Opinion

Scale Matters: Bigger and Better Health Systems

Freddy Mercury, rock band Queen’s legendary lead singer, synthesized his larger-than-life philosophy into “The bigger the better; in everything.”

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Mercury could easily be describing the current merger & acquisition activity in the healthcare services industry. In 2013, there were 98 separate hospital and health system transactions, many involving multiple hospitals. Accelerated consolidation/integration continues in response to increasing operating pressure, new market expansion and post-reform revenue uncertainty.

This increasing merger activity has ignited a vigorous debate from Boston to Boise regarding industry consolidation (more efficient, anti-competitive or both). The high profile and now controversial acquisition of three Boston area hospitals by Partners Health System is just the latest example of the tension between efficiency, outcomes, market presence and price.

Often lost in this debate is whether bigger health systems deliver better health care. In the battles for regulatory approvals and consumers’ hearts, minds and wallets, health systems that can demonstrate better post-merger outcomes, lower costs and improved patient experience will lead industry transformation.

The Debate

Detractors of hospital M&A activity believe that consolidating hospitals into larger organizations increases their price negotiating leverage with health insurance companies. As Economist and NY Times columnist Eduardo Porter asserts: “market concentration drives prices up – and quality and innovation down.” As widespread coverage of Time Magazine’s “Bitter Pill” cover story illustrates, public scrutiny of hospital pricing strategies has intensified.

Yet, as leading health systems seek to manage population health and lower costs, scale and the ability to coordinate care are critical to success. Post-merger pricing patterns are just one of several “vital signs” for successful combinations. Too often quality, satisfaction and health outcomes – the characteristics of “better care” – are absent from “post-mortem” merger assessments.
Successful Hospital Consolidations

In 2013 Deloitte and Booz & Company released insightful analyses of hospital M&A trends. Both reports highlight that most hospital acquisitions underperform. The Deloitte report finds national systems better integrate acquired hospitals into their networks than regional systems. The Booz report emphasizes the need for strategic clarity regarding operating models and capabilities when executing acquisitions. Both studies principally employ financial performance metrics, particularly operating and cash-flow margins, to measure success. This makes sense in industries where financial performance correlates with value creation; however, healthcare’s reimbursement-driven payment model (where activity, not outcomes, drives revenue generation) can divorce profitability from value creation.

What’s Missing

To become “better”, acquired hospitals must achieve more than financial success. They also must deliver better outcomes at lower costs. Until profitability and value correlate in healthcare (as they do in most industries), health systems should report post-merger cost, quality and customer satisfaction metrics at acquired hospitals. This will build public trust and establish a capabilities framework for transforming hospital operations.

Banner Health acquired Boswell Medical Center in 2008 as a part of its acquisition of Arizona-based Sun Health. In the subsequent five years, Banner Boswell improved its contribution margin by 16% while its net revenue per adjusted admission declined from $9300 to $8800. That’s a financial home run: higher profits with lower per-case revenues. It gets better. Banner Boswell’s patient/employee satisfaction scores, quality metrics and employee retention consistently improved post-acquisition. Banner shared a five-year progress report with the Boswell community. It showed better outcomes, lower costs, happier customers, engaged employees and increased profitability. The U.S. health system needs more Boswell-like transformations and more companies like Banner communicating post-merger cost and quality metrics.

“Better care” without lower prices often isn’t enough to satisfy regulators. Last year, the Federal Trade Commission and the Idaho Attorney General challenged Boise-based St. Luke’s Health System’s acquisition of the 43-physician Saltzer Medical Group on anti-competitive grounds, while acknowledging the acquisition’s potential for better care. In ordering St. Luke’s to divest Saltzer, U.S. District Court Judge B. Lynn Winmill acknowledged this perplexing reality when stating “the Acquisition was intended … primarily to improve health outcomes. … St. Luke’s is to be applauded for its efforts to improve the delivery of health care in the Treasure Valley.” In essence, the court concluded better health outcomes were insufficient to offset concerns regarding market concentration and anti-competitiveness.

M&A’s “Double-Edged” Potential

Like nuclear energy, hospital acquisitions can be both beneficial and destructive. Health systems that expand while reducing performance variance, eliminating overtreatment, enhancing prevention, managing chronic disease and improving quality will deliver better outcomes at lower costs. These companies deserve to become bigger and offer their distinctive capabilities to more communities. Health systems that acquire hospitals (and physician practices) to limit competition and artificially increase prices risk market and regulatory disruption.
Most national systems are either for-profit or religiously sponsored. These systems understand the mechanics of driving cost savings through economies of scale. Secular non-profit systems are largely regional. This group includes several of the most enlightened health companies – with business models that standardize care delivery and advance population health. Non-profit governance and community dynamics can create barriers to capabilities-based consolidation and partnership. However, as these barriers fade, more non-profit systems will emerge as national and super-regional health companies. Winning health companies will be bigger and better; more capable and adaptable; more efficient and responsive. Freddy Mercury wasn’t entirely right. Bigger isn’t always better, but it can and should be.

David Johnson is the founder and CEO of 4sight Health, a Chicago-based strategy, thought-leadership and venture investment firm. He previously served as a Managing Director & Group Head of Hospital and Health Care investment banking at Citi, Merrill Lynch and BMO Capital Markets.

Nathan Bays is General Counsel & Executive Director, Health Policy, at The Health Management Academy.

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