US Healthcare Industry Structure
Healthcare is one of the biggest drivers of the US economy. At it’s simplest level, Healthcare is about delivering clinical care from a clinician, mostly a physician, to a patient. This simple physician to patient interaction is surrounded by a very complex and convoluted industry structure that accounted for a total spend of $3 Trillion in 2014 and the spend continues to grow at approximately 5.8% per year and projected to reach $4 Trillion by 2019. This spend amounts to an average of $10,000 per person in the US annually.
In this industry, who is the customer is not a simple question to answer. At a very broad level, there are six key stakeholders:
Providers, including Provider networks such as IDNs and ACOs
Intermediaries (GPOs, RPCs, Distributors)
Amongst these six stakeholders, the US spent $3 Trillion in 2014. The 2015 numbers are not out yet. This number is projected to grow to $4 Trillion by 2019, a 5.8% CAGR. Figure 1 shows a very high level simplistic model of the major stakeholder interactions in the US healthcare industry for non-Pharma space. The Pharmaceutical chain follows a different path and we will cover that later in the report.
The Providers are at the center of all major Healthcare activity. To get a good understanding of the Healthcare industry in the US then, it makes most logical sense to analyze all the stakeholder interactions in the industry with the Provider as the central reference point. In Figure 1, the black arrows show the traditional GPO driven model on the cost side and IDN driven model on the revenue side. With the advent of ACA (Obamacare), the Providers are facing increasing pressure on both the revenue and cost fronts.
On the revenue side the new CMS bundled payment structure and the move from Fee-for-Service to Fee-for-Value is driving Providers to restructure their approach to patient care. This move is driving consolidation in the Provider space and giving rise to the IDNs or Integrated Delivery Networks. On the cost side, with the increase in number of patients coming into the pool due to the reduction of uninsured population, Providers are trying to get more efficient in working with GPOs to keep their purchasing/operating costs down.
As a result, new models of interaction are emerging as shown by the orange arrows in Figure 1. Historically, Providers delivered low margins in the 3-5% range. ACA is putting additional pressure on these margins that is forcing new models to emerge. In this paper, we will examine some of the new merging models.
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From a Provider perspective, in the US, care is administered in several facilities but they can be broadly divided into two groups – Acute Care and Alternate Care centers. Throughout this analysis, we will examine the industry dynamics under these two broad umbrellas. The Acute segment is comparatively more concentrated than the Alternate segment, which is highly fragmented. Both the segments present an interesting set of challenges and opportunities that are ripe for both optimizations of existing models and disruption with new models.
Acute Care, also known, in general as Hospital setting, accounts for majority of Healthcare aggregation. At the end of 2015, there were a total of 5724 Acute Care hospitals and 1000 other hospitals in the US. The total spend on clinical services in this segment was $1 Trillion in 2015 and is expected to rise to $1.3Trillion by 2019. Hospitals are expected to remain the leading provider of medical services in dollar terms due to their specialization in high-cost, complex treatments. The rise in the number of acute and chronic conditions will continue to drive demand for hospital services.
Alternate Care is the other broad segment where care is delivered. This segment is made up of everything that is not a hospital – physician and clinical facilities, nursing homes, long-term care, Dental, home healthcare, diagnostic imaging centers, stand alone cancer centers and other smaller providers. This is a highly fragmented market.
How does the money flow amongst these players?
Of the $3 Trillion spent in 2014, nearly 72% went into providing patient clinical services. A clinical service is any treatment or service a patient undergoes – from a simple wound management to more complex open heart or cancer treatments. There are 700 of such treatment classifications as defined by CMS. The official term for these treatments is DRG – Diagnosis Related Group. So, in 2014 we spent about $2 Trillion on these DRGs across all care settings – hospitals, nursing homes, physician offices etc.
The rest was spent on Medical Products and other non-personal areas such as government admin fee, cost of private insurance etc. Medical products were made up of Pharmaceuticals, Durable Medical Goods and non-durable or disposable medical goods. Pharmaceuticals accounted for almost $290 billion of spend, durable medical $44 billion and $64 billion spent on non-durable or disposable medical products.
From a profitability perspective, the Producers grab the major share of profits in the industry ranging from 16% for Med devices to 23% for Pharma. Insurance companies deliver in the 6-7% range, Pharmacies around 4%, Providers range from negative to 3% and finally Distributors are in the 1-2% range. GPOs are the most profitable at 45% EBIT. Although the net income percent of Providers and Distributors are low, their dollar net income numbers tend to be significantly higher as they have much higher revenues than the non-Pharma Producers.
Now, let’s shift gears a bit and provide a high level definition for each of the stakeholders in the Healthcare value chain. We will then examine how commerce flows amongst these stakeholders with a simple example. As discussed before, at a very broad level, there are six key stakeholders:
Patients: Patients are made up of the general population. We all have medical needs and often see our doctors on either scheduled basis (annual checkups, dental cleanups as examples) or in times when care is needed including times of emergency. Of the $3 Trillion spent in 2014, nearly 72% went into providing clinical services to Patients. A clinical service is any treatment or service a Patient undergoes – from a simple wound management to more complex open heart or cancer treatments. There are 700 of such treatment classifications as defined by CMS. The official term for these treatments is DRG – Diagnosis Related Group. So, in 2014 we spent about $2 Trillion on these DRGs across all care settings – hospitals, nursing homes, physician offices etc.
Providers: Providers form the center of the Healthcare universe where the needed care is delivered to a Patient. The Provider base is made up of two broad segments – Acute Care and Alternate Care. We have already examined the Acute and Alternate definitions earlier in this chapter. A discussion about Providers is incomplete without going into the details of the changes in this space that is spawning new institutions such as Integrated Delivery Networks or IDNs and Accountable Care Organizations or ACOs. IDNs are groups of Providers that were initially banded together so they could create a united front when negotiating with Payers – both CMS and private insurance, for fair reimbursement amounts. We will examine IDNs in depth in a later chapter. In 2015, almost 90% of hospitals were associated with an IDN and there were approximately 1400+ for-profit and non-profit IDNs in the US. ACOs are an emerging model in the Provider space that are rising as a result of the Affordable Care Act (ACA or Obamacare). ACOs are an organization of healthcare Providers that are accountable for quality, cost and overall care of it’s Medicare beneficiaries. An ACO could be made up of doctors, group practices, a network of group practices, hospitals, health systems etc. They are typically confined to a particular geographic area.
Payers: Payers are made up of three major groups – Government in the form of CMS that provides Medicare and Medicaid, Private Insurance Companies and Individuals who pay out of pocket expenses (insurance premiums, below deductible expenses and any expenses not covered by insurance). In 2015, 44% of medical reimbursements came from CMS, 45% from Private Insurance and 11% from Out of Pocket.
Intermediaries – GPOs: GPOs or Group Purchasing Organizations formed to help Providers consolidate buying power and benefit from volume discounts. In 2015, nearly 98% of hospitals belonged to one or more GPOs and nearly 75% of hospital purchases flowed through GPO contracts. Most IDNs and hospitals belong to one or more GPOs. 2015 numbers are not out yet, but in 2014 almost $350Billion of purchasing volume flowed through GPOs. The continued cost pressures for Providers are giving rise to another set of intermediaries called RPCs or Regional Purchasing Coalitions.
Intermediaries – RPCs: RPCs are a group of healthcare providers that have “Voluntarily” combined their respective purchasing volume to get higher tier (lowest or best price on a GPO contract) through their GPO or directly with suppliers. RPCs share geographic proximity but may or may not form a legal entity. RPCs vary in size and member make up but they serve the smaller hospitals or IDNs well as the smaller player typically don’t get the needed attention from the GPOs, leaving room for them to band with an RPC for better price negotiations with either their respective GPOs or direct with suppliers.
Intermediaries – Distributors: Distributors form an important part of the Healthcare value chain. They aggregate inventory from Producers and get it to Providers on a timely basis in the most efficient way as possible. Distributors serve the Acute market, Alternate Market and Pharma. 3 biggest distributors control 90% of the non-Pharma Acute market. Approximate dollars going through the Acute distributors are $18 Billion. These distributors are – Owens & Minor, Medline and Cardinal Healthcare. The Alternate market is more fragmented and made up of several smaller distributors. In the Alternate market, the dollar volume flows are as follows – Physician Offices: $6 Billion; Ambulatory Surgery Centers $1 Billion; Long Term Care facilities: $2 Billion.
Producers: Producers make up a large part of the Healthcare value chain. They can be mainly divided into 3 groups – Durable Medical Equipment, Non-Durable or Disposable Medical Equipment and Pharmaceuticals. In 2014, $400 Billion were spent on products made by the Producers in the US. Pharma made up a large part of the Provider business at 73% or $290 Billion; Durable Medical Equipment was at 11% or $44 Billion and Non-Durable or Disposable Products made up 16% or $64 Billion.
Regulators: While several Healthcare industry analyses ignore talking about the Regulators, it’s important to understand their makeup as the regulatory bodies have a significant impact on the Healthcare system overall in the US. Regulators are mainly made up of US government entities that exhort a substantial impact on both the economic and clinical direction of the US healthcare system. The government entities that make up this part of the stakeholders are Department of Health and Human Services, Food and Drug Administration (FDA), Centers for Medicare and Medicaid Services (CMS), ONC or Office of National Coordinator for Health Information Technology, CDC or Centers for Disease Control and Prevention, Office of Civil Rights, HIE or Health Information Exchange and more. Some of the key compliance controls involved are HIPPA, ICD 10, 21 CFR 820 Quality systems and more. We will cover these in detail in the Regulatory chapter. The Office for Civil Rights (OCR) within the U.S. Department of Health and Human Services (HHS) is responsible for enforcing HIPAA Privacy and Security Rules. To this end, the OCR investigates privacy violations and enforces penalties for noncompliance.
Prior to the HITECH Act, the OCR only audited a HIPAA covered entity when a patient filed a complaint with the agency. However, the HITECH Act now requires the OCR to conduct periodic audits of providers and HIPAA business associates to ensure they are HIPAA compliant.
In addition to holding covered entities accountable, the OCR publishes HIPAA Privacy Rule guidance materials, which are intended to help organizations meet requirements for compliance. The OCR also provides a variety of healthcare compliance resources in the form of training materials and guidance materials for covered entities.