Why Financial Success Eludes Majority of Healthcare Mergers

Hospital mergers are dicey business propositions.

You probably knew that either instinctively or through experience, but now there's plenty of data to back up the contention. According to a Booz & Company analysis, only 41% of all acquired hospitals outperformed their market two years after the deals were consummated.

Here are the particulars of the study: Booz analyzed a representative sample of 220 hospitals that were acquired between 1998 and 2008 for which pre and post-transaction hospital performance data was available.

They calculated changes in operating income andoperating margin for the acquired hospital over the period two years before the transaction and two years post transaction.

OK, so what does it all mean?

Get Strategic
Essentially, it means the healthcare industry overall is reactive right now, when it really needs to purposeful and strategic, says Booz partner Sanjay Saxena, who has advised on many mergers both inside and outside the healthcare industry.

"You see someone for sale, and suddenly there's a frenzy of activity concerning whether to go after them," he says. "If you look outside the healthcare industry, companies are very purposeful, and have acquisition playbooks with lists of other companies they want to buy."

This all sounds obvious, he says, but healthcare doesn't have this type of metrics-driven future game planning. In part that's because historically, the industry has not had to compete on value the way others have.

But it's not as if healthcare mergers are short on metrics. After all, these are transactions that are debated and deliberated all the way from the local newspaper to the board level, to the community, and even to the legislative level.

Detailed financial documents are shared among the parties before acquisitions are final. So how do so many fail to achieve the synergies many of the new partners love to boast of when an acquisition is announced?

Clarity, Not Urgency
Saxena says it all starts with what you ultimately want to achieve as an organization, and a sense of clarity—not urgency—about how the pieces of any acquisition will fit into that vision. That kind of long-term vision works for both acquirers and especially for those looking to be acquired, he says.

"The first thing the smaller guys need to do is make sure they can't go it alone or through sharing some capabilities with someone else," he says, referencing collaborations short of a merger. "Can they survive? Is there a need or niche in the market they're fulfilling? If not, their reason for existence as a standalone entity might not be there."

Maybe you serve the underprivileged. Maybe you're in attractive geographical areas that big players might not already be in. If you don't have those advantages, maybe you do need to court an acquirer.

"What are the strategies of the folks they would be partners or bought by, and what do they have that might fit into that? Continue to invest in those elements so they are attractive to potential acquirers," says Saxena.

The study does not include data for longer time periods, suggesting the data has been selected to deliver a bit of a headline number. But given even these statistics, it's clear that mergers should be contemplated with caution. The study does offer some detail about specifics of mergers that have worked out financially. To wit:

• Combinations involving academic medical centers had significantly lower outperformance rates versus all transactions (20% as acquirer, 18% as target)
• Hospitals acquired by large systems (15+ hospitals) had a 51% outperformance rate vs. 34% for hospitals acquired by smaller systems (<15 hospitals) suggesting some support for scale.

Dating Comes Before Marriage
Saxena suggests that time should be spent assessing something he calls "capability fit" before agreeing to a merger.

"Capability fit is really meant not as functions but as sets of activities which differentiate you and which you are good at in the marketplace," he says. "When there's a degree of coherence and consistency you see a great deal of success."

For instance, it's incoherent for a high-cost player, like an academic medical center, which has built around innovation and being leading edge, to try to become the value player by trying to appeal to the Medicaid population or small, price-sensitive employers, Saxena explains.

"They're not consonant with ability to be low-cost and affordable, and often the acquired entity takes on all the bad habits of the acquirer."

Don't Be a Wallflower
But here's what's interesting: Many hospitals and health systems are at least considering that full mergers aren't in the best interest of either party. That's why we continue to see innovation on the partnership front, something the study doesn't attempt to address, but Saxena will.

"The point you raise about minority ownership ranging from arms-length contracts to joint ventures and affiliation agreements is important," he says, equating such deals to "dating."

"Let's just say there's a lot of dating going on right now."

But what about those who may not be particularly well-positioned for the future, but happen to dominate their local markets? They shouldn't wait too long before exploring their strategic options, Saxena cautions. In other words, don't be a wallflower at the dance.

"If you wait until you're in a precarious position, you've probably waited too long," he says. "If you're just resting upon a strong balance sheet, you're arguably not adding the kind of value you need to in the community and you're existing for the sake of existing.

Those executives should be out in the marketplace looking for partners and doing scenario planning exercises where with a certain trigger they'll go one way or another and agreeing on those triggers with their boards."

Should any of those "triggers" be set off, a sense of urgency would come into play around creating a transaction, he says. In the case of smaller hospitals, you could call it a "living will."

"That would serve them well and ensure they get the most value from a transaction and can name their terms," he says. "If you wait too late, it's just a fire sale and you've destroyed value in the community."