Determining physician compensation — Part I - Nuts and Bolts of Business

Physician Executive, March, 2002 by David P. Tarantino

Likewise, you may use a modification of the concept of "return on investment" (ROI) to distribute the funds. Return on investment is calculated by multiplying margin and turnover. Individual ROI may be determined by multiplying individual contribution margin by billings, then dividing this product by the average accounts receivable balance (turnover) of the individual. You may then take a weighted average of the ROI to distribute profits.

If, in our example above, "D" billed $800,000 over the year and maintained an average accounts receivable balance of $250,000, then "D's" ROI is $75,000 x $800,000/$250,000 or $240,000.

If "E" and "F" achieved ROI's of $175,000 and $150,000 respectively, then the pool would be distributed as 42 percent for "D,", 31 percent for "E," and 27 percent for "F."

When using a productivity model for employed physicians, I recommend setting a hurdle rate above a predetermined target of collections to be achieved, before a productivity bonus is received.

A common measure used to set the hurdle rate is the weighted average cost of capital (WACC) of the practice. This is determined by adding the products of the percent of debt times the cost of debt and the percent of equity times the cost of equity (your accountant can assist in determining your WACC and I will discuss the methodology in a future column on practice valuation).

For example, if the cost of debt is 6 percent and it comprises 30 percent of the capital structure, while the cost of equity is 15 percent and it comprises 70 percent of the capital structure, then the WACC = (6% x 30%) (15% x 70%) = 12.3%.

So an employed physician would have to achieve a level greater than 12 percent of a predetermined collection target to be eligible for incentive funds.

The major disadvantage of this model is that it may create intense competition among partners for the better-insured patient population within a practice. As a result, the administration of this model is more difficult since payer mix, as well as proper overhead allocation, must be taken into account.

Salary is usually based on the previous year's productivity, with withholds built in to prevent overpayment for decreases in productivity. Therefore, it is more difficult to plan what actual compensation will be from year to year.

No matter what model you choose, all parties involved must understand and accept the methodology. By using sound business principles in the day-to-day operations of a practice, fair and equitable compensation models can be developed.

David P.Tarantino, MD, MBA, is the executive medical director of Shock Trauma Associates, P.A., a 50 physician, multispecialty practice associated with the University of Maryland School of Medicine. In addition, he is the chief executive officer of The MD Consulting Group, LLC, a health care management consulting firm in Baltimore, Md. Tarantino can he reached by phone at 410/328-3198 or by e-mail at tdoc5@aol.com.