Diagnosing the Obamacare digital health symptoms undermining Xerox's transformation

Profile picture for user slauchlan By Stuart Lauchlan July 27, 2014
Summary:
Xerox's digital health play looks appealing, but the problems keep stacking up as the company seeks to re-invent itself. Is the firm another tech victim of Obamacare?

We know that more needs to be done especially in government healthcare, where we continue to stand-up a new Medicaid platform and deal with a couple of challenging contracts.

That’s putting it mildly, Ursula Burns!  The CEO of Xerox is being remarkably understated given the ongoing problems that the firm has been experiencing as it attempts to transition to a new more services-based revenue model.

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Ursula Burns

The potential for business in the Medicaid-related space has expanded with the implementation of the Affordable Care Act, but just as Obamacare has had its own teething troubles, so too has Xerox’s play in this sector.

On the face of it, the firm’s doing pretty well, with Medicaid contracts in 37 states across the US. But in at least six of those states - Alaska, Montana, New Hampshire, North Dakota, California and Washington - the projects have run behind schedule.

Meanwhile Nevada dispensed with Xerox’s services on a $73 million contract to build software that enrolled and billed consumers on Nevada’s exchange, on the grounds of poor performance after Deloitte produced a 90 page report highlighting thousands of problems with Xerox’s work.

The most high profile problem to date stems from the termination of Xerox’s contract with the state of Texas two months ago amid allegations the company had improperly approved $1.1 billion in Medicaid payments for orthodontia between 2004 and 2012.

Texas is suing Xerox for recovery of those payments, stating in its complaint:

Xerox’s unlawful acts resulted in a substantial breach of safeguards intended to protect taxpayer dollars, maintain the integrity of Medicaid policies, and ensure the appropriate delivery of services to Medicaid clients. Xerox permitted an unprecedented loss of Medicaid funds to predatory and unscrupulous dental providers. As a result of the conduct of both Xerox and these providers, the Medicaid program was deeply compromised.

Accenture has now been selected to run the Texas program for 3 years while a long term contractor is selected.

And the troubles continue today. A decision by New York State to award a $550 million Medicaid management project to Xerox should come as a welcome vote of confidence, given that New York's $54 billion a year Medicaid program is the largest in the US.

But before it even gets to formal contract stage, the procurement has been challenged by Hewlett-Packard and CSC, who both argue that the company's recent history of Medicaid management in other states should quite simply bar it from being in the running here.

For his part, Bob Zapfel President of Xerox Services, is defiant about his firm’s abilities:

Our view would be we’ve really learned a lot through the prior implementations. We think that we will be able to execute New York well for the citizens in the state and for us.

Margin pressure

But the reality is that this ‘learning’ process is costly in terms of margin decline in the firm’s services revenue, a decline that will be exacerbated by the loss of the Texas contract and any subsequent legal costs presumably.

In its most recent quarter, Xerox turned in a profit of $266 million, down from $271 million for the year-ago period, while overall revenues fell 1.8% to $5.29 billion. Services business makes up 56.5% of total revenue on $3 billion.


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While Xerox remains committed to the opportunities of the healthcare market, there are others who question whether it can deliver the necessary margins. The reason CSC didn’t bid for the New York State deal, in which they were the incumbent provider, was simply because the firm didn’t see that it could make money on the deal.

For her part, Burns remains defiantly on track:

The government healthcare market is a very attractive market. We went through one cycle when this market started many, many years ago that shows that we could invest in a new platform, stay in that platform up and have it last for many, many years and continue to drive growth on topline and profitability on the bottomline. That remains our expectation.

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There have been problems along the way for Obamacare tech

According to Everest Group's research, the market opportunities for IT services players in the healthcare and life sciences segment in the US stood at $30 billion in 2013. It is expected to be upwards of $43 billion by 2016. Meanwhile a new report from RNCOS - US Healthcare IT Market Outlook 2018 - the sector is looking at a compound annual growth rate of 10% between 2014 to 2018. Against that backdrop, the ongoing appeal of the market is understandable.

It’s also hardly the case that Xerox is the only tech firm to have taken some Obamacare hits of late, with the likes of IBM in Minnesota and Oracle in Oregon having their own issues. Burns reckons that the corner is being turned:

If you look at some of the contracts that are more mature, moving towards more maturity, California, for example, we have been able to literally move that contract from investment phase to flat profitability now, to looking for growing profitability in a very predictable kind of a standard way. It took a little bit longer but on a go forward basis California is going to be beautiful.

And we expect as we implement New York to be beautiful as well. So we’re not de-emphasizing commercial in favor of government, not at all. We’re focused on all of them at a demographic show that we should be focused on them as well.

I’m confident that we have the right strategy and the right team in place to deliver on that strategy. We’re making progress.

Jacob Gordon, Research Analyst at Technology Business Research, reckons that Burns could be right:

Despite challenges in its government healthcare business, Xerox managed to accelerate revenue growth in 2Q14 by ramping up acquisition activity and capturing increased demand for commercial healthcare offerings as clients upgrade their IT and business processes to meet Affordable Care Act regulations.

Although Xerox’s 8.9% operating margin in 2Q14 is below its 10% goal, the company’s restructuring efforts and Project Compete initiative, combined with expanding margins in commercial healthcare, position the company for margin growth in 2H14. Xerox’s continued execution of its five-plank strategy and anticipated New York Medicaid contract protest win, as well as a recovery in renewal rates to its targeted range, will position Xerox for growth in 2H14.

My take

Something certainly needs to be done - and kudos to the Xerox management team for facing that head-on. The firm’s Document Technology arm’s revenues are falling - down 6% year on year in the second quarter - and a new direction needs to be found.

Whether that direction is in fact the healthcare market remains to be seen, although on paper the appeal is obvious. It was reckoned that there was a $1.4 trillion business to build and market President Barack Obama’s Affordable Care Act.

But whether that opportunity for tech and services providers comes at too high a cost is a question that has yet to be answered.

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