Joining Matthew Holt (@boltyboy) on #THCBGang on Thursday August 17 at 1pm PST 4pm EST are futurist Jeff Goldsmith: medical historian Mike Magee (@drmikemagee); policy expert consultant/author Rosemarie Day (@Rosemarie_Day1); and patient safety expert and all around wit Michael Millenson (@mlmillenson);
So in this week of THCB’s 20th birthday it’s a little ironic that we are running what is almost a mea culpa article from Jeff Goldsmith. I first heard Jeff speak in 1995 (I think!) at the now defunct UMGA meeting, where he explained how he felt virtual
vertical integration was the best future for health care. Nearly 30 years on he has some reflections. If you want to read a longer version of this piece, it’s here—Matthew Holt
By JEFF GOLDSMITH
The concept of vertical integration has recently resurfaced in healthcare both as a solution to maturing demand for healthcare organizations’ traditional products and as a vehicle for ambitious outsiders to “disrupt” care delivery. Vertical integration is a strategy which emerged in US in the 19th Century industrial economy. It relied upon achieving economies of scale and co-ordination through managing the industrial value chain. We are now in a post-industrial age, where economies of scale are in scarce supply. Health enterprises that are pursuing vertical integration need to change course. If you look and feel like Sears or General Motors, you may well end up like them. This essay outlines reasons for believing that vertical integration is a strategic dead end and what actions healthcare leaders need to take.
Where Did Vertical Integration Come From?
The strategy of vertical integration was a creature of the US industrial Revolution. The concept was elucidated by the late Alfred DuPont Chandler, Jr. of the Harvard Business School. Chandler found a common pattern of growth and adaptation of 70 large US industrial firms. He looked in detail at four firms that came to dominate markedly different sectors of the US economy: DuPont, General Motors, Sears Roebuck and Standard Oil of New Jersey. They all followed a common pattern: after growing horizontally through merging with like firms, they vertically integrated by acquiring firms that supplied them raw materials or intermediate products or who distributed the finished products to final customers. Vertical integration enabled firms to own and co-ordinate the entire value chain, squeezing out middlemens’ profits.
The most famous example of vertical integration was the famed 1200 acre River Rouge complex at Ford in Detroit, where literally iron ore to make steel, copper to make wiring and sand to make windshields went in one end of the plant and finished automobiles rolled out the other end. Only the tires, made in nearby Akron Ohio, were manufactured elsewhere. Ford owned 700 thousand acres of forest, iron and limestone mines in the Mesabi range, and built a fleet of ore boats to bring the ore and other raw materials down to Detroit to be made into cars.
Subsequent stages of industrial evolution required two cycles of re-organization to achieve greater cost discipline and control, as well as diversification into related products and geographical markets. Industrial firms that did not follow this pattern either failed or were acquired. But Chandler also showed that the benefits of each stage of evolution were fleeting; specifically, the benefits conferred by controlling the entire value chain did not last unless companies took other actions. Those interested in this process should read Chandler’s pathbreaking book: Strategy and Structure: Chapters in the History of the US Industrial Enterprise (1962).
By the late 1960’s, the sun was setting on the firms Chandler wrote about. Chandler’s writing coincided with an historic transition in the US economy from a manufacturing dominated industrial economy to a post-industrial economy dominated by technology and services. Supply chains re-oriented around relocating and coordinating the value-added process where it could be most efficient and profitable. Owning the entire value chain no longer made economic sense. River Rouge was designated a SuperFund site and part of it has been repurposed as a factory for Ford’s new electric F-150 Lightning truck.
Why Vertical Integration Arose in Healthcare
I met Alfred Chandler in 1976 when I was being recruited to the Harvard Business School faculty. As a result of this meeting and reading Chandler’s writing, I wrote about the relevance to healthcare of Chandler’s framework in the Harvard Business Review in 1980 and then in a 1981 book Can Hospitals Survive: The New Competitive Healthcare Market, which was, to my knowledge, the first serious discussion of vertical integration in health services.
Can Hospitals Survive correctly predicted a significant decline in inpatient hospital use (inpatient days fell 20% in the next decade!). It also argued that Chandler’s pattern of market evolution would prevail in hospital care as the market for its core product matured. However, some of the strategic advice in this book did not age well, because it focused on defending the hospital’s inpatient franchise rather than evolving toward a more agile and less costly business model. Ambulatory services, which are today almost half of hospital revenues, were viewed as precursors to hospitalization rather than the emerging care template.Continue reading…
BY JEFF GOLDSMITH
Robert Frost once said, “Home is where, when you have to go there, they have to take you in.”
Increasingly, in our struggling society, that place is your local full service community hospital. During COVID, if it wasn’t your local hospital standing up testing sites, pumping out vaccinations and working double overtime helping patients breathe, we would have lost several hundred thousand more of our fellow Americans.
But it wasn’t just COVID where hospitals leaped into the breach. As primary care physicians’ practices collapsed from documentation overburden and chronic underpayment, hospitals took them in on salary. If it wasn’t for hospitals, vast swatches of the northern most three hundred miles of the US and large stretches of our inner cities would be a physician desert. Hospitals subsidize those practices to a tune of $150k a year to have a full service medical offering and keep their own doors open.
As our public mental health system withered, the hospital emergency department (and, gulp, police forces). became our main mental health resource. Tens of thousands of mentally ill folks languish overnight in hospital observation units because, despite not being “acutely ill”, there is nowhere for the hospital to place them. And as our struggling long term care facilities withered under COVID, those mentally ill folks were joined in observation by seriously impaired older folks too sick to be cared for at home. As funding for public health has withered on the vine, hospitals have become the de facto public health system in the US.Continue reading…
Joining Matthew Holt (@boltyboy) on #THCBGang on Thursday July 20 at 1pm PST 4pm EST are futurists Jeff Goldsmith; patient advocate Robin Farmanfarmaian (@Robinff3); Suntra Modern Recovery CEO JL Neptune (@JeanLucNeptune); and our special guest Investor at Bessemer Sofia Guerra (sofiaguerrar)
Joining Matthew Holt (@boltyboy) on #THCBGang on Thursday June 29 at 1PM PT 4PM ET are futurist Jeff Goldsmith: medical historian Mike Magee (@drmikemagee); and patient safety expert and all around wit Michael Millenson (@mlmillenson).
Joining Matthew Holt (@boltyboy) on #THCBGang on Thursday June 15 were double trouble futurists Jeff Goldsmith and Ian Morrison (@seccurve); patient safety expert and all around wit Michael Millenson (@mlmillenson); Suntra Modern Recovery CEO JL Neptune (@JeanLucNeptune); and policy expert consultant/author Rosemarie Day (@Rosemarie_Day1). Lots of discussion about United and their hold on the US health care system, the continued hype around AI, and where the rubber is meeting the road or not on health equity.
Joining Matthew Holt (@boltyboy) on #THCBGang on Thursday June 1 at 1PM PT 4PM ET were double trouble futurists Jeff Goldsmith and Ian Morrison (@seccurve), and delivery & platform expert Vince Kuraitis (@VinceKuraitis). Lots of discussion about Kaiser and Geisinger and what this means about the model for the future of care delivery. Do incentives or professionalism matter more?
By JEFF GOLDSMITH
Envision, a $10 billion physician and ambulatory surgery firm owned by private equity giant Kohlberg Kravis Roberts, filed Chapter 11 bankruptcy on May 15. It was the largest healthcare bankruptcy in US history. Envision claimed to employ 25 thousand clinicians- emergency physicians, anesthesiologists, hospitalists, intensivists, and advanced practice nurses and contracted with 780 hospitals. Envision’s ER physicians delivered 12 million visits in 2021, not quite 10% of the US total hospital ED visits.
The Envision bankruptcy eclipsed by nearly four-fold in current dollars the Allegheny Health Education and Research Foundation (AHERF) bankruptcy in the late 1990’s. KKR has written off $3.5 billion in equity in Envision. Envision’s most valuable asset, AmSurg and its 257 ambulatory surgical facilities, was separated from the company with a sustainable debt structure. And at least $5.6 billion of the remaining Envision debt will be converted to equity at the barrel of a gun, at dimes on the dollar of face value.
KKR took Envision private in 2018 when Envision generated $1 billion in profit, in luminous retrospect the peak of the company’s good fortune. Envision’s core business was physician staffing of hospital emergency departments and operating suites. In 2016, then publicly traded, Envision merged with then publicly traded ambulatory surgical operator AmSurg. This merger seemed at the time to be a sensible diversification of Envision’s “hospital contractor” business risk.
Indeed, Envision’s bonus acquisition of anesthesia staffing provider Sheridan, acquired by AMSURG in 2014, helped broaden its portfolio away from the Medicaid intensive core emergency room staffing business (EmCare), which required extensive cost-shifting (and out of network billing) to cover losses from treating Medicaid and uninsured patients. It is clear from hindsight that where you start, e.g. your core business, limits your capacity to spread or effectively manage your business risk, an issue to which we will return.
The COVID hospital cataclysm can certainly be seen as a proximate cause of Envision’s demise.
The interruptions of elective care and the flooding of emergency departments with elderly COVID patients, which kept non-COVID emergencies away, damaged Envision’s core business as well as nuking ambulatory surgery. By the spring of 2020, Envision was exploring a bankruptcy filing. An estimated $275 million in CARES Act relief and draining a $300 million emergency credit line from troubled European banker Credit Suisse temporarily staunched the bleeding. But the pan-healthcare post-COVID labor cost surge also raised nursing expenses and led to selective further shutdowns in elective care and further cash flow challenges.
While one cannot fault KKR’s due diligence team for missing a global infectious disease pandemic, with hindsight’s radiant clarity, there were other issues simmering on the back burner by the time of the 2018 deal that should have raised concerns. Two large struggling investor owned hospital chains, Tenet and Community Health Systems, began divesting marginal properties in earnest in 2018, placing a lot of Envision’s contracts in the pivotal states of Florida and Texas at risk.
More importantly, there were escalating contract issues with UnitedHealth, one of Envision’s biggest payers, as well as increasing political agitation about out-of-network billing, which provided Envision vital incremental cash flow. These problems culminated in a United decision in January 2021 to terminate insurance coverage with Envision, making its entire vast physician group “out of network”.Continue reading…
BY JEFF GOLDSMITH
As they emerge from the COVID pandemic, US hospitals have a terrible case of Long COVID. They experienced the worst financial performance in 2022 in this analyst’s 47 year memory. As the nation recovers from the worst inflation in forty years, hospitals will find themselves locked in conflict with health insurers over contract renewals that would reset their rates to the actual delivered cost of care. “Last in line” in the US battle with inflation, hospitals will be exposed to public criticism when they attempt to recover from pandemic-induced financial losses.
Hospital payment rates for commercial payers are backward looking. Commercial insurance contracts between hospitals and health insurers were multi-year contracts negotiated before the pandemic. They continued in force during the pandemic, despite explosive rises in people and materials costs. As a consequence, health costs were conspicuously missing from the main drivers of the 2021-22 inflation surge– food, housing, energy, durable goods, etc.
Hospitals’ operating costs blew up during COVID due to a shortage of clinicians, the predations of temporary staff agencies, shortages of supplies and drugs and crippling cyberattacks that disabled their IT systems. Hospital losses worsened during 2022 because they are unable to place patients who are no longer acutely ill but who cannot be placed in long term, psychiatric or home-based care (a problem shared by Britain’s disintegrating National Health Service). Thousands of patients are stuck in limbo in hospital “observation” units, for which government and commercial payers do not compensate them adequately or at all.Continue reading…