"So, let's see if I understand this," the doctor says to the representative of the physician practice management company. "In exchange for my assets, you'll improve my information systems, manage my office operations, keep up with the byzantine requirements of managed care companies, do the worrying for me about how much of the premium dollar I collect and free me to just practice medicine? It's a dream come true!"
Or maybe the same meeting ends with the physician saying, "Yeah, and next you'll be merging us with the practice down the street, and then you'll move on to a new conquest and forget who we are. You're more worried about what investors want than what I deserve. What do I really get out of the deal?"
Paul Keckley, vice president of strategic development for PhyCor, and Jeffrey J. Denning, a practice management consultant in Long Beach, Calif., don't always see eye to eye in this discussion moderated by former Managed Care Editor Timothy Kelley, but agree more than you might expect.
PhyCor, based in Nashville, Tenn., is the nation's largest PPM, operating multispecialty practices and clinics and managing independent practice associations. Denning also publishes UnCommon Sense, a monthly newsletter that addresses issues of interest to smaller practices.
MC: Let's start by getting a sense of what it is we're talking about. Paul, let's say I work for a physician group that sees managed care taking over our market, and reimbursements are coming down. We decide that we need access to more operating capital or, perhaps, greater economies of scale to improve negotiating clout with HMOs. How might a physician practice management company help us?
Keckley: One would be creation of a structure whereby physicians can get a higher share of premium. Two would be development of processes that would allow the physician organization to differentiate its performance from a competing organization on the basis of clinical performance as well as utilization and cost management. Three, we would bring national contracts that are better than local groups or physicians can get on their own.
MC: The options include selling much of a practice's assets?
Keckley: We have two basic models — independent practice associations and group practices. In the case of a group practice where there is an asset transaction, then obviously you go beyond that to providing the capital required to recruit additional physicians, to put in ancillary services, to grow the group to achieve critical mass, and usually the associated bread-and-butter elements of better cost controls and probably better management. In a group practice transaction, we purchase the assets of the group and the physicians are in a PC, a professional corporation. We provide management services and capital.
MC: Jeff, you're generally negative about PPMs, and you've suggested that some of them are more interested in acquiring practices than in fostering the growth of the ones that they have.
Denning: Our clients and our readers are physicians — the 75 percent of physicians who find themselves in what we would call mainstream medical practice of the 1- to 15-physician size — and almost all in single-specialty practices, which is quite a bit different from the market that PhyCor has gone after. The position we take is to look at what you give in exchange for what you get when you swap your assets. Why does the management company need to own your exam table? Why do you need to sell your assets and then rent them back? The benefits sound good at the presentation level. It does take a little additional capital to start mining your data for outcomes and cost-performance information. Unfortunately, most of the organizations that are approaching our clients are not more experienced at this stuff than the doctors.
Keckley: I think there's more commonality of concern than there is a difference of opinion. When we started in '88, we had no concept that we'd create an industry and that, literally, within the last three years there would be 30-plus publicly traded companies that are out there seemingly more interested in doing deals than in actually operating. I think that's your concern. And I think there is a lot of that.
MC: Is that your concern, Jeff?
Denning: It is.
Keckley: The single-specialty market offers this promise, and I think it's almost universal: "Dr. Orthopod, if you'll join with five other orthopods in this market, you'll have more leverage with the plans because you'll get a carve-out." Factually, what PPMs have done is say, "In exchange for your assets, we'll give you stock in a company that's going to go public and you're going to have a windfall. Reality is, these things have not performed, and Wall Street is looking at them very cautiously, saying, "If the growth of the PPM is simply doing more deals and there's no same-store performance [growth of a practice by drawing more patients to a given location, as opposed to growing by acquiring more locations — Ed.], if you've not increased revenues and reduced costs and increased the physicians' leverage with the HMOs and created equilibrium with the hospitals in the process, you haven't really added value. It takes a PPM about three years to go from being a Wall Street startup to actually having to perform. The other thing you bring up is, why would a doctor sell a lab table? The answer is that an asset transaction gives you a balance-sheet basis for investing in the future growth of that business and amortizing it over 25 or 40 years.
Denning: I understand that problem but I had a chance four weeks ago at a California Medical Association meeting to ask of Mark Wagar, one of your colleagues now or soon to become....
MC: The president of MedPartners?
Denning: Yes. He had chronicled this continual difficulty getting physicians to invest in the future and I asked, "That is a real problem, but looking at the figures you've just put up on the screen, it looks like MedPartners has raised over $1 billion in the capital market, and the way I compute it, those investors or lenders are going to want something like $250 million a year return. If you divide it by the 3,600 doctors you've got in your group practice or IPA arrangements, that comes to $80,000 apiece per year. Where's that going to come from?" He said only that there is, indeed, a cost of capital to be paid.
Keckley: That's not the way Wall Street calculates this. We're trying to get about an 8.1 percent bottom line. Wall Street invests on the future growth in value of a business, not on its current value. And most of Wall Street's assessment of performance is based on a combination of growth of new business as well as same-store performance, which is the reason we have carried a price-earnings ratio that's much higher than MedPartners and other practice management companies.
Denning: I'm talking about investment yield, not just bottom-line earnings. These are both good companies, but they're not blue chips. I'm looking for 25-percent return on anything that's not blue chip....
Keckley: I think you're oversimplifying the investors' side of the business. Venture capitalists expect 40 to 50 percent, and they typically sell before a company goes public or when it goes public. We don't have any venture capital in PhyCor at all now. As you move from a small-cap stock, under $100 million, to become a larger company, institutional investors come in, more pension funds — and those funds are investing typically more for the types of returns that the mutual fund industry produces — from 10 to 20 percent, which is probably the ceiling for aggressive-growth funds. When we announced the MedPartners acquisition, we had a fund pull out.
MC: Paul, you mentioned at the outset a certain concern with some companies in the industry. Do you feel the demands of shareholders can be met with the growth that can be achieved on what you call a same-store basis? You are competing against companies that are achieving growth by rapid acquisition.
Keckley: We don't get up in the morning and worry about whether the stock is 32 or 25 or whatever it is. Wall Street is a source of capital. For every dollar you earn, you can get investors to give you that dollar times your P/E to invest in your operations. So if we're running a 35 price-to-earnings ratio, we can get $35 to invest in our local markets for every dollar of profit we earn. We invest the capital in each of our operations, interest-free to the doctors. If they go to the bank, they've got to pay for the capital. So does Wall Street have expectations? Yes. And they're pretty simple. They want to see sustained growth from same-store performance and new markets.
MC: Does this assuage your concern somewhat, Jeff?
Denning: He hit the nail when he said that there is a big difference between the large multispecialty management companies and the plethora of new single-specialty ones.
Keckley: At the end of a year, if we've not either increased revenues or reduced costs by 4 to 6 percent, it has cost the physicians for us to be their partner.
Denning: There may be economies of scale in operating those big groups. But if you go to Modesto, Calif., and sew up half the urologists in that town in your urology practice management company, there isn't any new business for them to get. They're already getting all of it.
MC: Most of the physicians who read Managed Care are in primary care, and they're the bulk of the readers of your newsletter, too. You've been critical of PhyCor in the past. Are you in some way changing that verdict now?
Denning: Well, I'm watching it carefully. I'm not as cavalier with it as I used to be, for primary care physicians.
Keckley: Primary care-only practices are the toughest to run — highest overhead, least leverage, worst infrastructure. The reason we do multispecialty groups is strategic. We believe that you need primary care doctors and specialists with parallel incentives to be able to manage clinical processes across the population. If we really just wanted to make some quick bucks, we'd line up a bunch of primary care doctors and say "We don't want to buy your assets. We just want to be your contracting arm and we'll commoditize the specialist and we'll commoditize the hospitals."
Denning: We used to say that there were only two reasons to have a multispecialty group. One was to have specialists who could subsidize primary care physicians and the other one was to do research and teach. But now the notion of keeping it all in one organization makes a lot of sense and, all of a sudden, the primary care physicians have an opportunity to be paid for managing care. We're not at all certain that they need to be owned by a giant corporation to do that, which is not to say that the corporate entities won't be successful in replicating the knowledge across the system. But we've seen very good examples of people doing it on a local basis already.
Keckley: The HMOs would love you for that because they have maximum leverage when the doctors stay in their practices without any kind of critical mass. When the HMO can go doctor by doctor, it has more leverage.
MC: HMO executives are among our readers also, and the tone that you've just struck, Paul, is one that they should read with some sort of trepidation, it strikes me, because you're talking about a deal presumably more advantageous to physicians than to an HMO. Or does everybody win?
Keckley: We don't want to be in the HMO business. We want to contract with those that will delegate medical management — PacifiCare, United Healthcare. Aetna is going this way.
MC: Looking at it from the point of view of the physicians who read Managed Care, it looks like, if they have not already made a big compromise of what traditionally has been their professional and their business independence, they will have to very soon. How should physicians decide whether the compromise they should make is affiliating with a PPM rather than with a PHO or something like that?
Denning: I would want to ask, how exactly are you going to add value to my practice? How are you going to bring me business that I can't get now and make this practice more attractive in order to take market share from those people that we're already competing with? And what do I have to give up to get it? And I ask a physician, What problem are you trying to solve? Quite often, they haven't given any thought to that question at all. But I think you've got me lumping PhyCor with everybody else when I'm actually not. I can imagine, for example, taking over academic practices, which don't function very well because they've always been subsidized, and turning them into much more efficient operations.
MC: Jeff, do you want to sum up your current picture of PPMs concerns?
Denning: The medical industry is still big and it's moving a lot slower than most people think. If you believe all the press releases, we're going through a whirlwind of cataclysmic change. But the fact is, after 16 years of Medicare HMO contracting, HMOs account for less than 20 percent of Medicare patients. I don't call that moving like wildfire. The PPM industry has done a lot in just a few years, but there's going to be a huge shakeout. But even in 1997, three-quarters of all physicians practice in organizations of 20 or fewer doctors.
MC: And the current penetration of PPMs is something like 8 percent. Paul, do you see that 8 percent turning into something substantially larger in the next 15 to 20 years?
Keckley: I would think so. The sector is growing at about 35 percent a year. You've got a lot of surrogates that are coming on the scene. You have got hospital ownership of practices, which is not included in those numbers. There are actually more hospital-owned primary care practices than all the PPM-affiliated primary care practices. So it's hard to put a number on it. I think Jeff's right. The reason for being for a PPM should be to empower physicians to sit as equals with hospitals and plans so they can manage cost and quality of care for their patients. It's not about capital. Hospitals will give you capital. The bank can provide you capital. It's not about better management, though I think we probably are able to attract that. It's about the ability, long term, for the physician to be at that seat at that table.
MC: Gentlemen, thank you both.