By: Andrew Duncan
26.11.2021
The COVID-19 pandemic has been hugely disruptive for most global industries, although disruption in the healthcare industry is nothing new: healthcare has been changing rapidly since its inception, driven by demographic and epidemiological forces, alongside relentless innovation. It is an industry that has constantly needed to adapt and evolve as the world has changed.
That is not to say that the pandemic has been easy for the global health system. It is hard to think of another industry that has been so fundamentally affected, with the strain at times appearing to come close to breaking point. Thankfully this has been avoided up to now, in no small part due to the tireless work of frontline staff and medical researchers, supported by policy- and decision-makers who made the necessary tough choices to help battle the virus.
“Healthcare is arguably the most complex industry in the world.”
Whilst the pandemic is clearly not over yet, it is clear that it has thrown into sharp relief just how badly flawed the healthcare system was for the modern age and modern risks. Not enough beds, not enough equipment, not enough hospital staff… the list goes on.
It could be argued that the issue is not one of funding but of efficiency, and how that funding is spent, driven by decades of underinvestment, alongside misaligned incentives and poor management. However, healthcare is arguably the most complex industry in the world. After all, it has as much brain- and computing power as big tech and high finance, but the stakes are much higher – the end result can directly impact whether a person lives or dies.
It is hoped that the pandemic may turn out to be a watershed moment that may bring about a seismic shift in the industry, and not just through increased investment but in how the industry fundamentally works for all stakeholders. Given the complexity, it will surely take time and resources to turn this ‘oil tanker’ around, but the good news is there are reasons to be positive.
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For example, the industry has rapidly adopted new ways of working, such as virtual visits (telemedicine), which now account for as much as 10% of all visits, up from 1% before the pandemic. These visits cost less and allow for much wider access, especially for rural or underserved communities. In addition, breakthroughs in mRNA technology bode well for future vaccine development as well as potentially other treatments, including cancer. It appears the general population is also beginning to do its part, with a greater focus on individual health through fitness and diet that it is hoped will reduce future strain on the system. Furthermore, regulators and lawmakers appear finally to be ready to do their part, with a renewed focus on prescription drug prices, which have remained stubbornly high for years. In fact, between 2015 and 2020, list prices on branded drugs rose on average almost 7% annually in the US (although after rebates and discounts, this was closer to 1%). This is despite increased competition from generic and biosimilar drugs that come at much lower prices.
The rising cost of medication is a key debate globally, but nowhere more so than in the US, which accounts for as much as half of overall drug sales and more than half of profits, and where prices are far higher than the rest of the world. However, after decades of political posturing but little action, it appears there is now a credible path to lower drug prices in the US. In the first instance, a new agreement will allow the government, through its Medicare plan (which accounts for roughly one third of all drug spending), to negotiate directly with pharma companies on certain products.
“R&D spending and outsourcing trends are likely to continue to grow ahead of GDP, as pharma companies try to stay ahead of the curve.”
To begin with, it is estimated that this will have a modest impact on the major drug companies’ revenues and profits (estimated to be -3% and -6% on average, respectively). Whilst these numbers are not immaterial, they are unlikely to pose an existential risk to drugmakers. However, the direction of travel is clear, and we could see further pressure on pricing in the future.
This reinforces our pessimistic view on the pharmaceutical and biopharma industries. Not only do we have little visibility on the success of new drug development, but it seems these companies may no longer be able to make such outsized returns on existing or new product launches in the key US market. Whilst we appreciate the need for the economic returns to be high enough to incentivise investment in R&D, it is clear that these companies have been over-earning in the US market compared to the rest of the world. In addition, the threat from the loss of exclusivity remains a headwind for these incumbents, with generic or biosimilar drugs now accounting for 90% of all prescriptions made (by volume, not value).
What we can say with greater certainty is that R&D spending and outsourcing trends are likely to continue to grow ahead of GDP, as pharma companies try to stay ahead of the curve in developing new treatments, whilst reducing the overall cost burden of running not-so-exciting parts of the healthcare value-chain such as clinical trials and drug production facilities. Herein lies the opportunities for some of our favoured plays in Healthcare: Danaher and Thermo Fisher Scientific. Both of these conglomerates have diverse portfolios serving the industry, spanning diagnostics, drug discovery and development, and production (although there is remarkably little overlap). Diagnostics in particular is a key part of the healthcare value chain and is a crucial step in delivering better outcomes – as much as 70% of all clinical decisions in hospitals are based on diagnostic tests.
Another major player in clinical diagnostics is Abbott Laboratories, which also operates a best-in-class medical devices franchise. Devices are less likely to face price scrutiny than drugs (where overprescribing and mis-prescribing have been an issue for years), given that devices are sometimes used as a last resort when medication has failed, and the impact is seen immediately. Therefore, it is easier to demonstrate value for money for payors. This benefits a healthcare system that is increasingly embracing value-based or outcome-based care, the main premise of which means payors will only pay for solutions that deliver value or reduce cost (although arguably this should always have been the case).
With this in mind, payors are now looking at the entire cost of treatment and not just the headline price – it is becoming clear to many that in healthcare, the old adage applies: “buy cheap, buy twice.” A good example of the shifting paradigm is the rapid adoption of robot-assisted surgery (RAS). Whilst the cost of installing a robot can be high (over $2m per robot) the benefits can be substantial – significantly reduced length of stay in hospital for patients with fewer costly complications. Penetration of RAS in overall surgery remains low but is growing quickly, and with a market share as high as 80%, Intuitive Surgical stands to be the clear winner in this attractive market.
Standing at the intersection of all of these trends is UnitedHealth Group, a healthcare services conglomerate which spans health insurance through to data-driven healthcare provision (think of it as a private NHS, without the hospitals). It is the leading player in the US with unrivalled scale, which gives it significant real-world data. This can be used to make the best decisions and achieve the best outcomes, thereby reducing costs for its customers (including the US government and major private employers), and helping to lower the cost burden of healthcare across the entire system.
If you would like to discuss anything raised in this article in more detail, please don’t hesitate to get in touch.
