Merger Mania: Multi-Market Healthcare Consolidation as the New Normal

Medical-Dealer_Cover-Story_Merger-ManiaBy Matt Skoufalos

Consolidation and expansion remains one of the dominant narratives of the U.S. health care industry. Efforts to drive greater economies of scale, cutting costs instead of jobs, have reverberated throughout the market, as deeper affiliations are brokered at every level of business. In adapting to the dynamics of an ever-fluid and now increasingly vertical industry, getting bigger helps diversify risk, but it also complicates things for everyone involved.

Olivier Martin is the executive vice president of sales and marketing at ARxIUM, a pharmacy automation business headquartered in Winnipeg, Manitoba. Since 1989, the Canadian health care system has undergone federally ordered regionalization of independent hospitals in each of its provinces, reorganizing them into an integrated network. The process is akin to the merger-and-acquisition atmosphere of the U.S. health care market, in which the combined businesses aren’t always evenly joined, and the market leader doesn’t always come out on top in a consolidated network.

In adapting to the dynamics of an ever-fluid and now increasingly vertical industry, getting bigger helps diversify risk, but it also complicates things for everyone involved.

Martin said the costs of assimilation are also borne by vendors. Some caught in the middle of consolidation plans are invited to take on more work than they may capably assume; others may be asked to renegotiate their fees at rates they can’t meet profitably.

“There is a point where you can’t afford, as a vendor, that little bit of pressure,” Martin said. “There is a limit to what you can do. Some of the vendors out there, it’s probably a signal that you have to be less dependent on a key few customers. You decide who you want to be.”

Medical-Dealer_Cover-Story_Merger-Mania_Olivier-MartinAnticipating that trend, some smaller medical equipment providers are focusing on designing technology that works better in a consolidated network, he said. But Martin warns that there is also a cost to standardization, including clinical retraining, practice changes, and retiring existing inventory.

“What do you get by standardizing?” Martin said. “[On the hospital side], you get contract pricing; you get better volume. But you have to buy new equipment, lease new equipment, train thousands of nurses on the equipment, and these [things] cost hundreds of thousands of dollars.”

“Are you going to change practice equipment, patient-facing equipment, clinical equipment every time you do an M&A?” he said. “Are you going to postpone best clinical practice because you have to wait for corporate contracts?”

Depending upon the size of the entities at work in the deal, larger companies might only want to negotiate with equally large partners in pursuit of economies of scale. In cases such as these, Martin believes smaller vendors will survive only if they offer unique value propositions that can’t be scaled up.

Medical-Dealer_Cover-Story_Merger-Mania_Quote-1“Not everybody has the best product in every category,” he said. “There’s decades of evidence that there’s always bigger happening, but there are niche players that come up because they’re able to respond to a specialty offering that the big ones cannot. There is still a market for niche if you understand who you are in the game. If you’re small, you’re not going to win by your size, but by the necessity of your equipment.”

“It is one thing to have this rosy picture about reducing the number of vendors, but the path to get there may be prohibitive sometimes,” he said.

Doug Golwas, senior vice president of corporate sales for Medline Industries of Northfield, Illinois, points out that health care consolidation doesn’t necessarily have to take the form of a full takeover in order to achieve the same effects. Despite the higher-profile nature of such deals, providers, manufacturers, payers, and even GPOs may make other arrangements to derive greater leverage and market share, including forming channel partnerships and pushing into non-hospital business.

“Population health is moving outside the walls of the hospital,” he said. “The guys we deal with from a supply-chain standpoint now have responsibility across all these classes of trade.”

Medical-Dealer_Cover-Story_Merger-Mania_Doug-GolwasAs the buying power of any health system improves, its partnership needs become more sophisticated, which Golwas said raises internal questions about the “market relevance” of its contracts within the size and scope of those expanded lines of business. These agreements can lead to changes along lines of geography or class of trade, and their value is ultimately related to the ability to align resources and drive scalability. Vendors looking to earn that business need to provide solutions across a continuum of care, which Golwas said leads to an expanded focus on custom solutions – an approach that’s particularly useful as corporate culture shakes itself out in the merger process.

“Even with all this activity, we don’t do anything off the shelf,” he said. “Everything’s customized. Some people want bigger technology. Some people want a local relationship with the people they’ve dealt with for many years. Organizations come together either formally or informally. As long as they’re aligned with what their strategy is, it allows us as vendors to align our resources with what they want.”

“I always say if you’ve seen one health care system, you’ve seen one health care system,” Golwas said. “Our philosophy has always been, let’s go have a direct, honest conversation and figure out what the goals and objectives are of the new, combined organization and how to best have them get what they want. Create a solution that works in the short term, and adjust that as these things either scale or there’s changes for the continuum of care.”

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There’s precedent for stopping large, concentrated mergers that create monopolies for patient services, but the Department of Justice (DOJ) and Federal Trade Commission (FTC) don’t pay much attention to the increasingly more common vertical integrations, said Thomas Greaney, a visiting professor at the California Hastings College of Law and a senior fellow at the UC Hastings/UCSF Consortium on Health Science, Law & Policy. Greaney, who studies the legal impact of mergers in the health care space, said the FTC hasn’t yet challenged a vertical merger.

“The issue has been usually the DOJ or FTC doesn’t get notified of these mergers,” Greaney said. “Health care is among the most important priorities for antitrust enforcement, and that is something that will continue.”

Mergers are profitable for health care systems because they lead to increased revenues, but increased market concentration inevitably leads to higher prices, which generally get passed along to consumers in the form of higher insurance premiums, as insurers lack the leverage to play one against another. Although insurance providers may claim, in order to satisfy an FTC investigation, that the deal will produce cost savings, those savings must be specifically derived from the merger itself.

“The requirement as a matter of law is to show that those cost savings are merger-specific, and can’t be achieved otherwise, not just by the fact that you’re going to bargain harder,” Greaney said. “The breaking point on the consolidation side maybe has been reached in many markets, at least horizontally. The question is how much they can save vertically.”

Medical-Dealer_Cover-Story_Merger-Mania_Thomas-GreaneyBut because the United States relies on a market-based approach to the business of health care, it’s built on a competitive delivery system with natural limits, Greaney said.

“If you’ve locked up all the business, there’s nowhere else to go,” he said. “It has a foreclosure effect. If it’s too much, you lose the benefits because of market power.”

Some consolidation is also reactive to competition, as institutions snap up other pieces just to keep pace with their rivals.

“If you see a rival buying up practices, you have to explain to your board why you’re not buying up practices,” Greaney said. “You’re going to do it just out of self-preservation rather than proven documentable savings.”

At some point, Greaney believes, however, that “You have areas where you really think you’ve hit a saturation point, where there are no mergers left except to absolute monopoly, but on the other hand, there is a strong impulse, at least on the vertical level, to consolidate,” he said.

“I think that impulse is going to be around for a while,” he added.

Jordan Health Products President and COO Steve Inacker agrees. In an environment where reimbursement continues to decline precipitously, scale is often tapped as the solution to revenue shortfalls. A consequence of that activity is that capital budgets get ratcheted down, which can save jobs, but drives further supply-side consolidation. As companies like Medtronic and BD “gobble up a bunch of people and spit some pieces out,” they’re working to both diversify their holdings and insulate themselves from the impact of future cuts, Inacker said.

Ultimately, he believes the strategy “is going to get figured out” by the rest of the market.

“Part of it is survival of the fittest; part of it is the scale play,” Inacker said. “When you’re acquiring other companies, you’re buying yourself time. There’s a bad day coming for most of the large, publicly traded, high-end capital equipment companies that are living on lofty margins. The provider is going to get squeezed. You have to do more with less.”

As the financial pressures of reduced reimbursements heighten, doctors are ever driven to affiliate with hospital networks. Greaney described pressure to be part of a bigger system as being “as strong as it’s ever been” at the physician level. And while ever-evolving payment mechanisms offer stronger incentives for independent practitioners to consolidate, the culture of general practice also changes dramatically when doctors move from being independent operators to being employees. In general, he believes it has weakened their position.

“Doctors have had a very strong voice; while they were independent, they had enough voice to have some say in it,” Greaney said. “Once they’re employees, that changes quite a bit.”

Medical-Dealer_Cover-Story_Merger-Mania_Steve-InackerInacker, too, believes that provider-side culture clash “doesn’t seem to be as much of an issue today” specifically because “people understand the market dynamics at play today, and they want a secure job.”

That outlook on the premium value of a secure job only strengthens the positions of companies who specialize in managing human capital. Businesses like Sodexo, Crothall, Aramark, and TriMedX will continue to benefit from increased consolidation, as will third-party providers who offer better margins on services that are not directly related to provision of care. The same kinds of outsourcing that is helping administrators cut costs on food services, IT, laundry, and groundskeeping will continue to drive additional bargain-hunting and pursuit of longer-term deals that contain additional cost protections. Those independent service organizations (ISOs) that offer a competitive advantage or unique business opportunity will come out on top, Inacker said – as long as they are cautious to not overstep their capabilities.

“I’m bullish on the opportunity for highly qualified, reliable, and trustworthy ISOs to gain a bigger share of the service market in a constrained environment,” he said. “In almost all cases, the ISOs are a low-cost alternative to the OEMs. If the provider believes and understands that the service is better, that bodes very well for the ISOs. The refurbished market is going to see a better return.”

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Inacker believes ISOs operating in 300-bed hospitals and smaller facilities will be “the sweet spot” for service provision in an increasingly consolidated health care space. And although the bigger systems will only get bigger, he doesn’t foresee them squeezing out entities focused on the smaller markets into an untenable position – until, inevitably, they start to expand beyond their traditional footprint.

“If you see these mega-systems outside of their natural geography, that starts changing the dynamic,” Inacker said. “They’ve played fairly nice so far, but you will see competitors moving into other markets. There are less and less unaffiliated entities every year.”