Regulatory barriers that once thwarted any pressure felt by hospitals and health systems to consolidate and uncover economies of scale or scope have eased. But consolidation doesn't always come via an acquisition.
This article appears in the June issue of HealthLeaders magazine.
It's difficult not to notice that healthcare is undergoing a consolidation boom. For years, waste and danger to patients in healthcare has been blamed on decentralized and antiquated operations. Many experts say the industry has been long overdue for a period of consolidation that countless other industries routinely and regularly undergo.
But healthcare, perhaps among the most regulated of industries, has always effectively resisted this pressure, at least until recently. That high level of regulation, along with a desire to protect the local hospital, often has thwarted any pressure to consolidate to uncover economies of scale or scope. No longer.
"We're committed to helping reform healthcare by reforming ourselves to deliver value rather than volume," says Michael Connelly, president and CEO at Cincinnati's Catholic Health Partners. "In order to make those changes, you need economies of scale."
CHP, a nonprofit health system with 2012 net operating revenues of $3.8 billion, is pursuing that scale through an aggressive look at new partnerships and acquisitions. With 24 hospitals in Ohio and Kentucky, CHP is one of many organizations that are effecting consolidation in healthcare, but it's not always by acquiring assets.
In fact, it may be through strategic partnership that saves capital and avoids many of the regulatory hurdles that must be overcome in a full merger of healthcare entities. In February, CHP signed a letter of intent to create a strategic partnership with neighboring Summa Health System in Akron, which owns or operates eight hospitals in Ohio and had total revenue of nearly $1.5 billion in 2011.
Like some other creative partnerships now proliferating in healthcare, CHP will acquire only a minority interest in Summa when the deal is completed. Summa will retain local ownership and control.
Sign of strength
Prognosticators are fairly consistent in predicting that an increasing emphasis on population health strategies—which is intended, among other goals, to keep people out of expensive acute care environments like hospitals—will heavily pressure hospital revenues. In fact, some expect hospital volumes to decline between 20% and 25% over the next 10 years, which would lead to similar revenue losses in real terms.
So in addition to the focus on preventive healthcare and connected care across multiple modalities, economics will play a significant role in this remaking of the industry. And the hospital piece won't necessarily be the high-value target it once was.
Rather, the growth will be in the outpatient arena and, more specifically, on an organization's ability to effectively connect care among a variety of sites and treatment modalities, such that patients are effectively managed, not treated episodically.
Experts have identified effective care management as the key to cutting the unsustainable high cost of healthcare, so future-focused healthcare entities know that success will be measured less in terms of volume and more in terms of patients under effective management, which is where value—long divorced from the healthcare business equation—comes in.
The number of hospitals that are part of systems has increased from 38% two decades ago to 62%, according to a Navigant Consulting study, and that trend shows signs of accelerating following the passage of the PPACA. At the same time, the total number of independent hospitals decreased by one-third (to about 2,000). The odds, especially if you are a small presence, are not good that you can remain independent. So the question is: Does a partner need you?
The answer is complex, but it determines whether your organization can stay somewhat independent (as Summa will be able to do in Ohio) or whether it needs a capital-rich acquirer that will essentially take over big portions of the management of your hospital or system.
Summa was very attractive, says Tom Strauss, its president and CEO, who adds that while Summa had recently recorded some of its best years in terms of margin, it lacked the scale to compete over the long term.
Recognizing its position of strength, however, let Summa control the process of finding a partner, as well as retain local governance and its majority interest in Summa (the minority investment CHP made in the partnership has not been disclosed). Some 10 organizations, which Strauss calls "like-minded nonprofits" were interested, and Summa took five of those to face-to-face meetings. Three were selected as finalists before the CHP deal was announced at the end of February.
Of course Summa has been on the other side of this kind of transaction many times since 2007, Strauss says. In 2007, it consisted of three hospitals and a health plan. Now there are eight hospitals and a health plan with 250,000 lives.
That track record of successful integration proved potent when Summa began shopping for a partner that could deliver scale. Critically, CHP fit beautifully in terms of a vision for the future, Strauss says.
"We think local autonomy and control is important, but most important is the belief by both organizations that the future of healthcare is not to grow mass and raise our prices to burden the employers in our communities," Strauss says.
Both organizations are committed to some of the value-based programs that have recently roiled the healthcare marketplace. Both are enrolled in CMS' accountable care organization program, and both were among the few organizations that received a shared savings award from CMS in 2012. Both are advanced in the creation of patient-centered medical homes through their owned and affiliated physician practices.
"We know that if we can combine these synergies, we can impact not only the health status of our communities but also decrease the total cost of care for our communities," says Strauss.
For his part, CHP's Connelly says health systems have to stretch for scale, even though CHP is by far the larger of the two organizations. But he also notes Summa's particular attributes that fit well with CHP, and may not have fit as well with the other two organizations Summa chose as finalists.
For one, says Connelly, Summa has all of the elements of an integrated delivery system. They have a well-organized and highly reputable employed physician group, "which is the top of the pyramid in terms of the importance of reform," says Connelly.
Second, Summa has a healthy balance in other divisions of care, such as behavioral health and outpatient-focused care. And finally it has extensive experience with insurance products through its health plan.
"Medicare Advantage is very critical for the future, and they have a four-star Medicare Advantage plan—one of the highest-rated in the state with close to 30,000 members—and that's a real asset," says Connelly. "Finally, they're a perfect geographic fit. They sit right where we have a hole in our markets."
What's attractive about you?
As executive vice president and chief development officer for LifePoint Hospitals, a Nashville-based for-profit chain with 57 hospitals in 20 states, Leif Murphy is in charge of its M&A activities. Most of LifePoint's hospitals are the only provider in their local area. Some such hospitals are financially stable, of course, and others not so much, leading to a variety of deal types surrounding whether the organization needs a strong infusion of capital, operating expertise, or clinical ties.
A strong balance sheet can put hospitals in a good bargaining position and could result in interest from multiple suitors, but just because you have a strong balance sheet doesn't mean you shouldn't be seeking a partner, Murphy says.
"There's undoubtedly an advantage available to the ones who have very strong balance sheets because they can reinvest or retain ownership in the hospital going forward through a joint venture structure," he says. As in Summa's case, that balance sheet strength can also afford you at least equal say in governance.
"But unfortunately," he adds, "there are many opportunities where the hospital's not capitalized well enough" for ownership to be maintained locally.
Increasingly, as mergers become less about conglomerating assets and more about transforming the way care is delivered, some acquirers have separately developed joint venture organizations featuring clinical partnerships with academic medical centers or brand-name, high-reputation clinics, such as the partnership between LifePoint and North Carolina nonprofit Duke University Health System or the recently announced partnership between the Cleveland Clinic and Nashville-based for-profit chain Community Health Systems.
Such partnerships can help ease concerns that local governance and control will be ceded to a company whose only allegiance is to stockholders, although both for-profit companies deny, with some justification, that their joint ventures with brand-names like Cleveland Clinic or Duke were created for that purpose alone. The conversations with administration, physicians, boards, and workers to ease those concerns begin well before a letter of intent is signed, Murphy says.
"The biggest misperception to overcome is that things are going to change so drastically as a new partner with a for-profit hospital company," says Murphy.
Things will change, but most of the change, he says, deals with previous underinvestment in technology, process improvement, and sometimes, bricks and mortar.
"During the initial stage of the transaction, there is a great deal of involvement related to all aspects of the hospital. While this level of activity can be challenging, we have found that the hospitals are pleasantly surprised by the quality of resources and support we bring to them," Murphy says.
Hospitals should realize that any flirtation with partnership can be a liberating process, if you have a vision for your future. You might need expertise and outside investment to achieve those goals, but those goals usually are the first thing potential suitors want to review, because you and your team have the most important knowledge about what works and what doesn't in your local market—it's not just an opportunity for suitors to add mass.
"The first thing we want to evaluate is what the hospital's affiliation objectives are," says Murphy. "The partnerships that go the best are the ones where the board and the management team invest the most time on the front end determining their objectives for the affiliation."
That can take a surprising amount of time, because Murphy says the suitor will always seek to discover how well thought out those objectives are. That allows the suitor, especially in a formal RFP process, to determine how much value it can add and in what areas—essentially, if it can meet the local objectives for affiliation.
"Places where we tend to hit home runs are with folks looking for strategic help in areas where our hospital support center has expertise and resources to offer," he says, referring to a centralized group of resources within LifePoint that provides its facilities with operational support, such as dealing with the complexities of healthcare reform. Support ranges from navigating government regulations to providing guidance about changing business realities in dealing with commercial payers to collaborating with other care providers that may not be integrated with the local hospital or health system.
"The marketplace has become so complicated, given the more sophisticated ways of engaging with physicians, payers, and health exchanges," he says. "We know how to do that. For an independent hospital, it can be very difficult."
Murphy says some hospitals may be looking for a partner that will allow them to continue making all the decisions, while each suitor has a different approach to local decision-making. "The management and boards at our company are the teams that want to be there actively involved with their partner in decision-making going forward."
But it's hard to look at an income statement and make a determination on whether the hospital or system seeking a partner is doing what it needs to do for its community.
"They could be doing all of those things wonderfully and still not have a good balance sheet or income statement," he says. The reverse is also true.
Smaller hospitals and boards that recognize early the need for a partner are getting more sophisticated in seeking that partner. "It's very rare we're the only seat at the table, and it is frequently difficult for me to figure out how many folks are at that table," he says. "My impression is that these processes have become very competitive. Many hospitals have north of 10 parties looking at their transactions."
In opportunities that are in strategic markets, there can be a lot of activity. Most acquirers are very strategic in making the decision as to where they will do a deal, and there are a lot of opportunities.
LifePoint evaluates each situation to determine whether it is a LifePoint or Duke-LifePoint opportunity. Those opportunities lie with larger, tertiary care facilities "where we can combine our operational strength with Duke's expertise in higher-level clinical programs, like cardiology, oncology, and neonatology," he says.
Summa's deal was somewhat unique, in that it controlled the partnership selection process, but Strauss is convinced similar deals can be replicated.
"Not every organization can demand these kinds of relationships, but deals like these will be the future," Strauss says. "The biggest thing is that a lot of people—especially from larger organizations—didn't understand this concept of minority interest. We had to continually clarify and some were skeptical we'd get this kind of commitment." He stresses the need to "overcommunicate," not only with potential suitors but also with your organization's own stakeholders.
"It was important to communicate to employees, management, and physicians about what this was, but also what it wasn't," he says. "You have to commit to your mission vision, values, and culture and be relentless in that pursuit. Because at the end of the day, you have to live by those values and you can't give in even for something that appears to be more attractive for the short-term but in the long-term could hurt the community's assets."
Reprint HLR0613-5
This article appears in the June issue of HealthLeaders magazine.
Philip Betbeze is the senior leadership editor at HealthLeaders.