Status Spring 2015

This spring has been uncommonly busy, and I regret that has caused me to slip a couple of self-imposed deadlines here.  Here’s what we’ve been up to.

Blended Value

I continued to work with TKA Director and branding expert Jay Gronlund on our Blended Value initiative — which seeks to redefine strategic enterprise goals beyond the limits of shareholder value, and to incorporate Environmental, Social, and Governance (ESG) factors in a balanced mix.

Knowledge-Based Security

Next up was a small pilot intervention for a section of the Special Operations Command of the US Department of Defense.    It seems that “knowledge” has great value not only where economic conflict is concerned, but also where geopolitical conflict is concerned — especially in this era when the nature of military conflict is continually shifting.

Knowledge to Value

Following that was a major address to the second annual summit of the International Management Consulting Association, with many of their members working in the Middle East and Eastern Europe (include the former Soviet republics).  I presented an initial treatment of a new methodology “Knowledge to Value”, which is designed to systematically mine enterprise knowledge in support of business development strategies.

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Ebola Reveals the “Unwieldy” State of our Medical Records

In late September 2014 a man showing symptoms of the Ebola virus came into the United States from West Africa, was examined by doctors at a hospital in Dallas — and was then released back into the community.  There he came into contact with other people before finally being readmitted to the hospital, where he died within a matter of days.

Our radar failed

If the entry of the Ebola virus into the US wasn’t itself shocking enough, one doctor claims that this will not be the last time such an error occurs — due to what she calls “a simmering crisis in medical data management.”

ebolaWriting in the New York Times on October 14, Dr. Abigal Zuger warns, “Even scarier than that mistake is the certainty that similar ones lie in wait for all of us who cope with medical information stored in digital piles grown so gigantic, unwieldy, and unreadable that sometimes we wind up working with no information at all.” (My emphasis).

Dr. Zuger claims that “hospital servers store great masses of trivia mixed with valuable information and gross misinformation, all cut and pasted and endlessly reiterated.  Even the best software is no match for the accumulation. When we need facts, we swoop over the surface like sea gulls over landfill, pick out what we can, and flap on.  There is no time to dig and, even worse, no time to do what we were trained to do.”

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Up Close and Personal: Our $2.7 Trillion Cottage Industry

I recently had the experience of intensively studying an industry as a consultant — then subsequently (and unrelatedly) becoming a client of that industry.

The industry, as you probably have guessed, is health care.  There are things you learn when you are a patient that you never see when you’re not. (I’ve heard doctors report this as well.)

In the past year I spent a few hours as a “client” in each of two major New York hospitals.  The net results from a clinical perspective were excellent, and I’m relieved to report that in both cases their work is now finished.

One of these hospitals was ranked near the top in NYC hospital quality by the US News and World Report polls, the other somewhere down in the low 40’s.  But my observations apply to both.

Systemically speaking, hospitals as seen from the inside seem almost artisanal in nature.  Very hands-on, customized, laid-back — and, well, expensive.  It’s as if you were a guest in the city’s best private club, where no expense or courtesy is spared.

This has both positive and negative consequences.  On the one hand, the leisurely pace and attention are welcome, especially when one is in a state of discomfort and/or anxiety.  The most obvious negative — the cost of doing things this way — is often hidden, at least until later.

The quest for cost

Inside “the club”, of course, money is never discussed.  It’s just not done — and if you try, you don’t get very far.  In one case I asked my doctor’s office assistant what the cost of a routine, elective outpatient surgical procedure was going to be.  I was honestly trying to decide if it would be “worth it” at this time.  I was told that I would not pay more than 20% of the cost, due to my excellent private insurance plan coverage.  “Sounds good…but 20% of what number?”  was my obvious question.  “Well, let’s see,” she responded, clearly taken aback by my question. “The surgeon’s fee is $7500, the anesthesiologist is probably about $1500…then there is a hospital fee, I don’t know what that is.”

My positive feelings for my doctor notwithstanding, I couldn’t stop myself from mentioning that $5000 per hour sounded like a lot.  “Of course you won’t pay 20% of $7500 — it will be based on whatever your plan has negotiated with the surgeon.  It could be much lower. You’d have to call your plan to find that out.”

Not wanting to give myself sticker shock, and only having so much time in my day to spend on this, I did not pursue her recommended option.  When weeks later the Explanations of Benefits (“the tab”) arrived, she was shown to be nearly 20% low on the professional fees — which were actually $9000 for the surgeon and a little over $2000 for the anesthetist.  But the part she didn’t know — the hospital charge, was over $26,500 — more than twice the combined fees of the three doctors involved.  My afternoon in the hospital cost $37,900 “list price”, of which my insurance plan paid the “discount price” of $17,200 (a discount of nearly 55%).

Hospital costs a

Her advice to me not to worry about it too much, though, was sound.  The cost to me was nothing.  (Thanks, excellent health care plan!)

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The Pharmaceutical Innovation Crisis

I used to read a lot of management books.  Or rather, buy a lot of them, then take a quick look — and promise myself to get around to reading them someday.  When (and if) I finally did, I’d often find the information dated and the advice stale.

Not so with most of Peter Drucker’s work.  In Drucker I find things that sound timely — sometime prophetic — even today.

The productivity of knowledge

Drucker spoke of the productivity of knowledge, and how firms, industries, and even countries who managed to excel at it would over time come to dominate their respective sectors.

When I first heard him use that term, it sounded abstract — and not immediately relevant to my work in business strategy. That changed recently when I conducted a study of the innovation crisis in the US pharmaceutical industry (which represents 80%  of the industry’s R&D worldwide.)  This is widely known in the press as the patent cliff that affects most major pharma manufacturers to some extent.

How pharma creates value

pillsIn a nutshell, a significant portion of the industry’s revenues and profits depends on branded drugs — the more successful of which you see advertised on TV.  Most of these are discovered by rapidly scanning lots of molecules, or computer models of the molecules, for potentially beneficial properties.  The most promising of these are first matched with diseases for which they might be useful, then registered under patents.  Then they are developed by being rigorously tested, first on animals, then on humans in a range of clinical trials.

The data from all these tests are presented to the Food and Drug Administration (FDA) for approval.  Drugs that are approved, and that are added to the ‘formularies’ of insurance companies and government payers who will reimburse patients for their use, can becomes wildly successful.  Lipitor, the statin used to control cholesterol in the blood, is the most successful drug to date, with total sales over $125 billion.

These blockbuster drugs (generally defined as those with annual sales over $1 billion) command prices in the marketplace much higher than their cost to manufacture.  Their gross margins can be as high as 75-80 percent.

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Competition: the Wonder Drug for Health Care

Bubble chartOne broad goal for US health care that most of us can agree on is the need to rationalize and reduce overall costs. As a society, we can meet this goal — but only if we ensure that the health care industry remains competitive in each of its component sectors.

Competition update

Unfortunately, in key sectors this goal remains distant — one that in some cases we are even moving away from. Here’s some of what’s happening in three of the largest sectors:

Pharmaceuticals. Most of the profits here are made in branded drugs, where prices are significantly higher than in the corresponding generics.  Some of these drugs generate revenues in the tens of billions of dollars each year.  When a period of patent protection expires, these revenues typically fall drastically (the ‘patent cliff’).

Certain pharma companies have begun to pay generics manufacturers not to produce a generic version, which presumably would erode the branded version’s profitability.  Such ‘pay for delay’ seems on the face of it to be designed to discourage competition, and has the net effect of keeping drug prices relatively high.  The US Supreme Court has apparently reached the same conclusion, and on June 17 ruled that these agreements could be pursued by the Federal Trade Commission as anti-competitive. Whether or not FTC enforcement will follow through remains to be seen, but it’s a step in the right direction.

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Health Care Spending III: Alice in Health Care Land

AliceWhen Alice tumbled down the rabbit hole, she entered a world (“Wonderland”) reminiscent of her own—but in which everything seemed upside-down, and nothing worked as expected.

After spending over a year researching the economics of the health care industry, I’ve concluded that health care is its own economic Wonderland.  If you were given the hypothetical task of designing an economic system in which the laws of ‘economic physics’ had been miraculously suspended, you could not do a better job than the current US healthcare system.

As a result, health care costs continue to escalate considerably faster than most other household expenses.  Our $2.6 trillion in 2010 health care spending represented nearly 18% of GDP, a proportion that has doubled during the past 30 years.

Economic fundamentals

Most of my knowledge of economics comes, not from academics, but from working as a researcher and adviser to businesses over a period of 40 years.   As a result, I always err on the side of empiricism (i.e., what is) and pragmatism (i.e., how to improve it).

For reference I always come back to capital fundamentalism—the basics of supply, demand, and market exchange.  A ‘pure’ economic exchange works something like this:  you own a product or service that I want to acquire.  You name your price (or we negotiate and agree on a price), I decide whether it’s ‘worth it’ or not, then I decide whether I want to buy, and (if appropriate) in what quantity.  In the purest form, I am also the consumer or user of the product or service, so I can make this value choice first-hand.

Then we ‘do the deal’. I pay you and acquire the product or service, and everyone’s immediate economic needs and goals are presumably satisfied.  We all live happily ever after.  Or if not, and I’m not happy with the result you provided relative to the price I paid you, I buy from another provider next time.

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Health Care Spending II: Where Does It Come From?

Last time we looked at where our health care funds in the US are spent.  At more than one-sixth of our GDP, it’s undeniably a huge factor in our financial lives.  Who pays for all this?  Ultimately, of course, we all do—but the mechanisms by which this happens may surprise you.

Since non-personal spending ($407 billion) is accounted for somewhat differently at the federal level, our focus here is just on the $2.2 trillion in Personal Health Care (PHC) spending in 2010.  A similar pie chart as in the previous post, but this time broken out by funding source, looks like this (figures in millions):

Health care by source

About one-third of PHC spending ($746 billion) is by private health insurance companies—Aetna, ‘the Blues’, Cigna, Humana, United, Wellpoint, and smaller companies.  Medicare, federal health insurance for the elderly, accounts for nearly a quarter of spending ($494 billion).  Medicaid, a joint federal-state program for the poor and disabled, pays for $372 billion.  Of that, about two-thirds is federal, one-third from state and local sources.

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Health Care Spending I: Where Does It Go?

Everyone knows health care is expensive, and is a significant part of our individual and collective budgets.  How expensive, exactly?  And how is that money spent?

In 2010 we in the US spent $2.6 trillion on health care. That’s 2.6 with twelve zeros behind it, or 2.6 million millions if (like me) you get lost in the zeros.  That comes to about $8,500 for each US resident, and more than $11,000 for each adult over age 18.

World GDP b

GDP Data (IMF as reported by Wikipedia)

This is nearly 18% of our $14.5 trillion Gross Domestic Product as a country.  For perspective, it’s larger than the entire US durable goods manufacturing sector ($2.3 trillion), which includes, among others, the computer industry ($377 billion) and the auto/truck industry ($360 billion).  If US health care were its own country, it would stand at number five in the world, behind Germany and just ahead of France.

Where does it go?  The following chart summarizes our outlays of funds (in millions):

Total Health NS

Five of every six health care dollars are spent on Personal Health Care (PHC) — the professional direct care we actually ‘consume’ when we visit the doctor or take our medicine.  The other categories, together about one-sixth of health spending, represent much of the ‘overhead’ of health care.  Administration ($176 billion) includes state and local government program admistration expenditures, as well as the portion of private health insurance that does not directly pay for care.  Public Health activities like vaccinations and disease prevention make up another $82 billion.

Structures & Equipment ($100 billion) includes new building construction and capital equipment.  Research ($49 billion) represents non-profit and government activities like grants for medical research.

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Competitive dynamics: a basic typology

“I love you, you’re perfect…now CHANGE.”  That’s what the market in effect continually tells high-achieving companies—because the world always changes around them.

Companies tend to do best today what they did best yesterday…not what they’ll need to do best tomorrow.

In working with companies of various sizes, in various industries, I’ve noticed that the most significant strategic challenges are those brought on by some fundamental type of industry change.  Anticipating and adapting to industry change is at the heart of what competitive strategy is.

I’ve also noticed that not all industry changes are of the same magnitude or carry the same degree of strategic implications.  I’ve begun informally categorizing these changes with regard to their impact on industry players.  We’ll call these—in ascending order of how difficult they are to manage successfully—Levels 1, 2, and 3.

Level 1 industry change – “New kid in town”

In a Level 1 industry change, a major player enters or leaves the industry.  This could be a major buyer, a major competitor, or a major supplier for the industry.

WB recardsExamples of Level 1 change abound, and you can usually pick up a financial journal at random and find one.  I just now did exactly that, and find two pages into my search an article reporting that Warner Music Group is selling its music publishing business (leaving one less player there), in hopes of clearing anti-trust to be able to buy the foundering EMI (leaving one less player there as well).  EMI owns, among other assets, the master recordings by my all-time favorites, the Beatles.

Level 1 changes can require significant adjustments in any industry.  However, relative to other types of industry change, the impact of a Level 1 change on existing other players is low.

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