How US Healthcare Companies Can Thrive Amid Disruption
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JUNE 2014 How US healthcare companies can thrive amid disruption The healthcare industry is undergoing sweeping change. To emerge as winners, incumbents should learn from other industries that have faced similar upheaval. Disruptive change is now a fact of life for in dustry leaders with broader and more Brendan Buescher many industries. Healthcare is no excep- compelling business models to emerge. and Patrick Viguerie tion. Although healthcare has been chang- ing for decades—think about the introduc- The promise of opportunity creation and tion of diagnosis-related groups (DRGs) upside is far from certain. In fact, the or the initial push toward managed care in historical record is unambiguous: incum- the 1980s—the Affordable Care Act (ACA) bent companies are often unseated by promises to accelerate both the rate of industry disruption. Thus, we expect that change and the level of uncertainty con- many payors could be unseated in the fronting the industry. Payors face navigating years ahead. However, our research a difficult transition: from an industry in reveals two key insights for payors that which the customer is often a corporation want to thrive despite disruption: or small company and the business is paying claims to one in which consumers • There are three strategic paths that make healthcare purchasing decisions, companies in other industries have used the direct provision of care may be neces- successfully to thrive during and after sary for success, and consumer and retail disruptive change. capabilities really matter. Furthermore, payors must make this transition amid • Regardless of which path they took, these regulatory and consumer uncertainty and companies built the organizational capac- in a fairly short time frame. This industry ity and agility required to lead during the and business-model shift is on a scale disruption. They made big shifts in leader- that few companies and few sectors in ship focus and major changes to resource the economy have been through. allocation, and they developed a faster organizational clock speed and leaner Over time, however, the transition should cost structure. create new opportunities with significant upside. The entrance into the market of Understanding more than 30 million new consumers, disruptive change many of whom have never bought health- care products before, may ultimately trigger Industries change for different reasons. changes that drive real productivity im- Sometimes, the cause is a crisis. The provements in an industry that has lagged subprime mortgage meltdown, for example, in this regard. It may also allow new rocked the financial-services industry. 2 Payor Book — January 2014 Exhibit title: Industry leadership volatility has risen steeply Exhibit 1 of 6 EXHIBIT 1 Industry leadership volatility has risen steeply. % of companies that fell out 5-year topple rate1 of the S&P 500 during the years shown (n = 1,320 companies in 35 industries) 29 0.35 0.30 0.25 2.5X 0.20 0.15 11 Includes toppling due to M&A 0.10 0.05 Excludes toppling due to M&A 0.00 1989–1994 2004–09 75–80 80–85 85–90 90–95 95–00 1 The “topple rate” is the likelihood that an industry leader will lose its dominant position during the next five years. The graph includes data through 2002. Source: S&P 500; McKinsey analysis Insti tutions that had existed in some form for more than doubled during the past 25 years a century or more, such as Lehman Brothers, (Exhibit 1). And the odds that an industry disappeared rapidly. More commonly, com- leader will lose its position during the subse- petitive dynamics (anchored in a variety of quent five years—what we call the “topple drivers, including product quality, performance, rate”—tripled during the 25 years from and cost) produce big changes in the com- 1977 through 2002.1 petitive landscape over time—think about how Japanese competitors gained share When an industry faces disruption, compa- in the US automobile industry over several nies often fail to appreciate quickly enough decades. In some cases, a distinct catalyst the nature, extent, and velocity of the triggers a discontinuous change. The iPod, changes taking place. A number of reasons for example, transformed the music industry, explain this failure. Often, disruptions start just as the iPhone and its applications changed at an industry’s periphery, among compa- the game in mobile handsets, demonstrating nies that provide specialized value proposi- the power of creative destruction. Healthcare tions to different customer segments. In is facing such a discontinuous change. these cases, market penetration begins slowly, with barely perceptible impact. The healthcare industry’s disruption is tak- However, change can occur much more ing place at a time when the overall pace quickly when the “rules of the game” are of change in the economy continues to in- altered. McKinsey research has identified 1 Caroline Thompson and Patrick crease. Two measures highlight this long- eight characteristics that are commonly Viguerie, “The faster they fall,” term trend of increasing “industry leadership found during industry disruptions, particu- Harvard Business Review, March 2005, hbr.org. volatility”: the churn rate in the S&P 500 has larly those triggered by significant regula- 3 tory shifts.2 Healthcare executives can ex- only on competitive advantage but also on pect to see most or all of these in the next operational efficiency. Many of the airlines few years: that survived deregulation did so in large part because of continuous productivity Competitors churn. Lots of new players en- improvements and organizational restruc- ter the market, but most fail. (For example, at turing. As a result, they fly considerably one point after the US telecommunications more passengers now than they did a couple industry was deregulated, there were more of decades ago and at a significantly lower than 50 different long-distance fiber networks cost per seat mile, even though fuel prices in the country. Almost all of them are gone.) have more than doubled. However, churn is not limited to new entrants. Although a few incumbents are able to gain New value propositions reveal new cus- stronger posi tions, many shrink, are ac- tomer segments. Few people knew they quired, or disappear. wanted smartphones until smartphones were invented. In healthcare, new customer Battles occur on two fronts. During indus- segments will emerge as innovative products try disruptions, companies often face regula- are introduced into the market and consum- tory as well as competitive challenges. (In the ers become more aware of the diversity of first few years after telephone deregulation, their choices. more battles were fought in the courts than in the marketplace.) This is apt to be true in Profit pools often shift. During disruptions, healthcare. Not only are the political battles the most attractive industry segments often over the ACA likely to continue for a while, become the least attractive, and vice versa, but numerous negotiations may be required as new entrants flock to the more attractive to settle finer points of implementation. segments and compete away profits. Structural advantage prevails. When market The volume of mergers and acquisitions forces become more important than regula- rises. Deal activity tends to increase during tory rules, real competitive advantage deter- industry disruptions, but it often comes in mines the winners. Understanding and exploit- waves as competitors attempt to keep up ing the future points of advantage can enable with one another. A few decades ago, the 2 These observations are based on both direct industry experi- companies to thrive despite disruption. introduction of DRGs led to a large wave ence and McKinsey research— of provider consolidations. ACA enactment in particular, analysis of a wave of deregulating industries in the Performance differences widen. As the has already resulted in a high volume of both United States. See Joel A. Bleeke, 3 “Strategic choices for newly level of competition increases and the basis payor and provider deals. opened markets,” Harvard of competition shifts to true sources of Business Review, September– October 1990, hbr.org. advantage, the difference in the financial The net result of disruption is usually a mas- 3 For more information about per formance of top and bottom players in- sive reshaping of the affected industry and recent payor M&A activity, see Ankur Agrawal, Celia Huber, creases—and the gap often persists for years. its key segments—where the profit pools lie, and Bryony Winn, “Riding the next wave of payor M&A,” who gets them, and through which business Beyond reform: How payors Productivity and innovation increase. models. Entire parts of the value chain may can thrive in the new world, January 2014, healthcare Strong financial performance depends not be unseated or change in importance. .mckinsey.com. 4 Disruptive change in disruptions, for many reasons. Many the healthcare industry incumbents focus on the status quo; have incentives that encourage profit-and-loss Even before the ACA was enacted, health- leaders to concentrate on near-term, “Horizon care had the hallmarks of an industry vul- 1” performance across existing businesses; nerable to disruption. For more than half and are hobbled by significant organizational a century, healthcare expenditures have complexity that makes major adaptations risen considerably faster than GDP growth. difficult. For most companies, it is also quite Furthermore, healthcare has not achieved hard to create an effective strategic response the types of productivity increases that to disruption. A robust strategic response most other industries have experienced. requires an incumbent to navigate a change in In fact, healthcare ranks near the bottom business models—to strike the right balance in terms of productivity improvements between the new and the old at the right since 1990 (Exhibit 2). time—something an attacker does not need to worry about.