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Cost containment as a stimulative force.

A roundtable discussion with health care analysts on the cost-control movement and other competitive forces sweeping the industry.

One constituency keenly interested in the cost-containment issue is the investment analysts who cover the health care industry. Directors & Boards met with five representatives of the analytical community to add their perspective to this edition's examination of health care cost management. Participating in the roundtable discussion were:

-- Viren Mehta, Patner of Mehta & Isaly, which provides research and investment advice on the pharmaceutical and biotechnology industries to individual and institutional investors.

-- Sam Navarro, Medical Technology Analyst at Needham & Co., the investment banking firm, where specializes in the devices and supplies segment of the health care marketplace.

-- George D. Pillari, a co-founder and Chief Executive Officer of Health Care Investment Analysts Inc., a Baltimore-based information company that, through its data bases and publications, tracks the hospital and nursing home sector.

-- Barbara A. Ryan, Vice President and Senior Drug Analyst in the Equity Research Department of Prudential Securities Inc. She has been covering the drug industry since 1981, with a focus on both the major pharmaceutical companies and smaller special-situation firms.

-- Martha Ventilla, Executive Director of PH II Inc., an investment banking firm in which she specializes in financing and merger advisory work, often with a cross-border focus, for biotechnology and pharmaceutical companies.

Excerpts from the discussion follow.

Directors & Boards: Let's start by looking at one major segment of the health care industry -- the pharmaceutical business. The cost of drugs is a controversial issue. What are we as nation spending on drugs?

Barbara Ryan: Total spending for drugs is on the magnitude of 8% to 10% of all health care expenditures.

George Pillari: Ten percent is well over $70 billion.

Ryan: Right. But people will sometimes say, |Why worry about drug prices, because it is such a small piece? If it is 10% and you lower it to 8%, so what? You have to focus on the other 90%, which is the doctors or the hospitals.'

D&B: It is a very visible 10% because many people have to pay for these prescriptions out of pocket.

Ryan: Another factor is that we re all on a continuum toward the age of 65, and it is at that age that drugs costs are very significant. For patients over 65, the drug portion of the total costs of health care is 35%. You never meet a person over 65 who can't recite to you every single prescription they take and how much it cost last week and the week before that. And many elderly people live on cost-of-living increases.

D&B: How has cost containment begun to impact the pharmaceutical industry?

Ryan: It pervades the competitive environment. A lot of changes are being forced on the industry by corporate managements, because they are paying the bill. Corporations are banding together globally to reduce their health care costs and, as such, the buyers have become large institutions, and the individual doctor, who has been the traditional target of marketing, is less important. The influx of managed care is the competitive force driving the industry now.

If you have a litany of products in one therapeutic category -- let's take arthritis, where you have some 15 products which are not terribly distinguished from each other -- those products are slowly going through a commoditization process among managed-care buyers. What the industry must do is come up with truly unique products. Historically, if you look at the industry, many companies were very successful whether they did groundbreaking research and developed unique products or whether they just developed a host of |me too' drugs. The rewards for the research dollars spent were still very high in either case.

Now, the onus is on the pharmaceutical companies to show the cost-effective features of their drugs, and clinical trials must be designed with this in mind. No longer do you design a clinical trial to show merely safety and efficacy, but you must also show that the new drug is more effective than either currently available other drugs or other treatments, such as surgery.

The companies that develop unique value-added products will get rewarded and will have the money to continue to put toward research. Those companies that can't are either getting merged or doing joint ventures to acquire technology. The consolidations, mergers, and joint ventures that we have seen to date show that the competitive structure of some companies is very inadequate for the world that we are moving toward. There have been companies in the industry that have spent, cumulatively, billion of dollars research and yielded nothing but a bunch of me-too kinds of products. Clearly, those companies, for the long haul, can't compete. It is an evolutionary issue. In the past the whole industry did well. Now there will big winners and big losers.

D&B: Who will be the winners?

Ryan: The winners will be those companies that consistently come up with unique products. Our favorite is Merck. Merck has consistently come up with value-added drugs, and we see many more on the horizon. One, Proscar, which is used to treat enlarged prostate disease, has been filed with the FDA. Enlarged prostate disease afflicts 50% of men over 50 and eventually gets everyone if they live along enough. Right now there are two treatments -- surgery and watchful waiting. For obvious reasons, watchful waiting is the most attractive, until symptoms get very high. This will be the first drug that would not only treat the problem but could reverse or prevent it.

There are a lot of opportunities. I can't think of one therapeutic category in which we couldn't use better drugs. I mentioned the number of arthritis drugs. If anyone ever developed one that didn't burn a hole in your stomach and did more than just relieve symptoms, they would have a multi-billion-dollar drug, and the rest of the drugs would be displaced. In many therapeutic areas -- Parkinson's, Multiple Sclerosis, Alzheimer's -- the industry really has nothing to offer patients. So, there is huge opportunity, but it's not in developing the me-too compounds.

What that means is that the research dollar has to be more carefully spent. Rather than working in 10 or 12 therapeutic categories and doing a mediocre job in most of them, drug companies must truly do groundbreaking research, so they must select a very focused group of research areas to go into.

Martha Ventilla: If there is a case to illustrate this point very sharply, it is in Japan. In Japan, which is the second-largest and the most expensive pharmaceutical consumer market, the national health care system reimburses for drugs. In recent years, the reimbursement policy changed, severely penalizing the me-too drugs and putting a very tight lid on what prices can be charged. The only way pharmaceutical companies can even stay alive, never mind make a profit, is by ensuring that they have a constant stream of innovative drugs.

Viren Mehta: We re on the threshold of a glorious dawn, with the new science yielding drugs that go well beyond treating just symptoms. But, the same science makes it possible to develop new drugs much more rapidly, so that the product line cycles are shrinking. If anyone has a lead that is exciting, it is mandatory that they get it registered in all the major markets simultaneously and market that product effectively in that shortening life cycle. That, in a nutshell, is what the industry is facing as a competitive force within itself.

To the issue of how much is spent on which component of health care, there is no debate that the U.S., in spending 12% and perhaps very soon 14% of GDP, is spending too much on health care. I would defer to others about health care expenditures, as that is not my expertise. But in the U.S., we are spending about 8% of the health care dollar on drugs. In the European arena, it is around 12% to 18%. In Japan, it is 30%.

You can ask this question in one of two different ways. Why only 8% going toward drugs? Well, the simple answer is that that is all the pharmaceutical industry has deserved up to this point. Their drugs have done very little except treat symptoms.

Now, for the first time, we are able to come up with drugs that go beyond treating symptoms. Proscar was cited as an example, and there are dozens of others. And this is only the first generation. We have a long way to go. Wouldn't it suggest that we can control health care costs by, in fact, spending a greater proportion of every health care dollar on pharmaceuticals?

I would endorse the concept that to be successful, companies have to focus on fundamental scientific breakthroughs. Focus on the areas in which there is a tremendous need and produce drugs that go well beyond treating symptoms. If that happens, which we are pretty confident will happen based on the progress in the first generation so far, that will be quite beneficial for those companies in the pharmaceutical and biotechnology arena that are fulfilling that objective.

D&B: Let's move on the devices, supplies, and services segments. What cost-containment trends are evidencing themselves in these areas?

Sam Navarro: Anybody who points to the devices part of the market as a cost culprit is really not looking at the whole picture. The entire industry for devices and supplies is only a tiny portion of the pie of health care expenditures.

I will give you a perfect example. One of the most important areas in health care is the cardiovascular sector. Cardiovascular disease is the leading cause of death in this country. That is $100 billion market -- meaning the doctors, the hospitals, everything dealing with cardiovascular procedures. But the devices part of that market is only between $3 billion and $4 billion. If you address that sector, you have to address what happens beyond the device -- how is it being used, not whether it is being used too many times.

So, the problem is not in the devices end. I see it as being in the services end. The multiplier is what is big -- the multiplier being the $3 billion in sales of devices creating a $100 billion industry on top of that.

Pillari: Right. Because it will always be looked at as an honor in a community for a hospital to get a new million-dollar piece of equipment, whatever it is. Everybody will be excited and happy that this is now available. But what will get people upset is when they find out that you need a support staff of a dozen people making $80,000 a year a piece just to move patients in and out of the machine, and maybe a whole building to house it. That is what is going to catch the attention, not the cost of the equipment. The American public will pay for the equipment because the perception is that it will improve the medical system and make everybody healthier. But the management of the service end of it is where there are big problems.

Navarro: When the recession began in this country -- a little over a year ago, I guess -- and as the economy began to lose hundreds of thousands of jobs, I kept seeing every month 40,000 to 50,000 new employees being added in the health care industry. When you think about it, with 65% to 70% of that expenditure related to wages, how can you stop this monster unless you stop employment and inject productivity into the employee base? I just don't see how the health care cost issue can be addressed without addressing the employment side, in terms of productivity.

Pillari: The new job creation in health care is unbelievable. It was about 600,000 jobs this year. In New York City alone, 10,000 new health care jobs were added in 1990. As a result of new payment methodologies instituted by the federal government, more than 20% of the patient days in the system were removed -- a patient day being a patient in the hospital for one day. Twenty percent the industry's volume was taken out of the system. And employment in the industry went up each year by about 2% to 3% even though the industry was 20% smaller. So. what Sam is saying is exactly right.

Navarro: The interesting thing is that in many product and service areas there is technology available to address these productivity issues. Nevertheless, it is either not being utilized or is penetrating very slowly.

You hear of shortages of nurses. There is technology that could take care of that situation. Let's talk about bedside and patient monitoring systems. There are close to one million hospital beds in the country. Yet, you find out that nurses spend probably 40% of an eight-hour shift in documentation and unproductive non-patient activities. The nurses are supposed to be there to be with the patient take care of the patient, to do productive things. If you inject these bedside-type monitors that allow you to chart and input information on the spot, you can save an hour or two hours per shift, as estimated by some companies that are addressing this market. That is significant.

The hospitals that are beginning to install some of these systems have an easier time attracting nurses because the nurses spend less time in bureaucratic activities and more time in patient interaction. And you can save a lot of money in the hospital environment with this kind of technology.

Pillari: This type of equipment is going to allow the hospital to hold onto its nursing staff, which is its biggest asset that it has. The nursing staff is a hospital's biggest single expense item in addition to being its most valuable resource. But, in talking about competitive dynamics and cost containment, an interesting fact is that in competitive hospital markets -- markets in which there are four, five, six hospitals fiercely competing for patients -- prices and costs per unit in those hospitals are actually 15% to 18% higher than in noncompetitive markets. So, despite this focus on cost containment, when you get into a competitive situation among hospitals, they do not compete on price. They compete on amenities and services that they offer. If Hospital A down the street just purchased a new MRI (magnetic resonance imaging system), then Hospital B is compelled to run out and buy one as well. There is more of that going on in the hospital sector than anywhere else. And what is sad is that hospital expenditures account for 40% to 45% of all health care expenditures. So, that is something that I think is going to have to change.

D&B: What are some of the other emerging opportunities to help contain rising costs?

Navarro: Surgical procedures, which total about 23 million to 25 million per year in this country alone, are to some degree amenable to significant cost cutting if you change the technique. In that regard, the minimally invasive surgical are is emerging and will have a tremendous impact on the cost of health care delivery.

Minimally invasive surgery includes using new instrumentation and new surgical techniques to perform surgeries in a way that reduces patient trauma and reduces cost significantly because the patient can recuperate a lot quicker. A specific example is gallbladder removal. Typically, the patient would spend a week in the hospital and three weeks at home recuperating before going back to work. With this new instrumentation and surgical technique, the patient goes back home practically the next day, and can go back to work, on average, three to four days later. You have 600,000 gallbladder procedures done every year in the U.S. In 1989, approximately 10,000 were performed using less-invasive techniques. In 1990, I estimated 100,000 procedures, and by the end of 1991, this figure probably reached 450,000 procedures. So, the adoption of minimally invasive surgery is extremely rapid.

It is beginning with abdominal procedures and is moving very quickly into the thoracic area. I can foresee in three or four years the possibility of advanced clinical trials dealing with thoracic surgery -- heart bypass operations -- without having to open up the chest. I see this specific segment of the industry eventually exploding -- meaning opportunities for companies that provide the devices and supplies the are used per procedure. All of these companies are in the midst of a tremendous surgical revolution. That is a benefit to the system. It is lowering the cost significantly -- 50% or more per procedure.

Ventilla: Third-party reimbursement has a very clear effect on the entire health care industry. There has been a dramatic change in the reimbursement policy toward preventive medicine, and that has been an enormous stimulus to the industry. One direct example is mammograms. In the past, mammograms were costly and dangerous because of the high radiation dosage, so they were not part of the routine screening protocol. Right now mammograms are reimbursable by most health insurance companies. And the equipment that has been developed has greatly reduced the dosage and, consequently, the health hazard associated with regular screening. So, here you have a very clear example of how health care insurance reimbursement policy works along with medical technology, making it possible to provide regular screening against an illness that is terribly costly, both in human and monetary terms.

Ryan: As Martha mentioned earlier, something that is very different outside of the U.S. is that governments pay for all or most of the health care. There is a huge opportunity for over-the-counter products for that reason, because all governments are looking for ways to reduce their costs. Governments do not reimburse for OTC medications, hence there is a clear movement of drugs from prescription to OTC status. Today, people are more concerned with their health. If their health problem is a symptomatic one, people will self-medicate. Products for symptomatic relief that switched from prescription to OTC status have been enormously successful. They also ease the burden of payors.

So, the OTC market remains an opportunity for pharmaceutical companies. Even Merck, considered America's greatest research company, has hustled to get into the OTC business though a joint venture with-Johnson & Johnson. This tend was obviously a big element in the merger of Bristol-Myers and Squibb. There is a scarcity value for that kind of business. I think increasingly you will see joint ventures so companies can access and complement each other's strengths. Merck has been very adept at supplementing its own internal strengths by accessing strengths from other companies.

Ventilla: What Barbara says signals a very interesting overall shift. When I think about the health care industry, I segment it in three great columns: the column on the left is hospital and hospital-related; the center column is doctor's office; and the one on the right is OTC. What we have been seeing is a consistent shift, under the pressure of cost containment, from the left column to the right column. Most procedures that 10 years ago could only have been done under hospital care are shifting to the doctor's office as out-patient care. In the pharmaceutical industry, there is a similar shift from doctor's prescriptions to the OTC market. This is a very natural response of the market to avoid astronomical costs and to have more autonomy. Those pharmaceutical and instrumentation companies that recognize this shift and are willing and able to swim with the current in that direction will be the winners.

Ryan: There is clearly a huge opportunity for self-medication in many areas where we haven't had it to date. The real snag, however, in this development is how long it will take the FDA to come around. The FDA is going to be worried about things like whether people who may have stomach cancer and will mask the pain by treating themselves with over-the-counter H-2 antagonists, therefore delaying a doctor's visit and diagnosis. While the medical community is moving very quickly, the regulatory issues may protract the timing for OTC products to get to market.

D&B: How about biotechnology as an opportunity to impact health care costs?

Ventilla: I would address that question in this way. Traditional Western medicine was usually reactive and 'poison' oriented. The solution generally was to give enough poison to the body to fight illness, yet to make sure that the patient didn't die. Very often the patient did die. Western medicine, back in the Middle Ages, started with opening corpses -- learning from the dead and extrapolating the knowledge gained from cadavers to be of use to the living.

In the Orient, the thinking was different. It was far more 'life' oriented. Biotechnology, oddly enough, is more of an Oriental concept. The basic concept of biotechnology is to boost the body's immune system. For example, you start by considering the blood as an organ, then you raise the level of certain key immune components so they can defend you against invaders. The second concept of biotechnology is to tone down the toxicity, when medicine is necessary, and to make the poison more specific. If we have to live with poisons because we don't have a better way of treatment, at least let's make sure that the poison is directed and contained in a very narrow and specific area so when we treat the body there will be less overall damage done. To that end, there has been great progress made in the drug delivery area.

So, the contribution of biotechnology is not only to make medicine more efficient but to come up with delivery systems and therapeutic alternatives that are less dangerous to the existing organism. Now, if you look at the demographic picture, with life expectancy being so much longer, you have full array of new diseases that are hard to treat with traditional pharmaceutical products. Fermentation has been the one key technology of traditional medicine, with penicillin one of traditional medicine's greatest inventions. It really did all that it could and it was tremendously effective. Basically, a wide variety of traditional diseases have been treated successfully. But when we come to cancer, to diseases of the central nervous system, to diseases inflicted on us by our very own civilization, somehow those have increasingly escaped the capabilities of traditional medicine. That is why there was a new tool, a new approach, that was needed, and that is the void that biotechnology is trying to fill -- to a large extent, successfully.

Revolutions underway in the biotechnology and research areas will make it possible in the next 10-plus years to treat diseases in an entirely different way. The latest use of biopharmaceuticals have the promise of being capable of artificially engineering the major components of our immune system and thereby attacking diseases on the receptor level. That is not only a highly specific way of treatment but also presents an effective therapeutic approach against most diseases, including cancer, AIDS, diseases of the central nervous system, and the variety of autoimmune diseases.
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Title Annotation:Chairman's Agenda: Managing Health Care Costs
Publication:Directors & Boards
Article Type:Panel Discussion
Date:Jan 1, 1992
Previous Article:Taking the pulse of the industry.
Next Article:What to do about retiree health care.

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