Are Mergers and Acquisitions the Cure for Shrinking Hospital Margins?

One consulting firm offers three factors that could support hospital M&A strategies in 2021 and beyond.

The human toll that COVID-19 is taking is painfully obvious, always heartbreaking, and often inspiring. But could the pandemic also put some hospitals on life-support, as it greatly reduces consolidation strategies within the industry, and with that, the ability for hospitals to cut losses?

That is the view of consulting firm Ernst & Young (EY), which recently completed its Global Capital Confidence Barometer and discovered a dramatic drop in the number of healthcare executives that are contemplating a merger or acquisition in the next 12 months.

According to EY, 34% of healthcare executives now say they plan to pursue M&A through next year. That number is significantly down from the 60% that made the same claim a year ago. Whether this is good news or bad depends on who you ask, but according to EY, it could have impacts on the long-term outlook of healthcare organizations.

"As hospitals increasingly face significant margin challenges driven by an ever-increasing cost of care and a relentless pressure to reduce reimbursement for those care costs, M&A has an ever-important role to play," EY noted of the barometer findings. "In fact, only the largest hospitals, with operating margins averaging 6.6%, have comparable margins to the largest US payers (which ranged from 5.0% to 8.1% in 2019). The rest of hospitals actually had negative operating margins in 2019."

Despite the current decline in M&A interest, EY cites three major factors that could support hospital M&A strategies in 2021 and beyond. They are:

• Hospital margins are shrinking. "The average hospital operating margin fell to 0.3% in 2019 from 1.8% in 2015. To combat this, ratcheting up hospital M&A can lower costs and increase margins through economies of scale, capture broader patient volumes, enhance coordination of care delivery across the care continuum, and develop sustainable reimbursement solutions with managed care and corporate payers," the firm noted.
   
• Vertical integration between payers and providers. "In the long run, convergence may be critical to enable the US to break away from the 'pay for volumes' paradigm. In the meantime, health systems and payers can work together to find solutions that can work for sustainable economics today and bridge to tomorrow," EY stated.
   
• The need for hospital systems to scale to compete. "Consolidation of hospital peers or systems may reduce costs by increasing scale. M&A, with an academic medical center, can allow a health system to increase its scale and improve its regional brand presence as a provider of world-class, innovative care," the consulting firm states.

But not everyone agrees that M&As are the right tourniquet for stopping the financial bleeding at many hospitals. Indeed, the AHIP (America's Health Insurance Plans) trade association says that one of the main drivers of rising healthcare costs is the increasing consolidation among hospitals and hospital systems. The Federal Trade Commission shares that view.

"Too many hospital mergers lead to jacked up prices and diminished care for patients most in need," the commission noted in a statement last month.

In a separate blog by the AHIP in August, the association noted that "Arguments in favor of hospital consolidation often tout higher quality of care or other benefits for consumers. A number of recent studies have found this to be untrue. According to a study on hospital mergers and acquisitions in 2009-2013, 'Hospital acquisition by another hospital or hospital system was associated with modestly worse patient experiences and no significant changes in readmission or mortality rates.' "

Desperate times, and desperate measures

Even in good times, the healthcare industry is under tremendous pressure to keep costs down while keeping patient care and patient satisfaction up. COVID-19 made everything much worse, says Simon Joyeux, EY's U.S.-East health sciences and wellness strategy and transactions leader.

"Everyone's fighting for resources. There isn't a level playing field, and there are a lot of players in and outside the industry that are trying to change the way we deliver healthcare," Joyeux explained. "COVID added more pressure. So, can the industry stay the way it has been, or is M&A the prescription that will help those hospitals continue to be competitive?"

In addressing that question, EY consultants developed a six-step process to help financially challenged hospitals decide whether consolidation is just what the doctor ordered.

Think of step one as the equivalent of a financial check-up, Joyeux explains. The check-up starts with three questions that the leader should ask to determine the organization's ability to do a deal, and if so, the size and scale of the deal that is right. Those questions are:

• What is their equity?
   
• How much cash do they have at their disposal?
   
• What is their debt capacity and how much can they draw on that?

Step two is looking at the competitive dynamics in the market. This includes evaluating the choices that patients are making for where they seek care, and how care is being delivered.

Step three is the reimbursement dynamic. Healthcare organizations need to know whether they are in a market where payers are consolidating, or at risk of consolidating, and how either could impact pricing power.

Step four is looking at the patient demographics in the local market. Is the population growing, shrinking, aging or getting younger, getting sicker or less sick, and how these factors will impact the type of services needed in the future.

Step five is evaluating whether there is a trend to more outpatient versus inpatient services needed, and how your organization stacks up in meeting that trend.

Step six is looking at your competitors and evaluating what new opportunities there might be in the local market based on gaps in current services.

There is no one-size-fits-all formula for making the decision to pursue consolidation.

"The criteria for each hospital will be different," Joyeux stresses. "They'll be specific to the hospital. Every market is going to be different. It's very much a local business. So, the challenges and the opportunities for hospitals in Nebraska will be wildly different than a hospital in the New York area."

Finally, Joyeux says hospitals need to be clear on what they're trying to accomplish with a consolidation. A merger should cut costs and streamline operations. But it should also enhance the quantity and quality of healthcare services the organization can provide.

David Weldon is a contributing writer for HealthLeaders.