‘Go Big or Get Out’ No Sure Bet

The following is an excerpt from Navigant Healthcare’s Pulse Weekly. Click here for a complete copy of this week’s article. 

Friday, Advocate Health Care, Illinois' largest health system, and NorthShore University HealthSystem, a large health network in Chicago's northern suburbs, announced they will merge to form a 16-hospital system to be called Advocate NorthShore Health Partners.(1)

Together, the two non-profit systems generated $7.3B in revenues and $361M in operating income in 2013, according to the Modern Healthcare Financial Database.(2) It will be the 16th largest health system in the U.S.

“The merger would be the largest in recent memory in the state. It would be the latest in a flurry of local hospital consolidation, as health systems fight to build geographic reach and financial brawn in an industry beset by increasingly stingy insurers and steeply-rising operating expenses. Being bigger helps health systems command more favorable reimbursement rates from payers and lower per-patient costs through economies of scale.”(3)

‘Go big or get out’ seems to be a mandate across the health system these days. Across the continuum of healthcare products and services, consolidation is a given. Consider:

  • Total enrollment of the top 10 insurers increased from 20% in 2003 to 46% in 2011
  • The share of total revenues for pharmacy benefits management services for the top 2 Pharmacy Benefit Managers increased from 27% in 1999 to 61% in 2012
  • The numbers of physicians practicing in groups of 5 or fewer physicians decreased from 66% in 2001 to 51% in 2012, while physicians in groups of 100 or more increased from 3% to 12% in the same period
  • The employment of physicians in medical practices owned by hospitals increased from 24% in 2004 to 49% in 2011
  • The numbers of hospitals in multi-hospital systems increased from 53% in 2003 to 60% in 2013 (4)

It’s not a trend unique to healthcare: Remember the Big 8 accounting firms; they’re now the Big 4. Continental and United Airlines married, then Southwest and AirTran, and last year, U.S. Air and American. The Big 10 is now 14 schools, the Southeastern Conference expanded from 12 to 16 members, and the PAC 10 became the PAC 12. The phrase “too big to fail” became associated with large banks in recent years, so in transportation, athletics, banking and certainly in healthcare, there’s growing attention to size and scale as consolidation becomes the norm.

I have worked for and with big-name organizations in healthcare in a variety of roles-- as an advisor, independent director, and CEO. Consolidation via mergers and acquisitions was an important focus in all of them driven by three aims: to achieve market share advantage, to acquire needed competencies/capabilities necessary to growth, or to improve operating efficiency. Some worked out as planned; others failed to deliver the value anticipated. It turns out that going big is no guarantee of success: Case studies about big-name failures are standard fare in business schools. So a few observations about consolidation in healthcare:

  1. Most of the consolidation in our industry is about scale. Shrinking operating margins in core businesses, risk and cost pressures are hitting every sector, so achieving better scale consistently is necessary to fund growth and remain competitive. Consolidation to acquire new capabilities is less prominent in our industry: it’s likely that it’s going to change.
  2. Most deals get sidetracked due to leadership issues often reported as “culture clashes.” Who’s in charge post-acquisition matters, but it gets tricky when egos get in the way.
  3. The short-term value resulting from consolidation comes from cost reduction: eliminating redundant functions and overhead and streamlined supply chain relationships are keys to immediate value creation (though in many deals, synergies are not realized). But it’s a short-term result. Cutting unnecessary costs is not a strategy: it’s standard operating procedure. Where new investments are made as a result of these cost-cutting efforts is the strategy.
  4. Long-term value is created by introducing new solutions to expanding markets. Consolidation to acquire new business capabilities/talent, therefore, is vital. Some consolidators welcome fresh ideas and new thinking; others are not so inviting.
  5. Consolidators tend to obsess about their competitors of like-size, but competition from nimble niche players with a unique value proposition is often more problematic to bigger incumbents.
  6. Boards must be kept well-informed and actively engaged: The intent of consolidation is to enhance value, not to build empires for bragging rights.

In every industry, consolidation is closely scrutinized by regulators looking to assure markets remain competitive. The same is true in healthcare, as the U.S. Department of Justice weighs in on deals like Advocate. Consolidation among hospitals faces added scrutiny from health insurers threatened by the potential they’ll lose leverage as health systems become more sizeable.

Friday, after the Advocate announcement, health insurance trade group America’s Health Insurance Plans posted this reaction: “With news of Advocate Health Care and NorthShore University HealthSystem forming the largest system in Illinois, it’s time to revisit the serious consequences of anticompetitive hospital consolidation: Research shows bigger hospital systems can lead to higher prices, not necessarily better healthcare.  And as healthcare M&A activity continues to accelerate, hospital systems are getting so big that they can dictate and increase the prices of medical services… Recognizing the harmful consequences of anticompetitive provider consolidation on consumers and the overall healthcare system, the health plan community is committed to developing innovative ways to improve care management and control costs.”(5)

Hospital consolidation is reflective of the broader market’s appetite for deals and consolidation. It’s a megatrend in healthcare, and it’s likely to continue. But ‘going big or getting out’ is no guarantee of success or sustainability; it’s about what happens after the deal is done.

Paul

Sources:
(1) “Advocate and NorthShore Combine to Create Preeminent Health Care System,” News Release AdvocateHealth.com, September 12, 2014
(2) The Modern Healthcare Hospital System Financial database (Beta version) offers searchable fields to locate FY 2013, 2012 and 2011 financial data from the largest healthcare systems in the country (www.modernhealth.com)
(3) Andrew L. Wang,“Advocate, NorthShore merger would create giant health system in Illinois,” Crains Chicago Business, September 12, 2014
(4) Hamilton Moses, David Matheson, et al, “The Anatomy of Healthcare in the United States,” JAMA, November 2013, Vol. 310, No. 18; David Cutler, Fiona Morton, “Hospitals, Market Share and Consolidation,” JAMA, November 2013, Vol. 310, No. 18
(5) Alicia Caramenico, “Big hospital systems mean higher prices,” AHIP Coverage, September 12, 2014

The opinions expressed in this article are those of the author and do not necessarily represent the views of Navigant Consulting, Inc. The information contained in this article is a summary and reflects current impressions based on industry data and news available at the time of publication. Any predictions and expectations noted herein are inherently uncertain and actual results may differ materially from those contained in this article. Navigant undertakes no obligation to update any of the information contained in the article.

© 2014 Navigant Consulting, Inc.