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Options for health system MD groups

By Howard J. Peterson

Substantial financial losses by hospital-owned physician groups is a generally recognized phenomena. It is a major contributor to poor financial performance, even a contributor to bankruptcies. It is a prevalent concern of health system boards and is a matter of escalated scrutiny by bond rating agencies.

Hospitals are beginning to explore options in charting a course for financial improvement of their controlled primary care groups. Board members often focus on only the financial performance of the group. However, consideration of future options is a more complex issue requiring consideration of such matters as the broader effect on the health system as a whole, its market share, strategies and the residual effect on physician relationships.

Fundamentally, four options exist for organizations to make material change. They are presented here as discrete options. However, they may also be taken in combination in establishing a course to improve the physician organization’s fiscal performance and its contribution to the health system.

The options are:

• Management Improvement: The efforts of management to reduce cost, improve revenue, selectively close and consolidate practices.

•Transformation:Aggressive closure/divestiture of those practices with significant economic problems; restructuring the remaining practices within new corporate entities which are strategically aligned with the health system. Typically this includes the transfer back of certain ancillary services and revenues. It also typically requires negotiated transitional funding.

• Privatization: The sale or conveyance of practice assets and physician contracts to a commercial physician practice management company (PPM). This results in selective divestiture. It requires, typically, transitional funding in the current economic climate. The PPM in this case establishes a strategic relationship with the parent hospital or health system. Again, it includes transfer of certain ancillary services and revenues.

• Divestiture: Closure, or sale back to the physician of all practices. This requires subsidy until the conclusion of the process. It is tied directly to the contractual obligations of the parent organization.

Direct Financial Performance

With respect to direct financial performance, it can be anticipated that the initiatives through management improvement efforts are less predictable with respect to the results they will produce. This option does not establish direct physician accountability for performance, and, management is less able to achieve and maintain improvements.

Direct financial performance under transformation is dependent on how aggressive decisions are made with respect to selective divestiture. The transformation establishes direct physician accountability for performance. It also, typically, provides relief from the cost structure of the parent health system. Long term subsidies by the health system is eliminated after initial transitional funding.

Privatization and divestiture are not materially different with respect to direct financial performance. Both require a resolution of financial issues related to contractual obligations.

Market Share/Revenue

Retention of controlled physician groups and attempting to improve practice through management improvement effort provides the greatest opportunity to control the activity which remains within the health system. Transformation supports a high level of retention of patient care activity within the system. It also provides the opportunity to attract new physicians to the transformed structure. It erodes direct revenue of the system, however, by the transfer of ancillary revenues.

Privatization unavoidably creates a new competitor to the parent system even with strategic alignment between the PPM and the health system. It reduces the ancillary revenues controlled by the system.

Divestiture has the most damaging effects with respect to market share and revenue retention. It is likely that the best physicians who are divested will align themselves with a competitor organization, at least in competitive markets.


The initiatives through management improvement preserve existing strategies. Transformation more effectively aligns the interest of physicians with the health system. Privatization impact on strategy is entirely dependent on the negotiated relationship with the acquiring PPM. It is likely, however, to cause a certain degree of loss to strategic control. Transformation is likely to foster competitors and a direct loss of market share. Divestiture eliminates the opportunity to use their formal relationships for strategic purposes.

Physician Relationships

Physician relationships under management improvement initiatives will always be strained because of the lack of alignment and conflicts in perceived effectiveness of the performance of management. Transformation represents the greatest opportunity to improve physician relationships and to attract other physicians to the transformed organization. It specifically sets out to retain the best physicians.

Privatization fundamentally changes the relationship with the physicians, positioning them as potential competitors. At the very least their interests are not directly aligned with the parent organization.

With divestitures, there is a high potential for acquisition of some of the divested practices by competitors. It is also likely that the reaction of some divested practices will deem the health systems action as bad faith when taken in the context of their original relationships. It is very likely that divestiture simply will lead to a requirement for a new initiative by the parent organization to mount a physician strategy.

Management Effort

The greatest effort required is internal management efforts, with limited return. Management efforts in the short-term for transformation, privatization and divestiture are substantial. They decline rapidly with respect to privatization and divestiture, and continue only if part of the arrangement under the transformation structure.

This comparison of future options strongly argues against continued management improvement internal to a health system or the pursuit of divestiture. It should focus health system and board leadership on consideration of either a transformation or privatization.

Howard J. Peterson is principal-in-charge of Health Care Services, East Region, of Larson, Allen, Weishair & Co., in Philadelphia.

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