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    Timothy Smith, CPA, ABV

    Part 2 of the series: Examining Losses in Health System Physician Practices

    As discussed in the first installment of this article series about practice losses, the MGMA Cost and Revenue data indicate the vast majority of hospital/IDS-owned physician practices lose money, while nearly all physician-owned practices breakeven or make a small profit. This economic phenomenon raises a critical question: Why do most hospital/IDS-owned physician practices lose money, while most physician-owned practices breakeven or make a profit?

    The answer to this question is found in how each practice is managed and what the goals and purposes are for the practice. These strategic differences impact the ultimate economics of the practice, particularly the role of physician compensation in the practice’s bottom line.

    The strategic goal of a physician-owned practices is to maximize the earnings of the practice, while also providing patients with quality clinical care. (While making money may be a goal, we should always remember that physicians are healers. That characteristic remains an essential part of how they think and do, compassionately affecting how they run their practices.) A consequence of owning a practice, however, is that practice earnings are at risk, making physician compensation self-adjusting or self-leveling. Rather than creating a loss, physician compensation for physician-owned practices is lowered so that the practice breaks even or makes a small profit.

    Paying physicians based on their practice net earnings is known as “eat what you catch” or “eat what you treat” or the ironic “eat what you kill.” For solo physicians or those in small practices, there is usually a direct relationship between individual physician compensation and net practice earnings. Compensation for physicians in larger groups may be more indirectly related. Yet, the total compensation for all physicians in a large group is usually limited to the group’s net practice earnings.

    Earnings-based or “eat what you catch” compensation is a key economic metric because it creates a single “bottom-line” number that incorporates multiple practice variables. For starters, the amount of net practice earnings reflects the mix and volume of services a physician or practice provides, ranging from the procedure mix (E&M, diagnostic, surgical, etc.) to other services such as hospital call coverage, medical directorships, APC supervision, and value-based payments.

    One often ignored service that is included in the earnings of physician-owned practices is owner compensation. There are two types of owner compensation. Physician owners frequently perform various senior management functions in their practices. When they do, some portion of their compensation reflects the value of these management services.

    Physicians may also provide investment capital to their practices. This investment can take two forms. The first is reduced compensation that creates excess earnings that can be used for financing practice expansions and development. The second is simply making cash contributions to the business. In either case, some portion of a physician-owner’s ongoing distributions should be viewed as a return on investment and not simply as compensation for doing “doctor stuff.”

    Earnings-based compensation also reflects the value of medical services in the local market, i.e., the reimbursement paid for services by insurers. Many industry players are not aware that payers reimburse at widely varying levels from one local market to the next, even within the same state. They may also pay different practices at widely varying rates within a local market.  Net practice earnings, therefore, provides an indication of the local-market value of physician services, although this value may be affected by “noise” from poor revenue cycle management.

    Earnings-based compensation may also point a physician’s economic efficiency: What is the total cost of the resources a physician uses in providing services? Some physicians are high resource utilizers when it comes to support staff, office space, supplies, and other operating expenses. Other physicians, by contrast, may use lower amounts of resources to produce at the same level as their higher resource-using colleagues. In physician-owned practices, physicians with high economic efficiency can make more money than their less efficient peers.

    As the market moves towards payment for value rather than volume, net earnings will also reflect the value-based performance of the practice. Higher value clinical outcomes will be rewarded with higher reimbursement levels in contrast to lower clinical performance. Net earnings in physician-owned practices will increasing reflect such outcomes as the market shifts to value from volume.

    Strategically, physicians-owners in physician-owned practices understand these practice dynamics and economics. They make operational decisions in the context of increasing revenues and lowering costs, while maintaining quality patient care. Their decision-making horizon is straightforward: Increased productivity or revenue means higher compensation, while higher overhead means reduced compensation.

    Consequently, “eat what you catch” creates natural boundaries for physician compensation because it is self-leveling to practice net earnings. As a result, use of earnings-based compensation generally explains why physician-owned practices in the MGMA data do not show net losses.
    The critical question now becomes why do hospital/IDS-owned physician practices mostly show losses. In the next installment of this article series, we’ll examine the critical strategic and economic factors that answer this question.

    To read the first part of the series click here

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