Integration and Diversification in Healthcare: Financial Performance and Implications for Medicare
Jones, Jane, Health Sociology Review
This exploratory study compares the financial performance of all companies listed on the Australian Stock Exchange pursuing vertical or virtual integration, horizontal integration or diversification in the pathology, diagnostic imaging and general practice sub-sectors over 2001-2005. Financial ratio analysis indicates vertical integration is the most profitable strategy. Accounting measures of performance also show horizontal integration is profitable; however, recent market developments raise questions about the viability over the long-term of horizontal integration of diagnostic imaging practices as a core business in the context of public corporations. With one exception, the study also found medical centres yield modest to poor financial performance, suggesting the revenue generated directly by general practice is unlikely to provide sufficient returns for GPs and investors, and is probably a result of cross-subsidies from diagnostic services owned or provided by the corporation. As all firms that provide general practice also provide diagnostic services, collectively, results provide tentative empirical support for the proposition that the value of general practice, at least to some listed corporations, is not in general practice per se, but its ability to generate referrals. The findings have significant implications for the public financing of health care services. These include: the potential for increased expenditure on healthcare from co-locating general practice with diagnostic services; the extent to which the provision of medical services by listed corporations represents the best use of limited public funds; and the efficacy of the use of Medicare to finance offshore expansion by public Australian companies.
Sociology, pathology, general practice; hospital ownership, Medicare, health care services financing
Received 2 February 2007 Accepted 20 February 2007
In Australia, as elsewhere, the nature and organisation of medical practice is undergoing significant change. Over the past few years, a number of models of corporate medical practice have emerged. These models range from the relatively simple management service model at one end of the continuum, to the actual divestment of medical practice and employment status at the other (AMA 2001). Thus at one end of the continuum, a corporate entity may simply take over the administration of existing medical practices in exchange for an agreed fee. At the other end of the continuum, substantial market penetration has been achieved by large public companies acquiring and integrating general practices, diagnostic imaging and/or pathology practices. In some cases, these services are colocated into multi-purpose healthcare facilities, together with ancillary services, and sometimes, hospitals. This represents the vertically integrated delivery system, consisting of multiple providers covering the full continuum of healthcare.
Although corporatisation of medical services is not a new phenomenon, there has been an accelerating trend in corporatisation in Australia in recent years, with Catchlove (2001:68) concluding '[t]his process appears inevitable and unstoppable'. Yet while there is significant debate occurring within the medical profession, government, media and wider community concerning the rationalisation of healthcare providers and growth of corporatised healthcare, relatively little academic research has focussed on the financial performance of listed corporations pursuing integration and growth in medical services. This lack of work is surprising, given corporatisation of medical practices is seen by some as a more convenient vehicle compared to traditional practice models through which private health commerce may be effectively organised and conducted on a large scale (AMA 2001).
The purpose of this exploratory study is to begin to fill the identified gap by means of an empirical examination of the financial performance of companies listed on the Australian Stock Exchange (ASX) pursuing integration and growth in pathology, diagnostic imaging and/or general practice. The pathology, diagnostic imaging and general practice sub-sectors are the primary focus of this research as, in Australia in 2005, these sub-sectors accounted for $1.52, $1.48 and $2.9 billion respectively, or collectively, two-thirds of Australia's universal health insurance system, Medicare (Quinlivan 2005). Moreover, these subsectors have been the focus of listed corporations pursuing integration and growth. Today, four listed corporations control about 80% of the private pathology market (Quinlivan 2004), while three account for over 50% of the private diagnostic imaging market (Grant Samuel 2006). Industry sources suggest three public companies have a combined 8% of general practice (Parmenter 2006).
This paper proceeds as follows: the central tenets of integration and growth are briefly reviewed and illustrated in the Australian context. Prior research examining the financial performance of these types of growth is then presented. Thereafter, the research design is outlined. The findings of the research are then discussed. The paper concludes with implications and future research directions.
Horizontal integration refers to two or more separate organisations which produce the same service, combining to form either a single firm, or a strong inter-organisational alliance (Conrad and Shortell 1996). In healthcare, horizontal integration involves affiliation under one management umbrella, firms which provide a similar level of healthcare, or are at the same stage in the process of delivering health services (Gillies et al. 1993).
In Australia, horizontal integration, at both the primary and secondary care levels, has occurred, with the acquisition and integration of general practices in the former case, and diagnostic imaging and/or pathology practices in the latter. According to Robinson (1996) acquiring and merging similar firms within and across local geographic markets improves efficiency through economies of scale, by spreading overhead expenses, volume purchasing of consumables and equipment, and eliminating duplicate facilities and/or functions. Burns (1997) suggests gaining market share by acquisitive growth is the key to short-term success; however, 'same-store' or organic growth is likely to be more successful over the long run.
Vertical integration refers to the combining, within a single firm, successive stages of production (Thomson 1967). In healthcare, vertical integration involves '... the coordination or linkage of businesses (service lines) that are at different stages in the production process of health care' where 'stages' may denote the number of levels of care in which a business participates (Conrad and Dowling 1990:10). Thus a vertically integrated healthcare organisation may involve affiliation under one management umbrella, firms which provide different levels of healthcare, where one provider is able to provide a broad range of patient services to patients and customers from a geographically contiguous area (Brown and McCool 1986). In contrast, virtual integration involves non-ownership linkages (e.g. joint venture or strategic alliance) (Robinson 1996). Thus a vertically integrated organisation may provide primary and secondary and/or tertiary services, with primary care an input into secondary and/or tertiary care, since GPs refer patients to specialist medical consultants at secondary and/or tertiary levels.
Historically, vertical integration emphasised reducing gaps in service availability and improving continuity of patient care (Conrad and Dowling 1990). However, today the focus is on controlling demand and/or distribution channels, as controlling the flow of patients to an organisation is often the key to maintaining market share.
Diversification refers to expansion into different product and/or geographic markets (Robinson 1996). Diversification can be further categorised according to the degree of relatedness of existing activities to new products, new markets or both (Snail and Robinson 1998). Related diversification involves a firm's new services employing similar production technologies to those already used, or when an organisation serves markets similar to those already served (Clement 1988). Unrelated diversification occurs when dissimilar assets and skills are used because of dissimilar production technologies, consumer groups and consumer functions.
In Australia, a number of corporations have diversified from diagnostic imaging into pathology and vice versa. This could represent related diversification, as both services share similar funding arrangements, government regulations, and importantly, 'customers', namely the referring (specialist and/or general) medical practitioner.
It is assumed business units which are related in some way are able to share activities or resources, (for example, by providing multiple patient services in a single visit, i.e., One-stop shopping') generating benefits or operational synergies (Burns et al. 1999). In contrast, unrelated diversification frequently ends in failure with the firm refocusing on a narrower product line, demonstrating the problems in outperforming financial markets at what they do best (Robinson 1996).
Integration and financial performance
There is a paucity of peer reviewed empirical research examining financial performance of listed corporations integrating medical practices, although scholars have made a number of observations. For example, Fitzgerald (2002) argues compared to corporations owning their own pathology, diagnostic imaging and other specialist services, corporations without vertical integration of referrals are less profitable.
The AMA (2000:4) points out while highly fragmented and operating predominately on a small business basis, general practice constitutes a substantial part of the Australian economy. As a result:
The large volume of transactions highlights the potential gains to investors from a substantial market share and improving margins through economies of scale and vertical integration.
In a report prepared on behalf of the Commonwealth Department of Health and Aged Care, KPMG Consulting (2000:30) also suggest vertical integration has the potential to be more profitable as:
The modest margins in general practice suggest that, irrespective of levels of efficiency, the revenue generated directly by general practice is unlikely to be sufficient to provide a reasonable income for the CP and a satisfactory return to the investor. The required returns for the investor must therefore come from the centre tenants, from negotiated arrangements with other service suppliers and/or cross-subsidies from other businesses (e.g. pathology and radiology), owned partially or wholly by the investor.
As Robinson (1999:173) observes:
Primary care is a high volume, low margin business whose greatest financial asset derives from its influence over where patients are referred for specialty services. Specialty care is a low volume and high margin business that is dependent on referrals but is able to leverage referral volume into revenue through discretionary control over testing and procedures.
A number of commentators argue, from the corporation's perspective, the real benefit lies in this revenue: capitalising on the GP's 'gatekeeper role' and associated referrals, prescriptions and alike (AMA 2001; Catchlove 2001; Collyer and White 2001). International empirical research provides support for this proposition; for example, Burns et al. (1999:471) found 'inhouse integration of physician and ancillary services internalises high-frequency transactions, provides patient convenience, and reduces throughput time'. Further, in-house provision of diagnostic services not only augments same-clinic growth, but also earns greater income (Burns et al. 1999).
However, the challenges of accomplishing integration are immense, with the US peerreviewed literature revealing a negative relationship between publicly traded (physician practice management) corporations which integrated physician organisations, and financial performance, as evidenced by their dramatic decline, dissolution (i.e. delisting or bankruptcy) and/or exit in the late 1990s (Bazzoli et al. 2004; Outterson 2001; Reinhardt 2000; Robinson 1999).
Another stream of related research examines vertical integration of hospitals and physicians in the US. Following a literature synthesis of studies on vertical integration in healthcare in the US, Bazzoli et al. (2004:318) conclude that while the findings are mixed and contradictory, 'perhaps the most telling finding is ... hospitals were shedding their physician-hospital arrangements since 1996' suggesting vertically integrated arrangements did not return value to hospitals.
In summary, the literature suggests there may be differences in the financial performance of corporations pursuing vertical or virtual integration vis-à-vis horizontal integration or diversification. However, to date, no empirical study has investigated this issue. Therefore the purpose of this exploratory study is to examine the financial performance of corporations listed on the ASX that have diversified, horizontally or virtually or vertically integrated physician practices in three medical service sub-sectors.
To achieve this objective, financial data is collected from annual reports and/or annual results presentation, and financial ratio analysis used to assess the financial performance of all seven corporations listed on the ASX pursuing horizontal integration, vertical or virtual integration, and/or diversification in diagnostic imaging, pathology and general practice over the 5-year period ending June 30 2005.1 The seven firms are:
1. Foundation HealthCare Limited ('Foundation' and following its merger with Lifecare, Independent Practitioner Network, IPN);
2. Sonic Healthcare Limited ('Sonic');
3. MIA Group Limited ('MIA', formerly Medical Imaging Australasia);
4. I-Med Limited ('I-Med', a subsidiary of DCA Group);
5. Gribbles Group Limited ('Gribbles');
6. Mayne Group ('Mayne', or Symbion Health Limited, 'Symbion');2 and
7. Primary Health Care Limited ('Primary').
However during the period of the study, three firms (MIA, Foundation and Gribbles) were acquired by other firms. Ratio analyses for these firms are conducted until the financial year of acquisition. This analysis is followed by case studies of these acquisitions. Following Burns (1997), Burns and Robinson (1997), Marsh (1998) and Robinson (1996; 1998; 1999) qualitative analysis of these acquisitions is based on multiple sources of data including: annual reports and other company documents; reports by independent experts; and industry and financial press. Using multiple sources of evidence enables the researcher to triangulate information, improving reliability and validity of data.
Corporations are classified as horizontally integrated, vertically or virtually integrated, or diversified, using the framework described above (see Table 1). Technically, horizontal integration at the secondary level includes both pathology and diagnostic imaging, since both are delivered at the same (secondary) stage. However for the purposes of this study, a firm providing diagnostic imaging and pathology services is classified as diversified, as an objective of the study is to evaluate the effects of horizontal integration relative to diversification.
Data shortcomings preclude direct evaluation of general practice. However, medical centres, which include general practice, together with pathology and/or diagnostic imaging, constitute vertical integration. Virtual integration is indicated by integration via a strategic alliance or joint venture. To provide a basis for comparison with US studies on vertical integration with hospitals, the financial performance of vertically integrated companies in the study, which also operate hospitals, is examined.
Financial performance is measured using two standard accounting-based measures: profit margin on sales and return on assets (ROA). While ROA is the more common accounting measure of performance (Palich et al. 2000), one of the difficulties in this study is profit measures (e.g. operating profit before interest and tax or earnings before interest and tax). These are used inconsistently and hence limit inter-firm comparisons. Rather than attempt to harmonise measures, only comparable measures of performance are analysed.
Profit margin on sales is increasingly popular compared with other accounting measures (e.g. return on equity) because of its resistance to distortions due to the equity base of corporations, thereby providing a stable measure of performance (Palich et al. 2000). Moreover, in this study, all firms provide data enabling profit margins to be calculated. Despite its limitations, the measure is available and enables, as much as possible, a 'like for like' comparison. Profit margins are also the universal measure of financial performance used by management of all firms in the study, industry observers and market analysts. For the most part, profit margins and ROA give similar results. Thus in general, only profit margins are reported.
To smooth out short-term fluctuations and irregularities and obtain a more reliable longterm measure of performance, profit margins are computed for each firm as a 5-year median (Palich et al. 2000). Unless otherwise stated, earnings before interest, tax, depreciation and amortisation (EBITDA) is the earnings base as it is available. Profit margins using earnings before interest tax and amortisation (EBITA) are also computed for firms which only break down divisional performance at the EBITA level. However, some data are only available for some companies, for some segments, and/or in certain years. A related constraint is some companies changed their segment identification during the period of the study. It is also possible for a firm to be engaged in more than one form of integration and growth. For example, Sonic is virtually integrated and also internationally diversified. Where data is available, the performance of integration vis-à-vis diversification is evaluated. However, direct comparisons between firms should be treated with caution due to possible differences in reporting arrangements.
Discussion of results
Table 1 shows median profit margins over the 5-year period for firms with vertically integrated operations range from 16.2% to 31.5%, indicating substantive differences between firms, with margins of Primary double those of Mayne (31.5% and 16.2%, respectively). Table 1 also reveals the inclusion of hospitals appears to attenuate Mayne's profitability: from 16.2% to 12.7%. However following its acquisition of Australian Hospital Care, Mayne's pathology division took on the pathology contracts for a number of its hospitals, while its diagnostic imaging network provided services to an increased number of Mayne hospitals, highlighting a central premise of vertical integration (Devers et al. 1994:9):
Assessments of individual operating units and/ or relationships between operating units must be viewed not only in terms of their individual performance but how and what they contribute to the 'system' as a whole.
Segmental analyses of Primary's businesses show, while margins of medical centres exceed pathology (43.5% and 17.1%, respectively), ROA from pathology exceed medical centres (13.2% and 12.3%, respectively), by leveraging higher asset turnover. Taken together, this may suggest Primary is capturing the expected benefits of vertical integration: capitalising on GPs and/or specialist referral generating capacity, including for diagnostic services (Robinson 1999). Indeed, in a results update following listing, Primary's Managing Director (MD), Dr Bateman stated the profitability of centres would continue to improve, and full potential be realised as additional facilities and services were added (Bateman 1999).
Comparing the profitability of integration strategies of firms in the study reveals Primary is also the most profitable firm in the study (measured by profit margins and ROA), providing empirical support for the widespread belief vertical integration is highly lucrative (e.g. Burns et al. 1999;'Fitzgerald 2002; KPMG Consulting 2000). Conversely, the comparatively poor performance of Mayne and Cribbles (among the least profitable of the firms in the study, measured by ROA) highlights the challenges of managing vertical integration (Robinson 1999), and suggests Cribbles and Mayne are unlikely to have had the knowledge, skills, resources or capabilities needed. In the period leading up to their sale in February 2004, Cribbles 'non-core' medical centres and diagnostic imaging businesses also incurred a loss of $4,641,000 and an aggregate loss to the consolidated entity of $98,000 (Cribbles Group 2004).
Consistent with international studies (e.g. Burns et al. 1999), the acquisition and integration of diagnostic imaging practices is substantially more profitable, with I-Med yielding profit margins of 27.1%. Its international diagnostic imaging division was also profitable (18.4%, measured by EBITA/Revenue), although this was largely a result of the Group acquiring MIA, rather than an explicit strategy.
MIA achieved similar profitability (26.1%). Segmentai analyses reveals the profitability of domestic imaging operations exceeded those from diversifying into UK diagnostic imaging markets (22.3% and 19.4%, respectively, measured by EBITA/Revenue); however diversification into the Australian and UK pathology sector was negative (-27.6%, measured by EBITA/Revenue), and as a result, had an adverse impact on the Group's overall profit margin, and profitability, culminating in a net loss after tax of $25.6 million in 2003, largely reflecting the sale of its pathology business. Thus MIA did not realise the purported marketing and other operational synergies assumed to exist between diagnostic imaging and pathology (Burns et al. 1999). Indeed its chief executive officer (CEO) Paul Mirabelle admitted '[w]e regard pathology as fundamentally different from the core service provided by our radiologists' (quoted in MIA Group 2003:5).
The Group's poor performance also likely highlights the difficulties of managing concurrently service diversification (from diagnostic imaging to pathology) and international diversification (to the UK). Since MIA diversified into pathology and the UK market in the year following listing, it is unlikely to have developed the requisite skills or organisational structure needed to manage such diversification.
Since Sonic does not break down its businesses into Australian and international segments, the profitability of its virtually integrated operations cannot be computed. However its strategic alliance with Foundation - which provides Sonic with the opportunity to establish diagnostic services in Foundation medical centres and according to its MD, Dr Goldschmidt '... aggressively grow its diagnostic businesses ...' (quoted in Sonic Healthcare 2001:16) - was profitable. In consecutive annual reports (Sonic Healthcare 2001, 2002) directors stated:
Significant market share growth has been achieved ... driven by ... service ... and ... reputation together with gains achieved through Sonic's strategic alliance with Foundation HealthCare Limited (quoted in Sonic Healthcare 2001:15).
However, Dr Goldschmidt acknowledged the inclusion of IPN in Sonic's 2005 accounts adversely affected the Group's profitability: 18.9% versus 19.4% without IPN (measured by EBITA/Revenue).
Segmental analysis of general practice/medical centres and diagnostic services
Prior to becoming a subsidiary of Sonic in August 2004, the median profit margin for Foundation was 7.0%. With the exception of Primary, segmentai analyses of general practice or medical centres reveal comparatively poor profit margins, ranging from a low of -0.6% (Mayne) to a high of 8.8% (Cribbles). Conversely, Table 1 shows profit margins of pathology and diagnostic imaging segments are overall, double (or more) of those of general practice or medical centres. For example, margins for pathology range from 26% (Cribbles) to 16.2% (Mayne) while diagnostic imaging generates margins ranging from 27.1% (I-Med) to 17.4% (Mayne).
Thus with the exception of Primary, medical centres and/or general practice generate profit margins3 which are at best (i.e. Cribbles and Foundation) half or less of those of diagnostic services, and at worse (i.e. Mayne) negative, indicating comparatively modest to negative financial performance vis-à-vis pathology and/ or diagnostic imaging.
KPMG Consulting contend the modest margins in general practice suggest the revenues generated directly by general practice are likely to be insufficient to provide a satisfactory return to investors and GPs, and instead must come from centre tenants, agreements with other service suppliers and/or cross-subsidies from diagnostic services also owned partially or wholly by the investor. As financial performance of medical centres includes the former, the probable explanation is cross-subsidies, with all firms in the study with exposure to general practice also providing, either through ownership or contractual agreements, pathology and diagnostic imaging services. Further support for this proposition exists, with Mayne's Chairman Peter Willcox acknowledging its 53 medical centres and 394 GPs provides '... a strong referral base for Mayne's Pathology business' (quoted in Mayne Group 2004a:6), while Sonic's Dr Goldschmidt admitted '[t]he value of (Foundation) to Sonic is more in the referrals that come from Foundation medical centres and doctors ... ' (quoted in Price 2001:26). Thus financial analysis, coupled with admissions from senior management, provide tentative empirical support for the proposition that the real value of general practice, at least to some listed corporations, is not in general practice per se, but its ability to generate referrals. Because GPs are an important source of patients to secondary medical service providers, general practices which incur operating deficits as standalone enterprises may still offer considerable overall benefits to vertically integrated businesses. However, market-based developments (discussed below) cast doubts about the long-term prospects of some strategies in the context of public corporations.
DCA Group/CAID Pty Limited
In 2006, DCA Group, the parent company of I-MED Network, the largest provider of diagnostic imaging services in Australia, accepted a $2.7 billion takeover from privateequity firm CAID Pty Limited (1CVC'). The takeover followed a sharp fall in its share price4 - from $3.87 to less than $3.00 - as the Group announced an earnings downgrade in May 2006 (Grant Samuel 2006). DCA had earlier disappointed the market with its first half year results for its diagnostic imaging subsidiary IMed, citing: market share losses to public hospitals, and an increasing number of new, small independent practices; increased cost pressures, as doctors who vended their original businesses to the I-Med/MIA networks transitioned to a more regular employer/ employee relationships reflecting market-based remuneration; and setbacks with its diversification into the UK diagnostic imaging market (Grant Samuel 2006). Further, DCA acknowledged I-Med's performance would be flat in 2006/07. These factors contributed to negative market sentiment, with the Group's share price falling to $2.21 on August 2. In September the Group advised the ASX that it had received offers. On 12 December DCA shares were transferred to CVC. The Group delisted from the ASX on 21 December 2006.
The I-MED Network was formed in October 2004 following the merger of I-Med with MIA. As a result, I-Med became Australia's largest private diagnostic imaging provider with about a third of the private domestic market. MIA listed on the ASX at 80c in July 2000, peaking at $1.71 in November of the same year (Your Money Weekly 17 October 2002). By the end of its first financial year, MIA was the market share leader with about 20% of the private domestic diagnostic imaging market. Beginning in May 2002 however, the Group issued a number of earnings downgrades, followed by concomitant falls in its share price. By the end of 2002, it was looming as a takeover target.
According to Scott Power from ABN Amro Morgan 'MIA has disappointed the market ... with a failed move into the UK pathology market, together with a number of specific underperforming centres in Australia' (quoted in Greenblat 2004a). The Group had earlier credited the successful integration of acquired practices to a '... model whereby doctors retain equity and have involvement at all levels of the company ... ' (Macintosh 2001); however, it was later reported to be 'plagued by radiologists selling out as escrow provisions expire' (Clegg 2002:18). Between 2001 and 2004, the proportion of MIA equity held by doctors fell from over 50% to 30% (KPMG Corporate Finance 2004).
Recognising the difficulties of integrating acquired practices, MIA appointed a new CEO, restructured management and divested its lossmaking pathology business. However, its share price remained below its issue price5 and in June 2004, the Group announced it was merging with I-Med.
In December 2004, Gribbles was acquired by hospital operator, Healthscope. While Gribble's Australian pathology business was profitable, earnings downgrades and unmet (earnings) expectations, diversification into international markets, particularly India, coupled with corporate governance issues contributed to a parlous share price. Following the appointment of a strategic advisor to review its strategy and operations, and amongst widespread media speculation about its future, Cribbles accepted a $285 million public market takeover offer from Healthscope. The acquisition provided Healthscope with the opportunity to diversify its earnings, and also capture pathology revenues from the Group's hospitals. According to its MD Bruce Dixon 'inclusion of pathology services greatly enhances economics of the hospital business ... two revenue streams from one asset (dramatically improved ROI)' (Dixon 2005).
Although Foundation/IPN was a perennial lossmaker until recently, it was only acquired by Sonic after a takeover bid by rival, Primary. In June 2004, Primary increased its stake in IPN to 20 percent, and simultaneously announced a takeover offer. However, according to IPN, Primary's offer did not reflect IPN's significant strategic value, with the Group pointing out more doctors practised in Foundation medical centres than any other group in Australia (Shreeve 2004). The acquisition by Sonic was described by Andrew Goodsall of Citygroup Smith Barney 'as an unplanned impost to secure IPN's pathology referrals' (quoted in Greenblat 2004b), and Dr Goldschmidt acknowledged 'IPN's business is not particularly material to us; however, it is important for Sonic to defend its pathology revenues' (quoted in Greenblat 2004c).
Today, as a result of these acquisitions, only four publicly listed companies remain in the sector: Sonic/IPN6, Healthscope, Primary and Symbion. Moreover, all firms share a common integration strategy: vertical or virtual integration, Sonic via its strategic alliance with Foundation; Healthscope, through Gribbles provides pathology services to its hospitals; and Primary and Symbion whose medical centres provide patients to their respective pathology and/or diagnostic imaging groups. As one industry participant put it, it seems likely diagnostic operators [are] seeking to secure/own revenue source to protect business, i.e. Sonic IPN; Symbion - Medical Centres; Primary Medical Centres; Healthscope - hospitals (Dixon 2006).
Both the private pathology and diagnostic imaging (albeit to a lesser extent) markets are largely consolidated. Therefore it is likely corporations are trying to secure their referral base, consistent with the proposition noted earlier: the focus of vertical integration is controlling demand and/or distribution channels, as controlling the flow of patients to an institution may be the key to maintaining market share (Conrad and Dowling 1990). In contrast, the merging of MIA with I-Med and subsequent privatisation of I-MED raises questions about the viability over the long-term of horizontal integration of diagnostic imaging practices as a core business. Indeed if a broader measure of performance is adopted - survival these developments suggest vertical integration may be the only sustainable strategy. Confronted with these tentative finding, a salient issue is: What about the theorised advantages of horizontal integration of diagnostic imaging practices?
In the case of horizontal integration, performance is predicated upon the assumption aggregated practices can improve efficiency through economies of scale (Burns 1997). By definition, economies of scale exist when average production costs decrease with increases in the scale or size of the firm. Existing public information indicates pooled purchasing reduces costs for consumables, medical indemnity insurance, equipment and IT, and centralisation of corporate functions reduces practice overheads. For example, MIA pointed to procurement savings of over $3 million per annum (recurring) in film and contrast, equipment maintenance, telecommunications and financing costs; better capital utilisation as a result of improved buying power and (some) clinic rationalisation; and increased efficiency from centralised administration (MIA Group 2001). Similarly, I-Med quantified the financial impact of cost savings from its acquisition of MIA as $15 million per annum within two years (DCA Group 2005a). However, the provision of diagnostic imaging services mean individual clinics, staffed with a radiologist, technicians and support staff, usually service a small geographic catchment area (Grant Samuel 2006). Thus in contrast to pathology, where there are significant cost savings from rationalising laboratories and automating operations (Sethuraman and Tirpuati 2005), such savings are unlikely in diagnostic imaging as individual clinics need to be located geographically proximate to patients and referring practitioners. As the single largest cost category in diagnostic imaging, labour, is to a large extent fixed (Grant Samuel 2006), it seems unlikely economies of scale per se would confer a significant cost advantage. Conversely, labour costs can rise to the extent that they adversely affect profitability. In 2006, I-Med's margin declined as a result of significantly increased remuneration costs, particularly for doctors, together with less than expected revenue growth (Grant Samuel 2006). Similarly, Sonic's diagnostic imaging division impacted by wage pressures had an adverse impact on Group margins (Goldschmidt 2006), while benefits of cost focus were offset by wage pressures at Symbion's diagnostic imaging business (Cooke 2006). Moreover, this trend is expected to persist (Grant Samuel 2006:49):
Remuneration for a scarce resource such as ... radiologists is always likely to face upwards pressure. In almost any plausible scenario the rate of growth in remuneration rates is almost always likely to exceed the price increases that cart be obtained on procedures.
In response to these challenges, I-Med (and prior to its acquisition, MIA), together with Sonic and Symbion, are implementing performancebased pay structures to align doctors with corporate interests. As in the US '[t]he fundamental issue ... [may be that] [n]o one has come up with the right model operationally to work with the physicians' (Seism and Rundle 1998). MIA and I-Med also pointed to more efficiency from benchmarking and implementing best business and clinical practices. However, Robinson (1998:149) observes 'these improvements are difficult to implement in a context of rapid organisational growth yet are essential for long-run profitability'. As illustrated by MIA and I-Med above, there are significant challenges in marrying the short-term perspective of investors (expectations) with the longer-term required to change physician practice and patterns. Recent remarks by DCA's MD David Vaux may also speak to this issue: 'Private equity does have a lot to offer ... You can put in place strategies for the long term. The [share] market can have too short-term a focus' (quoted in Tyndall 2006).
Implications and future research
Presumably, by taking I-Med private, CVC removes the short-term financial imperatives of public equity markets and shifts the focus to longer-term returns. However this begs the question: if, as suggested above, economies of scale are indeed limited, how does CVC plan to improve performance? Since Vaux denied the focus would be on cost cutting and staff rationalisation, the Group could grow the size and patient volumes of practices already owned. In practice however, 'same-store' or organic growth often turns out to be negative because economies of scale promised for every new acquisition fail to materialise (Reinhardt 2000). Moreover, Burns and Robinson (1997:24) contend there are limits on how much efficiency can be 'wrung out' of physician practices.
A related research question is what are the benefits of privatisation and to whom do they accrue? This is a salient issue in light of recent questions regarding why DCA's shareholders should sell their stock if DCA's senior management invested alongside CVC for potentially significant gains under private equity ownership (Tyndall 2006)? Interestingly, equity investment opportunities were also available to doctors within the I-MED Network, as well as other DCA management.
A number of research questions with significant implications for health management policy and practice are also evident, for example: What, if any, differences exist in other key performance measures (e.g. cost and quality of care, access to care and health outcomes) between types of integration? While it is less difficult to quantify success in terms of financial returns, measuring other aspects of performance is important from both patients' and policymakers' perspectives.
It seems unlikely horizontal integration of diagnostic imaging practices by public corporations will overall, deliver significant (health) cost savings; there is, however, evidence to suggest that some segments of the market are better off: DCA attributed I-Med's loss of market share to small, independent practices which bulkbill, avoiding co-payments for patients; and public hospitals (run by State Governments) capturing a share of the private diagnostic imaging market, thereby providing incremental revenue to the State from the Commonwealth Government, while the former's cost base remained unchanged. However, if recent media reports are an indication, this may be at the cost of their duty to look after public patients (Greenblat 2007).
Similarly, Primary highlights the benefits of large-scale multi-purpose medical centres to patients (access to competitively priced, convenient, comprehensive care); payor/ government (provider of services in an efficient, voter endorsed cost efficient manner); and GPs (financial and professional) (Bateman 2005). Yet to date, peer reviewed empirical studies have not critically examined these claims. Rigorous scholarly work is needed to shed light on this area, in order to determine the extent to which value is transferred back to the broader community.
A further line of inquiry is to critically examine who are the 'winners' from corporatised medicine? A corollary public policy issue is whether Medicare should provide a return to medical practitioners and investors? As Collyer and White (2001-.v) cogently observe '... the maximising of profit is neither illegal nor unethical indeed, it is a duty to the shareholders'. These issues are not only a particular concern for healthcare executives, who need to assess costbenefits of various types of integration, but also the Federal Government, as they, through Medicare, are the primary source of revenues.
A further line of inquiry is to investigate why some vertically integrated firms outperform others. The study clearly showed differences between financial performance of firms pursuing the same integration strategy, with Primary significantly more profitable than Mayne or Gribbles. Examining other dimensions of integration such as breadth and degree of integration may be a useful starting point. For example, what degree or proportion of in-house vis-à-vis GPs external to the integrated entity account for 'in-house' diagnostic or other referred services? The range of performance of vertically integrated firms also highlights the difficulty of managing vertical integration.
A related area warranting investigation is whether vertical integration could encourage undue use of diagnostic services via supplierinduced demand, especially if patients are bulkbilled for such services. Incentives could exist for companies to use GPs as a 'loss-leader' and rely on referrals to the more profitable areas of their business. However, as these services are subsidised by Medicare and patients are dependent upon medical practitioners with respect to what services they should use, it raises a significant issue for professional and government policy. An associated issue is the potential for increased healthcare spending. While the potential impact on referral rates, diagnostic and pharmaceutical expenditure from co-locating general practice with diagnostic, specialist and ancillary services has been pointed out before (Catchlove 2001), the need for oversight applies more forcefully now as all remaining listed corporations pursue vertical or virtual integration.
A final issue meriting attention is geographic diversification. One area of diversification not explicitly considered in existing healthcare literature (e.g. Conrad and Shortell 1996; Robinson 1996), is diversification into international markets. A number of firms diversified into international markets, whilst remaining in the same product market, most likely due to companies needing to access larger markets because of limited growth opportunities in the Australian market. This trend is likely to continue, as the domestic market becomes consolidated and opportunities for further acquisitions diminish. To fund international expansion, public companies use cash on hand, debt and/or their stock (Reindhart 2000). In the case of debt-finance, the acquiring company incurs fixed future interest payments that are, in part at least, likely funded by domestic earnings derived from Medicare. Alternatively, if equity raisings are used, companies must still provide returns to shareholders, again using domestic earnings. Either way, an important issue for policy-makers is whether Australia's universal health insurance system should finance such activities. It is, of course, possible for corporations to expand offshore and re-invest returns to improve the quality of domestic services. In this way, multi-national health service companies may enable the globalisation of health care financing and provision.
This study sought to investigate the financial performance of vertical or virtual integration visa-vis horizontal integration and diversification in three medical service sub-sectors, adding to the very few scholarly empirical studies published to date. By empirically examining the financial performance of medical centres, the research may begin to shed light on the 'true' value of general practice, at least to some listed corporations.
The findings raise a number of significant issues for the public financing of health care services, including the potential for increased healthcare expenditure from the co-location of general practice with diagnostic and other Medicare funded services. Moreover, as the private sector is heavily subsidised by the Federal Government through Medicare benefits, a salient concern is whether the provision of medical services by listed corporations, whose duty is first and foremost to shareholders (Baxt 2000), represents the best use of limited public funds. An equally important and related question is whether large scale multi-specialty medical centres owned by public corporations constitute a viable avenue for the delivery of cost-effective community-based healthcare? Before these issues can be addressed, empirical research examining other important dimensions of performance is needed. These include quality of care, access to care and health outcomes.
Finally, should Australia's universal health insurance system, Medicare, designed to provide Australians with affordable, accessible and highquality health care, be able to be used by companies to help fund overseas expansion? The import of the need for public debate on this issue, now more than ever, derives from the fact that international diversification is a trend likely to continue.
1 Following its acquisition of Cribbles in December 2004. Healthscope pursued vertical integration for the second half of the year ending 30 June 2005. However, it is excluded from the study as data for its pathology segment includes veterinary pathology.
2 In November 2005 Mayne Pharma demerged from Mayne Group. Mayne Pharma retained the Mayne brand and Mayne Group changed its name to Symbion Health Limited.
3 These margins are also substantially below 27.6% (measured by operating profit before tax) reported by ABS (1997) for non-specialist services pre-corporatisation (KPMG 2000).
4 Prices accorded to shares of publicly traded corporations (as discussed in this and subsequent company synopses) can provide an indication of how companies are perceived by the market (Marsh 1998).
5 Prior to market speculation of a merger. On the business day prior (26 May 2004) to the announcement, MIA shares were trading at $. 7 7 per Share. MIA's six month VWAP up to and including 26 May 2004 was $.743 per Share (MIA Group 2004).
6 Technically, IPN remains a listed company. However, it is a subsidiary of Sonic Healthcare Limited.
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Flinders Business School
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Publication information: Article title: Integration and Diversification in Healthcare: Financial Performance and Implications for Medicare. Contributors: Jones, Jane - Author. Journal title: Health Sociology Review. Volume: 16. Issue: 1 Publication date: April 2007. Page number: 27+. © 2007 eContent Management Pty Ltd. Provided by ProQuest LLC. All Rights Reserved.
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