Healthcare modernization solves now – COVID kick-started private investment and slashed costs.

Healthcare services and technology: Long-term growth supported by software and platforms

The HST segment has been a long-term growth story. HST continued its growth trajectory during the pandemic, with profit pools rising from $45 billion in 2019 to $50 billion in 2021. The outlook continues to be positive. We estimate that the segment will grow at an 8.2 percent CAGR between 2021 and 2025, to about $70 billion by 2025. That would likely make it bigger than the payer profits pool by 2025.

HST has had broad overall growth but software and platforms and data and analytics have performed especially well, with CAGRs of 10 percent and 17 percent, respectively. Business model shifts for payers and providers account for much of that growth.

The rapid adoption of data and advanced analytics and software is spurring innovation in areas such as population health management, revenue cycle management, and patient engagement. Furthermore, virtual health—take-up of which increased substantially during the pandemic but since stabilized—is accelerating care-model innovation and technology solutions.

Pharma services: More spending, led by the specialty drugs

Pharmacy services have undergone major changes in recent years, including new models of patient engagement, establishment of partnerships across stakeholders, and the entrance of new digital pharmacy models. Drug spending has increased, with dispensing revenue growing from $450 billion in 2019 to $500 billion in 2021. The growth was primarily driven by specialty drugs, which now account for 40 percent of dispensing revenue.6 Continued innovation in drug development could expand specialty profit pools further; these are expected to increase at an 8 percent CAGR from 2021 to 2025.

Hospital-owned specialty pharmacies have expanded their participation, with nearly 40 percent of provider-owned pharmacies attaining accreditation.7 In infusion-related value pools, COVID-19 accelerated site-of-care shifts, enabling growth in home infusion as patients reduced in-person visits to hospitals. Additionally, payers are becoming more directive in shifting infusion therapies from hospital outpatient settings to lower-cost sites of care such as the home and ambulatory infusion centers, further accelerating volume shifts.

Traditional drug dispensers such as retail and mail pharmacies continue to face margin pressure, leading to a contraction of profit pools. New technology-enabled pharmacies have emerged, featuring direct-to-consumer models with digital prescription management, automated workflows, and faster home delivery services. Although these players have not yet reached substantial market share, they are growing quickly, spurred by substantial private equity investment. Competition from these players could promote innovation around convenience and experience in the business models of larger retail and mail pharmacies as well, creating potential margin upside.

The wholesaler segment continues to benefit from increased drug spending. We estimate that drug distribution revenue is likely to increase at a 5 percent CAGR from 2021 to 2025; wholesalers’ profit margins from drug distribution are expected to remain flat over the coming years.

Outside of overall specialty growth, the pharmacy benefit managers (PBMs) segment is under pressure for more transparency into rebates and network spread pricing from payers and sponsors. Employer demand for cost containment and predictability has given rise to a wave of new and innovative pricing models. Specialized players (such as specialty drug managers, therapy management, benefit optimizers, and pharmacy benefit administrators) are now taking on some PBM functions. In the face of these trends and commoditization, PBMs have launched group purchasing organizations (for example, Ascent Health Services, Zinc Health Services, and Emisar Pharma Services) to better negotiate with drug manufacturers. They continue to invest to improve employer and employee experience and ramp up efforts to better manage medical benefit specialty drugs.

The growth in drug spending, including the rise of specialty drugs, has focused increasing attention on the role of pharmacy in coordinating care for patients. Of particular interest is the use of pharmacists and patient services in promoting greater adherence to medication regimens and providing medication-related counseling. Payers, PBMs, and dispensers alike are focusing on reducing the total cost of care and pursuing enhanced patient outcomes and experience.

Evolving business models

These shifts in industry economics are prompting business model change in three areas—diversification, vertical integration, and new business building.

Diversification

As the industry profit pools diversify, healthcare players are reviewing the scope and scale of their business lines. They are expanding their scope of services to adjacent segments as well as building businesses to monetize capabilities.

Hospital systems have been expanding across the care continuum, accumulating assets in ambulatory sites, virtual and digital health, primary care, and post-acute care. A majority of the net patient service revenues of the largest 50 hospital systems are now outside inpatient care. In addition to outright acquisitions, hospital systems are pursuing partnerships with innovators in these spaces, including primary care disrupters, risk-bearing management services organizations (MSOs), and virtual care companies.

Others in care delivery are moving to diversify as well. For example, home health and hospice companies are expanding into more sophisticated care delivery like hospital-at-home. Pharmacy players are scaling their primary-care businesses with acquisitions of physician and clinic assets, including value-based physician players. Announced investments seem to suggest a substantial expansion into primary care and value-based care well beyond the retail clinics space they have entered previously.

As players build new capabilities, they are recognizing that these capabilities can become large, profitable businesses in their own right. Many payers have created HST businesses of their own to both serve their core payer business and sell these services to other healthcare players. For example, payers are building MSOs to take a much more active role in managing the care of their patients. This kind of diversification has two benefits: it addresses new value pools while potentially creating value for the core payer business by reducing total cost of care through more robust analytics and reporting and improved care coordination to more effectively look after patients.

Also, several provider systems have launched venture funds aimed at diversifying the core business into attractive revenue pools such as data and analytics; some have created start-up incubators to build a range of digital health products and services. Other health systems are starting and expanding specialty pharmacies. About 20 percent of accredited specialty pharmacies are now owned by health systems and hospitals. Hospital-owned pharmacy programs have unlocked a new, growing revenue stream while demonstrating improved patient outcomes and experience through their integrated care programs, highlighting faster time to therapy and improved adherence rates among its specialty patient population.

Vertical integration

The continued rapid expansion of value-based care models is leading to realignment across the healthcare value chain. The realignment is in pursuit of models that can better deliver affordability, quality, enhanced access, and experience of care but also holds the promise of superior economic returns. Payers, for example, are innovating their Medicare Advantage business to move beyond providing just the health plan to ownership and orchestration of care models inclusive of physician practices, virtual care, home care, and pharmacy as well as care management, medication adherence, and other enablement services. These models are increasingly powered by data- and analytics-enabled clinical services such as care coordination and enhanced member engagement. Such an approach may offer superior care to members while expanding the profit pool available to payers by two to three times (Exhibit 3). To access these capabilities, payers are pursuing acquisitions, minority investments, and partnerships with private equity firms.

New business building

Private equity and venture capital players are continuing to increase investment in healthcare; in 2021, they invested over twice as much as they did seven years ago. “Platform creation” is the investment thesis for many of these healthcare investments—identifying opportunities to create value beyond the immediate asset through M&A and business building (Exhibit 4). The financial sponsors are building the business, then leveraging a platform to create a more expansive set of offerings. In many instances, this approach ends up transforming the underlying business.

For example, during COVID-19, a private equity-owned, home-based provider built out a clinical trial within a few months to facilitate vaccine trials, enrolling five times the number of diverse participants compared to normal approaches, based on our experience. In another case, a provider of non-emergency medical transportation expanded into nutritional meal-delivery services for high-need and high-risk patients.

This high speed of innovation is upending the incumbent healthcare players’ traditional approach of transforming or incrementally adding to existing business models. Instead, business reinvention has become a critical priority. While the approach includes making anchor acquisitions, it must also often rely on high-speed business building to take advantage of incumbent assets and fast scale-up to make a difference to their business. Many are pursuing this model. For example, one pharmacy services player created a digital pharmacy from scratch within a year. In another instance, a large healthcare player built an entire value-based care business in 18 months.