Finance and Business Strategy

Marcus Whitney: Inflation puts innovation pressure on healthcare executives

September 1, 2022 2:10 am


In the wake of the COVID-19 crisis, healthcare is encountering something it has not seen since the 1980s: severe value network disruption in the form of labor shortages and supply costs.

In the near term, reduced access to care is likely, if it isn’t occurring already. And the next point of pressure is coming in the form of negotiations with employers. As inflation and an uber-competitive labor market drive higher cash wages, employers will be pushing back on premium increases for the 2023 plan year and asking more questions about prices.

Yet, it is over the long term where generational opportunities lie. Healthcare must look beyond its half-century of over-dependence on labor and come to terms with its desperate need for innovation, just as manufacturing was forced to evolve rapidly in the 1990s under pressure from globalization. That innovation should not be defined by external influences like the latest, probably overfunded Silicon Valley unicorn. 

Instead, hospital administrators, health system CEOs and their partners should ask themselves what fundamental aspects of their businesses need to change to thrive in a world where labor is expensive and in limited supply, and shortages for basic materials persist.

Identifying necessary change is just the first step. However, the daily realities of operating a health system make it nearly impossible to develop and implement alternative solutions independently. Institutional biases and practice traditions are the enemies of productive change. 

No going back

Post-pandemic, the wage and supply cost increases presented are likely to be durable. For a variety of reasons, the pandemic shifted American demography in a completely unforeseen manner that economists still are trying to comprehend. According to a recent report in The Wall Street Journal, 46 million people changed their ZIP code in the year ending February 2022.1 That is more than 13% of the American population. As healthcare is local, even short-distance moves from an urban center to the suburbs can profoundly affect available labor and create new demand patterns.

Fortunately, America’s greatest natural resource is its creative problem solvers who may have just the answer to adopt. 

The challenge now is how both innovators and the healthcare industry can begin making real progress. The pandemic had a negative effect on the innovation industry as well. 

The Federal Reserve’s strategy to save the U.S. economy during lockdowns with 0% interest rates and by printing money dramatically overheated the venture capital market. Hedge funds with no experience in the venture capital space began dumping billions of dollars in the market, raising valuations, decreasing diligence requirements and propping up many companies that weren’t ready for prime time. 

Coveted valuations

Billion-dollar valuations and nine-figure fund raises became the false measure of success, creating appropriate skepticism from a pragmatic healthcare industry that knows how to read an income statement. 

And now that the Fed has reversed course, the venture industry has been rocked. Hedge funds have retreated, 10% to 40% layoffs have become the norm and valuations have decreased by greater percentages than headcount. It’s hard for the healthcare industry to take innovators seriously when such wild swings occur due to exuberance. 

This is why the healthcare industry has to roll up its sleeves, build its own muscle to innovate and learn how to discern the dedicated and sensible healthcare innovators from the disruptors who don’t understand the industry and are merely looking to grab their slice of the pie. 

4 pressures limiting innovation in the short-term

During this recent inflationary period, healthcare has exhibited in more ways how it differs from other American industries. 

Fixed pricing. After trying everything else, like shrinking the size of the toilet paper roll and putting fewer crackers in the box, manufacturers were forced to raise prices. Most healthcare businesses, however, cannot raise prices intra-year due to contracts with insurance carriers and third party administrators. Add-on payments for COVID cases have softened the blow, but as the pandemic has become endemic, healthcare service providers are left with putting fewer crackers in the box or surrendering margin.

2 Lag time. The 1980s-era Medicare prospective payment system was not designed to accommodate price shocks. CMS’s model for payment adjustment seems to assume, right or wrong, that providers have sufficient capital to weather temporary increases in wage and supply costs. For example, wage demands increased after the Affordable Care Act (ACA) was implemented, but Medicare payment did not. It took about 24 months for demand to recede, Medicare to catch up and things to fall back into balance. As labor costs have increased, high-margin service lines, like orthopedics, become even more valuable. Staff resources and supplies are directed accordingly. The situation is particularly fraught when Medicare is the primary payer.

3 ACA. The ACA was passed in the wake of the Great Recession. Not wanting to catalyze unpleasant employment numbers, the Obama White House made few demands for innovation or cost controls from providers. In effect, the law provided significant additional resources in the form of coverage mandates, enabling healthcare to continue to displace manufacturing in many states as the top employer.

Geopolitical-driven pressures. Supply costs were also rocked by the pandemic, but more due to geopolitics than domestic shifts. Internationally, manufacturing countries disproportionately governed by non-democratic institutions have deployed varying approaches to limiting disease spread. Those approaches range from laissez-faire, which contributed to high death tolls, to extreme limits on the movement and activities of people. The effect of both on U.S. healthcare is the same; supplies of inexpensive goods that support care in the United States can now be unreliable. Manufacturers of protective equipment, surgical supplies and medical equipment all report some level of increased risks to their supply chains. These new threats mean manufacturing must move to more expensive locations — likely democratic-governed western countries — where factory operations and labor and labor-related expenses are more costly. 



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