Target hospitals may see a small savings, but not nearly as much as promised. Acquiring hospitals are likely to see none at all.
The flurry of M&A activity has been driven, in large part, by the promise of cost efficiencies, with CEOS and hospital boards holding on to the idea that buying power simply must increase with the hospital system’s size.
But CEOs and boards might want to reconsider that assumption, as new research by the National Bureau of Economic Research suggests the gains are marginal, at best.
With M&A activity continuing at a brisk pace, and standalone hospitals finding it harder to survive on their own, the potential for cost savings might be more hype than reality. The hospital or system being acquired (or target hospital) can expect to save, on average, $176,000, or 1.5%, annually, according to the research.
That is still not a huge savings, but the data suggests that—at least as far as cost efficiencies on supplies—an M&A opportunity should be seen more as a good bet for the target than for the buyer.
The savings for target hospitals were driven by “geographically local efficiencies in price negotiations for high-tech physician preference items [PPI],” explains Ashley Swanson, assistant professor of health care management with The Wharton School at the University of Pennsylvania and coauthor of the paper addressing the marginal cost efficiencies of M&A.
Those efficiencies result in a 2.6% decrease in costs for PPIs, which include expensive implantable devices for which physicians have strong preferences.
ZERO SAVINGS FOR SOME
Swanson and her colleagues studied the effects of horizontal mergers on marginal cost efficiencies, using data containing supply purchase orders from a large sample of U.S. hospitals from 2009 to 2015. The results were not the same as what health leaders often read in M&A proposals.
The data “translate into targets saving 10 percent of the amount that might be claimed in a merger justification, and acquirers saving 0 percent,” the report says.
The savings from PPI efficiencies at the target hospitals did not continue at the acquirer-level, where a 1.1% increase in PPI overwhelmed a 6.4% savings on less expensive commodities.
“We find no significant evidence that savings are mediated by supplier concentration, downstream market power, or standardization,” the report says.
PPI COSTS LOWER LOCALLY
At the target hospital, there is little effect on the cost of many products, but the cost of PPIs go down by about the same rate as within-brand prices on other items that happen at the time of the merger, Swanson says.
The decrease in PPI costs for target organizations is not related to utilization changes, she says, but rather the buying power of the larger entity coming in and shaving a little more off of the price previously negotiated by the target hospital.
Everything changes at the acquirer level.
“We see a very mixed-bag picture for acquirers. Costs at the category level seem to go down for commodity products and seem to go up for physician preference products. That’s a little curious because PPIs are big-ticket items, and you might think facilities or systems are going to go after them the fastest if there is a new opportunity around a merger event,” Swanson says.
She continues, “But when we look at mechanisms, it doesn’t seem to be driven by negotiation. It seems there is a shift in utilization post-merger for acquirers purchasing commodity-like products, rather than prices being negotiated downward.”
The differences in PPI expenditures surrounding a merger make more sense when considering how different the merger participants might be, Swanson says. The within-brand prices for PPIs increase about a half percent for acquirers post-merger, not a huge increase but certainly in the wrong direction.
That may be because the acquirer is already large enough that it doesn’t gain more stature from taking on the new hospital or system, but it does gain a handful of physicians who have strong preferences about what expensive items they use.
“It may be that the acquirers have already leveraged their scale to a great extent. They may already be paying lower prices, the lowest they’re going to be able to negotiate, when they acquire the next hospital,” Swanson says. “They may have already squeezed the orange as much as they can. The fact that they can’t gain any additional economies of scale from acquiring another hospital may not be that surprising, in that light.”
REALISTIC M&A EXPECTATIONS
This reality about supply cost savings may come as a surprise to some healthcare leaders post-merger, Swanson says. The promise of savings from economies of scale is always a big selling point when mergers are proposed, she says, right alongside a commitment to quality improvement.
Realistic portrayals will focus more on the cost savings at the target level, with the acquirer sharing its economy of scale with the smaller entity, she says.
The nature of M&A has changed over time, Swanson notes, with the 1990s seeing more local hospitals and smaller, within-market M&A activity. More recent years have seen more cross-market mergers and large multi-market systems acquiring hospitals, and that is driving these most recent effects on costs, she says.
The results might be different for targets and acquirers on a smaller scale in the same market, she says.
“Even though there is always a lot of focus on cost savings in merger discussions, I don’t think the large multi-market acquirers usually go into it expecting a major cost saving from the acquisition of a hospital. That they see none and even some negative effect might be surprising,” Swanson says. “I think this could be more surprising to policymakers and regulators.”
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