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Industries In Transition
 

With the public increasingly clamoring for medical-costs cuts, the best prescription for continued fiscal growth is low-tech, low-ticket products.
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Health care is no longer a price-is-no-object industry, in which success is based principally on break-throughs in the diagnosis and treatment of illness. With health-care costs now at 10% of the gross national product -- and rising nearly three times faster than the consumer price index -- the public is fed up, and clamoring for cost controls. Corporate leaders of the future are more likely to include managers of nursing-homes, providers of home-care equipment or personnel, and manufacturers of disposable hospital supplies -- such as those found among 10 companies on this year's INC. 500, all thriving in low-ticket, low-tech marketing niches.

The latest catalyst for change came with the arrival of Diagnosis Related Groups, the tools of a new government program to cap escalating Medicare reimbursements and hospital costs. As of October, when a three-year phase-in period began, participating hospitals are no longer allowed to collect whatever they spent on Medicare recipients. Instead, the DRGs determine a maximum reimbursement for 467 procedures, based on prevailing wages and costs in nine regions of the country.

"This represents major, long-term, structural change in the health-care industry," says analyst Robert Friedman of Montgomery Securities in San Francisco. "DRGs force hospitals to restrain costs, because for the first time, they find themselves at economic risk."

For example, if a hospital spends $13,000 on a procedure that has a maximum reimbursement under the DRGs of $11,000, the institution has no choice but to absorb a $2,000 loss. But the program is not all downside risk; there is a profit incentive built in, as well. Any hospital that can bring in that same procedure at $9,000 stands to pocket $2,000.

The nation's health-care burden should lighten, the theory goes, as hospitals see the fiscal benefits of cracking down on waste and inefficiency -- both their own and that of their suppliers. But some observers are skeptical. Noting that Medicare patients represent 17.7%, or $50.9 billion, of the nation's annual hospital bill, they fear that costs pushed down in one area will rise in another. Larry Haimovitch, a health-care analyst with San Francisco-based Sutro & Co., disagrees.

"First, due to the aging of the population," says Haimovitch, "the percentage of people on Medicare is only going to rise. Second, if DRGs work to cut Medicare costs, people are going to start asking why they won't work as well for everything else. Private payers and insurance companies are not going to put up with paying more." DRGs, he says, are the beginning of sweeping changes that will force administrators to run their hospitals more like factories -- with an eye on unit costs, productivity and efficiency.

"There's not going to be an incentive anymore for them to let doctors order 37 tests for diagnostic information they can get from 27 " he says. "Nobody is going to be as open to technology for the sheer sake of technology. There will be less emphasis on keeping beds full. In fact, anything that can be done to move patients out of what has become a very expensive hotel to a less-expensive setting is going to be very, very profitable."

Friedman shares that view, quoting statistics that forecast a 6% to 8% increase in the number of beds needed each year over the next decade in order to meet demand, and a 10% to 15% expansion in the home-care market. The shift is bound to be a "blessing" to service-oriented companies that already have a toehold in these areas, he says, in the form of rapid unit growth, and -- more important to those inclined to sell out -- an increased potential for being acquired. Johnson & Johnson, Baxter Travenol Laboratories, and American Hospital Supply are just three of an increasing number of conglomerates that have found these markets lucrative enough to warrant investment.

The fact is, the opportunities are looking so lucrative to so many that the biggest challenge facing most of these smaller enterprises is how to protect their turf against the onslaught of competitors and "me-tooers." Among them, Friedman says, will be lots of hospitals. "Don't forget," he warns, "hospitals are not going to be happy about giving up patients to outsiders. They're going to try to [get into these markets and] recapture that revenue."

Meanwhile, as hospitals and conglomerates court companies associated with the nursing-home and home-care markets, these same companies will be attempting to get a competitive leg-up on hospitals -- and one another. Consider Mission Home Health Inc., a San Jose, Calif., provider of home health-care professionals that, at #65, is the top-ranked health-care company on the INC. 500. "Our biggest hurdle will always be getting hospitals to send us the patients they discharge," says chief executive officer Gene Cochran. "That's why we'd like to buy a hospital in the next couple of years, or at least get into a joint venture of some kind with one."

For National Health Care Affiliates Inc. (#193), the goal is preventive diversification. Although Mark E. Hamister, CEO of the Buffalo, N.Y.-based nursing-home company, doubts that home health care poses any serious threat to his 17 facilities, "because most nursing-home patients have too many ailments to be properly treated at home," he is nevertheless interested in covering all the bases. "The idea of developing our own home-care agencies to operate out of the nursing homes has a lot of sex appeal," he muses.

Prospects are equally bright for manufacturers and distributors of health-care products geared toward ambulatory or home-bound patients. There are three such companies on this year's INC. 500: American Medical Therapeutics Ltd., of Norwood, Mass. (#404), which owes much of its growth to a portable machine that converts room air to oxygen for use in respiratory therapy; John Nageldinger & Son Inc., of West Babylon, N.Y. (#158), which has expanded its line of home-care respiratory equipment to include portable volume ventilators (life-support units) and automatic breast pumps (for nursing mothers); and Cormed Inc., based in Medina, N.Y. (#204), which has made its name with a device the size of a deck of cards that allows cancer patients to stay active while receiving continual chemotherapy.

Of course, there will always be procedures best performed in a hospital, and those companies that can help hospitals maintain the same level of service at lower cost are in increasing demand. For example, Perfusion Services lnc., of Brighton, Mich. (#395), provides perfusionists -- the professionals who run heart-lung machines during open-heart surgery -- plus equipment needed for operations. "Because we do all of this on a per-case basis," explains CEO Michael Dunaway, "hospitals can maintain a cardiac unit without having to employ full-time personnel or stockpile equipment and supplies. That's a winning argument to a hospital administrator trying to save money."

If any companies stand to lose as the result of health care's cost-containment push, chances are they will be found among those that sell consumable supplies exclusively to hospitals. "This segment of the market is going to become more and more generic and less proprietary," says health-care analyst Larry Haimovitch. Robert Friedman agrees, adding, "Hospitals aren't going to be looking for bells and whistles anymore. They're going to try to standardize, and it's entirely possible that they will start identifying a level of quality for lower-cost items, and then start bidding them out, or group-purchasing them with other hospitals." The increased competition and price sensitivity will probably be most acute for manufacturers and suppliers of disposable products, Friedman adds, pointing out that some hospitals may choose the option of sterilizing their equipment instead.

Many of the companies on the INC. 500 that would seem vulnerable to these changes already have contingency plans in place. "We plan a heavy commitment to R&D, to maintain our proprietary edge," says CEO Paul Dryden, of Dryden Corp. in Indianapolis (#470). His company established itself on that strategy by being among the first companies to market transparent surgical face masks, which allow doctors to spot, among other things, the first sign of oxygen deprivation in a patient -- the lips turning blue. As for the alleged lack of cost-effectiveness in using disposables, "I think that most hospitals realize that when you decide to sterilize, you incur a greater risk of liability [for contamination or infection]. You could wind up spending much more money than you'd save."

But there are people in the supply segment of the industry who have experience with DRGs, and many of them say the predicted pressure on their volume has failed to develop. Some hospitals are tougher talkers, says Terence D. Wall, CEO of Vital Signs Inc. (#96) in Totowa, N.J., another marketer of disposable breathing apparatus. But although his state has been testing DRGs for more than three years, "our sales haven't been affected one iota."

Research conducted by the Health Research & Educational Trust of New Jersey tends to support that assessment. "DRGs do little more than force companys to make the cost-benefit arguments to the hospital purchasing people, when before there was no incentive to do that" says Jeffrey Wasserman, vice-president for research. "Those companies that can successfully make such arguments have nothing to be afraid of."

Last updated: Dec 1, 1983




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