Hospitals Acquiring Physician Practices: 4 Key Lessons From the '90s

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Hospitals looking for ways to secure market share are increasingly finding the answer in acquiring physician practices in their communities or employing physicians. While this business practices failed miserably for most hospitals in the 1990s, hospitals acquiring practices today are taking lessons from previous failures.  

1. Understand your market first. While many hospitals rushed to lock down practices in the '90s without carefully performing due diligence, hospitals today have learned the importance of knowing their market before expending scarce capital on practice acquisitions, says Cheryl Waltko, vice president at Equation, a healthcare consulting firm. Ms. Waltko recommends that hospitals look at the acquisition not only from a competitive standpoint but also from the view of securing a specific service or program. If a practice is the only group in town for that specialty, an acquisition may not be necessary or prudent. However, an acquisition may protect a hospital from reduced or lost coverage of a specialty if there are competing hospitals within close proximity to the community.

Markets with more competition need to closely examine the market to determine if there is a large enough patient base to support the program. Additionally, hospitals must be very careful about changing the status of the practice. Programs set-up as hospital-based outpatient practices can reap higher Medicare reimbursements for certain services, but that can translate into higher out-of-pocket expenses for patients, says Ms. Waltko. "If there are two same specialty practices in town and one gets purchased and transitioned to a different status, patients may change to the other provider," she says. "You have to be very cautious."

Hospitals acquiring practices in designated Health Professional Shortage Areas could consider transition of the primary-care practice into a Rural Health Clinic if it does not already hold that status, resulting in increased reimbursement, says Ms. Waltko.

2. Do away with "goodwill" payments.
Hospitals are also no longer using the same practice purchase methodology they once were for practices. Practice valuations are now based on depreciated hard asset value, and there are no more goodwill payments, such as an additional "nebulous" payment for the positive reputation of the practice, says Ms. Waltko.

The compensation packages initially offered to physician members of the group also have changed significantly since the '90s. Back then, compensation packages were often based on the gross charges and collections of the physicians for the 3-5 years prior and most likely did not include a component to adjust for future productivity. Today, these initial packages are no longer based on history, but rather, the current fair market value with consideration of the physician,s current professional service productivity, says Ms. Waltko.

3. Consider loss of ancillary revenue in purchase price. In the past, many hospitals made the mistake of basing offer prices on the total revenue generated by a practice instead of considering the value of ancillary services that would flow into the hospital. The movement of certain ancillaries from a physician office to a hospital outpatient department will likely negatively impact the revenue a practice can internally generate. Thus, hospitals need to carefully analyze the downstream revenue value potential from these practices and compare that to any anticipated losses for the practice, says Ms. Waltko.

Hospitals may find the lowered future value of the individual practice may be recouped through downstream revenue to the hospital's inpatient and outpatient departments. For example, a study by researchers at the Ohio State University Medical Center published in Family Medicine in 2006 found that the downstream revenue from referrals from its 18 practice sites generated $14 million in one year, more than double the $8.3 million in operating losses the practices experienced in the same timeframe.

4. Productivity-based compensation. One final way practice acquisition deals differ today is they consider productivity in compensation packages. "We are now seeing hospitals with compensation formulas based on professional productivity with a lower base guarantee," says Ms. Waltko. Often these formulas consider the work relative value units (RVUs) of physicians, but some hospital-owned practices are beginning to include quality/outcome and/or "good citizenship" measures — such as measures for completing documentation on time and participating in committees — in these formulas. Ms. Waltko provides one caveat, however — "Rural areas with difficulty recruiting physicians may need to offer a flat compensation rate as there may not be a large enough population within the market area to ensure the physician can be successful on a productivity-based formula," she says.

Compensation offered to physicians should be based on fair market value, and employment agreements should include a "downside" for physicians that don't meet productivity requirements, such a reduced compensation, says Ms. Waltko. Hospitals using payment formulas that do not consider productivity can work this in by holding physicians to a certain number of hours of clinical availability and/or "measurable worked hours."

Learn more about Equation.

Correction: A previous version of this article incorrectly stated that the article "Analysis of Downstream Revenue to an Academic Medical Center From a Primary Care Network" published in Family Medicine was published by researchers at Ohio University Medical Center. The correct affiliation of the researchers is the Ohio State University Medical Center in Columbus.

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