Skip to content

Doctors Inc.

Physician practice management groups are revolutionizing health care, while Wall Street cheers

Doctors Inc.

Physician practice management groups are revolutionizing health care, while Wall Street cheers

The last thing that the medical world needs is another acronym. But add PPM to the list anyway, and write it in big, bold letters: The explosive emergence of the physician-practice-management industry promises to alter the balance of power in health care in the 1990s as greatly as the health-maintenance organization did in the 1980s. All across America, doctors by the thousand are joining forces under the PPM banner, giving rise to a profoundly new sort of enterprise: publicly traded, professionally run, ultra-acquisitive corporations assembled from doctors' practices.

At least 30 PPM companies have gone public already, and dozens more are waiting in the Wall Street wings, each angling for a share of the $200 billion-a-year market in physicians' services. To date, only about 8% of the nation's 527,000 practicing doctors have affiliated with a PPM company. But barring a stock market collapse, this fledgling industry is likely to sustain its high current growth rate into the next century as it drives one of the most momentous trends in health care: the massive consolidation of independent physicians into groups of increasing size, scope, and commercial sophistication.

STRONGER HAND. Peter S. Stamos, director of Stanford University's Comparative Health Research Center, predicts that the PPM industry could capture one-third to one-half of the physician-services market--that is, $70 billion to $100 billion in annual revenues--within five years. (In 1996, publicly traded PPMs generated revenues of about $12 billion.) Adds Dr. Jason Rosenbluth, a physician-turned-analyst at Volpe, Welty & Co. in San Francisco: "I'm convinced that PPM not only is here to stay--it will become the new center of the health-care universe."

The PPM industry is a potent counterrevolutionary force: It strengthens doctors' hands in negotiating terms with HMOs, PPOs, and the like. In recent years, these managed-care enforcers have impinged on doctors' medical authority by requiring advance authorization for even simple procedures and by often refusing to underwrite costly ones. "We did not like having to dial 1-800-mother-may-I every time we turned around," says Dr. Kenneth Brin, chairman of Summit Medical Group in Summit, N.J., in explaining why his clinic joined MedPartners Inc., the fastest-growing PPM company.

But the PPM is not primarily an instrument of physicians' revenge. To justify their very existence, PPM companies must continually find ways to make doctors more productive and cost-efficient. In this sense, the PPM industry is itself a creature of managed care but with a critical difference: For all the clout that they have amassed of late, managed-care administrators cannot practice medicine. Only doctors can. Thus, virtually by definition, physicians are better positioned than any other group to attempt the difficult feat of making health care less expensive without compromising quality. Even some HMO executives seem willing to concede that point. "Well-managed physician groups are the only way we can offer a better service," says Arthur Southam, CEO of Health Net, the second-largest HMO in California.

The PPM industry has its critics, to be sure. Even many doctors who acknowledge the benefits of professionalizing their business management are loath to join forces with a Wall Street-traded corporation, fearing that, in the long run, their best interests and those of their patients will be subjugated to investors' desire for profit. "In a nonprofit, while you certainly have a bottom line, we don't have investors looking over our shoulder," says Dr. David Drucker, the chief operating officer of the Palo Alto Medical Foundation, a 250-physician group that formed a joint venture with Sutter/CHS, a nonprofit hospital system, rather than affiliate with a PPM company.

By almost any measure, however, the leading PPM companies now rank among the most dynamic in the entire health-care field. Late last year, PPM stocks fell by 20% on average from their highs, but PhyCor, the industry prototype, still commands a price-earnings ratio in the mid-60s, compared with 18 for the leading hospital company, Columbia/HCA Healthcare Corp. Founded in 1988 by a quartet of former hospital administrators, Nashville's PhyCor has methodically built a far-flung network of 12,540 physicians by acquiring 47 large multispecialty clinics one by one.

PELL-MELL GROWTH. PhyCor has recently picked up its pace, snapping up 13 clinics in 1996, including the famed Straub Clinic & Hospital in Honolulu. PhyCor's stock, which was launched at $16 in 1992, now trades at a split-adjusted $108. "At this point, the only constraints on our growth are self-imposed," says Joseph C. Hutts, PhyCor's CEO.

PhyCor's archrival, MedPartners, was founded in Birmingham, Ala., in 1993 by Larry R. House, formerly chief operating officer at HealthSouth Corp., now the nation's largest operator of rehabilitation clinics. In racing to catch up to PhyCor, MedPartners has swallowed a half-dozen sizable PPM companies whole--even as it acquired dozens of individual clinics. In the process, the company's revenues have soared from $1.2 million in 1993 to $4.8 billion last year. Analysts predict that MedPartners will top the $6 billion mark in 1997.

In January, MedPartners announced a $490 million acquisition of InPhyNet Medical Management Inc., a Florida PPM company. The deal surprised Wall Street, which hadn't expected MedPartners to strike again so soon after closing its $1.9 billion purchase of Caremark International Inc. House, MedPartners' CEO, is unrepentant: "You have to be bold and aggressive to build what we want to build, and that's not going to change."

In a sense, the entire medical profession has been trying to catch up to the rest of the rapidly evolving health-care industry. Even as hospitals and health insurers by the hundreds merged in the 1970s and 1980s to create new corporate behemoths, medicine remained a cottage industry. A decade ago, 80% of physicians were still self-employed, mostly in solo practice. This figure since has dwindled at an accelerating rate--to 55% by the start of 1996 (charts). "If current trends persist," concluded a recent study in the Journal of the American Medical Assn., "a majority of physicians will be employees in the very near future."

THEIR OWN KIND. Kaiser Foundation Health Plans and other so-called staff model HMOs long have employed their own corps of salaried doctors. Over the past decade, many hospitals followed suit, often by buying practices. But surveys have found that as many as 80% of hospitals that acquire doctor groups operate them at a loss. HMOs have not fared much better. The evidence emphatically suggests that doctors are much better motivated and more productive when working with hospitals and HMOs, not for them.

By a wide and increasing margin, employee physicians prefer to go to work for other doctors in physician-owned group practices than to sign on with other sorts of employers. The medical group practice is akin to a law or accounting firm. Employees can ascend through the ranks to partner and thus share in the ownership of the firm. After inching up throughout the 1980s, the number of group practices jumped sharply from about 13,000 in 1991 to 19,800 in 1996, according to the American Medical Assn.

Ever since the Mayo Clinic rose to preeminence in the early 1900s, group practice has flourished as an alternative calling. During the long heyday of fee-for-service medicine, the minority of American doctors who took the Mayo as their model and banded together to found multispecialty clinics across the country were acting on the belief--by now well-documented--that collegial practice enhanced quality.

CUTTHROAT. These days, however, the allure of group practice is mainly economic. The cost-cutting imperatives of managed-care payment plans and the advent of complex new information technology have combined to make solo practice a Darwinian ordeal. On the other hand, group practice per se is no cure for what ails the physician in this era of cutthroat commerce. Even many of the largest and most advanced doctor groups have grudgingly concluded that they lack either the capital, the business knowhow, or the sheer nerve to go it alone into the brave new world of managed care.

Enter the PPM, a kind of holding company for group practices. Often, the PPM company buys the assets of a physician group--its clinic building, equipment, accounts receivable, and so on. However, the doctors continue as employees of their own professional corporation, which signs a long-term service contract with the PPM. The doctors retain full sovereignty over medical policy and physician personnel matters, including pay. Nonphysician clinic employees are transferred to the payroll of the PPM, which recapitalizes the practice and manages its business affairs in exchange for an annual fee amounting to 15% to 20% of clinic income.

The underlying idea is that the PPM and its affiliated physicians prosper together or not at all. At the Nalle Clinic in Charlotte, N.C., the average doctor's pay has risen every year since the old-line institution joined PhyCor in 1990, having decreased slightly over the preceding three years. "Are our doctors happy? No, not at all," says Dr. Raymond Fernandez, Nalle Clinic's CEO. "But with all the crap happening to doctors these days, they are relatively happy because they don't have to worry about the future anymore."

OILED MACHINERY. The PPM make-over of an acquired clinic usually begins with the business equivalent of a complete physical--an audit that analyzes the generation of revenues and of costs in minute detail. PPM acquirers tend to replace local administrators with their own people and may trim overhead by eliminating support staff positions in the bargain. The new owners also consolidate purchasing, obtaining everything from paper clips and envelopes to catheters and malpractice insurance at big discounts to what the clinic had paid previously. A well-oiled PPM machine can easily reduce overhead by 10% to 15% or more. Meanwhile, to boost the productivity of physicians and nonphysicians alike, well-run PPM companies invest heavily in new telecommunications and computer systems.

Many PPMs are wholly devoted to a single medical specialty such as oncology (American Oncology Resources), cardiology (MedCath), or neonatology (Pediatrix). But multispecialty PPMs such as PhyCor and MedPartners try to strike a balance between specialists and primary-care physicians, the gatekeepers of managed care. Optimal staffing is itself a potent form of productivity enhancement. Houston's Kelsey-Seybold Clinic, one of MedPartner's largest affiliates, added nearly $5 million a year in profit by increasing patient visits an average of 1.9 per primary-care physician per day.

PPM companies also look to spur revenue growth by underwriting the hiring of more doctors, opening branch clinics, seeking additional managed-care contracts, and purchasing the costly high-tech equipment needed to add such lucrative ancillary services as magnetic resonance imaging (MRI). One of the most telling statistical measures of PPM performance is "same-clinic revenue growth"--that is, gains generated by existing rather than acquired operations. Since 1992, PhyCor has boosted its same-clinic growth rate from 4% a year to a stunning 18%.

PPM is an industry of stellar growth but ordinary profitability. In multispecialty companies, only 7 cents to 8 cents of every dollar of net revenue falls to the bottom line before taxes. Single-specialty PPMs tend to have higher margins, reflecting the superior earning power of certain types of specialists. Companies of both sorts will become incrementally more profitable as they grow. But the PPM industry is pinning its principal hope for margin improvement on something that is becoming the bane of the typical physician's existence: capitation.

SAVVY AND LUCK. Most HMOs started out by paying doctors after each patient visit. Increasingly, though, managed-care plans are switching from reimbursement to prepayment, also known as capitation. Under capitation, the physician receives a modest sum in advance to cover all the care that each enrollee will receive over a given period. The effect is to restore physicians' clinical autonomy, but at the price of their accepting open-ended financial risk.

Obviously, capitation favors size; the larger a population of patients, the more predictable the incidence of serious illness and thus the cost of treatment. In many markets, capitation rates now are being set so low that for solo practitioners to be assured of maintaining their incomes they must not only have business savvy but be lucky--that is, spared the burden of treating an unexpected number of seriously ill patients. PPM companies are better equipped than individual physicians to analyze and assume the financial risks of capitation and negotiate terms with health plans.

But these and other dealings between big PPMs and HMOs are no longer the arm-wrestling contests that they were not long ago. "The essence of the interaction is not `I want you to give me a five-point rate increase' but `How do we work together to create a higher-value service of mutual benefit?"' says Mark L. Wagar, who runs MedPartners' West Coast operations.

On Mar. 5, MedPartners and Aetna U.S. Healthcare, a subsidiary of Aetna Inc., put this philosophy into practice on a grand scale, announcing an agreement under which many of the health insurer's 14 million health-care customers will gain access to the 10,688 physicians affiliated with MedPartners. This, the first nationwide alliance between an HMO and a PPM company, is certain to pressure other managed-care insurers to follow suit.

Other HMOs and PPMs are collaborating in more limited but no less significant ways. For example, in January, Pacificare Health Systems Inc. joined with MedPartners and 34 other physician groups to launch "Express Referrals," a pilot program under which a doctor can refer a patient to a colleague without an HMO review. This back-to-the-future innovation shows Pacificare's confidence in the physician groups' own internal controls--enough so that it's willing to let doctors again make autonomous decisions about patient care.

SORRY FATE. While many hospitals persist in converting independent physicians into salaried employees, a growing number of nonprofit hospitals in particular have begun adapting the infrastructure of PPMs to their own needs by joining with doctors to form management service organizations. Like PPMs, MSOs are physician-driven companies that use advanced business methods to rationalize medical practice. But MSOs are privately held entities in which ownership generally is split 50-50 between doctors and hospitals. One of the largest MSOs, involving 2,500 physicians, was recently formed by North Shore Health Systems, a nonprofit hospital group on New York's Long Island.

In the long run, the spread of MSOs could curtail the PPM industry's growth prospects. However, at the moment, the PPM companies are constrained not by competition from outside or inside the industry but by their own management capacity. Modest profit margins and heavy reliance on acquisitions, coupled with the intricacies of medical practice and the stubbornly independent ways of doctors, make physician practice management one of the most unforgiving businesses in health care.

Consider the sorry fate of Coastal Physician Group. Operating out of Durham, N.C., Coastal for a time vied with PhyCor for leadership of the PPM industry but turned out to be far better at acquiring practices than at running them. In 1996, Dr. Steven M. Scott, Coastal's founder and CEO, was ousted by his board but retaliated by launching a successful proxy fight. Coastal has been selling assets in an attempt to survive by shrinking. Its stock has plummeted from 40 to about 2.

Many PPM issues have fallen from their 1996 highs as a series of disappointing earnings reports sobered investors initially intoxicated by this emerging industry's long-term potential. Even so, PPM stocks continue to trade at much higher multiples--15 times earnings on average--than do privately held physician practices, which are available for 6 to 8 times earnings. As long as this valuation gap persists, PPM companies will be able to continue to use their shares not only to buy practices on the cheap but also to boost their earnings promptly.

TROJAN HORSE? The PPM industry is more dependent than most on maintaining favor with investors. "If acquisitions were no longer immediately accretive to earnings, I would expect a tremendous shakeout in the industry," says Gary M. Frazier, a managing director of Bear, Stearns & Co. "But I expect that growth in this industry will accelerate--not slow down--for at least the next three to five years."

There are those who view PPM as a kind of Trojan horse placed by Wall Street at the very heart of health care. Sooner or later, they warn, the pinstriped legions will burst forth and wreak havoc by sacrificing the interests of physicians and patients alike on the altar of earnings-per-share growth. Given the pivotal position of the physician in the health-care economy and the rapidly increasing size and scale of the PPM industry, the potential for abuse is indeed enormous.

On the other hand, PPMs are not instigating the corporatization of health care but bringing up the rear. By arming physicians with the weapons of Big Business, the PPM industry is at least making a fair fight of it. In the short term, at least, the patient is likely to benefit, too. After all, it is the doctor who takes the Hippocratic oath--"in every house where I come, I will enter only for the good of my patients"--not the HMO or hospital administrator.