Independent hospitals have successfully faced difficult circumstances in the past, but new challenges are pushing the hospital industry onto more difficult footing. Fundamental, long-term industry challenges, including competitive disadvantages in size and scale, limited access to capital and competition for and with physicians, have increased the need for independent hospitals to re-examine their operational and financial strengths and weaknesses. In addition to these historic challenges, the industry also faces sweeping regulatory and third-party reimbursement changes as the focus increases on reducing cost, increasing quality and adjusting to outcomes-based payment structures. Combined, these challenges are contributing to wide-reaching changes in the American health care delivery model.
A Measured Approach
Independent hospitals should develop a proactive, strategic approach to address these challenges. As health care leaders know, an ounce of prevention is worth a pound of cure, but when related to strategic planning in the current environment, the phrase should be “an ounce of proactive planning is worth a pound of reactive effort.” An assessment of the hospital’s current position and strategic objectives is the foundation on which a comprehensive plan to provide health care in the community can be built.
After assessing its current operating and financial condition, the hospital should ask some fundamental questions. Can the hospital’s operations be sustained and enhanced under its current structure? If not, what options are available to the hospital? Some hospital leaders can answer in the affirmative and quickly move on to enhancing the hospital. However, leaders at some hospitals will answer in the negative or with significant question marks, and those leaders should be aware of the broad range of available options. Providing health care under America’s changing delivery model may look different depending on a community’s specific needs and characteristics and those of its hospital. National market and reimbursement forces are encouraging some independent hospitals to explore relationships with other hospitals and health systems.
Strategic relationships in the hospital industry are taking a variety of forms, from loose affiliations to acquisitions. However, no relationship is one-size-fits-all. Every hospital has strengths, weaknesses, opportunities and threats. Through the wide range of collaborative relationships and transaction types and a managed negotiation process, many hospitals can reach an agreement addressing weaknesses and using strengths. The following diagram provides an overview of the most widely used organizational structures, along with the degree of control retained by the community and strategic benefit to the hospital.
Choosing to remain unaffiliated provides local control and community-based decision making. However, some unaffiliated hospitals may struggle to manage issues associated with lack of operational and financial scale and scope. Merging with or being acquired by another organization can provide significant operational and financial opportunities, but typically leads to significant loss of independent decision making for independent hospitals. Affiliations, joint operating agreements (JOA) and leases, found near the middle of the diagram, provide opportunity for hospitals to both maintain a measure of independence and gain operational and financial scale and scope.
Affiliations include a range of potential transaction structures, from loose cooperation agreements to virtual mergers. Most loose cooperation agreements are based around operations and patient care and can be unwound by either party at almost any time. Strong affiliation agreements, often cited as virtual mergers, typically build on a base of operations and patient care items to include financial and governance components. There are examples in the marketplace where strong affiliations contained significant financial components, including broader access to capital markets, funds for renovation or expansion, cost savings from shared back-office services and other financially beneficial arrangements. These virtual mergers can include a high degree of clinical integration, and strategic governance is typically collaborative while maintaining overall governing board independence. Financial, work force, material property acquisition and disposition and other broad strategic decisions are often shared by a joint board or by ex-officio board representation among the affiliates’ boards.
Joint Operating Agreements
A JOA typically provides a stronger financial footing for an undercapitalized hospital or a hospital seeking operational resources, while allowing the hospital to retain a separate board of directors and identity. The JOA allows hospitals to coordinate patient care services, financial decisions, construction and the purchase of strategic fixed assets, while allowing the hospitals to maintain some of their own policies. Under a JOA, religious hospitals can gain many of the benefits of a non-religious health care system and still retain their religious association. The converse applies to a community hospital executing a JOA with a religious system. Typically, the stronger of the hospitals or a new joint operating company is charged with operational responsibility, but assets and liabilities continue to be maintained separately, and the hospitals continue to be individually governed.
Fixed assets and related liabilities are maintained by the lessor under a lease agreement, but strategic governance and operation of the facility is vested in the lessee. Lease agreement negotiation is a critical factor in crafting a positive outcome for the community. Through the negotiation process, the hospital board could negotiate a broad range of items including continued or additional health care services for the community, contracts for key employees, initial staffing level commitments and the transaction price structure. The structure of the lease includes at least the term and lease rate, but might also include the purchase of furniture, fixtures and equipment and working capital, assumption of some assets, liabilities and contracts, a loss-share agreement, a no-shop clause, a right-of-first-refusal clause or a purchase option.
Risk Management & Planning to Succeed
Even as they are influenced by market forces, hospitals must be acutely aware of the risks associated with these strategic moves. Most leaders see the potential pitfalls in a tightly binding agreement, but even loose, informal relationships should be carefully considered because of their potential far-reaching effects. For example, moving to formalize an agreement with one organization could negatively impact a hospital’s relationship with other friendly competitors.
In addition to managing risks, hospitals must focus on planning for success. No strategic move should be taken without proper planning and guidance—this is a clear instance where failing to plan is planning to fail. Assuming the organization has objectively and proactively assessed the opportunities and threats to the hospital and health care in the community, there are three broad steps before moving toward a potential relationship:
1) Establish goals for the relationship that are specifically identifiable with the hospital’s goals and community needs.
2) Form a team of board members, executives and experienced outside advisors to guide the process.
3) Create agreed-upon, phased decision points throughout the process.
Once these steps are complete, the organization can identify a list of potential candidates for a relationship and negotiate an agreement with the most appropriate relationship structure based on the goals of both parties.
While a specific outcome is never assured, a proactive, strategic discussion and approach by community health care leaders is the best option to ensure their community health care needs are met for years to come. For more information about strategic hospital relationships, contact your BKD advisor.