Literature Review: Medical Practice Mergers and Acquisitions
By Lisa J. Vognild, MS, FASPR, Director of Physician Placement, Memorial Medical Group, South Bend, IN
A resurgence of medical practice mergers and acquisitions is among us again. Much like the frenzy of practice mergers seen in the mid 1990s due to managed care, medical practice mergers are on the rise today due to health care reform. According to a HealthLeaders Media survey in November 2010, nearly nine out of ten respondents believe that the enactment of healthcare reform legislation has driven the increase in healthcare mergers and acquisitions (Minich-Pourshadi, 2010). The lessons learned from earlier failed or dysfunctional mergers can help organizations and independent practices better prepare and plan for mergers today.
A convergence of economic and regulatory circumstances has changed the health care environment for both hospitals and physicians. Changing laws, capital constraints, reimbursement stressors and physician shortages have caused this increased consideration of mergers. Hospitals want to secure referrals while physicians are feeling more and more business pressures making an employment relationship attractive (Strode & Beith, 2009).
MGMA’s annual Physician Compensation and Production Survey showed that hospital-owned group practices grew from 25.6 percent in 2005 to 49.5 percent in 2008. Later in the same year, hospital-owned practices exceeded physician-owned groups. The prospect of bundled payments and penalties for readmission of patients provides a carrot-and-stick to bring hospitals and physicians together. Physicians and hospitals can work better together in accomplishing improved outcomes and consistency. Plus regulatory pressures are encouraging physician groups to seek hospital employment and owndership of practices. Today’s medical school graduates want work-life balance and reasonable workloads that are more feasible in a hospital employment relationship. While the physicians are better able to focus on medicine and quality, the hospitals can handle the business side of practice (Galloro, 2010).
Today’s health care leaders are taking a much more strategic approach to merger transactions. Likewise, physicians are being mindful of the arrangements they agree to—making sure to include fair market value, a certain level of autonomy and a voice in governance and management. Physicians are as concerned about having a voice in governance as they are about the major deal points of the merger. Today, valuations have become a necessity in hospital and physician relationships. The value of the physician’s practice assets will be limited to the expected cash flow generated from these assets after physician compensation is paid. Moreover, physicians know the value they bring to the hospital in ancillary or technical revenue as well as professional revenue and referrals (Strode & Beith).
Marc D. Halley of The Halley Consulting Group stated, “The healthcare industry is maturing, and as industries mature, they consolidate…” (Commins, 2009). He goes on to say that even though it is tough, small groups can survive. Survival depends on how well one plays and manages the environment one is in. Halley recommends a thorough review of the internal and external factors of the business. Internal factors include owner demographics, such as age of physicians. Practice performance is another internal factor. Questions such as: “Am I able financially to stay independent and retire with security?” need to be answered. Is the practice strong with a bank account, good credit and low debt? Is there enough capital to continue to grow, invest and compete? Does the practice have the leadership it needs to make good business decisions? Someone in the practice has to like the business of medicine. Or, the physicians must give over those responsibilities to someone else. From the standpoint of external factors, the practice must have the capability and expertise to respond to the changing health care environment, i.e. reimbursement, changes in laws. What if the market in your area changes; are you safe? Are you able to offer other services, not just cognitive (Commins)? Practices need to realize that the business of healthcare changes. Those items that made money at one point in time may not make money in the next point in time. Such is true for an insurance company’s reimbursement; one year the HMO may pay capitated dollars that are gone in the next year. To stay independent, a small practice must adopt the highest and most stringent business practices. Today’s economics are making it more and more difficult for small groups to survive. Operating costs are high while reimbursement is low (Popely, 2009).
Practices need a clear vision of what a merger will do for them: 1) Will a merger combine clinical skills into a practice that can serve a new group of patients and add revenue to the practice? 2) Will a merger allow for a new office to serve a new market? 3) Will a merger allow staffing efficiencies to reduce overhead? 4) Will a merger create financial strength to justify buying new technology to enhance the people resources (Mertz, 2001)? These are just some of the practical business elements in the evaluation of a merger.
In the evaluation of culture and philosophies, the practice needs to consider how they see themselves as a group and how they see their new partners or employers. The potential partnership must share similar ideas about their mission and work. Factors that separate the winning mergers from the losing mergers start with the motivation of the merging physicians and their willingness to operate as a group other than separate practices. In their book, Physician Practice Mergers, Tinsley and Haven share a sample physician survey on merger expectations and concerns. This short five-question survey helps to reveal the most important issues: motivations, perceived benefits and concerns. These issues should be openly discussed and dealt with at one of the first merger meetings (Tinsley & Haven, 2001).
During the evaluation process, recognized differences may reveal where problems, disagreements and discrepancies will evolve. Each side’s operational systems, policies and procedures should be evaluated. Critical elements include doctors’ work habits, billing, collections, personnel administration, facilities and location. In regard to personnel, each person’s job responsibilities should be evaluated. There may be differences, duplication or absent duties. Policies on employee compensation, benefits, duties and flexibility should be reviewed and compared.
Bringing solo providers into a structured system will be foreign to them. These providers will need to be introduced to the team atmosphere and committee structure. To staff, mergers can seem like second marriages: his, hers and ours. Physicians’ retirement and benefits need to be discussed (Terry, 2005). Possible anti-trust, pre-existing relationships, Stark compliance and conflicts of interest need to be exposed (Katz, 2010).
The biggest mistakes hospitals make when aligning or hiring physician groups involve not having the infrastructure to manage the medical group. They need to be ready to manage. Administrative complexities increase proportionally with the number of physicians. Therefore, a strong leader must be assigned to guide the day-to-day operations of the newly merged practice into the system. These administrative and management complexities may even add more layers to the management organizational chart.
The down side to employment, however, is that physicians are less rooted in the community. They have less skin in the game (personally vested capital) so if they want to pick up and leave, they can do so more easily. Competitive pay and involvement in decision making help to prevent a revolving door with employed physicians (Popely).
Experts say the secret to a successful merger is like that of a happy marriage—a long courtship, common interests and compatible personalities (Romano, 2004). One example is the merger of two cardiology groups. They started by building the administrative and clinical infrastructure to make their vision become a reality. They engaged in an intense peer review of each others’ work in an effort to become the standard-setters in quality. They took two years to prepare for the merger (Galloro). These groups demonstrated strong leadership and management to create a successful merger.
The major merger problems include culture, clinical philosophies and compensation.
If these key factors can be resolved, the probability of a successful merger is high. The number one concern among physicians considering a merger is loss of autonomy and decision-making ability. Number two is the compensation model. Changes in physician compensation are the most controversial decisions for merging groups. Philosophies can vary from the “all-for-one and one-for-all” mentality to the “lone-ranger” mentality. Dealmakers are advised to structure compensation models around productivity, quality and other important objectives such as patient satisfaction. Talk through any uncertainties. Hasty mergers rarely work. Many attempts at quick mergers made in the 1990s are evidence of that. A well thought-out and discussed process on value systems and practice philosophies will make all the difference in the short-term and long-term success (Romano).
Negotiate and agree ahead of time. Minimize the unknowns by making decisions for eliminations and consolidations ahead of time. Make objective assessments during the honeymoon stage of the merger discussions. Additionally, it is important to people to maintain some history and individual institutional pride from their respective groups. Take time to recognize and celebrate the people and successes that have gotten the groups to this point. These things can act as powerful incentives for cooperation and enthusiasm for the future.
Physicians and staff will recognize considerably more bureaucracy and a less nimble system. Small groups joining a larger organization will find more policies and procedures and structure in the decision-making process. This change can cause unintentional or unanticipated frustrations at first (Tinsley & Haven). However, after getting used to new forms and procedures, physicians may realize that things have changed for the better. They do not have to worry about the administration of pensions and health plans, leased space or human resource issues. They can focus on clinical quality instead (Galloro).
Sometimes mergers ensue for the wrong reasons. A new name on a building will not change what takes place inside. The groups need to share a common rationale and take it slow in order to reveal their value systems. If not managed correctly, egos, emotions, conflicting organizational cultures, clinical philosophies, situational differences, perception of goodwill value, loss of control, and compensation compile the list of issues that can present cause for a failed merger.
Other challenges and risks involve the investment of time, effort (willingness to change), and cost. A merger should take anywhere from six months to two years to complete. During this time, administrators need to make sure that physicians’ time is used wisely. Facilitators need to ensure progress is made at meetings. They need to reduce or eliminate passive resistance, gaming, bullying, and avoidance of conflicts of interest. Lack of full disclosure will create surprises and distrust. Attorneys need to be involved, but not too early lest they choose sides and represent only “their” group. Each group/side must accept the need to make changes. In the beginning, physicians realize the benefits and advantages to merge—but as the work begins and compromise is necessary, they can lose sight of the benefits to be gained and focus only on the fact that they are not getting exactly what they want. Physicians need to ask themselves if they are willing to give up the whole merger over an issue. Individual physicians may have to give up some of their own styles to become a group. Studies suggest that the likelihood of cultural conflict and coordination failures is underestimated, which explains why many organizations enter into mergers that are doomed from the start. There is evidence that conflict and blame arising from differences in culture point to the high failure rate of mergers (Weber and Camerer, 2003).
Mergers are very costly ventures. There are costs of professionals, such as attorneys and consultants, to evaluate and negotiate. There will be a loss of production (and thus revenue) due to physicians spending time on planning and meeting. If the merger “unwinds,” a de-merger is among the most expensive propositions one can be involved in. The cost is two to three times greater than the cost invested in a well-planned merger. This does not take into account lost revenue from decreased production and inefficient operations (Tinsley & Haven).
Another risk to merging is the impact on outside stakeholders. Some outsiders may not be comfortable with the merger because of the effect it has on their business. Those stakeholders may include other hospitals, other referring physicians, accountants, consultants, or attorneys. Anecdotal evidence indicates that 50 percent of all attempted mergers do not result in merger. In some instances, this is the right development because not all merger considerations should come to resolution as not all physicians share the same long-term goals. Every merger is a leap of faith, but an organized and structured process will help to minimize the risks and maximize the benefits to the physicians and the organization (Latham, 2002).
With escalating financial and operational pressures, hospitals and physicians are revisiting the employment business model and are hoping to take advantage of the lessons learned from the 1990s for the long-term success of these new ventures. The American Medical Association believes that new physicians are driven toward the employment model to enable a work-life balance and avoid financial pressures from the business side of medicine. Because of recent reimbursement changes, the model of physician-owned facilities has been significantly declining since 2007. Regardless of a universal health care mandate, hospitals and physicians will likely position themselves well together in the future (Walton et al., 2009).
Security is a reason physicians come to the merger table. The business risk for a small group might incent physicians to seek the peace of mind of a larger group. A group needs to be an important player in the area’s healthcare delivery system for the employers, patients and health plans. Without this, a group has no leverage. Small groups may lack the resources to implement today’s highly demanded e-business and interactive websites, and practice management systems. Some of the anticipated benefits of a larger group may include greater leverage with payers, pooling of financial and human resources, more efficient use of expensive resources (a new partner), expansion of patient cross-referral, capturing ancillary revenue, and greater attractiveness to physician recruits (Bernick, 2005). Larger groups can create efficiencies by taking advantage of support departments within the system and pooled, experienced staff. These achievements can secure practice growth and viability for years to come.
Regulatory requirements such as compliance and confidentiality are burdensome, but for small groups, they are extremely difficult to implement. Larger groups can support added services: clinical lab, home health, infusion, skin care and imaging revenue. The economy of scale is often one of the major benefits mentioned in mergers. However, repeated over and over again in the literature is a caution relating to “selling” the economies of scale benefit. A poorly planned merger can remove this benefit due to inefficiencies and other problems (Tinsley & Haven).
The mere success of a merger can create renewed enthusiasm and synergy among the physicians and staff. Overcoming obstacles and seeing a new vision come to life is gratifying. To a group merger in Boston, consolidation made great sense. They had greater leverage in contract negotiations. They were able to provide greater convenience for their patients. They were able to have greater access to capital for technology such an electronic health system. One group increased revenue by 10-15 percent while reducing expenses by 5 percent. These were accomplished mostly by expanded ancillaries and reduced malpractice. Quality of care, such as error prevention, can be improved with electronic systems. Also, collegial interactions, within the same specialty and outside of one’s specialty, can make for intellectual stimulation and improvements in the delivery of care (Romano).
From the perspective of the employing hospital or organization, the physician employment model may further its business plan. Areas where hospitals can use physician expertise involve clinical issues, quality, utilization review, patient satisfaction, and research, compensation allocation, capital prioritization, and resource utilization such as supplies, staff and equipment (Strode & Beith). Again, however, the acquisition should be well thought out. Relevant factors that should be examined as part of this process include: population growth and demographics, hospital coverage needs and utilization rates, disease and illness rates, physician supply and demand, market share, case-mix index, and compatibility with other hospital-owned physician practices and the medical staff in general. The hospital must ensure that any acquisition and relationship meets federal regulations, i.e. Stark Law (Walton et al.).
Management of the merger process
Common pitfalls in mergers and acquisitions include unclear business purpose and strategy, hurried and unbalanced due diligence, and unrealistic expectations. It is critical to have a clear and shared vision for the future along with a well-defined integration planning process. Practices need to include human resources, culture and philosophy as part of the due diligence process in order to uncover potential differences. A good due diligence process is not just about legal and financial matters. The process should look at the partners’ assumptions about how the business will be run and the core values that influence those presumptions (Dixon & Marks, 1999).
The planning process must be linked with the strategic vision. Leaders need to develop “critical success factors.” This starts with providing excellent patient care. Second, the staff members who do the work should be involved in the process of how best to make things work. Leaders need to talk about the merger syndrome. The merger syndrome is a reaction caused by the uncertainty and stress of consolidating; it is characterized by three types of reactions—personal, organizational and cultural. Stress and anxiety can cause people to feel uptight, defensive, suspicious and controlling. Organizational reactions can include restricting communication, adopting a crisis mode management approach and increasing interpersonal and intergroup tension.
Lastly, make sure to consider all the stakeholders: employees, families, trustees, patients, and community. If all factors are evaluated in the process, a long lasting desired effect will likely occur (Dixon & Marks).
Several tools are available for both the legal side and the business side of the merger planning process. The Medical Group Management Association (MGMA) offers a free due diligence checklist on its website. This checklist is in an Excel format and can be downloaded for functional use.
Included in the book by Tinsley and Havens is a sample merger planning information request form. This form provides the evaluator or consultant with the elements to consider in the evaluation of the current practice business and operations.
In his article “Medical Practice Mergers,” Will Latham offers an orderly list of inter-related steps in the merger process. Latham goes on to further state that the groups should develop a courtship — talking about shared interests and benefits to merge and how the merger will work. The groups should make a commitment to move forward — a letter of intent and terms of exclusivity. The groups should agree to confidentiality — a letter about confidentiality in sharing practice information and its use only for purposes of merger negotiations. The groups should gather and organize data—practice documents, financial information, physician interviews and surveys to identify merger concerns. These documents should be organized and prepared for future meeting discussions (Latham).
After the documents are signed, the toughest process begins: integration. Do not stop working the process once the merger is in motion. The first six months of the merger are crucial to success. Communicate frequently. Don’t avoid conflict early on. Dealing with issues early will be much easier than dealing with them later on. Once the deal is finalized, a clear and shared vision for the implementation should be developed. The creation of the vision should involve the staff as much as possible. They need to feel a part of it, not just a product of it.
Stay focused. Have those crucial conversations that are high emotion and high stakes. Someone, such as a manager, needs to closely watch the clinical financial performance. Test policies and procedures, payer numbers, practice billing, claims filing and collections systems. New employee staffing and management plans need to be discussed and laid out. Physicians’ time must be spent doing physician work while other clinical or non-clinical duties are delegated to others. Keep in mind that sometimes to increase a physician’s productivity, staff must be adjusted (Commins).
Major components in the integration process will be to minimize the unknowns, reduce anxiety and prevent misunderstandings. Even the little concerns (how we do things, how we feel about things, or how we deal with things) need to be negotiated and agreed upon ahead of time. Strong and effective leadership, both with the physicians and management, will get problems resolved. The management leader needs to focus on goals, staff need to do their jobs and not be allowed to question every decision, and physicians need to withdraw from day-to-day operations so the manager can do his/her job (Mertz).
Tinsley and Havens’ book contains a section on testing new operations, policies and procedures. This comprehensive list contains items to watch and review for overall systems and facilities, billing and collections, and daily operations, such as appointments and scheduling.
Caren Baginski describes four common post-integration issues that occur and how to address them. 1) Harmonizing the work culture — the most common issue after a merger. It is important for all employees to participate in the process. Leadership needs to concern themselves with the human factors between physicians and staff, i.e. interactions and attitudes. 2) Significant others in the work place — deal with these relationships before integration. 3) Unexpected delays and surprises — always plan for some unplanned events to occur after integration. Things will change in healthcare. Expectations will not always become realities. Don’t look to blame everything on the merger. 4) Lack of attention to build a new patient base — don’t forget to market. There will be reasons patients won’t follow the physicians into a new practice. They may not agree with the merger or have loyalties somewhere else.
A wholly integrated system will take several years to emerge and mature. The long term success of the merger will depend on the motivation, time and effort put into the merger from the very early conversations to a fully operational practice. The success of the venture is essential to the many stakeholders who depend on the viability of the medical practices. This includes not only the owners, physicians and employees but also the community and the patients.
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ASPR Journal - Fall 2011
Editor: Judy Brown, FASPR
Associate Editor: Lori Jackson Norris, FASPR
Publisher: Laurie Pumper