Why Vertical Consolidation May Be the Superior Strategy for Healthcare Mergers

In an era of decreasing payments and increasing healthcare delivery costs, many hospitals are exploring mergers to achieve economies of scale and improved market position. But the era of horizontal consolidation (providers acquiring providers) among hospitals may be slowing as markets mature and attention shifts to the next stage of healthcare’s evolution. This stage may reflect the underlying economic realities of “population health” and may prompt a trend of vertical consolidation (providers acquiring health plans and vice versa).

Vertical consolidation requires a profound and useful change in perspective that forces providers to recognize both patients’ needs and the needs of payers of all types including employers, employees and federal and state governments. It also helps remove the perverse financial incentives associated with fee-for-service medicine because providers operating in a vertical model are on the hook for cost and performance in ways fee-for-service providers could never be. 

Adopting this alternative perspective is key to achieving the four often stated but seldom achieved drivers of healthcare mergers: cost synergies, increased efficiency, improved quality, and better customer service.

Rethinking Horizontal Consolidation

While many surveys of the effects of healthcare mergers conclude that mergers seldom benefit consumers, surveys to the contrary are fewer and reflect mixed results. For example, a study of mergers of non-federal acute care hospitals by the American Hospital Association and Charles River Associates found that from 2009 to 2014, acquired hospitals achieved a 2.5 percent reduction in average operating expense per admission—but they also experienced a 3.9 percent decrease in patient revenue per adjusted admission. Importantly, this study neither attempted to quantify the effect on quality nor the cost impact to the acquirer, which would necessarily incur additional administrative costs no longer borne by the target. Instead, the study relied on interviews with acquiring health system executives, who indicated that the acquisitions resulted in net cost reductions. 

Three trends can explain the rationale for the consolidation of health systems over the last decade: market share and network expansion, the ability to maintain access to capital in the face of substantial IT and infrastructure investment needs, including acquisitions of physician practices, and a reaction to even more rapid consolidation among health plans. This consolidation helped to create the perception of market imbalance among healthcare providers, which then tried to maintain balance by also merging. 

As the industry searches for new business models to improve cost, quality, access, and satisfaction, early steps toward vertical consolidation show the potential for a profound, long-term impact on consumers.

Evidence of an Emerging Trend

While few publicly announced healthcare transactions can yet be described as true vertical consolidation, there is a prominent exception: Optum.

From 2011 to early 2015, Optum established itself as a service provider to health plans and providers by acquiring at least 13 companies involved in care management, revenue cycle, pharmacy benefits management, clinical support, clinical benefits management, clinical research, clinical IT, accountable care organization management, and digital health. 

However, 2015 saw a significant shift in Optum’s apparent strategy, reflected in its acquisition of MedExpress—its first significant acquisition of a healthcare provider. All but two of its next eight acquisitions were of provider organizations, with special emphasis on primary care physician groups and outpatient providers. 

Optum’s apparent strategy may be the industry’s first big sign that vertical consolidation may be the natural next step in healthcare’s evolution. 

Horizontal consolidation is a near-term solution that sometimes falls short of meeting consumers’ needs. But it could also be a useful—perhaps even necessary—precursor to a new wave of vertical consolidation as providers gain the scale necessary to assume the risk and deliver the benefits to consumers that vertical consolidation might one day deliver. Today, the greatest innovations in population health are found among integrated providers that attempt to address the economic imperatives of population health by aligning with the interests of employers and the insured, and finding ways to better meet the needs of Medicare patients at lower cost. 

Providers should pay attention to this trend and look for opportunities to learn from the experiences of others as early progress toward vertical consolidation unfolds.