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COPYRIGHT 2008 Healthcare Financial Management Association
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In both the corporate and not-for-profit healthcare worlds, the capital markets have long favored larger organizations. Is this view held by investors, rating agencies, and bond insurers justified, and do size and growth drive exceptional. sustained organizational success?
Scale achieved through growth is commonly recognized as essential in the corporate world. As established in basic economics, large companies share five traits:
* Lower fixed- and variable-unit costs from the economies of mass production
* Increased market visibility, which, if accompanied by growth and above-average profitability, yields lower borrowing and capital costs
* Greater debt capacity and access to capital, which enable large companies to be innovators in their marketplaces
* The ability to afford and attract expert management talent and specialists for research and development, thereby ensuring the capacity to introduce new and improved products
* The diversified geographic market or product/service mix needed to withstand cyclical industry downturns, abrupt market changes, shifts in consumer demand, and disruptions caused by technological breakthroughs (Thompson, A.A., Economics of the Firm: Theory and Practice, Englewood Cliffs, N.J.: Prentice-Hall, 1998)
Corporate Examples
As one of the world's largest and most profitable companies for decades, General Electric (GE) supports its platform for innovation and market leadership with an organic growth rate target of 8 percent per year. Growth and productivity initiatives have built GE to a scale achieved by only a handful of other companies. Its 2007 revenue of $173 billion, up 14 percent over 2006 with a 9 percent organic growth rate, makes it the world's sixth largest corporation. "Our companywide initiatives focused on organic growth, services, global expansion, and ecomagination[SM] are delivering positive results," says CEO Jeffrey Immelt. "We achieved our twelfth straight quarter of organic revenue growth of two to three times global GDP" ("GE Reports Record Fourth-Quarter and Full-Year Results for 2007," press release, Jan. 18, 2008).
Procter & Gamble (P&G), the world's largest consumer products company, with 2007 revenue of $76 billion, built a strong foundation for consistent growth, which now averages 5 percent to 7 percent per year. Its new model for growth, called Connect and Develop, seeks to acquire half of its innovations from small to midsize entrepreneurial companies and university and government labs. P&G leverages its strength by using new ideas to grow core businesses and by developing higher margin and more asset-efficient businesses where it can achieve global leadership.
Both companies' approach to growth and scale includes:
* Development of leaders who can provide required focus on growth and management competence
* A solid plan that is developed, adhered to, and "played" hard every day
* A view of the growth process as a marathon, not a sprint
* Use of an innovation pipeline
* A balanced portfolio approach to existing/new businesses and geographic markets
Leaders of today's largest and greatest growth companies work vigorously to achieve dominance in their fields. They are vigilant about managing operations as efficiently as possible, but they also know that long-term success almost always requires continued top-line growth and increasing economies of scale, as cost-cutting and operational improvements have finite benefits.
Scale in Health Care is No Different
Attaining critical mass enables not-for-profit healthcare organizations to obtain similar and increasingly essential benefits. Like their counterparts in other industries, hospitals and health systems that grow revenues and achieve a greater scale can better:
* Leverage their fixed-cost base
* Realize variable- cost efficiencies
* Build market visibility and leverage
* Diversify risk across markets or a broader base of programs and services
* Preserve long-term access to capital
* Access capital on more favorable terms
* Ensure ongoing competitive performance through strong capital reinvestment
Growth also has a direct effect on clinical excellence and the development of human capital, enabling organizations to attract and retain the best people, thereby improving the quality of patient care.
To quantify the financial benefits of scale, Kaufman Hall recently analyzed blinded data for the 270 healthcare organizations with more than $250 million in annual net patient service revenue in Moody's Investors Service's rating portfolio. The analysis focused on profitability, leverage, liquidity, and capital spending indicators between 2003 and 2006.
Organizations were divided into four groups based upon net patient service revenue:
* $250 million to $500 million (94 providers representing 35 percent of portfolio)
* $500 million to $1 billion (87 providers representing 32 percent of portfolio)
* $1 billion to $2 billion (54 providers representing 20 percent of portfolio)
* More than $2 billion (35 providers representing 13 percent of portfolio)
Profitability. Key indicators of organizational profitability--total margin, defined as net income/ total operating revenue, and operating margin, defined as (total operating...
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