There's little doubt that our industry has entered a new era of consolidation. While 2018 didn't see quite as many hospital and health system mergers as the year before (68 deals through Q3 2018, versus 87 through Q3 2017), the sheer size and scope of the deals this year underscores the popularity of this strategy. On a certain level, it's understandable. Facing challenges on all fronts (declining reimbursement, rising costs, demanding consumers, disruptive new competitors), health systems often believe that if they can just get big enough, they will be able to weather the storm—or at least not capsize.
But, just for a moment, I'd urge us all to take a step back. What's the actual evidence that M&A is an effective strategy? In my opinion, that evidence is not forthcoming. Rather, I see little support for the myriad advantages that are invariably claimed every time a new deal is announced. To dive in more, let's examine three of the most common claims in turn.
Claim 1: We will be more cost-effective
Perhaps the biggest advantage claimed by M&A proponents is that it's going to help both systems control costs. But the evidence for this is mixed, at best. While some analyses indicate that acquired hospitals realized cost savings of around 4% to 7% following the deal, other research has found that acquired hospitals tend to experience a post-transaction decline in operating margins.
Since this evidence isn't conclusive, let's look at it another way: If M&A can really help systems achieve better cost control, then shouldn't larger systems have better margins? This doesn't appear to be the case. A 2018 study by Navigant found no relationship between total revenue and operating profit. This is consistent with our findings at The Advisory Board: when we chart system size (using the proxy of total revenue) against margins on a graph, we see no apparent correlation. If larger health systems are actually better at controlling costs, the evidence for that is doing a remarkable job hiding itself.
In contrast, what we do know is that after a merger, even if there are cost advantages, those most certainly do not translate into lower prices. For instance, one study found that, when hospitals in the same market merge, prices tend to increase by 7% to 10%. Another estimated that the average price of a hospital stay in the markets with the highest rates of consolidation increased by 11% to 54% in the years following M&A. I am aware of no study that suggests that M&A leads to lower prices for consumers.
Claim 2: Merging will streamline our burdensome supply chain and human capital operations
A second claim asserts that creating a larger health system will streamline supply chain and human capital systems. Perhaps these deals won't help us cut total costs, the claim goes, but at least we can get a cost advantage in these areas. The evidence for this is also not as strong as would be expected. A working paper from the National Bureau of Economic Research analyzed the data of merged hospitals from 2009 to 2015, and found that acquired hospitals saved an average of 1.5% on common expenses in the supply chain—or an average of $176,000 across 50 supply categories. But the acquiring hospital actually saw its costs rise slightly—about $300 per year. And overall, acquired hospitals only saved 10% of what they expected in their merger justification, while acquirers saved 0%.
This evidence, like much other data, suggests just how hard it is to integrate two organizations. For every statement about the potential benefits of a larger, streamlined supply chain, there's often no word of accompanying caution about how difficult it is for systems to actually realize those benefits. Rather, M&A often results in bloated organizational structures, duplicative IT systems, higher legal and consulting fees, and overlapping (often ineffective) communication channels. Suddenly, merged systems have twice as many people to communicate with and twice as many stakeholders with opinions on the best ways to proceed. If the two organizations have separate EHRs, the challenges to ever achieving synergies are even more daunting. Effective integration is hard, takes a long time, and—quite frankly—if hospitals can't implement initiatives effectively on a small scale, I am far more skeptical of their ability to implement them on a large scale.
Having worked with many organizations that have merged during my 25 years as a consultant, my rule of thumb for executive teams is that whatever amount of management time you have budgeted for integration, multiply it by three. Now ask yourself, given all the operating challenges you currently face, can you really afford that opportunity cost? In most cases, I believe organizations would be far better off putting that time and energy into the business of providing a better clinical product.
Claim 3: Merging will improve care quality
Which brings us to the final claim: Larger systems will able to improve care quality. Again, the evidence that would support this claim is remarkably well hidden. Indeed, if you scan the hospitals with an 'A' Leapfrog's Safety Grade, you won't see a greater number of large health systems on the list. And there’s even some evidence that consolidating systems increase patient safety risks.
Again, this makes sense if you think about the forces behind it. Merged systems are going to inherently have issues of clinical variation at least as large as those faced by the individual systems on their own. Care variation reduction (CVR) is a difficult problem for most health systems; the larger the organization, the more opinions you have to manage on how care should be delivered, and the more people whose behavior you need to measure and change if you hope to see improvement. CVR is an activity that may in fact have diseconomies of scale.
So what is the true upside of M&A?
If we accept that the evidence for the claims above is lacking, then what is the true benefit of M&A? In my experience in one-on-one conversations with CEOs, they readily acknowledge that many of the common claims about M&A don't hold up to scrutiny. But there is one benefit that almost everyone acknowledges: Getting bigger provides the system greater leverage with payers. And that is certainly an important benefit, especially in markets where one or two payers often have dominant market share. I might argue that because pricing power has been so important historically, most health systems haven't needed to spend as much time thinking about cost. Higher prices forgive a lot of sins on the operational front.
But will this leverage really continue to be as effective the future? Will employers continue to absorb higher prices? Will the continuing trends of high deductibles, price transparency, and consumer shopping limit our ability to increase price? Further, will regulatory changes like site-neutral payments limit the ability to rely on the same price increases that health systems have in the past? I don't have a crystal ball, but I have to believe that it will be more difficult for health systems to raise (or even hold the line on) price in the next decade than it was in the decade just past.
Moving forward with a cautious approach
Now that we've stepped back from the hype, if you are still considering M&A as a strategy, I would urge you to ask: What's going to be different about your deal? Take a hard look at where others have fallen short and create a plan to address these shortcomings with your eyes open.
In particular, I urge you to think critically about several questions. Make sure you satisfy yourself with the answers to:
- Is there a history of compatibility and your systems working well together? Have you partnered in the past and partnered well?
- To what extent are you actually similar? Specifically, do you have similar compensation models, the same EHRs, the same approach to IT, and the same culture within your physician networks? Do you have a similar approach to identifying and reducing unwarranted care variation?
- Are both organizations serious about reducing operating expenses? With industry margins at an historic low point, there is no room for equivocation on cost.
- Do either of your organizations have a history of making hard decisions such as closing underperforming facilities, consolidating service lines that are under capacity, or migrating from an acute care center to an ambulatory center? If you've been able to do this on a small scale, I might believe that you could it on a larger scale. But if you have struggled in any of these areas in the past, then I think you are kidding yourself if you think size is going to make any of these problems easier to solve.
My purpose in writing this has not been just to be contrarian. I share these observations with you because I am genuinely concerned that many organizations are pursuing M&A for the wrong reasons, and with very little chance of success. If you disagree with me on any of these points, I welcome the dialogue—and if nothing else, I hope I've led you to question some of the conventional wisdom. M&A is a costly, time-consuming strategy. If we're going to pursue it, we need more than hope and vague statements about the benefits of scale. We actually need evidence that M&A is going to work.