Do hospitals and health systems face the same fate as big box stores? 3 key thoughts

'In the hospital arena like in the big box arena, we see erosion of revenue (or much smaller increases in revenues) paired with a cost structure that remains largely unchanged.'

1. Golfsmith, Sports Authority and Sears; Low Margins, High Cost Structures; Gradual Loss of Revenues. Over the last few years some of the most familiar big box stores in the country have gone bankrupt, e.g., Golfsmith and Sports Authority. Others find themselves headed in that direction, such as Sears. As one looks at these three big box stores, aside from their low profitability and margins, one notes the following.

Golfsmith was a true pleasure to shop at. Stores offered a great selection and an ability to try all types of clubs. Here, Golfsmith attributed its decline to a 2011 plan to open bigger stores that cost more to operate. At the same time that it expanded its costs, (1) the popularity of golf in the U.S. took a turn, losing roughly 1.5 million active players between 2011 and 2015, and (2) revenues were lost to the internet.

Sports Authority, — once the largest chain of its kind in the United States — provided a variety of merchandise across all kinds of sports and offered an expansive shoe and clothing collection for either casual or serious athletes. It struggled with brand differentiation and e-commerce competition.

Overall, Sports Authority and Golfsmith were each a pleasure to shop at. Sears, in contrast, had somewhat lost itself as a great place to shop. All three chains gradually lost substantial revenues/sales to electronic commerce (i.e., the internet).

These big box stores all have relatively low margins. In that regard, they are somewhat similar to hospitals and health systems. Generally, larger hospitals and health systems operate at a 0 to 10 percent margin and no more. Hospitals also have a very high cost structure, roughly half of which is comprised of overhead costs that are difficult to change. The same is true of big box stores. The small margins leave big box stores and hospitals vulnerable to relatively small losses of revenues.

2. Gradual Reductions and Changes in Revenues in Big Box Stores and Health Systems. Over the last few years, the big box stores did not at first see a dramatic reduction in revenue. Rather they saw a gradual reduction in revenues. This coupled, with the fact that they were already low-margin stores with steady overhead costs, left them increasingly vulnerable. It wasn't just that the internet took a great deal of their business. Rather it was also that the big box stores weren't that profitable to begin with. The internet over time took 10 to 20 percent of their business and they did not reduce their cost structure to keep in line with the reduction in revenues.

Hospitals and health systems do not face the exact same threat from the internet. Rather, they face a similar threat from the movement to outpatient care, changes in reimbursement levels and the loss of lots of little pieces of services to ancillary providers and alternative care settings. For example, the movement of spine procedures and joint replacements to outpatient settings and the movement of imaging, lab tests and other low-acuity services away from hospitals into urgent care and other settings may, over time, make an irreparable dent to hospital revenues. Many of these movements in isolation can be combatted. Here, like the gradual and then increased movement to e-commerce from big box stores, the combination of outward forces can be devastating.

As an isolated event, these changes are not deadly to hospitals. Rather, it is a cumulative, gradual movement of care away from the hospital. I.e., it is the loss of revenue by a relatively low margin business that puts hospitals and health systems at significant risk. In 2016, healthcare analytics firm Sg2 forecasted that inpatient volume would decline 3 percent by 2021 while outpatient volume would increase by 8 percent in that timeframe.

3. Countering the Threat and A Concerning Outlook. Hospitals and health systems have tried to counter this threat by becoming more integrated and trying to own markets. In the ideal situation, at least theoretically, the hospital is market essential or market dominant and can retain high prices and healthy margins. Alternatively, the health system takes directly or indirectly almost the entire insurance payment and is responsible for allocating it among itself and other providers. Health systems control more of the premium dollar by owning a health plan or taking risk and payment from a plan for services. However, many systems taking that route have found the insurance business is much riskier and tougher than they anticipated. Thus, this situation does not have an easy answer.

In the hospital arena like in the big box arena, we see erosion of revenue (or much smaller increases in revenues) paired with a cost structure that remains largely unchanged. As with a lot of the big box stores, the movement to reduced revenues was relatively slow and then grew stronger to a tsunami type wave. Akin to the old story of the frog boiling. On some days, we wonder if the hospital industry is positioned to undergo a similar crisis over the next 5 + years.

Editor's note: Forecasted changes of hospital inpatient and outpatient volume were updated Jan. 20 to reflect the latest data from Sg2's annual report.

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