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How big is big enough to effectively compete? Can excess growth hurt strategy? These are questions every CEO faces. They become especially pertinent when industries are undergoing rapid consolidation and reorganization. Arguably nowhere is such a change happening more than in US healthcare today.

Health systems are aggressively shopping for primary care providers. In 2012 40% of primary care physicians were hospital or health system employed, up from 20% in 2004.[1] Health systems want to secure the referral stream, reap the benefits of larger market share, and position themselves to take population risk. At the same time, many health systems are exploring becoming a health plan. In 2012, roughly 20% of health networks marketed an insurance product, with another 20% exploring doing so.[2] It is unclear how successful health systems will be with their primary care acquisitions or their forays into insurance. Many factors will determine the ultimate results. However, as incumbents reorganize the healthcare value chain it may be instructive to keep three concepts in mind:

  1. Health plan services greatly benefit from economies of scale.

  2. Hospital care, particularly procedural medicine, benefit from standardization and specialization.

  3. Primary care benefits from localization and personalization.

Winners will take full advantage of these three different, and at times seemingly contradictory, dynamics.

Health insurance, go big or go home

Many industries exhibit at least some economies of scale. A scale economy is created when the average cost to bring a product to market decreases as total production volume increases. There are many types of economies of scale. Top among them are the spreading of fixed costs over more revenue, the specialization of labor and IT systems, the ability to negotiate better input prices from suppliers, and the ability to raise prices charged to consumers. Within healthcare, insurance companies in particular reap tremendous economies of scale. For example, large insurers can:

  • Negotiate better pricing from providers and drug manufactures,

  • Automate claims processing and administrative services,

  • Build organizational expertise for specialized insurance tasks,

  • Run large scale, multi-modal marketing campaigns,

  • Invest in regulatory compliance expertise and infrastructure, and

  • Pool risk from a larger claims base.

These scale economies contributed to the massive consolidation of the US health insurance market. In 2001, nearly half of the major insurance markets were “highly concentrated,” i.e., there was little competition. By 2008, this number rose to 94%.[3] Today, the top 10 health plans in the US account for 56% of insured lives.[4] Not surprisingly, consolidation created certain operational efficiencies. In 2002, 71% of claims were processed within 14 days of receipt. By 2011 this number rose to 93%.[5] The consolidation helped keep overall health plan fee increases for Administrative Services Only (ASO) at less than 5% annually between 2002 and 2012. Total group medical spend never grew less than 9% a year over the same period.[6] (One would expect administrative costs to rise roughly alongside claims cost; hence this slower increase in administrative costs demonstrates at least some scale economy.) On the marketing side plans have built national brands, constructed online broker management tools, and created de novo direct­-to-consumer shopping experiences. Each of these is a scalable fixed cost. Finally, through concentrating market power, payers were able to negotiate aggressively with providers on the unit price for care services despite concurrent provider consolidation. To illustrate, in 2011 researchers at the RAND institute found hospital costs were 12% cheaper in areas where health plans has less competition.[7] Net net, while skill and agility matter in insurance like any other industry, scale seems to matter quite a bit.

Hospital care, where focus trumps size

Economies of scale exist in care provision as well as in insurance. Larger health systems can negotiate for better rates with insurers, reduce costs of supplies, distribute overhead and other fixed costs over several clinical services lines (i.e., “economies of scope”), and share IT deployments across an enterprise. The first of these, better pricing from payers, appears to be particularly important. A Robert Wood Johnson Foundation analysis found that hospital mergers in markets where providers were already concentrated resulted in ~20% price increases.[8] At least for hospital systems some size is a good thing. With that said, health care provision does not reap the same level of unit cost compression from scale efficiency as healthcare payment.

Paying for care is very different from actually providing care. The former consists primarily of administrative tasks. These lend themselves nicely to standardization and then automation. Delivering care, including making diagnoses, implementing treatment, providing care management, and effectuating patient behavior change, is harder to automate. While there is a concerted and important effort to reduce unwanted variation in care delivery, healthcare is just by its nature a messy process. Without automation getting large scale economies is more difficult. Hence, the pricing gains from consolidation will initially expand margins, but the system growth in itself will likely have limited impact on performance beyond a certain point.

One area where scale still matters a lot is surgical care. Here a factory-model of healing somewhat holds. For example a knee replacement patient experiences a pre-set pathway of care from admission, surgery, and discharge. Obviously, this is a gross simplification. No two patients or procedures are the same. However, some are closer than others. Hence, at least some of the care can be standardized and learning curves can be climbed. Data shows that surgical volume for a procedure is a strong predictor of outcomes.[9] As such, it behooves providers to procure as much volume as possible for specific procedure types, i.e., to specialize. Specialization means investing marginal clinical and marketing resources in select few areas, e.g., orthopedics, labor & delivery, cardiovascular, etc. rather than being a jack-of-all-trades. Already employers such as WalMart and Lowes are starting to employ “Centers of Excellence” models, where they route their employees to a select few hospitals for certain procedure types, and to another set of hospitals for different procedure types.[10] They appreciate the benefits of specialization.

Primary care, where skill trumps size

In primary care some consolidation beyond single-/two-physician practices helps. A critical mass allows implementation of an EMR, powers analytic models, permits the addition of some ancillary providers, and enables more sophisticated risk-sharing and compensation structures. (Low-cost cloud-based IT systems in particular make solutions affordable to even small provider groups.) However, these efficiency gains from scale very quickly plateau with growth. At the same time as systems expand they tend to become less flexible and adaptable. The lack of local autonomy hinders primary care providers’ ability to customize care models, workflows, and clinical foci to the individual communities and patients they serve. The rigid human resource processes typical of larger employers further thwarts practice customization. This is a real problem because customizing the experience to each locale and patient is a key element of successful primary care.

Two things separating acceptable primary care from great care are: (i) figuring out how to get the patients to trust their doctors as care navigators and (ii) getting patients to change behavior. Effectuating this trust and long-term patient behavior change all comes down to creating a strong provider/patient relationship. For example, the clinical programing required to improve diabetes care in an underserved, poor, non-English speaking community is markedly different from that in affluent suburb. The disease process may be the same, as are the medications available at the pharmacy, but the overall interventions are likely to be extremely different. Even within a single community, barriers to successful outcomes vary patient-by-patient. For some it is access to resources, others it is health literacy, overall engagement, access to support resources, personality, etc. Thus, the care needs to be less standardized. Rather it needs to be more localized and personalized. The old beloved family doctor did not a have clinical decision support system, a medication error checking solution, or Up-to-Date® on his iPhone, but he did know how to connect with each of his patients in a deeply meaningful way. Doubling the size of his practice and allowing him to get a better price on medical supplies would not have strategically impacted his business.

So what…

Successful healthcare deals are ones that allow each entity to do more of what they do best, and align incentives to the mutual benefit of all involved. Understanding the basis of competition for each major segment of the value chain, “scale” for payers, “specialization” for hospitals, and “skill” for primary care, may be instructive for health systems faced with buy/build/partner decisions. More generally, rigorously evaluating scale economies and diseconomies created in each deal will be critical for healthcare strategic planners, and the providers, patients, and communities those deals affect.

1. Shorett P. The Revolution in Primary Care. The Chartis Group. Sep 2012.

2. Rabin RC. Hospitals Look To Become Insurers, As Well As Providers Of Care. Kaiser Health News, Aug 26 2012.

3. Dafney L. et. al. Paying a premium on your premium, Consolidation in the US Health Industry.” Kellogg School of Management.

4. Deloitte. Unlocking value in health plan M&A, sometimes the deals don’t deliver. 2013.

5. AHIP. An updated survey of health insurance claims receipt and processing times, 2011.

6. Bender KK and BR Fritchen. Carrier Trend Report. January 2012 Analysis. Oliver Wyman, Inc.

7. Healthcare Payer News. RAND Corp: Health plan consolidation may lead to lower hospital costs. Sept 8 2011.

8. Gaynor M and R Town. The impact of hospital consolidation—Update. Robert Wood Johnson Foundation. Jun 2012.

9. Birkmeyer JD et. al. Hospital Volume and Surgical Mortality in the United States. N Engl J Med 2002; 346:1128-1137

10. Walmart Press Release. Walmart, Lowe’s And Pacific Business Group On Health Announce A First Of Its Kind National Employers Centers Of Excellence Network. Oct 8, 2013.

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