Case Study

Health System Strategy: The Affiliation Option

An independent community hospital may be nice, but it’s not automatically the best choice for sustainability and accessibility. Affiliation should always be considered an option in health system strategy – provided the process is deliberate rather than desperate. Here’s how one small system kept control of its destiny and its mission by choosing to pursue affiliation from a position of strength.

 

By Dawn Carter

Politicians and journalists often portray consolidation as a bogeyman of the healthcare industry: big systems getting ever bigger in an effort to knock out competitors and raise prices.

While there may be a kernel of truth to that storyline – particularly when it comes to for-profit systems – it also ignores the fact that many smaller healthcare providers are struggling for mere survival. Community hospitals are becoming an endangered species, forcing boards to grapple with one of the biggest questions in health system strategy: independence or affiliation?

That debate is fraught with emotion, community pride, and political implications, making it hard to discern the best path forward. At Ascendient, 30 years’ experience in health systems consulting has taught us that a transparent and methodical process is the only way to cut through the noise.

Here is a recent example of that process in action as Ascendient helped a small, forward-thinking health system select an affiliation partner to ensure sustainable care for residents of an isolated mountain region.

About Our Client

With three hospitals, 13 medical practices, and multiple specialty centers, Appalachian Regional Healthcare System (ARHS) primarily serves Watauga and Avery counties in the mountains of Western North Carolina, an area known as the High Country.

Watauga Medical Center is the largest of the three facilities, with 117 beds, while Cannon Memorial Hospital operates 18 beds as a Critical Access Hospital (CAH). In 2021, Cannon obtained an historic waiver from CMS to open the Appalachian Regional Behavioral Health Hospital, becoming the first-ever CAH with a behavioral health hospital on its campus.

That kind of innovation shows that ARHS is a well-managed system with a seasoned board and executive team – but even so, leadership could see clouds on the horizon.

“There’s always a catalyst for these discussions,” says Chuck Mantooth, the President and CEO at ARHS since 2017. “Ours was the need for better information technology.” When an older IT system started failing, “We were looking at replacement options and realized that scale was an issue. Then we asked if that was symptom of a larger problem – did we need to think about affiliation, and what would that look like?”

ARHS was doing well on all of its operational priorities – quality, employee engagement, patient satisfaction, and financial performance – but the IT issue raised flags for longer-term health system strategy.

“We could have accepted the status quo, but it would have been a long glide path toward a bad ending,” Chuck says. “Our situation was something that would catch us eventually, but it wasn’t a crisis. What we wanted to avoid was negative financial performance as the catalyst for affiliation.”

Complex Board Dynamics

At a time when struggling hospitals are being gobbled up for pennies on the dollar, ARHS was determined to approach affiliation from a position of strength. That’s not always the easiest choice in health system strategy, because boards members often resist giving up autonomy when current finances look strong.

At ARHS, the situation was further complicated by the system’s history and ownership structure: Watauga Medical Center is publicly owned, while Cannon Memorial is a private nonprofit. When the two joined forces to create ARHS in 2004, public officials in Watauga County reserved the right to control ten board seats while Cannon got five seats.

Fast-forward almost 20 years, and those complex board dynamics made it difficult to agree on the best path forward.

John Blackburn is an ARHS board member who spearheaded the creation of a two-county healthcare system. As a veteran leader of the smaller Avery County facility, he was more inclined to pursue a new arrangement because “we’d been through this all before.” On the Watauga side, however, “There were some who thought they didn’t need to merge, that they could do it all themselves. Their seats are appointed by the county, and they have to be very mindful of public perception and politics.”

With a board divided by geography and history, successful affiliation was hardly a foregone conclusion. In fact, ARHS had previously talked to a potential partner about an affiliation arrangement that never materialized. “It was something done by the board on the back of an envelope,” John says.

“What we needed was a really good, structured process to get all the parties to the table. If we’d just wandered into another affiliation meeting, we wouldn’t have been successful.”

Working with large boards can be unwieldy and unproductive, so we urged a smaller steering committee to vet our analyses and present recommendations to the full board. ARHS settled on a five-member steering committee, including John Blackburn, to spearhead a process focused on eight big questions.

 

Too many hospitals don’t think seriously about affiliation until the lights are about to go out. In that case, it’s too late for strategy – all you can do is look for a savior.

That certainly wasn’t the situation we found in the High Country. Boasting strong operations and solid financials, ARHS had the luxury of choosing among suitors who could offer the best resources for today and tomorrow.

We always say that strategic affiliation starts from a position of relative strength, but that begs the question: How strong … and relative to what? In Phase One, we set out to answer that question through both primary and secondary research.

Primary research included one-on-one interviews and small-group discussions with close to two dozen employees, local officials, and community members. Because any successful affiliation depends on public support, we wanted to know how stakeholders perceived ARHS’s values, its place in the community, and its future prospects.

Meanwhile, our health system strategy team analyzed dozens of operational and financial data points to better understand the business side of ARHS and its sustainability. Because any potential partner would surely evaluate the ARHS data against relevant peers, we provided the steering committee with comparative metrics for local competitors, statewide systems, and national benchmarks.

 

If all of that sounds like Strategic Planning 101, it’s no accident. Although we were engaged specifically to evaluate affiliation options, everyone involved quickly realized that the ARHS strategic plan was due for an update. As a part of that update, we carved out additional time to clarify the organization’s strategic vision and initiatives – in other words, to answer the question, “What are we all about?”

Hospitals and health systems are not generic, interchangeable widgets. Every one of them operates in a unique community with unique needs. Because ARHS wanted to approach affiliation from a position of strength, we needed to articulate what made this system unique and valuable.

By doing a mini-module in strategic vision and initiatives, we helped ARHS articulate the long-term difference it wanted to make in the High Country, plus the investments needed to make that vision a reality. Not coincidentally, most of the strategic initiatives touched on IT – a finding that further sharpened the profile of an ideal partner.

 

In total, our analysis files ran to more than 1 gigabyte for this engagement – far too much data for any steering committee to evaluate effectively. So, our next task was to shape all that data into a story that was more comprehensible and actionable.

Working with the steering committee to determine the most relevant data points, we analyzed the numbers to determine whether affiliation could move the needle in ARHS’s favor. For instance, ARHS wanted a partner with proven success in non-urban primary care, so we ranked potential matches based on their rural provider-to-population ratio.

Specifically on the question of IT, we analyzed the technology adopted by nearby systems along with their IT capital expenditures, IT personnel costs, IT operating expense as a percentage of net patient revenue, and similar data points. Before talking to potential partners, the goal was to clarify who best understood the importance of IT and who was making strategic investments at the system level.

At this point, despite some earlier doubts, the steering committee and the full board united firmly behind the need for immediate affiliation. Chuck Mantooth says it was data that made the difference: “Affiliation is an emotional deal, so you start with the data to take the emotion out of it. The key was seeing our current position and using the data to understand what our position might be in the future.”

 

For Phase One, the only remaining task was perhaps the most important: setting the criteria for affiliation. At Ascendient, this is something we insist upon based on nearly 30 years’ experience in strategic healthcare consulting. Without enumerating specific, objective criteria early in the process, it’s simply too easy for board members to be distracted when suitors come calling with empty promises and smooth sales pitches.

After evaluating their strategic position, vision, and initiatives, ARHS leadership found it relatively easy to settle on three criteria for affiliation. They were looking for a partner with:

• Mission alignment (specifically, the vision for a regional medical center plus community-based primary care and outreach in remote mountain areas)
• Experience with rural healthcare
• Expertise in technology infrastructure

Committing to that short list of non-negotiable affiliation criteria saved untold hours of frustration for ARHS (and Ascendient) later in the process. We used their criteria constantly throughout the rest of the affiliation journey, from vetting prospects to attracting interest to negotiating actual terms.

Prior to beginning private negotiations, ARHS went one step further and put its criteria into a press release so that members of the community could understand why affiliation was needed and how it would secure the future of local healthcare delivery.

 

Contrary to public opinion (and, apparently, the opinion of some public officials), affiliation doesn’t necessarily mean a change in ownership or control. Instead, systems like ARHS that are negotiating from a position of strength can deploy a range of legal structures, from a management contract to a joint venture to an outright sale. Each structure has its pros and cons, so we asked the committee to evaluate each option against the three overarching criteria.

As a mission-driven organization, ARHS wanted above all else to perpetuate its vision for serving the community, and that criterion led the committee to reject any structure that might eliminate local decision-making. An outright sale, in other words, was out of the question.

 

Next, Ascendient’s health system strategy consultants pulled together a list of potential suitors that most closely aligned with ARHS’s three criteria. Too many choices can sometimes induce paralysis, so we curated a list of eight logical partners and then asked the steering committee to evaluate each of them against the three non-negotiable criteria.

Our goal was to offer a limited number of “foolproof” options. With bad matches off the table, the steering committee could focus on selecting the best possible partner. We also provided supporting data for each matching system and a structured evaluation process to help keep discussions focused and objective.

Did the process work? “Absolutely,” says John Blackburn. Starting with eight possibilities, “we began to pare back and look at everybody individually with no preconceived notions. For instance, I had some prejudice about one group I didn’t want to go with because of some past experience, but we had a process for thinking through the criteria, and we did it in a structured way.”

What emerged from the steering committee was a list of three preferred partners – a small enough group to proceed with direct negotiations rather than a broad RFP.

Before putting the word out, however, there was one more question to answer.

 

As healthcare consolidation picks up pace, we see prospective partners requiring a much deeper level of due diligence before any significant discussions can begin. To speed the process along, our health system strategy team developed a list of data and documents that any potential partner would be sure to request. We managed the information as it came in, ensured review of sensitive documents by legal counsel, and compiled everything into a format that would expedite the decision-making process.

Based on decades of experience in healthcare mergers and acquisitions, we were able to shave weeks off the due diligence period by compiling much of the required information even before reaching out to potential partners. This proactive stance also helped ARHS save resources (and administrative headaches) by establishing a consistent format for data reporting, as opposed to answering requests in a variety of formats.

 

Up to this point, the affiliation process is a bit like listing all the characteristics of a “dream date” – without knowing whether the other party is even looking for a relationship. The next phase is where things finally get reciprocal.

In the case of ARHS, we sent a three-page, confidential letter to each potential partner outlining the history of the health system, its unique role in the High Country, and some of its key financial and operating metrics. We also explored the rationale for affiliation and the kind of partnership our client was looking for.

By putting all of this into writing at the start, we find that we can level-set expectations and create a common understanding to guide future discussions.

Given the strength of ARHS, it came as no surprise that all three potential partners expressed interest in exploring a relationship. One system had to drop out because it couldn’t meet the aggressive timelines set by ARHS, but two more entered into discussions that lasted almost three months.

Conclusion

On Feb. 15, 2022, ARHS publicly announced that it was beginning a strategic review and shared its criteria for a successful affiliation. Fewer than 90 days later, the deal was done, with UNC Health announcing on May 3 a long-term management services agreement based on “a shared commitment to enhance technology, expand local services and improve access to healthcare.” The agreement went into effect on July 1.

In the cautious world of healthcare, it was an unusually speedy timeline for a deal of this size – and it would likely have been impossible without Ascendient’s experience in health system strategy. Working behind the scenes on a compressed schedule, we led a structured process that fostered unity, objectivity, and data-driven decisions.

“It was a great process, and healthcare in this region will be better for both the process and the outcome,” says Chuck Mantooth. “At times I got impatient because I could see where it was going, and I just wanted to get there. But ultimately, the outcome was better because of the process.”

John Blackburn agrees. “I never felt at any time that Ascendient was pressuring us or leading us. They presented the facts, put us in touch with the right people, and allowed us – with some guidance – to make our decisions.

“It was a great process for the board and for the community. We held strong that this wasn’t about us, and it wasn’t about the hospital buildings – it was about what’s best for the people of the High Country. That was our clear vision from the beginning, and Ascendient helped us get there.”

Ascendient has a nearly 30-year track record as a trusted advisor in healthcare M&A. If your hospital or health system is considering affiliation as a strategic option for providing more sustainable care in your community, please contact us for a confidential consultation.