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Scaling up: good for healthcare system revenue, bad for net operating income

by John R. Fischer, Senior Reporter | October 28, 2019
Business Affairs
Smaller hospitals earned higher net operational
incomes in 2018 than larger hospitals
Scaling up may boost revenue but may not be the best move when it comes to raising a healthcare system's operating income, according to an analysis by Navigant Consulting.

The guidehouse company examined the earnings of 94 not-for-profit systems between 2015 and 2018, and found that smaller health systems earned more in net operating incomes than larger ones. It reported a significant negative correlation between size and profitability as providers expanded in size during this time period, a distinction from its report the year before, which found no such connection, according to Modern Healthcare.

"While executives may think that they can solve expense challenges through M&A activity, that isn’t always the case," Alex Hunter, managing director of Navigant, told HCB News. "Integration poses complex challenges, including figuring out which services belong in which facilities and how to best deliver those services across a health system. There are also cultural and political issues. Further, clinical synergies are difficult to realize for merging health systems, most notably the politics of service rationalization and issues related to integrating EHR systems."

Claimed synergies from mergers and acquisitions often are longer than expected and require a disciplined approach for controlling corporate overhead, clinical service integration and collaboration with physicians. Integration also creates cultural and political challenges, an example being when executives do not address if a poorly performing hospital needs to exist, and if the service line work enables sufficient operations.

"If the business model of a hospital is failing and it merges into a larger entity, that entity isn't going to wave a magic wand and make it better," Jeff Goldsmith, national adviser for Navigant and co-author of the report, said in a statement. "There really are not that many scale economies they can put their hands on."

Despite these negative findings around scale, operating margins rose 13 percent from their 2017 mark, with almost two-thirds of 103 for-profit and not-for-profit health systems experiencing improvements. Researchers attributed the rise to health system executives curbing labor and supply chain expenses, revenue growth, aligned operations and employed-physician management, reductions in redundant service lines, and expanded ambulatory networks to stay competitive.

The calculation, however, did not make up for the 38 percent average decline from 2015 to 2017, which resulted from mainly minimal (if any) return on complex risk-based contracts, a lack of resources for addressing the rise in Medicare and Medicaid beneficiaries, lower reimbursement rates, and increasing claim denials and declining collection rates.

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