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Back in the mid-1980s, hospitals began employing primary care physicians in anticipation of more tightly managed care and risk-based reimbursement. These PCPs in family medicine, general internal medicine, pediatrics and obstetrics became known as "gatekeepers." Limited panels of gatekeepers were expected to reduce unnecessary patient referrals to specialty physicians and hospitals, allowing all parties to benefit from the dollars saved. While restricting care proved difficult for many PCPs, the gatekeeper model demonstrated the critical role of PCPs as the holders and referrers of market share.

By the mid-1990s, the costs of hospitals employing PCPs had become big news. The HealthCare Advisory Board reported an average loss per employed physician of more than $80,000. Practice operating losses in the millions of dollars each year were draining precious hospital capital and decimating bottom lines. The effort required to understand and successfully manage this unique medical practice business sapped executive and organizational energy.

Importantly, the managed care threat that prompted many primary care practice acquisitions never materialized or else fizzled in most parts of the country, and the role of gatekeeper became moot as consumers demanded full access to physicians and hospitals of their choice. By the late 1990s, many hospitals had stopped employing additional physicians and some were divesting the practices they owned. Physician employment was considered a failed integration strategy by many in the industry and the search for a new business model began.

Hospitals Reconsider

Early in this decade, some of the hospital executives who had divested or pruned their employed physician networks realized that they were losing market share to hospital competitors that had remained in the primary care business. These leaders again confronted the reality that PCPs capture, retain and refer patients (that is, market share) to hospitals and their affiliated specialists. Few patients know what an otorhinolaryngologist is, let alone when they need one. In fact, most patients depend on their trusted PCPs to help them navigate specialty services and, with the exception of the emergency department, most patients depend on PCPs and specialty physicians to help them navigate a path to the hospital and its services. Consequently, employing or affiliating with adequate numbers of PCPs became a priority in competitive markets.

Another driving factor in this renewed employment trend was the preference of new PCPs to avoid the risk, hassles and time commitment associated with entrepreneurship. Many left residency programs preferring an employment model. Hospitals that failed to offer such an option were at a disadvantage in the PCP recruitment game.

In the early 2000s, some hospitals also began employing invasive specialty physicians. This trend reflected declining income for some specialties such as cardiac surgeons who had seen their compensation hurt due to cardiologists using new, less-invasive technologies to reduce the number of open-heart procedures.

The specialty employment trend was further driven by overwhelming malpractice premiums in some states. Like their primary care counterparts, larger numbers of surgeons completing their training programs wanted to avoid the risks, hassles and additional debt associated with private practice. Instead, they wanted a more secure paycheck and a better quality of life than their predecessors. Striving to protect their service lines, hospital executives accommodated many of these specialty employment requests. Even long-established physicians in some markets have found it difficult to remain independent due to declining reimbursement and are approaching hospitals seeking the protection of an employment model.

Today, physician employment in some markets has reached feeding-frenzy proportions reminiscent of the early 1990s. The employment option is back on the minds of most hospital executives trying to recruit, retain and align physicians, especially those now finishing their training programs. This time around, hospitals are employing both primary care and specialty physicians. Unfortunately, in some cases, the institutional memory of previous mistakes has been lost. Some new hospital executives are committing the same network development and practice operational blunders as their predecessors two decades ago. Consequently, financial losses in many hospital-owned medical practices are rampant. Some executives have convinced themselves and their board members that such losses are a cost of doing business. In many cases, this is simply not true.

Increasing numbers of hospital board members are being asked to support the acquisition of medical practices and the employment of physicians. These trustees are concerned about the risks of employing physicians, but feel compelled to act. Not understanding this unique business, many board members are unprepared to provide appropriate oversight of medical practice network development and ongoing management. Fortunately, based on successful hospital-owned medical practice networks, a number of proven strategies have become best practices. Following are six concepts board members should know in order to properly sponsor and oversee a hospital-owned physician network.

The Theory of the Business

The famous management theorist Peter Drucker reminds us that success in any venture requires an understanding of the rules for success in that venture. While McDonald's and Ruth's Chris Steak House are both restaurants, their rules for success differ.

Medical practices are not hospitals or hospital departments, and the rules for success are different. Importantly, primary care practices and invasive specialty practices have different rules for success, even if they are structured as a multispecialty group. Failure to acknowledge these differences and to organize and manage according to the rules will ensure suboptimal performance or even failure of the enterprise. For example, the hiring freeze and other expense reduction tactics are commonly implemented strategies for a hospital that is behind budget. This cost cutting works because half of a hospital's cost structure is variable.

On the medical practice side, a blanket hiring freeze can have a devastating effect on productivity and service quality because 70 percent or more of a medical practice cost structure is human resources, which is a fixed cost in the short term. While controlling key expenses is always important, the medical practice game is won or lost on the revenue side of the income statement. In their fiduciary role, board members must ensure that adequate measures and management rigor are applied to all eight revenue factors: provider capacity; payer mix; fees; customer service; physician productivity; coding and documentation; accounts receivable management; and service mix (including ancillary services provided in the practices). To support the management team, board members should be conversant in the rules of practice management just as they are conversant in the theory of the hospital business.

Rational Deployment

With the exception of the emergency department, most hospital services are dependent on referrals from physicians and others. Consequently, the strategic focus of most boards and executives has been the development of capacity in terms of facilities and equipment. But in today's competitive markets this "build it and they will come" model is not enough to guarantee sustainability.

Other common expansion strategies can prove equally dubious. Hospitals are building off-campus facilities such as ambulatory care and surgery centers and taking advantage of new technology that provides invasive and diagnostic services outside the walls of the hospital. While there is a role for such facilities, they must be carefully positioned to serve the primary market share in the area.

Otherwise, hospital executives can find themselves with underutilized buildings or worse, competing with members of their own medical staffs who have the distinct advantage of being able to direct their patients to facilities they or their associates own.

In response to these trends, wise hospital CEOs realize that they must become market managers. Market managers understand that PCPs are "relationship providers" who capture and retain patients until they need specialty or hospital services. Then they refer their patients to the specialists and hospitals preferred by the PCP.

Market managers also understand that women, who make the majority of the health care decisions for the family, generally prefer a PCP located close to home and the children's schools. They make sure that they have adequate numbers of PCPs in their targeted neighborhoods (the draw area around a practice where more than 50 percent of active patients reside) to capture the market share needed to support their hospital service lines and affiliated specialists.

They also use a retail strategy for capturing patients in owned or affiliated primary care practices and urgent care clinics strategically located for patient convenience. At the same time, market managers do not oversaturate a neighborhood with PCPs. Board members should be well aware of the primary care retail strategy as part of the strategic planning process and before approving capital to acquire established practices or to start up new practices.

Partnership Led

We hear a lot about integrated delivery systems or their medical practice subsidiaries being physician led. Proponents note the tremendous success of integrated organizations such as Mayo Clinic, Cleveland Clinic, Geisinger Health System and others that seem to effectively balance clinical objectives, social responsibility and financial viability. These organizations have a rich history of strong physician leadership.

Most for-profit and nonprofit hospitals are not physician led. Their board members and the CEO may or may not be physicians, yet they must still strive to achieve balance among the above priorities.
In the most successful of these organizations, the hospital-owned medical practice network is led by a partnership of physician and executive leaders. These partnerships include the hospital CEO as a member and acknowledge his or her ultimate legitimizing authority and veto power as the board-appointed fiduciary. Employed physicians and executives council together to ensure that every network strategy, tactic, policy and procedure meets the four critical success criteria:

  • Maintains or enhances clinical quality as the partnership defines it.
  • Maintains or enhances service quality as defined by their patients and referring physicians.
  • Maintains or enhances physician productivity, which is the key driver on the revenue side of the income statement.
  • Maintains or enhances practice operational and financial viability (to be discussed below).

The council model facilitates the engagement of the hospital CEO with his or her physician partners and, if properly managed, yields balanced decisions, physician engagement and clear direction for the management team and support staff. Using the council model, these organizations are partnership led. Board members are encouraged to support an appropriate council model that encourages physician and executive leaders to work together for the success of the hospital-owned medical practice network.

Management Structure

The best practice management structure for hospital-owned medical practice networks follows and supports the council model. Rather than being the employed physicians' boss, the management team is an implementation team. A network executive is accountable to a network council (chaired by a competent, employed physician leader selected by the hospital CEO) and implements council-approved strategies, tactics, policies and procedures, which are usually networkwide initiatives.

Each practice manager is accountable to a practice council composed of the physicians and other providers in each practice and the network executive (or executive designee in larger networks). The practice manager implements those site-specific initiatives approved by the practice council. Board members should ensure that an appropriate management structure has been implemented to support the council model.

Performance Expectations

In the past, hospital board members have been asked to accept financial losses in hospital-owned medical practices as a cost of doing business. In reality, most employed physicians are just as capable of achieving financial viability as their private practice peers. This statement is based on several assumptions. First, it assumes that the hospital-owned primary care practices have been geographically positioned to attract a viable patient base from the surrounding neighborhood. For specialty practices, it assumes that the hospital has adequate numbers of employed or affiliated PCPs through a well-implemented retail strategy. It also assumes that owned practices have the ancillary and procedural services that customers prefer within the practice, as well as the accompanying revenue. Critically, the physician compensation model in the employed physician arena must imitate the production incentives found in private practice.

Finally, this statement assumes that expenses allocated to the practice are consistent with private practice settings. While most primary care and specialty practices can break even like their private practice counterparts, there are some notable exceptions. First, primary care practices designated to serve mostly uninsured and underserved populations may have a difficult time generating adequate revenues to reach viability, although the productivity of physicians, other providers and staff should be just as high as private practices.

Second, those specialty practices that require more physician capacity to provide the service than the market can support—such as three neurosurgeons required to maintain service coverage when market volume is only sufficient for two-and-one-half neurosurgeons—will generate ongoing financial losses. Board members should insist that appropriate performance expectations are established for employed physicians and owned practices, and that those standards are rigorously enforced.

Culture of Accountability

Who's the boss? This important question often arises in an employed physician setting. Drucker indicated that knowledge workers cannot be supervised like other employees. However, both physicians and executives must be held accountable for their performance. In a hospital-owned medical practice network, physician professionals are ultimately held accountable by the person who signs their employment contract—usually the hospital CEO. The network council supports the CEO by setting appropriate performance standards that balance clinical, social and financial responsibilities for all.
On those occasions where a physician employee is unable or unwilling to play by the council-approved rules or standards, after proper intervention and opportunity for improvement have been provided, the CEO exercises legal authority to terminate that knowledge worker's contract. Board members will need to support the CEO and other physician leaders as they make difficult decisions to terminate employment contracts for poorly performing physicians even if it means a short-term decline in hospital revenue.

Increasingly, hospital executives will be faced with the need to offer employment options for physicians. Competitive trends in many local markets, declining physician reimbursement and physician preference will all continue to drive this trend. These principles are based on years of experience helping hospitals implement new medical practice networks and to improve the performance of established networks. While board members do not need to know all the details associated with owning and managing medical practices, these basics will help ensure the success of employed physicians, the hospital and their associated private practice physicians.

Marc D. Halley, M.B.A. (mhalley@halleyconsulting.com), is president and CEO of Halley Consulting, Westerville, Ohio.

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