The New Measurement of Value in Medicine: Understanding Outcomes & Competition in a Changing Industry

August 2017

By David Friend and Patrick Pilch

Lewis Carroll wrote in Alice’s Adventures in Wonderland & through the Looking-Glass, “If you don’t know where you are going, any road can take you there.” That has been an apt description of the alignment of healthcare payment and outcomes for some time. The roads are getting clearer and the destinations and goals measured and paid for are becoming more distinct. But new entrants and competition are disintermediating legacy providers and therapies, changing the determination of value for companies, therapies and episodes of care. This is disrupting traditional methods of value validation in the process.

What is value and how do you measure it?

In financial terms, value is often measured by discounting projected future cash flows back to the present. This has been an acceptable approach in many industries, including healthcare. However, value changes over time, as the sense of the future evolves.

Case in point is the rise and demise of Tower Records. In the 1980s, when the music industry distribution model increasingly utilized specialty focused full-service record stores, Tower Records flourished. By 2006, Tower Records filed for bankruptcy, brought on by debt that supported an aggressive expansion strategy that failed to understand that music downloads (plus streaming services) were becoming a new competitive force to Tower as an alternative, personalized distribution channel. Tower Records’ failure to recognize new forces of competition and innovation was fatal. By adhering to a facilities-driven channel strategy and continuing to pursue the wrong capital strategy, the company ended up with too much inventory and facility capacity, which ultimately led to its demise.

For the healthcare industry, as care becomes more consumer-focused and personalized, new entrants and competition are coming into the industry. In addition, reimbursement is migrating to episode-based bundles. The industry is facing a disruption scenario much the same as Tower Records. The value of healthcare assets is changing as their respective importance and efficiency shift risk and worth.

As Michael E. Porter, Harvard Business School professor and author of Redefining Health Care: Creating Value-Based Competition on Results, said: “The only way to truly reform healthcare is to reform the nature of competition itself.” This means disintermediation of incumbent players by new participants, (think the iPhone or Pandora vs Tower Records) new models (think streaming music vs buying vinyl records), diagnosis and measurement (think machine learning and artificial intelligence vs “American Top 40”).

The failure of many leading healthcare organizations to grasp this change is leading to an over-weighted, facilities-driven channel strategy, an inefficient capital strategy continuance and ultimately, costly facility capacity. There is no reason to believe the story of healthcare will end any differently than it did for music.

For healthcare institutions to survive and thrive, they will need to understand the nature of competition, how to create and measure value, and how to create sustainable competitive advantage through effective risk management and clinical performance. While this counsel may appear to be redundant to existing practices, changing payment and quality measures, new competition and innovative forces are converging into a power that can’t be ignored.

Healthcare institutions (including all providers of care and therapies like pharmaceuticals, life sciences, biotech and medical devices) will also need to understand how to respond to the demands of the federal and state governments, which will impose regulatory and policy directionality. They’ll also need to know how to concurrently please consumers and payers who continue to look for the best value based on cost, quality and experience.

Market (innovation and revolutionary forces) and regulatory drivers must be synthesized to plan for a new model that can work profitably and sustainably. These factors are converging to change delivery, pricing, access and value.

Market drivers

A profound movement of care has taken place from hospitals to non-hospital settings. This shift will only accelerate as integrated supply chains emerge to address high-cost fragmented care and therapies, and mobile technologies and telepresence access points continue to flourish in a world embracing greater site neutrality (think of music downloads and smartphones as comparable distribution channels). The convergence of molecular biology and computer science is already having a notable impact on value by displacing existing protocols and delivery models. Witness the emergence of digital life sciences in its displacement of legacy analog procedures in the diagnostic space. Lastly, there has been negative return on capital for healthcare companies. This is remarkable, as healthcare investment has historically been a stalwart with steady returns.

Regulatory drivers

Policies at the federal and state levels are changing, as well. The Obama administration focused on policies to speed up the adoption of payment reform through mandates, regulatory enforcements and subsidies. While the Trump administration’s policy counterpoints of choice—competition and actuarial soundness (possibly with assistance from tax credits)—are different approaches from the previous administration, payment reform acceleration is still on track. Adding to the mix, aging populations and increases in co-morbid and chronic illnesses are demanding resources from strained budgets.

At the state level, payment reform, particularly in Medicaid, continues to be explored as state budgets experience strain because of growing pension obligations and tax revenue shortfalls. At least 22 states face budget shortfalls for the current or next fiscal year or biennium (two-year schedule), according to the National Conference of State Legislatures’ Spring 2017 State Budget Update. Thirteen states will face a shortfall in both cycles. The report does not attribute shortfalls to any one cause, but lists a range of causes for many states, including “demographic changes, low energy prices and a sluggish agricultural economy.”

These market and regulatory drivers have led to varied responses, but clearly the healthcare ecosystem is experiencing shifts that ultimately affect the way, where, how and when patients receive care. Moreover, the focus of value has shifted to improving the patient experience and the quality of care while lowering costs. Payment reform in the context of federal and state Medicaid models and bundled payments, and aligning episodes of care with payment will continue to change what “value” means.

It is clear there is a mispricing of healthcare assets, which sets the stage for significant arbitrage opportunities between presumed value and actual value. The highest-cost provider of care and therapies are at the greatest risk of loss through disintermediation. The arbitrage gap accelerates with “industrialization” of healthcare through the integration of supply chains. Risk capital and the competence of the clinical enterprise will determine how efficiently providers of care and therapies will extend value multiples on assets. Exceptions to this likelihood—albeit temporary—include defenses associated with patent protection, price/clinical outcomes superiority to market and, in some instances, geographic dominance with full risk providers.

Existing regulatory barriers enforced through anti-kickback provisions and a volume-based predisposition held onto by hospital providers may stall near-term acceptance. Still, value-based pharmaceutical agreements will begin to take hold, and providers, pharma companies, patients and payers will participate in value-based therapies and networks. The federal policy favors this.

Healthcare_Summer-2017_charts-Artboard-1.pngSource: Kaiser/HRET Survey of Employer-Sponsored Health Benefits, 2006-2016

The changing model of healthcare

Payment (costs)
Moving payment from fee for service (reimbursement for every service) to value based (payments tied to outcomes) has been underway for some time, and there is certainly much further to go. The cycle of a fragmented payment system leading to fragmented care and an unsustainable healthcare system leads us to payment reform. Rising costs and outcomes not appropriately aligned have laid a foundation for the transition to value-based payment.

As seen in the data from Kaiser above, over the course of 10 years, employer contribution grew from $8,508.00 to $12,865.00, with a compound annual growth rate, or overall return, of 4.22 percent. The cumulative rate of inflation approximates 19.1 percent, or 1.91 percent on a compounded annual growth rate.

Also seen in the data above, over the course of 10 years, worker contribution grew from $2,973.00 to $5,277.00, with a compound annual growth rate, or overall return, of 5.91 percent. The increased cost of health insurance for both employers and workers has changed the derivation of value into the consumers’ hands.
There is a profound risk shift occurring that is changing the way healthcare and pharma/life sciences assets will be valued. The risk shift is from payer to consumer or intermediary. For example, the federal government continues to shift financial risk to the states and the population. Large employers have become increasingly self-insured, and they too have shifted risk to employees. Providers and provider systems have assumed greater risk associated with value-based payment, while insurers have decanted their risk by positioning themselves as service providers to those entities (providers, self-insured employers and individuals) where someone else is backstopping the risk.

When considering value, measurement systems need to be put into place to collect and measure viable data on performance, ensuring they meet accepted standards. This value-based payment model shows a clear movement toward consumers determining value in healthcare.

Delivery of care (patient experience)
There has been a shift away from institutionalized care to site neutrality where the site may be virtual or a step-down unit or location. The deinstitutionalization of care calls for site neutrality and creates other types of competition, often generating excess capacity in hospitals. To improve value for traditional “bed-driven” models, sites now need to realign beds with the right acuity and payer mix, leveraging its “circle of clinical competence.” Again, the application of a value-based pharmaceutical agreement will change the delivery of care model, particularly in new therapies.

In the shift from volume to value, the value multiple shifts from capacity to the circle of clinical competence and its ability to reproduce value (clinical outcomes) efficiently. Investment consideration and due diligence need to take this into account. It is not a simple exercise but certainly an important one.

Type of care (quality)
Value used to be tied to the number of specialties provided, particularly for acute care providers. The result has created important service lines in hospitals and often redundancy of services in a market. It has also generated a rush to develop competitive, but not necessarily differentiated, offerings to serve the market and drive volume to achieve revenue goals and absorb capacity availability. Bundling of care and payment is particularly disruptive on existing fee-for-service models and the effect could be either punitive or beneficial. The determining factor is the company’s circle of clinical competence—is it leverageable, and can it be extended efficiently? Though it has abated, the trend had been to organize care around Centers of Excellence for Advanced Medicine to build a strong reputation. Now, models will move to be aligned more specifically around episodes of care as payment for care is rapidly moving to cover an episode of care which addresses acute and post-acute care delivery. Again, as capacity value diminishes, the circle of high clinical competence value flourishes.

The path to success
Ultimately, regulators and payers (institutional and individual) are assessing and validating prices, quality and patient experience, which are determining value. Awareness and placement of the arbitrage risk is essential. The patient is the measurable determinant. Competition for differentiation by value requires assessment of cost of care to market and to the possible, understanding what clinical competence is needed to deliver value, and where a company can perform optimally in the supply chain of care as measured by how efficiently a company can reproduce assets. Clearly, there will be winners and losers, and many significant. Our counsel is to seek understanding of value; know where your company’s assets are participating in the supply chain and how well its circle of clinical competence can reproduce value through clinical outcomes more efficiently than the market on a sustainable basis.

As we started, we finish with what Lewis Carroll wrote in Alice’s Adventures in Wonderland & Through the Looking-Glass: “Where should I go?” asked Alice. “That depends on where you want to end up,” replied the Cheshire Cat.

David Friend is the chief transformation officer in The BDO Center for Healthcare Excellence & Innovation. He can be reached at

Patrick Pilch is the national co-leader of The BDO Center for Healthcare Excellence & Innovation. He can be reached at

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