Providing Capital For Physician Group Practices: New Opportunities For Hospitals - Statistical Data Included

Healthcare Financial Management, Dec, 1999 by Keith D. Moore, Richard L. Clarke, Dean C. Coddington

Healthcare organizations interested in acquiring physician group practices will find that today's market favors buyers, whereas only two years ago, it was a sellers' market.

As physician group practices grow and consolidate, they have an increasing interest in developing close capital partnerships to ensure access to capital. Yet as many healthcare organizations have sought to divest poorly performing acquired physician practices, physicians have seen their pool of potential capital partners shrink. Under these conditions, hospitals have a new opportunity to present themselves to physician group practices as attractive capital partners.

To understand the nature of this opportunity, one needs to know why group practices seek capital, how groups approach their investment strategies, and what criteria they use to compare prospective capital partners. To build stronger relationships with physicians, hospitals should focus on turning around their poorly performing acquired physician practices and pursue strategies such as collaborating with physician practice management companies and developing new models for partnering with physicians (eg, special purchase agreements and more advanced management services organizations).

Consolidation of physician group practices has accelerated recently as physicians have sought ways to meet the pressures of managed care and achieve economies of scale. As group practices consolidate, their need for capital tends to increase significantly due to factors such as increased fixed costs, the need for more sophisticated information systems, and new or expanded facilities.

Yet as the capital needs of the new, larger group practices have grown, the pool of potential capital partners has shrunk as many healthcare organizations have sought to divest unprofitable acquired practices. Thus, what was once a sellers' market for physician practices, with many different types of healthcare organizations (ie, physician practice management companies [PPMCs], health plans, and hospitals) all competing to acquire group practices, has become a buyers' market. These market conditions are largely a consequence of the generally poor financial record of PPMCs and the drying up of capital resources (due to the recent poor performance of many elements of the healthcare industry in the stock market, for example). As such, current market conditions offer hospitals and multihospital systems an important opportunity to invest in group practices to build stronger relationships with physicians and to improve their market position.

To understand the nature of current market conditions, and the opportunity facing hospitals and multihospital systems, it is important to understand factors driving consolidation of group practices, the reasons group practices seek capital, how group practices' investment strategies vary, and what criteria attract group practices to various potential capital sources.

Exhibit 1 (page 47) shows the relative attractiveness of various sources of financing for group practices. In the past two years, the position of hospitals has improved compared with that of other potential capital partners available to group practices. For example, the strategies of hospitals and group practices in a community now are likely to be more compatible, and the financial terms that hospitals can offer have improved relative to those offered by PPMCs, largely due to the recent poor financial performance of the latter organizations.

FACTORS DRIVING GROUP PRACTICE CONSOLIDATION

Physicians in the United States traditionally have tended to practice independently or in small group practices. Of the more than 500,000 physicians in private practice in the United States, 75 percent are in solo practices or single-specialty groups of fewer than 10 physicians. [a]

Over the past decade, however, consolidation of group practices has accelerated largely as a result of the acquisition activities of hospitals and hundreds of publicly and privately owned PPMCs. In many instances, hospitals and PPMCs have bought solo practices and merged them into larger groups. A survey by the American Medical Association found that from 1990 through 1996, the number of group practices with 10 or more physicians increased from 2,657 to 3,648, and the number of practices with more than 100 physicians increased from 118 to 238. [b] Moreover, the AMA found that the total number of physicians in group practices of more than 100 physicians increased from 38,603 in 1990 to 64,770 in 1996.

Physicians choose to consolidate their practices for many other reasons besides a desire to maintain a competitive edge. Often, they do so to acquire greater market influence or to ensure the financial security of the practice and potentially increase physician income. In many instances, they may consolidate to achieve the economies of scale necessary to develop resources required to more efficiently manage their practices, both financially and clinically. Such resources include information systems that facilitate the use of data physicians require to generate bills, measure outcomes, and improve clinical process. In some instances, physicians will consolidate to increase their practices' market value.