Is scale necessary to meet your organization’s goals?
For most organizations, the short answer is yes. Healthcare executives and hospital boards across the country are dealing with the reality that, in order to remain competitive, they must build greater scale within their organizations. Yet many healthcare leaders are still trying to determine what exactly they need to do in order to achieve the desired scale. This question is relevant for organizations that are struggling financially, as well as those that are performing well. After all, the issue of building scale is broader than just enhancing financial performance. Scale offers benefits related to access, quality, efficiency, and capital/resources. No matter the financial or market share advantages that may exist for some hospitals today, competition in a consolidating industry will only continue to increase, and health systems need to prepare.
This article highlights the benefits of scale, discusses commonly perceived barriers, and outlines a process for pursuing scale in a way that’s appropriate for your organization.
Benefits of Scale
Scale involves many factors, and the most important aspects that define a scaled organization revolve around sufficient size in terms of revenue, human capital, nonlabor expense spending, infrastructure, and service offerings. Each area enables an organization to influence borrowing abilities, better achieve operating efficiencies, spread fixed costs, and be relevant (if not indispensable) in the evolving payor market.
In creating the strategic direction and goals for their organization, health system leaders often focus on how to internally develop the capabilities needed for growth, but they might not consider how these capabilities could be gained through affiliations with other organizations. While these objectives can gradually be achieved with internal growth, partnerships and affiliations can serve as effective vehicles for quickly building scale in an effort to stay ahead of the competition. In addition, increasing scale presents a number of advantages, for both struggling and thriving organizations, such as:
- Talent Enhancement: Creating greater access to competitive talent pools, particularly as organizations transition to a value-based environment and new skill sets are required
- Unit Cost Advantages: Enabling the organization to acquire services, supplies, and equipment at more favorable rates
- Capital Availability: Beyond traditional uses of capital, investing in technology, new services (e.g., post-acute, chronic disease management), and process redesign to support care model transformation and value-based payments
- Provider Network Expansion: Accessing a larger network of providers that is capable of managing a population and desired by health plans for inclusion in new products
- Risk Diversification: Engaging in risk-based contracting strategies that incentivize diversifying the risk across a larger revenue base to protect against financial exposure
- Access to Emerging Technologies: Developing affiliations or partnerships to access new and innovative technologies, which are often made available first to the providers and hospitals with the highest patient base
- Financial Performance Improvement: Maintaining or improving profitability (often correlated to building scale), as scaled organizations are better suited to perform well on risk-based contracts and offset revenue losses from reductions in high cost services such as unnecessary hospital stays
Perceived Barriers to Achieving Scale
Traditionally, many health system leaders, particularly those in organizations with historically strong financial performance, have been hesitant to pursue scale through affiliations and partnerships. These leaders cite a number of valid questions and concerns regarding the implications of aligning with another organization, including the following:
- Loss of Control: Will affiliating with another health system dilute our ability to oversee and manage our operations?
- Community Perception: How will our patients view the affiliation? Will they see it as a benefit to the community through an expansion of services or a mechanism to control the market and charge higher prices? Will jobs be lost because of the partnership?
- Up-Front Costs: How costly will it be to find a suitable partner and negotiate the terms of an acceptable agreement? Is this the best use of organizational resources?
- Cultural Compatibility: Is the partner organization compatible enough with us to ensure a smooth transition? Does it have the same focus on quality and efficiency that we do?
- Pride in Existing Organization: As the leaders of this organization, we have achieved success independently—why do we need to partner with someone else?
These concerns often impede health system leaders from exploring or ultimately agreeing to terms of potential partnership or affiliation opportunities that could benefit their organizations in the long term. Given that the competitive landscape is consolidating, current market share advantages may be short term for organizations that decide to focus on internal growth. As discussed in the next section, greater scale can be achieved regardless of the current size of your organization and does not necessarily require the governance changes, cultural integration, or significant costs associated with a traditional merger or acquisition.
Scale Through Partnership
The process to achieve scale can seem daunting, especially if the perception of leadership is that pursuing scale is a bailout as opposed to a proactive strategic decision. The most common avenue to scale is merging with another system. This comes in many forms, including being acquired, finding a joint venture partner, pursuing a member substitution model, and so on. Yet recent statistics show a slowdown in overall hospital merger and acquisition (M&A) activity. In the third quarter of 2014, there were only 16 announced hospital transactions, the lowest level since the fourth quarter of 2009. This statistic, however, does not include affiliations and partnerships with limited or no change in the existing governance structures, nor does it include the creation of new jointly governed and controlled organizations. The industry is experiencing a material increase in the formation of partnerships such as clinically integrated networks, ACOs, and other multisystem collaborations. With the increased level of regulatory scrutiny over hospital and health system transactions, such looser affiliation models can provide many of the same benefits without the significant costs associated with typical M&A activity. Moreover, these structures often allow meaningful physician participation, which can further hospitals’ and health systems’ alignment goals.
Once health system leaders agree to pursue scale opportunities, it is critical that they establish a process for evaluating potential options. This process often includes an internal assessment, the consideration of scale options, and the selection of a preferred partner, as outlined above.
The internal situational assessment phase provides the foundation for understanding why pursuing scale is the right strategic move for your organization. During this process, it’s important to identify the specific benefits of scale that will be most impactful to driving long-term financial and operational success. In addition, by anticipating current and future competitive threats, you can help build the case for why seeking greater scale is necessary. Once you decide to pursue greater scale, your focus will shift to identifying the appropriate scale model and affiliation partner. This process is often iterative, requiring a third party to facilitate planning and negotiations. It can sometimes be beneficial to identify a partner before selecting the affiliation model, because, as discussed previously, the model can be adapted to the specific goals and objectives of the partners.
Greater Scale, Greater Success
Regardless of the size of your organization, or the current financial or market share advantages that you may possess, it is critical that you plan for the future in a rapidly consolidating industry. While traditional M&A activity continues, other innovative alignment vehicles are being used to realize the significant benefits of increased scale. With guidance through an appropriate affiliation planning process, your organization can achieve significant strategic, financial, and operational benefits with greater scale to ensure long-term success.