Monday, July 16, 2007

Hospitals and Doctors - Hospitals and Sutton’s Law: The Obvious and Not-So-Obvious

Have Hospital-Physician Relationships Reached A ‘Tipping Point’ Requiring Consolidation and Integration Driven by the Need for More Capital?

“Because that’s where the money is.”

Prolific bank robber Willie Sutton (1901- 1980) purported answer when asked why he robbed banks. Sutton’s actual words may have been,
“Go where the money is... and go there often.”

Sutton’s law has become known as stating the obvious.

It is obvious the greatest proportion of U.S. health care money is spent for hospital care. Most health care money and access to capital is in the hospitals – not in physician practices. Yes, doctors with their pens may be responsible for 80% of costs. But much of the money ends up in hospital pockets, while money doctors need to invest in their practices comes out of their own pockets.

Hospitals and Doctors Need Each Other

America’s 5000 hospitals consume 50% of the national health care dollar, $2 trillion annually. America’s 500,000 actively practicing physicians account for 25%, or $500 billion. Do the math. Revenues for hospital average $200 million for each hospital, and $1 million in revenues for each physician. These numbers are deceptive. Merritt, Hawkins, and Associates, physicians estimate on average doctors generate over $1.5 million a year in inpatient and outpatient revenue for affiliated hospitals.

•Hospitals need doctors. Hospitals would be empty shells without doctors admitting patients, ordering tests, and performing procedures.

•Doctors need hospitals even more. Most doctors need to be on a hospital staff to practice, and they need a hospital as a place to perform procedures and provide care for ill patients.

In 1997, the Croes-Oliva Group, a medical group management consulting firm in Boston, surveyed 31 CEOs throughout New England. They found 87.1% the CEOs believed doctor-partnering strategies were essential for their organization. Only 12.9% said they were exceptionally pleased with doctor partnerships. Less than half reported moderate satisfaction. (1)

In today’s competitive environment – with declining hospital reimbursements, mounting expenses, and the history of disastrous losses from hospitals acquiring practices in the last 1990s - boards of trustees are asking for hospital executives to be smarter this time around while recruiting and employing, and in purchasing doctor practices. Hospitals and doctors seek to consolidate and integrate care to leverage profits and control expenses.

Goals of Boards of Trustees

Hospital boards of trustees are,

•demanding clarity on why hospitals are seeking partnerships;

•asking hospital executives to justify physician recruiting expense and the return of investment ( recruiting a single physician can run $400,000 or more, but the ROI can run $2.5 million for high-profile procedural specialists such a orthopedic surgeons or cardiologists); (2)

•Requesting measurements showing the hospital is outperforming the market.

What’s Needed to Satisfy Doctors Entering into MoreIntimate Financial Relationships with Hospitals

The Croes Oliva Group says hospitals must “compete or retreat” thorough offering these service guarantees for their doctors.

•Provide higher compensation than the MGMA average compensation.

•Show superior billing performance -- reducing rejected claims to less than 5% and days in accounts receivable to less than 30 days.

•Grow practices by bringing in more patients.

•Reduce administrative burdens and accommodate to physicians life styles.

•Use IT expertise to improve care and integrate physician- hospital IT systems.

-Show integration and consolidation gives negotiating clout to reduce expenses.

•Demonstrate they can attract top-notch talent at all levels of the enterprise.

Hospital’s Inherent Fiscal Advantages

As hierarchical managed organizations, hospitals have certain undeniable fiscal advantages over scattered physician practices. Doctors function in a democratic environment where one-man-one vote prevails.

•In many communities hospitals are the biggest employer in town. This not only gives hospitals economics of scale, but brand name recognition and political power, e.g. the ability to impose a moratorium on physician-owned specialty hospitals and to prohibit their salaried medical staff from referring to these specialty facilities.

•Hospitals are where most invasive procedures are performed, most medical imaging is performed, intensive cancer care is carried out, critical care is done, and people go for emergencies.

•Hospitals have accesses to capital unavailable to physicians, who must dip into their own pockets or put their credit status on the line.

•Hospitals have a higher “brand-name recognition” than most physician groups, partly because the public knows they go can to hospitals 24 hours a day for emergency care,

Moreover and Furthermore

Hospitals are likely to remain the money centers of health care. American hospitals are undergoing an unprecedented building boom, have the most influential community business leaders on their board, possess the organizational structure allowing them to neutralize or engulf competitors. Hospital doors are open 24 hours a day, have access to capital, through tax-exempt bonds and other financial mechanisms; have seasoned executives in their “C” suites with talented managers below them. Furthermore, hospitals are on a physician hiring spree, as demoralized doctors flee insecurities posed by rising expenses, soaring malpractice fees, mounting federal rules and regulations, increasing pressures to install electronic medical records to document quality, performance, and outcomes. And hospitals have the “critical mass” to deal with issues like information technology systems.

Last, but far from least, everybody knows hospitals are where the money is. Ask almost any practice management consultant, Medicare official, supply chain vendor, drug or medical device maker, or physician recruiter, and they will tell you they derive most of their income from hospitals and affiliated physicians. Independent physicians, on the other hand, are notorious for hoarding their money, failing to set aside money for contingencies, and for not investing in needed infrastructure not giving an immediate and tangible return on investment.

Physician Capital Needs Have Outrun Their Capacity to Generate Revenue through Patient Visits and Managing Ancillary Revenues

There may be another factor as well. Doctor groups need for capital has outrun their capacity to provide it. Physician groups, even large physician groups of 100 doctors or more, can no longer generate the money or gain access to the capital needed --to recruit new physicians, to invest in widely heralded EMRs and physician websites, to buy ancillary technologies needed to supplement income from patient visits, to upgrade physical facilities, or to capture more of total health care revenues needed to maintain and grow their enterprises.

These limitations, say Daniel Zismer, PhD, President, Essentia Health and Dr. Peter Persons,MD, CEO, Essentit Health and St. Mary’s Duluth Clinic Health System, argue in a recent issue of the Group Practice Journal will force multispecialty group practices to merge or be acquired by community hospitals -- for economic leverage, greater brand recognition, more efficiency and less duplication, more negotiating clout with payers and vendors, capture of greater shares of total health care revenues, and, the ability to gain profitability from high tech ancillary services. (3)

Here is the crux of their economic argument. I shall quote in full because of my lack of economic expertise.

The prototypical large, multispecialty medical group practice is an aggregation of clinical specialties with comparatively unique operating economics and "financial leverage" potential, meaning physicians' ability to directly create "downstream" revenues from patient contacts differs by clinical specialty.

The multispecialty group practice business model's ability to leverage the revenue potential of physicians within specialties (and in the aggregate) is limited by its ability to import, own, and profitably operate a range of ambulatory ancillary services; e.g., diagnostic imaging, ambulatory surgery and invasive procedures, laboratory services, etc., up to, but not including revenues available from a full-service hospital.

The revenue leverage available from such ambulatory ancillary services strategies will typically produce a physician net professional revenue to net ancillary services revenue ratio of $1.00 to $0.50 - $0.75; i.e., for every dollar of net professional revenue, up to $0.75 is produced in net ancillary fees. (This ratio differs markedly from group to group.)

An examination of a similar ratio in a fully integrated clinical and business model where a full-service hospital is an integrated component of the health system demonstrates a very different leverage ratio picture, where $1.00 of physician net professional revenue can leverage to $3.75-$4.00+ of total "downstream" net revenue, including hospital revenues-a several-fold difference. This ratio is affected by specialty services' scope and emphasis, primarily.

What does this mean? Said simply, the fully integrated model has greater economic leverage. It aggregates more of the total health-care dollar within a unified business model. The potential for margin enhancement is driven by continuous process improvement and effective selection of the clinical services "menu" provided within the total "portfolio" of services. The model has superior capital regeneration potential, and debt markets see the mode as being more stable and credit-worthy over time.

Larger, multispecialty medical group practices are likely to consolidate with hospitals and hospital systems to create "fully integrated" clinical and business models. Why? Reasons were cited earlier in this article:

•More of the total health care dollar is captured within a unified business model;

•Competitive inefficiencies are eliminated, i.e., hospitals and clinics competing with each other for the same health care dollar with duplicative capital investments (facilities, clinical technologies, programs, etc.);

•Support services and infrastructures become "scaleable"-electronic health records, information technology systems, support services, etc.;

•Third party payer contracting is from a unified and predictably, more leverageable business model;

•Health "branding" becomes easier, Debt markets favor larger, more leverageable business models;

•Physician income requirements are more supportable as a result of a larger revenue base where physicians are positioned to influence the operating cost (case cost) structure to the financial advantage of the system and themselves;

•Patients are presented a unified,seamless and collaborative"system" of care;

•The need for personal capital investments by physicians and financial risk is eliminated;

•The model is more "recruitable" given the needs and wants of future generations of providers; and

•Corporate-tax burdens are lessened and cost of capital is reduced.

Said more succinctly, patients are provided what they believe they've had all along: hospitals and physicians working together from the same, consolidated clinical and business model.

What struck me about this argument is this. Conventional wisdom says independent multispecialty groups are where the future lies – where doctors can leverage teamwork and multiple skills to provide efficient, affordable care, to bring order out of the present “fragmented” and “individualistic “ system, and to bring stability and life style sanity to doctors’ lives. (4)


From the business point of view, Zismer and Persons present a compelling argument. Economic pressures, market forces, and need for central management, and more capital, will logically and inevitably compel hospitals and doctors to integrate and consolidate.

But there are counterarguments,

•Regina Herzlinger, In Who Killed Healthcare: America’s $2 Trillion Medical Problem – and the Consumer-Driven Cure, argues community hospitals already have too much power and misuse it -- by trying to be everything to everybody, acquiring competitors to consolidate power, overcharging the uninsured, crushing competition from physician-owned specialty hospitals and outpatient surgery and diagnostic units.

•The federal government –and its antitrust, OIG, and IRS divisions, and Stark Laws –may disapprove of combined hospital-physician enterprises perceived to monopolize care, fix prices, and stifle competition.

•The phenomenon Zismer and Persons describe – the merger and/or acquisition of multispecialty groups by community hospital, is so far is largely restricted to the upper Midwest and far West, where large multispecialty groups prevail.

•There are certain countervailing forces – business decentralization and the breakup of large enterprises into smaller more manageable pieces. The bigger the entity, the more it must be made up of smaller and smaller, more efficient parts to be successful.

The larger questions are:

•Can large community hospital-multispecialty-doctor-salaried- centrally directed enterprises be managed?

•Do hospital executive have the talent, flexibility, leadership skills and bent for collegiality to provide what doctors want – financial security, ease of practice, lifestyle control, and clinical control.?

•Will doctors, in their turn, buy into the concept bigger is better, and be willing to sacrifice their independence for a collaborative dream?

In the end, it may be that society will force hospitals and doctors into one business mold.

It may be the U.S. health system has reached an “age of discontinuity,” a tipping point. From now on, the public may entrust health care to large organizations, organized for convenience, visibility, and perpetuity and run by managers. It may be such organizations will govern health care and will overcome patients’ and physicians’ penchant for individualism. And it may be money – and the need for more control and access to it – will catalyze community hospitals and physicians to consolidate into one seamless entity.


1.Jayne Oliva, “Second Time a Winner: Managing Physician Practices with Success: A Proven Formula Based on the School of Hard Knocks, “ Tstyle="font-style:italic;">he Physician Executive, March/April, 2007

2.James Merritt, Joseph Hawkins, and Philip Miller, “Guide to Physician Recruiting: First Edition, “Practice Support Resources, 2007.

3.Daniel Zimmer and Peter Persons, “What Does the Future Hold for the Larger, Independent, Multispecialty Medical Group: Is a ‘Tipping Point’ on the Horizon,” Group Practice Journal, volume 56, April 2007.

4.David Lawrence, From Chaos to Care: The Promise of team-Based Medicine, Perseus Publishing, 2004.

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