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When M&A Is Not the Best Option for Hospitals

Geplaatst op nov 19, 2013 in News

Historically, larger scale has offered hospital systems a number of advantages, including increased referral volumes, better access to capital, stronger pricing power, and classic cost economies. For instance, larger scale has enabled many hospital systems to lower their per-patient operating costs significantly.

However, reform and other market changes are altering the scale equation for hospital systems, so some of the traditional advantages that larger scale has traditionally brought them may no longer apply. For example, hospital systems’ ability to receive premium prices for higher quality and more consistent care in a market is now being limited by greater consumer and employer price sensitivity, increased scrutiny on industry profits, and regulatory concerns about hospital mergers.

In addition, creating value through M&A deals always is challenging, and all M&A activity involves a certain amount of value destruction. (Many hospitals system executives underestimate the cost of both pursuing an acquisition and managing the post-merger integration.)

So while hospital systems must respond to growing pressure on their margins and some M&A opportunities should still be pursued, their executives should ask themselves two questions before taking the plunge: What other — perhaps new — advantages might scale bring that would enable them to overcome the inevitable value destruction associated with M&A? Are there other affiliation models beyond M&A that would allow them to capture these advantages with less risk and at a lower cost?

These questions are the heart of a new, smarter scale equation (PDF) that can help leaders of hospital systems to address the challenges ahead.

Advantages of scale

The advantages that hospital systems can derive from scale fall into four groups:

Classic economies of scale focus on lowering the cost per unit of care delivered (e.g., by spreading fixed costs across a larger volume of patients, consolidating administrative functions, or enabling a provider to negotiate lower prices for major cost categories).

Economies of scope can allow hospital systems to leverage their scale to develop new revenue streams. For example, Tenet Healthcare launched Conifer Health Solutions in 2008, and its technology-enabled services now help its more than 600 clients throughout the United States manage patient revenues, financial risk, and patient communication and engagement and support their efforts in accountable care and population health management. It currently assists these clients in managing $25 billion in annual patient revenues and provides services that support population health management for more than 4 million people.

Economies of structure can be captured by hospital systems that have a structural advantage in some of the local markets they serve. For instance, structural advantage can be gained if a hospital is a market share leader or has a large physician network, an extensive out-of-hospital footprint, or unique or differentiated services (such as being the only facility in a region that can provide advanced oncology services). A hospital system that can strengthen its structural position within a market is apt to have a more favorable negotiating position with its partners. It is also likely to be better able to take on risk pooling for population health management and improve its retention of patients.

Economies of skill can permit hospital systems to share or build best practices at a comparatively low cost. For instance, greater value can be created when a system with a strongly disciplined approach to operations shares this skill with another system than when the operations of two moderately disciplined systems are merged. In addition to operational excellence, other economies of skill include stronger physician alignment (on issues such as how to minimize waste and implement emerging value-based models), greater capacity for innovating on where and how medicine is practiced (e.g., through the adoption of evidence-based care pathways and care delivery in lower-cost settings), more effective IT deployment (to enable standardization and integration of care), and better management of financial risk. In many cases, it may be skill economies that best enable providers to create value in the next few years.

Affiliation models

Once a hospital system has determined which economies it wants to pursue, it can then determine which approach would be best for capturing them. A range of different models should be considered:

Inorganic scale can be purchased through a traditional asset-consolidation transaction — for instance, the merger of two hospitals operating in the same region, the absorption of one or more hospitals into a larger health system, or the merger of two systems on a regional or national scale. Deals such of these often result in considerable economies of scale and skill but at a high cost and with significant implementation risk.

Virtual hospital integration can allow a hospital system to capture certain benefits of scale without requiring it to directly control another organization or commit to a long-term relationship. This type of deal may involve the co-provision or outsourcing of shared services or the joint creation of knowledge and innovation. As a result, the health system can obtain some economies of scale and/or skill without the high upfront investment or risk associated with M&A.

Horizontal organic scale develops when a hospital system extends its footprint across the care continuum (e.g., by acquiring physician practices or outpatient facilities). This approach often strengthens the system’s reputation in the community, facilitates referral growth, and paves the way toward population health management. However, it offers only limited economies of scale.

Vertical organic scale requires a hospital system to build direct relationships with payers, employers, or both to enable it to capture greater patient volume. This may be accomplished through network design or risk-sharing arrangements with payers, or direct-to-employer strategies, such as onsite workplace clinics or “centers of excellence” that provide leading care for all employees of an organization. (For example, the retailer Lowe’s contracted directly with the Cleveland Clinic to carry out best-in-class heart procedures for all its employees). This option has the potential to create high value by enhancing the health system’s structural position. In addition, it can be pursued in parallel with horizontal expansion, particularly when the payer–provider collaboration aims to establish new care or payment methods with a care-management focus.

The Smarter Scale Equation

When deciding which affiliation model best captures the desired economies of scale, hospital system executives should consider the following questions: How much potential value creation is available with each model — and at what cost? And does the proposed model complement the system’s strengths, weaknesses, and objectives?

Answering these questions requires executives to shift their thinking away from the traditional scale approach and toward a more complex equation that evaluates the risks and costs of hospital integration, as well as the difficulty of actually capturing the potential upside value. This broader approach will enable them to achieve their desired outcomes at appropriate levels of risk and investment.

An expanded version of this article can be found on the website for publications of McKinsey’s Healthcare Systems and Services Practice.

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Leading Health Care Innovation
From the Editors of Harvard Business Review and the New England Journal of Medicine

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