ROUNDTABLE 4
Proceedings ••• Paper
Slide Presentation
Handouts
Case Study
ROUNDTABLE Caveat Emptor – Vendor Consolidations May Be Hazardous To Your Health Peter J. Weil Vice President and Principal Hamilton HMC The Healthcare Consulting Division Of Kurt Salmon Associates New York, NY
4
Elaine Remmlinger Vice President and Principal Hamilton HMC The Healthcare Consulting Division Of Kurt Salmon Associates New York, NY
COPYRIGHT © 2001 BY THE HEALTHCARE INFORMATION AND MANAGEMENT SYSTEMS SOCIETY.
1
INTRODUCTION Over the past five years there has been continuous erosion in the number of remaining viable health care system vendors and core product offerings. This trend is now becoming critical in view of the dramatic reduction in provider organization capital spending for information technology – primarily because the recent Year 2000 demands resulted in over 65 percent of 1999 capital budgets being allocated to either replacement or remediation of prevailing systems. It is estimated that, as a result, current vendors’ 2000 revenues are 30 percent below 1999, with a 50 percent short fall in the vendor sales pipelines. The situation is not expected to materially improve before the third quarter of 2001, by which time the growing demand for more advanced applications, the obsolescence of some of the retained systems, the forthcoming end of prevailing contractual arrangements, and the release of some capital funds currently allocated for facility improvements will fuel demand for new system acquisitions. All of these developments have imposed severe economic pressures of the health care vendor community, with those vendors under public ownership being especially subject to pressures for increasing revenues and reducing costs. The combined effect of these developments are accelerating the pace of vendor consolidations, and threaten the ability of providers to protect their current investments in technology, as well as drastically changing the provider’s leverage and risk when negotiating new acquisitions.
BACKGROUND The typical IT environment at an active provider organization, until recently, was likely to incorporate the offerings of a meaningful number of commercial sources. Typically, in order to support the continuum of care, a medical center deploys products from 10-to-30 vendors, with the connectivity challenge being addressed through point-to-point interfaces or a suitable interface engine. In acquiring any one of these products, buyers were likely to be able to choose between a number of alternate vendors and their offerings. This robust marketplace provides for some freedom of choice, a variety of alternatives, and an advantage to the buyer who utilizes the leverage afforded by competition to obtain a beneficial business arrangement while limiting exposure to business, financial, technical, and schedule risks. However, there also are a number of negatives, including the erosion of leverage on the part of the vendors as their number increases within the enterprise, and the problems inherent in dealing with and coordinating multiple sources. Most traumatic is the challenge of connectivity in a multi-system, multi-platform environment. This view of the marketplace is rapidly changing. Over the past three years there have been in excess of 50 mergers, affiliations, and business failures which have dramatically reduced the number of both legacy and specialty system suppliers. While there have been a small number of new marketplace supplier entries such as Siemens and McKesson, the net result is an environment consisting of four major legacy system suppliers, and a dramatically lesser number of independent wrap-around technology and specialty system suppliers. As a further complication, it used to be that vendors were acquired by others for one of two reasons – for goodwill, reflecting a large client base that could ultimately be converted to the new organization’s product (e.g., IBAX), or for product (e.g., SDK). The acquisition of the system deployed by the provider by a new vendor for goodwill introduces major concerns – would the acquiring organization attempt to obsolete the system and force replacement? On the other hand acquisition for product used to signify good news to the provider – a new deep pockets vendor who will aggressively support and upgrade the product. Unfortunately, recently even the latter type of acquisition does not insure longterm support – in a number of instances the acquiring vendor stripped the high technology product of certain components, to be incorporated in its own product line, and then proceeded to obsolete the acquired product. Recently, another factor has entered to further increase potential factors which could further erode vendor commitments – public ownership.
THE EROSION OF COMMITMENTS AS VENDORS (AND CONSULTANTS) GO PUBLIC Over the past few years, the health care software vendor and consultant marketplace has experienced an accelerated transition from private to public ownership. This is not atypical of the technology marketplace in general, and IPOs in the technology sector, particularly for Internet companies, are occurring on a frequent basis. However, this shift in ownership, and the resulting influence by the stock market, presents substantial new risks to the provider community. The investment community represents a new stakeholder to which the publicly traded firms must cater, causing fundamental changes
2001 HIMSS Proceedings: Roundtables
Roundtable 4 / Page 2
in the behavior of the firm. These behavior changes may potentially erode the commitment to quality deliverables for the provider community. Quarterly earnings and earnings projections are often paramount, not customer results. The entire business landscape has changed. In effect, the caution let the buyer beware” is more critical than ever before. The Wall Street motto is “what have you done for me today.” Wall Street analysts are continuously scanning public organizations for a multitude of factors reflecting current performance, near-term risks, and developing marketplace changes. Analysts use these combined factors to determine the likelihood that sustained revenue and profit growth can be maintained. Primary factors that influence a buy, maintain, or sell recommendation typically focus on the following: • Is there an assured stream of longer-term revenues (annuities in lieu of one-time sales revenues)? • Is the organization sufficiently spread across multiple industries, or is it exposed to a one-industry recession? • Is there sufficient diversity in the product or services portfolio to limit exposure to reduced demand by individual marketplace sectors? • Is there a reduction in demand and/or increased competition that will erode fees? • Do the products and services have a long-term sales potential? It is the perceived vulnerability of the supply side of the marketplace that has led to drastic negative recommendations by Wall Street, resulting in a dramatic decline in stock values of both publicly owned consulting and vendor firms. As a result the stock value of virtually all of these publicallyowned firms had sharply declined, resulting in meaningful exposure to the providers with whom these firms deal. In attempting to promote their bottom-line interests, vendors and consultants (immaterial of their ownership status, but especially evident as public ownership pressures mount) have more than ever engaged in practices that adversely impact the buyers of their products. These practices include: • Premature product and service line introduction. Publicly traded firms are pressured to announce new products to generate shareholder interest and customer sales. Often these products are prematurely introduced, and are no more than “vaporware”. Consequently, the vendor cannot deliver what is sold on the agreed upon schedule. For the customer, without adequate contractual protection, there is the requirement to pay license and implementation fees even though the product was not delivered as promised. The quality of the resulting implementation suffers, and the customer is dissatisfied. • Product sunsets/migration and service line curtailment. Most vendors are in the process of introducing and/or enhancing new client-server products to replace older legacy products. While this provides an opportunity for the customer to stay current with technology, its also requires new investments to upgrade software and hardware, develop new interfaces, convert databases, and retrain staff. All of these expenditures are incremental, and while they generate new revenue for the vendor, they are often unanticipated by the customer. Without adequate contractual protection, these expenses can be significant. • Unwise mergers and spin-offs. Oftentimes, mergers are ways for vendors and consultants to buy a client base and market share, but the products do not survive the merger. Similarly, when mergers come apart, products (new or old) may not survive unless there is a strong client base. From the Wall Street perspective, the merger or spin-off is often viewed positively as a mechanism to boost revenues or reduce expenses. From the customer perspective, change may not be positive if it means another application conversion. Typically, the vendor will offer existing clients a migration path in order to retain them and ensure future revenue. • Unacceptable deterioration in support services. Too often, just prior to positioning itself for a sale of its assets, organizations will cut their support levels in an attempt to reduce their expenses to revenue levels. • Lack of integration/disparate products. The enterprise vendors (e.g., McKessonHBOC, SMS) offer the full range of software products for the integrated delivery provider. These products often are not integrated, and may not be fully interfaced, even though they are packaged as a single product family. The origins of the products include different underlying architectures, databases, and user interfaces. Consequently, integration is difficult or even impossible. New GUI based front-ends simulate integration by providing a common look and feel, a single sign on capability, and context management, while interface engines manage the flow between the applications. For the customer, application integration means a more complex and expensive implementation. For the vendor and consultant community, integration activities mean more business.
2001 HIMSS Proceedings: Roundtables
Roundtable 4 / Page 3
• Artificial revenue recognition. Firms seek payment for software licenses within 12 months to meet GAAP (Generally Accepted Accounting Practice) rules regardless of whether the implementation is complete. Similarly, consultants invoice prematurely for services not yet delivered. Clients, on the other hand, want to withhold payments until measurable milestones are achieved regardless of dates. For vendors, this is problematic since it is not possible to book contingent liabilities. It takes creative contracting to work around this issue, and is often the key issue during negotiations.
MEANS FOR BUYERS TO PROTECT THEIR INTERESTS Providers and vendors have fundamental differences in their motivations when entering into agreements for products and services. The consolidations and financing pressures require vendors to focus in generating backlog and realizing revenue early in the relationship actions which are problematic for providers. It is important for providers, dealing with all vendors to minimize the risks while exploiting the potential benefits as follows: • Perform adequate due diligence. Exhibits 1 and 2 identify the issues, which must be considered as part of the due diligence process in evaluating potential vendor and consultant relationships.
Figure 1: What You Need To Evaluate Vendors
Figure 2: What You Need To Evaluate Consultants
2001 HIMSS Proceedings: Roundtables
Roundtable 4 / Page 4
• Negotiate performance-based milestone payments. In standard agreements, the vendor or consultant gets paid regardless of performance. In milestone based deals, payment is tied to performance. Vendors and consultants will balk at this requirement without a doubt, and will only agree if the provider takes responsibility for its failure to perform (the never-ending implementation project). The vendor or consultant should be sufficiently induced to perform on time with quality staff and deliverables. Some vendors and consultants are willing to enter into risk-sharing arrangements (e.g., UCSF/ Stanford and IDX) where penalties would be paid if project deadlines are not met. Similarly, the large outsourcing deals (e.g., FCG and Compuware) have incorporated these risk sharing arrangements into the joint ventures including a retaining a CIO who is employed by the provider to manage the relationship. Frankly, most outsourcing arrangements have been fiascos – a not so public disclosure increasingly becoming evident to the knowledgeable in the IT community. • Negotiate a solid contract. Vendors promote “partnerships”, where the formal contract can be discarded. This arrangement works until the contract is executed. Therefore, in addition to adequate due diligence and performance based payments, it is critical to negotiate a business and legal agreement that mitigates risks subsequent to the initial implementation including response time, future enhancements, new products, product sunsets, and ongoing support services. Relative to outsourcing, given the lack of health care industry experience, having a solid contract is essential including meaningful and measurable performance metrics and risk/reward incentives.
VENDOR CONSOLIDATIONS CAN ALSO PROVIDE BENEFITS With budgets tightening, boards and health care executives are questioning the value of further IT expenditures. CIOs are being asked to demonstrate, with tangible data, that new IT investments will have a quantitative bottom line impact – increasing revenue, reducing staff, increasing productivity, decreasing expenses. Many of the established vendors offer older systems and little new function has been added. The newer products are yet to be proven, and while the technology is appealing, available function is often less than the predecessor legacy products. In the long run, vendor consolidations and deeper pockets focusing on fewer independent products may also provide benefits to the user community: • More rapid incorporation of new technologies. Historically, health care lagged other industries in the introduction of new technologies by as much as 5-to-10 years. The availability of deeper pockets by the larger, consolidated vendor organization may accelerate the incorporation of new technologies. • Significant R&D investments. On the average, technology vendors invest 7%-to-20% of revenues in ongoing R&D. The consolidated vendor organization is likely to focus larger investments over a better defined portfolio of applications. • Industry standards. Larger, consolidated vendors, especially under under the scrutiny of Wall Street industry analysts, have been pressured to move from proprietary architectures to industry standards. • New products. As a result of significant R&D investments, use of industry standard technologies, and new acquisitions and joint ventures, it is possible to bring products to market more rapidly than ever before, thus narrowing the supply and demand gap. As indicated earlier, however, buyers must perform adequate due diligence to be certain that the product is ready for commercial introduction. • Large, financially viable firms. Public ownership gives legitimacy to previously privately held firms with limited capitalization. It enables new products to come to market that otherwise would not be possible.
AUTHOR BIOGRAPHIES Peter Weil is a Vice President and a National IT Practice Director at Hamilton HMC. A recognized expert in the field and a frequent speaker, he has 25 years experience in virtually every aspect of a national information technology practice. Elaine Remmlinger is a Vice President and a National IT Practice Director at Hamilton HMC. A frequent speaker and author, she has 25 years experience in health care information technology for a national client base.
2001 HIMSS Proceedings: Roundtables
Roundtable 4 / Page 5
Slide Presentation
Handouts
Case Study
ROUNDTABLE Caveat Emptor – Vendor Consolidations May Be Hazardous To Your Health Peter J. Weil Vice President and Principal Hamilton HMC The Healthcare Consulting Division Of Kurt Salmon Associates New York, NY
4
Elaine Remmlinger Vice President and Principal Hamilton HMC The Healthcare Consulting Division Of Kurt Salmon Associates New York, NY
COPYRIGHT © 2001 BY THE HEALTHCARE INFORMATION AND MANAGEMENT SYSTEMS SOCIETY.
1
INTRODUCTION Over the past five years there has been continuous erosion in the number of remaining viable health care system vendors and core product offerings. This trend is now becoming critical in view of the dramatic reduction in provider organization capital spending for information technology – primarily because the recent Year 2000 demands resulted in over 65 percent of 1999 capital budgets being allocated to either replacement or remediation of prevailing systems. It is estimated that, as a result, current vendors’ 2000 revenues are 30 percent below 1999, with a 50 percent short fall in the vendor sales pipelines. The situation is not expected to materially improve before the third quarter of 2001, by which time the growing demand for more advanced applications, the obsolescence of some of the retained systems, the forthcoming end of prevailing contractual arrangements, and the release of some capital funds currently allocated for facility improvements will fuel demand for new system acquisitions. All of these developments have imposed severe economic pressures of the health care vendor community, with those vendors under public ownership being especially subject to pressures for increasing revenues and reducing costs. The combined effect of these developments are accelerating the pace of vendor consolidations, and threaten the ability of providers to protect their current investments in technology, as well as drastically changing the provider’s leverage and risk when negotiating new acquisitions.
BACKGROUND The typical IT environment at an active provider organization, until recently, was likely to incorporate the offerings of a meaningful number of commercial sources. Typically, in order to support the continuum of care, a medical center deploys products from 10-to-30 vendors, with the connectivity challenge being addressed through point-to-point interfaces or a suitable interface engine. In acquiring any one of these products, buyers were likely to be able to choose between a number of alternate vendors and their offerings. This robust marketplace provides for some freedom of choice, a variety of alternatives, and an advantage to the buyer who utilizes the leverage afforded by competition to obtain a beneficial business arrangement while limiting exposure to business, financial, technical, and schedule risks. However, there also are a number of negatives, including the erosion of leverage on the part of the vendors as their number increases within the enterprise, and the problems inherent in dealing with and coordinating multiple sources. Most traumatic is the challenge of connectivity in a multi-system, multi-platform environment. This view of the marketplace is rapidly changing. Over the past three years there have been in excess of 50 mergers, affiliations, and business failures which have dramatically reduced the number of both legacy and specialty system suppliers. While there have been a small number of new marketplace supplier entries such as Siemens and McKesson, the net result is an environment consisting of four major legacy system suppliers, and a dramatically lesser number of independent wrap-around technology and specialty system suppliers. As a further complication, it used to be that vendors were acquired by others for one of two reasons – for goodwill, reflecting a large client base that could ultimately be converted to the new organization’s product (e.g., IBAX), or for product (e.g., SDK). The acquisition of the system deployed by the provider by a new vendor for goodwill introduces major concerns – would the acquiring organization attempt to obsolete the system and force replacement? On the other hand acquisition for product used to signify good news to the provider – a new deep pockets vendor who will aggressively support and upgrade the product. Unfortunately, recently even the latter type of acquisition does not insure longterm support – in a number of instances the acquiring vendor stripped the high technology product of certain components, to be incorporated in its own product line, and then proceeded to obsolete the acquired product. Recently, another factor has entered to further increase potential factors which could further erode vendor commitments – public ownership.
THE EROSION OF COMMITMENTS AS VENDORS (AND CONSULTANTS) GO PUBLIC Over the past few years, the health care software vendor and consultant marketplace has experienced an accelerated transition from private to public ownership. This is not atypical of the technology marketplace in general, and IPOs in the technology sector, particularly for Internet companies, are occurring on a frequent basis. However, this shift in ownership, and the resulting influence by the stock market, presents substantial new risks to the provider community. The investment community represents a new stakeholder to which the publicly traded firms must cater, causing fundamental changes
2001 HIMSS Proceedings: Roundtables
Roundtable 4 / Page 2
in the behavior of the firm. These behavior changes may potentially erode the commitment to quality deliverables for the provider community. Quarterly earnings and earnings projections are often paramount, not customer results. The entire business landscape has changed. In effect, the caution let the buyer beware” is more critical than ever before. The Wall Street motto is “what have you done for me today.” Wall Street analysts are continuously scanning public organizations for a multitude of factors reflecting current performance, near-term risks, and developing marketplace changes. Analysts use these combined factors to determine the likelihood that sustained revenue and profit growth can be maintained. Primary factors that influence a buy, maintain, or sell recommendation typically focus on the following: • Is there an assured stream of longer-term revenues (annuities in lieu of one-time sales revenues)? • Is the organization sufficiently spread across multiple industries, or is it exposed to a one-industry recession? • Is there sufficient diversity in the product or services portfolio to limit exposure to reduced demand by individual marketplace sectors? • Is there a reduction in demand and/or increased competition that will erode fees? • Do the products and services have a long-term sales potential? It is the perceived vulnerability of the supply side of the marketplace that has led to drastic negative recommendations by Wall Street, resulting in a dramatic decline in stock values of both publicly owned consulting and vendor firms. As a result the stock value of virtually all of these publicallyowned firms had sharply declined, resulting in meaningful exposure to the providers with whom these firms deal. In attempting to promote their bottom-line interests, vendors and consultants (immaterial of their ownership status, but especially evident as public ownership pressures mount) have more than ever engaged in practices that adversely impact the buyers of their products. These practices include: • Premature product and service line introduction. Publicly traded firms are pressured to announce new products to generate shareholder interest and customer sales. Often these products are prematurely introduced, and are no more than “vaporware”. Consequently, the vendor cannot deliver what is sold on the agreed upon schedule. For the customer, without adequate contractual protection, there is the requirement to pay license and implementation fees even though the product was not delivered as promised. The quality of the resulting implementation suffers, and the customer is dissatisfied. • Product sunsets/migration and service line curtailment. Most vendors are in the process of introducing and/or enhancing new client-server products to replace older legacy products. While this provides an opportunity for the customer to stay current with technology, its also requires new investments to upgrade software and hardware, develop new interfaces, convert databases, and retrain staff. All of these expenditures are incremental, and while they generate new revenue for the vendor, they are often unanticipated by the customer. Without adequate contractual protection, these expenses can be significant. • Unwise mergers and spin-offs. Oftentimes, mergers are ways for vendors and consultants to buy a client base and market share, but the products do not survive the merger. Similarly, when mergers come apart, products (new or old) may not survive unless there is a strong client base. From the Wall Street perspective, the merger or spin-off is often viewed positively as a mechanism to boost revenues or reduce expenses. From the customer perspective, change may not be positive if it means another application conversion. Typically, the vendor will offer existing clients a migration path in order to retain them and ensure future revenue. • Unacceptable deterioration in support services. Too often, just prior to positioning itself for a sale of its assets, organizations will cut their support levels in an attempt to reduce their expenses to revenue levels. • Lack of integration/disparate products. The enterprise vendors (e.g., McKessonHBOC, SMS) offer the full range of software products for the integrated delivery provider. These products often are not integrated, and may not be fully interfaced, even though they are packaged as a single product family. The origins of the products include different underlying architectures, databases, and user interfaces. Consequently, integration is difficult or even impossible. New GUI based front-ends simulate integration by providing a common look and feel, a single sign on capability, and context management, while interface engines manage the flow between the applications. For the customer, application integration means a more complex and expensive implementation. For the vendor and consultant community, integration activities mean more business.
2001 HIMSS Proceedings: Roundtables
Roundtable 4 / Page 3
• Artificial revenue recognition. Firms seek payment for software licenses within 12 months to meet GAAP (Generally Accepted Accounting Practice) rules regardless of whether the implementation is complete. Similarly, consultants invoice prematurely for services not yet delivered. Clients, on the other hand, want to withhold payments until measurable milestones are achieved regardless of dates. For vendors, this is problematic since it is not possible to book contingent liabilities. It takes creative contracting to work around this issue, and is often the key issue during negotiations.
MEANS FOR BUYERS TO PROTECT THEIR INTERESTS Providers and vendors have fundamental differences in their motivations when entering into agreements for products and services. The consolidations and financing pressures require vendors to focus in generating backlog and realizing revenue early in the relationship actions which are problematic for providers. It is important for providers, dealing with all vendors to minimize the risks while exploiting the potential benefits as follows: • Perform adequate due diligence. Exhibits 1 and 2 identify the issues, which must be considered as part of the due diligence process in evaluating potential vendor and consultant relationships.
Figure 1: What You Need To Evaluate Vendors
Figure 2: What You Need To Evaluate Consultants
2001 HIMSS Proceedings: Roundtables
Roundtable 4 / Page 4
• Negotiate performance-based milestone payments. In standard agreements, the vendor or consultant gets paid regardless of performance. In milestone based deals, payment is tied to performance. Vendors and consultants will balk at this requirement without a doubt, and will only agree if the provider takes responsibility for its failure to perform (the never-ending implementation project). The vendor or consultant should be sufficiently induced to perform on time with quality staff and deliverables. Some vendors and consultants are willing to enter into risk-sharing arrangements (e.g., UCSF/ Stanford and IDX) where penalties would be paid if project deadlines are not met. Similarly, the large outsourcing deals (e.g., FCG and Compuware) have incorporated these risk sharing arrangements into the joint ventures including a retaining a CIO who is employed by the provider to manage the relationship. Frankly, most outsourcing arrangements have been fiascos – a not so public disclosure increasingly becoming evident to the knowledgeable in the IT community. • Negotiate a solid contract. Vendors promote “partnerships”, where the formal contract can be discarded. This arrangement works until the contract is executed. Therefore, in addition to adequate due diligence and performance based payments, it is critical to negotiate a business and legal agreement that mitigates risks subsequent to the initial implementation including response time, future enhancements, new products, product sunsets, and ongoing support services. Relative to outsourcing, given the lack of health care industry experience, having a solid contract is essential including meaningful and measurable performance metrics and risk/reward incentives.
VENDOR CONSOLIDATIONS CAN ALSO PROVIDE BENEFITS With budgets tightening, boards and health care executives are questioning the value of further IT expenditures. CIOs are being asked to demonstrate, with tangible data, that new IT investments will have a quantitative bottom line impact – increasing revenue, reducing staff, increasing productivity, decreasing expenses. Many of the established vendors offer older systems and little new function has been added. The newer products are yet to be proven, and while the technology is appealing, available function is often less than the predecessor legacy products. In the long run, vendor consolidations and deeper pockets focusing on fewer independent products may also provide benefits to the user community: • More rapid incorporation of new technologies. Historically, health care lagged other industries in the introduction of new technologies by as much as 5-to-10 years. The availability of deeper pockets by the larger, consolidated vendor organization may accelerate the incorporation of new technologies. • Significant R&D investments. On the average, technology vendors invest 7%-to-20% of revenues in ongoing R&D. The consolidated vendor organization is likely to focus larger investments over a better defined portfolio of applications. • Industry standards. Larger, consolidated vendors, especially under under the scrutiny of Wall Street industry analysts, have been pressured to move from proprietary architectures to industry standards. • New products. As a result of significant R&D investments, use of industry standard technologies, and new acquisitions and joint ventures, it is possible to bring products to market more rapidly than ever before, thus narrowing the supply and demand gap. As indicated earlier, however, buyers must perform adequate due diligence to be certain that the product is ready for commercial introduction. • Large, financially viable firms. Public ownership gives legitimacy to previously privately held firms with limited capitalization. It enables new products to come to market that otherwise would not be possible.
AUTHOR BIOGRAPHIES Peter Weil is a Vice President and a National IT Practice Director at Hamilton HMC. A recognized expert in the field and a frequent speaker, he has 25 years experience in virtually every aspect of a national information technology practice. Elaine Remmlinger is a Vice President and a National IT Practice Director at Hamilton HMC. A frequent speaker and author, she has 25 years experience in health care information technology for a national client base.
2001 HIMSS Proceedings: Roundtables
Roundtable 4 / Page 5
