They are striving to be the best of both worlds. In their heavily regulated industry, there is a relatively high degree of commoditization between different health care plan offerings. There is high intensity of rivalry in the industry as well. This intensity of rivalry pushes down costs, but the cost structure of the industry is fairly rigid, such that it is difficult for a health care plan provider to fully engage a cost leadership strategy. Consumers are demanding both low costs and superior product offerings. WellPoint is attempting to meet these conflicting demands to their best of their abilities.
This strategy stems in part from WellPoint's position within the industry. The industry itself is relatively fragmented, despite significant barriers to entry. WellPoint is the #2 player in the industry, behind the United Health Group. WellPoint holds at 9.75% market share. Other competitors are Aetna, Humana, Kaiser, and many smaller firms. The industry is heavily fragmented, with the top ten firms accounting for less than 50% of the market share (Insurance Information Institute, 2008). WellPoint's large size, strong competition and the industry's heavily regulated nature essentially remove the differentiation option. Yet, skyrocketing health care costs remove the low cost option. The industry is struggling along with WellPoint as firms within the business attempt to find a balanced position, as a matter of business strategy.
WellPoint's financials are solid, but have seen deterioration recently. The company grew premiums 7% in 2007. The company had seen an increase of 27.7% in their premiums in the previous year as they built upon their recent merger with Anthem. The increased investment income 14% in 2007, building on a 38.8% increase the year previous. The companies benefits paid out grew at 9% last year, faster than the growth in premiums. This resulted in an increase in the benefit expense ratio from 81.2% to 82.4%. Selling and administrative expenses, however, declined last year as a result of synergies from the merger. The decline was from 15.7% to 14.5%. Overall, WellPoint recorded an increase in net income of 8% over 2006. The increase in net income for 2006 was 25.6%.
In 2008, however, WellPoint has struggled to maintain their success. They are on track for modest improvements in revenue, but their benefit expense ratio had risen in the early part of the year. The first quarter BER was 85.9%. This has been reduced to 83.3% in the third quarter, but the level is still higher than it was last year. WellPoint has also seen declines in its investment income as well and is on pace for a double-digit percentage reduction in investment income. As a result, the company's net income is on pace to fall below 2006 levels.
The company's balance sheet has also deteriorated over the course of this year. Total assets have fallen from $52 billion to $49.7 billion in the past nine months. Total liabilities have fallen by about $1 billion in the same time frame, but have been increasing over the past few years. Total liabilities are currently $28.085 billion compared with $26.999 billion at the end of 2006. The debt ratio has therefore increased from 52.3% at the end of 2006 to 56.4% at the end of Q3 08. The debt-to-equity ratio has gone from 1.098 at the end of 2006 to 1.295 at the end of Q3 08.
The company is for more heavily leveraged than their industry and sector peers.
WellPoint has a few strengths from which they can draw. One is that they are large - the #2 player in the industry. This gives them increased leverage when dealing with suppliers. It also allows them to offer a wider range of product offerings and provide better service than many of their competitors. Another point of strength for WellPoint is that they have a well-established brand in the industry. When they merged with Anthem, they kept the WellPoint brand because of its strength and good reputation. This gives it an advantage in marketing, as buyers will gravitate towards larger, more established insurance companies.
WellPoint's weaknesses at present are mainly financial. They have seen a deterioration of their financial position over the course of the past year. They have seen a reduction in liquidity and an increase in their benefit expense ratio. WellPoint will need to control their benefit costs and shore up its balance sheet. Failure to do so will leave the company more exposed to economic difficulty than its competitors and less flexible in terms of its ability to adjust to changing industry circumstances.
WellPoint has a couple of key opportunities. The first is that they can continue to build market share. The industry is heavily fragmented, which gives WellPoint the opportunity to build market share by exploiting weaker competitors. This plays to WellPoint's strength as derived from its large size. WellPoint has the option to grow through acquisition or from incrementally picking off competitor's customers through aggressive sales tactics, superior service offerings or leveraging economies of scale to offer products at a lower cost. Another important opportunity for WellPoint is geographic expansion. The company operates in a handful of states, and within some of those states only in certain counties. The result is that there is significant opportunity for geographic expansion. There are barriers to expansion, such as licensing and regulatory considerations, but WellPoint can overcome these either via acquisitions or by carefully selecting new markets in which they wish to enter.
WellPoint faces a diverse range of threats. One is the intense competition. The competitive intensity of the health care insurance industry is marked by high intensity, especially given the fragmentation. This intense competition has driven WellPoint to a business level strategy focused on both differentiation and cost leadership, a very difficult position to attain and retain. Another threat is the increasing cost of health care. Medical care items have increased in cost 45% in the past ten years and physician's costs have increased 32.1% over the same period. This compares with just a 27.2% increase in overall cost of living. That health care costs are escalating more rapidly than inflation represents a significant threat to WellPoint.
Another threat is increased regulation. The Obama administration and several states have threatened to make significant changes to the structure of the industry, which could dramatically change WellPoint's operating environment. Another threat is the economy, which has hampered revenue growth for WellPoint this year. Increases in unemployment and in corporate spending on health care benefits can significantly impact WellPoint's performance. The economy is also a threat in that WellPoint's investment portfolio depends on healthy markets to achieve robust growth. The abysmal stock markets of this past fall have no yet translated to WellPoint's income statement so it remains to be seen, for example, how the company's investments have fared of late.
Strategic Alternatives & Recommendation
WellPoint has few alternatives. There are two broad strategies they can adopt - either to expand or to reduce costs. Expansion can be done through greenfield expansion into new jurisdictions or by acquisition.
Expansion by acquisition has the benefit of acquiring all the necessary licenses and a customer base in the region. Many insurance companies are depressed in value due to the recent collapse in the stock market. Additionally, WellPoint would gain local expertise. There are several drawbacks, however. One is that the company already has a high degree of leverage and the equity markets are at present averse to new issues. Combined with a credit crunch, it will be difficult for WellPoint to finance acquisitions. Also, when they combined with Anthem, they had antitrust difficulties in California (May, 2004), and future acquisitions could result in similar difficulties.
Expansion by greenfield is also costly, so has the same disadvantage with regards to capital financing. It also does not deliver an existing customer base nor does it deliver all the legal and paperwork requirements of setting up in a new jurisdiction. This alternative does allow WellPoint to expand at a level they can afford with cash. It also avoids any potential antitrust difficulties.
Cost reduction is a difficult option because of the rapid increases in health care costs. WellPoint already reduced its selling/general/administrative ratio last year by 120 basis points. Thus, it appears as though they are already embarking on this strategy, but were forced to increase premiums earlier this year despite the cost reductions.
It is recommended that WellPoint expand via acquisition. They should stick with smaller players that will be cheaper to acquire, especially ones whose valuation has been depressed by the poor stock market performance. The industry is going to consolidate as much as antitrust authorities will allow (Carroll, 2006), so WellPoint should take the initiative and attempt to grow their business by swallowing smaller competitors. Expanding their reach will also allow WellPoint access to more multisite employers (Seligman, 2006).
They should attempt to finance these acquisitions from cash. However, if they need to finance them with debt, this is…