The Disruption of American Hospitals

John McCracken, PhD

From their humble origin in Philadelphia in 1751, U.S. hospitals have evolved into large, expensive, technology-laden institutions at the epicenter of the healthcare system.  But that is changing as new players, the deployment of advanced technologies and the expansion of digital health is driving a shift of patients from large, centralized facilities to smaller, more convenient and cost-effective sites of care.  This inexorable change marks a real threat to the traditional dominance of American hospitals. 

Annual inpatient admissions have dropped 12% over the past decade despite an 8% increase in the U.S. population over the same period.  Hospitals have tried to offset declining inpatient census by expanding outpatient services, but operating margins have steadily eroded as growth in operating expenses has outpaced revenues.  Moody’s reports that median hospital operating margins shrank to just 2.7% in 2016, and today one in four of the nation’s 4840 community hospitals faces a negative operating margin.  Moody’s has revised down its 2018 outlook for non-profit hospitals from stable to negative based on its expectation that cash flows will contract even further over the next 12-18 months. 

Until the beginning of this century, centralizing care around a hospital made sense.  Without electronic health records, patients had to be brought to a central location where information could be stored and shared, and reliance on expensive technology required a financial model that allowed the aggregation of high fixed costs.  In a fee-for-service environment that rewarded hospitals for any and all care provided, there was no reason to limit services or try to become more efficient. 

Today remote monitoring, wireless communications and new technologies are making it less necessary for patients and physicians to interact in a hospital setting.  Electrocardiograms, x-rays and ultra sounds can now all be performed in patients’ homes with the use of portable technologies, significantly lowering the cost of care.  Moreover, those many services that are not yet amenable to an ambulatory setting can be performed at new, more efficient micro-hospitals, independently licensed facilities with acuity comparable to a community hospital but at a fraction of the size and cost.  

With increasing pressure to create a healthcare system that is more efficient, value oriented and patient-centric, there is a growing demand for alternatives to hospital-based care.  While hospitals will continue to serve the critical role of delivering high-intensity inpatient care, decentralized care that meets the majority of consumer needs will take an ever increasing share of total healthcare spending. 

The biggest threat to hospital’s traditional dominance comes from the mega-deals involving CVS-Aetna, Humana-Kindred, Optimum-DaVita, Walmart-Humana and undoubtedly soon-to-be others.  These new combinations in the healthcare ecosystem are huge, and enjoy millions of loyal customers and vast amounts of data that can be used to manage individuals’ health purchasing decisions.  Their scale and access to financing gives them a significant competitive advantage over traditional hospitals in brand recognition and number of consumer interactions. 

What these new combinations do not have is hospitals.  The rising cost and declining use of inpatient care make that segment of the market unattractive.  They will be content to carve off the profitable portions of outpatient care and use their negotiating leverage to contain hospital costs. 

The sweet spot for these new players will be chronic care management.  Chronic care consumes over 90% of Medicare outlays and 80% of total U.S. health spending.  That’s the rationale for CVS-Aetna to re-make their 9800 retail sites into community health centers and expand the capabilities of their 1100 retail clinics to include preventive health, medication management and chronic care management. 

More than 75% of the U.S. population lives within five miles of a CVS pharmacy, and the time required for a visit to a MinuteClinic, from check-in to check-out, averages less than half that of a scheduled appointment with an office-based clinician.  By offering an attractive value proposition to consumers in the form of lower costs and convenient access, CVS-Aetna, Walmart-Humana are poised to represent a major threat to reduce hospital ER visits and inpatient days. 

The hospital industry is on the verge of major disruption.  During the past few years other industries, including retail, banking and higher education, have suffered significant market disruption from technological change, new entrants and changing consumer preferences.  Hospitals are not immune, and their future will be much different from their past. 

John McCracken is Director of the Alliance for Physician Leadership, an educational partnership between the University of Texas at Dallas and The University of Texas Southwestern Medical Center which offers an MS/MBA program in leadership and management exclusively for physicians.