Posted: 04 Jun. 2019 6 min. read

As health and life sciences companies bet on the future, a specialty focus might have the greatest payoff

By Sarah Thomas, managing director, Deloitte Center for Health Solutions, Deloitte Services LP

The Preakness Stakes might not have the same prestige as the Kentucky Derby, but it’s a huge deal in Baltimore and in nearby Washington, D.C. where I live. In horse racing, it’s the jockeys, the owners, and, of course, the horses who receive the glory and the prize money. But it’s often the breeders who see the biggest return on capital (ROC)—a measure of profitability that is relatively standard among for-profit and nonprofit entities across all industries. Last year, Justify won the Derby, the Preakness, and the Belmont Stakes. While his racing life was short-lived (just four months), his second career promises to be much longer and far more lucrative. His breeding rights were purchased for a record $75 million with the expectation that he will sire more champions.1 A stud might breed more than 200 times a year, and the average foal from a Triple Crown winner could fetch an average of $150,000.2

I see some parallels between the ROC in horse racing and the ROC in health and life sciences where the greatest returns aren’t necessarily obvious. We all know where most of the spending occurs in our industry, but there is often less understanding about the ROC.

Like the people sitting in the grandstands at the horse track, C-suite and other executives at life sciences and health care companies should determine where to place their bets to improve and sustain financial performance over time. A solid understanding of ROC also can be invaluable for health care and life sciences organizations as they look inside and outside the industry for potential partners and new opportunities.

While company leaders often focus on margins, profits, and revenue, ROC offers a fresh lens through which they can see how the efficient allocation of capital can drive profitability. An ROC lens, for example, can highlight some of the challenges a diversified life sciences manufacturer might face.

Where are returns the highest in health and life sciences?

Drug intermediaries and retailers tend to have the highest ROC across the health care sectors, according to our recent report, which takes a look at return on capital performance in life sciences and health care. Organizations in this sector, including wholesalers, pharmacy benefit managers (PBMs), and pharmacies, are transactional and tend to operate on low margins. They are typically not as profitable as other health care businesses. But if we look at these companies through an ROC lens—rather than a profitability lens—it becomes clear that drug intermediaries and wholesalers are among the best-performers in life sciences. In 2017, drug wholesalers had an average ROC of 15 percent, PBMs were at 12 percent, and pharmacies were at 18 percent. By contrast, pharmaceutical and medical technology companies had an average ROC of between 10 and 12 percent.

Over the years, ROC levels have declined across each of the seven sectors we studied, with life sciences companies experiencing the largest drops. Between 2011 and 2017, the ROC for pharma companies declined from 17 percent to 11 percent. Similarly, the ROC in the medtech sector fell from 14 percent to 10 percent. While drug intermediaries and retailers had the highest returns among all sectors during this period, their returns have fallen, too. This is particularly true for drug wholesalers—despite significant industry consolidation.

Here’s a sector-by-sector look at some of the ROC trends we saw in our research:

Specialization could translate to a higher ROC. Pharma companies that are focused on oncology, musculoskeletal diseases, disorders of the central nervous system (CNS), and anti-virals had among the highest returns. Several companies are strengthening their pipelines in these specialties. For instance, our research found that oncology assets represented 39 percent of late-stage pipelines in 2018 among big pharma companies, compared to just 18 percent in 2010. Structural and operating model implications can underpin the lower performance in diversified portfolios and provoke strategic questions like “what if we moved operations for primary care off-shore?” We know that the cost of capital needed to support brands for chronic diseases is higher than for specialty products. Further, big portfolios tend to be weighed down by the legacy infrastructure built to support primary care.

  • Medtech companies: While R&D productivity is one reason for falling ROC among medtech companies, another key factor might be pricing pressure from health systems. In the past, sales in this sector relied on the relationship between medtech companies and the physicians who decided which devices, equipment, or supplies to use. Today, hospital and health system procurement experts typically make those decisions. These professionals tend to buy fewer items and drive harder bargains. Medtech products can be difficult to differentiate in terms of patient outcomes, and product development is often focused on incremental changes based on physician preferences rather than on unmet patient needs. As a result, some medtech companies are competing solely on price, which has led to ROC deterioration. In the medtech business, companies that focus on certain diagnostic specialties—such as robotic surgery, cardiology, otolaryngology (ENT services), and in-vitro diagnostics (IVD)—outperformed device makers that had more diversified portfolios. Specialty-focused medtech companies had an ROC of 11 percent in 2017, compared with diversified companies’ nine percent.
  • Hospitals and health systems: These are the most capital-intensive organizations in the health care ecosystem, and their ROC levels are the lowest. Larger health systems tend to have higher ROC than the industry average. In 2017, the average ROC among the five largest health systems by revenue was double (12.3 percent) the average ROC for the rest of the hospitals and health systems we studied. The Affordable Care Act (ACA) expanded health insurance coverage, which helped to reduce losses from bad debt. This, combined with consolidation, contributed to relatively stable returns for hospitals and health systems in recent years. However, in the era of value-based payments and accountable care organizations (ACOs), the importance of being part of a health system network has increased, and some independent hospitals have struggled. The independent hospitals we studied had a 4.5 percent ROC in 2017, compared to seven percent for hospitals that were part of a health system.

Hospitals that specialize in certain types of care had much higher ROC than acute general hospitals, according to our research. Specialty hospitals tend to deliver care for indications or illnesses that might need intensive care. For instance, surgical hospitals, and hospitals focused on heart, orthopedic, and gynecological services had an average ROC above 20 percent in 2017, compared to six percent among general hospitals. However, our findings for hospitals that focus on oncology and cancer care suggest that specialization in and of itself is not always an ROC driver. Health systems might want to incorporate these findings into both their corporate and merger and acquisition strategy going forward.

  • Health plans: The health plans we examined said their returns were cut in half—from 13.2 percent in 2011 to 6.8 percent in 2015—in the wake of policy and market turbulence. Various ACA provisions, including the establishment of health insurance exchanges, the individual mandate, and guaranteed issue, initially resulted in losses in the individual line of business, which affected the overall profitability of health plans. However, performance in the individual market, as well as in other business lines, has improved recently. As of 2017, health plan underwriting profitability had recovered to pre-ACA levels, and ROC rebounded to 12 percent.

Where should we place our bets?

We have recently been trying to predict some of the changes that might occur in health and life sciences over the next 20 years. Our vision for the future of health is an opportunity to consider how our existing system might evolve across the industry—and over time. Today, the health care and life sciences sectors are made up of traditional players. But consolidation is happening within each sector, as is convergence (organizations that partner or combine across sectors). The pace of convergence has accelerated over just the last 12 months. Many surprising partnerships are emerging as stakeholders pursue new revenue streams, increase their focus on outcomes, and try to gain more control over parts of this growing market.

When it comes to the future of health, we are nowhere near the home stretch (getting back to my horse-racing analogy). What might be the best long-term bets? Organizations that can successfully mine data to deliver personalized solutions that keep people healthy and functioning at their highest potential could see the greatest returns. These companies will learn to harness interoperable and real-time data and a wide range of technologies that are just beginning to emerge.

Endnotes
1. Justify worth record $75 million after Triple Crown, Reuters, June 10, 2018
2. Why Triple Crown champs Justify and American Pharoah remain stars, ESPN.com, May 3, 2019

 

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Sarah Thomas

Sarah Thomas

Managing Director | Center for Health Solutions

Sarah is the managing director of the Center for Health Solutions, part of Deloitte LLP’s Life Sciences & Health Care practice. As the leader of the Center, she drives the research agenda to inform stakeholders across the health care landscape about key trends and issues facing the industry. Sarah has more than 13 years of government experience and has deep experience in public policy, with a focus on Medicare payment policy.