Executive Interview


Banner Health, a Phoenix-based not-for-profit health system that includes 23 hospitals, used an "intense integration" strategy after acquiring the two-hospital Sun Health system and a multispecialty group practice during the recent economic downturn. By employing this strategy, Banner Health was able to improve its financial position and expand its presence in the rapidly growing Phoenix market. "We needed to improve both our performance and our financial position quickly, and an accelerated, intense integration of the Sun Health operations was one of the opportunities we took advantage of," says Dennis Dahlen, senior vice president of finance and CFO at Banner Health. Dahlen recently provided insight on his organization's experience with the intense integration strategy.

hfm: Tell us the background of Banner Health's integration with Sun Health. What was the strategy behind the acquisition?

Dahlen: The driving strategy behind the acquisition was to gain entrance to a rapidly growing segment of the Phoenix marketplace. During the middle of the past decade, Phoenix was growing rapidly-3 percent or more population growth per year-but the growth was concentrated in two areas of the greater metropolitan region: the far northwest (Sun City and neighboring developments) and the far southeast (Gilbert and Queen Creek). As the largest hospital provider in the market, Banner Health had a well-developed presence across the metro area with two exceptions: Scottsdale and the northwest valley. Opportunity in the southeast valley included a new medical campus, Banner Ironwood Medical Center (opened in 2010), but we did not have similar plans for the northwest valley market.

In late 2006, we began discussions with Arizona Medical Clinic (AMC), a multispecialty group practice of approximately 80 providers serving both Sun Health hospitals, on the potential to acquire them and build a new hospital in the northwest valley with the group's physicians providing the beginning of a medical staff for such a hospital. By March 2007, we had reached agreement on the terms of an acquisition of AMC and, almost by sheer luck, contacted Sun Health's CEO to gain additional insight into the marketplace (without disclosing that we were acquiring AMC). We learned that Sun Health had engaged a broker to put them in play, that these efforts had been under way for some time, and that they were close to choosing a finalist. The CEO asked if Banner Health had any interest.

The acquisition of the Sun Health system was a significantly better option for entering the northwest marketplace than was the AMC strategy since it avoided building expensive new hospital capacity, allowed Banner and Sun Health to complement each other's strengths, and would create a sustainable partnership between the healthcare provider (Banner Health) and the community (Sun Health Foundation). Due to the advanced state of negotiations with AMC and the uncertainty of the ultimate success of the business combination of Banner and Sun Health, we purchased AMC in 2007 and continued negotiations and solving regulatory hurdles, primarily FTC challenges, until the acquisition of Sun Health was completed in September 2008.

hfm: What was the financial state of Sun Health at the time of the acquisition?

Dahlen: Sun Health's financial state at the time of the acquisition was stable with 2 to 3 percent operating margins, a solid BBB credit rating, and little competition in its primary market. That said, underneath that stable performance were a handful of challenges that were beginning to affect their long-term viability.

Because the Sun City market is a retirement community, Sun Health's payer mix was overwhelmingly composed of Medicare patients. Although Sun Health had successfully employed tactics to supplement Medicare's low rates, such as a wholly owned Medicare Advantage plan, an advanced philanthropy program, and significant use of community volunteers to staff its hospitals, the organization had not generated sufficient capital over the long term to invest the necessary amounts in replacement and maintenance of existing assets. Furthermore, Sun Health realized it needed to invest in new infrastructure such as clinical IT to remain competitive. In short, its future capital needs were beginning to overwhelm the ability to pay for them. Finally, the rapid growth of its primary service area was as much a negative for Sun Health as it was a positive for Banner. Sun Health's leadership correctly concluded that the rapid population growth would attract competitors to its primary service area and that it would have limited ability to respond.

We continue to hold the Sun Health board of directors and its leadership up as an example-too rare in not-for-profit health care-of doing the right thing at some personal and organizational sacrifice. Sun Health could have continued in existence for a decade or more before possibly being forced to consider a business combination. There was no wolf at the door, no urgent reason to contemplate wholesale change in 2007, but choosing to do so before it was necessary allowed the organization to have better choices and improved negotiating leverage, which led to a good outcome for the community, the employees, and the medical staff.

hfm: When Banner Health acquired Sun Health, Banner Health implemented what you have called an "intense integration" strategy. Tell us about this strategy. Why opt for rapid integration? What results were achieved?

Dahlen: Two factors played a role in the choice of pursuing an intense integration. First, Banner is organized as an operating company, meaning that our operating entities are bound together and supported by business and clinical support functions that are centralized, are standardized, and take advantage of scale. We knew that the advantage of this already-built infrastructure allowed us to add the volume of work from the two Sun Health hospitals and the Medicare Advantage insurance plan with only minimal increases in resources. Second, the timing of the transaction played a part in the intensity of the integration. With the acquisition's completion in September 2008, we added significant debt (approximately $600 million) to our balance sheet and three weeks later, the failure of Lehman started the downward spiral in financial markets that continued for the next six months. By the end of 2008, our debt-to-capital ratio was at 60 percent, our cash-to-debt was 50 percent, and we had 111 days of cash on hand-hardly consistent with our AA- credit rating. We needed to improve both our performance and our financial position quickly, and an accelerated, intense integration of the Sun Health operations was one of the opportunities we pursued.

The execution of the integration was led by a multidisciplinary team at the Banner system level that included representatives from business and clinical support functions as well as operating leadership and project management. In addition, we intentionally transferred existing Banner C-suite leaders to the acquired hospitals to provide front-line support for the integration efforts. The results were impressive. We achieved full enterprise resource planning implementation, including payroll and human resources for 4,500 employees, in 120 days, and full revenue cycle implementation in eight months. In addition, a fully functional clinical suite and computerized provider order entry were put in place in two years. We were also able to achieve a reduction of $21 million in annual costs and 177 FTEs in support areas.

hfm: What role did finance play in your organization's intense integration strategy?

Dahlen: Finance played a key role in the development of the strategy by assisting in identifying the opportunities to leverage existing infrastructure, testing the assumptions used as actual results began to be realized, and keeping score and creating accountability for those responsible for implementing the plan. Finance also served as an example by integrating the finance functions of the two organizations-remember that Sun Health was a $600 million enterprise-with literally a handful of additional FTEs.

hfm: What lessons did you learn from your organization's experience with the intense integration strategy? What went well, and what would you do differently in the future if you were to do it over? Are you planning future acquisitions?

Dahlen: The most significant lesson we learned was that our operating infrastructure was indeed scalable in a significant way. We were able to reduce our business and clinical support costs by 120 basis points of revenue, from 7.3 to 6.1 percent, as a result of leveraging those investments. It would have been difficult and certainly painful to achieve that level of improvement (the equivalent of nearly $50 million in cost) through incremental cost reduction. We also learned the value of deploying seasoned Banner leadership to the acquired entities. They were able to address employee concerns, explain the reasons for change, dispel "urban legends" that tend to develop in an environment of radical change, and generally provide a calming presence to sustain these organizations in a way that leaders unfamiliar with Banner could not.

As far as doing anything differently in the future, we approached this acquisition from the beginning as total integration, using Banner's tools, processes, and infrastructure, but weren't committed to the accelerated pace until our financial position required it. I suspect that all things being equal, we will approach future acquisitions with an accelerated intensity from the outset. Are we planning future acquisitions? It's safe to say that we're prepared for them and are open to the prospect on a selected basis, but there are no immediate plans in the works.

hfm: Cost management was clearly part of your integration approach. What are your other approaches to cost reduction, especially given that Arizona hospitals are seeing significant Medicaid reductions?

Dahlen: Banner Health has an approach to environmental challenges that can be summarized as "planning for the worst and working for the best." To that end, we've been successfully reducing costs for the past three years and, in fact, our annual cost trend per unit of service has been only 0.2 percent for the past two years-the primary reason for our performance improvement.

We are employing some specific cost-reduction approaches. Admittedly, not all the efforts are innovative, but they are measurably effective. We have found there is a synergy present in multiple projects targeting different cost pools yet with a common purpose of overall cost reduction. The combined effect along with sustained organizational focus on them has created a healthy culture of performance.

One approach that we're taking is improved blocking and tackling in labor cost management. We've deployed real-time tools to help front-line managers with staff planning, scheduling, and decision support. And we've seen a significant improvement in labor spend due to two factors: an improvement in staff mix, which resulted from giving managers direct line of sight to the most cost-effective incremental additions to staff for each shift, and a reduction in beginning and end-of-shift overages, which is attributable to transparency and reporting of results.

Another approach is improved staffing plans through benchmarking and data analysis. Although we've employed benchmarking tools for many years to provide a baseline for staffing, we've "kicked these tools up a notch" by creating accountability for like departments to understand the benchmarking data and setting goals that require improvement to the next performance level. Sometimes that level is another Banner operation, and sometimes it is a non-Banner entity.

A third cost-reduction approach is a continued focus on supply chain savings with greater emphasis on utilization opportunities. Our supply chain is organized at a system level with centralized procurement and regional distribution. We have been successful at finding $30 million to $40 million in discreet annual savings (one year's savings is scored only once) each year but largely on the contract price side. By using our existing clinical practice groups to vet utilization opportunities, we've started to gain some traction in changing utilization patterns for the better. I'm drawn to the wisdom of saving 100 percent of a supply item's cost by not using it rather than saving 20 percent from negotiating a lower price.

We have also taken a more aggressive approach to consolidation of service lines to reduce our costs. With the economics of reform, we are evaluating the combination of programs at multiple hospitals into single site centers that will allow us to maintain high clinical quality in an environment of cost reduction. Most of this activity will be in the Phoenix market where we have 12 hospitals covering the metro area. We intend to provide a comprehensive network of services to the community, but that doesn't necessarily mean that every service will be at every hospital.

Finally, we are expanding our use of operating company approaches. We've demonstrated success with our approach, and its effectiveness was proven in the Sun Health acquisition so we're exploring the application of the "centralize, standardize, and specialize" model to areas we haven't looked at to this point. Areas under consideration include clinical departments such as laboratory, imaging, and pharmacy as well as support functions such as environmental services, facilities, dietary, and even medical staff services.

All of these approaches will help us to continue to improve our performance going forward.

Publication Date: Monday, August 01, 2011

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