Health Care Reform will Change Innovation - Not Decrease It

I’ll be part of a panel at the Harvard Business School this weekend on the potential impact of health care reform on innovation and investment of private equity in health care.   I’ve heard a lot of concern and hand-wringing over whether managing health care costs would decrease life-saving innovation that nourishes the ‘knowledge economy’ of the US.  The worry is especially intense in Massachusetts, with our economy deeply dependent upon health care delivery, and pharmaceutical, medical device and basic science research.

While it seems that the brakes are on health care reform right now, I wanted to share my perspective on how health care reform and meaningful cost control could impact innovation.

First of all – the need to lower the rate of inflation in health care cost is real.  Medicare is a giant deficit-generating machine for the federal government. The Medicare trust fund will have a negative balance in just a few years, and states cannot afford rapid rates of increase in Medicaid costs. US manufacturers send their work overseas in part because of high US health care costs.  Many Americans are uninsured, and more are underinsured.   Americans have effectively gotten no real wage increases since 1988 while productivity has soared; this extra wealth has been used for health care expenses.

Things that are unsustainable don’t continue forever, and medical costs can’t continue to rise at a rate far higher than inflation.  If they do, they crowd out other meaningful uses for our resources.   A dollar wasted in health care could have been better deployed in education or in infrastructure investment – and either of these is likely to spur more innovation.

In the US, there have been examples of big disruptions in health care revenue – and these have not led to a decrease in innovation. Rather they have led to a change in innovation.

The transition of Medicare inpatient payments from a “cost plus” basis to a ‘diagnosis related group’ (DRG) payment method in the early 1980s led to dramatic changes and innovations in health care.  Under the “cost plus” system, hospitals were rewarded for capital investment that increased the cost basis – and there were cranes all over the country building new medical meccas to be funded by Medicare.   Under the DRG system, hospitals were paid a fixed fee for each hospitalization, and so they innovated to decrease lengths of stay.  The fruits of this transformation in hospital payment included minimally invasive surgery, ambulatory surgery centers, and home intravenous therapy for infections and other maladies that once required a hospitalization.  So – a decrease in health care payments led to system changes, and an opportunity to innovate that was different (but not less) than under the previous system.

Many other countries impose strict, even ominous, controls on prices.   This has many consequences – and sometimes leads to shortages. However, even draconian price control can lead to increased, not decreased, innovation.   In Japan, the government mandates prices, and lowers prices for services where volume increases sharply.  Japan has an even higher rate of MRI use than the US, and as a result, the “list price” of an MRI is under $100.  Have MRI manufacturers stopped innovating?  Hardly.  Toshiba has developed an MRI unit that is lower powered (less magnetic strength, lower resolution, less computing power) that can be purchased for under $200,000 – compared to multimillion dollar price tags for the most technologically advanced MRIs available in the US.  So  - the low prices didn’t lead to a decrease in innovation – but rather a change in innovation.

Here’s a graphic demonstrating four quadrants of “value” (cost vs. quality).   The upper right always increases value – costs are lower and quality is higher.  Public health interventions usually are in this quadrant, as are pediatric vaccines.   Not much else, I’m afraid – the medical delivery system was designed to improve lives, not to save money.  We can all agree that we want more innovations in the upper right quadrant. 

The lower left quadrant shows unequivocal value destruction – we spend more and get less quality. In retrospect, Vioxx is a good example of this – a medicine just as effective as Ibuprofen, dramatically more expensive, and associated with a substantial increased risk of heart attack.  We can all agree that we want to eliminate spending in the lower left quadrant.

The challenge is the other two quadrants.  Folotyn, a new chemotherapy medicine that costs $30,000 a month and shrinks tumors a bit over a quarter of the time but doesn’t increase life expectancy, is in the lower right quadrant (small increment in quality but large increase in cost).  That’s where innovation has focused in recent years – and that has not made the US health care system “higher value.”

I’d submit that meaningful health care reform (which will come sooner or later, because we can’t afford not to) will move interest and private equity investment into the upper left quadrant.  That’s the “disruptive innovation” quadrant – where we accept innovations like generic drugs and the Toshiba MRI machine that is decrementally cost-effective -  i.e. we get less quality, but the cost savings are dramatic.

In the US, we’re historically not very interested in ‘decrementally cost effective’ innovations.  I think that controlling health care cost inflation is likely to lead to more innovation like the lower quality MRI machine, and less innovation like a new $36,000 a year chemotherapy agent that is not associated with extending life.

I’m at peace with the upper left quadrant.