Operating Room Mishap

When Medical Care International Inc. merged with Critical Care America Inc. last September, the new company seemed tailor-made for the increasingly competitive health-care market. By combining Medical Care's outpatient surgery centers with Critical Care's home-infusion business, the company would be a virtual hospital without walls. That, in turn, would allow the newly rechristened Medical Care America Inc. to profit handsomely from the rising demand for low-cost outpatient services. All in all, it "was an incredibly brilliant idea," says Patrick S. Smith, the former CEO of Critical Care who served for a while as chairman of Medical Care America.

As it turned out, though, the idea was one thing, the result quite another. Unable to keep costs--and prices--in check and slow to aggressively market its services, Medical Care has been losing business to nimbler, lower-priced rivals. The upshot: Analyst Erik D. Wiberg of Hambrecht & Quist Inc. estimates Medical Care's 1993 profits could tumble 27%, to $51 million, as revenues rise by 6%, to $643 million. At the same time, Medical Care's stock price--541 4 at the time of the merger on Sept. 9, 1992--has slid to about 17. And a group of angry shareholders has filed a lawsuit against Medical Care, alleging that the companies concealed many of their problems to make sure that the merger went through. Medical Care America CEO Donald E. Steen denies the charge.

Many of the company's woes stem from its Critical Care subsidiary, which accounts for about a third of total revenues. The unit supplies outpatients with the equipment and training necessary to administer their own intravenous drugs or nutrients at home. During the 1980s, Critical Care, based in Westborough, Mass., thrived by providing complex treatments, such as posttransplant therapy and specialized blood transfusions. Cost wasn't an issue. After all, traditional indemnity insurers never seemed to question the company's prices.

Now, however, the health market is increasingly dominated by managed-care networks, such as health maintenance organizations, whose profit margins depend on low costs. Not surprisingly, many HMOs passed over Critical Care, where analyst John R. Runningen of Robinson-Humphrey Co. says prices were as much as 26% higher than at such rivals as Northbrook (Ill.)-based Caremark Homecare and Home Nutritional Services Inc. in Parsippany, N.J.

Insiders say Smith, the former CEO, was slow to grasp the increasingly competitive nature of the industry. Smith became chairman of the new company after the merger. But last November, the board removed him after the depth of Critical Care's difficulties became apparent. Smith, who denies he was responsible for Critical Care's problems, remains a director.

Just how badly off Critical Care was became painfully apparent less than three weeks after the merger. That's when Steen announced that third-quarter profits before merger-related charges would be flat at $16.7 million, far below the 30% rise most analysts expected. Steen blames the surprise on Critical Care's poor internal reporting and slow payments from insurers. But the 15 shareholders who have sued Medical Care charge Critical Care's problems were so severe that managers had to have known about them. Analysts don't think the suit poses a long-term problem because no big institutional shareholders have joined the legal challenge.

Despite Medical Care's faltering first year, Steen vows a resurgence. And few in the industry are about to count him out. An accountant who founded Medical Care in 1981, the 46-year-old Steen battled back after another disappointing merger in 1984. That deal, with Surgicare Corp., was also supposed to produce rapid profit growth. Instead, the company racked up millions in losses after expanding too aggressively. Steen ended up closing money-losing surgical centers while acquiring more profitable ones. Prior to his latest merger, Medical Care was back on top, with its earnings up 40%, to $64 million, in 1991.

This time around, Steen is focusing on costs. He has trimmed Critical Care's staff by 20%, or 100 jobs, and has taken a hard look at costly medical gear. Earlier this year, he scrapped a state-of-the-art pump used in antibiotic treatments and replaced it with a far simpler model that needed less servicing. The result: The company cut its costs to $3 a day per patient for this procedure, from $30, without affecting the quality of care. Ultimately, Steen hopes to save $20 million to $25 million over the next two years with such cost-cutting efforts.

The cuts should enable Medical Care to start bringing prices in line with rivals'. Indeed, Critical Care is already discounting its prices by 50%. Still, Medical Care will need more than just competitive pricing to bring in patients. That's why Steen has beefed up its efforts to market Critical Care's services to managed-care groups. Critical Care wasn't even among the bidders for most managed-care contracts last fall. Now, says Steen, "we may not win the bid, but at least we're beginning to show up as finalists." These days, 15% of the company's business comes from managed-care groups vs. 8% a year ago.

MORE DEMAND. Steen is betting that marketing could also boost business at Medical Care's 92 surgery centers, which account for 66% of the company's revenues. The surgical centers, too, are being squeezed by managed-care customers and competitors. Among the challengers: hospitals that are opening outpatient surgery wards. In April, he created a 10-person staff to market surgical services to managed-care groups. In the past, the company relied on local administrators to promote the centers in their spare time. Longer term, Steen hopes to expand services at the surgery centers. He is already building elaborate recovery rooms at some facilities to allow for more complex and expensive operations, such as hysterectomies.

Most analysts believe Steen is slowly getting the company back on track. They also point out that demand for less-expensive outpatient services can only rise after the Clinton Administration's health-care reform package is unveiled. Still, turnarounds take time. And Steen will have to produce more evidence to convince shareholders that the merger was indeed such a brilliant idea.

         PRICING Slashing costs at its Critical Care subsidiary to bring pricing in 
      line with competitors. Cutting the prices on home-infusion services by 50% this 
         MARKETING Steps up marketing of home infusion directly to managed-care 
      customers, such as HMOs. Roughly 25% of Critical Care's marketing staff is 
      pursuing managed-care groups. Also created a 10-person staff to sell its 
      surgical services.
         SERVICES Longer term, company intends to expand services at surgical 
      centers. Medical Care is already building more elaborate recovery rooms at some 
      facilities to allow for more complex surgeries.
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