Squeezing the Balloon:  Thoughts on a High-risk, Low Margin Business

I recently ran into an old colleague who works as a consultant to one of the large national pharmacy chains.  We got to talking about the various clinical services that the pharmacy has explored over the years, beyond low acuity retail care.  It turns out that, after an auspicious start, the big national pharmacies are increasingly shying away from providing clinical care and are beginning to lease their in-pharmacy clinics to local healthcare systems to run.

22355239325_8d7596dccd_zNow, theoretically, the corner pharmacy is a perfect place to deliver healthcare.  But it turns out that the pharmacies have run into a barrier: simply, the margins on clinical services can’t compare to the margins on things like cosmetics.  Eyeliner, in some cases, generates a 90% profit–much of which goes to the retailer. No clinical service can deliver these types of returns.  As readers know, it’s uncommon to find any direct provider of clinical services that can generate anything beyond 7- 10% margins at the high end.  2-3% is more common.

Physician groups generate particularly unenviable returns:  here is one of my favorite charts from a American Healthcare post a couple of years back: Pricing Risk: What Margin Should Risk-Bearing Healthsystems Reasonably Expect?  The chart is from a 2014 AMGA report showing operating margin per physician nationally, by region from 2009- 2013.

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Operating Margin per Physician by Region

Why are clinical margins so squeezed?  How did healthcare become a high-risk, low margin business? What is it about clinical care compared to, say, cosmetics?

Here’s one hypothesis:  The problem lies in the clinical healthcare’s supply chain and it’s multiple supplier dependencies.  Everybody, from administrators, doctors, pharma, medical device makers, hospital bed makers and so on is at the table.  Every product, even if essential and fairly priced, also comes with supplier margin expectations.  Add enough suppliers (each with 20% margin expectations to keep their investors happy) and and the system begins to run out of money.

Of course, plenty of pricing is not fair.  Nowhere is this better illustrated than the recent drama over the pricing of epinephrine.  Mylan pharmaceuticals was accused of charging over $600 for what’s basically a 2$ medication when dispensed in vial form.  It’s a separate problem from medical inflation caused by innovation: medical advances will of course lead to higher healthcare costs.  We now treat, at great cost, metastatic melanoma and save lives.  The unfair pricing of a $2 medication is a different matter.

A wise colleague who has decades in the insurance business regularly explains that healthcare resembles a “balloon”.  If the dollars available for healthcare are relatively finite, then increases in the cost of everything from durable medical equipment to drugs to hospital beds, implants, surgical equipment and the like need to be offset by decreases in the cost of something else.  Squeeze one part of the ballon, and another part needs to give.

From the medical group’s perspective, most FFS medical groups have been relatively shielded from the increases in the cost of everything from Epi-pens to X-ray machines by what’s basically a payment firewall.  Physician charges have been paid from a different bucket of money than hospital and drug charges and physician salaries could traditionally be protected through aggressive negotiation with insurers and market domination. It’s led to factious relationships between insurers and providers.

In risk, though, the dynamic between the insurance company and the provider group is different.  In global cap (or at in the case of episodic risk payments) there is no firewall between payment buckets.  The risk bearing groups themselves need to figure out how to juggle the dollars to pay for $600 Epi-pens.  And, the amount of money available to pay for physician salaries and overhead ultimately depends on how effective the insurance companies are in negotiating vendor costs with suppliers. In the absence of national medical pricing policy, the insurance company is the only brake for the middleman.  The insurance company’s ability to drive down vendor cost is critical for risk bearing groups and is what will distinguish a good insurance partner from a bad one going forward.

This is increasingly important in a time of big increases in pharmacy costs.  The AMA reprinted a chart showing the rate of growth in various sectors of the healthcare system.  (Physician services, btw, represents about 15% of the national healthcare spend).


This increased reliance on the insurance company to serve as the brakeman for vendor costs is one reason why I’m increasingly less concerned about health insurance company consolidation. If you’re in risk, what you want is a couple of big insurance companies administering your risk contracts.  The bigger the insurance company, the tougher the push-back on pharma and medical suppliers which is where the bleed is happening.

Of course, your other option is to get out of clinical services and into the eyeliner business… I hear that it’s easy money.


Photo: Art Gallery ErgsArt via Flikr, cc license.