The future of physician practice management companies

Healthcare Financial Management, August, 1997 by Michael S. Thomas

Physician practice management (PPM) companies are a growing sector of the healthcare industry and have caught the attention of Wall Street, as evidenced by the number of initial public offerings of PPMs in the past three years. The cost of operating efficiencies, declining premiums, integration, oversupply of specialists, shift from a gatekeeper to a direct-access model, and cultural challenges are the emerging market forces that may affect PPM viability. The challenge for PPMs is to maintain earnings growth in the face of these market forces.

During the past couple of years, Wall Street clearly has been infatuated with initial public offerings (IPOs). Nowhere has this infatuation been more evident than in the healthcare industry where managed care growth, state and national reform measures, and technological advances have created opportunities for more than 400 healthcare-related companies to access equity capital through public markets in the past two years.

Within the healthcare industry, Wall Street investors have demonstrated a particular affection for physician practice management companies (PPMs). There are currently more than 30 publicly traded PPMs, and in 1996, PPMs raised a record $1.7 billion in capital through public equity and debt offerings.(a) The growth of the PPM sector has been fueled by the need to bring capital resources, economies of scale, management expertise, advanced information systems, and managed care contracting capabilities to a tremendously fragmented market of more than 600,000 physicians in the United States.

In recent years, hospital, ambulatory surgery center, infusion therapy, and urgent care center sectors included a large number of investor-owned companies; only a few large companies, however, have survived. Many healthcare insiders are questioning whether PPMs will endure, or whether only a few such companies will survive, a few entrepreneurs will get rich, and many investors will be left disappointed.

In most markets, numerous privately owned and not-for-profit entities compete with investor-owned healthcare companies for patient and physician loyalties. Most physicians can choose from a variety of strategic partners, including PPMs, hospitals and health systems, integrated delivery systems, large physician organizations, and health plans. While all are capable of financing the consolidation, integration, and management of physician organizations, each potential partner has different motivations and, therefore, unique expectations regarding willingness to invest capital, required return on investment (ROI), and investment holding horizons.

For example, an HFMA study showed that although only 17 percent of surveyed hospitals and health systems that had purchased physician practices in the past five years achieved a positive ROI, very few either restructured their existing physician relationships or divested the acquired practices.(h) In contrast, Wall Street's intolerance for poor PPM performance was shown in 1996 when several PPMs saw their respective market capitalization plunge by 50 to 85 percent after reporting lower-than-expected earnings.

Most PPMs are achieving significant earnings growth primarily through incremental practice acquisitions, not through sustained improvements in practice operating performance. PPMs will be pressed to maintain their earnings growth when the frenzied pace of practice acquisitions wanes. The survivors likely will be those that continuously focus on reducing administrative costs, enhancing customer service, and improving clinical outcomes and quality through advanced medical management protocols. Several emerging market forces, however, may challenge many PPMs as they strive to sustain Wall Street's long-term earnings expectations.

Effects of Emerging Market Forces

Emerging market forces that may affect the viability of PPMs include the cost of operating efficiencies, declining premiums, integration, oversupply of specialists, shift from a gate-keeper to a direct-access model, and cultural challenges.

Cost of operating efficiencies. Most experts agree that physician practices need to operate efficiently. In fact, many PPMs promote their ability to provide participating physicians with economies of scale, national purchasing discounts, administrative support, information technology, and capital resources (eg, ancillary services, equipment).

Medical Group Management Association (MGMA) data indicate, however, that consolidating physicians into larger medical groups will not necessarily result in economies of scale. In fact, according to MGMA, the overhead rate for multispecialty group practices with 26 to 50 physicians (53.95 percent) is essentially the same as that for multispecialty group practices with 11 to 25 physicians (53.28 percent).

Also, national purchasing discounts generally can be applied only to medical and office supplies and professional liability insurance. Yet these expenses typically account for less than 10 percent of a practice's total overhead. Therefore, a five percent savings on supply and insurance costs would result only in a 0.5 percent reduction in the practice's total overhead expenses.(c)