The Future of Hospitals…not BUH-BYE, but B2B.


Disrupting the drug cost chain by creating a non-profit generic drug manufacturer is a brilliant move by the hospital industry. Driven largely by the looming wave of capitation and bundled payment models, the hospitals are starting to recognize that cost management will be an important competency for sustainability. However, the fact is that their strategy is still reactive, and this does not bode well for their future.

In 1950, business life looked good for the US Railroad system. With almost 100 years of dominance of the American transportation system, the US railroad system had 7 times the intercity passenger-mile traffic of the then-30-year-old commercial airline industry.

However, by 1970 the tables had turned, with airline service carrying passengers then 9 miles for every mile traveled by rail services, which ended up bankrupt and nationalized. (Interestingly, the proportion of passenger traffic maintained by inner city buses during this time changed very little).

While many forces drove this change — the Interstate Highway System, the familiarity and comfort of returning WWII veterans with airplane travel, and shifts in mail sorting technology were all factors — one of the biggest failures of the railroad industry itself was the way they defined themselves.

By not envisioning themselves as being in the transportation business, railroad executives created an artificial isolating barrier where airplanes were outside their operational frame of reference, and, in fact, ignored as a potential threat to their survival. If the railroads had decided to categorize themselves as being in the ‘transportation industry’, they could have invested in airlines and modified their rail service strategies based on market forces, allowing a more productive evolution, but hubris and legacy blinded them to the reality of social dynamics.

This phenomenon was largely repeated when the Internet emerged as a competitor to the print publishing industry…amd it and looms prominently in the future of the inpatient hospital and ‘health system’ industry.

As one historical reference on rail transformation notes: “An entire generation of rail managers had been trained to operate under (a restrictive) regulatory regime…Labor and their work rules were likewise a formidable barrier to change.”

Which could be rewritten thus: “An entire generation of healthcare administrators had been trained to operate under an increasingly restrictive fee-for-service model. Physicians and the existing operating model for care delivery were likewise formidable barriers to change”

Reducing preventable primary and secondary hospitalization rates in a defined population is a well-proven competency for health plans (and their “Plan Sponsors”, usually self-insured employers); their financial incentives are aligned to do so (they get to keep any unspent money), and by and large, their success is driven by improvements in the quality of care delivered to covered patient-employees (e.g., closing evidence-based gaps in care and focusing on clinical risk-reduction strategies) and targeted shifts in patterns of resource utilization and patient engagement (introducing Care Management for example).

While the absolute levels of engagement and quality improvement by Health Plans is quite low (only closing 26% of identified gaps in care in one study; only reaching 13% of patients eligible for Care Management in another), the results still have been quite dramatic; a 9% reduction in hospitalization rates can save (tens of) millions of dollars; shifting emergency department utilization via telephonic and urgent care is both financially and operationally valuable under risk- or bundled payments models.

“Accountable care” shifts the locus of control (and costs) of these care delivery strategies from the employer to the provider. However, as the health plans know very well, when the patients physician recommends care management, engagement and compliance levels rise, raising the potential for successful prevention of the ‘most impactable hospitalizations’ under the population health model. Combine this with “bundled payments” or “capitation+ bonus”, or full risk, there is an incentive for more intensive resource (cost) management by providers by sourcing and using lower cost/high efficacy tools and interventions.

However, what happens when inpatient services become “cost” rather than “revenue”? When might it stop making sense for a value-based health system to own an inpatient facility? How do value-based health systems make the determination as to which resources to own and which to contract for on an “as-needed” basis?

Another problem with the railroad industry (and the print publishers as well) is that even when there was a recognition that things were changing, there was a concerted effort to shape the change to retain the status quo.

I once heard a publisher, whose magazine was getting thinner and thinner every month, say “We’ll give away web banner ads in order to sell more print pages”. On the surface, 15 full-page ads at $20,000 does not have the same value as 3,000,000 ad impressions at $25 per 1000. The real problem was that his P&L had to pay for the print production infrastructure. The print margins were 15%, leaving $45,000 in profit on $300,000 in revenue; the web margins were 45%, leaving $33,750 profit on $75,000 in revenue.

Divesting the print production infrastructure and leveraging the subscriber list to build web traffic would have resulted in lower revenue, but much higher profit — as many newspapers and magazines eventually figured out, but often too late to maintain their market share.

With the gradual decline in healthcare fee-for-service revenue will come an associated sea change in the concept of “return on investment”. First, the administrative infrastructure for coding and billing will no longer be necessary, although some of the coding functions can be repurposed for clinical and operational analytics. No longer will the value of an infrastructure or resource-related expense be assessed on its dollar-for-dollar return.

In value-based care, ROI calculations will have to be determined under an operational efficiency model. Performance consistency, flexible operations, clinical supply chain management and customer value will become new standards of health system operations.

You can’t walk into Home Depot and name your own price for a refrigerator, but in healthcare, payers regularly reduce, and often deny, payments, even after services have been rendered. This occurs under the guise of a set of rules called “medical necessity”, which pits the professional judgment of practicing physicians against insurance company determinations.

The requirements of documentation required to receive payments — know colloquially as “reimbursement” — are burdensome and designed in favor of the payer keeping their cash as long as possible. The phrase ‘reimbursement’ is a euphemistic acknowledgement of the fact that the physician has already delivered value to the patient and shouldered the economic responsibility for the costs of their staff, supplies, and infrastructure.

In some cases, the payers have a conflict of interest due to economic incentives around plan-specific quality measures or goals to reduce overall spending on the ‘covered lives’ of their plan. This, by the way, is why simple bandages are billed by hospitals for extraordinary amounts, as a work-around to balance losses imposed by denial rates.

Today’s attempts at payment models for system-attributed populations — hybrid fee-for-service + gainshare, bundled payment models or ACO’s — are offering a transition window of economic comfort to health systems. But will require new competencies at understanding actual costs per episode or per patient, and more rational approached to resource allocation.

The likelihood of any one modest system-attributed population succeeding when saddled with the cost of an inpatient infrastructure on the books is very low.

As such,the economics of ‘accountable care’ will naturally lead to a divesture (or abandonment) of the infrastructure and overhead costs associated with running inpatient services whose success was based on fee-for-service ROI models, and some specialty services with limited ‘need’ in an attributed population.

Since the population health model is also based on keeping patients in the ‘network’, hospitals (and some specialists) will not compete for share of mind of patients, but share of market from “ACO’s”.

So — just like for the publishers — in the midst of this will come a realization of the folly of scaling to hundreds of thousands of patients in order to justify retention of inpatient infrastructure. Why keep the building and staff on the books when you can divest it and competitively negotiate terms and rates?

With regard to specialty services; the only ones an ACO might want to invest in will be driven by the population analytics — the others will be outsourced. One ACO I worked with has no need for a bariatric obesity program because the vast majority of their population was underweight; while analytics may justify primary care and certain specialties ‘on staff’ there will be some entirely new forms of private practice for specialties where services are provided to system-attributed populations, not geographic communities.

The future of the inpatient hospital will be as a freestanding ‘on-demand’ service competing for business-to-business contract with value-based systems of care under a population health management model. Even when an inpatient hospital and an ACO are under part of the same corporate parent, it will increasingly be a zero-sum game to have the profitable ACO offset the losses or required investment of the inpatient service; the hospital will have to become ‘market competitive’, wooing and negotiating with a all the local “ACO’s” to provide value-driven services at competitive levels of quality and cost.

While entering the generic pharmaceutical market is a brilliant first play at cost containment, it will end up being more disruptive to the pharmaceutical industry then it will end up supporting long-term productive evolution of our systems of care delivery.

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