Over the past decade, the number of hospital mergers has doubled from 50-60 annually to more than 100 the past few years. In the same period, the number of hospitals operated by a multi-hospital system has also increased by 18%. Today, three in five hospitals in the U.S. is operated by a multi-hospital system including the vast majority of those with more than 150 beds. Here’s why:
Operating margins were expected to shrink as wages, supply chain expense, costs of capital and reimbursement from Medicare and Medicaid dipped. And looming in the background has been the potential impact of the Affordable Care Act (March, 2010) and the Budget Control Act of 2011 that cut Medicare and Medicaid funding via sequestration.
Even more challenging, a hospital CFOs anticipated the need for expanding their scope of operations. Investments in digital connectivity, clinical analytics, retail health services, physician practice management, population health and more means capital budgets were deemed necessary as C suites and boards contemplated the resurgence of managed care by insurers, Medicare and Medicaid."
Thus, the urge to merge was a dominant theme of the past decade for hospitals, even as payers and academics were demonstrating these results rarely equated to lower costs or better care.
When I started my healthcare career in the late 70’s, hospitals were essentially hotels for the sick and injured, consuming 45% of total health spending. Today, they’re morphing into regional systems of health wherein the legacy inpatient-outpatient business is 31%. In those days, the mantra was “all healthcare is local” but it no longer applies. Competitors today come in a variety of shapes and sizes: niche players that siphon off pieces of a hospital’s business, insurers who own hospitals, clinics and medical practices, employers that contract for high cost hospital services with out of town providers, retail drug chains that operate primary care services, limited service hospitals, independent emergency rooms and so on. The competitive landscape is dynamic and complicated.
With the American Health Care Act sidelined for the time-being and the Affordable Care Act, with its intrinsic flaws, the law of the land, hospital boards are taking a fresh look at the road ahead. Every hospital is seeking ways to cut costs. Every hospital is forecasting reimbursement cuts resulting from sequestration and the delegation of Medicaid to private managed care organizations. All are watchful about increased scrutiny of fraud and abuse and the majority are rethinking their clinical programs to harvest winners and rethink losers. Improving efficiency and cutting costs are table stakes. But the aim is sustainability. Thus, affiliations and partnerships has been standard fare.
Recently, the Census Bureau released its assessment of industries in transition from “independent and local” to “dependent and bigger.” It found market share strength in larger companies (with 10,000 or more employees) in every industry increasing faster than their smaller competitors. It found sectors, like healthcare, that are dominated by smaller organizations, losing clout.
Hospitals face pressure and competition against industries that are more consolidated with national/regional clout: the four biggest airline carriers (UA, AA, Delta, SW) control 87% of passenger miles. Similar trends are observable in commercial banking, discount merchandising, telecom and many others. The data show bigger in these industries has resulted in more market share and stronger clout.
In healthcare, hospitals are still fragmented compared to other sectors: the 4 largest retail pharmacy chains control 70% of retail drugstore purchases nationwide, up from 44% in 1997. The five biggest insurers (United, Aetna, Anthem, Cigna and Humana) control 44% of the insurance market. Comparatively, the five biggest multi-hospital systems (HCA, Kaiser, Ascension, CHI and Tenet) control 10% of the hospitals and 9% of total hospital revenues (1).
I spend lots of time with hospital management teams and their boards. Partnerships, affiliations and asset mergers are a hot topic and many are rethinking the terms and conditions of their agreements. The due diligence process was systematic but conditions change. Their consultants did a credible job profiling the scale and scope of prospective suitors and a reasonable estimate of the cost-reduction synergies of the combined entities. Key operational and infrastructure distinctions are usually pretty accurate and management team strengths delicately shared with trustees. Distinctions in performance, reputation and culture are presented and the decision-making process about capital and clinical program investments is discussed. But the reality is this: the marriage is rarely as predictable as the parties are led to believe and results of hospital-hospital mergers/affiliations do not live up to expectations.
Going forward, as current affiliations are evaluated and new ones pursued, it seems to me there are three areas that need for more attention:
1-Management Structure and Span of Control: Ego’s get in the way, even for managers leaving the organization post-combination. Often Boards concentrate on the top slots, but successful post-deal synergy is negated due to well-positioned narcissists more insistent on maintaining their personal control than enhancing enterprise value. And in building a new org chart, ascribing decision accountability and spans of control top down and bottom up needs specific attention.
2-Clinical Strategy: Healthcare delivery is changing fast. Innovation in the diagnosis and treatment of diseases and maladies is dynamic, as is the widening scope: the integration of alternative therapies, behavioral health, self-directed care and social determinants are as vital to an institutions future as its fiscal plant and technologies. And clinical program enhancements paralyzed by traditional physician preferences can neutralize the potential for market success. Thus, the process for innovating in each clinical discipline and the capabilities of the Chief Medical Officer are critical factors often overlooked.
3-Provider-sponsored risk: Every hospital/health system is assuming financial risk for costs and quality and more than 100 hospitals/health systems sponsor a health plan to achieve this end. Owning the issue of affordability, and defining how the hospital/health system will navigate shared risk arrangements with employers, insurers, Medicaid and Medicare requires thoughtful planning pre-consolidation. It’s expensive to operate a health plan but for many a logical means to their end. In other scenarios, it makes no sense. Though elements of the Affordable Care Act are likely to change in coming weeks and months, it’s a safe bet the administration will cater to insurers hoping to enter the 2018 and 2020 election cycles with news about lower premiums and greater plan participation. That bodes well for them and dicey for hospitals.
In addition to access to capital and reputation, these are keys to generating the ROI sought and necessary to the sustainability for every hospital.
The return on invested effort in the next wave of hospital consolidation will be more about capabilities and competencies outside their walls and less about the balance sheet impact of bricks and sticks. Being part of a larger organization is inevitable; making sure that system partner is focused in the right areas is critical.
PS: Our industry lost a great man, Dan Cain, last week. I’ll forever remember his self-deprecating sense of humor, his humility and his savvy orchestration of deals in healthcare as an advisor. This topic, consolidation, was one I discussed with Dan many times. He’d encourage thoughtfulness as we consider the next wave of activity. We lost a good one: easily one of the most influential in our industry though he did not aspire to be listed as such on any list.
1-Community Health Systems operated 197 hospitals in 2015 but has been selling hospitals of late to pay down debt.
American Hospital Association, Irving Levine Associates, “Hospital consolidation and costs: another look at the evidence” David Dranovea, Richard Lindroothb, , Journal of Health Economics November 2003, “The Impact of Hospital Consolidation” Robert Wood Johnson Foundation June 2012, “Hospital Consolidation, Competition, and Quality Is Bigger Necessarily Better? “Thomas; et al JAMA. July 2, 2014