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North American industry clusters display distinct preferences in digital focus: efficiency or growth

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2015 Impact of Mergers on Payer Industry IT
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Impact of Payer Industry Mergers & Acquisitions on IT

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The recently announced acquisition of Merge is one in a string of initiatives by IBM to increase both its market presence and depth of offerings to the healthcare sector. With birth rates increasing in many parts of the world and the aging population growing in developed countries, the race is on for data driven and highly efficient healthcare.

IBM is clearly targeting this market. Its recent activities have included:

  • Entering into new partnerships with companies such as Apple, Johnson & Johnson, and Medtronic for health-related data collection, analysis, and feedback
  • A partnership with CVS Health to develop care management applications for chronic diseases
  • Acquiring Explorys, a healthcare data provider, and Phytel, a hospital care coordination information provider
  • Buying AlchemyAPI to include text analysis and computer vision capabilities into Watson’s computing platform
  • Establishing a dedicated business unit called IBM Watson Health, headquartered in the Boston, MA, with the specific remit of growing its healthcare business
  • Collaborating with leading hospitals and research institutes including Memorial Sloan Kettering Cancer Center, University of Texas MD Anderson Cancer Center, the Cleveland Clinic, and the Mayo Clinic to leverage Watson’s healthcare capabilities at the cutting edge of medical research
  • Setting up IBM Watson Health cloud to bring together data for healthcare and research

The US$1 billion acquisition of Merge brings IBM a medical imaging platform to combine with Watson’s image data and analytics capabilities and an extended client base. Excellent and Elementary, Dr. Watson.

With these initiatives, IBM is building specialist competences, to capture, analyze, and recommend treatments or actions that would help healthcare providers, payers, pharmaceuticals, as well as individuals achieve positive health outcomes.

Gaining a wide range of capabilities in specific areas has helped IBM generate specific segment revenue in good and bad times. For example, its large number of information management and WebSphere portfolio acquisitions (e.g., Cognos, Netezza, and SPSS, to name but a few) has seen segment-specific revenues maintain steady growth over the years.

If IBM was to successfully combine its deep specialization in healthcare with Watson’s cognitive computing to enhance its services, it could gain a big edge over competitors at a time when demand is set to grow. At the moment we are seeing more of IBM in healthcare IT infrastructure modernization contracts than data-driven care provisioning and support services. Recent examples include:

  • A contract to update the UK NHS’ electronic staff record (ESR) system, adding mobile access and self-service capabilities for 1.4 million employees
  • A contract to provide mainframe and data center server and storage infrastructure services for Anthem Inc, a U.S.-based health benefits company, for the next five years at TCV of US$500 million

These types of contracts give IBM opportunities to tap into new solution and services openings at existing clients.

Other challenges for IBM’s intelligent and data driven healthcare offerings include:

  • Collecting enough data for its solutions to be relevant to, as well as accessible in, different parts of the world
  • Data protection barriers in Europe
  • Poor cloud infrastructure in emerging economies.

IBM is going all out when it comes to showcasing Watson as a competitive differentiator. In an uncharacteristic move (and a sign of the times), it has launched Watson Developer Cloud, an open platform for developers to build apps on top of Watson for industry-specific solutions (through a set of APIs and SDKs). It is also working with app developers such as Decibel, Epic, Fluid, Go Moment, MD Buyline, TalkSpace, and Welltok to build apps embedded on Watson technology, thereby, rounding up a robust ecosystem. It is abundantly clear that IBM views healthcare as the principal vertical where Watson’s computing prowess can make its mark. In the meantime other service providers are likely to build or acquire their own cognitive capabilities to challenge IBM on pricing and specialist offerings.

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While the healthcare industry is reeling over the massive size of the Department of Defense’s (DoD) US$9 billion EHR contract just awarded to Cerner, Leidos, and Accenture, less attention is being paid to the fact that this team won the deal over the hot favourite joint bid of Epic Systems and IBM. Those who know the EHR landscape know there is scant anything that Epic loses (of course, the same used to be said about IBM, and that is where irony can probably find solace). Hence, the focus of this blog is on the fact that the invincible Epic Systems lost the mother of all deals in the EHR space.

Why are we hung up on Epic Systems? For the uninitiated, here is some context:

  • Predominant market leader: With over 40 percent market share, Epic has precipitated a large ecosystem of providers that are on its EHR platform. Epic has intelligently used its dominant market position to work with its customers in defining the roadmap for the evolution of EMR systems, and to make its competitors react to the steps it is taking to innovate across various care practices. Epic has focused primarily on large hospital systems, with minimal attention on the mid- to low-sized segment of the market. With its hold on the market, one is led to believe that Epic chooses its clients, rather than the other way around

  • Highly relationship-driven: Clients have traditionally loved Epic for being proactive in evolving its products, responding to suggestions, and quickly fixing issues. This is what set it apart from the biggies, such as Allscripts and Cerner, in its initial days. Epic has strong consultative sales teams that work closely with administrators, CMOs, and physicians. For large pursuits, it deploys dedicated product customization teams that can deliver POCs, manage change, and implement Epic in record time with partners. And most of Epic’s key product people, who can actually understand and address issues, are just a phone call away.

What could be going wrong with Epic Systems?

  • The “Epic” standard EMR? In an era where healthcare is actively pursuing consumer-focused and highly flexible technological innovation, Epic is facing flak – outside of its existing customer base – because of its highly standardized and rigid architecture. Key areas of question include lack of interoperability, lack of efficient APIs for consumer/end-user application development, and foreseen inability to innovate in a digital world due to its MUMPS-based legacy platform. This is what came out starkly when you read between the lines of Frank Kendall, Under Secretary, Department of Defense’s statement: “Market share was not a consideration, we wanted minimum modifications.”

  • High upfront capital investment: The upfront cost of Epic adoption is increasingly being mentioned as one of the hindrances. Cost is a major factor, and EMR implementations are hospitals’ biggest IT spend and budget areas. More importantly, some of the highly cited large EHR implementations (such as the US$700 million Duke University and Boston Partners deal) create an impression of a highly rigid commercials image for Epic. The case on cost versus benefit of having EHR has not been settled yet. Epic’s high premium positioning put it in a tight corner, despite the US$35 billion subsidies riding the EMR industry, and the general customer preference for Epic. The irony here is that the US$9 billion size of the deal is the reason Epic was such a natural choice for this DoD deal, but it probably lost it because the government needed a more flexible arrangement

  • Declining quality of services: Epic is facing the classical quality versus quantity challenge when it comes to managing its growing list of clients. The increasing shortfall in expert support staff is impacting its ability to maintain and support its products across many new and old clients. In the last 18-24 months, an increasing number of client executives have raised flags about outstanding and unresolved issues

  • Training has become a major area of concern, as more and more hospital systems are complaining of lost revenues due to their staffs’ below par or behind the curve Epic readiness. Epic’s inability to provide efficient training modules, and its tendency to keep things close to its chest, is driving wariness among new clients

  • Vendor-neutral storage: Given dependency concerns, customers are increasingly demanding vendors be aligned to some sort of vendor-neutral storage or archiving architecture. This is likely to lead to more thought leadership on vendor-neutral technologies, which will be directed at Epic’s predominant control regime.

There may be other commercial reasons for this massive DoD EHR deal not going Epic’s way. However, organizations already had a strong sense of circumspection while evaluating Epic’s EHR in terms of interoperability, next generation technology, digital enablement, and control. While before these reasons were less salient because of Epic’s trailblazing success, this lost deal will spur prospects to question them with a far more discerning eye.

On July 27, Israel-based Teva Pharmaceutical announced the acquisition of Allergan’s generics business unit for US$40.5 billion in cash and stock, consolidating its position as the leader in off-brand drugs. The deal which becomes the latest in a wave of high-profile consolidation in the pharmaceutical industry, combines Teva, the world’s largest generics drug company with its third largest competitor. The acquisition gives Teva enhanced scale in the intensely competitive generics market (over 20% market share) with cost savings potential due to product overlaps and economies of scale (through operating synergies of nearly US$1.4 billion) as it looks to cope with end of patent expirations. The deals comes at a time when the entire healthcare and life sciences continuum is witnessing rapid consolidation moves including large payers teaming up.

Core Competence – the New Life Sciences M&A Mantra

The deal is another indication in a long line of recent transactions as life sciences firms undergo a realignment of strategic focus and choose to concentrate on business of core competence. Following the big bang “acquire all” days of Big Pharma, pharmaceutical firms have realized that they need to reorient strategic goals and narrow down their focus to specific service lines and markets. This was the principal driving factor in the seminal Novartis-GSK asset swap announced in April 2014, which typified the new normal.

For Teva, this wraps up an increasingly messy four-month long pursuit of another generics rival, Mylan. The company withdrew its latest US$40.1 billion hostile offer to acquire Mylan as the deal prospects became bleak. Mylan itself is busy chasing rival OTC drugs company, Perrigo, which has so far snubbed Mylan’s attempts. The deal also has interesting implications for Allergan. The company has been at the center of major M&A activity in the last two years. This sale allows it to pay off debt from the US$70.5 billion integration with Actavis in 2014. That deal also signaled the end of one of the intense takeover struggles as Actavis beat Valeant Pharmaceuticals for Allergan. The sale to Teva allows Allergan to focus on building its branded drugs business. It could also mount an effort to purchase large peers such as Amgen or AbbVie.

Implications for Service Providers

As with any major consolidation exercise, the primary beneficiaries will be service providers with exposure to both merging entities and account-level relationships as they help with the integration initiatives. A natural consequence of such an exercise is the tendency to go for vendor rationalization as enterprises look to trim the sourcing pie. Demonstrating value across the life sciences value chain will emerge as a crucial differentiator in retaining presence across accounts. Given the diversified operational footprint of pharma firms, global presence becomes an important qualifying criteria for large scale deals, especially when it comes to areas such as infrastructure management. As the spotlight shifts on pockets of core competence, mapping enterprise-specific business outcomes and challenges to technology/process solutions will be key in getting management buy-in for forthcoming sourcing initiatives. The following image illustrates the current exposure of key service providers across major life sciences firms. As you can see, these mergers will lead to overlapping accounts for several services providers.

Account exposure across life sciences firms

The Road Ahead

Life sciences buyers stand at interesting crossroads right now. They seek technological preparedness to tackle multi-faceted challenges arising out of stifling R&D efficiency, dwindling margins, increasing M&A/restructuring, and evolving customer profile. Blockbuster-drugs-led growth has paved way for more pragmatic business models in this new reality. While the digital Kool-Aid continues to sweep the landscape, life sciences firms tend to struggle with digital enablement due to factors such as fragmented service provider landscape and non-standardized internal structures. How they navigate this challenge while digitizing operations will be crucial. Our recent report on IT Outsourcing in the Life Sciences Industry focuses on how global life sciences organizations need to enable their systems for digital enablement through a well-thought out services integration strategy. Pharma is in a continually evolving state of flux and these changes are only going to intensify. Service providers need to up their game to ride this wave.

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