It is no secret that the healthcare landscape is rapidly changing. Traditional players are experiencing increased pressure on their core business models—from shifts in care settings to heightened expectations for stronger cost management and better consumer experience. As McKinsey’s Power Curve analysis has shown, a willingness to make bold moves in response to such industry trends can help businesses achieve strong profit growth.
In contrast, organizations that choose to hold onto the past and protect their traditional models often struggle.
For payers and providers that want to achieve strong profit growth, bold moves beyond their core can give them access to new profit pools (healthcare technology and services, for example) if they focus on areas that have natural synergy with their core. Our research shows that healthcare organizations that invested to diversify into multiple industry sectors are delivering stronger returns than peers that have not yet diversified (see exhibit). Diversification beyond an organization’s core sector is not without risks, however, and we have seen many organizations struggle along their diversification journeys. Five lessons we have learned in our work can help healthcare organizations contemplating potential step-out moves develop a winning strategy to grow new businesses while enabling their core.
Diversification can protect the core
A common misperception is that diversification will distract from core operations. We have found, however, that if managed properly, diversification can help organizations strategically protect core businesses. Health systems that expand their ambulatory footprint, for example, not only gain new revenue streams but also may increase patient inflow to their acute care services. Payers that expand into pharmacy benefits management can potentially lower costs in their core insurance business as well as deliver additional value, as we discuss below.
Diversification can accelerate growth
Historically, many healthcare organizations relied on incremental improvements or organic changes to fuel growth. Future growth, however, could be accelerated with greater focus on non-core areas of healthcare—early evidence suggests that moving into these areas can pay off. As part of our healthcare profit pools research,
we estimated 2016–2020 EBITDA growth in a range of healthcare industry sectors and found that core sectors such as hospitals are likely to see compound annual growth rates (CAGRs) between zero and 5 percent during that time, whereas adjacent sectors (ambulatory surgery centers and home health, for example) could enjoy CAGRs of 5 to 10 percent. We also found that EBITDA is declining in the large group insurance business, but companies that specialize in network management services may see 5 to 10 percent CAGRs (and 20 percent margins). To combat the headwinds in their core business, some players have successfully used diversification to achieve breakout new growth.
Diversification is attractive to investors
Today’s investors view growth into new healthcare sectors as a way to access higher-value revenue streams and thus regard it positively. Diversification can enable companies to build new businesses—payers could enter the care management space to better manage population risk, for example, or providers could add digital services (for example, telemedicine or technology-enabled care management) to better connect with patients and accommodate changes in care delivery. Investors’ view of diversification is well-founded: we have found that when compared with healthcare companies that tried to optimize the core only, those that diversified into new businesses delivered excess total return to shareholders (TRS).
Leveraging your core can create advantages
Valuation multiples for healthcare technology companies are at an all-time high—since 2010–2012, they have grown from almost 11X EBITDA to about 19X EBITDA.
To justify investments in companies with such high multiples, payers and providers will need to create additional value. Our experience suggests that success stories will most likely come from organizations that can take advantage of natural synergies with their core to extract additional value when they expand strategically. Using existing resources, such as strong customer relationships and distribution capabilities, can accelerate the growth of a new business. Payers adding new technology-enabled services, for example, can utilize their current customer base to rapidly scale the new services.
Diversification should be programmatic
In our experience, organizations that diversify successfully often undertake M&A programmatically—they build the capabilities needed to do multiple deals. In the past 10 years, for example, the payers that had completed the most M&A deals also achieved the highest gains (in percentage terms) in excess TRS.
While the past is not always a predictor of future results, organizations that hope to replicate this value and succeed through diversification should develop a repeatable model they can use programmatically as they embark on M&A. The model should begin with agenda setting and opportunity identification and also include defined plans for entering new spaces (either organically or inorganically), integrating the new businesses, and supporting these efforts with additional strategic investments to rapidly scale. This approach can enable an organization to make the act of diversification a core strength.
Given the increasing pressure on traditional businesses, healthcare executives should strongly consider the advantages of strategic diversification in areas where their core can give them an inherent advantage. To succeed, they will need to spend real time and invest resources to develop a strategy and approach that will harness the full potential for this breakout growth move.