served by the 500 ACOs that currently exist,” he said. “However, in just three years, there will be 1,000 ACOs.

“So if your customers include ACOs, your market has doubled from 500 to 1,000 potential customers,” he noted. “However, due to consolidation, in 10 years there will be just 50 ACOs.

“The market will grow from 500 to 1,000, then shrink to about 50 within 10 years,” predicted Schwab. “Thus, even as a huge explosion in these networks happens, the shakeout and consolidation will be quick.

“So, what does that mean to you?” he asked. “It means your lab better pick the right partner. Some of these ACOs are going to lose massive amounts of money, even as other ACOs are going to control wide swaths of geography. Those 50 surviving organizations will be huge and my advice is to pick as partners those organizations that have figured out what they are doing and how to be one of those survivors.”

Schwab called attention to the erosion of profit margins happening in healthcare. “The single most important thing I will discuss today is the great profit margin shift that we see in healthcare,” declared Schwab. “Margin is important because it triggers the formation of capital. And until recently, most of the margin and most of the capital in the American healthcare system came from hospitals and the growth of inpatient services.

“This enabled hospitals to form capital and that allowed them to go to the bond market,” he explained. “However, for those of you following the bond ratings of the big delivery systems, you’ve seen many of their ratings fall dramatically.

“Their bond ratings are degrading because they invested their capital into bricks and mortar,” explained Schwab. “Today, bond companies point out that hospitals are losing money on those bricks-and-mortar investments.

“And here’s a big prediction. It came from the survey of CEOs; not from me,” he emphasized. “Within three years, one of the biggest health care systems in the United States will fail. It will fail financially because it will have gotten too big and too financially unstable to refinance its debt in the bond market.

Shift to Budgeted Care

“This will be a consequence of the shift to budgeted care and the shift in margins,” continued Schwab. “You will see this organization (which was not identified by the CEOs)—and others like it—investing in the new healthcare business on the backs of an old business that no longer has margin. This will contribute to the financial turmoil within healthcare that triggers more consolidations and bankruptcies of major healthcare organizations.”

Next, Schwab addressed the coming change in healthcare leadership and a growing role for clinicians in management and administration. “My clients talked to me about what they call the new force of leadership,” he said.

“Here’s an interesting statistic: in the next five years, 50% of the CEOs of hospitals, provider organizations, and insurance companies in the United States will reach retirement age,” noted Schwab. “You’ll see administrators and executives hoping to just hang on for the next two to three years to make it to the retirement finish line.

“Following them is a new generation of leaders of hospitals and healthcare organizations that talks a different language,” he said. “These leaders are powerful and they use terms like ‘radical change.’ As the current generation retires, you will see this new and more forceful leadership put more emphasis on clinical services.

More Power to Clinicians

“These new leaders are thinking about new forms of clinical partnerships,” he said. “They think it makes sense to turn the industry over to clinicians and those who support clinicians.”

As he prepared to conclude his remarks, Schwab identified three questions that lab executives and pathologists should answer as part of their strategic planning. “Question number one is how do you play in a multi-chain healthcare world?” he asked.

“Number two, as the horizontal business model becomes dominant, do you compete or do you partner?” he asked. “Question number three is: Will your clinical lab or pathology organization have the speed to market and the speed of change that is essential to survive and prosper in an era of budgeted care and horizontal healthcare organizations?

Partner for Now & Future

“All of these trends are background for pathologists and clinical laboratory directors who are trying to decide how to proceed and how to choose an appropriate partner for now and in the future,” concluded Schwab. “That’s because the lines between various segments of the industry are blurring.”

Another element of healthcare’s transformation that Schwab uncovered during his interview with the 40 healthcare CEOs is what he describes as “Culture continues to eat strategy for lunch.” Schwab said that “healthcare leaders are increasingly concerned about how change is affecting their corporate culture. Phrases like ‘change fatigue,’ ‘initiative overload,’ and ‘organizational stress testing’ crept into the interviews, showing a clear concern with both the scale and speed of transformation.”

This is a significant finding with profound implications for pathologists and lab administrators. It is widely-recognized that medical laboratory scientists value stability and constancy and consider change to be highly disruptive. Schwab wrote that change-fatigue is why CEOs “are keenly focused on managing their cultures. They are addressing change overload by retooling into teams built around patients. …flexibility and focus will be keys to success.”

Lab managers and pathologists would be wise to concentrate efforts within their labs and pathology groups to help staff accept and adapt to the new reality of constant change.

Healthcare’s Rationalization Will Include Shift From Fragmented Care to Integrated Care

HEALTHCARE WILL UNDERGO MUCH RATIONALIZATION IN THE COMING YEARS. “Every ACO will go through a natural progression from fragmented care to clinical and financial integration,” observed Ted Schwab, partner at Strategy&.

“Provider organizations will take a more rational approach to healthcare and, as they do, redundancy will be eliminated,” he commented. “For example, does Indianapolis really need five heart hospitals? Does Dallas need seven oncology centers? Probably not. Redundancy in our healthcare system is going to come to a rather swift end.

“Part of this process will cause healthcare administrators to consider that, in the process of rationalization, they need to achieve clinical integration,” said Schwab. “Think about the difference between rationalization and integration.

“Rationalization says: ‘I have too much of something, so I am going to close it,’’’ he continued. “I will then bring things together by consolidation while using my ability to achieve scale in ways that increase my margins. Compared to rationalization, integration is very different.

Rationalization of Services

“Here’s an example that shows the difference between rationalization and integration,” he stated. “Last year, one of the largest delivery systems in the United States recognized that it needed to change. Two years ago, it made almost $1 billion in profit. Last year, it lost $100 million. To respond to this new reality, it adopted strategies for clinical integration but not rationalization.”

Schwab described how this health system revamped a still-booming oncology business. “Pathologists and lab directors know how oncology has transformed in recent years,” he said. “Oncology has gone from being an inpatient-focused business— where hospitalized patients received extensive care, including radiation therapy and chemotherapy—to where it is now becoming almost like primary care. The goal today is to keep patients out of the hospital.

Horizontal Integration

“This large and now-profitable oncology business worked hard to become a horizontally integrated business,” said Schwab. “That’s the difference between integration and rationalization. Rationalization is the elimination of redundancies, the cutting of services. By contrast, integration involves radically changing services into a new model of care delivery that is horizontal.

“You a see a similar integration happening with physicians,” he observed. “Today, fewer physicians go to hospitals. For example, most primary care physicians haven’t gone into hospitals for years. Cardiologists don’t go into hospitals as much anymore. Even ob-gyns don’t practice in hospitals as they formerly did.

“Instead, physicians are transforming hospitals into what Harvard Business School Professor Regina Herzlinger calls focused factories,” noted Schwab. “These are smaller shops that specialize in delivering specific kinds of healthcare. Soon, we will see many focused factories being launched within the healthcare system.”

 

Democratization of Care, Rise of the ‘New Patient’ and How it Relates to Kaiser Permanente’s ‘Thrive’

CONSUMERS WILL HAVE PLENTY OF INFLUENCE in how healthcare is organized and delivered. Futurists such as Ted Schwab, a partner at the consulting firm of Strategy&, consider patient engagement to be a significant trend.

“Larger numbers of patients are moving into health insurance programs that require substantial annual deductibles and out-of- pocket requirements,” noted Schwab. “At the same time, efforts that increase transparency will make it easier for these patients to shop for providers based on price and quality.

“A client described this to me as the ‘democratization of healthcare,’” he said. “This is an excellent term and aptly describes how the influence of patients and consumers will become a major driver in defining the quality of clinical services delivered by hospitals, physicians, labs, and other types of providers.”

Schwab then described how Kaiser Permanente was tapping the power of this trend. “While conducting market studies, Kaiser did not speak to its physicians. Nor did it speak to its hospitals or its insurance arm,” stated Schwab. “Rather, it went out to this new ‘democracy of healthcare.’ It talked to consumers and patients and asked them:

‘What do you want to do? What do you want to be?’ The answers that came back were: ‘I want to live. I want to live well. I want to thrive!

“These findings sent Kaiser off in a very interesting direction,” he explained. “It caused this organization to discuss the concept of the ‘free labor of healthcare.’

‘Free Labor Of Healthcare’

“This is a term that I love,” continued Schwab. “Kaiser defines it as all the things that happen among family and friends when no healthcare professionals are around. Think of when, in the middle of the night, a mother deals with her child’s earache. Or when an adult goes to his/her father’s bedside to help with hospice care. Another example is when a neighbor picks somebody up off of the ice who slipped and takes him or her to the emergency room.

“This has triggered a change in strategy,” concluded Schwab. “People at Kaiser have begun to ask how they can engage this type of family contribution within the overall care continuum. I find this fascinating and the organization’s first step down this path was the ‘Thrive’ campaign. In this regard, Kaiser is moving in a very different direction than most healthcare organizations.”

 

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