Physician practice management companies: A failed concept - Book Excerpt

Physician Executive, March, 2002 by Stephen Kraft

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IN ORDER TO SURVIVE, a business must create value and capture some of that value. The health care industry in the United States creates value, for consumers. The "captured value" becomes income for health care workers and return on capital for investors. It is instructive to look at a failed concept, an idea that failed the test of the marketplace. We will look at physician practice management companies (PPMCs), a concept that caused massive financial problems for thousands of doctors. PPMCs failed because they failed to create value.

The concept

PPMCs attempted to add value by bringing management services to physicians and facilitating access to capital. Further, PPMCs proposed the development of multispecialty delivery systems by linking together previously independent practices and contracting with national managed care organizations (MCOs) or insurers. The aggregation of independent practices into a network was promoted as a way of increasing negotiating power when dealing with MCOs and other payers.

"The business model originally promised by the industry had been heralded as a vehicle endowing physicians with the financial capital they would need to harvest the synergism of larger groups, to build sophisticated clinical information systems that would help to manage care more efficiently and to develop as a countervailing power against the growing market clout of the managed care industry. The advertised idea was to create genuine value that could be shared at least by physicians and their capitalist allies in the financial markets, but perhaps also by patients, in the form of lower prices or higher quality." (1)

Finally, PPMCs accelerated the growth of their networks by using venture capital funds and money from the sale of stock to purchase thousands of physician practices.

The reality

The two largest PPMCs were Phycor and MedPartners. MedPartners went public in 1995 and had almost 6,000 physicians in acquired practices. Revenue grew from $2.6 billion in 1994 to $6.7 billion in 1998; however, 1994 profits of $80 million turned into a loss of $1.2 billion in 1998. (2) The stock price was as high as $30 in 1997 and had fallen to $1.50 in 1998. (2) By 1998, MedPartners had exited the PPMC business and was reborn as Caremark, a pharmacy benefits company. Phycor went public in 1992 and had 3,800 physicians in acquired practices. In 1996, the company reported earnings of $81 million and a stock price of $40. By 1999, the company reported losses of $444 million and a stock price of $0.10. Other PPMCs had similar trajectories.

The problems

Traditionally, running a physician practice was focused on managing a small staff of office employees. Physicians managed their own practices, using accountants, lawyers and other outside consultants when necessary. Large physician groups often hired professional managers. In the 1980s and 1990s, running a practice became more complicated. With the disappearance of "usual and customary" billing arrangements, physicians found themselves dealing with complicated managed care contracts and multiple fee schedules. Paperwork multiplied, as insurers required detailed documentation and layers of administrative approvals. Many practices required additional management expertise, which PPMCs promised to provide.

Did PPMC management services provide value to the practices in their networks? Some practices found small increases in collections, as a few PPMCs were able to implement better billing processes. However, the PPMC industry was able to offer little that saved money on practice operations. Physician owners had always been careful to control costs in their own practices and the PPMCs added little in this area. In fact, the scattered structure of the PPMC network made it more difficult to manage individual practices. Where physician owners had carefully overseen daily operations of a small office, PPMC managers were supposed to run a network of perhaps thousands of physicians scattered in hundreds of offices. The PPMCs failed to meet this challenge. William R. Dexheimer, co-founder of MedPartners described the dilemma. "I have felt that the tools to manage the industry have been running significantly behind that growth. By "tools" I'm referring to resources such as knowledge base and human capital, but above all I'm referring to the software and other elements that make up those all-important systems." 3

The PPMCs were unable to manage the system they had created. In some cases, the PPMCs produced a negative synergy and destroyed value, as the new arrangement was less efficient than the previously independent practices. Most physicians were disappointed to discover that PPMGs added little or no value to the management side of the practice.

Small physician practices had limited capital requirements. With a traditional office needing little more than furniture, exam tables and simple diagnostic equipment, cash flow from the business was able to finance most capital expenditures. Successful practices were able to borrow money from local banks or vendors for investment in buildings or expensive equipment. It is not clear that physician practices ever suffered from a shortage of capital. Perhaps PPMCs could provide easier access to capital in the form of loans or lease arrangements. In fact, this made little difference to most PPMC practices. Most of the capital raised by the sale of stock was used to purchase practices. Little was invested in sophisticated clinical information systems or other management technology.