Doctors in discussion during a conference

How the right M&A can help hospital CEOs cure shrinking margins

M&A is an important tool for US hospitals to address increasing costs and the continuing pressure to reduce reimbursements.

In brief

  • All but the largest hospitals have had negative operating margins.
  • M&A can help hospitals scale to meet changing patient dynamics.
  • Hospital executives can conduct a diagnostic to determine which types of M&A they should pursue. 

Hospitals in the US face significant margin challenges, driven by an ever-increasing cost of care and a relentless pressure to reduce reimbursement for those care costs. By contrast, payers are largely concentrated, and those same payers are also competing directly with providers as they extend across the value chain. The whole industry is looking for breakthrough innovation that can disrupt these dynamics and create a healthier, more innovative system of care delivery. In this environment, hospital M&A has an important role to play. 

Only 34% of health care executives say they expect to actively pursue M&A in the next 12 months, down from 60% a year earlier, according to the latest EY Capital Confidence Barometer. But CEOs might want to rethink M&A intentions now to improve their hospitals’ long-term growth outlook. Several factors could support M&A in 2021 and beyond, including low interest rates, vertical integration between payers and providers and the need for hospital systems to scale to compete.

We offer some suggestions for assessing specific needs, calibrating investment appetite, and deciding which M&A options are right for their organization.  

Hospital margins under pressure 

Hospital margins have been shrinking over the past several years. The average operating margin fell to 0.3% in 2019 from 1.8% in 2015, according to Kaufman Hall.

Drivers of margin pressure stem from rising labor and other operating costs and the increasing negotiating strength of managed care players. As hospitals shift care to lower-cost, outpatient settings (which is good for patients and our overall health economy), their individual margins often suffer. Hospitals also face new potential pricing pressures after being forced publicly to disclose their rates for the first time in 2021, a move intended to enable easier comparison shopping by patients and payers.

COVID-19, meanwhile, resulted in the delay or wholesale cancellation of elective procedures across a range of categories and caused patients to forego many regular health screenings altogether. This loss in volume, resulting in unexpected unrealized revenue, played out as hospitals also faced a slew of pandemic related costs. And the pandemic’s effects linger, with hospital revenue in 2021 expected to decline by at least $53 billion, according a a study commissioned by the American Hospital Association and as reported by Kaiser Health News.

Hospital margins have been shrinking over the past several years. The average operating margin fell to 0.3% in 2019 from 1.8% in 2015

At the same time, hospitals are responding to changing patient dynamics and the increasing demand to serve patients at home or in other settings, increasingly enabled through a digital experience. Ultimately, meeting patient needs in their daily, at-home lives, and pushing further into wellness (away from sick care) tend to be accepted elements of a solution to the ever-growing burden of national health expenditures on the overall US economy. In the short term, however, these moves come at the expense of our nation’s hospitals, who still derive economic stability from volumes through their doors.

Ratcheting up M&A is an option to lower costs and increase margins (see Figure 1) through economies of scale, capture broader patient volumes, enhance coordination of care delivery across the care continuum, and develop sustainable reimbursement solutions with managed care and corporate payers.

Only the largest hospitals, with operating margins averaging 6.6%, have comparable margins to the largest US payers (which ranged from 5.0% to 8.1% in 2019). The rest of hospitals actually had negative operating margins in 2019.


Payers consolidate, while also competing with hospitals


Gaining the strength of scale could be even more important for hospitals as payers consolidate (giving them more pricing power). 

The level of payer consolidation varies widely by market, though an American Medical Association study showed that in 2019, 74% of the combined HMO, PPO, POS and exchange markets were highly concentrated. Other data has shown that high payer concentration is associated with lower hospital prices. 

In the long run, convergence may be critical to enable the US to break away from the “pay for volumes” paradigm. In the meantime, health systems and payers can work together to find solutions that can work for sustainable economics today and bridge to tomorrow. Hospital M&A will likely play an important role as health systems (1) extend beyond the hospital to develop more effective solutions for care and wellness that the payer community should value; (2) increase their presence in provider-sponsored health plans to manage risk more effectively; and (3) invest, together with payers, in innovative solutions such as tech and analytics that can accelerate transformation toward new models of care.


Six steps to determining M&A viability


Hospital executives can take several steps to determine if M&A is a viable option and to examine what types of deals might be most advantageous for growing in a consolidating health care environment. 

  1. Conduct a financial checkup 
  2. Examine the competitive dynamics 
  3. Review reimbursement dynamics
  4. Consider demographic changes 
  5. Address outpatient migration 
  6. Look for M&A target opportunities

Explore different M&A deal types


Of the health care executives that expect to pursue M&A in the next 12 months, 64% say they are focusing on bolt-on acquisitions, according to the EY Captial Confidence Barometer. A bolt-on could be the right type of acquisition if it allows a hospital system to address skill sets such as digital care or gives patients more treatment options or locations. A more transformative deal may have its own benefits, allowing for healthier margins, heightened capacity fungibility, and other financial benefits. Perhaps most importantly, owning more resources along the care continuum and being able to provide the spectrum of services a patient might need gives a provider oversight across the patient’s care, which can lead to better quality of care. 

But health care is a highly local industry. Dynamics will differ by geographic footprint and different systems may require a different type of partner, so it is essential to understand what different deal types may deliver:

  • Consolidation of hospital peers or systems may reduce costs by increasing scale.
  • M&A with payers to construct provider-sponsored health plans (PSHPs) offer health delivery organizations the opportunity to capture the full dollar of patient care costs, enable revenue diversification, and provide an opportunity for systems to pursue value-based care models. 
  • M&A with an academic medical center can allow a health system to increase its scale and improve its regional brand presence as a provider of world-class, innovative care. 
  • M&A to acquire technology can help speed the development of new capabilities, such as artificial intelligence, data analysis and automation, that can improve both patient outcomes and hospital operational excellence.
  • M&A to expand across the care continuum also can improve patient outcomes by offering primary care, home health, rehab, post-acute and sub-acute care coordinated under one organization across the value chain.

How one health care center re-evaluated its growth priorities and selected M&A targets 

EY-Parthenon helped a New England-based academic medical system evaluate strategic opportunities for expansion and growth. The work included prioritizing settings of care by identifying both current capabilities and potential new ones.

The medical system was able to identify three to five priority settings after analyzing the payer mix, stand-alone unit economics, reimbursement outlook and value to the system from each.

Category-specific selection criteria were then identified for targets. The best selection criteria for each category was determined, with current market guidance from the system’s leadership team factored in. Targets were chosen and value cases helped enable revenue realization. The value cases included geographic analysis and a look at how expansion can be realized to enhance value to the system, including ability to address specific concerns about keeping patients in network. 

The result was that the system moved forward with an acquisition that fit the appropriate goals.

Kate Elfers, Shivam Jaitly and Navneet Dagar contributed to this article.


Many hospitals can benefit from M&A as they simultaneously try to offer patients different access to care, try to increase their negotiating ability with consolidated payers, and deal with new competitors from outside of traditional provider networks.

But M&A is not a one-size-fits-all solution. Hospital executives need to decide what they want to get out of a deal and which types of M&A will help them realize those strategic goals.

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