Opportunities for value creation in healthcare

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Anita McGahan, Professor of Strategic Management, Rotman School

In October 2005, General Motors and the United Auto Workers reached a compromise to reduce GM cash outlays on healthcare benefits for active and retired personnel by an estimated $1 billion. The agreement was hailed as a victory for both parties because it would lower the company’s costs while preserving jobs. But the seeds of GM’s demise had already been sown.  In that same year, its annual report had warned investors that escalating healthcare costs were an existential threat:

Healthcare in the United States is one of our biggest competitive challenges, and if we do not make progress on structurally fixing this issue, it could be a long-term threat to our company. In 2005, GM was challenged with the compound impact of escalating healthcare cost rates and falling discount rates used to determine future healthcare liabilities. As a result of these factors, in 2005, GM’s U.S. other post-retirement employee benefits (OPEB) expense, consisting of retiree healthcare and life insurance, increased to $5.3 billion, an increase of more than $1 billion from 2004.

Four years later, on June 1, 2009, General Motors filed for bankruptcy in the U.S., Canada and Ontario. In hindsight, it is clear that the structural issue of escalating healthcare costs had indeed set the foundation for failure. As The Economist explained, “Every year, the cost of retired workers’ healthcare diverted billions of dollars from developing innovative new models and added $1,400 to the cost of each car compared with those made in Asian and European plants.”

In other words, the company’s past success created obligations that eventually took it down.

GM’s problems are not unique. Over the years, escalating healthcare costs have been cited in the bankruptcies of Kodak, Xerox and Data General, among others. Of course, healthcare expenditures and issues have both positive and negative implications for firms: Healthcare benefits help to attract and retain talent, drive productivity and reinforce a company’s values and image of being social responsible. However, as the cost of providing healthcare escalates, the achievement of competitive advantage through each of these mechanisms becomes more difficult.

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