US healthcare leaders are actively pursuing innovative business models, including both vertical integration and pure-play specialization (Exhibit 1). However, the growth rates of these business models have diverged in the past few years. While no organization focuses on just one of them, business models that emphasize vertical integration have produced the strongest growth in the past few years, our research finds (Exhibit 2).
Much opportunity remains across all types of business models; even among the fastest-growing models, not all organizations are creating value. Leaders who can align their organizations with drivers specific to their business model archetype could position them for superior value. This article offers an in-depth exploration of the business models that US healthcare organizations are pursuing.
Vertical-integration-focused business models
There are two kinds of vertically integrated healthcare business models (see sidebar, “How to improve outcomes in vertically integrated models”):
- Traditional integrated delivery networks (IDNs) have existed for decades. These models, in which hospital-centric health systems own health plans, have continued to derive 65 to 70 percent of their revenue from care delivery. From 2017 to 2022, they grew faster in overall revenue than pure-play hospital systems, unlocking value in areas such as Medicaid by taking ownership of total managed-care dollars. In Medicare Advantage, traditional IDNs have delivered higher quality scores than other business models, but their relative lack of scale has left them unable to generate sustainable margins.
- Capital-light IDNs emerged only in the past few years. These vertically integrated models combine traditional payer and provider functions, but notably without owning capital-intensive acute-care facilities. There are two types of capital-light IDNs: payer-centered and provider-centered. We focus on these models below.
Payer-centered IDNs
This business model has a payer at the center accompanied by ownership, or strong alignment with and enablement, of physician groups, nonacute care delivery, pharmacy, and healthcare services and technology (HST) assets. This model had the fastest growth in revenue from 2017 to 2022, and its organic growth has been higher than that of pure-play payers. Inorganic growth has been robust, featuring an active programmatic M&A agenda focusing on small to midsize companies and scaling them rapidly by retaining spending from the members within their payer business. As a result, the proportion of revenue from nonpayer businesses has grown to almost half (Exhibit 3).
While payer-centered capital-light IDNs have delivered substantial growth, not all organizations are creating value (Exhibit 4). Deriving the benefits of vertical integration beyond volume aggregation is challenging. These businesses must focus on operating each individual area as well as the pure plays do while ensuring coordination that unlocks the value of vertical integration. The capabilities and operating rhythms required to accomplish this dual objective are difficult to master.
Provider-centered IDNs
This model includes physician aggregators, clinical risk-bearing management services organizations, and value-based care (VBC) physician-practice ownership. These IDNs generate value by improving patient outcomes and appropriately managing utilization of care. McKinsey analysis of organizations’ public filings found that leading provider-centered IDNs have reduced inpatient admissions per thousand by 40 percent compared with fee-for-service.
While it often takes a few years to deliver strong economic performance given investments in enhanced care, successful models are demonstrating average medical expense ratios close to 50 percent, according to McKinsey analysis of VBC organizations’ investor materials. But organizations pursuing this model face challenges, even as their number grows. These IDNs operate predominantly with Medicare Advantage members, leaving them exposed to changes in reimbursement and rule changes to risk adjustment. They also rely on capital markets to finance losses in the first few years, which is more difficult to do when interest rates rise and financing tightens. Lower scale and diversification raise the risks for these organizations. Nonetheless, improvements in outcomes and policy support for VBC suggest that organizations that can invest to promote fundamental practice transformation will continue to grow.
Pure-play, specialization-focused business models
Pure-play specialization models seek to promote superior performance through a focus on core activities. These models can derive considerable value by excelling in three areas:
- Productivity. Wage increases in the aftermath of the pandemic and persistent shortages in clinical labor have increased the importance of productivity. The value of productivity is not only in reducing costs but also in removing low-value work often associated with staff burnout. This is only one example of productivity. Enhancing productivity across its four subcategories—administrative, technological, care delivery, and clinical—can improve healthcare efficiency by $1 trillion.
- Economies of scale. Scale plays a pivotal role in profitability within the market. The minimum scale required for payers to break even has continued to increase, necessitating strategic investments in scale in search of lower administrative costs, according to McKinsey analysis of financial data from the National Association of Insurance Commissioners (NAIC). In the HST segment, scaling has resulted in a noteworthy decrease in administrative loss ratios from more than 60 percent to 20 percent, accompanied by revenue increases, our analysis of company financial data shows.
- Automation, digitization, and application of artificial intelligence. Adoption of technology capabilities presents substantial opportunities. For example, in many nonhealthcare areas, AI technologies, including generative AI, have equaled or surpassed certain human capabilities. Adopting these technologies to redesign business models can deliver 5 to 10 percent in net savings as a percentage of total costs.
Facing severe economic pressure since 2022, leading pure-play health systems have taken steps to improve productivity across their businesses. In addition, they have attempted to gain scale. Some have pursued innovative approaches to building shared capabilities and obtaining new sources of revenue through partnerships. Some pure-play systems are expanding their ambulatory footprints. For example, one system repositioned its portfolio to increase focus on ambulatory surgery centers, leading to a substantial improvement in return on invested capital.
Pure-play payers have also pursued scale through partnership models and capability-oriented or tuck-in acquisitions. The larger payers have achieved higher growth as scale requirements have risen, particularly in Medicare Advantage. For example, about 60,000 lives were needed to achieve EBITDA breakeven in 2022, up from 15,000 lives in 2017, McKinsey analysis of NAIC data found. Unlike vertical-integration-focused business models that have delivered growth, many businesses pursuing pure-play models have yet to fully tap into the improvement potential of their businesses.
The healthcare industry has a value creation opportunity worth more than $1 trillion (Exhibit 5). In the past few years, more companies have grown through business models focused on vertical integration. Looking ahead, opportunity exists across both types of business models. To succeed, healthcare leaders should seek to clarify the business model their organizations are best suited to pursue. Then, they should build capabilities specific to the business model and strive for superior execution.
