The Looming Impact of Healthcare Service Consolidation

St. James' and Murray Hospitals, Butte (1915)
Image by Butte-Silver Bow Public Library via Flickr

Last week, the Boston Globe reported that Lahey Clinic and Beth Israel Deaconess Medical Center held early discussions on a possible merger.

Last November, Cereberus Capital, a private equity firm, bought Caritas Christi, a group of six hospitals in the Boston area.  In December the newly named Steward Health Care System bought two more hospitals in the region.  This April, Steward added its ninth local hospital.  In June, Steward offered to purchase Landmark Medical Center in Rhode Island. More acquisitions are planned.

In January, Northeast Hospital Corp (owner of Beverly Hospital, Addison Gilbert Hospital in Gloucester, BayRidge psychiatric hospital in Lynn, and a Danvers outpatient clinic) began exploring a merger or sale to a larger regional player. By June, Lahey Clinic, Beth Israel Deaconess, Steward Health Care System, and Vanguard Health Systems had all made offers to buy.

In April, Beth Israel Deaconess Medical Center and Milton Hospital announced plans to merge in six months.

Provider consolidation isn’t just a Boston phenomenon. Healthcare services M&A is heating up all across the US. What’s going on, and what does consolidation mean for medical device companies?

Everywhere you turn, US healthcare providers are consolidating. According to Levin Associates, there were 77 hospital M&A transactions in 2010, the largest number since 2001. Including all types of healthcare providers, there were 441 M&A transactions across all health care services in 2010, including 103 transactions in long-term care.

City-based hospitals are expanding regionally.  Mass General opened facilities in Foxborough, Waltham, and Danvers. Children’s Hospital of Boston has facilities in Peabody, Weymouth, Waltham and Lexington.

Traditional inpatient hospitals are expanding their outpatient care. Mass General opened North Shore Medical Center in suburban Danvers in 2007.  James Mongan, CEO of Partners HealthCare, said “Health care is moving away from the inpatient (model).” Peter Slavin, CEO of Massachusetts General Hospital added, “As the population ages, the demand for outpatient services will likely grow 15 percent.”

Hospital systems are expanding into primary care. According to their website (on 6/10/11), “Mass General provides comprehensive primary care … to 200,000 patients in 15 locations in Greater Boston.”  Brigham and Women’s provides care for “approximately 97,750 patients” at 13 locations.  Johns Hopkins Community Physicians provides primary care to more than 200,000 patients at 25 locations in Maryland and the Greater Washington D.C. region

Hospitals are hiring physicians as employees, as I wrote about in a previous post.

What’s driving these trends?

Pricing Power. “As They Consolidate, Hospitals Get Pricier” reported Kaiser News in September.  “The Rationale Is Market Power, Not Healthcare Reform” states Ken Terry, a former senior editor at Medical Economics Magazine.  “Eye-popping differences revealed in hospital prices,” reported the Boston Globe in May.  Trudy Lieberman, a longtime contributing editor to the Columbia Journalism Review wrote that last summer “in New York City, Continuum Health Partners Care, a big system controlling such hospitals as Beth Israel and New York Eye & and Ear Infirmary, battled Aetna over prices. Continuum asked for a forty percent increase in payments.”  There’s a pricing battle going on across the country between hospitals and insurers. Bulking up is a highly effective strategy for health care providers.

Shifting Demand To Outpatient Services. Reimbursement, patient demand, and clinical innovation are moving procedures to outpatient settings. Rather than lose patient revenue to competitors, inpatient facilities are expanding their outpatient capabilities.

Control Over Patient Flow. When primary care patients need outpatient or inpatient services, they can be referred to the appropriate inpatient and outpatient facilities.

Economies of Scale. In Fortune last fall, Chris Jedrey, a partner at McDermott Will & Emery, said that to be cost-efficient, hospital systems need to get to $4B in annual revenue. He added, “this will be big guys getting bigger.” Despite the fact that “the percentages of hospitals that are part of a healthcare system [rose] from 38 percent in 1990 to 62 percent in 2009“, the hospital market is still incredibly fragmented, with the three biggest players (Hospital Corporation of America, Community Health Systems, Quorum Health Resources) accounting for less than 7% of the 5,795 hospitals in the US. The vast majority of hospitals systems are operating well below an efficient scale.

Competition Among Healthcare Providers. A merger of Lahey and Beth Israel Deaconess might be better able to compete with Partners, the owner of Mass General and Brigham and Women’s.

Healthcare Reform. Last fall, Kaiser News and the Washington Post reported that “Hospital leaders from Baltimore to Seattle say the health law approved by Congress in March gives them even more reason to merge with or buy rivals because of its emphasis on integrated systems where hospitals and doctors better coordinate care.”

Loosened FTC Merger Regulations. Last September ushered in more lenient hospital m&a guidelines from the US FTC, and a reclassification of many “concentrated” Metropolitan Statistical Areas to “moderately concentrated.” It’s easier than ever to get a deal approved.

Strong Stock Market for Public Health Care Services Companies. In March this year, Private Equity-backed HCA, the largest US Hospital System, raised $3.79 billion in an IPO.  Last week PE-backed Vanguard Health Systems (a small system controlled by Blackstone Group) filed to raise up to $661 million in an IPO.  Darren Lehrich, a managing director at Deutsche Bank, points out that stock values of public health care providers were up 40%+ in 2010, and that “Within the last year, nearly all major transactions have involved strategic buyers.” (at the McDermott, Will & Emery 2011 Healthcare Services Private Equity Symposium March 10, 2011).  Larger healthcare service companies have the wherewithal and will to make deals.

All signs point to increased consolidation of health care providers. This may impact medical device companies in several ways:

Increased pricing pressure from bulked up buyers. Central purchasing organizations will negotiate on behalf of dozens of hospitals to extract lower prices.

Reduced physician influence on technology and brand decisions. Centralized approvals may be needed for new technologies and services. We see this today in systems like Kaiser Permanente.

Centralized decision-making at hospital systems leading to GPO-like contracts. Policies such as “All hospitals within our system will buy catheterization supplies from vendor X” provide an advantage to broad-based suppliers.

National accounts that cut across traditional sales territories. When HCA headquarters in Nashville makes decisions for hospitals in 20 states, the role of the local sales rep may change. For example, local reps may focus on driving device usage instead of purchase orders.

Hospital systems that demand a higher level of support. Capital equipment providers may be required to provide same-day repair service and specialized phone support. Single-use disposable suppliers may be asked to consign inventory and manage expiration.

Hospital system technology assessment centers. As hospital systems and Accountable Care Organizations (ACO’s) take on more risk, hospital systems may might form or contract with technology assessment centers, like those that exist today at insurance companies. The most influential organization today, the Blue Cross and Blue Shield Association Technology Evaluation Center, already serves Kaiser Permanente and the Centers for Medicare and Medicaid Services (CMS).

Increased focus on cost-effectiveness. As health care service companies focus on the bottom line, the financial impact of medical devices will come under increased scrutiny. Hospital systems will likely titrate the clinical evidence required, depending on the product economics. Products that improve care at an increased cost will find that the clinical hurdles for adoption become ever more difficult, as hospital systems demand multiple RCT’s plus supporting evidence from non-investigational settings. At the same time, cost-saving technologies will be adopted more rapidly, with less clinical evidence needed.

Provider consolidation will transform US medical device markets over time, but not overnight. Medical device companies still have time to plan for a new market reality.  The time to begin is now.

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