Sentara CEO Howard Kern: 5 strategies that will define mergers of the future

Mergers are the defining characteristic of the contemporary healthcare landscape, but the mergers of today bear little resemblance to ones in decades past.

Providers previously utilized mergers to reap the benefits that come with increased size. These "1+1=3" mergers leveraged the scale gained by combining two hospitals or systems for three primary objectives. Economies of scale enabled the newly formed entities to achieve lowered administrative and other fixed costs, improved IT efficiency and increased buying power for supply chain management.

As more health systems have pursued mergers as a strategy, healthcare policy experts, government leaders and regulators have looked more critically at many completed and proposed deals. They have raised questions as to why some of these mergers are not delivering or even proposing documentable value, even at the "1+1 =3" level.

Often, the "1+1=3" merger is a reaction of hospitals and health systems to large-scale consolidation among health insurers. Mergers done for reactionary reasons have limited staying power and will not provide sustainable value for the health system partners.

I believe innovative health systems are currently working to implement a new kind of merger in order to be strategically focused and successful in today's highly competitive marketplace.

We will refer to these advanced mergers as "1+1=5" because of the extensive value they leverage for five core strategic and operational areas.

1. Economies of scale. The initial value offered in these mergers is the economies of scale characteristic of "1+1=3" mergers. Two systems that are smart about forming a multi-market integrated delivery network will always appreciate savings in administrative costs, IT expenditures and traditional supply chain management that are inherent to any well-executed merger. While cultivating economies of scale was the primary focus of mergers past, and is still relevant today, this is just one component of this new class of deals.

2. Economies of structure. Though often overlooked when systems consider a merger, certain core components of organizational structure can determine whether a merger will be a boom or a bust. Merger partners must complete an objective inventory of current operating competencies and identify best practices to standardize and adopt after the merger is complete. There should be a highly defined plan for performance expectations paired with a transparent and well-designed reporting system to support implementation. These systems must be communicated across the newly formed entity to facilitate identification of market overlaps and understand how the strengths of a partner organization can change the ways individual hospitals and other operating divisions offer services.

Leaders must evaluate the competencies of both organizations and commit to standardizing core systems, such as employee management and marketing apparatuses. As an example, if one system has highly effective ambulatory services but their partner does not, the newly formed organization must create a plan for rapid adoption of these ambulatory competencies and plan how to roll out ambulatory capabilities across the entire system to bring these services to market quickly.

The combination of economies of scale and structure should result in one best way to do things for the enterprise. By creating value through the sharing of best practices across the system, implementation will be accomplished with greater speed and gain the required value for the enterprise quickly.

3. Economies of scope. Economic focus on scope is perhaps the most difficult concept to grasp but the most important opportunity for mergers of the future. Economies of scope are typically grouped into three broad categories. 

First, economies of scope help organizations maximize consumer centricity by providing the newly partnered organizations with the resources and technical systems to dedicate solely to advancing consumer relationships and improving integration with the customer. This consumer integration can be achieved through digitally enabled journeys, mobile initiatives, or other strategies that touch customers in a genuine way. Through this unified design, consumers will not be confused about how their care experience will change in the wake of a merger.

Second, economies of scope maximize the value of market diversification. It is immensely valuable for health systems to diversify their market presence into multiple geographic regions. If one market were to go into economic decline, the risk to the health system would not be as significant if its assets were dispersed into diverse markets.

The third, and perhaps most vital, aspect of economies of scope is integrated delivery system competency. Most health systems operate some form of integrated care, whether it is an accountable care organization, clinically integrated care network, episode of illness bundle or a full-risk health plan. In each of these models, the clinical components of the delivery system must work in concert with one another to coordinate care and manage clinical data. Typically, this integrated delivery competency also requires organizations to assume some level of actuarial risk. Operating some form of a risk-based model in the future will likely be a defining strategic competency for an integrated health system.

This competency does not happen through simple osmosis, but instead takes active work on the front-end by clinical, financial and executive leaders. This economy of scope is often enabled through mergers where the scale allows the partners to develop the infrastructure and accumulate the lives necessary to assume the kinds of risk that make managing the total cost of care and actuarial revenues feasible.

4. Economies of skill. Merging to form a larger organization allows hospitals and health systems to recruit and retain top talent. In a competitive job market, it is often difficult for small hospitals and systems to compete with larger players to attract and retain the best leadership, clinical and technical talent. Multi-market systems can dedicate significant resources to the pursuit of talent, in addition to focusing on succession planning and talent development. Standalone hospitals rarely have the capabilities to identify upcoming talent shortages and often scramble to fill these holes once they become apparent. Health systems are ultimately human resource organizations driven by the quality of the people they employ. The more resources they are able to dedicate to people and talent, the more successful they can be.

5. Economies of risk. Tight margins at freestanding hospitals and smaller health systems leave no room for executives to take many financial risks. Leaders are forced to constantly evaluate ways they can lower costs, and dedicating resources to innovative ideas is a luxury they cannot afford. Larger, diversified health systems are able to make measured risk-based decisions, and they can even afford to be wrong once in a while since they do not face an intensity of margin pressure as their smaller neighbors. It is only through this kind of experimentation that innovation is born, and only through strategically executed mergers can health systems obtain the financial leverage to innovate at the scale necessary to compete.

Hospitals and health systems face a multitude of much larger competitors in adjacent industries that have access to extensive risk-based capital and are able to make risk-based investments in technology or other areas of innovation on a much larger scale. If we cannot keep pace, we will face serious risk of disruption in a variety of areas. Creation and deployment of risk-based capital in and among health systems is a vital strategy that we must develop if we are to be successful as an industry.

Some ideas in this article were drawn from a strategic plan developed in partnership between Norfolk, Va.-based Sentara Healthcare and McKinsey & Company

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