The frenzy to buy physician practices drives up acquisition costs in some markets but doesn't inflate physician salaries, a survey shows.
In fact, there is often a tradeoff between the sale price of a practice and a physician's salary once on the hospital payroll.
According to the 1995 Physician Practice Acquisition Resource Book, family practitioners whose practices were acquired by hospitals had a median initial base salary of $120,000. That's slightly lower than $122,625 for family practitioners working in all settings, according to an average of surveys compiled by MODERN HEALTHCARE (July 10, 1995, p. 41).
It's one sign that hospitals have set limits when negotiating with doctors.
"I think that's good news. It means we're not as an industry reacting quite as badly to the frenzy. It's calmed down," said Carson Dye, a consultant with the Toledo, Ohio-based firm of Findley, Davies & Co. who advises hospitals on physician arrangements.
The survey of 245 practice acquisitions involving 101 hospitals and more than 650 physicians was conducted by the Center for Healthcare Industry Performance Studies in Columbus, Ohio, and Findley, Davies.
Hospitals paid the most for practices in markets where managed care had medium penetration (40% to 52% of residents enrolled in an HMO or PPO). The average sale price in those markets was $134,000 per physician, 41% higher than the $95,000 paid in areas with low managed-care penetration and 26% higher than the $106,000 paid in high managed-care markets.
That suggests that demand for practices-especially primary care-peaks as markets move into managed care, then subsides as managed care fully develops.
Thus, hospitals that don't buy practices early in the cycle might consider an alternative, such as establishing a management services organization to link with physicians, Dye said. However, he said, the urge to buy practices even at high prices is justified in the race to ensure access to primary-care feeders.
Doctor supply also appears to play a major role in practice value. Practices acquired by hospitals in the Northeast were consistently valued lower than those in any other region. Those in the Near West (defined as 11 states stretching from Texas to Minnesota), where there are lower doctor concentrations, were valued highest.
Not surprisingly, financially strong hospitals tended to pay more. The survey noted a correlation between higher acquisition costs and hospitals with high profitability and large cash reserves.
Also, valuation methods had a major impact. Most hospitals surveyed used a practice's net asset value, which resulted in a median value of $95,000 per physician. Discounted cash flow, the method preferred by the Internal Revenue Service but used half as often, produced values with a median of $200,000.
The authors expect discounted cash flow to become more common, which could lead to higher acquisition prices.
The report sheds some light on why practice valuation can be complex, and comparisons misleading. Ranges in practice values were very large. For example, family practice acquisitions ranged from $10,000 per physician to $725,000 per physician. The $10,000 was paid to acquire a retiring physician's charts. The $725,000 practice included $350,000 for a building and $82,500 for accounts receivable.
Noncompete clauses, which help ensure that patients return to a practice, carry significant value. In fact, the survey indicates, practices have little value without them.
Acquisitions with noncompete clauses, which comprised 80% of the sample, had a median value of $136,000, 94% higher than those without noncompete restrictions, which went for $70,000. Accounts receivable alone average around $60,000 per physician.
The authors believe that in some cases, hospitals agree to pay more for practices in return for lower future compensation. For example, hospitals paid an average of $224,000 per physician for multispecialty and specialty practices, but paid those doctors a modest initial base salary of $125,000.
Most hospitals fail to profit on the operation of physician practices, according to two recent reports-one by New York-based Moody's Investors Service and the other by the Westchester, Ill.-based Healthcare Financial Management Association and Louisville, Ky.-based Sterling Physician Services of America (Nov. 13, 1995, p. 16; Sept. 25, 1995, p. 64). Moreover, a significant number have lost money.
One possible factor is that physicians seldom have strong financial incentives to be productive once they are on the hospital payroll. Eighty-two percent of salary arrangements had some incentive compensation arrangement, but typically just 15% to 25% of base pay was at risk. Also, few compensation plans emphasized controlling expenses or reducing downstream costs.
The search for proper incentives is ongoing, Dye said, because productivity is difficult to define and because many physicians, especially in primary care, are not motivated purely by money.