Principles for provider investments in 2025

October 14, 2024The past two years have been challenging for investors in the healthcare provider sector. Tight credit markets led to increased uncertainty among investors. In parallel, the lapse of COVID-19-era revenue protections and ongoing input cost inflation compressed margins at most target provider organizations.¹ As a result, buyout deal activity declined by 19 percent per year from 2021 to 2023,² as buyers perceived sellers’ value expectations to be not consonant with market realities.

Despite the bearishness, investors with a long-term mindset have recognized three important themes.

The exuberance has subsided, but the underlying trends that make provider investments attractive persist

Despite recent margin pressures, the fundamental trends driving growth and margin generation in the provider sector persist. For example, performance transformation and cost containment efforts helped EBITDA margins for health systems recover by up to 100 basis points in 2023. Based on McKinsey analysis, we expect that margins for most provider segments will continue to recover.

Segments that align with community-based, patient-focused, and value-based care (VBC) models will likely grow the fastest, at more than 10 percent CAGR. This includes primary care and specialist physician practices, ambulatory surgery centers (ASCs), and services and technology companies that support these segments, such as VBC enablement platform companies. Investors have recognized this trend; acquisition activity for physician practice management (PPM) platforms and ASCs held up better between 2021 and 2023, compared with overall healthcare deal activity (declines of 14 percent for PPMs and 10 percent for ASCs versus 19 percent overall), according to McKinsey analysis.

Headwinds have deterred some investors, but others see an opportunity to drive value through sustained performance improvements

Investors increasingly recognize that long-term sustainability will require an ability to weather headwinds from provider reimbursement changes and input cost inflation. As a result, the basis for evaluating portfolio companies has shifted from the potential for future value creation to a record of demonstrated performance. As an example, while valuations for loss-making VBC organizations have gone down, the public market has rewarded profit-making VBC groups.

Since the start of 2023, VBC organizations have increased their investment in capabilities to drive clinical outcomes and bend the medical cost curve, relative to their focus on membership and revenue growth. Similarly, within the PPM space, tuck-in deals declined by roughly 35 percent between 2021 and 2023, as organizations focused on investing in their operations and improving EBIDTA growth via margin enhancement.³

Building capabilities for sustained success is critical

As investors and executives look to the future of healthcare and considerations for provider organizations, the aim is to create capabilities for enduring success. Their focus is on four capabilities—patient engagement, care delivery, productivity solutions, and new value pools—to spur performance and ensure long-term viability:

• Patient engagement. Across multiple efforts, we have seen that improving the patient experience via better engagement and continuity of care increases revenue by 10 to 20 percent and reduces process costs related to serving patients by 20 to 30 percent.⁴
• Care delivery at low-cost but high-quality sites. To reach more patients and improve overall patient experience, it is important to continue building the infrastructure and capabilities needed to deliver care virtually or in the community. For example, the number of jobs for home-health and personal-care aides is expected to increase by 21 percent between 2023 and 2033, outpacing the average growth rate for all professions.⁵ There is a lot of headroom to improve and potential to grow in this area. For instance, even among specialties with long-standing ASC use, such as gastroenterology and orthopedics, 35 to 55 percent of care is still performed in hospital outpatient departments.⁶ A set of common procedures, when performed at ASCs, usually costs around 50 to 60 percent of what it does in hospital outpatient departments, while also ensuring the same quality, according to McKinsey research.
• Productivity solutions, particularly those enabled by technology. Ongoing labor shortages have made a focus on productivity an imperative. It is estimated that the United States could have a shortage of 86,000 physicians by 2036.⁷ And according to McKinsey’s 2024 analysis, the nursing deficit could reach roughly 400,000 by the end of 2030. AI, including machine learning, has the potential to contribute and could lead to annual savings of $200 billion to $360 billion.⁸
• Addressing new value pools. Finally, going beyond traditional ancillary services (for example, ambulatory surgery centers and imaging) can enable providers to expand margins on their existing facility footprint. Specialty pharmacy is an example, with an estimated 5 to 10 percent growth between 2021 and 2026, based on McKinsey analysis.

While there is good reason to be cautious about near-term pressures, the fundamentals of value creation remain strong for investors in the provider space. We believe that investors with the courage to focus on capabilities, the execution discipline to streamline operations, and the resilience to enhance their value proposition will drive improved outcomes for patients and be rewarded in the long run.

Amit Kunte is a partner in McKinsey’s Southern California office, Gunjan Khanna is a senior partner in the Pittsburgh office, Rupal Malani is a senior partner in the Cleveland office, and Zahy Abou-Atme is a partner in the New York office.

This article was edited by Querida Anderson, a senior editor in the New York office.

_{1. “US health care inflation rate,” US Bureau of Labor Statistics, as of November 2023.}

_{2. McKinsey analysis, based on PitchBook data, as of April 2024.}

_{3. McKinsey analysis, based on PitchBook data, as of April 2024.}

_{4. Decrease in process costs, but not total administrative costs. McKinsey analysis, based Medallia data and typical ranges of customer experience engagements.}

_{5. “Occupational outlook handbook,” US Bureau of Labor Statistics, updated on August 29, 2024.}

_{6. McKinsey analysis of 2022 encounter volume for spine surgery or major joint replacement (hip, knee, shoulder) third-party claims for commercial and traditional Medicare members (Truven commercial claims, Centers for Medicare & Medicaid Services limited data set).}

_{7. The complexities of physician supply and demand: Projections from 2021 to 2036, AAMC and GlobalData, March 2024.}

_{8. Total annual savings (in 2019 dollars); Nikhil Sahni, George Stein, Rodney Zemmel, and David M. Cutler, The potential impact of artificial intelligence on healthcare spending, National Bureau of Economic Research working paper, number 30857, January 2023.}