One idea that has gained a significant amount of traction in the past few months is that of "Big Medicine." Brigham and Women's surgeon and writer Atul Gawande, MD, propelled the phrase in his New Yorker op-ed last summer, in which he drew analogies between American healthcare and The Cheesecake Factory restaurant chain.
"Big chains thrive because they provide goods and services of greater variety, better quality and lower cost than would otherwise be available," Dr. Gawande wrote in the piece. "Size is the key. It gives them buying power, lets them centralize common functions and allows them to adopt and diffuse innovations faster than they could if they were a bunch of small, independent operations."
As it turns out, an analogy between hospitals and cheesecake eateries isn't too far-fetched: America's hospitals are moving steadily toward conglomeration. Data by Irving Levin & Associates shows that 2011, the latest year available, brought 86 hospital merger or acquisition deals — the highest number in the past decade.
And there are more colossal deals under way for 2013 and beyond. Last fall, Detroit-based Henry Ford Health System and Beaumont Health System in Royal Oak, Mich., announced their signing of a letter of intent to begin merger discussions. If they do consolidate, the systems would form the largest health network in southeast Michigan, with more than 42,000 employees and roughly $6.4 billion in annual revenue.
In Texas, Temple-based Scott & White Healthcare and Dallas-based Baylor Health Care System announced plans in December 2012 to merge into a 42-hospital, $7.7 billion organization with approximately 34,000 employees. The deal would drive the newly created organization to one of the top 10 largest non-profit systems in the country.
There's also the pending merger between Livonia, Mich.-based Trinity Health and Newtown Square, Pa.-based Catholic Health East, which will create an 82-hospital system across 21 states — potentially the fifth-largest hospital system in the country.
These transactions can result in improved quality, more seamless care coordination and increased access to capital. But Big Medicine and mega-mergers involve an entirely new set of organizational challenges, too.
Mergers can face shaky odds for success
Minoo Javanmardian, vice president of Booz & Company's global health practice in Chicago, says merging is not a strategy. Rather, "mergers are the result of a strategy that [organizations] define and are meant to leverage the differentiating capability systems of the partners," she says. If a system identifies a set of capabilities they do not possess, merging is one way to bridge capability gaps or further leverage the existing capabilities in an expanded market. But health systems may put the cart before the horse, especially when pursuing horizontal M&A defensively or as an expansion strategy.
System mergers, often justified for their economies of scale, still carry a certain air of risk. An early 2013 study from Booz & Co. found only 41 percent of all hospital and health system mergers between 1998 and 2008 to be financially successful by outperforming their peer group. The study analyzed health systems' financial performance two years prior to the merger and two years after the deal. More disturbing was the fact that almost one in five acquired hospitals went from a positive margin prior to acquisition to a negative margin after acquisition.
"When you look at this, it says, 'Here is the evidence that the traditional levers of mergers and acquisitions, such as geographic expansion or increasing the number of hospital beds, are not indicative of a successful merger,'" says Ms. Javanmardian. "Any merger is fraught with risk. If the real reason for a merger is to improve position in marketplace, then you need to be very thoughtful of how you integrate [and] how you preserve differentiated capabilities on both sides."
More frequently, financially robust systems are merging to create networks that span throughout states or regions, such as the aforementioned pending transactions. Many of those systems are well-regarded and have national reputations for certain specialties. These types of marriages are different deals from those of struggling community hospitals for access to capital or mere survival. Instead, these mega-mergers resemble a land grab.
"We think you'll see more mergers happening not necessarily from hospitals and health systems in distress," says Ms. Javanmardian. "A lot of healthy systems are trying to figure out how to position themselves to be successful, given the pressures on the financial side of the market. To us, what drives that merger is very important. So far, most have happened based on traditional levers. We don't believe that's necessarily translated to better performance."
Paul Levy, former president and CEO of Beth Israel Deaconess Medical Center in Boston and healthcare author, agrees that there is an inherent risk to organizational expansions across the board.
"Think about firms in general that have grown over time by mergers, in all kinds of fields — banking and airlines, as well as hospitals," says Mr. Levy. "They start as sensible business propositions, but some don't work out very well because of cultural differences among [their] various parts, or lack of experience or expertise on part of the CEO as to how to run a system versus an individual entity. It's almost a truism that as organizations grow, have more tentacles and cover more geography, it raises a whole new set of challenges for managers."
The power of clout
Another traditional benefit to consolidation? Getting a leg-up on a commercial insurers' rates. "To the extent [systems] become a monopoly in their service territory and are able to hold it over the payors, [systems] have less incentive to be efficient because they have market power," says Mr. Levy. "That's what has happened in the Boston area with Partners HealthCare. It's such a dominant system that they can extract higher rates from payors and don't feel the same cost pressures as other hospitals."
Although merged health systems have been accustomed to increased bargaining power with payors, Ms. Javanmardian says this may be on the decline, largely due to pressures from the Patient Protection and Affordable Care Act. "Going forward, there will be less money to go around. There's not another option," she says.
In the past, providers essentially viewed commercial reimbursements as subsidies to ease the hit from government health programs' less robust reimbursement. But now, private payors face their own pressures, and providers may not be able to rely on commercial rates as much as they previously did. "[Providers] won't be able to do that," says Ms. Javanmardian. "You can merge, but if you think you'll merge and increase your revenue per patient, I don't think that's a realistic expectation."
What might happen if one of these large mega-merged systems does fail?
A single community hospital falling onto hard times and ultimately failing is one thing. But the failure of a statewide or regional system poses even more pressing, albeit ambiguous questions. In attempts to explain what might happen if a mega-merged system does fall into bankruptcy or other distress, sources featured in this article largely lacked a common answer.
First, it's important to start by defining the various ways a health system can fail. Bankruptcy is the most comprehensive scenario, but a system could fail if, post-merger, it must sell off individual hospitals it acquired. Another form of failure is shutting down unprofitable hospitals or facing legal and regulatory setbacks, which are a token risk for any large corporation. In general, the larger a system gets, the more legal and regulatory risk it faces.
In 2008, the government came to the rescue for banks, largely to protect consumers from financial distress. But is there an analogous agency or rescuer in American healthcare?
"The FDIC is the designated agency to take over for a failing bank. If you have a healthcare organization that is too big to fail, and it fails, who comes in?" says Casey Nolan, managing director at Navigant Health in Washington, D.C., and leader of the firm's healthcare strategic planning practice.
At this point, it's speculation. But as systems expand beyond their local status into statewide or regional networks, it's difficult to say what might happen if a merger eventually leads to their systematic collapse. After all, many experts are convinced the merger is pursued to avoid just that.
It's not always a matter of size, but also importance
Generally, the larger a health system, the less likely it is to fail. "The size of the parent company makes the risk of failure lower," says Jordan Shields from Juniper Advisory, an independent investment banking firm exclusively focused on hospital mergers and acquisitions, in Chicago. "It is a bad outcome if a community's hospital fails. Small hospital companies have a higher risk of failing than large systems. That's one of the reasons the credit rating agencies place emphasis on business scale."
In that sense, the concept of "too big to fail" may hold true for large, integrated systems — their size will reduce their risk. But this is still different from the traditional meaning of the phrase, which really came to life after the banking collapse and bailouts in 2008. In healthcare, especially in urban markets, the phrase can also go another way. "The safety-net [hospital] isn't too big to fail — it's too important to fail," says Mr. Nolan of Navigant Health.
In urban markets, safety-net hospitals or health systems are essential to the community. Detroit Medical Center, Caritas Christi Health Care in Boston and West Penn Allegheny Health System in Pittsburgh are three examples of systems that are, or were, pillars of non-profit healthcare in their respective urban communities.
But within the past four years, all three systems underwent or are in the process of unorthodox transactions. For-profit Vanguard Health Systems, based in Nashville, Tenn., purchased DMC in November 2010. Boston-based Steward Health Care System, a new affiliate of private equity firm Cerberus Capital Management, purchased the Catholic Caritas Christi in March 2010. And Pittsburgh-based health insurer Highmark was working to buy West Penn Allegheny at the time this article went to print.
Studies suggest only hospitals that are financially viable and essential to the market need to be saved. As for the examples mentioned above, DMC employs approximately 12,000 people. Caritas Christi was the 10th largest employer in Massachusetts with more than 13,000 employees, and West Penn employs roughly the same number. These organizations were also critical in their markets for the volume of charity care they delivered in underserved areas. DMC was, for instance, the largest charity care provider in the state of Michigan.
"Local governments are going to view some hospital systems as too big to fail, and they won't allow a hospital to just go by the wayside," says Rex Burgdorfer with Juniper Advisory. "As a result, they'll be more amenable to concessions on the transaction terms for a company to come in and save the hospital."
The larger the system, the more pressure to find the right CEO
The boards of integrated health systems may fall prey to a search for perfection when looking for the best CEO candidate to lead their multifaceted organization. For example, if a system includes hospitals, a health plan, a physician group and a home care setting, that board may want a CEO who has touched all service lines and is equipped with prior leadership experience at each part of the system. This is faulty thinking, says Kimberly A. Smith, partner and managing director of executive search firm Witt/Kieffer's Eastern region in Burlington, Mass.
"Surely those people are in extraordinarily short supply," she says. Instead, boards should ensure their requirements for an incoming CEO are divided between technical skills and leadership abilities. If these requisites are disproportionately sought, with more focus on one or the other, the executive search can quickly become arduous.
"There's a moment when the governing group steps back and says, 'What are we really looking for in the defined future, in the next three to five years?' And that refocuses governance on exactly what core leadership competencies are needed; not so much the technical competencies," says Ms. Smith. "There's a real difference between the two."
It's also critical for governing bodies to remember the distinct roles of the health system CEO and COO. For the latter, prior experience or specific expertise with each sub-entity of a system is more crucial.
"[The COO] is the person charged with delivering an end product and making sure the pieces of the organization come along," says Ms. Smith. "But the CEO is a much more strategic role. I think it's increasingly important for organizations to recognize that the vision and capacity to develop followership and get all entities on board with a common direction — that's the skill set you're looking for. Not so much whether the CEO has run a home health agency."
More Than 1k Mergers Recorded in U.S. Hospital Sector Since 1994
What's Ahead for Hospital Consolidation: 4 Healthcare Leaders Respond
"Big chains thrive because they provide goods and services of greater variety, better quality and lower cost than would otherwise be available," Dr. Gawande wrote in the piece. "Size is the key. It gives them buying power, lets them centralize common functions and allows them to adopt and diffuse innovations faster than they could if they were a bunch of small, independent operations."
As it turns out, an analogy between hospitals and cheesecake eateries isn't too far-fetched: America's hospitals are moving steadily toward conglomeration. Data by Irving Levin & Associates shows that 2011, the latest year available, brought 86 hospital merger or acquisition deals — the highest number in the past decade.
And there are more colossal deals under way for 2013 and beyond. Last fall, Detroit-based Henry Ford Health System and Beaumont Health System in Royal Oak, Mich., announced their signing of a letter of intent to begin merger discussions. If they do consolidate, the systems would form the largest health network in southeast Michigan, with more than 42,000 employees and roughly $6.4 billion in annual revenue.
In Texas, Temple-based Scott & White Healthcare and Dallas-based Baylor Health Care System announced plans in December 2012 to merge into a 42-hospital, $7.7 billion organization with approximately 34,000 employees. The deal would drive the newly created organization to one of the top 10 largest non-profit systems in the country.
There's also the pending merger between Livonia, Mich.-based Trinity Health and Newtown Square, Pa.-based Catholic Health East, which will create an 82-hospital system across 21 states — potentially the fifth-largest hospital system in the country.
These transactions can result in improved quality, more seamless care coordination and increased access to capital. But Big Medicine and mega-mergers involve an entirely new set of organizational challenges, too.
Mergers can face shaky odds for success
Minoo Javanmardian, vice president of Booz & Company's global health practice in Chicago, says merging is not a strategy. Rather, "mergers are the result of a strategy that [organizations] define and are meant to leverage the differentiating capability systems of the partners," she says. If a system identifies a set of capabilities they do not possess, merging is one way to bridge capability gaps or further leverage the existing capabilities in an expanded market. But health systems may put the cart before the horse, especially when pursuing horizontal M&A defensively or as an expansion strategy.
System mergers, often justified for their economies of scale, still carry a certain air of risk. An early 2013 study from Booz & Co. found only 41 percent of all hospital and health system mergers between 1998 and 2008 to be financially successful by outperforming their peer group. The study analyzed health systems' financial performance two years prior to the merger and two years after the deal. More disturbing was the fact that almost one in five acquired hospitals went from a positive margin prior to acquisition to a negative margin after acquisition.
"When you look at this, it says, 'Here is the evidence that the traditional levers of mergers and acquisitions, such as geographic expansion or increasing the number of hospital beds, are not indicative of a successful merger,'" says Ms. Javanmardian. "Any merger is fraught with risk. If the real reason for a merger is to improve position in marketplace, then you need to be very thoughtful of how you integrate [and] how you preserve differentiated capabilities on both sides."
More frequently, financially robust systems are merging to create networks that span throughout states or regions, such as the aforementioned pending transactions. Many of those systems are well-regarded and have national reputations for certain specialties. These types of marriages are different deals from those of struggling community hospitals for access to capital or mere survival. Instead, these mega-mergers resemble a land grab.
"We think you'll see more mergers happening not necessarily from hospitals and health systems in distress," says Ms. Javanmardian. "A lot of healthy systems are trying to figure out how to position themselves to be successful, given the pressures on the financial side of the market. To us, what drives that merger is very important. So far, most have happened based on traditional levers. We don't believe that's necessarily translated to better performance."
Paul Levy, former president and CEO of Beth Israel Deaconess Medical Center in Boston and healthcare author, agrees that there is an inherent risk to organizational expansions across the board.
"Think about firms in general that have grown over time by mergers, in all kinds of fields — banking and airlines, as well as hospitals," says Mr. Levy. "They start as sensible business propositions, but some don't work out very well because of cultural differences among [their] various parts, or lack of experience or expertise on part of the CEO as to how to run a system versus an individual entity. It's almost a truism that as organizations grow, have more tentacles and cover more geography, it raises a whole new set of challenges for managers."
The power of clout
Another traditional benefit to consolidation? Getting a leg-up on a commercial insurers' rates. "To the extent [systems] become a monopoly in their service territory and are able to hold it over the payors, [systems] have less incentive to be efficient because they have market power," says Mr. Levy. "That's what has happened in the Boston area with Partners HealthCare. It's such a dominant system that they can extract higher rates from payors and don't feel the same cost pressures as other hospitals."
Although merged health systems have been accustomed to increased bargaining power with payors, Ms. Javanmardian says this may be on the decline, largely due to pressures from the Patient Protection and Affordable Care Act. "Going forward, there will be less money to go around. There's not another option," she says.
In the past, providers essentially viewed commercial reimbursements as subsidies to ease the hit from government health programs' less robust reimbursement. But now, private payors face their own pressures, and providers may not be able to rely on commercial rates as much as they previously did. "[Providers] won't be able to do that," says Ms. Javanmardian. "You can merge, but if you think you'll merge and increase your revenue per patient, I don't think that's a realistic expectation."
What might happen if one of these large mega-merged systems does fail?
A single community hospital falling onto hard times and ultimately failing is one thing. But the failure of a statewide or regional system poses even more pressing, albeit ambiguous questions. In attempts to explain what might happen if a mega-merged system does fall into bankruptcy or other distress, sources featured in this article largely lacked a common answer.
First, it's important to start by defining the various ways a health system can fail. Bankruptcy is the most comprehensive scenario, but a system could fail if, post-merger, it must sell off individual hospitals it acquired. Another form of failure is shutting down unprofitable hospitals or facing legal and regulatory setbacks, which are a token risk for any large corporation. In general, the larger a system gets, the more legal and regulatory risk it faces.
In 2008, the government came to the rescue for banks, largely to protect consumers from financial distress. But is there an analogous agency or rescuer in American healthcare?
"The FDIC is the designated agency to take over for a failing bank. If you have a healthcare organization that is too big to fail, and it fails, who comes in?" says Casey Nolan, managing director at Navigant Health in Washington, D.C., and leader of the firm's healthcare strategic planning practice.
At this point, it's speculation. But as systems expand beyond their local status into statewide or regional networks, it's difficult to say what might happen if a merger eventually leads to their systematic collapse. After all, many experts are convinced the merger is pursued to avoid just that.
It's not always a matter of size, but also importance
Generally, the larger a health system, the less likely it is to fail. "The size of the parent company makes the risk of failure lower," says Jordan Shields from Juniper Advisory, an independent investment banking firm exclusively focused on hospital mergers and acquisitions, in Chicago. "It is a bad outcome if a community's hospital fails. Small hospital companies have a higher risk of failing than large systems. That's one of the reasons the credit rating agencies place emphasis on business scale."
In that sense, the concept of "too big to fail" may hold true for large, integrated systems — their size will reduce their risk. But this is still different from the traditional meaning of the phrase, which really came to life after the banking collapse and bailouts in 2008. In healthcare, especially in urban markets, the phrase can also go another way. "The safety-net [hospital] isn't too big to fail — it's too important to fail," says Mr. Nolan of Navigant Health.
In urban markets, safety-net hospitals or health systems are essential to the community. Detroit Medical Center, Caritas Christi Health Care in Boston and West Penn Allegheny Health System in Pittsburgh are three examples of systems that are, or were, pillars of non-profit healthcare in their respective urban communities.
But within the past four years, all three systems underwent or are in the process of unorthodox transactions. For-profit Vanguard Health Systems, based in Nashville, Tenn., purchased DMC in November 2010. Boston-based Steward Health Care System, a new affiliate of private equity firm Cerberus Capital Management, purchased the Catholic Caritas Christi in March 2010. And Pittsburgh-based health insurer Highmark was working to buy West Penn Allegheny at the time this article went to print.
Studies suggest only hospitals that are financially viable and essential to the market need to be saved. As for the examples mentioned above, DMC employs approximately 12,000 people. Caritas Christi was the 10th largest employer in Massachusetts with more than 13,000 employees, and West Penn employs roughly the same number. These organizations were also critical in their markets for the volume of charity care they delivered in underserved areas. DMC was, for instance, the largest charity care provider in the state of Michigan.
"Local governments are going to view some hospital systems as too big to fail, and they won't allow a hospital to just go by the wayside," says Rex Burgdorfer with Juniper Advisory. "As a result, they'll be more amenable to concessions on the transaction terms for a company to come in and save the hospital."
The larger the system, the more pressure to find the right CEO
The boards of integrated health systems may fall prey to a search for perfection when looking for the best CEO candidate to lead their multifaceted organization. For example, if a system includes hospitals, a health plan, a physician group and a home care setting, that board may want a CEO who has touched all service lines and is equipped with prior leadership experience at each part of the system. This is faulty thinking, says Kimberly A. Smith, partner and managing director of executive search firm Witt/Kieffer's Eastern region in Burlington, Mass.
"Surely those people are in extraordinarily short supply," she says. Instead, boards should ensure their requirements for an incoming CEO are divided between technical skills and leadership abilities. If these requisites are disproportionately sought, with more focus on one or the other, the executive search can quickly become arduous.
"There's a moment when the governing group steps back and says, 'What are we really looking for in the defined future, in the next three to five years?' And that refocuses governance on exactly what core leadership competencies are needed; not so much the technical competencies," says Ms. Smith. "There's a real difference between the two."
It's also critical for governing bodies to remember the distinct roles of the health system CEO and COO. For the latter, prior experience or specific expertise with each sub-entity of a system is more crucial.
"[The COO] is the person charged with delivering an end product and making sure the pieces of the organization come along," says Ms. Smith. "But the CEO is a much more strategic role. I think it's increasingly important for organizations to recognize that the vision and capacity to develop followership and get all entities on board with a common direction — that's the skill set you're looking for. Not so much whether the CEO has run a home health agency."
More Articles on Healthcare Consolidation:
3 Reasons Why Hospital Consolidation Could Hurt HealthcareMore Than 1k Mergers Recorded in U.S. Hospital Sector Since 1994
What's Ahead for Hospital Consolidation: 4 Healthcare Leaders Respond