Why Value Generation Doesn't Grow Your Risk-Bearing Medical Group: On Being Foiled by the Middleman

Imagine that you are an electronics manufacturer who has figured out how to build a superb stereo system at a far lower cost (20% less) than your competitors. Over time you’ve perfected the system, created a reputation for high quality and have a machine that sounds great.  Your manufacturing efficiencies position you to sell at a great price to consumers: that's your major strategic advantage in fact. You bring your machine to the “Good Buy” electronic retail chain. They say they’re happy to sell your stereo, with a catch: they’ll pay you 20% less  than they pay your competitors wholesale to reflect your lower manufacturing costs—which you’re happy to do. The catch is that Good Buy insists on selling your machine at the same retail price as your competitor’s machine. You argue with the retailer: if you can’t sell for less, then you forfeit your primary strategic differentiator. Good Buy nods their head. The problem, they say, is that the wholesale price offered by your competitors is too high. They need the margin your stereo provides to offset the high prices they have to pay the other less efficient manufacturers.   They don’t want to forfeit any profit by selling your product for less than similarly complex machines. Tough luck. What you have is a classic case of misalignment with the middleman. Your ability to grow by leveraging your low-cost position depends on the willingness of the middleman to pass on the savings to the consumer.  If you're not aligned it's impossible to craft a growth strategy.  Your savings get lost.

The scenario sounds far-fetched, but it’s a real phenomenon in risk-bearing healthcare right now. I’ve previously written here and here about some of the challenges of being a risk-bearing group. These problems, to one degree or another,

stem from the misalignment between insurance companies and provider groups.  

These are problems inherent to capitation. As a reminder, my overall impression is that risk-bearing groups are, as a rule nationally, taking on more and more financial risk while not having the critical levers and oversight needed to appropriately manage that risk.  Most of my earlier posts on this topic have looked at the expense side of the capitation equation (i.e. the dance between direct expense vs. TME reduction.)

What I haven’t discussed before is the

revenue side of the equation

, and the ways that misalignment with the insurance company can cause real problems with revenue and growth. There are two primary problems-- one dealing with the

rate

you get from the insurance company, and other with the

number of members

:

1)

The rate problem.

 Risk contract renewals come up every few years and inevitably factor in earlier TME performance.  In general (and this is highly variable depending on your environment and the types of contracts you sign)

the lower your expenses, the lower your future revenue

when the next round of negotiations comes around. It's a

perverse incentive

particularly common in ACO contracts. 2)

The number of members (growth) problem.

It's

hard to leverage a low cost position into patient growth

 when the insurance company, who sets the consumer-facing pricing, sits between you and the buyer. Yes- there are some advantages to being in the right "tier" of providers.  But, in aggregate, 

unless a provider is large enough to merit a “pure-play” narrow network insurance offering

, the insurance company needs to blend it with a group of other less efficient providers, thus averaging medical loss ratios among the groups.  

The high-performing, low-cost medical group can’t use its low-cost position to market to consumers

. Patients, after all, buy an insurance product at a middle-of-the-road price which gives them access to all of the network providers—high, middle and low-value alike. It’s great for everyone if they go to the high-value group. But there is no real incentive for patients to pick the value leader once they’ve bought their insurance.  All the hard work that a provider group does to control costs serves as a de facto subsidy to the insurance company.

The various limitations inherent to risk aren't news to the most progressive groups in the country. Crystal Run Healthcare, a group of 370 providers in NY-- that I admire greatly-- is one of the most progressive risk-bearing medical groups in the country.  They recently announced that they're starting their own insurance company. The Crystal Run Health Plan promises to correct some of the mis-alignment between the provider group and the insurance companies, and to allow the group to translate it's strong performance directly to consumers via exchange-based narrow-network plans. It's a gutsy but important move at a critical time. A newspaper interview notes:

  --- Image: nevil zaveri via Flikr, creative commons license