Unleashing the Innovation Monster

I have been absent from the blogosphere for about two months. The fact is, there just isn’t all that much new to write about. Healthcare spending growth continues to moderate, but not by enough to stave off forecasts of doom for Medicare and Medicaid. Nor can employers begin to shift money from health benefits back into wages. But wheels are turning. Health networks are expanding as providers prepare to offer ACOs and/or increase their bargaining clout. A handful of states are poised to start up exchanges with the feds ready to take the reins in the laggard states. Aon/Hewitt is about ready to launch a private sector exchange. We will start to learn whether exchanges save or destroy private health insurance.

The Affordable Care Act has had many detractors but at least it has disrupted the status quo. We needed to see fundamental changes in how we pay for and deliver healthcare services and the ACA has delivered. But ACA has brought us a very particular set of changes. Time will tell if we have chosen the right path.

Even as the industry changes the way it does business, one critical aspect of change is missing. The faces are all the same. The same large systems that dominated the fee for service world seem poised to dominate the shared savings world, and the same insurers that dominated the traditional employer-based insurance market stand ready to dominate exchanges. Value might be created when old businesses play by new rules, but even more value is created when new players are free to enter and perhaps even break the rules.

Entry is the engine that drives economic progress. Entrants bring new technologies to manufacturing and new service models to sales. Threatened by entry, incumbents strive to innovate and improve customer service. This is as true in high tech industries as it is in the service economy. Research confirms that entry is ubiquitous – in a typical manufacturing industry, fully one third of established firms are replaced by entrants within five years. Though the data is not as readily available, turnover in the service sector is likely even higher.

If entry is the engine that drives change, the healthcare sector is out of gas. Turnover in the healthcare sector is slow to nonexistent. Ask yourself, who are the biggest health insurers today? In nearly all states, the answer is the Blues. Who were the biggest health insurers 50 years ago? The Blues. Now name the biggest hospital in your home town and then look up historical data to find the biggest hospital in your town in 1960. Odds are good it is the same hospital.

I have long wondered why turnover is so slow in healthcare, and I think I know part of the reason. In most industries, successful entrants find lower cost ways to deliver products and services. Think Wal-Mart and Lenovo. But find a way to reduce the cost of delivering healthcare and where does that get you? Insured patients won’t take their business to you. Insurers might add you to their provider network, but not if it means excluding traditional providers that dominate the market. And if an insurer did find a way to cut costs, employers would be reluctant to exclusively offer the plan, in part because the tax code makes cheap health care plans seem not so cheap. Given a choice between a cheap and expensive plan, employees would also be reluctant to choose the cheap plan, both because of the tax code and because employers usually subsidize part of the cost of choosing the expensive plan.

There is also a host of regulatory barriers. Many states still enforce Certificate of Need. There are rules governing what allied medical personnel can and cannot do, stifling the search for innovative care models. ACO payment rules under Medicare limit the incentives to cut costs by allowing only for “shared savings” (apparently in recognition of theoretical studies that suggested, contrary to much available evidence, that the HMO full savings model would lead to excessively low quality care.)

I also see a lack of vision in the healthcare management realm. Nearly every sector of the general economy is dominated by “virtual” organizations that keep vertical integration to a minimum. Apple designs products but outsources production and sales. Nike doesn’t make or sell anything (it does design and brand management in-house). Likewise, Wal-Mart and CostCo produce nothing. Pharmaceutical companies outsource research, clinical trials, and even sales and marketing; government relations remain the only task that is nearly always performed in-house. The virtual corporation works because modern telecommunication technology allows independent businesses to coordinate even complex processes, relying on the skills of highly motivated specialized independent business partners, without the need for a vertically integrated corporate bureaucracy.

But healthcare is different. Faced with uncertainty, healthcare providers circle the wagons. They go on acquisition binges and then go business only with the set of providers in the same giant bureaucratic organization. In the Balkanized market that results, entrepreneurs become employees, agile independent firms become part of large bureaucratic structures, and efficiency suffers. We have seen this movie and it does not end well.

I have mentioned how some regulations stifle innovation. Let me mention one more regulation that stands in the way of efficient production. Anti-kickback laws effectively prohibit hospitals from providing financial incentives to independent doctors who deliver efficient care. I suspect the latter is the biggest reason why hospitals are acquiring doctors rather than dealing with them at arms length.

Ironically, the key to unlocking the power of market forces may be a bit more regulation. Of course we need more vigorous antitrust enforcement. But we also need to bring order to the world of electronic medical records. One advantage enjoyed by the integrated firm is the ability to get all of its providers to use the same EMR platform, thereby facilitating the exchange of information that is vital to improving efficiency and quality. Independent physicians are reluctant to adopt EMR, due to the cost, but they also are reluctant to choose a particular EMR system for fear of aligning themselves with a particular hospital that uses the same system. (This would weaken the physician’s bargaining position.) President Bush established a commission to develop EMR standards, but the result was unsatisfactory and incompatible systems continue to coexist. Without enforced compatibility (and either carrots or sticks to assure adoption), the virtual healthcare organization will remain a pipe dream. Even the most visionary healthcare executive will be reluctant to do business with an independent provider if the potential for information exchange is limited.

David Dranove, PhD, is the Walter McNerney Distinguished Professor of Health Industry Management at Northwestern University’s Kellogg Graduate School of Management, where he is also Professor of Management and Strategy and Director of the Health Enterprise Management Program. He has published over 80 research articles and book chapters and written five books, including “The Economic Evolution of American Healthcare and Code Red.” This post first appeared at Code Red.

14 replies »

  1. One of the great benefits of the Affordable Care Act is for mothers needing breast pumps. A major change is that breast pumps and lactation services are now covered. One point that needs to be heard is that preventative care actually saves money in the long run. By allowing mothers to provide their babies with breast milk now, it helps the baby stay healthier, which in turn saves money from doctors visits, doctor care in the future. a $275-$300 pump now could save thousands of $$$ later.

  2. In many American cities, hospitals have been propping up the labor market and even propping up the construction market.

    Many families have stayed in the middle class only because one spouse got a hospital job, even while the other spouse was being laid off from manufactuing.

    There are few if any ‘junkers’ in the employee parking lots of hosptials.

    Now we are running out of money to sustain those hosptials which are overbuilt, over-equipped, over-indebted, and overstaffed. We may be in a Wily-coyote moment, when the health care system is running in place but not daring to look at the canyon below.

  3. Stop the gimmicks. Pay the doctors to provide cost-effective medical care.

    There is but one problem with that: hospitals will go broke, since at least 30% of all hospital admissions are unnecessary as are many operations and MRIs and ancillary services.

  4. Incentives matter.

    In most parts of the American health care system, a hospital or doctor or drug company makes more money when it raises prices.

    If a hospital now collects $15,000 for a surgery and raises the price to $25,000, most insurers will demand a discount down to $18,000. Big deal.

    Someone at the American Enterprise Institute put this more elegantly a couple of years ago, I apologize for forgetting the cite.

    He said that the providers of health care had no incentive to lower their prices. Medicare would pay all of them the same rate. Lowering prices would not increase volume, because most parts of health care are relentlessly local. A business will buy steel from Japan to save 5% in price, but it will not send its employees to Mexico for operations to save 40% in health costs. The renowned ability of Massachusetts hospitals to raise prices is just one example of the alternative economic universe of health care. Massachusetts insurers could just send their patients to Vermont and save money, much less Mexico.

    There are a few parts of health care where lower prices lead to more profits.
    Eyeglasses and generic drugs at Walmart come to mind.

    The issue is whether any other parts of health care can be moved into this category where lower prices pay off, and higher prices drive customers away. Reference pricing in health insurance is a good start,

  5. Considering the number of construction cranes, economies of scale must have led to better profit margins…. and considering the slick ER ads (make appointments online and watch TV until it’s time to go) operations are much improved….

  6. “there are still 30 or so hospitals, but they are owned by three major systems”

    Just a guess: “economies of scale” haven’t led to lower prices?

  7. The question in my mind is how did we end up with such powerful incumbents (on the delivery side). At one time in my city there were 30 or so hospitals. Today there are still 30 or so hospitals, but they are owned by three major systems.
    What happened and is still happening to hospitals, is now also happening to independent physician practices. That’s how you end up with powerful incumbents that can lobby for higher and higher barriers to entry.
    Case in point would be physician owned hospitals which government is killing off right now at the behest of hospital conglomerates. The logic of keeping doctors from self-referring to their own facilities, and instead having them self-refer to facilities that employ them as a contractual employment obligation, is pretty much lost on me.
    Unfortunately, the ACA is just making incumbents bigger and therefore the barriers higher. I don’t see what type of entity, other than doctors, can now open a new little hospital, perhaps a specialty one, and hope to compete for business in a market dominated by St. Elsewhere, and doctors are not allowed to be entrepreneurs any more.

    Just a thought, but is it possible that the consolidation of the delivery system is also causing (or sustaining) the barriers to entry on the payer side?

    As to technology, I think here too, the government is fighting a war from days gone by. The technology lever zealously applied through endless regulation cycles, consists of huge expenditures and complexity, and in my opinion is aimed at driving out of business any remaining small establishments.
    It’s funny (or sad), but technology is being regulated into a barrier to innovation in the delivery model and any hope of lower costs without severely hurting quality (more on exactly this here: http://onhealthtech.blogspot.com/2012/12/the-arithmetic-of-health-care.html ).

  8. Not to mention the remarkable lack of market share volatility in insurance markets.

    Let’s face it, healthcare markets have stagnated for decades. We need to find out why. Government regulation seems to be one candidate. Powerful incumbents enjoying a host of entry barriers may be another. I am open to hearing about and discussing others.

  9. Entry rates in manufacturing industries are far higher than in healthcare, where the vast majority of the costs are for labor and materials (and therefore not fixed.)

    Even airframe manufacturing has seen more turnover of market share than many hospital markets.

  10. Docs don’t need financial incentives to deliver lots of procedures and treat well insured patients. But a hospital that accepts risk based payments cannot reward physicians who reduce the number of procedures unless they employ them.

    Hard to believe anyone still defends the status quo method of organizing and delivering care.

  11. Entry may be the norm for industries that don’t need much capital to enter, but there are plenty of sectors where entry is not the norm: oil, steel, aircraft manufacturers, car manufacturers, etc. Two guys in a garage cannot “start” a new hospital.
    I do agree however with the virtual approach to organizing health services, instead of the very wasteful and expensive consolidation out of mostly fear.

  12. Three decades of free market in the HIT experiments and little innovation to show for it, other than the likes of Judy F. and Neal P. and other HIT robber barons using the illusion of innovation to become filthy rich at the expense of the patients.

    “Anti-kickback laws effectively prohibit hospitals from providing financial incentives to independent doctors who deliver efficient care.”

    Really??? Errr, do you mean, delivering large numbers of procedures and well insured patients?

  13. “incompatible systems continue to coexist”

    Ya think? As of today there are 1,486 and 277 ambulatory and inpatient “Meaningful Use 2011 CHPL Certified Complete Systems” littering the health IT landscape. A total of 1,763 complete EMR systems, all “standardized” to the narrow Meaningful Use criteria and virtually nothing else that matters to end-users.

    But, hey, Differentiation+Opacity = Margin