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American Association for Physician Leadership
American Association for Physician Leadership

Trends in Medical Practice Mergers

by Nick Hernandez, MBA, FACHE

February 8, 2019


Summary:

Recent years have seen a noticeable increase in practice mergers among physician groups.

The ever-evolving reform of the U.S. healthcare industry has provoked a lot of uncertainty among private practice physicians. Some practices are content with no organizational changes, whereas some have decided to be acquired by hospitals. Others have gone the route (or are pondering it) of merging with another private practice, either in the same specialty or a different one.



Abstract:

As I work with physician groups throughout the country, I am often asked, “What is the secret recipe for successful practice mergers?” To be honest, like most things in life, there is none. A well-etched strategy, an astute management team, and an eye for details are what lead to a successful merger. Although strategy is important for most mergers, cultural compatibility is the soul.

Many physician group mergers happen every year. Some of them gather media attention, whereas others just happen with no fanfare. But that’s not what is important. What actually matters is how many of these stand the test of time and how many remain a memory, at best. Before investigating further, let us first try to comprehend why mergers happen in the first place. Why do two independent entities come together to forge a new relationship when they can make it on their own? Mergers can be risky if approached haphazardly, and one miscalculation can cascade into huge financial losses.

##Five Reasons Behind Practice Mergers

Although physician group mergers can have a profound impact on the business, too often practices view the merger itself as the strategic end game. The goal of any merger is primarily creation or enhancement of value. These are business combinations, and the reasons behind physician group mergers are based on economic elements.

Increased Capacity

One of the most common driving forces of a merger is to increase capacity through combining forces. Physician groups usually make such a move to leverage expensive practice operations. However, “capacity” might pertain not only to practice operations; it may, for instance, emanate from procuring a unique technology platform instead of the practice having to finance the technology.

Achieving Competitive Edge

Let’s face it. Competition is cutthroat. Without adequate strategies in their pool, physician groups will not survive this wave of healthcare transformation. Many physician groups take the merger route to expand their footprints in a new market where the partnering physician group already has a strong presence. In other situations, an attractive brand portfolio lures physician groups into mergers.

Surviving Tough Times

Tweaking the adage, let’s say, “Tough times don’t last; tough physician groups do.” The healthcare industry is going through a phase of uncertainty, and combined strength is always better in tough times. When survival becomes a challenge, combining is the best option.

Diversification

Sensible physician groups do not believe in keeping all of their eggs in a single basket. Diversification is the key. By combining their providers and services, they may gain a competitive edge over others. Diversification is simply adding products (i.e., providers, services, and technology) that are not part of current practice operations into the portfolio.

Cost Cutting

Economy of scale is the soul of most businesses. When two physician groups are in the same specialty, it makes sense for them to combine locations or reduce operating costs by integrating and streamlining support functions. This provides a large opportunity to lower costs. The math is simple here. When the total cost of patient care is lowered while volume is increased, total profits are maximized.

##Making the Decision to Merge

Mergers represent a challenging and risky strategic decision. The decision to merge should be fully challenged before physician groups decide to go ahead, particularly given the average performance of the returns and risks associated with the potential outcomes. Even with thoughtful planning and preparation, best practices, and focus, success is not guaranteed. However, applying best practices should enhance the chances of success and help avoid catastrophic pitfalls.

Identifying the Right Reasons for a Practice Merger

Like every long-term relationship, it is imperative that physician group mergers happen for the right reasons. When two practices hold a strong position in their respective arenas, a merger aimed to enhance their position in the market or capture a larger share makes perfect sense. However, practices often fail to realize this. Many physicians consider a merger as a last-ditch effort to save their flagging position. Combining forces can augment their footing in the market and lead to a successful merger.

Have an Eye for Risks

A merger is an extremely significant move for each of the physician groups involved. It is a tightrope walk, and even a small slip can pour millions of dollars down the drain. Timely identification of weaknesses, risks, and threats, whether internal or external, can save huge costs and effort. Internal risks can include cultural friction, potential layoffs, low productivity, or power struggles at the helm. External risks may include a low acceptance by patients of service lines garnered through collaboration, sudden changes in market dynamics, regulatory changes, and so forth. Although it is not possible to predict the future perfectly, precision in dealing with such potential risks is a must.

Cultural Compatibility

Although absolute cultural congruency is not always possible, it is advisable to find the closest fit when planning a merger. Both physician groups must recognize their similarities and, more importantly, acknowledge their differences. Then can they strive to create a new culture that reflects the core beliefs of the practice. The creation of a brand new identity with employee support leads to a sense of belonging and inspires continued efforts towards a shared goal. Thus, staff can be engaged in a new culture, new goals, and a new future.

Maintaining Leadership

As much as it is required to identify the correct reasons for a merger, it is equally important to retain the correct people after the merger. The success of a merger hinges on a seamless transition and effective implementation of post-merger tasks. Many physician groups take too long to set their key leadership in place, thus creating confusion and apprehension. Choosing whom to retain and whom to let go is a dicey game, but this is where judgment and skill play a role. If the pillars of each physician group are selected judiciously and retained, the path becomes easier. If employees feel out of place from the beginning, they may drift away, leaving a big vacuum in the newly merged practice.

Communication Is the Base

Studies have shown that management of the human side of a merger is an important factor in maximizing the value of the deal. Effective employee communication and culture integration are difficult to achieve, but they have maximum importance in the success of the merger. Presenting the decision to merge at the appropriate time helps to reduce a lot of uncertainties in both the pre- and post-merger stage. Uncertainty leads to speculation and weakens trust. Grapevine conversations result only in loss of productivity. The more open the communication, the better it is for everybody.

Successful Integration Is Critical

Life comes full circle after the merger has been implemented. Identifying concerns at the pre-merger stage is just one side of the coin. It is the post-merger implementation that decides the fate of the new entity (this will be addressed in a future article). It is how the newly formed relationship is nurtured. There is stress about performance in core business areas in the new, changed circumstances, and the time pressure is tremendous. Unlocking synergies quickly and obtaining support from key personnel is critical at this juncture.

##Physician Practice Merger Considerations

For a merger to be successful, it is critical in the pre-deal phase to carefully identify, capture, and price the potential cost and revenue synergies. Although valuing synergy requires assumptions about future cash flow and growth, the inexactness of the process should not be a deterrent. With due diligence, it is possible to obtain an unbiased estimate of value. Moreover, when assessing a deal’s assigned value (market value plus the premium) it is important to understand that pricing should be set based on both operational impacts (e.g., cost savings and economies of scale) and financial impacts (e.g., lower cost of capital, higher return on investment potential, and potential for a lengthier growth period from increased competitive advantages).

##Projected Synergies

It is important to understand synergies and valuation, because many mergers have the potential to reduce the cost of operations. In general, it is much easier to cut costs than to attempt to increase the revenue of a practice on its own. When similar practices merge, they are presented with an opportunity to improve savings through expense reduction strategies such as optimizing operations and lowering redundancies. Skillful implementation of cost-cutting measures and combining redundant departments can reduce training and turnover expenses while also helping to promote employee loyalty. Arguably the biggest error in planning mergers is overconfidence in projected revenue synergies. It is difficult to project revenue synergies because in most cases they are matters of speculation, and manifest themselves in many different ways. Ideally, the merger should help improve market reach and permit better negotiations with payers. The new practice now encompasses a larger catchment area, where revenue increases can be realized by increased patient volume, which, in turn, can boost provider productivity in the long run.

Despite these benefits, projected benefits must be carefully considered and priced before any transaction, because overly rosy visions of the combined practices’ future can lead both physician owners and managers astray. To be sure, there will always be uncertainty surrounding future growth. However, qualified healthcare consultants should attempt to make the best estimate of how much value cost and revenue synergies will be created in any merger before advising the parties to proceed.

Performing such a benefits valuation is significant, even though doing so requires the consultant and practice owners to make assumptions about an uncertain future. Failure to perform the lengthy but necessary due diligence will result in mergers that are dead on arrival, no matter how they are managed after the deal is complete. Realizing these future collaborations requires significant management actions—the core driver of a merger must be a marriage of sound management philosophy and the implementation of force multipliers. Without both, there is no foundation for the merger.

##Strategic Diligence of Physician Practice Mergers

The decision to buy, sell, or merge a medical practice is more complicated than ever, and determining a medical practice’s worth is just one of the crucial elements in this process. For those who are considering merging with another private practice, there are many things to strategize about—and that is assuming that such a merger will provide a windfall of benefits.

Physician-owners must have a clear rationale for a transaction or truly understand a deal’s impact on their practice’s long-term financial future. Too often, however, there is a misguided sense of why the merger should take place at all, and far too little time is spent defining how the merger enables the new entity to beat competitors and increase organizational value. Those who fail to take this into account contribute to the failure rate of physician group mergers.

For many physician groups, the link between strategy and a transaction is broken during due diligence. By focusing strictly on financial, legal, tax, and operational issues, the typical due diligence around a proposed merger fails to test whether the strategic vision for the deal is valid. Physician groups should bolster the usual financial due diligence with strategic due diligence. They should test the conceptual rationale for a deal against more detailed information that becomes available to them after signing the letter of intent. They should also see if their vision of the future operating model is actually achievable.

The aim of a merger should be to achieve mutually reinforcing advantages.

A strategic due diligence should explicitly confirm the assets, capabilities, and relationships that make a buyer the best owner of a specific target acquisition. It should bolster the physician-owners’ confidence that they are truly an “advantaged buyer” of an asset. Advantaged buyers typically are better than others at applying their established skills to a target’s clinical and business operations. They also employ their privileged assets or management skillset to build on things such as a target’s practice reputation, patient experience, or relationships with referring physicians. Naturally, they also turn to their special or unique relationships with vendors and the community to improve performance, leading to advanced synergies that go beyond what’s normal.

When change comes suddenly, it can turn strengths into weaknesses and sweep away dreams of success. The aim of a merger should be to achieve mutually reinforcing advantages. Michael Porter wrote that competitive advantages stem from how “activities fit and reinforce one another. . . . creating a chain that is as strong as its strongest link.”(1) By undertaking strategic diligence, physician owners will be able to not only define their main objectives, but also gain greater control over the desired direction of the new entity after the merger is consummated. Some of the strategic diligence questions to ponder include:

What are the strengths of each practice?

What could our practice be doing better?

What opportunities exist as a result of this merger?

What threats do we face by completing this merger?

What is the current culture of each practice?

It is critical for physician-owners to be honest and thorough when assessing their advantages. Ideally, they develop a fact-based point of view on their beliefs—testing them with anyone responsible for delivering value from the deal, including physicians, physician extenders, clinical staff, and front and back office personnel.

Physician group mergers must take place for strategic reasons, such as improving competitive capabilities, expanding footprints, achieving economies of scale, increasing patient base, testing new geographies, and enhancing brand equity, rather than superficial reasons such as tax benefits or to protect oneself from market risks. A physician group merger must be considered as a means to fulfill far greater strategic outcomes rather than a mere end in itself. Above all, when it comes to the merger of two physician groups, culture is a key decision criterion. Culture should be evaluated and discussed prior to any financial considerations. This is of paramount importance for practice-to-practice mergers, and it is meticulously examined only through strategic diligence.

Reference

Porter M. What is strategy? Harvard Bus Review. November-December 1996:1-21.


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