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The flywheel and the hedge

Vertical consolidation limits
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We've been talking about the hedge-and-flywheel strategy of the big vertically consolidated healthcare companies for a while now, most notably in my post from a year ago on consolidation vs. integration, and most recently in the comment I made on Jeff Goldsmith's LinkedIn post comparing Optum (part of the UnitedHealth Group conglomerate) to the truly vertically integrated Kaiser Permanente system. A few people messaged me separately to ask what I meant by hedges and flywheels. How do they work? Probably worth taking a quick step back first, and (of course) grossly oversimplify things.


The major insurers have a natural desire to consolidate horizontally, for all the normal reasons why a financial services company would want greater scale (better cash management, low borrowing costs, greater risk mitigation, etc.). But that's increasingly difficult to do, for regulatory reasons. And so the insurers that are national in scope have been steadily acquiring (or merging with) profitable assets along the health care value chain—pharmacies, PBMs, and medical groups are the most notable. In Optum's case, you also see revenue cycle technology, consulting services, and clearinghouse assets (much to its recent chagrin), among dozens of other businesses.


Some of those assets act as diversified hedges on others: as some businesses cyclically thrive and struggle, they are supported by others not locked to the same business cycles. But arguably the most valuable assets are those that serve as flywheels to the rest of the enterprise. Physicians in medical groups move patients onto Medicare Advantage (of which United is the largest plan issuer), which allows them to be appropriately risk adjusted and more-centrally managed. They in turn get their pharmacy benefits managed in-house, with revenue capture services managing billing (both to internal and external customers). And, perhaps most significantly, the mere existence of these businesses under the same corporate umbrella allows for money to be moved between business lines and subsidiaries in ways that maximize overall profit—a concept known as transfer pricing. It also, perhaps not entirely accidentally, makes it a lot harder for outsiders such as purchasers, policymakers, or the media to assess the true profitability of any particular business unit. All of this is old news to regular followers of these companies. This strategy has been a solid growth driver to companies with national insurers for at least the past decade.


But as we detail in this week's Slides of the Week, there are signs that this approach is losing steam. Not dead, mind you, but facing a number of challenges that call into question future growth. Like nearly all large conglomerates (and empires, one of which in particular I really do think about at least daily), the sheer complexity of the portfolio becomes unwieldy and requires an unmanageable level of oversight. But more important, the flywheels that have supported these companies' valuations for so long seems less potent than before. The MA and PBM flywheels, in particular, are showing signs of distress as regulators/legislators push on reimbursement, and (on the MA side) as demand becomes more unpredictable.


So what's a major healthcare conglomerate to do? For years, vertically consolidated healthcare firms have promised greater integration in the form of a platform strategy à la Kaiser—not only as a means of appeasing skeptical regulators pre-acquisition, but also to establish a future option. Well that option might need exercising sooner rather than later. With overcomplexity becoming a burden, and MA's profitability under threat, greater asset integration may be the only key to ensuring future profitability, both to streamline operations and more-profitably manage patient care under MA reimbursement. In other words, a platform strategy might be what saves them.


So, to recap: most vertically consolidated healthcare companies publicly say they want to be integrated platforms, have very obviously eschewed that strategy in favor of a far more profitable portfolio/flywheel model—but might have to do it anyway (at least to some extent) to preserve the very conglomerate structure they have created.


And that's pretty funny.


The slides this week were pulled from our recently completed State of Healthcare 2024--which we've been presenting to member organizations already. We'll be posting the book version and full slide deck online for members in the near future--and announce plans for a members-only webinar series at the same time. If you'd like to get access to that work, you can schedule time to chat with me here or contact us using the form below. And for non-members, we'll be talking more about this issue in our upcoming June 13 Board Briefing on the state of plans and insurers more generally. Sign up, if you haven't already!



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