The volume of healthcare mergers and acquisitions lately has been stunning. But to some hospital and health system executives, it's nothing compared to what's coming over the next decade.
This article appears in the October issue of HealthLeaders magazine.
In fact, Cleveland Clinic President and CEO Delos "Toby" Cosgrove, MD, boldly predicts that what he calls a "big dozen" integrated regional systems will come to dominate the healthcare industry. While this consolidation is "a long way away" from completion, he says, independents will continue to disappear—a trend that will pick up speed as time goes on—thanks to declining reimbursement, lack of capital access, and their inherent inefficiency compared to integrated systems.If many of the most influential health system leaders are to be believed, independent hospitals are a dying breed, and small systems might be right behind them on the endangered list. The United States has around 5,700 hospitals, according to the American Hospital Association, and already more than half of them (slightly more than 3,000) belong to systems. Expect that trend not only to continue but to accelerate, industry leaders say.
What's more, Cosgrove says, the drivers of consolidation have changed. While the healthcare industry has gone through M&A waves before, this time around consolidation isn't a play for market dominance. For one thing, government regulators are watching closely and often are breaking up even completed mergers that they deem have local or regional monopoly at heart more than operating efficiencies. Instead, today's mergers and affiliations are more a reflection of several factors that are making independent hospitals, and, in fact, comprehensive service hospitals of all kinds, functionally obsolete.
This trend is most visible as organizations formerly known as hospitals change their names to reflect "health system" or just "health" while eliminating the word "hospital." This change implies that instead of focusing on acute care, such organizations can provide a continuum of healthcare services. Whether the actual transformation of service offerings (typically incorporating primary care, rehab, and other services outside the acute care setting) is nascent or well in progress is another story.
The new dynamics of consolidation
Today, many systems of significant size are combining—or in some cases, trying and failing to combine. The dynamism around the acquisition and affiliation game has never been stronger. Unlike acquisitions of a different era, much of this activity is centered on linkages in disparate markets. In other words, it's not the traditional play to gain market share in a particular small area that is driving this trend.
Instead, the impetus stems from the increasing complexity of healthcare, the ability to drive efficiencies in the back office by leveraging technology, and the push to cut costs engineered by the federal government, employers, and health plans. It's also about reducing duplication of services—not just in small local areas—but in large regions.
The health plan sector, for example, has consolidated markedly over the past couple of decades. The top 25 health plans in terms of market share account for nearly two-thirds of total premium dollars, according to the most recent (2009) data from U.S. News & World Report and the National Association of Insurance Commissioners. So why won't hospitals and health systems consolidate in a similar fashion?
They will, says Bill Thompson, who, as president and CEO of St. Louis–based SSM Health Care, recently inked a merger with Madison, Wis.–based Dean Health Systems, a physician-owned system that approved the merger with a 97% majority of its physicians voting for it. SSM had operating revenue of $3.3 billion in 2012.
Thompson says delivering value is the key metric for hospitals and health systems going forward, and that systems that want to grow and prosper need not only to lower their prices for care over time, but must also lower their internal cost structure so that they can compete with other low-cost interlopers like drugstore chains that will eat away at their margins through better and cheaper primary and chronic care management. In other words, hospitals and health systems in the future will have to compete on value and price through expanding the portfolio of businesses that health systems own or with which they affiliate or otherwise share risk, and also through economies of scale.
"We're looking for opportunities to lower our cost structure while we lower our price point. That will enable us to make a profit," he says. "The other economic pressure at work here is that the organization that continues to deliver value—that is, that manages its price point lower while improving quality—is typically rewarded in the marketplace by attracting more and more business. We're facing what other industries have been facing for years—particularly retail. The current environment is asking us to behave similarly."
He argues that's in part because the consumer of care—the patient—is less insulated from the cost impact of their decisions than in the past. While many patients are far from influencing what health services they consume, it's clear that the federal government and, to a lesser extent, employers are forsaking the fee-for-service economic model and using evidence-based guidelines to affect consumption.
"There are more and more individuals who are feeling this price pressure, which means the individual has much more skin in the game," says Thompson. Couple that with cost pressures on government and the employer, "and with the cost of care approaching 18%–20% of GDP, that puts pressure on government and employers to the point where it becomes unsustainable."
Thompson says the merger with Dean—a network of clinics and medical facilities that provide primary, specialty, and tertiary care throughout southern Wisconsin—will work to lower costs because "consolidation and economies of scale allow me to control my internal cost because I have negotiating leverage with my vendors and can apply that to lowering my cost structure."
Thompson, who says he is excited to bring many aspects of Dean's model into SSM, says he doesn't expect the market for M&A to subside for a while. He sees consolidation accelerating as standalone hospital boards become more aware of their inability to compete, and, like Cosgrove, predicts that several big systems will end up dominating the provider landscape.
Meanwhile, the hospital industry continues to experience a degree of churn. "I'm always puzzled by the lack of equilibrium. You have Tenet acquiring Vanguard. Later we'll see them spin off assets in some markets, [and] those will be acquired by someone else who's striving to get larger in a particular market," he says. "They'll all still be trading assets even if you have the 'Big 12,' so to speak."
Monopoly concerns misplaced?
There is disagreement about whether the consolidation ultimately will lead to monopoly power within a few systems and thus no bending of the cost curve. Cosgrove, for one, discounts those concerns.
"When people ask me about that, I point out that right now 50% of our hospital bill is being paid for by the government, and what we get paid is fixed. You get roughly the same amount for gallbladder surgery, for example, in Boston, New York, and San Francisco," he says. "Everyone in Washington and the insurance industry says we'll get to 75% of the hospital bill being paid by the federal government. If that's the case, it will be hard to have a monopoly when you have prices that you don't have control over. Of that remaining 25%, some will be no-pay and some will have private insurance."
So will government as payer have the monopoly power, as is the case in many nations with single-payer healthcare?
"I haven't really thought about it like that, but I think that's exactly right," Cosgrove says.
CMS has its own projections about payer mix in the near to medium–term. CMS expects the total government share of healthcare spending (local, state, and federal) will reach nearly 50% by 2021, up from 46% in 2011.
Still, even health system CEOs in relatively stable markets and who are not looking to grow through acquisition are not so sure monopoly is not on the minds of at least some players orchestrating merger activity in healthcare. After all, many hospital operators are for-profit companies, and allegiance to shareholders comes first.
And there has been an explosion of private equity operators in healthcare as these groups have acquired struggling hospitals and systems in an effort to turn around their finances and reap the benefits of consolidation. (See related story, page 14.) Even such nonprofit stalwarts as Cleveland Clinic and Duke University Health System have entered into affiliation agreements with for-profits, exemplified by Cleveland Clinic's "strategic alliance" with Community Health Systems and Duke's joint venture with LifePoint Hospitals, called Duke LifePoint Healthcare.
Bill Atkinson, president and CEO of WakeMed Health & Hospitals, an 1,100-licensed-bed nonprofit health system in Raleigh, N.C., says the insurance industry can serve as a cautionary tale for those who expect consolidation to reduce overall healthcare costs for the government, employers, and individuals.
"If you look at the insurance industry, there is stability in size," he says. "But the real snapshot is looking at insurance consolidation and asking if insurance costs went down. The answer is no, so what does that tell you? Where the money is going is changed, but it has ended up in the hands of the companies and has not generally trickled down to the people it should be about—the consumers."
"We'll all lose if consolidation is just an opportunity to squeeze out more margin," he continues. "You have to start with the assumption that the system needs to meet the needs of the patients in the community. This is not first and foremost in some organizations."
He says WakeMed, which reported 2012 total operating revenue of nearly $1.1 billion, with total margin of 8.10%, is content to focus on its local area, and if another system is looking to acquire it, it may have to wait a while.
"What it means is we're not always looking for the next economic angle," he says, and performing its mission of improving health in the local community "doesn't have to be about ownership."
He cites as an example Harnett Health System, a two-hospital system in nearby Harnett County that WakeMed manages and which just opened a new 50-licensed-bed hospital with help from WakeMed's A1 bond rating.
"We've not had to own it to make it a healthy system," he says. "We built that hospital with them. They wouldn't have had access to the loans to build it in our absence, but at the same time they didn't need us to own them to make that happen."
Still, Atkinson says the way his system operates isn't for everyone, and concedes that following "the economic angle" can produce value in healthcare as it has in other industries.
"There are plenty of organizations that have reduced cost and at the same time have produced value. Look no further than Amazon," Atkinson says. "The question is whether healthcare organizations will effectively use the resources they have to increase value overall. All of us have demonstrated time and time again in micro attempts that that can be done."
No longer hospital-centered
As Cleveland Clinic and others have demonstrated, integration and achieving economies of scale and scope are not dependent on ownership. In truth, the fact that headlines in healthcare are focused on hospital ownership is a bit of a relic. Inpatient care is no longer a growth area, given the focus on population health and treating patients in lower-cost settings engineered by both the Patient Protection and Affordable Care Act and commercial and employer emphasis on preventive care.
Many local hospitals—typically dominated by community-based directors and focused on provincial interests—often lack the capability to expand their offerings much beyond the inpatient care space. Over time, that could lead them to seek affiliations or acquisitions with systems that can build out that outpatient capability, among other business imperatives like investment in IT and care pathways.
But just because some hospitals and small health systems are realizing they don't have the firepower to make that transition, getting to that point is often frustratingly slow, Cosgrove admits. That sluggish pace presents an obstacle to Cleveland Clinic becoming one of the Big 12 that Cosgrove envisions will eventually dominate healthcare.
"A lot of communities and boards have difficulty giving up that control and responsibility for their community hospital. That has been a real process. Every time we've done it it's taken as much as two years to get from the point of them insisting on being independent," Cosgrove says.
At the same time, the process is getting easier, he says.
"It has accelerated because people are feeling the financial pressure, and as reimbursement goes down, they'll feel that increasingly."
He contends that inpatient bed count has to go down one way or another.
"There are 200,000 fewer beds than there were because of shorter hospitals stays and because more is being done in an outpatient setting," he says. "As hospitals have empty beds and decreased reimbursement, they're incented to be part of a system."
Cleveland Clinic has put together an impressive array of care sites that Cosgrove says "is built on the principle of doing the right thing for the right person in the right location."
It's got partnerships not only with Franklin, Tenn.–based Community Health Systems but also with national drugstore chain and pharmacy benefit manager CVS/Caremark, and has developed its own family health centers for chronic care. Cleveland Clinic's community hospitals perform common procedures such as deliveries, orthopedics, and general surgery but increasingly don't do complex procedures such as heart care or neurosurgery. Those cases are fed to the clinic's main campus.
"We've connected all of that to our EMR and transportation system," he says. "So we move people around and their records follow them."
This process will become more ingrained over time as Cleveland Clinic becomes increasingly integrated and more of a system.
"Our model of care is something that's appropriate for the 21st century—particularly because we're an employed-physician group, so we don't have incentives to do more operations and tests," Cosgrove says.
Acquiring struggling hospitals does not have to be part of the equation for whether a hospital or health system ultimately is able to remain independent, says WakeMed's Atkinson. Consolidation will continue, he says, and that's neither good nor bad, "but a rural hospital with a tough population base to cover is the same thing the next morning after you buy it."
Perhaps that money earmarked for growth through acquisition would be better spent improving ways to manage patient health, which is part of what Cleveland Clinic and others are doing, although they are also acquiring formerly independent hospitals.
"We're doing that pretty assertively," says Atkinson. "We were the first in the area to create freestanding EDs."
WakeMed has four of those, with a fifth planned, and Atkinson says they can treat everything except level I trauma or imminent birth, and claims that about 90% of what's presented in those EDs can be handled without a bed.
"What I'm saying is you can get out on a limb and find new ways to get care closer to people and probably improve the clinical outcome and significantly reduce cost. Those EDs allowed us to stop building as many beds as we had been. Our biggest campuses are ambulatory and don't have inpatient beds and may never have them."
Reaping the rewards of population health
Cleveland Clinic's relationship with CHS—which owns, operates, or leases more than 135 hospitals and reported 2012 net operating revenues of $13 billion—originated about a year ago when CHS leaders asked Cleveland Clinic to help CHS with its quality, says Cosgrove. Though Cosgrove doesn't describe the partnership this way, it could be considered a virtual merger in that both organizations are seeking to leverage each other's perceived competitive strengths—Cleveland Clinic on quality and CHS on operations.
Cleveland Clinic puts a priority on publicizing its treatment outcomes on its website, and has spun off a company, Explorys, that now has 40 million patient test histories, physicals, and lab results in an effort to offer reporting, analytics, clinical integration, at-risk population management, and pay-for-performance solutions for its clients.
"The more we talked, the more they realized there were things we could do for them, but we realized they could do a lot for us," Cosgrove says. "While we've concentrated on quality, they've really concentrated on efficiency. If you're looking at value for your healthcare dollar, those two things are what you have to focus on. So we each brought different strengths to the relationship. The relationship came about because both leadership teams believe effective population health management will increasingly be a differentiator for patients and the payers for healthcare services.
"Our ability to access big data will be a tremendous advantage for us," Cosgrove says, "and we think there are economies to be had without necessarily owning the other or merging."
Another step many organizations are already busily taking is the idea of expanding services outside the outpatient arena—even to the payer side in bigger systems—says Dennis Vonderfecht, president and CEO of the 13-hospital Mountain States Health Alliance, based in Johnson City, Tenn. Its health plan, CrestPoint Health, has 15,000 members, but significant expansion is on the horizon.
"You're seeing volume declines across the country, and part of it is due to the ACOs and focus on keeping people out of high-cost settings. We're seeing the same declines in our organization," he says. Vonderfecht expects to lose as much as 30% in inpatient volumes over the long term if recent trends hold true.
"If we lose 30%, that's a lot of our revenue, so we're working on backfilling that by moving to the top of the healthcare food chain to capture part of the savings through creative initiatives with other insurance companies," he says. "But we can capture all of it if we're the insurer. Also, to lessen the impact of volume declines, we're focusing on outpatient ambulatory and retail activity. For example, we now own seven pharmacies."
Burgeoning health systems won't be the only source of competition, however.
"You'll find the major disruptor will be in primary care," Cosgrove says, adding that drugstore chains like Walgreens, CVS, and even Walmart are emerging to fill gaps in primary care.
"They're getting more sophisticated and with the shortage of primary care physicians, they'll take up more primary care—we hope, linked with providers."
Size and success
Vonderfecht says no one has all the answers, but at every conference he attends, "the size you will need to be successful keeps growing. You can only take so much cost out, and larger systems have an advantage there."
He believes very large regional systems like his, which operates in four contiguous states, will be most successful.
For his part, SSM's Thompson couldn't agree more, and he worries about the same things leaders worry about with any combination—that the promise of better efficiencies and lower healthcare costs will never be realized. "There will be organizations executing on this and at the end of the day they will not have derived any benefit from it," he says.
He also questions how big his organization needs to be, and whether there is such a thing as being too big.
"We're on the same bigger-is-better bandwagon as everyone else, but can I derive the same or better significant economies of scale as a $15 billion [revenue] organization as I can as a $5 billion one? The jury's out that everyone can achieve the cost savings they're targeting."
And Thompson has advice for anyone else on this road:
"You have to fully understand what you're trying to achieve when you go into these deals, make a detailed integration plan, and work with an organization that understands there will be equal disruption to achieve the benefits we believe are there through the transaction. The worst outcome will be if you don't change following these deals."
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This article appears in the October issue of HealthLeaders magazine.
Philip Betbeze is the senior leadership editor at HealthLeaders.