The physician practice management industry fueled its mid-1990s growth spurt on the promise of a pot of gold.
Its stocks were held aloft by the notion that consolidating doctors would transform the healthcare system. Physicians, desperate for capital and management assistance, rushed to sell their practice assets to the highest bidders. In about five years, the industry scooped up an estimated 10% of the nation's doctors.
Suddenly, like HMOs and hospitals before them, PPM firms have collided with reality. Running practices is a lot tougher than it appears, and making a profit in a climate of risk contracts and declining reimbursements can be nearly impossible.
Now the industry is being forced to
change its core strategies. Some observers wonder whether PPMs will even survive as relevant players.
A deluge of missed earnings targets has left some previously high-flying companies with stock valued at less than a box of used tongue depressors. Things are so bad that one recent industry research report was titled "Life Among the Embers."
The biggest disasters were MedPartners, No. 1 in revenues last year, which is selling assets as it tries to turn around huge deficits in its California operations, and last year's No. 3, FPA Medical Management, which filed for Chapter 11 bankruptcy protection this summer.
More tarnish has appeared as groups of disgruntled physicians seek to cancel long-term management agreements because their incomes have diminished or they have lost control of their practices. Investors are also peeved. Shareholders have filed class-action lawsuits against Advanced Health, FPA, MedPartners and PhyCor, charging the PPMs with having misled them about the companies' prospects.
Venture capitalists and banks have clutched their wallets, and public offerings are on hold. The Securities and Exchange Commission has added to earnings pressure by decreasing the time that companies can take to amortize goodwill.
For the first time, the industry appears to be shrinking. The New Rochelle, N.Y.-based Corporate Research Group expects total revenues to drop 7% this year to $10 billion from $10.7 billion in 1997. It predicts a 4% slide in the number of physicians under professional management, to 68,000 from 71,000.
The number of publicly traded, nondental PPMs is expected to drop to about 15 from 35 within two years, according to the CRG.
Survival of the focused. Emerging from the ashes are players with focused strategies, conservative capital plans and lower expectations for growth.
Where the buzzword used to be "growth," it's now "value"-as in adding value to practices. Companies are trying hard to close an operational credibility gap with their two key constituencies, physicians and investors. To do that, PPMs must show they can consistently run practices at a profit.
The strategy change also is due to a capital shortage. The pace of practice acquisitions has slowed dramatically since last spring. In one bellwether move, leading multispecialty manager PhyCor announced last month that it doesn't anticipate acquiring any new clinics through 1999. Instead, it will expand its 57 clinics.
"If companies can add value to physician practices, I think money is going to pour back into this sector. It may evaporate if they don't hunker down and turn this around by the end of the millennium," says Michael Blau, a partner in charge of health law at McDermott, Will & Emery in Boston.
That means going back to basics: containing costs through group purchasing of supplies and malpractice insurance, negotiating risk contracts, enhancing customer service and growing practices by recruiting new physicians and hiring physician extenders. Some firms are aggressively trying to beef up revenues and physician incomes by adding ancillary services such as outpatient surgery centers, clinical research contracts and product sales.
For example, Boca Raton, Fla.-based BMJ Medical Management has developed four surgery centers and plans to open a fifth this month; each one cost $2 million to $4 million.
Physicians may buy shares priced at $10,000, for which they can expect an annual return of $3,000 to $4,000, says BMJ Chief Financial Officer David Fater.
"What we try to do is bring ancillaries to our physicians as soon as possible so they can replenish their management fee," which is 10% to 15% of practice revenues, he says. Fater adds that ancillaries will help the company develop disease management programs and case-rates down the road. "You need control of the entire patient flow through the disease process, which includes therapy, imaging costs and surgery. By having the ancillaries, we're able to feed the data into the disease management system," he says.
Ancillary risk. But developing ancillary services carries a big risk, particularly if utilization is suddenly slashed by a shift toward managed care. At the same time, ancillary development could actually slow because of the capital shortage.
Several firms, including BMJ and PhyCor, have reportedly tried to negotiate ancillary joint ventures with hospitals. "There's recognition that the doctors decide where they're going to do the cases, so it comes out better if the hospital decides to be a co-participant," Fater says.
Last month, an ear, nose and throat PPM firm, Physicians' Specialty Corp., bought a 14.5% interest in an Atlanta surgery center owned by hospital operator Columbia/HCA Healthcare Corp.
"Our options were (to) build our own facility or build with another entity," says Physicians' Specialty Corp. Chairman and President Ramie Tritt, M.D. "(Columbia) didn't want to lose our business."
Hospitals are usually reluctant to give up control. Traditionally, sharing revenues with doctors isn't part of the hospital mind-set.
"There is skepticism on both sides and some fear, particularly on the hospital side, about getting into bed with PPMs," says Blau, of McDermott, Will & Emery.
Yet partnering may be the only choice for some hospitals that want to keep their specialty services intact.
Hospitals are behind the curve in aligning with specialists, who have been shunned as hospitals rushed to cozy up to primary-care physicians, says Gregory Mertz, executive director of Horizon Group, a Virginia Beach, Va.-based consulting firm.
"If the hospitals don't begin to get smart and get with doctors in win-win relationships, the PPMs are going to have that allure," Mertz says. "Those relationships where the hospitals and specialists both benefit, I think, are going to become the real models for the future."
Physicians are not always comfortable with some of the revenue-enhancing tactics of the management companies. Avon, Conn.-based Women's Health USA, which manages obstetrics and gynecology networks in Connecticut and New Jersey, offers an array of services, including clinical trials, bone density screenings, outpatient surgery centers, nutrition counseling and incontinence programs.
The firm also gives physicians the option of selling vitamin supplements at a profit. The American Medical Association's Council on Ethical and Judicial Affairs recently recommended that physicians not sell health-related goods at a profit, although that recommendation wasn't adopted at this year's annual meeting of the AMA House of Delegates.
"They're potentially preying on a patient population that may be coerced into buying products they don't need," says Robert Tenery Jr., M.D., chairman of the AMA ethics panel.
Women's Health USA President and Chief Executive Officer Robert Patricelli said introducing vitamin sales "was an uphill push with physicians," who didn't want to be perceived as hustling products. He declined to say how much doctors pocket from the sales.
Patricelli said many patients want one-stop shopping. "It builds loyalty to the physician and the physician's staff to offer these value-added services," he said.
Another target of reform is the management deal itself. At their worst, PPM companies were arbitrage vehicles that enabled physicians to sell their practice assets at Wall Street's inflated valuations. Physicians signed 40-year management agreements with fees that lopped off 15% to 20% of their revenues-a margin that couldn't be sustained.
By all accounts, physicians are getting less money for selling their practices. Management fees also have decreased to about 12%, says Jill Frew, managing director of Townsend Frew & Co., a Durham, N.C.-based investment banking firm that often represents large multispecialty groups.
"There is still (physician) interest, and there still are capable acquirers out there," says Jeffrey Barlow, managing director for healthcare investment banking at Hartford, Conn.-based Advest, which negotiates deals between management firms and medical groups. "What we're finding is the models are being adjusted to provide less capital upfront."
There's also renewed emphasis on escape clauses for doctors. With the industry in turmoil, many physicians are wary of long-term commitments. Some experts believe trial contracts of five years or less, in which physicians retain their practice assets, are the wave of the future. "One of the most fundamental changes that need to occur is PPMs need to provide data on how they can add value to physicians," Frew says. "Until that occurs, I think there is going to be skepticism on the part of physicians."
Just like vendors. Some companies have already begun to experiment with vendor-type arrangements. Sarasota, Fla.-based Pendulum Practice Management Co., for example, doesn't buy practice assets or make direct capital investments in practices. Instead, physicians can borrow money from the company at favorable rates for capital improvements and practice expansions.
Using that strategy, Pendulum has won contracts with 440 physicians in Florida, Georgia and New Jersey since it started operating in January.
Pendulum's management fee is a relatively modest 5% of a group's collections. The firm's agreements run 40 years, and physicians may cancel with 30 days' notice. However, physicians may not opt out for eight years after an initial public offering or five years after the practice repays a loan.
President and Chief Operating Officer Douglas Badertscher says the strategy will work because physicians keep more of their "skin in the game" than under traditional acquisition deals.
"You can't be the physician's advocate if you are owning the assets and telling them what to do," Badertscher says.
The strategy has its drawbacks, however. If the going gets tough, physicians can easily bolt, making it difficult for the company to implement meaningful operational changes, some experts say. Also, capital may be insufficient for aggressive practice expansion.
Debate is emerging over whether it's worthwhile to build large multispecialty groups-a model that some tout as the ideal.
Consolidation brings efficiencies of scale and better management, but those gains are offset by corporate overhead, returns to investors, capital costs and an inevitable decline in productivity when physicians dilute or transfer the ownership of their practices, experts say.
"The model that's probably the best-accepted by patients and most comfortable to doctors is a two- to six-physician group," says Alan Muney, M.D., chief medical officer at Norwalk, Conn.-based Oxford Health Plans. "They have a tremendous sense of ownership."
Albert Barnett, M.D., former chairman and founder of La Habra, Calif.-based Friendly Hills Healthcare Network, which was purchased by MedPartners in 1996, believes the ideal size for a multispecialty group is 50 to 100 physicians. "When they get so big that physicians aren't accountable, they start having problems," he says.
Barnett, who was fired by MedPartners after the company purchased Friendly Hills in 1996, is an outspoken critic of the industry. He believes Wall Street's focus on quick profits is anathema to clinical-care innovations. "When you look around at the effective systems out there-the use of internists as hospitalist physicians, the use of clinical guidelines-many were developed prior to the advent of PPMs," says Barnett, now chairman of the Institute for Healthcare Advancement, a Whittier, Calif.-based educational foundation.
Barnett predicts a shift toward "educational companies," akin to private consulting firms, that will teach better practices to physicians. As for capital, Barnett believes physicians' need for it has been exaggerated and used as an excuse for doctors to sell out.
"What they really needed capital for was their senior physicians who wanted to retire," he says. "I think doctors are just going to have to learn to manage their own affairs better."
Industry defenders say medicine can't remain a cottage industry, and the investor-owned firms remain a logical catalyst for reform. Most physicians don't want to risk their personal assets to grow their practices and hire better management.
Health plans have mostly abandoned the operation of physician practices. Meanwhile, hospitals appear to be gun-shy because of financial losses suffered by most of their peers that have purchased primary-care practices. Doctors aren't eager to cast their fortunes with hospitals, either.
"Hospitals are pointing to the press coverage and saying, `Why would you want to hook yourselves to (PPMs)?' " Frew says. "But I still think the evidence is strong that hospitals have not added value to physician practices. I think physicians have gotten stronger and are not as easily influenced by a hospital's accusations about PPMs."
PhyCor President and Chief Executive Officer Joseph Hutts admits the industry faces big challenges. But he calls its survival "inevitable. Some companies have just gotten into this to make a big hit. But this is not a business you want to get into unless you've got it in your belly. If we don't get it right the first time, we'll try it a second time. There will probably be a third, a fourth and a fifth," he says.