Will Healthcare reform of the 90's be more significant then the DRG's of the 80's?

Messenger, Spring 1994, Vol.21, No.1, pp.8

Achieving economies in the U.S. healthcare market is currently an acute social/political priority as payers, providers, and suppliers scramble to respond to industry and government healthcare reform initiatives. While it is not clear what "reforms" will be legislated, it is absolutely clear that these recent initiatives have catalyzed and accelerated a transformation that has been in the making for at least a decade.

This is not a passing, isolated domestic phenomenon. Worldwide, there are increasing concerns about medical expenditures as the cost of healthcare in more and more countries approaches or exceeds 10% of the gross national product. The U.S.is certainly among the most concerned as it's expenditures lead the pack at 14%. And the problem is worsening as:

• growth of the elderly or "medically intensive" age bracket as a percent of the population; and the increased sophistication of medical technologies are driving costs up, and
  
  
• the desire and ability of economically strained governments and industry to absorb the financial burden of "healthcare" is diminishing.
  
  

These are long term trends confronting the U.S. and most of the major industrialized nations. While "reform" is now at the center of the U.S. political stage, it should be kept in perspective that it is just one more in a series of reforms to stabilize and / or shift health care costs.

THE IMPACT OF DRG REIMBURSEMENT

During the mid-1980s, DRGs were used to attack steadily rising healthcare costs by decreasing hospital inpatient revenues. DRG based reimbursement and the subsequent reaction of the private insurers resulted in a 27% decrease in hospital days per capita. While it's arguable whether overall healthcare costs were actually curtailed, it is clear that the hospital industry experienced a dramatic change...

• 500 hospitals closed (7%) between 1983 and 1992... slowing the growth of IVD revenues and changing the character of institutional customers;
  
  
• an additional 400 hospitals (6%) were consolidated spurring the growth of commercial hospital chains, such as Humana and Hospital Corporation of America, which created a more savvy and price sensitive volume buyer; and
  
  
• 450 "true" GPOs and hospital alliances emerged, such as the Voluntary Hospitals of America, SunHealth and AmeriNet, with many vying for position with member hospitals; often promising manufacturers volume purchase opportunities but providing insufficient guarantees, thereby requiring manufacturers to both "work with" and "work around" their systems to be successful.

Much of the impact of "change" was absorbed by the providers with mostly secondary effects on their suppliers. The net effect on the IVD industry after 8-10 years was an overall slowing of growth as manufacturers adjusted to a reduction in the number of institutional customers, complications in the buying process (changing the actual buyer and buyer roles within the purchasing site), and increasing price pressures.

MANAGED CARE CUTS DEEPER

Managed care is emerging as the "reform" of the 1990's. It is widely known that the Clinton plan favors "managed care" groups. And, based on recent growth, it appears that U.S. industry has already discovered and is embracing HMOs, and PPOs as a cost management and control venue.

Clearly, the advantage of managed care groups lies in their ability to tackle "healthcare" cost on a broader front, and thereby minimize the propensity to cost shift... the recognized shortcoming of DRG based reimbursement. And managed care companies are gaining a reputation of not only being tight fisted, but as being the leaders in the development of tools to manage costs down. For example, some of the most sophisticated managed care payers and providers already have the information systems and experienced staff to attack their pharmacy costs with methods such as:

• controlling price through discounts, contracts and capitation agreements;
  
  
• controlling volume with closed formularies and drug utilization/medical procedure reviews; and
  
  
• restricting demand by prohibiting sales reps from calling on member physicians and even "counter detailing" member physicians to combat pharmaceutical marketing messages that may conflict with established formulary policies.

We are still early in the evolution of managed care and, so far, hospitals and physicians are bearing the brunt of this reform as they compete with each other to obtain the captive patient populations of various managed care plans... usually under stingy capitated rate agreements.

However, unlike DRG based reimbursement, the impact of managed care already promises to extend well beyond providers (hospitals and physicians) and encompass their health care product suppliers as well.

This is apparent in the pharmaceutical industry with the growth of commodities/generics, changes in market access strategies, the restructuring marketing/sales organizations, and the reorientation of price and strategies.

We are already seeing the pharmaceutical industry beginning to make fundamental changes in the way it does business. For example:

• Lilly is jettisoning profitable non-pharmaceutical businesses to provide the resources and focus required to restructure its pharmaceutical core;
  
  
• beginning with Marion Merrell Dow's buyout of Rugby-Darby's generic business and Miles' recent purchase of a minority interest in Schein Pharmaceutical, the trend is for manufacturers of brand-name products to invest heavily in generics - either through buyouts or by establishing their own generic subsidiaries. Wyeth-Ayerst, Rhone-Poulenc Rorer, Merck, Upjohn, and Zeneca have all recently started their own generic units. The trend is spurred by drug companies' desire not only to seek an edge with managed care purchasers but to retain as much revenue as they can from products with patents that are about to expire; some companies have begun to construct new means of market access. Most notably, in a $6 billion deal, Merck acquired Medco Containment Services last July, a pioneer of mail order distribution in the managed care environment; and
  
  
• Marion Merrell Dow became the first in the industry to cut its sales force in an effort to adapt to the changing environment when it announced an 18% reduction last summer. Syntex followed close behind with an announced 13% reduction.

WILL IVD BE EXEMPT?

The fact is, the diagnostics industry has not yet been challenged as aggressively as the medical/surgical and pharmaceutical industries by these same managed care companies. But this is not necessarily a reprieve.

As should be expected, priorities have been focused on bigger ticket items such as hospitalization (length of stay) and physician expenses. Pharmaceuticals are a bit further down the line... and diagnostics still further down the line.

Diagnostic tests have been a lower priority than pharmaceuticals for good reason.

First, at 4% of the total healthcare spending, they represent less than half of the total US healthcare premium for pharmaceuticals.

Secondly, there is much less "profit" to be wrung out of the diagnostic manufacturers:

• unlike pharmaceuticals, diagnostic tests aren't protected by patents (generally) and do not command extreme "premiums";
  
  
• hospital and reference laboratories have been relatively cost conscious buyers since the advent of the DRG system in the mid-late 1980's and have "shopped down" the excesses in the market; and
  
  
• the diagnostics industry is over-capitalized in general, and manufacturers have been competing fiercely for survival.

And, third, unlike pharmaceutical costs which are largely outside product costs, fully two-thirds of diagnostic testing costs are inside costs for labor and facilities. This means that the product portion of diagnostics is less than 1% of healthcare spending in the US or 1/10 of that of pharmaceuticals.

Furthermore, there are numerous other tactical issues that when taken as a whole, complicate and hinder a more rapid transformation of the laboratory market (such as the investment in physical plant and the cost of prematurely retiring capital equipment).

But just because it is not "in your face" today, don't be lulled into thinking its not going to happen. The effects of these long term health care trends are now coming into focus and need to be an integral part of your marketing planning .

As managed care covers a greater percent of the "insured population"... as providers become more sophisticated about their costs and more sophisticated with their tools... the "managed care" impact on diagnostics will likely be more significant than anything we experienced under "DRGs".

Robert Bauer is President of CaseBauer, a Dallas based business development consulting and marketing research firm specializing in In Vitro diagnostic markets, worldwide. 

CaseBauer has 5 practices:
Market Modeling, Strategy / Business Development, Benchmarking, Market Research and Business Services.