Merger mania: physicians beware. (Health Care Mergers).

AMONG THE MANY ORGANIZATIONAL CHANGES THAT have characterized the nation's health field during the past decade, none is more striking than the trend toward forming integrated networks of hospitals, physician practices, and managed care plans. In 1983, the number of acute care facilities that were owned, leased, controlled, or managed by multi-hospital systems constituted 34 percent of all community hospitals in the United States. (1) Thirteen years later, in 1996, the share of facilities in various networks (excluding loose affiliations and joint ventures) climbed to 44 percent. (2) This trend of corporate consolidation is projected to accelerate during the next decade.

Competition among health providers attempting to increase their market share has encouraged physicians and hospitals to consummate mergers that center on improving access, reducing operating costs, and enhancing quality of care. These corporate mergers are a unique form of organizational consolidation, in the sense that they bring together all policy formation and management aspects, including expediting common governance, under the complete control of a newly formed entity. An additional incentive to achieve this level of consolidation comes from the bond rating agencies that look favorably upon physician and hospital mergers, inasmuch as these arrangements can yield greater leverage in negotiations with managed care plans and other private insurers. (3) In contrast, only a portion of an existing organization is subject to external management in joint ventures or affiliation agreements. Conventional wisdom suggests that by fully integrating two or more free-standing providers, superior economies of scale tha t are measured in terms of additional efficiencies and effectiveness should soon be realized to the benefit of consumers.

Despite the conceptual appeal of consummating a merger as a strategy for effecting enhanced market share, lower cost, and improved quality of care, and even with the increasing frequency of integrating health resources over the past decade, only a few studies have been published in the United States and Canada examining how a merger actually affects hospital performance (4-12) The primary purpose of this article is to summarize the available studies that explore empirically the impact of hospital mergers. Another objective is to advise health executives and public policy makers of the most likely effects of these mergers on physicians, hospitals, and consumers in the context of such market-driven initiatives-now underway in almost every metropolitan area-as the formation of fiscally and politically powerful health networks with annual revenues of more than $1 billion.

Findings concerning hospital mergers

The most successful mergers (9, 11, 13) involve medium-sized, not-for-profit hospitals in the same community where: (1) the market power of two or more organizations is greater than severally; (2) there is significant opportunity for the possible consolidation of high-fixed cost services, such as obstetrics and open-heart surgery; and, (3) if specific service volumes are combined, it becomes feasible to offer to the community additional clinical programs that could not be supported effectively by either institution as a free-standing facility. (8) Unfortunately, only a limited number of communities remain in the United States where such a merger strategy is feasible, where all parties concerned can agree, and where clearance can be easily obtained from the Department of Justice and the Federal Trade Commission.

Health executives have been warned to avoid entering into a merger agreement where the potential partner in operational and fiscal terms has experienced historically much weaker performance. Columbia/HCA, prior to its recent legal problems, used the following more precise guidelines in its pre-merger evaluations: fewer Medicaid patients, lower proportion of outpatient revenues, higher operating cash flow per bed, lower occupancy rates, lower salary expense per discharge, fewer beds, and a higher case-mix index relative to the facility's local competitors. (14) This listing may explain why the investor-owned groups usually prefer management contracts, rather than acquiring governmental (mostly county) hospitals, as these organizations usually portray: (1) significant outstanding capital needs and underfunding of operational expenditures; (2) a high percentage of their patients representing uncompensated care; and, (3) serious governance and political difficulties are usually faced when attempting to change own ership to either a voluntary not-for-profit or a for-profit status.

When examining the short-term effects of hospital mergers occurring in the 1982-1989 period, the most noticeable change reported was related to improved operating efficiency as measured by a higher percent of occupancy and a decrease in the rise of total expenses per adjusted admission. These merged facilities were less successful in generating more admissions or reducing their total personnel or nursing staffing patterns. (7) After consolidating their operations, these 92 mergers that were studied evidenced an overall slowing down of the rates of pre-existing trends, rather than demonstrating dramatic improvements in operating patterns.

In fact, the short-term impact of these mergers was generally modest and differed considerably by the conditions under which and when the corporate amalgamation occurred. Mergers that were consummated after the introduction of the Medicare prospective payment system (PPS) and those between similar-sized hospitals displayed greater positive changes in operating patterns. These findings were explained by the increased cost pressures experienced after PPS was enacted and by the greater opportunities for efficiencies perceived to be achievable in mergers that involve facilities of similar size.

Responses in 1991 received from 60 of the 74 mergers that occurred between 1983 and 1988 indicated that 58 percent of the hospitals acquired (i.e., the smaller of the two institutions) were closed as acute inpatient facilities and were converted to other services (e.g., substance abuse, long-term care) or were completely shuttered (17 percent). (9) None of the 18 mergers involving a rural hospital was reported to have resulted in a closing, being vacated, or being used for non-inpatient purposes. This outcome was probably due to the protracted travel time to the nearest facility, considering the greater proportion of elderly residents in these more sparsely populated areas.

Nevertheless, it is reasonable to assume in the long-term that the acute inpatient services in some rural hospitals will be curtailed as increased cost pressures, particularly among major medical centers that are experiencing an increasing number of vacant beds, force health systems to more effectively deploy all resources. Improved integration of telemedical services in America's health system could also make these "downgrading" decisions more palatable to a rural hospital's leadership faced with severe financial difficulties.

In mergers in which both physical plants were staffed for acute inpatient care, the acquired (average complement of 143.8 beds) and the acquirer (310.1 beds) had a greater resemblance in service mix, in the number of equivalent full-time personnel per occupied bed, and in the percent of occupancy rates compared with mergers in which one hospital's acute inpatient bed complement was eliminated. Hospitals that merged, but retained both physical plants for acute care services, illustrated greater distance (measured in miles) between facilities. Conversely, in those cases in which acute care was terminated at one of the facilities, the greater disparity between the merging hospitals in terms of their respective service mixes suggests this variable as being a major factor in eliminating acute inpatient services at one of the sites.

This study (9) evidences two potentially different merger strategies: (1) reducing direct competitors; or, (2) building the infrastructure for a larger horizontal, regional network for hospital care, although in both cases the respondents emphasized that strengthening their financial position and consolidating their services were among the key reasons for amalgamating the two organizations. It is rather significant that in the case where one of the two hospitals' acute inpatient services was eliminated, the respondents indicated that these facilities prior to the merger had been highly competitive with each other for both inpatient and ambulatory services. However, when both hospitals continued to offer acute inpatient care, significantly fewer respondents reported that pre-merger competition between the facilities was intense.

A more recently published study (11) of 3,500 U.S. short-term hospitals, including 122 mergers between 1986 and 1994, support as well as amplify these findings. It was concluded that mergers in more concentrated market areas (i.e., tending toward a more monopolistic position) had merger-related cost savings (-2.7 percent) that were less than half those of mergers in less concentrated market areas (-7.3 percent). Mergers in more "monopolistic" market areas had a slight price rise (+1.4 percent) instead of a price decrease, suggesting that: (1) the cost savings and consumer benefits from hospital mergers in more concentrated market areas are either marginal or even negative; and, (2) regional health systems functioning as an oligopoly may, in the future, require more antitrust constraints. Cost savings interestingly were found to be greater among mergers that involved hospitals with these characteristics: low occupancy, non-teaching, non-system, and not-for-profit.

These studies of hospital mergers illustrate the most modest improvements in operations and cost savings--and, are certainly less effective to date than often envisioned when these corporate consolidations are first announced to the local public. Maybe, in the future, these mergers will result in a significant reduction in cost and an improvement in quality of patient care, difficult parameters for any organization to readily achieve.

Major findings concerning mergers generally

There are significantly more citations in the general management than in the health field literature on the overall success and failure of mergers. (15) Except for an amalgamation of equal partners (particularly with a management buyout), corporate consolidations in the non-health field in the United States and in Europe have resulted in less than impressive outcomes if gauged by usual and customary operational and fiscal criteria. (16-17)

A major reason given of why so many mergers yield disappointing results is that the leadership group in the pre-merger period devotes insufficient critical study to determine how the potential partners' operations can be most effectively integrated to achieve maximum efficiency. Equally critical is for the management team to identify what cultural, strategic, and management problems could arise that might interfere with the new merged organization attaining its projected goals and objectives.

For example, whether to consolidate the two medical staffs is a critical issue, and frequently more pivotal is whether to amalgamate organizationally and physically the emergency, pathology, radiology, and other similar clinical departments. Or, to be worked out before the merger is consummated, is whether the two medical groups will stay in their existing facilities, one of these plants will be expanded, or a new consolidated physicians' office building will be sought.

Because of the overall economic and political ramifications of mergers, it would be unrealistic to assume that all mergers will be problem free. Divestiture is often necessary because of a desire to pay down debt, due to an overall financial distress, or a "misfit of objectives. " (18) Possibly the most concrete finding concerning corporate sell-offs is that conglomerate control (i.e., essentially unrelated in the products they produce and distribute) made matters worse.

Although there could be understandable disagreement of whether the example of hospital systems acquiring physician practices or HMOs fits the definition of conglomerate control, the more institutionally-oriented type leadership, when responsible for implementing a complex merger, has shown evidence of experiencing more difficulty in managing physician practices and HMOs than managing a newly acquired hospital (19) In addition, as the physician and hospital leadership argue in the media about who is ultimately responsible to control the region's delivery of health services, a divestiture of the more clinical-medical aspects of some health networks can he expected to occur with increasing frequency.

Consummating horizontal mergers (two medical groups with the same clinical specialty) should offer more attractive cost reduction opportunities than forming conglomerates (several medical groups acquiring an upscale nursing home) because of the former's ability to implement enhanced clinical and managerial expertise across more closely akin operations, and the possibilities for postmerger integration of complementary or competing operations. Yet, the general management literature reports that differences in profitability among horizontal and conglomerate-type mergers appear to be insignificant. (20)

The European experience is more directly relevant to the outcome of large horizontal mergers. (21-22) With weaker antitrust laws and governmental policies that often actively encourage large horizontal mergers, countries across the Atlantic Ocean provide a fertile environment for comparative analysis. The weight of findings there is that predominantly horizontal, often large, European mergers on the average have exhibited little or no tendency to raise profitability or efficiency. (23) The research of European horizontal mergers, like the evidence to date in the general management and health field in the U.S., provides limited support to believe that, on the average, the efficiency gains through merger will be appreciable without possibly some additional fiscal incentives, and critical internal and external forces. (24)

Options for physicians

Facing an increasing supply of available doctors (particularly specialists), a decrease in reimbursement per unit of service and a rise in the percent of gross revenues expended for office overhead, an attractive option for an increasing number of physicians and medical groups is being acquired by a nearby health system. This alternative becomes more advantageous if the hospital is willing to assist with day-to-day operational issues and its productivity standards in the agreement are considered to be relatively low.

Hospitals are anxious to bond with their primary care physicians and other major admitters, and until relatively recently were willing to offer attractive cash terms. These arrangements between physicians and health systems or insurers, however, are destined over the next decade to result in highly contentious disputes. On the one hand, physicians once having been "bought out" expect to work less and earn more. On the other hand, hospitals anticipate being the recipient of additional inpatient admissions from these doctors and in obtaining a reasonable return of their capital expenditure having made a sizable investment when acquiring these practices.

While the growth in managed care enrollment has encouraged physician groups to "sell their practices, the fiscal incentives in capitated payment (i.e., reduced utilization and cost) and how the available premium dollars are divided between doctors and hospitals are major factors complicating any potential operational and fiscal arrangements between any acute care hospital and its medical staff. With a decline in the dollars available for direct medical care services adjusted for health care inflation, physicians and hospitals, particularly when both are highly leveraged, will become involved in disputes that are primarily related to ambulatory care services that should be provided in doctors' offices or under the hospital's aegis.

As a result of either financial distress or "misfit of objectives," there is a reasonable likelihood of myriad divestitures of physician practices or physician groups from integrated health systems that are dominated by hospital leadership who lack the appropriate clinical-type acumen. Health insurers, such as HMOs and Blue Cross/Blue Shield plans or major employers who want to contract directly for medical services may well acquire these physician practices.

It is questionable whether the American medical schools will significantly curtail their enrollments. Predictable in almost every metropolitan area, therefore, is a surplus of specialty physicians and a restricted number who are eligible (because of being excluded from specific panels) to receive payment from some capitated HMO plans. It is conceivable that Medicare physician provider numbers could be allocated by health service area and by specialty as now partially implemented in Germany (25) to improve the current poor distribution of doctors nationally.

Although there would be serious constitutional questions raised concerning such a proposal, as a result of tying physician office locations to billing Medicare and HMOs, U.S. residents of less desirable places to live and for doctors to practice might thereby benefit from improved access to a broader range of medical services. It is unlikely that such a draconian approach will be mandated in the foreseeable future, although it theoretically could be an unexpected favorable outcome of capitated payment and mergers in the health field.

More immediately, the Balanced Budget Act of 1997 will allow more than 1,000 hospitals nationwide to participate in a program that provides continued payment for medical residency positions that are phased out over a five-year period. The program is modeled after a similar one in New York state where the Health Care Financing Administration agreed to pay 41 hospitals $400 million for a 20 to 25 percent reduction in the number of physicians trained over six years.

Other issues raised by mergers

Mergers in the health industry have a number of implications in a field that emphasizes achieving wellness. Mergers between competing health providers may: (1) increase market power (i.e., the ability and likelihood of market manipulation by restricting output and, therefore, being able to raise prices); and, (2) increase efficiency through economies of scale, economies of scope, or reductions in the duplication of services, facilities, and administrative overhead.

Any efficiencies due to a merger must be weighed against any increase in market power. Therefore, it is critical for physicians to determine whether the merger may be used to substantially lessen competition and will tend to create a monopoly as defined by the nation's antitrust statutes and related court decisions. More simply stated, with mergers and capitated payment that includes selected panels of doctors, some physicians eventually will be virtually excluded from obtaining sufficient patient revenues within a specific community.

Whether mergers of medical groups and hospitals are efficacious for the public will be a continuing question for the health field because providers throughout the nation are persistently experiencing high degrees of overcapacity of inpatient beds, tertiary services, and specialty physicians, combined with an overwhelming community and institutional resistance to close a physician's office, any hospital, or one of its major services.

A hospital closure or consolidating a major program after a merger is consummated under the guise of rationalization is more likely to be successfully implemented than such a strategy being attempted by a single free-standing institution, Organizations, much like humans it seems, abhor dying alone and without contributing in a meaningful manner to future generations.

Closing a facility or consolidating a specific service at one location seems to be politically easier to achieve within a broader corporate structure than in isolation, simply because the surviving corporate entity can provide erstwhile stakeholders of the closed facility or service with guarantees of alternative available resources. Implementing significant operational changes following a merger is still difficult, however, owing to inertial forces that perpetuate the organizational status quo--vested interests among the powerful stakeholders; disagreements among the policy leaders concerning the new organization's strategic direction; and, communication and coordination problems that frequently result from combining two formerly independent entities each previously having different organizational cultures.

The various parties sponsoring a proposed consolidation of health facilities serving the same population base often state that increased efficiency is their primary motive, As a complicating factor, there is conflicting evidence whether higher costs were evident among hospitals in highly competitive areas or where there is one institution serving the region. (11, 26) A recently published study (12) focusing on those facilities involved in forming local strategic hospital alliances concluded that these networks are being designed to keep competition out and prices high. Surprisingly, it was uncovered that consumers on the average paid S140 more per stay at an alliance hospital than a free-standing facility.

The medical arms race, spurred by competition among major hospitals and a reimbursement system that previously encouraged the rapid adoption of technology that was often then underutilized, was the main cause of hospital cost inflation in the 1980s. (27) On the other hand, competitive contracting has forced some acute care facilities to be more diligent in enhancing their revenues and decreasing their expenses.

What should be worrisome to physicians is that increased consolidation eventually affords the opportunity among those networks, which are able to achieve significant market penetration, to undertake tacit collusion at maximizing prices among major providers and insurers. (28) Thus, physician and hospital mergers which enhance efficiency and effectiveness in the short-run can potentially fail to yield expected savings to the community in the long-run, unless there is intensive bargaining among providers and insurers on prices and quality standards.

Of concern is simply that a concentration of hospitals, physician practices, and insurers will have the ironic consequence that market-driven forces currently underway may no longer continue to serve the public interest by requiring providers to compete. In the near future, eliminating most weak competitors could easily culminate in a single or few networks dominating each region's health services by segmenting the market (geographically and clinically) into virtual monopolies (i.e., oligopolies). Giantsized providers would then be in a position to exercise regional dominance to further their own self-interest, rather than applying their fiscal and managerial resources to such social objectives as expanding access for low-income populations or providing more and better care at little or no additional cost.

These oligopolistic concentrations in the health field present serious problems. The dissatisfaction of some business coalitions or similar groups with the performance of local HMOs have led them to contract with providers directly. However, what happens when there are few survivors" left and the employers are no longer able to play integrated health systems against each other? At that juncture, do state governmental officials have the responsibility to step in and provide the necessary additional regulations to protect the public? Or, does state government threaten the providers that a health services commission as a public utility should be established soon? In this connection, it is not far-fetched to project that the continuing expansion of oligopolies and managed care with capitated payment could serve as a back door to further regulatory controls and global budgetary approaches (e.g., state capitated Medicaid plans) for the health field. (29)

Conclusion

Despite the conceptual promise that multi-hospital systems have been perceived to be superior in allocating health resources and in promoting operational efficiencies, research to date has not demonstrated that organizing hospitals and medical groups into systems (often formed by consummating several mergers) resulted in enhanced access, lower health care costs, or improved quality of care. (30-31) Therefore, it is of no surprise that a summary of the empirical studies of hospital mergers, which have been a topic of less intensive examination than multi-hospital systems, illustrate either modest or limited conclusions. However, it could well be that insufficient time (in years) has elapsed where it is possible to allow local health executives to implement the changes that would demonstrate the true efficacy of consolidating various health organizations.

Possibly an equally critical question is whether mergers of medical groups and hospitals in the long-term will serve to reduce direct competition and potentially generate savings or do they expand into fiscally and politically powerful oligopolies that eventually adversely affect physicians and the public and, therefore, require stringent government regulation.

What needs to be carefully examined is how these mergers can be structured so that strong horizontal and vertical networks are formed that eliminate existing overcapacity, reduce health care costs, provide improved access, and ensure high quality of patient care. Meanwhile, the overall evidence is that physicians need to be more cautious in their various negotiations with other providers or insurers, because in all this current merger mania, some doctors can be expected to face significant decreases in personal income, relocation, or changing clinical specialty.

References

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(2.) Billian's HealthDATA Group. Hospital Blue Book. Atlanta, GA: Billian Publishing, Inc., 1997.

(3.) Moody's Investors Services Municipal Credit Research. Rating Volatility Ahead for Philadelphia and Pittsburgh Hospitals. Moody's Investor Services, Inc., May 1997.

(4.) Treat, T.F. "The Performance of Merging Hospitals." Medical Care. 14(3):199-209, 1976.

(5.) Mullner, R.M., and Anderson, R.M. "A Descriptive and Financial Ratio Analysis of Merged and Consolidated Hospitals, United States, 1980-1985." Advances in Health Economics and Health Services Research. vol. 7, Greenwich, CT: JAI Press, Spring 1987, pp. 41-58.

(6.) Lynch, J.R., and McCue, M.J. "The Effects of For-Profit Multihospital System Membership on Hospital Financial and Operating Performance." Health Services Management Research. 3(2):182-192, 1990.

(7.) Alexander, J.A., Halpern, M.T., and Lee, S.Y.D. "The Short-Term Effects of Merger on Hospital Operations." Health Services Research. 30(6):827-847, 1996.

(8.) Brooks, G.R., and Jones, V.G. "Hospital Mergers and Market Overlap." Health Services Research. 31(6):701-722, 1997.

(9.) Bogue, R.J., et al. "Hospital Reorganization After Merger." Medical Care. 33(7):676-686, 1995.

(10.) Markham, B., and Lomas, J. "Review of Multi-Hospital Arrangements Literature: Benefits, Disadvantages and Lessons for Implementation." Healthcare Management Forum. 8(3):24-35, 1995.

(11.) Connor, R.A., et al. "Which Types of Hospital Mergers Save Consumers Money?" Health Affairs. 16(6):62-74, Nov-Dec., 1997

(12.) Clement, J.A., et al. "Strategic Hospital Alliances: Impact on Financial Performance." Health Affairs. 16(6):193-203, Nov.-Dec. 1997.

(13.) Anderson, H.J. "AHA Lists Hospital Merger Activity for 12-Year Period." Hospitals. 66(11):62-62, June 15, 1992.

(14.) McCue, M.J. "A Premerger Profile of Columbia and HCA Hospitals." Health Care Management Review. 21(2):38-45, 1996.

(15.) Ravenscraft, D.J., and Scherer, F.M. Mergers, Self-Offs, and Economic Efficiency. Washington, D.C.: The Brookings Institution, 1987.

(16.) Litchtenberg, F.R. Corporate Takeovers and Productivity. Cambndge, MA: MIT Press, 1992.

(17.) Bishop, M., and Key, J.A. European Mergers and Merger Policy. Oxford, England: Oxford University Press, 1993.

(18.) Clement, J.P., and McCue, M.J. "The Performance of Hospital Corporation of America and Healthtrust Hospitals After Leveraged Buyouts." Medical Care. 34(7):672-685, 1996.

(19.) Goldsmith, J. "Hospital/Physician Relationships: A Constraint to Health Reform." Health Affairs. 12(3):160-169, 1993.

(20.) Mueller, D.C. "Mergers and Market Share." Review of Economics and Statistics. 65(5):261-166, 1985.

(21.) Mueller, D.C. The Determinants and Effects of Merger: An International Comparison. Cambridge, MA: Oelgeschlager, Gunn & Ham, 1980, pp. 299-302.

(22.) Geroski, P.A., and Jacquemin, A. "Large Firms in the European Corporate Economy and Industrial Policy in 1980s," in Jacquemin, A. (ed). European Industry: Public Policy and Corporate Policy. Oxford, England: Clarendon Press, 1984, pp. 344-349.

(23.) Cowling, K., et al. Mergers and Economic Performance. Cambridge, MA: University Press, 1980.

(24.) Weil, T.P. "Mergers in the Health Field: Some Practical Realities," Health Care Management Review, submitted for publication. This manuscript contains more of the theoretical underpinnings and provides additional examples of the issues caused by the current merger mania on hospitals, insurers, and the public. The discussion relating to physicians and physician groups is contained herein.

(25.) Weil, T.P., and Brenner, G. "Physician and Other Ambulatory Services in Germany." Journal of Ambulatory Care Management. 20(1):77-91, January 1997.

(26.) Nguyen, X.N., and Derrick, F.W. "Hospital Markets and Competition: Implications for Antitrust Policy." Health C'are Management Review. 19(1):34-53, 1994.

(27.) U.S. General Accounting Office, "Hospital Costs. Adoption of Technologies Drives Cost Growth," GAO-HRD-92-120. Washington, D.C.: U.S. General Accounting Office, 1992.

(28.) Mobley, LR. "Tacit Collusion Among Hospitals in Price Competitive Markets." Health Economics. 5(2):183-193, 1996.

(29.) Weil, T.P., and Battistella, R.M. "A Blended Strategy by Using Competitive and Regulatory Models." Health Care Management Review. 23(1):34-45, 1997.

(30.) Shortell, SM. "The Evolution of Hospital Systems: Unfilled Promises and self-Fulfilling Prophecies." Medical Care Review. 45(2):177, 1988.

(31.) Shortell, SM., et al. Strategic Choices for America's Hospitals: Managing Change in Turbulent Times. San Francisco, CA: Jossey-Bass, 1990.

Thomas P. Weil, PhD, is President of Bedford Health Associates, Inc., a management consulting firm for health and hospital services based in Asheville, North Carolina. He can be reached by calling 704/252-1616, via fax at 704/253-3820, or via email at [e-mail].

Glenn M. Pearl, MHSA, is Editor of Rate Controls, a publication for hospitals and health services management, based in Phoenix, Arizona. He can be reached by calling 800/975-8100, via fax at 602/995-9458, or via email at [e-mail].