Skip to main content

Cost Concerns Drive M&A Activity

Analysis  |  By Gregory A. Freeman  
   August 16, 2018

Hospitals and health systems join forces to optimize quality and lower costs, but both goals can be hampered by unexpected challenges. 

Cost concerns are driving many mergers and acquisitions, but hospital and health system leaders are finding that there are hidden challenges when bringing their operations together.

Left unchecked, those issues can degrade quality of care and threaten the cost savings that motivated the mergers in the first place.

There have been more than 70 deals per year recently, with consolidation occurring mostly in midsize systems (those between $1 billion to $5 billion).

Many of the remaining smaller systems are not attractive acquisition targets, notes Peter Bonis, MD, chief medical officer for clinical effectiveness with Wolters Kluwer Health, which provides data, software, and consulting for healthcare organizations.

The brisk M&A activity stems from hospital systems trying to achieve cost reductions and leverage other economies of scale in response to growing margin pressure, Bonis notes.

The Congressional Budget Office (CBO) estimates that overall operating margins were 7.7% in 2016 but up to 30% of systems had negative margins. The CBO forecasts that average margins will be negative 0.2% in 2025 unless hospital systems increase their productivity at rates faster than expected for the overall economy.

At current rates of growth, healthcare will represent 20% of the total economy—$5.7 trillion—by 2026, Bonis notes.

"The incongruent reality is that the U.S. provider system is facing a financial crunch when overall spending and growth in healthcare is at the highest point in history," Bonis says. "Consolidation offers the promise of catalyzing productivity gains."

"However, results so far have been mixed," he says. "On average, two years after the transaction expenses have declined, revenue and margins have declined even more. Best practices around M&A continue to evolve."

Spending May Increase

In the short-term, consolidation may increase healthcare spending in some regions as consolidated systems leverage their scale in negotiating contracts with payers and suppliers, Bonis says.

"In the long term, system consolidation has the potential to benefit patient care by achieving a more consumer-friendly experience, [and] reducing unwanted variability in care, thereby altering the cost-versus-quality equation," Bonis says.

He continues, "About one-third of healthcare spending is wasted and a sizeable portion of the waste results from clinical variability. Provider networks offer the scale to address unwanted clinical variability, which, while challenging, is one of the most impactful means to achieve a sustainable cost structure and better quality of care for all of us."

Addressing that clinical variability, including the supply chains that are intertwined, is a hidden challenge for CEOs, says Lee Ann McWhorter, director of strategic alliances for First Databank, a company that manages a medical device database. (See correction note at bottom of story.)

McWhorter previously worked with Adventist Health and Carolinas Healthcare, systems that acquired multiple hospitals in recent years.

In the merger of even a relatively small hospital into a larger health system, or a partnership between two hospitals, back office and logistical operations can affect quality in ways that are hard to identify at first, she says.

Cost concerns may arise before long, but that often means quality issues are often underneath the surface, she says.

Downstream Quality Effects

The effects on quality may come from areas of the merger that at first seem to have a distant relationship to quality of care, she says.

"These are issues that seem like they might take care of themselves seamlessly in the background, but, in fact, this has to be a top-level concern for CEOs when you're merging operations, McWhorter says.

"CFOs are very concerned about the financial costs, but the CEOs are more concerned about the cost/quality/outcome assessment. They want to ensure that patients have the best possible outcome, and what goes on in the supply chain has definite downstream effect on outcomes," she says.

Hospital and health system leaders can be surprised by the complexity of combining their back-office operations, McWhorter says. Their supply chains and other behind-the-scenes functions may be radically different and integrating them can disrupt patient care.

"You have various parties using disjointed systems, a lot of different processes, and manual processes that are not easily transferred from one system to another. You also have a lot of discrepant data, and the healthcare system is so dependent now on data of all types," she says.

A huge challenge in M&A activity is reconciling the item master list, essentially the clinical supply catalog, for each facility, McWhorter says.

The master list can vary widely from one facility to another. McWhorter has seen 80-bed hospitals with a 600,000-item master list, but large health systems can have dramatically smaller lists because they have vetted the available items for quality and value.*

"Whatever is on that master list, people are going to order. So, if you have 600,000 items on an item master, you've got a lot of rogue spending, people buying things off contract and things that have not been evaluated by value analysis and product evaluation committees," she says.

"Standardizing that process, and the data that flow from it, has to be a top priority in the M&A effort. Otherwise the parties are going to find that one of the main motivations for the merger is being undercut, sometimes in a huge way," McWhorter says.

Correction: This story has been updated with the correct spelling of Lee Ann McWhorter's name and the name of the company for which she works.   

*Editor's note: An earlier version of this story stated that large health systems can have master lists with items numbering "in the hundreds." That phrase has been removed to more accurately reflect Lee Ann McWhorter's statements.

Gregory A. Freeman is a contributing writer for HealthLeaders.

Tagged Under:

Get the latest on healthcare leadership in your inbox.