The past few years have seen a frenzy of health system mergers, as providers look to consolidation as a means to get on solid strategic and financial ground. But for many, although consolidation has often succeeded in bringing greater price leverage and buying power, the larger, hoped-for financial benefits have been elusive. According to a study of recent mergers and acquisitions, 59 percent of acquired hospitals failed to outperform their market peers two years after acquisition. Moreover, one in five acquired hospitals actually went from having positive margins before being acquired to negative margins two years after the acquisition.
Although delivering on the true promise of consolidation is a journey that is unique to each organization, successfully integrating corporate services is a common practice and can be an important step toward improved financial viability. But this must mean more than an initial focus on the post-merger “wins” of department consolidation and savings. More progressive systems are now reevaluating their system-level corporate services and looking to optimize their performance while also identifying new sources of cost savings. Doing so requires an understanding of the unique challenges that “systemness” brings, and the exercise of a thoughtful balance of power between system and local needs.
Revisiting the Consolidation of Corporate Services
When hospitals merge, corporate services are among the first areas to be consolidated. Departments such as human resources, finance and accounting, planning and marketing, purchasing and supply chain, information technology, and revenue cycle offer opportunities for significant savings through elimination of duplicative staff functions and improved contract negotiating for outside services. But over time, some problems have emerged.
First, achieving better cost performance has been much more difficult than expected. A host of operational challenges of full integration of services persist, sometimes even leading to actual cost increases rather than decreases. According to a recent revenue cycle benchmarking survey, cost-to-collect performance has been flat since 2013 and is actually a bit higher compared to 2011, suggesting that for many systems, economies of scale have not had as much impact as expected. The inability of systems to meaningfully reduce such administrative expenses is especially frustrating to local leaders across the system, who typically have little visibility into how these costs are allocated to their budgets.
Second, these consolidated departments often don’t adequately meet the service needs of the individual institutions. As an example, a large, multistate hospital system consolidated IT across the system and established one standard electronic health record (EHR) platform, a fairly common practice in large health systems. However, policies put in place at the system level limit the ability for local hospitals in the health system to adapt certain elements of the EHR setup to align with some unique workflow practices. If clinicians at one hospital want to make a specific change to key workflow setups, they must submit a request to corporate IT leadership. System IT governance policies sometimes block useful local modifications in order to preserve a desired level of systemwide continuity. This friction between corporate objectives and local challenges plays out frequently in hospital systems across the country.
In some cases, it is not unusual for a local hospital in a system to hire additional staff on the local payroll to fill perceived corporate service gaps. While these costs are not reflected in the total corporate services costs, they are effectively adding an extra layer of hidden costs. At one regional health system, a member hospital was experiencing high nurse turnover and struggled to fill multiple open positions. Frustrated by the inability to secure enough time and support from the system’s human resource function, hospital leadership opted to hire a dedicated recruiter.
Reassessing Performance and Cost Together
With the margin impact of rising operating expenses being compounded by slowing revenue growth, health systems face new urgency in driving more value from integrated corporate services. Health systems need to reassess both cost and performance within the context of system finances to identify where corporate services are not cost effectively meeting the needs of system-level and local constituencies.
The first part of this assessment is to consider is whether the overall level of corporate services cost is sustainable. Is the total cost of corporate services as a percentage of total operating revenue too high? And equally important, how is this percentage trending? Similarly, is the corporate services allocation to local hospitals a higher proportion of their total costs compared to independent hospitals of similar size and complexity? The answers form the basis for determining the necessary and appropriate cost ceiling for overall corporate services.
The second part of the equation is then to uncover which departments may be underperforming and understand the root-cause drivers. Looking for those hidden costs being incurred at the local hospital level to offset deficiencies in the corporate function is a “bottoms-up” endeavor, undertaken at each facility. Conducting a routine survey of end users within the health system to identify specific gaps in performance that need to be addressed is also a useful tool for surfacing performance gaps. Together with the top-down financial picture, these insights into the overall cost and effectiveness of corporate services give health system leaders the information needed to set cost ceilings and performance goals.
John Johnston, CPA, MHA is senior vice president at Advisory Board, Washington, D.C.