In the last 30 days, medical device and drug megadeals involving more than $170 billion have dominated headlines:

  • Zimmer Holdings (the second largest orthopedic device manufacturer) agreed to acquire Biomet (No. 4 in orthopedic devices) for $13.35 billion — the biggest device deal since the 2012 Johnson & Johnson acquisition of Synthis for $21.2 billion.
  • Novartis and Glaxo Smith Kline announced a $20 billion deal to swap assets strengthening the core businesses in each organization.
  • Valeant’s $45 billion hostile bid to acquire Allergan and its Botox franchise, financed in part with Pershing Capital, continued to get attention.
  • Pfizer announced a $99 billion deal to acquire Astra Zeneca.

The health care industry is accustomed to deals. In our communities, consolidation of physicians with hospitals is standard fare. Hospitals are integrating with long-term care providers and merging with peers to achieve scale in regional systems. At a national level though, our industry lags banking, investment banking, airlines and discount retailing where a few global players dominate activity. Relative to these, health care remains a highly fragmented industry in the United States: 4,000 biotech companies, 6,000 medical device manufacturers, 5,200 hospitals with more than a third independent/nonsystem-affiliated; 397 insurance operators; and 880,000 physicians  — 70 percent of whom are in small, independent practice settings. Granted, some bigger players are playing bigger roles ….

  • 25 percent of U.S. hospitals are now owned by investor-owned multihospital systems and only one in three hospitals is independent. The deals are accelerating — Community Health System’s pending acquisition of HMA; Tenet’s acquisition of Vanguard; the merger of Trinity Health System and Catholic Health East, and so on. 
  • Drug distribution is dominated by three major players — McKesson, Cardinal and AmerisourceBergen.
  • More than 80 percent of the insured population is covered by one of the big investor-owned plans or one of 37 Blues.  

What does it all mean for hospitals?

Tougher negotiation in the hospital supply chain. The Congressional Budget Office forecasts health spending to increase 5 percent this year and for the foreseeable future — good news! More dollars in the system! But in the first quarter of 2014, aggregate health spending increased 9.9 percent — so resurgent concern about health costs looms large for hospitals. These megadeals mean higher supply chain costs and tougher negotiations in pricing for drugs, devices, technologies and disposables. They mean our GPOs may or may not be able to deliver more purchasing clout in their contracts with global powerhouses that dominate certain drug and device classes. So these deal sectors are part of a larger story about the ability of biopharma and device manufacturers to increase their leverage in the domestic market while expanding globally.

Increased interaction with private equity as a key player in deal financing. Private equity-backed deals will be a permanent part of the health care picture going forward. It’s a $3 trillion industry. Four of the biggest names have gone public — KKR, Carlyle, Blackstone and Apollo. Their capabilities and methods in deal financing, restructuring, management and acquisitions are central to the industry’s transition from fragmentation to scale and growth. While many in the industry will continue to depend on borrowing as their primary capital source, the solvency, liquidity, and costs for debt will increase. Thus, through strategic relationships including private equity-backed deals, the health industry’s appetite for capital increasingly will include the role of private equity. The skill sets, therefore, of our chief financial officers and the experience, independence and expertise of each board’s audit committee must be examined closely by leaders.

Regulators will pay closer attention. As stewards of the public’s demand for fair competition and limits on monopolistic behavior, the Department of Justice and Federal Trade Commission’s enforcement efforts will be focused sharply on health care. And the federal government has a second lever to police the health system: Spending for Medicare, Medicaid, the Children’s Health Insurance Program, Federal Employees Health Benefits and military health is 28 percent of the federal budget. As a result, the federal government can leverage its role as a major purchaser through policies and laws that change its structure and performance. The Medicare Prescription Drug Act of 2006 and the Accountable Care Act are prominent in our current regulatory landscape; other laws or regulations will follow. Fraud, conflicts of interest, unnecessary care, comparative effectiveness of drugs, inducements, predatory pricing, workforce rules, access to personal health information, medical tourism, scope of practice, accelerated transition to value-based reimbursement and many other issues on the horizon likely will be marked by federal legislation that changes how we operate. The net effort of the industry’s consolidation is a steady transition to a bigger federal role and, with it, enormous new importance to the role of the chief compliance officer, legal counsel and board leadership.

Profitability, executive compensation, board conflicts and transparency in business relationships will be in the spotlight. The U.S. health system has had enormous success in being profitable for the past four years: Among the Standard & Poor’s 10 industry sectors, health care and energy stand out for impressive profits during the 75 months since the economic downturn. The spotlight will be on the health care industry’s profitability: the adequacy of operating margins to fund indebtedness and creditworthiness; and with it, a sharp focus on how management is compensated, and boards composed. Profit remains a sticky issue in health care: All expect the latest technologies, modern facilities and best drugs; most understand that it takes capital to fund these, but a vocal and growing number question whether our profits are a means to an end or an end in itself. The recent release of the Medicare Physician Database adds fuel to the fire. Profit that’s purposeful and transparent is a business imperative for every player in the U.S. system, whether comfortable or not. And, as hospitals seek to achieve scale, partnerships and business relationships will be covered widely by media and scrutinized with renewed vigor by state and federal regulators.

I try to understand how industries operate and their market leaders sustain their positions. The $35 billion deal pairing cable operators TimeWarner and Comcast was a response to growing competition from noncable operators like Netflix. The combination of advertising giants Omnicom and Publicis is a response to competition from online advertising giants like Google. Wal-Mart recently announced it was entering the banking industry with its cash wiring business sending its vendor, Moneygram, packing. Facebook, Apple and Zynga announced impressive first quarter 2014 results calling attention to their mobile market opportunities. And Barnes and Noble’s operating losses for the third year in a row resulted in additional store closures as the company continued to struggle with the Amazon factor. The common threads to all these: big players executing strategies in light of changes in their competitive landscapes. They navigate regulatory hurdles, structure deals that enhance synergies from combinations and sustainability or revenues, and the dynamics of their supply chain costs, even if it means vertical integration or sole sourcing to achieve more predictable costs.

I have no doubt that the health care industry is on the brink of massive consolidation. The notion that “all health care is local” is being replaced by “most health care is delivered locally.” These megadeals in the device and biopharma sectors impact every hospital directly.

Access to capital, leaders who are competent to manage complexity and confident to recruit talent that’s unafraid to bring new competencies and ideas, and boards prepared to understand the organization’s future objectively are as essential to hospital leadership as in every other sector.

Yogi Berra said, “It’s hard to make predictions, especially about the future!” In health care, it’s not hard to see that we have to change. And it’s easy to predict more big deals in every sector of our industry.

Sources:;;;;;;; Morningstar; Standard and Poor’s; Paul Ziobro, “Wal-Mart Dives Deeper into Banking,” The Wall Street Journal, April 18, 2014; Elizabeth Harris, “Wal-Mart Will Enter Cash Wiring Business,” The New York Times, April 18, 2014; Jeffrey Trachtenberg, “What’s Barnes and Noble’s Survival Plan?” The Wall Street Journal, April 17, 2104.

Paul H. Keckley, Ph.D.,  a health economist and leading expert on U.S. health reform, is managing director at the Navigant Center for Healthcare Research and Policy Analysis. His H&HN Daily column appears the first Monday of every month. He is a member of Health Forum's Speakers Express. For speaking opportunities, contact David Parlin.