Problems In PPM lndustry Affect Pathology Practices

Experts now raising serious questions about the viability of PPM companies

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DURING 1998, THE FINANCIAL WOES of many physician practice management (PPM) companies caught healthcare experts, investors, and financial experts by surprise.

Problems with the PPM industry could not come at a worse time for the pathology profession. At the very moment that several pathology-based PPMs are bidding strong prices for selected pathology practices, the PPM industry is doing poorly.

Financial analysts and venture capitalists, whose expertise is devoted to studying successful businesses, have made revealing comments about the PPM industry during the last 40 days.

“I have yet to find a PPM that adds value,” stated Larry Feinberg, partner at Oracle Partners, a healthcare investment fund in New York City. “The only winners in this game have been the investment bankers.”

“To make a profit, PPMs have to pay doctors a below-market compensation, “observed Michael Thomas, Principal at the healthcare consulting firm of BDC Advisors in San Francisco. “This isn’t a very durable business proposition unless they [PPMs] enhance operating performance. No one has been able to do that.” The comments of these two experts strip away the hype and expose the key weakness of the typical PPM business plan. PPMs, as they operate today, do not enhance the doctor’s ability to practice better medicine. Nor does the typical PPM add value to the services its doctors provide to customers: patients, hospitals, and insurers. In some cases, it actually adds costs.

Critics say PPMs haven’t lived up to their promise and may even raise costs by adding a layer of bureaucracy…

The Wall Street Journal

Physicians, pathologists understand better than any corporate executive that medicine is about more than money. Yet, the larger PPMs have failed to demonstrate that they can combine the business skills of the corporate executive with the clinical skills of the physician and create added value in the marketplace.

So how did MedPartners, PhyCor, FPA Medical Management and other PPMs grow into multi-million and multi-billion dollar companies? The answer is simple and carries a warning to any pathologist considering the sale of a practice to a pathology PPM.

PPMs grew into billion-dollar companies by acquisition, not by operational excellence. The financial arithmetic of acquisition permits them to do this. But once a company gets large, it must still compete one day at a time, one customer at a time. None of the large PPMs deliver healthcare on a day-to-day basis any better than a well-managed group or clinic practice.

Partnership Emerges

“Acquisition strategy” should raise a red flag to any pathologist currently considering the sale of his/her practice to a PPM. It means the PPM wants to get big, and do it fast. But the ability of that PPM to convert its size into value added services is probably lacking.

Growth through acquisition can best be illustrated by the Columbia/HCA example. Former President and CEO Rick Scott leveraged two hospitals in El Paso into a $20 billion company with 400+ hospitals in about ten years. How did he do it? He bought hospitals using debt and Columbia stock.

As he acquired new hospitals, he amortized the purchase cost over a multi-year period. This increased his cash flow from the hospitals’ unchanged revenue base. He also installed new hospital CEOs who squeezed 10% to 20% cost savings from the hospital in the first year or two after Columbia became owner.

As investors saw cash flow and operating profits increase, they bid up Columbia’s stock price. Scott turned around and used the more valuable stock to purchase more hospitals. It was a self-financing loop… so long as profit margins increased each quarter.

This is how the acquisition cycle works. Buy assets and use accounting rules to write them off over a long time period. It gives the buyer more cash flow from the revenue than the seller got. The buyer uses the additional cash flow to increase operating profits and earnings. Investors respond by bidding up the stock price. Now the company can use its higher-priced stock to buy more assets.

By itself, there is nothing inherently wrong with the acquisition business model. Currently entrepreneurs are acquiring individual auto dealerships and “rolling them up” into mega-dealerships. A similar acquisition wave during the 1980s consolidated regional department stores into national corporations.

But the acquisition strategy cannot succeed beyond a few years unless there is recognizable economic value to a larger business unit. That supports the acquisition phase with an operational plan to generate added value from day-to-day operations. This seems to be true of auto dealerships.

It was not true in an industry familiar to all pathologists: the commercial laboratory industry. From the mid-1980s through 1995, the large commercial laboratories pursued an acquisition strategy, buying up small labs and moving that testing to their regional hub labs.

Pathology Income Symposium Deals With Money & Profit

PATHOLOGISTS WILL HAVE the opportunity to learn effective strategies to preserve and enhance their income when the 1999 Private Pathology Income Symposium and Workshop convenes in Scottsdale on November 13-14, 1998.

Attendance is exclusively limited to pathologists and their business advisors. Due to the sensitive nature of the techniques and savvy business methods to be discussed, the symposium is closed to hospital administrators.

This year’s event will include presentations about pathology PPMs and how to negotiate for the best sales prices. Also to be covered are strategies for contract negotiations, how to increase AP and CP revenues through value added pathology services. Those interested in registering or more information can call the offices of The Dark Report at 503-699-0616.

Size Not A Guarantee

Unfortunately for the large commercial laboratory operators, size did not guarantee that their huge laboratories could offer discernibly better service than the local pathologist-owned lab down the street.

Pathologists watched the commercial lab industry vigorously pursue the acquisition strategy. Pathologists know the resulting national laboratories have not brought added value to the day-to-day service they provide their customers.

Which brings us to the jackpot question: Why would pathologists sell their practice to a pathology PPM, if they understanding the following facts:

  1. An acquisition strategy for growth only works in the long run if the resulting company offers true added value to its customers that smaller competitors cannot.
  2. Columbia/HCA followed an acquisition strategy, but could not deliver added value as a large corporation.
  3. Commercial laboratories pursued the acquisition strategy from 1985 through 1995. But since 1995, when it became impossible to do further acquisitions, none of the remaining laboratories has brought added value to day-to-day services, nor have these labs made adequate operating profits.
  4. Med partners was the $5 billion darling of the PPM industry. It almost pulled off the granddaddy acquisition of them all, a merger with $1.4 billion PhyCor last fall. But the merger fell apart and MedPartner’s losses in the last year have topped $1 billion.

Given these facts about the performance of healthcare companies which relied on an acquisition strategy, is it a sound business proposition for a pathologist to sell a practice to a PPM at this point in time?

Here’s what the leading observer of the PPM industry has to say. “The $10-billion physician practice management industry-battered by bankruptcies, litigation and physician discontent must scrap its losing strategy of growth by acquisition and show that it can actually manage doctor’s practices better,” stated Efrem Sigel, publisher of the Physician Practice Management Report.

THE DARK REPORT subscribes to that adage “those who ignore history are doomed to repeat it.” If the history of business teaches us any one thing, it is that an acquisition strategy alone means strong success for several years, followed by financial turmoil.

Of course, these are our opinions, based on our business experience and ongoing study of the healthcare marketplace as it relates to the pathology profession and the clinical laboratory industry.

There are those who hold different opinions on this subject and possess war chests with tens of millions of dollars earmarked for the purchase of pathology practices. In future issues we will look at the reasons why they are convinced that pathology PPMs can succeed.

(For further information, contact Robert Michel at 503-699-0616.)

COMING NEXT ISSUE …

PART TWO: A comparison of the differences and similarities between pathology-based PPMs and other PPMs.

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