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Consolidation in the Hospital Industry: 3 Key Concepts

In the past decade, hospitals across the country have been merging with and acquiring other facilities, leading to an increasingly consolidated market. This consolidation is expected to increase in 2011 and beyond due to reimbursement pressures and other factors, says Chris Myers, director in the healthcare provider strategy practice at Navigant.

As hospital consolidation continues, independent hospitals need to understand the pressures associated with remaining a stand-alone facility and assess whether a sale, merger or some other type of partnership better ensures the hospital's long-term sustainability and success. Here are three key concepts to consider.

1. Hospitals are a shrinking industry. In roughly the last three decades, the number of hospital admissions in the United States has decreased due to the increased use of outpatient and office-based facilities.

In 1980, there were approximately 36 million hospital admissions in the U.S., and that number dropped to 35 million in 2009, according to Mr. Myers. However, the decreasing demand for hospital services becomes more significant when evaluated on a per capita basis. From 1980 to 2009, hospital admission per thousand people dropped 27 percent — from 159:1000 to 116:1000.

The supply of hospitals (i.e., the number of hospital in the U.S.) also dropped roughly 14 percent during the same period, meaning both supply of hospital services and demand for them has decreased.   

2. More hospitals are joining systems. The number of stand-alone hospitals has also dwindled over the last decade. In 1990, roughly 38 percent of hospitals were part of systems, according to Mr. Myers. That percentage jumped to 62 percent by 2009.

Mr. Myers expects this consolidation to accelerate to as much as 70 to 80 percent in the next five years. "The industry is contracting," says Mr. Myers. "Decreasing reimbursement and the recession has forced hospitals to focus on managing costs, and merging with other entities may help achieve this goal." Many times larger entities can be more efficient than smaller ones. They also have stronger buying power and the ability to command higher rates from commercial payors.  

While the hospital industry is consolidating, many individual markets across the country remain unconsolidated. "The industry, when take as a whole, across the U.S. is still very unconsolidated," says Mr. Myers. "For example, the 10 largest health care systems hold less than a 15 percent market share of the entire country." This is in stark contrast to insurers, which are very consolidated. "Just a handful of insurers have more than half of the covered lives in the U.S.," he says.

However, Mr. Myers doesn't expect hospitals to ever reach the same level of consolidation as insurers because the mission of many hospitals and health systems is defined as improving health in their own communities. Because growth and national dominance isn't part of the mission, it is unlikely to become part of a system's strategy.

3. For-profit companies more interested in the sector. The hospital sector has experienced significant growth in the number of for-profit hospitals over the last several decades, and this trend continued during 2010, with a unique twist — private equity interest in the sector grew significant.

Two landmark deals culminated in 2010 — for-profit Vanguard Health Systems (backed by the private equity arm of The Blackstone Group) announced plans to acquire the previously non-profit Detroit Medical Center, and private equity firm Cerberus Capital Management acquired of Boston's Caritas Christi Health Care — the firm's first foray into the hospital business.

This increased interest by taxable companies is largely driven by new opportunities created by healthcare reform. "Healthcare reform presents an opportunity in that 1) hospitals may get a little payment [for newly covered persons] where in the past they got no payment for the uninsured and 2) once a person has an insurance card there is some thinking that they may use more services than in the past," says Mr. Myers.

Hospitals looking to sell may increasingly find themselves weighing the benefits and drawbacks of a transaction with a for-profit operator, rather than a non-profit system already in their market.

What does this mean for your hospital?
As more and more hospitals move toward sales, mergers or other partnerships with other facilities, Mr. Myers recommends that stand-alone hospitals that haven't seriously considered a partnership at least examine their viability without some sort of transaction.  

Hospital should start by revisiting the mission of their organizations. "If it is to deliver healthcare to its community in as efficient and high-quality manner as possible, hospital leaders should evaluate how they're doing at achieving that mission and whether a merger with a competitor [or other transaction] would be able to help them achieve that mission in a better way," says Mr. Myers.

Mr. Myers also encourages hospital boards to improve their understanding of the hospital M&A process. "In healthcare, it's a complicated process with a lot of steps," he says. "From start to finish a merger could take 18-36 months. Even if a hospital isn't looking for a merger right now, leaders need to keep in mind the horizon is long and deals need to be explored in advance."

Mr. Myers also says that having exploratory discussions with other hospitals in the market isn't something to shy away from. "If you are in a market with different partnership options, hospitals should think about starting exploratory conversations to assess the pros and cons of different partners," he says. "Most merger conversations don't result in a transaction for a number of reasons, so it doesn't hurt to have exploratory conversations."

Learn more about Navigant's healthcare practice.

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