Acquisition/Affiliation – Scenario 2

Star Medical Center, an academic medical center, asks, “What is a sustainable model for the future?”

Assessing the Situation

Star Medical Center is an academic medical center (AMC) prominent in the region it serves. It is sizable, with 800 inpatient beds. It is in a contractual arrangement with the medical school, which has 500 clinical faculty. The faculty and research activities of the combined organization are highly regarded, and, like many AMCs, Star enjoys a positive market brand.

Star operates in a highly competitive provider marketplace. These competitors are actively pursuing the types of capabilities required to be successful under value-based reimbursement. A key competitor is a financially aligned integrated system that already has the expertise and infrastructure for population health management.

The commercial payer market is fragmented, with no one insurance carrier dominating the market. Commercial payers continue to offer attractive rates of reimbursement, particularly to academics. Two payers in particular are actively collaborating with providers, including on value-based reimbursement experiments. To date, Star has not engaged in these types of payment experiments.

Although it is not significantly involved with value-based payment yet, Star Medical Center has invested over the last three years in capabilities required for care management at the population level. It has also invested in an excellent information technology platform, including significant interoperability capabilities with its broad base of network physicians.

Given these particular organization and marketplace characteristics, leaders at Star Medical Center have prioritized the following needs:

• Secure closer relationships with a broad base of primary care
• Insure that Star is a leader in moving to population health
• Navigate carefully the financial transition from fee-for-service to value-based reimbursement

Unlike some academic medical centers, Star is fortunate that it is not constrained by financial limitations, or by a dominant competitor or hostile payer. Further, Star benefits from having a leadership team that is unified in its vision for the organization. Both Star’s leadership team and board members understood that a variety of consolidation options could help the organization best meet its prioritized needs.

Evaluating Options

Because it functions in a highly competitive provider marketplace, Star has an unusually wide range of options available, including different forms of mergers and other forms of consolidation. Early investigation suggests that other large systems in the region have similar needs and are willing to collaborate. Large systems outside of the region might also be potential partners. Some area community hospitals are attractive as acquisitions.

While Star is fortunate to have so many options available, its early analysis also suggests that these potential partners are eager to move forward, and they may not wait for Star if the organization takes too long to decide how to proceed. In other words, time is not on Star’s side. Some potential partners may act without Star.

Star’s early investigation reveals the following viable options:

• Merge the community hospital systems into Star to create a regional network, and tighter linkages to community primary care physicians. This arrangement provides the additional potential benefit of tying strong community specialists into the academic medical center.
• Merge with other large non-academic organizations in the region.
• Merge with like-minded organizations outside of the region.
• Lead a collaborative organization that has the potential for achieving substantial economies of scale and pushing toward population health.
• Star leaders also envision the possibility of a collaborative alliance that ultimately extends outside the region.

Star leaders realize that they need to consider acting in several directions at once. Each option requires its own detailed assessment. The merger evaluation process consists of the following key steps:

• Send a letter of interest to all potential partners and await responses. In these correspondences, Star details the type of consolidation option it envisions. These details are further refined in collaboration with potential partners.
• After data exchanges and site visits, the two regional systems and two of the for-profit systems submit detailed proposals.
• The field is narrowed. Presentations and follow-up questioning occurs.

The process for evaluating options for collaboration is different than that for assessing merger opportunities. Star Medical leaders work with potential partners to detail each collaboration option.

Part of this effort involved discussing a collaborative that extended outside the region. Star leaders believe that this particular option offers major cost savings potential plus the advantage of rapidly accelerating skills necessary for population health management. However, this particular collaborative model also presented some unique challenges. Ultimately, executives at Star recognize that they lack the bandwidth for this type of model at this time, so it is removed from consideration as a consolidation option.

These evaluations (e.g., acquiring a hospital and joining a collaborative) lead to important decisions. Specifically, Star aims to simultaneously merge selected community systems into its corporation, as well as lead a broad regional collaborative in pursuing population health.

First, Star Medical Center decides to acquire Circle Community Hospital. Circle Community Hospital is highly motivated to be acquired. It historically has operated at break even. Circle needs to be part of Star in order to have financial strength and borrowing capacity to make needed strategic investments.

Star Medical Center leadership’s assessment is that the acquisition will be accretive; that is, it will generate cost savings and has potential for revenue gains. Circle Community was expected to begin a major IT upgrade. By merging with Star Medical Center, the expected IT costs will be 20% of the estimate on an independent basis.

Further, this addition makes sense geographically. A 5 percent increase in referrals to Star’s faculty practice is anticipated from the merger with Circle. Community, physician and rating agency reactions to the proposed merger are favorable. 

Is the transaction accretive? (Are the cost savings—including reduction in central management, IT, facilities operations, re-purposed facilities, and other economies—plus any revenue gains sufficient to create a net gain?)

Figure 3. Factors to Consider When Acquiring a Community Hospital

Is this a geographically attractive addition? (Demographics, growth potential, payer mix, and other factors are considered.) Does the management team add to the combined system talent? (Alternatively, must part of the team be re-trained or replaced? What are the physician groups’ strengths and weaknesses? (Employed model characteristics, physician demographics, quality, interest in collaboration, attitudes towards the proposed merger, independent practices’ loyalty…) Are there important cultural differences with other community hospitals merged into the system (existing or anticipated)? Ease or difficulty in reducing system leakage (keeping more patients in the system) Other factors (e.g., strong board members or donors, special community needs or attitudes, resistance to giving necessary governance powers to the fiduciary board…)

Source: McManis Consulting

Despite the positive aspects of this acquisition, Star Medical Center leaders recognize they will need to be thoughtful to ensure that the gains envisioned are realized. The figure below describes some of the unintended consequences experienced by health care organizations that have embarked on similar arrangements. 

Figure 4. Potential Frustrations from Mergers among Health Care Providers

Cultural alignment proves more difficult than expected. Physician groups are unable to come together and perform well under value-based payment. Regulatory concerns delay, alter or jettison the merger. Physicians are not sufficiently aligned with the system. Despite due diligence, one of the combined organizations performs well below expectations. Management teams do not perform well together – members of one or both teams need to be changed out. Expected savings from scale economies are less than expected. Leakage of cases outside of the system is greater than expected, leading to higher costs of care. Boards chafe at new roles. Tensions continue for several years and limit performance. Key players leave.

Source: McManis Consulting

Figure 5. Potential Advantages and Disadvantages/Challenges of Strategic Affiliations

Potential Advantages	Potential Disadvantages/Challenges
Pathway to achieving economies of scale without giving up total autonomy	May not address critical capital needs
Can serve as a means of accessing resources that may be difficult for smaller hospitals to acquire and own on their own (EHRs, clinical protocols, administrative and clinical expertise)	Could lead to a growing dependence on a larger and more powerful institution (de-facto change in control w/out corresponding capital benefit)
Can create opportunities for participating in value-based payment models (ACOs – commercial and MSSP, bundled payments…)	Collaboration may require capital, infrastructure and human resources from all parties
Easier to unwind (which may be beneficial in anti-trust analysis)	Legal considerations include anti-trust, fraud and abuse and tax exemption

Source: Doug Hastings, Epstein Becker

Given its high strategic priority, the CEO of Star Medical Center directly participates in the negotiations related to establishing the governance structure of the collaborative, as do the CEOs of the other participants. All parties agree to make capital contributions to start up the collaborative, and agree to recruit initial staff rather than try to resource with existing personnel. The collaborative participants agree to focus narrowly on the creation of the CIN and the population health infrastructure required for it to be effective. A common goal is to establish value-based contracts within a year from inception of the collaborative. The CEOs agree to hold committee chair positions for a year, to ensure that the initiative continues to have high level engagement, and to help foster trust among the participants.

Figure 6. Factors to Consider in Organizing a Collaborative Among Health Systems

What “glue” is expected to hold the collaborative together? (Relationships between CEOs, good geographical combination, a common enemy, a common vision…?) Why is it reasonable to expect this group of systems to be able to generate substantial value added?(Standard system-wide economies, a good combined region for joint population health management, specialized talents in aspects of value-based care and reimbursement, similar IT platforms or care approaches…?) What are the initial areas of focus? (CIN, supply chain, joint learning between physician groups…?) Is the initial capitalization sufficient? What is the commitment? (How easy to get out? Is there a commitment term?) Are CEOs and key board members involved? What is the quality and commitment of the leadership core collaborative staff? What is their level of informal influence within the member organizations? What is the initiative’s approval (and monitoring) process?

Source: McManis Consulting