Becker's Hospital Review

8 Sign up for the COMPLIMENTARY Becker's Hospital Review CEO Report & CFO Report E-Weeklies at www.BeckersHospitalReview.com or call (800) 417-2035 Is Bigger Always Better? Exploring the Risks of Health System Mega-Mergers (continued from page 1) 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 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. 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. "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." 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 Another traditional benefit to consolidation? Getting a leg-up on a commercial insurers' rates. "To the extent [systems] become a monopoly The power of clout 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 megamerged 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

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