It was an entrepreneur's dream, a multi-billion-dollar market opened to competition for the first time. Hundreds of small companies responded by manufacturing, supplying, leasing, installing, and servicing the interconnect equipment. "These companies found whatever piece of equipment they could and sold it on the basis of it being cheaper than what you could rent from AT&T," says Stephen Ide, who was then vice-president of operations for Rolm of New England, an operating company of Rolm Corp. "I remember sales calls in the mid-70s when you had to explain to customers that it wasn't illegal to be doing what you were doing [selling non-Bell hardware]."
In 1980, Ide and a few colleagues left Rolm to start Computer Telephone. The opportunity that had its genesis in Carterfone had changed substantially by then. "The small-business person was not getting the full spectrum of technological services available to Fortune 1,000 companies. They were dealing with people who couldn't provide the things we could -- the full spectrum of services. We were for small business, to get around the problem of people supplying little parts, but not the whole."
Ide started the company with the idea of providing comprehensive phone-system design, installation, and maintenance services, primarily to businesses with 150 or fewer phones. But it was a terrible time to start a business, opportunity or no."Our first two years were extremely tense," says Ide. "Thirty percent to 40% of our business is leased, and that makes it extremely interest-rate sensitive. Customers buying into our phone systems locked into fixed rates. But as interest rates rose, we had difficulty attracting new customers away from Bell's rentals. There were months [back in '82] when we sold or leased nothing -- zero. We began wondering if it took some sort of death wish to start a company when we did."
Though it sold itself as a sophisticated telecommunications firm, the company could afford only a single-line phone in its own office, a converted stable in Natick, Mass. "Here we were, selling very sophisticated equipment, but we couldn't even afford it for ourselves. We made every effort to keep customers away from headquarters in those early years," Ide says. To survive, Ide continues, "everyone had to be a salesman. Our single technician was not a salesman, but he used to telemarket for us."
Ide never spent much time speculating about a possible divestiture of AT&T's operating companies. "Back then," says Ide, "asking ourselves, 'What if AT&T deregulated?' was like asking, 'What if we could run wires to the moon?" Yet when divestiture came, Computer Telephone moved quickly to capitalize on an opportunity created by the change. It signed on as a partner with New England Telephone & Telegraph Co., a NYNEX Corp. subsidiary, to sell its facilities and services. "[These] are the same people we fought tooth and nail in 1980 to 1983," says Ide, a little incredulously.
"Our industry is at a transition point," he says. "In the next couple of years there will be three or four dominant players in any given region. Everyone's lowering profit margins to keep market share, but whether they can keep that market share is another question. We might wind up acquiring other companies or the deserted customer bases caused by company failures.
"It's still survival of the fittest."
Fittest." Now that word has a nice ring for Phil Bredesen, who founded HealthAmerica Corp. (#20) in 1980. The company owns and operates HMOs, which provide health-care services for a prepaid fee. Bredesen can make a healthy profit by keeping people fit. Even written in a doctor's scrawl, the prescription is easy to read: administer a lot of preventive medicine, and try to catch problems early. If hospital care is needed, treat patients efficiently and get them back home quickly.
That wasn't where the big opportunities resided in health care in the 1970s and early '80s. Third-party payers, including the federal government, reimbursed hospitals and other health-care firms for whatever services they provided to patients; with no incentives to hold down costs, national health-care expenditures rose from $75 billion in 1970 to $248 billion 10 years later. For investor-owned hospitals and other health-care companies, double-digit increases in sales and profits were routine. Meanwhile, employers were hard hit as their bills for health-insurance benefits soared about 20% a year.
Bredesen, an executive with a hospital management company, saw that this situation couldn't continue. "Around 1980, the health-care field in general seemed ready for new approaches," he says. "Everywhere, you heard a whole chorus of employers' complaints about health-care costs." And no wonder. "Hospitals were doing anything to get patients to stay in longer. I mean, you'd get a woman in maternity for a normal delivery, no complications -- and if she was still there on the third night after giving birth, the hospital would throw a steak dinner for the husband and wife."
Bredesen started HealthAmerica in 1980 with just $50,000 in seed capital from a quartet of private investors and a $250,000 line of bank credit. Venture capital was so tight that he didn't even bother to try. "Starting out with more money might have made us fatter and happier," he says, "but I'm not sure that would have been good for us. If you're starting out to run HMOs and you've got only $50,000, you do everything as if every cent counted -- which it does."
HMOs have been operating in the United States for half a century, but Bredesen moved into the market at just the right time. After passage in 1973 of a federal law promoting them, the number of HMOs increased 214% to 226 by 1980. But many were badly run and losing money. "A lot of the HMOs were starting to fail, and there was a feeling that if Reagan got elected, there would be an even greater drive to pare down costs," says Bredesen.
HealthAmerica got contracts to manage sick HMOs, with an option to purchase. But the gathering storm over health-care costs was changing the market faster than Bredesen had figured. One change was that employers, trying to hold down the rising cost of benefits, were pushing more and more workers into HMOs. The second change shook the industry to its core. In 1983, the government threw out the cost-plus method of reimbursing treatment of Medicare patients, replacing it with a schedule of fixed fees for each diagnosis. Now hospitals lost money by keeping patients too long. Only the most efficient hospitals -- those that conducted fewer tests and sent patients home faster -- could make money.
