Healthcare seems ripe for disruption by new entrants, and there has been no shortage of trying. According to a recent report published by PWC’s cbInsights, healthcare was the second largest US sector for investors in 2017, knocking the mobile and telecom sector into third place.
It’s not hard to understand investor interest in the healthcare space. Most consumers, after all, find their healthcare to be pretty “meh”. The most recent numbers I could find revealed the top-rated legacy healthcare provider in the country, measured by Net Promotor Score, to be Kaiser Permanente. It received a somewhat paltry Net Promoter Score of 31 points. This was, unfortunately, still 19 points higher than the industry average.
Yet, despite this flood of investor interest, an industry primed for disruption and a range of ambitious new care delivery companies, we’ve yet to reach a tipping point where patients abandon legacy care for new entrants en masse.
One example: for some years I’ve been a patient of the investor-backed One Medical Group. One offers a high touch approach to primary care with an attractive commercial membership model. It beats traditional primary care in every way and it’s been good to see their steady growth. According to their website, after being founded in 2007, One Medical is now in eight markets and has around 50 practices.
Which is pretty admirable growth…. till you contrast it with health club phenom Orangetheory Fitness. Founded in 2009 in Fort Lauderdale as a single club, Orangetheory Fitness, (which started franchising in 2010) had 26 clubs in 2012, 61 clubs in 2013, 157 clubs in 2014 and 338 clubs in 2015. Today, it has more than 400 studios in 38 states and seven countries.
That growth is pretty extraordinary for a service industry that is already well served by a range of high quality competitors. Orangetheory’s benefits appear incremental at best, but are clearly enough to earn a quick loyal gathering of customers.
In contrast to Orangetheory’s rabbit-like reproduction, healthcare has a long gestational period.
Is there something about healthcare that makes growth harden than in other consumer sectors?
Harvard professor Michael Porter has written extensively about five forces that determine the intensity of competition in a given market. One of the these is “barriers to entry”. These barriers favor the incumbent provider while making market entry difficult for new companies. They impose a cost element which incumbents do not have to bear:
- Economies of scale: Established companies are able to provide a unit of service for less than a smaller firm, forcing new entrants to pay more to enter a market.
- Product differentiation: Incumbents have brand identification and customer loyalties. This forces entrants to spend heavily to overcome these loyalties.
- Capital requirements: The financial resources required for infrastructure.
- Access to distribution and sales channels: These may be locked up by incumbents.
- Cost disadvantages independent of scale: Including learning or experience curves, proprietary product technology, favourable locations and government subsidies.
- Government policy: For example, licensing, etc. Incumbents have fine-tuned their business to meet regulatory requirements.
- Switching costs: These are one-time costs the buyer faces when switching to a new entrants
All of these barriers need to be considered by new entrants in any industry, but some are particular concerns for healthcare delivery firms. In particular, healthcare carries a big regulatory burdens, has high capital requirements and product differentiation is an issue. Switching cost, though, is probably the most important and undervalued factor for new healthcare entrants.
What are healthcare switching costs? In short, they range from administrative hurdles like transferring medical records, to finding a new practice, establishing new trusting relationships, adapting new treatment plans and the like. There are high practical and emotional costs to switching doctors, no matter how middling a patient’s current care experience may be.
The reason switching costs are a prime concern for new entrants is because, unlike many of the other barriers that can be overcome by better funding, management and vision, switching costs are borne by the consumer and there isn’t much that new entrants can do to mitigate them other than make their offering so compelling that they outweigh the costs.
Even still, plenty of consumers won’t switch, despite better terms elsewhere, if the immediate pain is too high. Banks are a perfect example of this dynamic: Many consumers hate their bank; Wells Fargo Bank apparently has a NPS score of -2, Bank of America’s NPS is -24, and Santander’s is -25. The industry average for Commercial Banks is 0. These are the largest banks in the country, who hold onto millions of customers, even as thousands of smaller, better banks offer more interest, free checking, ATM fee reimbursement and the like.
A report by the Federal Reserve found that bank switching costs (time, effort, aggravation, forms, direct deposit, but also “trust” in a large brand…) not only limits consumer mobility, but also allows incumbents to keep costs high.
In healthcare, there are plenty of patients who like what they have and won’t consider a switch, and that’s fine. For some patients, especially those with chronic, severe and complex disease, maintaining an established relationship with a trusted doctor is paramount.
But there are plenty of other patients where the barrier to buying better healthcare is simply administrative nonsense– such as managing the hassle of records transfers, logistics, scheduling and the like. New entrants can try to make this as easy as possible, but if healthy competition is seen as a good thing, there is a role for regulation too.
America has a long history of encouraging competition by passing regulations to reduce switching costs. For example, back when long distance was a thing, utility commissions limited switching fees imposed by carriers. The same idea happened when federal regulations were passed to require “unlocking” of cell phones by carriers.
As a start, many states have now passed laws limiting “copy fees” charged when patients ask for their records to be transferred to a new doctor. Improved health information exchanges, consistent IT formats and standards regarding access to intra-operable IT would go a long way to also reducing the pain of switching.
In the end, getting switching costs as low as possible will be essential for entrepreneurial healthcare to reach the tipping point.