The smarter scale equation
Given today’s realities, health systems must look beyond the traditional economies of scale if they want to reap the full benefits of M&A. They must consider other economies that M&A can offer, commit themselves fully to the effort, and execute flawlessly.
During times of upheaval (regulatory, economic, or both), a kneejerk reaction in many industries is to pursue mergers and acquisitions (M&A) in hope of achieving economies of scale through asset consolidation. Historically, the hospital industry has been no different. In 2011 alone, US health systems completed 90 deals involving more than 150 facilities; the total transaction value exceeded $8 billion (in comparison, there were 52 deals involving 80 facilities in 2009).1 The consolidation appears to signal providers’ quest to achieve scale benefits, especially in the context of a recent decrease in their ability to drive pricing—the lever the industry has used for most of its growth in the past decade.
During that time, providers were able to realize value primarily through increased contracting leverage with payors. Today, this leverage is disappearing, in part because the Federal Trade Commission is scrutinizing deals more frequently and closely, and blocking some on the basis of their potential impact on price. Now that their ability to create “quickwin” value through M&A deals is limited, providers must find and exploit other economies to create value through those deals. The other economies may require greater upfront investment, however.
Thus, we believe that the current wave of M&A is fundamentally different from prior ones because the “traditional scale equation” no longer applies. This is not to say that M&A should be avoided—it will still be the right answer in many situations. However, a smarter, more sophisticated scale equation should be used today to evaluate potential value creation. Before health system leaders rush to pursue deals, they should outline what they hope to achieve through scale and carefully weigh the risks and benefits of various strategies. In particular, they should take care to avoid overestimating the potential value creation that can be gained through M&A and underestimating the investments (in funding, leadership bandwidth, other resources, etc.) that will be required to realize value. In addition, they should expand their thinking to consider strategies other than M&A that might enable them to achieve their scale goals, because some of those strategies could entail less overall risk and require less investment than M&A.
1. Health Care Services Acquisition Report, 17th edition. Norwalk, CT: Irving Levin Publishers; 2012.