McKinsey Predicts Most Hospitals Must Specialize to Survive

Labs and Pathology Groups To Be Affected

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CEO SUMMARY: Imagine a healthcare system where successful hospitals specialize in particular clinical services, treat patients like customers at a Ritz Carlton Hotel, and have close clinical and financial collaborations with top-performing physicians. This is the American healthcare system of the 21st century, as envisioned by healthcare strategists at McKinsey & Company, one of the world’s premier business consultancies. McKinsey’s insights provide pathologists and lab directors with an early perspective on the major strategic changes now transforming healthcare in America.

IF HEALTHCARE STRATEGISTS at global consultants McKinsey & Co. are correct, the era of the all-service, acute care hospital is ending. In its place will be a healthcare system dominated by specialist hospitals which are organized to be both consumer-friendly and price competitive.

This prediction lies at the heart of a newly-published study by McKinsey consultants Kurt D. Grote, Edward H. Levine, and Paul D. Mango. Titled “U.S Hospitals in the 21st Century,” the study was released a few weeks ago. While acknowledging that U.S. hospitals “were once a hallmark of 20th-Century achievement,” the authors argue that economic pressure, the emergence of more focused alternative sites of care, and value-conscious consumers will bring about a swift decline in the pre- eminence of the general, acute care hospital business model that dominates today’s healthcare system.

Think More Like Retailers

For today’s hospitals to survive and thrive in the 21st century, the study’s authors predict that “many hospitals will have to re-organize around a narrower range of clinical activity, differentiate themselves on quality and service, think more like the retailers they are fast-becoming, and overhaul their relationships with physicians.”

Laboratory administrators and pathologists should pay close attention to the predictions outlined in the McKinsey study. These strategic insights are at the core of the advice McKinsey is giving to the nation’s biggest healthcare corporations and organizations. DARK REPORT briefings like these give our clients and regular readers access to the same strategic business thinking that multi-billion-dollar healthcare organizations are using to craft their own business priorities.

THE DARK REPORT considers it significant that McKinsey endorses the view that successful hospitals in this century will need to “overhaul” their relationships with physicians and organize themselves around a smaller range of specialty services. These changes will fundamentally alter the way hospital-based laboratories interact with, and serve, client physicians in inpatient, outpatient and outreach settings. In a similar way, these changes will also alter long- standing clinical and business relationships that local pathology groups have maintained with hospitals and office-based physicians in the community.

Why Hospitals Will Change

For these reasons, senior laboratory leaders and pathologists who want to protect the competitive position of their laboratories and group practices need to under- stand why McKinsey predicts that successful hospitals will have a more limited clinical service menu and be good at competing for customers.

Authors of the study note that, during the last century, American hospitals gained their dominance by achieving vertical integration and economies of scale. They combined pharmacies, imaging departments, laboratories, and emergency rooms. They used professional nursing and aseptic procedures to deliver high-quality medical treatment. Hospitals also offered physicians a more productive practice environment than going “door-to-door.”

Hospitals Are “Price Takers”

This success formed the foundation of today’s problems. The study states that “Little noticed were the seeds of future problems. Hospitals never really had to depend on their most direct customers— patients—for revenue. The generosity of philanthropists and volunteers, the rise of employer-sponsored insurance in the 1930s and 1940s, and the emergence of government-sponsored insurance in the 1960s all insulated hospitals from the need to compete for patients. Today, hospitals are ‘price takers’ for nearly 50% of their revenues, which is subject to the political whims of the federal and state governments. Hospitals are also required to see, evaluate, and treat virtually any patient who shows up, solvent or not.”

THE DARK REPORT considers the characterization of hospitals as “price takers” to be a significant point. Every business or enterprise, including hospitals, laboratories, and pathology groups, must be able to compete for customers by offering added value at a price that will produce a net profit over the cost of the product or service. McKinsey is observing that hospitals, in the current healthcare financing scheme, must serve a large proportion of patients at either an inadequate price, or no price at all (for uninsured and indigent patients).

Hospitals Are Vulnerable

That is why the McKinsey study authors argue that the current business model of the American hospital is vulnerable, stating that “these structural weaknesses have created openings for more focused providers that increasingly offer superior value: lower prices, higher quality, and better service. Stand-alone ambulatory service centers (ASCs), diagnostic imaging centers, endoscopy suites, and specialty hospitals have become powerful competitors. More are surely on the way as equity markets (both public and private) and physicians themselves pour capital into that sector.

“At the same time,” continues the study, “payers and consumers are becoming much better at recognizing and acting on price and value differences. Patients have much more at stake with the advent of high-deductible health plans.”

The telling observation is this: “Knowledgeable, value-conscious
patients are beginning to view some hospitals as less effective places to seek care compared with many of their alternatives, including physicians’ offices.” This is a point THE DARK REPORT has repeatedly stressed to laboratory administrators and pathologists. Growing numbers of consumers are actively seeking the highest-quality provider and, where possible, they will avoid their local hospital and choose care that’s provided in non-hospital settings.

Financial Viability

These trends are already at work reshaping the American hospital system and undermining the financial viability of the community hospital business model. Pathologists should take careful note of this fact, since they have an ongoing clinical partnership with the hospital. As hospital-based physicians, the majority of pathologists are almost totally reliant on their local hospital remaining clinically relevant and financially viable. Anything that causes fundamental change in today’s hospital business model will have significant effects—both clinically and financially.

20th Century Hospital

Authors of the McKinsey study have important things to say on this subject. As noted earlier, the 20th century hospital model made physicians more productive, because, as they write, “hospitals put a great deal of capital at their [physicians’] disposal. Yet hospitals didn’t enforce standardized and efficient approaches to the delivery of care. At many hospitals today, doctors still bear only limited economic responsibility for the care decisions they make. Little wonder that it is often they [physicians] who introduce expensive—and sometimes excessive—non- reimbursable technologies or that hospitals not only suffer from declining margins, but are also performing less well [financially] than other players in the healthcare value chain.”

Because today’s healthcare buyers, both payers and patients, are increasingly interested in selecting hospitals and physicians based on quality of service, the pressure on hospitals to respond to this service demand will grow steadily. As the authors declare, “Hospitals can’t respond to this shifting competitive and consumer landscape without tackling the underlying structural issues. A vital first step is to compete on the basis of strengths in specific clinical service lines rather than relying on the power of full integration.

Rationalize Activities

“In areas such as cardiology, neurosciences, and oncology,” continues the study, “it’s impossible to sustain excellence with just a few patients a day, so all but the largest hospitals will need to rationalize their activities and become more focused: only with a critical mass of patients for individual service lines will they achieve competitive quality at a reasonable cost. Several large payers are already nudging hospitals in this direction by adopting a ‘center of excellence’ approach, which allows these payers to inform patients about (and reward them for using) preferred institutions.”

This is why the general, acute care hospital is confronting market forces which encourage clinical specialization and customer-friendly services. McKinsey’s recommendations to hospitals and physicians are simple. Instead of relying on a fully-integrated healthcare institution to sustain and expand existing market share, hospitals will need to develop specialized clinical expertise. The emergence of a new generation of women’s hospitals in recent years is one sign of this trend, as is the growth of heart hospitals and hospitals organized specifically to serve only cancer patients.

“…since different patients want different types of improved services (such as private rooms, catered meals, and more attentive nursing), hospitals must understand what customers want and how they want it.”

The consequences of failure to accomplish this may be severe, as the McKinsey view is that “hospitals that resist organizing around a narrow set of clinical services will probably enter a downward performance spiral as they experience greater difficulty recruiting top physicians, paying for the best specialty-service and equipment providers, exploiting economies of scale, and implementing best practices consistently. But hospitals that do these things well will also capture direct financial value from the quality improvements.”

Laboratory administrators and pathologists should take note that the study’s authors are describing a more intimate clinical and operational relationship between physicians and hospitals than has been true to date. First, hospitals must offer patients and payers the highest quality clinical outcomes possible. That can only be accomplished by aligning with top-performing specialist physicians.

Well-Run Facility

For example, this implies that hospitals that specialize in obstetrics and women’s health will need to attract the best ob-gyns in the community. They can only do that by offering top-performing ob-gyns a state-of-the-art facility that is fully staffed and extraordinarily well-run. Currently few hospitals in the United States would meet that complete definition.

Second, hospitals must provide a customer-friendly experience for patients. The McKinsey healthcare consultants are specific in the picture they paint, writing that, as “hospitals become more focused and their patients more value focused, they will start to resemble companies in other competitive service industries. Like cutting-edge retailers, they must identify the characteristics of the patients they can best serve and attract those people by creating specific value propositions. Indeed, since different patients want different types of improved services (such as private rooms, catered meals, and more attentive nursing), hospitals must understand what customers want and how they want it.”

Frontline Tasks

“Along with players in many other competitive service industries, hospitals are likely to find that a key source of differentiation is the consistent execution of frontline tasks, such as adhering to clinical protocols, maintaining efficient patient flows, administering drugs safely, and coordinating disparate activities effectively.”

There is no question that this will challenge the existing mindset of most hospital and health system administrators. “The importance of execution will extend beyond clinical activities,” states the study. “Hospitals that can’t or won’t quote prices before delivering service will drive away selective, value-conscious consumers. Hospitals with weak skills and systems for extending credit or making collections at the point of service may have higher bad debts. Better execution will require drastic behavioral changes from physicians, nurses, administrative personnel—and senior executives, whose jobs are becoming more complex. Better training, performance metrics, and compensation structures will all be needed to help hospitals change.”

Of course, for hospitals to succeed in this strategic transformation, they will need a different relationship with physicians. The study addresses this particular point by saying “Given the central role of physicians in operational and resource allocation decisions, it will be difficult to effect change without building a much stronger cultural and economic alignment between physicians and hospitals. For many physicians—particularly clinical specialists in the service lines where hospitals hope to differentiate themselves—the traditional arm’s-length and more recent competitive relationships must give way to some sort of formal employment or gain-sharing schemes such as joint ownership of equipment or even whole facilities.”

Quality, Service, And Prices

At this point, the McKinsey consultants turn to the need for physicians to change if the new hospital business model is to succeed. “Furthermore, performance criteria for physicians must shift,” notes the study. “In a world in which transparent quality, service, and prices help patients choose places to seek treatment, metrics such as admissions volumes will become less relevant. The more important considerations will include a physician’s adherence to well-established standards of medical practice, willingness to embrace teamwork, and bedside manner, as well as a selection of services and equipment that strikes the right balance between cost and performance.”

McKinsey’s message to physicians, including pathologists, is unmistakable. Three attributes are likely to separate physician-winners from physician-losers. First is the ability to consistently follow established clinical protocols. Second is to serve patients like retail businesses serve customers. Third is to provide clinical services in a cost-effective manner.

It’s going to be a healthcare environment where successful physicians are team players and both hospitals and physicians recognize the need to meet and exceed the expectations of patients
as customers. The transition to this type of healthcare system is likely to be highly stressful for hospitals, pathologists, and the clinical laboratory staff.

Since any hospital that moves to develop a clinical specialty, like orthopedics or cardiology, will rely on specialist physicians to provide these clinical services, they will need to interact more effectively with such physicians to achieve the goals of a patient-friendly institution with a published track record of superior clinical outcomes. Not every hospital administrator will find it easy to make the mental shift from the old paradigm to this newer, as yet-to-be defined paradigm.

There is another dynamic that needs to figure in the strategic planning of pathologist business leaders and laboratory administrators. The McKinsey & Co. study describes a healthcare marketplace organized around consumer choice, price competition, and the need to demonstrate value to build and retain market share.

The McKinsey & Co. study describes a healthcare marketplace organized around consumer choice, price competition, and the need to demonstrate value to build and retain market-share.

Thus, over the next five years, in many clinical areas, office-based physicians will have an incentive to develop services which allow patients to bypass a visit to the hospital, while providing these patients with better services and a higher outcome per healthcare encounter. It is likely to be a healthcare marketplace where regional, consolidated primary care and specialist supergroups will have the necessary capital, a critical mass of patients, and the economic incentive to compete more directly with their local hospitals.

All of this means it will be a con- fusing healthcare market in the coming years. Office-based specialists are likely to be approached by hospitals seeking closer collaboration. At the same time, larger specialist groups will have clinical opportunities that they can develop independently of hospitals and which have the potential to generate ample revenue.

Transition Will Take Time

For both hospital-based laboratories and pathology group practices, the consequences of McKinsey’s predictions point to a radical change from today’s status quo. Yet the transition should take enough time for savvy pathologists and laboratory directors to keep their organizations positioned as effective providers, whether the patient is served as an inpatient, outpatient, or in the outreach marketplace.

In fact, many hospital laboratories have been doing just this by creating a laboratory outreach testing program. Having a presence in the outreach market means that these hospital-based laboratories can compete for the specimens generated by patients who are not coming to any of the hospital’s facilities.

Frequently the laggards are the pathology groups embedded in the same hospital. Too often they are slow to take advantage of the hospital’s laboratory outreach program by creating a comparable outreach program with specialized anatomic pathology sales and marketing. More pathology groups will need to adopt a pro-active stance toward outreach and outpatient services to successfully make the coming transition in the American healthcare system.

Watch Bad Debt Ratios Climb at Nation’s Hospitals

MUCH HAS BEEN WRITTEN in THE DARK REPORT about how the growing acceptance of consumer-directed health plans (CDHPs) is already triggering significant changes. Hospitals will be first to feel the major impact of these changes.

One prediction that McKinsey & Co. has made about the long-term effects of the CDHP trend is that the bad debt ratio of hospitals will increase. The source of this increased bad debt will be from insured patients—enrolled in CDHPs with high deductibles—who are either unwilling or unable to pay their hospital bill. This is a change from past years, when most bad debt originated from uninsured patients.

THE DARK REPORT recommends that pathologists and laboratory administrators look for published figures for hospital bad debt, by state and nationally, when the year-end financial performance of the hospital industry is evaluated at the end of this calendar year. The number of individuals enrolled in CDHPs exploded during the past 18 months and it is likely that hospitals are beginning to see their bad debt ratios climb from that category of patients.


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