Anthem Blue Cross Blue Shield, the second largest commercial health insurer in the country, is sending a strong message to hospitals about their prices. That message is: “enough.”

In July 2017, Anthem began rolling out a new policy under which it will no longer pay for ambulatory MRIs and CT scans performed within hospitals without preauthorization of medical necessity. Anthem will provide physicians with names of alternative free-standing imaging locations for patients to use. The hospital, not the insured individual, would bear the cost of a procedure performed in a hospital that Anthem deems not medically necessary for that setting. By 2018, the policy will be effective in 14 of the 15 states that Anthem serves.

The policy comes on the heels of Anthem’s decision to deny claims for non-emergent services provided in emergency departments in three states, pushing for patients to be seen through retail clinics, urgent care centers, and virtual visits.

Anthem is not alone in this message to hospitals. The Centers for Medicare & Medicaid Services is reducing payments for outpatient services provided in hospitals and off-campus hospital outpatient centers, and is considering paying for total knee and hip replacements in ambulatory surgery centers.

Large employers are also looking askance at hospital prices for outpatient services. A recent study led by large employers in Indiana found that those employers paid 359 percent of the Medicare rate, on average, for hospital outpatient services.

We are rapidly approaching a point at which hospitals can expect both significantly lower payment rates and a significant migration of patients to freestanding outpatient centers. The result will be a revenue decline in one of the more profitable parts of hospital operations, and a hit to bottom lines that are already under attack.

A Case of Disruption

In industry after industry, we have seen the Clay Christensen-defined path of disruption. An innovator takes a complex, high-priced service and offers it in a more convenient, lower price way, attracting consumers, and drawing volume and revenue away from legacy companies. Borders and Blockbuster are the poster children for legacy companies that suffered this type of disruption.

As a complex, high-priced, and not consumer-friendly industry, healthcare is highly vulnerable to disruption. However, the disruptive process has been slow to develop in healthcare for a few reasons. One is that the breadth of services and the extreme complexity of healthcare make unlikely the kind of one-fell-swoop disruption seen with, for example, streaming video. Another is the lack of a homogeneous group of consumers that could drive a rapid exodus from a legacy provider. And finally, the traditional role of physicians as gatekeepers and drivers of service consumption creates a barrier to change and non-traditional competitors.

The decisive move by Anthem to stop paying for high-priced hospital-based outpatient services is perhaps the strongest signal yet that forces holding back healthcare disruption are starting to fray. We have seen the entrance of freestanding imaging, surgery, urgent care, and retail care companies that offer quality, convenience, and lower prices. And now we have insurers, large employers, and consumers—all of whom share the burden of high healthcare costs—aligning around the desirability of having routine services performed in these non-hospital settings.

Two Options for Hospitals

Once disruption begins, legacy companies face two basic options. One is to protect the status quo. That effort inevitably is overwhelmed by customer demand for a more desirable price and experience. Legacy companies are left in a downward spiral of reduced volume, painful cost cuts, and diminished relevance. Blockbuster and Borders fell into this downward spiral and were unable to emerge. ESPN is in the middle of this spiral as consumers disconnect from expensive cable bundles. The network is cutting costs by firing valuable talent as it struggles to retain its position of essentiality. While it is unlikely that ESPN will go out of business, it could very well emerge a smaller, less relevant company.

The second option for legacy companies is to rethink their business model. This involves acknowledging the change in customer expectations, and aligning the company’s cost position, product delivery, and revenue model with those changing expectations.

Few companies in the throes of disruption have been able to make this type of change, and never without a certain amount of pain. The Wall Street Journal and New York Times, for example, have successfully shifted their revenue models from print advertising to a combination of subscriber revenue and digital advertising. However, the process has not been easy. Both papers have had to reshape their presentation of the news for a digital age, and both continue to cut costs through painful layoffs.

The first option of maintaining the status quo clearly is not desirable. It is a path toward becoming a commodity, a position no company wants to occupy in today’s economy.

The second option, although more desirable, is extremely difficult to carry out. It requires transforming the culture, role, structure, and operations of the organization. For America’s hospitals, this hard work can only begin after coming to three critical realizations:

The long-term trajectory of payment is downward. Medicare and Medicaid already do not cover hospital costs. Enrollment in those programs is projected to rise, while Washington contemplates restructuring both programs to cut costs further. The decision by Anthem not to pay for hospital-based MRIs and CT scans is strong evidence that commercial payers are running out of patience with high hospital prices and with the cost shift to commercial payers that offsets shortfalls in Medicare and Medicaid payments. Hospitals need to accept the possibility that, in the near future, they will need to maintain a margin with all payers at Medicare rates.

Cost targets should be based on lower future payment levels. Historically, hospital cost targets have been based on each year’s revenue. When hospital revenue has increased, operating costs have increased, and when revenue has decreased, costs have decreased. In general, cost reduction has been accomplished through incremental changes to supply and labor expenses, and costs have crept back into the system, either through the original sources or investment in new initiatives. As payment continues to decline, such cuts will become more difficult to find and more painful to execute. Longer term change to the cost structure needs to occur as part of a more fundamental transformation that allows the organization to perform at a high level within a new revenue reality. For most organizations, fundamental changes will be required to their portfolio of facilities and services, eliminating duplication and repurposing or divesting low-performing facilities. Organizations also will need to redesign clinical and operational processes for maximum efficiency, use of technology, and a positive patient experience.

Growth will look much different in the future. Traditional methods of growth will not be enough to fund hospitals’ future. Payment rates are declining. Inpatient volume is down. Outpatient volume is growing, but non-traditional competitors are drawing that volume away from hospitals. Given this landscape, organizations will need to look for different ways to fund new capabilities, technologies, and initiatives. Those methods likely will include creative partnerships with other health systems, collaboration with non-traditional entities, and redefining the traditional services and customers of a hospital or health system—for example, by marketing unique capabilities to other providers.

A New Measure of Success

Anthem’s move to stop paying for hospital-based MRIs and CT scans is only the latest sign that healthcare disruption is underway. Payers, employers, and consumers are moving on from high-priced hospital services to innovators that can provide high-volume services in a more convenient manner and at a lower price. The measure of success for legacy organizations will be the extent to which they can transform themselves for the expected new levels of cost and service. Payers are running out of patience, and hospitals are running out of time.

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