The Anatomy of Rural Health System
Affiliations
David C. Hoffman, Ph.D.
Introduction
Five years after federal health care
reform fizzled on the launch pad, the industry continues
to be in a state of dynamic flux, driven primarily by
market forces. Aside from the passage of the Balanced
Budget Amendment of 1997, and its implications for shifting
Medicare into the risk arena, there has been little
in the way of major governmental initiatives set in
motion -- at least nothing substantial enough to warrant
the spate of mergers, consolidations and strategic alliances
that continue to involve rural health care systems with
each other and urban partners. As is typical of most
consolidating industries, mergers and affiliations in
the health care sector appears to be driven by some
common themes: the "regionalization" of health care
delivery by large and well-capitalized provider systems;
limitations on capital resources; the need for various
forms of technical, clinical and management support;
and maturing managed care markets.
Questions still abound regarding the
scope, reasons, and the necessity for all types of business
partnering arrangements. Rural hospital governing boards
especially whether a partner is needed, or whether they
can continue to "go-it-alone." The answers to these
questions can be complex, bringing into play financial
and market factors, the desires of the local medical
staff, and sensibilities of the community.
This article focuses on the concept
of affiliation between rural and tertiary health care
systems and it is designed to help rural systems as
they ponder the need and desirability for strategic
partnerships. The intent is not to be prescriptive,
but rather to provide guidance and suggestions for rural
systems whose circumstances make it necessary for them
to consider this type of relationship.
Affiliation Defined
The term "affiliation" is open to misinterpretation
and often construed to mean a single type of corporate
relationship between business partners. Often, affiliation
is inferred to mean the most intimate of corporate business
relationships -- merger with or acquisition by the other
partner -- when such a relationship is not desired or
needed. The continuum of affiliation relationships is
depicted in Figure 1 demonstrates that a broad range
of relationships can be formed. Short of merger, affiliations
can range from simple contracts for vended services
to complex ventures involving capitalization of multiple
service lines. The choice of "landing spot" (or spots)
for the rural system on the continuum depends on resource
needs, and how well it can negotiate with potential
partners.
What's Driving Affiliations and
Consolidations?
Market forces are still the most common
drivers for most rural hospital affiliations. Competition
in urban areas and geographically broad-based managed
care contracting strategies are bringing rural service
areas into the marketing cross hairs of regional providers.
What may have once been an easily defendable rural health
care market area is now more vulnerable, as well-capitalized
tertiary care systems look for new business opportunities
and access points. To survive among their own competitors,
tertiary systems are creating broader delivery platforms
-- including both physicians and hospitals -- and mining
new markets for referrals and managed care contracts.
The decisions of rural primary care
physicians to seek affiliation partners weigh heavily
in the plans of the local hospital to also seek some
form of alliance. Under separate but parallel pressures
to stabilize income and patient bases, rural physicians
&emdash; especially primary care physicians &emdash;
are either seeking or are being sought by regional systems.
Because of the strong influence of primary care physicians
on local referral patterns, the affiliation of the local
primary care base with a regional partner often dictates
the affiliation choices for the local hospital.
How Regional Systems Move Into Rural
Markets
Competitive pressures in urban markets
are forcing regional systems to move out of their traditional
confines and establish service relationships and delivery
capacity in key rural markets. Typically, geographic
expansion occurs in areas that are experiencing economic
and population growth. Common strategies include securing
lines of referrals, through the acquisition of part
or all of the local primary care physician base in a
key community; and sometimes, but not always, affiliation
with the local hospital. In markets that have become
geographically "hot," a regional provider might build
new or expanded facilities to support and promote new
services; including, outpatient surgery, imaging, and
other diagnostic and therapeutic services.
Regional Strategies Can Create Vulnerabilities
and Opportunities for Rural Systems
Properly structured and negotiated,
regional-rural affiliations can enhance local services,
preserve and more wisely use local capital resources,
and bring significant value to rural communities. Few
regional systems design their strategies with predatory
intent. They are merely trying to better position their
own system. Unfortunately, intent means little to the
rural system that loses its market in the process. The
message conveyed here is important and not so subtle.
Regional systems do not necessarily need to preserve
the local rural hospital in order to achieve their business
objectives. The challenge to a rural health system is
to make themselves indispensable to the regional system's
success in the rural service area and to influence how
a regional system enters the market. To meet this challenge,
rural systems must have strong financial and operating
performance.
Taking Control of and Crafting the
Affiliation Relationship
In considering affiliation relationships,
merger or consolidation are not be the only options.
Depending on local circumstances, rural systems can
retain significant local control of governance and assets.
Figure 2 illustrates an example of a non-merger joint
venture involving a rural referral center and a regional
tertiary care system. Rural systems can and should influence
and control the entry of the regional system into the
local market, to the advantage of the community. This
requires a preemptive look at affiliation before there
is a critical economic and operational need to do so;
and the willingness to enter into significant financial
and service relationships, short of corporate merger.
Ironically, financially strong hospitals are not usually
pre-disposed to seek partners -- at least not in the
short-term. However, shifts in utilization, coupled
with changes in reimbursement and major market initiatives
from regional providers can change the picture rapidly,
making long-term survival problematic.
Decide and Act
Affiliation timing can be critical.
Once a regional system has secured its provider platform
in the rural area, it is less likely to need or want
another; and consequently, the effective bargaining
power of the rural system can be greatly decreased.
To maximize its bargaining position, a rural hospital
and its medical staff should act and initiate discussions
before a regional provider implements a strategy in
their service area without them. Rural providers need
to recognize that their negotiating "currency" is local
control of the local referral base -- especially the
primary care physician base. Using the latter as a bargaining
tool requires close cooperation between all elements
of the rural provider system &emdash; board, primary
care, and specialty physicians. This requires compromise,
leadership, and informed judgement about the characteristics
of the local health care market.
To make themselves indispensable, rural
systems must be able to link their need for improved
primary care and specialty service availability to the
regional system's need for greater tertiary care market
share. Meaningful affiliations intertwine the economic
and strategic interests of regional and rural systems
so that they are interdependent upon each other for
future success; and they do not necessarily require
loss of local governance. Affiliations can include contractual
arrangements to develop new services and single or multiple
joint ventures for new service lines (e.g., cardiology,
dialysis, oncology). However, the form of affiliation
is generally less important than its substance. To be
successful, each party must have enough at risk strategically
and financially so that they take the alliance seriously
(i.e., a minimum of 20- 30% of each partner's potential
local business is a good benchmark). Affiliations that
fail to create substantial risk and reward, for example,
vended services-only relationships, encourage neglect
of the venture and make it too easy for either party
to walk away.
Figuring Out Where You Fall on the
Continuum
Too often, placement on the alliance
continuum is based on the degree of partner-to-partner
integration that meets the psychological "comfort level"
of the organization, rather than the degree of integration
necessary to achieve the most competitive advantage
in the market. From a business perspective, optimal
positioning on the continuum requires an honest assessment
of the rural system's ability to: 1) control its own
geographic service area in terms of physician referral
and critical patient volumes; and 2) provide the necessary
capital to fund its critical strategic activities.
Most affiliations based on one or more
of the following needs:
- Some form of clinical or management
expertise
- Access to markets or managed care
products
- Access to capital
Affiliations formed to share expertise
or markets seldom require or achieve higher orders of
affiliation. Most forms of clinical and managerial expertise
can be negotiated on a contractual basis through vended
arrangements between rural hospitals and regional tertiary
care systems. Participation in rural hospital networks
and alliances which function as shared services organizations
are extremely useful in obtaining these services. Joint
ventures -- of various types -- usually governed by
separate corporate or partnership agreements that are
negotiated between the alliance partners, rarely have
any affect on local governance. Affiliations begin to
involve governance issues when loans, long-term debt
guarantees, or other financial arrangements are part
of the relationship. However, even in the case of loans
and the guarantee of debt, merger or sole corporate
member sponsorship arrangements are not necessarily
required. Often, in exchange for loans or debt guarantee
the parties may agree to a limited board representation,
or some form of reserved powers that ensures the capital
contributor that they can effect key decisions concerning
their financial contribution.
More than one form of affiliation relationship
may be necessary to compete effectively; drawing from
multiple points on the continuum and with more than
one partner (e.g., contractual relationships for specialty
services coupled with a joint venture in an ambulatory
surgery center).
Ensuring a Successful Affiliation
Affiliations fall short of their objectives
for a variety of reasons. The following check can help
to ensure that your efforts are on track:
Be certain that:
- The reasons for the affiliation
are sound and understood by all stakeholders (i.e.,
board, medical staff, administration, community)
- The business purpose of the affiliation
is "solution-oriented" and addresses the critical
problems that need to be solved
- The needs of local physicians are
and their professional concerns are understood and
considered
- Key physician leaders are involved
and play an active role in designing the affiliation
- The relationship between the partners
creates sufficient risk and reward incentives for
all parties
- The risk and reward incentives are
properly aligned and do not preferentially favor a
single partner
- The affiliation is sufficiently
capitalized to achieve its objectives
- There is sufficient leadership commitment
&emdash; from hospital partners and physicians &emdash;
to promote the affiliation objectives
- The structural form of the affiliation
is flexible enough to change and build upon as working
relationship develops
- There are not competing strategies
by one or both partners that could undermine the affiliation.
-
The current pressures affecting rural
providers are likely to continue. While not every rural
system will find it necessary to partner with a tertiary
system, many will find it necessary to consider some
form of non-merger alliance to meld local community
and regional provider interests. The need for a strategic
business relationship between health care partners is
dictated by the characteristics of a specific market
and the financial circumstances of the partners. A thorough
understanding of these factors and a careful analysis
of the need for an affiliation can help to ensure that
the best decision is made.
* * * * * *
David C. Hoffman, Ph.D. is President
of Hoffman & Associates, Ltd., a Wisconsin-based
health care consulting firm that
specializes in designing affiliations between urban
and rural health systems. He can be reached at 608/437-7440.
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Figure 1
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