Health Business Blog

Health care business consultant and policy expert David E. Williams share his views

New York Times is sleeping –luckily National Transportation Safety Board is awake

Last week I criticized the New York Times for running a front page story about air ambulances that focused only on their cost, while ignoring the most interesting issues: that air ambulances are dangerous, slow, and hard to administer care in.

This morning’s Wall Street Journal reports that the National Transportation Safety Board (NTSB) is aware of the danger of air ambulances and is drafting rules to make air ambulances less dangerous. (NTSB to Push for Safety Upgrade of Emergency Medical Helicopters by Andy Pasztor.) According to the Journal, the recommendations may include:

  • Standardized use of night-vision goggles
  • Installation of ground-collision warning devices
  • More-stringent regulations regarding limited-visibility operations
  • Flight-data recorders and cockpit voice recorders
  • Cockpit-video recorders

The Journal also points out that “air-evacuations end up saving relatively few lives, while costing as much as 10 times more than ground ambulances.” Kudos to the Journal.

Tax policies distort pharmaceutical manufacturing operations

Today’s New York Times reports that pharmaceutical companies have been able to minimize US income tax payments by allocating the majority of their profits to tax havens such as Singapore, Ireland, and Puerto Rico. (Drug Makers Reap Benefits of Tax Break by Alex Berenson.) The main tactic is to claim that manufacturing activities carried out in the tax havens are adding a lot of value to the product, so that the IRS and local tax authorities will be satisfied and a disproportionate share of profits will be taxed at the tax haven’s rate. It’s worth the trouble, because rates in tax havens are typically 2-15% versus roughly 40% in the US.

The article doesn’t mention that the tremendous tax advantages gained by these tactics have caused pharmaceutical manufacturing organizations to become inefficient and isolated from market forces. Unlike other industries such as consumer electronics and apparel, where manufacturing is mainly outsourced to efficient third-parties, pharmaceutical manufacturers make minimal use of outsourcing and often run their plants at low levels of capacity utilization and with little attention to cost. In fact, plant level accounting systems are often so distorted that senior management has no idea of the real costs. The manufacturing groups get away with underperforming because when manufacturing is outsourced, tax advantages are usually lost.

However, as the industry becomes desperate for the capital and operating cost savings associated with outsourcing, a more sophisticated “tolling” model has emerged. In this scheme, the pharmaceutical company rents and nominally operates the outsourcer’s facility. This qualifies the company for most of the tax benefits of insourcing and all of the cost benefits of outsourcing. Expect to see senior management of pharmaceutical companies –who in general barely understand manufacturing operations– to increase the use of outsourcing over the next few years.

Cardinal takes another step away from the trading business

Cardinal Health will end its pharmaceutical trading activities, a business that bought and sold drugs from secondary sources such as hospitals and wholesalers rather than manufacturers. The move is another step in the shift by Cardinal and the other big players, Amerisource Bergen, and McKesson away from trading and toward fee-for-service arrangements with drug companies. (See Cardinal Health Ends Drug Trading in today’s Wall Street Journal.)

In the past, the wholesalers made a large part of their profits through forward buying. They loaded up on inventory before manufacturer price increases, then sold the drugs at the higher price once the price increase was announced. Trading in the secondary market was another opportunity to make big profits. Meanwhile, the main business of acting as an intermediary between drug companies and retailers had essentially zero margin. The announcement that the trading business was insignificant because it accounted for only $180M of Cardinal’s $36B of revenues should be taken with a grain of salt, because the profit margin on trading is potentially much higher than on distribution.

Unfortunately for Cardinal and the others, the old system caused a lot of problems. Order volumes would surge in anticipation of price increases, then plummet once price increases were announced. The link between market demand and production was cut, and shady accounting practices flourished. In the post-Enron world, this situation was no longer tolerated. The death of the trading business was precipitated by concerns that it could be a conduit for counterfeit drugs to enter the system.

Cardinal’s new strategy is to charge manufacturers modest fees for its services. It’s a less exciting but more straightforward way to make a living.

BCBS of MN demotes some famous hospitals to Tier 2 status –and hears them complain

Blue Cross and Blue Shield of Minnesota is using a combination of cost and quality measures to sort hospitals into two tiers. Fifty-two hospitals are in Tier 1 and 16 in Tier 2. Patients who go to the Tier 2 hospitals will pay double the usual co-insurance, according to the Minneapolis Star Tribune.

Tier 2 hospitals include famous names like the Mayo Clinic. Of course all the hospitals in Tier 2 are complaining that the methodology is unfair and superficial, and that cost plays too much of a role.

The Blue Cross move is a small step toward using quality ratings to drive patient volume to specific hospitals and physicians. In the near future we can expect to see better data on quality as well as the introduction of patient satisfaction data for hospitals and physicians. In Minnesota, this effort is being spearheaded by MN Community Measurement and in Massachusetts by Massachusetts Health Quality Partners.

As insurers and patients take this information into account, brand names alone will no longer be enough to ensure high market share and bargaining power with health plans. Patients, payers, and cost-effective, high-quality community hospitals and physicians will be the winners.