The past decade has seen a significant shift in the US healthcare industry as managed care segments gained market share at the expense of other healthcare organizations. This shift helped produce such value-creation winners as health maintenance organizations (HMOs) and pharmacy benefit managers (PBMs), which delivered $40 billion and $15 billion, respectively, to shareholders between 1983 and 1993.

But as the industry continues its transformation, new winners are emerging. Collectively, the 15 largest competitors in 1993 increased their economic value by only 7 percent in each of the following two years. The main reason was the sub-par value-creation performance of some of the largest HMOs and the indemnity insurers. In comparison, HBO, HealthSouth Corporation, and Oxford Health Plans—three examples of a remarkable surge by smaller healthcare competitors—tripled their total economic value in 24 months. For all the focus on the acquisition-driven growth of larger competitors such as United HealthCare/MetraHealth, the industry as measured by the market value of public companies is fragmenting, not consolidating.

How they created value

Analysis of the new value creators in healthcare reveals the continuing importance of strong medical cost management skills, collaborative relationships with other healthcare participants, and a performance-oriented organizational culture that strives for profitable growth. It also sheds light on several new areas that are likely to generate the greatest shareholder value during the remainder of the decade.

Exhibit 1 shows the largest 15 healthcare payor/provider institutions in the United States in 1993 and late 1995, measured by estimates of economic value. Exhibit 2 lists the largest creators of economic value over the 1993-95 period on a dollar value basis; Exhibit 3 lists the same winners by their increase in value as a percentage of their average common equity. The companies in Exhibit 2 and Exhibit 3, then, are those singled out by the capital markets as having strong growth prospects. If the markets are right, the winning companies will be those that manage healthcare information, those with aggressive local market growth, those that deliver innovative specialty care, and those that take part in the further consolidation of US hospitals.

Information management. Between 1993 and 1995, HBO created more than $2 billion in increased market value for its shareholders. It has focused on providing information systems, helping other institutions improve their basic medical cost management, and enhancing information management. Even PhyCor, a physician practice management company, has created significant value through providing information management knowhow to physician groups.

Some of these information technology players have combined effective hardware, network, and database capabilities to unlock medical cost management opportunities in the most mundane settings. Rather than focus on complex outcomes measurement and clinical protocol software, for example, HBO has concentrated on the information payors and providers need to manage their business better. But a good many pitfalls lie in wait for organizations that rush into the IT arena without keeping a grip on productivity basics.¹

Attractive local markets. The capital markets’ modest enthusiasm for large HMOs such as US Healthcare and WellPoint supports the view that traditional healthcare payors have passed their prime in terms of value creation. However, the recent performance of Oxford Health Plans, one of two new HMOs in the list of the top 15 healthcare organizations, shows there is still value in the basic fundamentals of healthcare management—particularly in attractive and rapidly growing markets.

Oxford Health Plans outperformed its New York City competitors by investing in a growth strategy, working collaboratively with providers, and tailoring its marketing techniques and products to individual market segments. It has successfully penetrated the high-end professional firms in New York City and proven adept at penetrating Medicare and Medicaid segments. In late 1995, the company had more than one million lives and 40 percent of the HMO market in the greater New York City area.

Alternative settings and specialty care. In the space of two years, HealthSouth, Omnicare, and Surgical Care Affiliates created $2.6 billion of value—more than doubling their value—by capitalizing on the continuing shift of services away from traditional in-patient settings. When coupled with effective physician governance and appropriate management information, these provider organizations will continue to grow in importance in the US healthcare system.

For example, HealthSouth, a company that offers comprehensive rehabilitative services in low-cost settings, saw its revenue grow from about $100 million in 1989 to nearly $1.5 billion in 1995 through both internal growth and acquisitions. Its target markets include cost-conscious employers and managed care organizations nationwide.

Further hospital consolidation. The sustained success of Columbia/HCA—the largest hospital chain in the United States—along with the recent strong value-creation performance of Tenet Healthcare and Health Management Associates, is evidence of continued in-patient rationalization. With 30 to 50 percent of hospital capacity still needing to be removed from the US market, the next five to seven years may offer Columbia/HCA and other consolidators significant additional running room.

The next wave of hospital consolidation will be difficult, however. Capacity will be reduced in not-for-profit community hospitals and academic medical centers, but because these institutions have a variety of stakeholders, the process is likely to be slow and cumbersome.

Questions for large payors and providers

The common link between the winning companies of the past two years has been an emphasis on profitable growth. Value creation in any industry is difficult without growth, and the degree of change in the healthcare marketplace means winners will be those that capitalize on and grow with change, rather than manage conservatively. They will achieve this not necessarily via acquisitions or a price-driven strategy, but rather by carefully analyzing how growth can best be secured.

The rise of smaller, more agile growth-oriented competitors raises important issues for senior executives of larger organizations. They need to ask themselves the following questions:

• Is our growth strategy clear and aggressive? In the face of declining revenue growth rates, many healthcare institutions have entered a cost-cutting spiral without apparently paying attention to the task of identifying and penetrating new markets or developing new products.
• Are we dividing the organization into smaller business units to unlock entrepreneurial energy? Decentralization may be the key both to attracting employees who can out-compete smaller entrepreneurs and to allowing them significant latitude in how they run their business. In the New York City market, for example, large national payors may have constrained their local management by comparison with the entrepreneurial freedom enjoyed by Oxford Health Plan’s management.
• How are we placing our bet in the healthcare information and technology segment, if at all? In the late 1980s, several large healthcare payors, such as New York Life and United, invested in the emerging PBM world. Others, like Prudential and Metropolitan, decided not to. Largely because of their PBM investments, several payors have remained among the overall leaders in the industry, while a number have dropped off the list. Information systems and technology may become the PBM of the 1990s: large payors and providers who neglect this area may find themselves relegated to also-rans in the industry. If an organization does not enter the information and technology segment directly, it must at least adopt a pragmatic approach to investing in its own information systems to support its core business.
• Do we have local market strategies mapped out, and are we pursuing them aggressively? Conservatism among today’s high-share players in markets with relatively little managed care may lead to the emergence of more organizations like Oxford Health Plans at the expense of today’s leaders. Large underpenetrated markets where aggressive managed care growth is possible include Atlanta, New York, Chicago, Orlando, and other cities in the south-east with populations of over 250,000.
• Are we taking advantage of opportunities in alternative settings and specialty care delivery? The trend toward moving care out of hospitals and other institutions will continue. The low real estate costs and enhanced service levels characteristic of in-home care, neighborhood-based specialty clinics, and even mobile care delivery units offer compelling competitive advantages over hospitals saddled with high fixed costs.
• Is there a way for us to play in the hospital consolidation trend as either a complement to or a substitute for Columbia/HCA? Organizations with strong hospital management and marketing skills and a willingness aggressively to pursue restructuring deals with existing hospital management and governing boards will find enormous opportunities to create value. Just as Wal-Mart is not the only retail discounter in the United States, Columbia/HCA will not remain the sole hospital consolidator over the next few years.

Industry experts who assert that the healthcare delivery and management sector has lost its luster are missing broader trends. Growth and change in the industry will offer many opportunities to create economic value. Healthcare’s new value creators have proved that it is possible.