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4 Emerging Models Provide Strategy Roadmap for Future Transactions

A majority of mergers and acquisitions in the healthcare industry result in questionable success. From 1998 to 2008, only 41 percent of approximately 220 hospitals in hospital acquisitions analyzed outperformed in their market, according to a data analysis conducted by Booz & Company, a management and strategic consulting firm. In fact, 18 percent of the acquired hospitals went from positive margins before the deal to negative margins two years following the deal.

For this reason, the healthcare industry needs new and different approaches to hospital and/or health system mergers and acquisitions, especially as financial outcomes become increasingly important and the complexity of transactions increases post-reform, according to Sanjay Saxena, MD, partner and North American hospital and health systems practice co-leader at Booz & Co. Hospitals need to base their transaction strategies on their capabilities, clearly identifying their value proposition, so that they may develop and pursue a transaction that will be successful.

Use a capability-based strategy
In order to improve financial success, hospitals and health systems need to make sure they are very clear and distinctive in their vision and goals. Booz & Co. suggests that a hospital develop a clear view of its desired future or end-state before venturing into transaction discussions. Once it has clarity around its future strategic direction, acquisitions as well as partnerships or affiliations can be evaluated against this frame for more successful outcomes.

"Capability-based M&A logic is decisively superior to traditional merger logic — deals that demonstrate capability fit achieve demonstrably greater financial returns," says Dr. Saxena.

Booz & Co.'s data analysis, mentioned above, found that deals with capability coherence outperformed those with limited capability fit. On average, coherent deals — where both parties had a clear set of capabilities in line with their strategy — had a 27 percent performance premium above the limited-fit deals, which had negative 32 percent returns compared to the market. According to Dr. Saxena, this suggests that capability-based M&A creates superior results.

Diana Hueter, senior knowledge leader with Greater Yield, a change management consulting company, and former CEO of St. Vincent Health System in Little Rock, Ark., agrees. "A capability-based strategy will help [a hospital] identify value in a merger or acquisition. It will begin to provide a vision of where the hospital wants to go," says Ms. Hueter. "Through that process executives begin to identify other hospitals, physician groups or even post-acute providers that may have strength in a market place, service lines or capability that would complement their organization."

So, how does a hospital pursue capability-based transactions?

Identify value proposition
In order to adhere to a capability-based strategy, it is critical that hospitals, looking to be acquired and/or to acquire, ask a few questions aimed at developing a value proposition. Dr. Saxena recommends asking: What is your hospital's distinctiveness in the market place?

Then, given how your hospital desires to differentiate its services: What kind of capabilities does the hospital need? What kind of footprint does it need?

"Part of doing a strategic assessment of your organization is identifying its capabilities. Where are its strengths and weaknesses?" points out Ms. Hueter. "How do you continue to shore up your strengths? How do you begin to diminish your weaknesses?"

Once executives know their hospital or health system's value proposition in the market, they can assess what type of transaction they need in order to achieve, bolster and maintain that value. When hospitals employ a capability-based strategy, they identify their goals and strategic visions in a way that informs future transaction choices. Those choices may be to affiliate, merge or acquire. Whatever the decision, it will be focused on their current and desired capabilities.

Once executives have this clarity, the following four models may help them think through and evaluate their transaction decisions. "These are pure tone models. In reality, hybrids or variants of them are likely to emerge for health systems depending on the specifics of their mission, brand or market position," says Dr. Saxena.  

Four transaction models

1. Scaled portfolio. This model characterizes systems that operate a portfolio of care delivery assets, typically across a broad geographic footprint. "This model drives value by sharing capabilities (e.g., electronic medical records, revenue cycle management, regulatory compliance, etc.) across a portfolio to generate economies of scale and lower cost," says Dr. Saxena.

A hospital or health system may pursue a scaled portfolio model if it needs the size to justify capital expenditures, survive in the market place, reach a certain reimbursement level with payors or engage physician investors with antitrust issues, says Mike Malone, JD, an attorney and shareholder at Greenberg Traurig.

Most often, hospitals that have excelled in operations succeed with a scaled portfolio. The hospital system is efficient and can easy replicate its operating model as it grows its scale through affiliations and acquisitions.

"These entities can identify clinical best practices and protocols through their learning experience within the network and apply them throughout," says Dr. Saxena. "An example might be Brentwood, Tenn.-based Life Point Hospitals or Livonia, Mich.-based Trinity Health. Those health systems successfully run hospitals in many geographic reasons. They are very good at leveraging their capabilities and repeating them in different locations."

2. Geographic cluster. According to Dr. Saxena, with the geographic cluster model systems concentrate care delivery assets in a contiguous market, typically close to where patients live, enabling the hospital to take care of a whole population. "You usually benefit because you are strong in the local market and can manage risk across populations. Boston-based Steward Health Care System, Advocate Health Care in Oakbrook, Ill., and Fairview Health Services in Minneapolis are good examples," says Dr. Saxena.

According to Mr. Malone, a geographic cluster model also gives a hospital or health system more advantage with managed care payors. "You can show a payor, or even an employer, that you have market strength in their patients' geographic area," says Mr. Malone.

Dr. Saxena agrees. "This model creates value by enhancing market power and building virtuous physician referral relationships within the network," he says.

3. Hub and spoke. The goal of the hub and spoke model is to position a care delivery facility as a central hub and build a network of feeder or spoke facilities. The hub is typically a tertiary or quaternary care hospital, says Dr. Saxena.

According to Mr. Malone, a large hospital may develop a hub and spoke model to broaden a suburban or rural area's access to services. "The hospital will affiliate with or acquire hospitals, creating a system that includes outlying hospitals. Those hospitals will not have every specialty service so physicians will refer patients to the hub hospital," says Mr. Malone.

"These systems create value by generating learning curve benefits at the hub (e.g., complex heart transplants) as well as by operating all assets within the network at maximum utilization. The idea is to isolate complex cases to the central hub. It appears that it is a strategy [Chicago, Ill.-based] Northwestern Memorial Hospital is pursuing," adds Dr. Saxena.

While a hub and spoke model can help a hospital reach success in specialization, according to Joe Lupica, chairman of Newpoint Healthcare Advisors, there could be downfalls for communities where spoke hospitals are located. "You have to keep your eye on the higher purposes in healthcare, more so than trying to reduce the risk to the health system stakeholders," says Mr. Lupica. "Unless it's a question of quality, making patients travel from their 'spoke' just to secure the profitability of a hub model really disturbs me. That kind of thinking can fracture access to care for real people."

4. Innovation. According to Dr. Saxena, a hospital or health system pursuing the innovation model wants to be a destination hospital. Its value is offering a distinctive product or service. "You can be a clinical innovator if you are pursuing the other strategies, but with the innovation model a hospital works to increase its clinical innovation. MD Anderson Cancer Center in Houston, Cleveland Clinic or Mayo Clinic in Rochester, Minn., are examples," says Dr. Saxena. "[In this model], the intellectual capital obtained [through] innovation may be exported and monetized at other health systems, [such as] through co-branding and affiliations."

Keep the models in perspective
Some of these models may be in place today, but Dr. Saxena believes most of them are still emerging. "In the coming years, [the industry may see] more health systems assembling the pieces and building the capabilities that will allow them to be more closely aligned against these models," he says.

Although the four models are descriptive of many transactions that have occurred in the industry, Mr. Lupica believes executives should exercise caution when looking to the models to provide advice for future-decision making. "Of course we should be aware of previous patterns. Whether they are merely descriptive or should induce behavior is a serious question. These aren't hedge funds; every community embeds its own variables in the numbers," says Mr. Lupica. "Behind the models and theories are real patients. We have to keep that in mind as we pore over our precious spreadsheets."

According to Ms. Hueter, these models are an aspect of strategy. "If you have a strategic plan following the vision for your organization, and you are following that plan, you are going to be much more successful than if you do not have a strategy," says Ms. Hueter. "With each one of the models, I don't look at them as you select one of the models. I look at them as you select the aspects of each of the models that can further enhance your decision making."

The main message here is that the financial success of mergers and acquisitions between many hospitals and health systems has been questionable in the past, but there are techniques to make consolidation successful in the future. According to Ms. Hueter, the difference between successful and non-successful deals will be the thought involved. Executives will need to place emphasis on strategy and understanding their own needs as well as another entity's needs before a deal can be formed with positive financial outcomes. By identifying its ideal future state, what that looks like and the required capabilities, a hospital can move toward a positive transaction with clarity. The four models may then act as a strategy roadmap, guiding the hospital toward its destination.

More Articles on Healthcare Transactions:

Capturing Transaction Synergies: 3 Critical Steps for a Financially Successful Deal
Is Hospital Consolidation Exacerbating Higher Healthcare Prices?
3 Characteristics of Successful Community Hospitals

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