Provider consolidation has been accelerating at a rapid clip in the healthcare industry in recent years. In fact, the pace has increased 14 percent on average in each of the past seven years, affecting all delivery system types. a “Mega-mergers” involving combined assets of $2 billion or more also are becoming more frequent, having averaged four per year, with an uptick in the trend in 2017. These transactions are likely to continue, by some estimates reducing the number of independent health systems by half or more over the next 10 years. b
Numerous factors fuel this consolidation, including reduced payment and the concurrent linkage of payment and outcomes, health plan consolidation, the growing administrative burden of regulation spurred by the Affordable Care Act (ACA), the Medicare Access and CHIP Reauthorization Act of 2015, and other legislation, and the resulting pressure on operating margins. For many, consolidation offers a path to greater scale and price leverage with suppliers and health plans. However, it’s important to note that consolidation comes with its own challenges and tradeoffs, with no guarantee of success.
Before accepting the conventional wisdom about safety in numbers, independent executives must ask themselves whether they are best positioned to deliver on their mission and objectives as an independent organization, or as part of another, larger entity.
Choosing the Right Path for the Organization
It’s important that a hospital follow a sound process to evaluate options fully and carefully. Executives and trustees should think critically about their organization’s ability to continue down the path of independence by taking the following steps.
Assess the organization’s financial stability. The business environment for healthcare delivery organizations has grown increasingly challenging over the past decade. A primary factor has been decelerating growth and in some instances even shrinkage in payment, led by Medicare and Medicaid. Demographics of the primary service area weigh heavily here, with future downward pressure on revenues expected in proportion to the percentage of older and disadvantaged populations.
On the financial side, labor costs and the investment needed for technology are rising inexorably, and as risk-based care models become more common, both new investments and reserves are required to cover losses. Although the ACA offered some relief in this period, the percentage of charity care and bad debt is almost certain to rise under the current administration.
Trends in operating income and days of cash on hand are starting points in a financial assessment. How has the organization performed from a margin perspective, relative to peers? Are reserves growing or shrinking? Clearly, plunging performance indicators can make the decision to consolidate a relatively simple one. But even if performance has been average compared with that of peers, future projections are imperative. Key considerations include the likely impact of policy changes and how demographic projections for the primary service area might affect future revenues. Sophisticated financial planning tools that evaluate the potential impacts of anticipated changes in patient volume, patient and payer mix, policy, and payment are necessary to understand how the organization’s financial status could change over time.
Typically, financial projections offer insight into a possible future. For an even more refined view of future potential, other dimensions of an assessment are needed. Factors such as the competitive situation, the internal processes currently being used to manage cost and quality, prospects for growth, and the organization’s internal capability to effectively accommodate and execute change can make the difference between marginal and robust performance. With a relatively stable financial picture and room to boost top-line revenue and reduce underlying costs, independence might be the best alternative.
Assess the external market position to determine whether opportunities for growth or expansion exist. Many independent hospitals have benefited from a particularly affluent demographic, or from geographic boundaries that have constrained competition. But market conditions are changing. An aging population means that Medicare will account for a larger share of the total cost of patient care. And geography, once a defense against competition, is becoming less so as mergers and acquisitions enable large organizations to reach into previously untapped territories. With continued provider consolidation and the emergence of new players, no market is immune from competition. As a result, the extent to which an organization can consolidate its primary market area position and expand into other nearby markets is a critical factor in determining whether it can afford to stay independent.
Determining whether an organization’s market share is defensible requires an understanding of where the local market is headed as well as the potential impact of any changes on current and future market position. It also requires an analysis of physician supply and referral flow trends to meaningfully project future patient volume.
Growth through expansion also requires a sound understanding of surrounding markets in terms of community needs, competitive position, and market perceptions of the organization. Here, executives should consider conducting a comprehensive market assessment that includes demographic trends, physician supply, competitive set, community health needs, market share, and trends. Output from this assessment can help executives identify potential opportunities for top-line revenue growth and guide the development of strategies to be positioned for the future.
Evaluate the organization’s infrastructure. To move forward in a value-based environment in a way that will ensure financial viability, growth, and ultimately long-term success, independent organizations must focus on mastering the business side of healthcare delivery.
Smaller organizations often struggle to receive the same price concessions that their larger counterparts can command. Meanwhile, the smaller organizations also likely must cope with greater financial exposure under at-risk contracts because individual cost outliers have greater impact on the bottom line. Yet smaller, more nimble organizations can meet this challenge with more effective internal controls and faster, more timely execution. Processes that provide early warning of variation in cost and quality—combined with project management discipline that enables solutions to be rapidly identified, developed, and implemented—can give smaller organizations a competitive advantage.
For instance, routine tracking and reporting on key clinical outcome measures and case costs will enable executives to identify variation in cost and quality early, while there is still time for remedial action. In cases where significant variation from trends is identified, assigned analysts can drill down to uncover key drivers. Action recommendations follow, to be pursued by the management team, including feedback loops to ensure sustained operational improvement. A potential starting point for executives who have yet to embed these tracking and reporting disciplines within their organizations would be to focus on the limited number of procedures that account for 80 percent of revenue.
All of the data required to do this analysis can be found within the EHR. Although ready-made “dashboards” are convenient, they’re not essential to creating this infrastructure. Therefore, organizations don’t need to invest in expensive data collection and analytic tools to put such a monitoring system in place. What is required is a small group of people with the analytic skills to set up the process and the dedicated time to diagnose the causes of variance when it occurs, and a management team with the focus and interpersonal skills to facilitate timely solutions.
Identifying and addressing deficits can provide a solid infrastructure for growth and financial sustainability as an independent health system. These actions also will ensure that an organization approaches discussions about strategic partnerships or mergers from a position of strength.
M&A Success: No Sure Thing
On the one hand, the case for mergers and acquisitions is compelling. If carefully planned and executed, mergers and acquisitions have the potential to address significant business and financial challenges and fuel growth and sustainability. Consolidation also can support diversification across markets, revenue sources, services, and technologies/facilities while more efficiently deploying limited capital.
On the other hand, despite the increased consolidation across the industry, it is important to keep in mind that standalone organizations can still be successful. The reality is that growing an organization does not necessarily mean success: Up to one-third of mergers fail within five years, and as many as 80 percent never yield the strategic, operational, and financial gains that originally prompted the deal. c
In the years to come, independent hospitals will continue to face considerable headwinds in this historically challenging economic and regulatory healthcare environment. Against this backdrop, hospital leaders must grapple with difficult choices about how to stay competitive and whether to remain independent.
It is the rare hospital today that is operating at peak performance with respect to financial stability, external market position, and business infrastructure. Like the proverbial legs of a stool, all three are required. Organizations that dominate their local geography may believe that competition is less a concern for them than for those in metropolitan markets with overlapping service areas. Although that may have been the case in the past, competition has a way of shrinking the map, and the need for growth is relentless. Even a hospital that dominates its market must consider the factors described here to ensure its financial sustainability.
As competition grows more intense, physician referral flow becomes more critical in driving growth prospects. There are two ways to secure referral flow. The first is to purchase physician practices. The other, and the only reliable path to referral volume growth, is to establish meaningful market differentiation. An independent organization that can differentiate itself from the competition (e.g., better quality/outcomes or equivalent quality/outcomes at lower costs) and become the preferred choice among patients, employers, and insurers will be well-positioned to secure and grow its market share.
Hospital and health system executives also should realize that assessing their organizations’ competitive viability is an ongoing process, not a one-time undertaking, because the industry is constantly shifting, requiring a continuous recalibration of assumptions and strategic planning. By focusing on their organizations’ financial stability, external market position, and business infrastructure, as described here, executives can meaningful assess their institutions’ competitive postures and make well-informed decisions regarding future options.
Michael N. Abrams, MA, is a managing partner at Numerof & Associates, St. Louis.
Michael J. Kuchenreuther, PhD, is a research analyst at Numerof & Associates, St. Louis.
a. Irving Levin Associates, Inc., The Hospital Acquisition Report 2014, July 2014.
b. Deloitte Center for Health Solutions, “The Great Consolidation: The Potential for Rapid Consolidation of Health Systems,” 2014.
c. Senn, L., “Cultural Clash in Mergers and Acquisitions,” Senn Delaney, 2014; Christensen C.M., Alton, R., Rising, C., and Waldeck, A., “The Big Idea: The New M&A Playbook,” Harvard Business Review, March 2011.