The healthcare industry has long relied on mergers and acquisitions to speedily scale up, despite warnings from experts. In fact, the academic literature in support of M&A as a source of long-term value creation across a variety of industries is generally disappointing.

And yet healthcare executives have been unable to resist the siren song of M&A, resulting in a historic merger wave that has left the industry more highly concentrated than any time in history.

There are few signs of the M&A craze slowing down. Luckily, there are ways for healthcare leaders to make smarter decisions about how to scale in an efficient way that results in financial stability and sustainability.

If you're considering jumping into the M&A fray, here are six lessons to consider.

Don't Scale up Just Because You Can

A healthy dose of skepticism is always required before any major M&A decisions. There are sound reasons to chase scale, and there are also dubious ones. A dominant rationale for healthcare providers' M&A activity in recent years has been to increase market power and thereby raise prices. However, there are signs that the increased profitability that price-jacking provides may be fleeting for some of these organizations, particularly as payers look to reward cost-effective care.

As Leemore Dafny, a professor at Harvard Business School, wrote in the Harvard Business Review, “Despite its short-term appeal, consolidation for the purpose of increasing negotiating clout will diminish the potential for the healthcare sector to create value and thrive in the long run."

A diminishing ability to create value may be manifesting itself already. When athenahealth researchers examined the financial data of its client base, they found that bigger wasn't always better for providers or for clients. Scaling up could mean significant losses in terms of provider productivity, patient loyalty, and even the rate of payment by each patient.

Chase Scale for the Right Reasons

Of course, scale can bring tremendous advantages and create real, long-term value. Indeed, organizations that have used scale to successfully position themselves for long-term success have a lot in common, according to Kevin Grabenstatter, a managing director at L.E.K. Consulting, who advises healthcare organizations on growth strategy.

First, they rationalize fixed costs and back-office functions and centralize purchasing to streamline the cost structure. Then, they use their newly enhanced clout to negotiate favorable payer contracts. Crucially, they don't stop there. “They remain focused on building a healthcare delivery chassis that is high quality and cost efficient," Grabenstatter says.

With the Centers for Medicare & Medicaid Services pushing value-based reimbursements, the ability to deliver quality care at low cost will be the best way to future-proof an organization and ensure long-term value creation, Grabenstatter says. “A key lens through which any acquisition or merger should be viewed is: 'Will it help me deliver high-quality, cost-effective care?'" he adds.

Look Beyond Hospitals for Help (and Capital)

In the first part of the decade, consolidation was driven primarily by independent physicians selling their practices to local hospitals or health systems. Indeed, some 44% of physicians were employed by hospitals or health systems as of January 2018, compared to just 1 in 4 in 2012.

Several factors drove this trend. Independent physicians faced rising costs and administrative burdens, and so they joined hospitals that promised to relieve them of bureaucratic drudgery. However, this motivation may be less relevant today because of technological innovations. Cloud-based vendors that offer revenue-cycle management and electronic health records have made it easier and cheaper for independent groups to outsource paperwork without relying on a hospital's existing infrastructure.

What's more, the healthcare industry has seen an influx of investment from private equity firms, which means that independent groups have access to the capital needed to form or join large, multi-specialty groups. Healthcare private equity deals, including providers, rose 50% to $63.1 billion in 2018, according to Boston-based consulting company Bain & Company. What this means in practice is that doctors that once may have needed access to a hospital's coffers to fund capital expenditures now have relatively easy access to financial resources for both capex improvements and acquisitions.

Digitize, Then Optimize

One of the advantages of scale is the experience curve; organizations become more efficient as they gain experience. Today, organizations with modest scale can partner with vendors that have national reach and essentially achieve the same effect. For instance, a cloud-based revenue-cycle management vendor that works with physicians all over the country can help benchmark performance metrics for local organizations, even segmenting them by cohort (faith-based versus secular; rural vs. urban, and so on). This allows best practices to spread quickly and spur innovation. (The best management services organizations offer similar services.)

Steve Kahane, a former athenahealth senior executive, points to a firm where he is doing advisory work, RemedyPartners as an example. RemedyPartners works with organizations all over the country on executing bundled payments, which allows the company to bring the benefits of scale to its clients, according to Kahane. Kahane says that provider organizations too often attempt to do the work themselves, but that they should consider looking to partner with firms with wider experience and scale. “I would have a strong bias to partner with firms that have visibility into what's going on all over the country." It is extremely useful for health system leadership to understand what is possible and see what constitutes, or appears to constitute, “best practices, especially when the partner can provide cohort-specific insight, that is, metrics and practices at other organizations like mine," he says.

This is not to say that vendors obviate all the advantages of scale, only that smaller organizations need not feel provincial or isolated; they can come at growth from a position of sophistication and strength. Indeed, Monish Rajpal, a managing director at L.E.K. Consulting, says that one of the benefits of partnering with private equity firms to achieve scale is that they often will have a good knowledge of the landscape for such national vendors and technology providers. “They provide a well-researched, corporate backbone for everything you need to do, including who are the best partners," he says. “That's one of the benefits they can bring to the table."

Scale Up for Physician Power at a Lower Cost

Many physicians feel frustrated by a lack of power in today's healthcare industry. Brandon Hull, who serves on the advisory council of New Mountain Capital, a private equity firm, likes to cite a statistic to physicians who raise this lack of confidence with him. “The tips of physicians' pens control 85% of healthcare spending in the U.S.," Hull says, referring to doctors' ability to control everything from prescriptions to clinical referrals.

“The physicians control the demand”

As the healthcare industry moves to value-based reimbursements, Hull believes this gives doctors a unique opportunity to regain power and control. Doctors should be seeking scale too, both so they can have the clout to coordinate and control their patient's care, and so they can be rewarded for providing quality healthcare and cost efficiency.

Instead of thinking of scale only to reduce administrative costs, Hull says physicians should have their eyes on the bigger prize, asking themselves, “How can we reduce the magnitude of that 85% of spending and be paid our appropriate share for doing it?" When they approach scale in this way, Hull adds, they will come to see that hospitals are far from the powerful monoliths that they appear to be.

“The physicians control the demand," he says.

Of course, smaller provider organizations can win on quality and cost-effectiveness by understanding where to refer patients, where they best serve the market and themselves by keeping folks in their own network or system, and how to keep their own costs down, for example. But Kahane says scale is key for one important task: negotiating with the 500-pound gorilla in each market, which is to say a local, highly respected hospital or health system —often an academic medical center — that patients don't want to lose access to. Unfortunately, these hospitals are often the most expensive.

“Enlightened physician groups can run into trouble when a dominant player with great brand recognition is in their market, because their patients want to know that if they get a serious or rare disease they have access to the 'best' doctors and institutions," Kahane says. “So you need a certain amount of critical mass/size to negotiate a win-win-win (patients-health system-physician group) deal with 'the big guys.'"

Look Outside Your Industry to Study Scaling Success

Organizations seeking a merger should start by hashing out the basics with counterparties: staffing, payer contracts, malpractice insurance, technology,and so on. As negotiations progress, all parties need to have honest conversations about each other's capabilities and their approaches. According to Len Schlesinger, a professor at Harvard Business School, “Both sides should be very willing to lay everything out upfront as part of the process of acquisition. They don't overlook the cultural differences with the target."

Schlesinger says that healthcare leaders should look beyond their own industry to organizations in the private sector that are notoriously good acquirers, such as Cisco. These organizations understand that sometimes a successful M&A strategy leans heavily on the ability to walk away from deals.

Schlesinger remembers an interaction he had with a healthcare executive who confided that his organization was “buying up every poorly run little practice that we can find within our geography, and a critical part of the negotiation of buying them is to promise them autonomy." As Schlesinger dryly told athenaInsight, “That's clearly not a recipe for success."

As Schlesinger puts it, “This is a leadership capability — setting a principled approach to growth."

As consolidation continues to gallop through the healthcare industry, leaders of smaller organizations will face increasing pressure to chase scale for fear of being outmaneuvered. But they should look before they leap — the history of business is littered with M&A frenzies that failed to create long-term value. Scale does bring many real advantages, but only if leaders understand how their actions will help them better serve their patients, and be rewarded for doing so.

Jessica Sweeney-Platt is executive director of segment marketing at athenahealth.