Healthcare Mergers are the End of the Beginning: Some Lessons From the US Airline Business

img-thingThere has been a lot of recent discussion about the value of large healthcare mergers, such as Partners ongoing acquisitions in the Boston area and the recent large merger between Baylor and Scott & White in Texas.  Supporters argue that these create better integration of care and economies of scale.  Opponents argue that these deals ultimately drive up costs, restrict options and worsen care. Physician bloggers on Forbes’ website write:

It seems like every day another large hospital system or pharmaceutical company is acquiring or merging with another large entity to form a giant healthcare system that claims “bigger is better.” It reminds us of the big fish gobbling up all the smaller fish and getting bigger and bigger. Eventually, it becomes so big that all of the small fish are gone. The pond can barely support the one big fish.  What has been the result in other industries that have gone through such consolidation? In every case, we’ve seen higher prices, less consumer choice, and heavy government regulation to control the new near-monopolies.

I’m simply not sure that this is true. I was recently reading about the history of the US airline industry, and was struck by the similarities to modern healthcare.  Rather than hyperventilate about mergers, it might be helpful to look at another industry to see how mergers are part of the usual ebb and flow of a healthy consumer market responding to market pressures. Might healthcare follow a similar trajectory?

First, a brief history of the domestic airline market in the US.  I think that you can categorize the evolution of the airline industry into discreet phases.

Phase 1- Free-for-all Prior to Regulation:  Pre- 1940’s there were a large number of airlines serving tiny airports with point-to-point service.  An example of this kind of airline was Northeast Airlines which began as Boston-Maine Airways. This small airline served Boston and Maine, and tiny small airports such as Fitchburg MA. In the 1940’s, the federal government began to regulate the airlines, leading to Phase 2.

Phase 2- Regulation and Consolidation to Compete for Business: Around 1940, the Civil Aeronautics Board was created to regulate rates and routes.  Screenshot 2014-07-10 08.45.14The CAB based airfares on average costs, so because airlines couldn’t compete with each other by offering lower fares, they competed by striving to offer the best quality service.  (This became the era of the martini and ice cream sundae bar in the sky.)  It was hard for small airlines to break into routes because they couldn’t offer service and schedules comparable to bigger airlines, and a wave of consolidations began. Big airlines such as Braniff and TWA emerged and competed aggressively, but scale was needed to succeed in the regulated world.

Phase 3: Deregulation and More Consolidation as Growth of High Cost Platforms Tanked Airlines–  The Airline Deregulation Act passed in 1978 intended to remove government control over fares, routes and competitors. The CAB’s powers of regulation were removed and airlines competed for business.  Competition led to heavy losses and conflicts with labor unions for a number of carriers. In the subsequent twenty years, nine major carriers (including Eastern, Midway, Braniff, Pan Am, Continental, America West Airlines, Northwest Airlines, and TWA) and more than 100 smaller airlines went bankrupt or were liquidated. The remaining airlines survived competition by reducing service and by migrating to hub-and-spoke models while reducing point-to-point service among smaller cities.  All struggled with high cost platforms:  little standardization of service, multiple models of aircraft, and low passenger loads.  Many airlines entered and left bankruptcy during this period.  Braniff, which went on a massive expansion in an attempt to corner the market found that rapid growth of a high cost platform led to unsustainable costs.  Wikipedia notes:

Up to 1980, Braniff was one of the fastest-growing and most-profitable airlines in the United States. But deregulation of the airline industry was introduced in December 1978, and Braniff — as well as many of the United States’ major air carriers — misjudged this unprecedented change in airline business. Lawrence [CEO] believed that the answer to deregulation was to expand Braniff’s route system dramatically or face an immediate erosion of Braniff’s highly profitable routes as a result of unbridled competition caused by new low cost carriers. He therefore enlarged the domestic network by 50% on December 15, 1978, adding 16 new cities and 32 new routes, which Braniff said was the “largest single-day increase by any airline in history”. This historical expansion was successful both operationally and financially.

Phase 4: Disruption of the Low Service, High Cost Model-  Southwest Airlines became the first US low cost carrier (LCC) in 1971.  Between 2008 and 2011 these LCCs grew and now claim 30% of the US domestic market.  This segment of the industry has exploded, and now there are even ULCC’s- ultra low cost carriers (seats are cheap as dirt but where everything is an “extra”) competing with the LCCs.  The idea behind these airlines was to find a cost effective way to provide point-to-point airline service in a low cost fashion. LCCs shed legacy labor rates, standardized planes and used secondary airports to reduce landing fees.  In other words, these airlines “shed the platform” that used to be considered necessary to provide the basic service of getting people from one place to the other. These airlines have helped to significantly drop the cost of airline tickets.  PWC prepared a monograph looking at the impact of LCCs and found that they pushed prices down in every route where they were established:

 

Screenshot 2014-07-10 08.03.51

 

Now, let’s have a thoughtful discussion about the business of healthcare mergers in America.  We currently have a rapidly consolidating system of healthcare in America.  I have heard the statistic somewhere that in the next few decades there will be only a few hundred remaining healthcare systems: each will be a mega-system, vertically integrated and with a hub and spoke (academic hospital in the center) model.  In other words, we are at Phase 3 of the airline experiment.

Small systems are coming together to establish large regional systems and they need to route patients through expensive hubs.  Labor costs are high.  Service and quality aren’t great.  Consumers feel that they pay too much and get too little.  There is massive lack of standardization of care, including incompatible EMRs which cost millions to upgrade and which are sinking health systems.

In other words, we are primed for Phase 4 of the airline experiment.  Who will be healthcare’s Southwest, a “LHP” (low-cost healthcare provider) who can provide standardized, reliable care free of legacy high-cost platforms and inconvenient hub-and-spoke systems of care?

Whoever it is (and I have a few ideas), I’d buy stock.  After 41 years of consecutive profitability, here is Southwest’s shareprice since 1980.

Screenshot 2014-07-10 12.09.39

 

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