When M&A is not the best option for hospitals

Short take

Historically, larger scale has offered hospital systems a number of advantages; however, reform and other market changes are altering the scale equation for hospital systems.

Historically, larger scale has offered hospital systems a number of advantages, including increased referral volumes, better access to capital, stronger pricing power, and classic cost economies. For instance, larger scale has enabled many hospital systems to lower their per-patient operating costs significantly.

However, reform and other market changes are altering the scale equation for hospital systems, so some of the traditional advantages that larger scale has traditionally brought them may no longer apply. For example, hospital systems’ ability to receive premium prices for higher quality and more consistent care in a market is now being limited by greater consumer and employer price sensitivity, increased scrutiny on industry profits, and regulatory concerns about hospital mergers.

In addition, creating value through M&A deals always is challenging, and all M&A activity involves a certain amount of value destruction. (Many hospitals system executives underestimate the cost of both pursuing an acquisition and managing the post-merger integration.)

So while hospital systems must respond to growing pressure on their margins and some M&A opportunities should still be pursued, their executives should ask themselves two questions before taking the plunge: What other — perhaps new — advantages might scale bring that would enable them to overcome the inevitable value destruction associated with M&A? Are there other affiliation models beyond M&A that would allow them to capture these advantages with less risk and at a lower cost?

These questions are the heart of a new, smarter scale equation (PDF) that can help leaders of hospital systems to address the challenges ahead.

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Dr. Saum Sutaria Senior Partner