Why health systems need a hybrid strategy and ambidextrous leadership to ensure financial sustainability

Reprinted from the
                                                                                                                    February 2020 edition
                                                                                                                     of HFMA’s Financial
                                                                                                                    Sustainability Report

Why health systems need a hybrid
strategy and ambidextrous leadership
to ensure financial sustainability

When the Affordable Care Act first began to roll out its programs aimed
at encouraging provider organizations to take medical risk from payers
and deliver value-based care, many hospitals faced a daunting challenge
knowing where to start.

                                         he ACA offered providers                    The effect of these combined trends was to force
                                         opportunities to participate                provider systems to compete in a much more
                                         in shared savings programs,                 complex set of inter-related markets, as shown in
                                         bundled payment models and                  the exhibit.
PhD                                      other risk-based programs, and                  Health systems have little choice but to com-
                        it created a medical loss ratio floor to give health         pete across the board; ignoring any one market
                        insurers an incentive to shift care management               would create vulnerabilities in the others. As a
                        activities to providers. The underlying                      result, health systems now compete with each
                        assumption was that shifting risk from payers to             other for inpatient admissions and ambula-
                        providers would give health systems an incentive             tory care, with each other and with insurers
STEVE WEYLANDT,         to “manage population health” and make care                  for members, and with each other and a wide
MHA                     more affordable.a                                            range of companies for other clinical services
                            Many health systems’ initial response was to             (including insurers, many of which now employ
                        “launch 1,000 ships” by developing accountable               physicians).
                        care organizations (ACOs), clinically integrated                 Given this complexity, and facing tighter
                        networks (CINs) and other vehicles, hoping                   margins, health systems can no longer afford
                        that some of them would find safe passage to                 to launch more ships. They need coherent and
                        the new value-based world. Because no amount                 effective hybrid “strategies for the middle” that
                        of business planning could predict which ships               can generate reasonable ROIs, and leadership
                        would arrive safely, this was a reasonable initial           flexible and skilled enough to play in a variety of
                        response.                                                    different markets.b What makes this challeng-
                                                                                                                                           photo – andrea behrend

                            At the same time the ACA was pushing health              ing is that the different markets shown in the
                        systems to pursue population health manage-                  previous exhibit require fundamentally differ-
                        ment, many clinical services markets (e.g.,                  ent approaches to strategy development and
                        ambulatory care) were being disrupted by new                 implementation.
                        competitors and rapid technological change.

                        a. The Affordable Care Act set maximum medical loss          b. Eggbeer, B., Wesslund R., Weylandt, S., “It’s not so
                        ratios that health insurers can earn on their insurance      simple: Why provider organizations need a ‘strategy for
                        products, limiting their administrative costs and profits.   the middle,’” hfm, December 2016.


Inpatient markets are traditional markets that
                                                       Examples of the "1,000 ships" provider
health systems understand well. Inpatient care
                                                       responses to cost and quality pressures from
is subject to substantial economies of scale, and
                                                       ACA-driven health reform
barriers to entry are high. As secondary care
moves to the outpatient setting, inpatient care
has become focused on the most acute condi-                                                    Segments
tions, and volumes (numbers of discharges,                                                     • Medicaid Temporary Assistance to Needy Families
                                                                                               • Medicare-Medicaid dual eligible
patient days) have declined dramatically. Under                                                • Medicare fee-for-service
these conditions, health systems must con-                                                     • Medicare Advantage
centrate on building sustainable competitive                                                   • Commercial administrative services only
                                                                                               • Commercial, fully insured
advantage, and consolidation is a proven strat-                                                • Commercial health insurance exchange and private
egy for accomplishing this purpose, as discussed         Types of Initiatives
in the sidebar, “Inpatient market consolidation          • Private and public exchanges
                                                                                               • Inpatient
                                                         • Direct contracting with employers
has led to stable inpatient markets in metro                                                   • Outpatient surgery, routine
                                                         • Network affiliations
areas.”c                                                                                       • Outpatient surgery, specialized
                                                         • Narrow and tiered networks
                                                                                               • Outpatient diagnostics, ancillary
                                                         • High-deductible health plans
                                                                                               • Cancer care
                                                         • Medicare reference pricing
COMPETING IN POPULATION                                                                        • Clinical rehabilitation
                                                         • Centers of exclellence
HEALTH MARKETS                                                                                 • Emergency department treatment and release
                                                         • Value-based risk contracts
                                                                                               • Transplant
Like inpatient markets, markets for population
health are governed by traditional competitive                                                 Unique Mission
                                                                                               • Academic research
rules. The principal players in these markets
                                                                                               • Not-for-profit enter
are health insurers, which are paid 10% to 20%                                                 • Private enterprise
of total healthcare costs to manage the quality                                                • Complexity of cases
                                                                                               • Subsidization of Medicare and Medicaid
and cost of healthcare services. Competing for
                                                                                               • Payer-broker-employer-consumer dynamics
members is their main way of growing revenue.
Relationships between members and insurers
involve substantial switching costs, making
health plan purchasing decisions sticky, and
                                                       “Fortune 500” list, two health insurers (United
creating long-term value for customer rela-
                                                       HealthGroup and CVS Health) are now among
tionships. Market share matters because large
                                                       the 10 largest public U.S. corporations, each with
insurers can negotiate lower rates with pro-
                                                       more than $200 billion in annual revenue.d
viders and gain a cost advantage over smaller
                                                          Health insurers have a significant advantage
insurers. As a result, like inpatient markets,
                                                       over health systems in markets for population
barriers to entry are high.
                                                       health, because they contract at scale with mul-
   Building sustainable competitive advantage
                                                       tiple providers to deliver a wide range of services
in population health markets requires a variety
                                                       across broad geographies. Health systems that
of competencies, including plan design, pricing,
                                                       own insurance products and employ physicians
provider network contracting, claims processing,
                                                       who can manage the quality and cost of care, like
member services and cost management. Scale is
                                                       Kaiser Permanente and Geisinger, can compete
also critical, and since the 1980s, the market for
                                                       successfully, but these skills take a long time
managing population health has been consoli-
                                                       to develop. Health systems that don’t market
dating rapidly. Based on Fortune’s most recent
                                                       insurance products directly to employers or indi-
                                                       viduals must have contractual relationships with
c. Porter, M.E., Competitive Advantage: Creating and
Sustaining Superior Performance, New York, The Free
Press, 1985.                                           d. “2019 Fortune 500,” Fortune, 2019.

                                                                                 FINANCIAL SUSTAINABILITY REPORT | February 2020 |                  2
Health system competition in the world of
            the Affordable Care Act
                                                                           Clinical services markets

                                     Population      Inpatient                  Ambulatory               Consumer
                                   health markets      care                       care                 health services

                     Traditional                                                                                         Emerging

            insurers, raising questions about whose “mem-                     benefits and unsentimentally disinvesting when
            ber” a given person or family is — the insurer’s                  life cycles start trending down. Success requires
            or the provider’s.                                                a portfolio manager’s mindset of making good
               As a result, despite all the ACA programs,                     short-term bets, maximizing benefits from
            relatively few health systems are competing                       investments, getting in and out at the right time
            vigorously in population health markets to date.                  and moving on. Building transient advantage
            Most health systems remain heavily dependent                      does not replace traditional concepts of busi-
            on fee-for-service revenue, taking little financial               ness strategy, but it does have different rules of
            risk. In a recent profile of the not-for-profit and               engagement. Some of the most important are the
            public health sectors, Moody’s Investor Service                   following.
            found that only 3.7% of the revenue of 284 free-

            standing hospitals and provider systems in 2018                       Pick the right areas for investment. The
            was truly risk-based, up from 3.0% in 2014.e                          most fertile areas are those that meet im-
                                                                              mediate needs of healthcare consumers and/or
            COMPETING IN EMERGING                                             purchasers (“customer experiences and solu-
            CLINICAL SERVICES MARKETS                                         tions”).g Go-to-market initiatives – new retail
            In contrast to inpatient and population health                    care delivery vehicles, new risk contracts with
            markets, most other clinical services markets                     employers, etc. – are less risky and more pro-
            are local, fragmented and chaotic. Barriers to                    ductive than projects requiring large, expensive
            entry are low, and as a result, new cross-sector                  infrastructure.
            competitors are emerging all the time. Building

            sustainable competitive advantage is challeng-                         Choose champions wisely. Introducing
            ing in chaotic markets. Professor Rita Gunther                         new products is an entrepreneurial activi-
            McGrath of Columbia Business School describes                     ty, and provider systems need internal leaders
            an approach to strategy development that may                      with an entrepreneurial mindset to champion
            suit these markets better, which she calls build-                 key initiatives. Independent physicians with
            ing “transient advantage.”f                                       business acumen often make good champions,
               Building transient advantage requires scaling                  because they interact in the marketplace every
            new business initiatives rapidly, managing                        day. Clinical investigators also can make good
            short product life cycles to maximize near-term                   champions because they compete in fast-moving,
                                                                              highly competitive markets for ideas.
            e. Moody’s Investor Services, “Not-for-profit and public
            healthcare US medians: Revenue growth inches ahead of
            expenses as margins hold steady,” Sept. 3, 2019, Appendix I.
            f. McGrath, R.G., “Transient Advantage,” Harvard Business         g. Zenger, T., “What Is the Theory of Your Firm?” Harvard
            Review, June 2013                                                 Business Review, June 2013.

Inpatient market consolidation has led to
    stable inpatient markets in metro areas
    Inpatient markets have consolidated rapidly, and most major metro markets are now
    oligopolies with a small number of competing provider systems selling inpatient services to a
    small number of health insurers. In a sample of 36 major metro markets between 2010 and 2018,
    the median market share for the top two health insurers was 52%, and the median inpatient
    market share for the top three provider systems was 61%.a Creating horizontally and vertically
    integrated delivery systems has enhanced health systems’ competitive position, built their
    brands and expanded their access to capital markets, all of which has improved their financial
    performance. Consolidation has been especially important for academic medical centers, which
    need substantial scale to support their academic missions.

    Over the past few years, the pace of inpatient consolidation has slowed.b As long as anti-
    trust laws are enforced — and it appears they will be — most of today’s metro market
    oligopolies are likely to remain relatively stable.c Existing players will continue to pick up the
    few remaining stand-alone hospitals, and national players (e.g., HCA, Providence St. Joseph
    Health, CommonSpirit Health) will acquire local and regional systems across markets. But the
    fundamental structure of most metro inpatient markets will not change much.

    a. BDC Advisors LLC, analysis based on HealthLeaders Market Overview data, 2019.

    b. The average annual increase in inpatient care concentration in 112 core-based statistical areas (CBSAs), as
    measured by the Herfindahl-Hirschman Index (HHI), was 53 out of 10,000 points from 2012 to 2016, which is
    not statistically significant. [Healthcare Cost Institute and the RWJ Foundation, “Healthy Marketplace Index”;
    BDC Advisors analysis

    c. Many health economists believe that hospital consolidation has enabled health systems to use their
    market power to stifle competition and increase prices without clearly improving quality. See, for example,
    Gaynor, M., and Town, R., “The impact of hospital consolidation – Update,” Robert Wood Johnson Foundation:
    The Synthesis Project, June 2012. The FTC recently announced it will be evaluating them more closely in the
    future. See Prvulovic, M., “FTC Commissioner Warns Hospital Mergers Will Be Closely Scrutinized In 2020,” The
    Motley Fool, Jan. 17, 2020.

     Give champions the tools and support they               of internal venture funds. Providing release time
     need for success. Entrepreneurial proj-                 and seed funding, candid advice and counsel and
ect leaders need clear accountability, relevant              protection from traditional organizational pro-
metrics and appropriate incentives, both carrots             cesses (e.g., budgets) is essential to cultivating
and sticks, to guide their efforts. Incremental              successful “intrapreneurs.”h
revenue is a useful metric for champions and the

executives managing them.                                        Promote small initial investments and
                                                                 condition future investments on success.

     Create internal sponsorship. Champions                  Innovative companies adopt an incrementalist
     need sponsors. In external capital markets,             philosophy of business development, captured
venture capitalists with direct financial stakes             by 3M’s motto, “Make a little. Sell a little. Make
in the success of entrepreneurs play this role. In
health systems, this role can be played by chief             h. Pinchot III, G., Intrapreneuring: Why you don’t have to
innovation or transformation officers or leaders             leave the corporation to become an entrepreneur, 2013.

                                                                     FINANCIAL SUSTAINABILITY REPORT | February 2020 |    4
a little more.”i Because the risk is great, initial             health plans — like Intermountain Healthcare
       investments should be limited until initiatives                 in Utah, Henry Ford Health System in Michigan
       prove they have legs.                                           and Sentara Healthcare in Virginia — manage
                                                                       their health plans separately from their delivery

            Encourage partnering. Because emerging                     systems. Of course, creating separate divisions
            markets are dynamic, solo plays are relative-              focused on different markets raises the question
       ly high risk. Partnering with other companies                   of how common activities like care management
       with similar goals but different skills and net-                should be integrated across divisions.
       works — e.g., supplier companies or co-investors                   At the corporate level, implementing differ-
       — is a much less risky strategy.                                ent strategies requires ambidextrous leaders
                                                                       who can balance the needs of diverse businesses

            Exploit business interdependencies. In                     and cultivate diverse leadership teams. Finally,
            many cases, ambulatory and consumer                        scale and resources are essential to success, and
       initiatives may not move the revenue or profit-                 vertical and horizontal consolidation is creating
       ability needle much on their own. But they may                  the large, capable health systems required to
       enhance other businesses. Remote patient mon-                   compete in this complex, chaotic world.
       itoring, for example, while unlikely to generate
       much revenue, may enable health systems to
       react quickly to changing patient conditions and
       provide other services that improve outcomes
       and generate incremental revenue.

            Build innovative cultures. Innovative
            cultures are characterized by a certain set of
       values, starting with an emphasis on sales and
       growth. Innovative companies value experi-
       mentation and adopt an ethos that celebrates
       blockbuster successes but doesn’t penalize good
       tries that fail.

       Straddling traditional and emerging markets is
       challenging, requiring substantial investments
       in people, facilities and systems. One organizing
       strategy that some health systems have imple-
       mented is creating separate operating divisions
       to address these different markets — e.g., an
       ambulatory division separate from an inpatient
       division. Most provider systems that own large
                                                                       About the authors

       i. Peters, T.J., and Waterman, R.H., In Search of Excellence:   David G. Anderson, PhD, is a senior adviser, BDC Advisors,
       Lessons from America’s Best-Run Companies, 1982,                Boston.
       reprinted in 2016.                                              Steve Weylandt, MHA, is a director, BDC Advisors, Houston.

                    Reprinted from hfma.org. Copyright 2020, Healthcare Financial Management Association,
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