One of a hospital board's most important jobs is to decide the best use of limited capital resources. Which is the better investment? A new bed tower or an emergency department expansion? A surgical robot or another operating room suite? Increasingly, trustees are being asked to evaluate another investment alternative—physician employment.

Expensive Decisions

Physicians' interest in employment has been growing as they seek ways to stabilize their income and achieve a better work-life balance. In addition, physicians are showing increased interest in the full range of hospital support scenarios—from recruitment guarantees to medical directorships and management agreements. Unfortunately, boards asked to approve a physician employment contract typically face an information gap.

When a building project or technology purchase is on the table, the management team supplies trustees with detailed market analyses, expense scenarios and revenue projections. But when the board is asked to consider a contractual relationship with a physician practice, trustees often don't receive the same type of business analysis or cost justification.

Yet, the financial scale of these contracts can be surprising. Employing one physician can cost roughly $1 million per year in salary, administrative expenses and other costs. Contracts with just two surgeons easily could match the price of a PET scanner.

Most hospitals do not have enough money to hire every physician currently seeking employment. What boards need is a way to evaluate physician contracts against other strategic spending options.

The following five-step process for evaluating physician contracts is adapted from common techniques for scrutinizing capital spending. These steps can help leadership teams understand exactly how much a proposed physician contract will cost and what the hospital can expect in return.

1. Define Strategic Value
The first step in evaluating a proposed physician contract is to identify the specific ways it could benefit the hospital. Gains in patient volume are important but are not the only consideration. Benefits also can include clinical gains like enhanced quality or better patient access, marketing benefits such as improved brand perception, and strategic benefits like the mitigation of a specific competitive risk.

It is also important to understand how the contract will benefit the physician or practice to ensure a win-win relationship. Clarifying physician needs also can help identify contractual alternatives. For example, if a group of doctors is seeking employment, but what they really need is practice management assistance, the hospital might do better to create a management services offering rather than a full employment structure.

When considering physician relationships at this level, the board will be looking at concepts, not detailed contracts. Trustees should focus on filtering out proposals that do not support the hospital's mission and provide basic strategic viability.

2. Verify Market Support
The next step is to analyze how the relationship will perform in the marketplace. This analysis will look at both market share and market trends and estimate the contract's impact on inpatient and outpatient service-line volumes. It also should identify critical success factors for the relationship, including personnel, technology and management issues. In addition, the evaluation should identify potential market risks and administration's plans to mitigate them. A good market analysis will help trustees evaluate the cost of inaction.

3. Analyze Financial Impact
Once the market opportunity has been validated, financial impacts should be quantified in detail.

Administration should prepare five-year pro forma income and cash flow statements for the proposed contract. They should estimate financial returns using at least two different methods (for example, return on investment, net present value or internal rate of return). The projections should give the board a clear view of key decision factors (such as capital spending requirements) and the hospital's total financial exposure, which includes such costs as salary and recruitment guarantees.

4. Create the Business Plan
Hospital administration should now develop a written business plan that summarizes the results from the previous steps and details performance metrics, critical success factors and implementation time-shares.

At this point, the board already has seen a great deal of analysis. Trustees now should be looking for a clear definition of success. Make sure the business plan includes performance benchmarks for practice productivity and expenses, including baselines and milestones. Benchmarks should be built around strategic goals.

5. Review, Verify and Revise
To avoid throwing good money after bad, the board needs to review the performance of signed contracts on a regular basis. The best approach is to request an annual performance report for every physician contract. The report should examine outcomes against business plan benchmarks and compare actual financial results with the pro forma financial statements. All contracts should include provisions allowing the hospital to revise the agreement if benchmarks are not met.

The annual review should include a re-evaluation. In many cases, changes in medical technology, competitor strategy and the local market will require adjustments to the agreement or a fresh round of decision-making.

An Accountability Tool

These five steps outline an expectation for decision quality. Trustees do not perform the analyses, but they can drive the evaluation process by asking key questions at each stage. Used consistently, the contract evaluation tool will help hospital leadership teams:

  • Compare physician contracts with other capital investments on an apples-to-apples basis. If trustees are reviewing two strategic spending alternatives—renovating the hospital's outpatient rehabilitation facility or employing an OB-GYN group to build the women's health service line—the contract evaluation tool will enable the board to place a clear price tag on each plan and compare their value in terms of hospital strategy and downstream revenue potential.
  • Make better decisions about specialty focus. What is the better move for the hospital—employing the pulmonologist, the intensivist or the breast oncologist? Based on the investment and return analysis, it may make sense to employ only two of these physicians. And between the two, one may warrant a larger investment than the other.
  • Ensure the hospital is getting the most out of existing physician contracts. A cost-benefit picture likely has never been established for most older contracts. In addition, many hospitals have a different contract in place with every employed physician. As legacy contracts come up for renewal, the evaluation tool can be used to verify the value of each relationship and standardize contracts in terms of compensation and financial expectations.

Govern Effectively

This evaluation tool gives trustees an effective means for steering the hospital away from poor contractual choices and toward financially sustainable physician-employment relationships that support the organization's mission, goals and strategy. The tool filters out problem deals before the hospital spends a single dollar and helps trustees and executives refine basically solid proposals and equip them for the best chance of success.

Timothy R. Shoger, M.B.A. (, is senior vice president of Health Directions, Chicago.