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Product line approach to building a practice

By Thomas Reinke, John Hobson, M.D. & Adrian Scipione, Esq.

The health care industry is a growth industry. Contrary to the dotcom and other “new economy” stocks without a sustainable business model, the growth of the health care industry is driven by at least two underlying and persistent factors: changing patient demographics and the constant advance of medical technology.

HCFA projects that total expenditures will double from $1.3 trillion in 2000 to $2.6 trillion in 2010. Generally, expenditures on outpatient care will increase faster than those for inpatient care. The growth in outpatient care reflects several major forces, including cost containment efforts, changing treatment protocols and patients’ increasing concern, knowledge and interest in playing an active role in their health care. More specifically, patients are demanding more comprehensive services ranging from alternative medicine to the latest and most sophisticated medical technologies.

Medical care is driven by technology. Physicians’ ability to accurately diagnose patients and provide precise treatment is enhanced by increasingly sophisticated diagnostic tests, technologically enhanced surgical procedures, assistive devices and improved pharmaceuticals. The crystal ball is not bright or clear enough to indicate if the human genome project and other advances will spawn the day when preventive medicine surpasses remedial care. So, for the foreseeable future, technological advances will not substitute for knowledge and cognitive skills. Therefore, in the current world, the best doctors are still those who combine their intellectual, personal and interpersonal skills with the appropriate application of the latest technological advances.

As a group, physicians are rapid adopters of medical technology but often they are conservative in their approach to other changes. It’s an interesting dichotomy, especially as it relates to the management of their practices. While doctors readily accept medical advances, they generally have not taken advantage of the need and opportunity to expand their practices by logically incorporating new technologies into the services they offer.

The focus in other segments of the industry is on “product line development,” an approach that takes an expanded view of a specialty or service. The objective may be to alter the emphasis on certain steps in the continuum of care or it may be simply to expand the scope of services.

In some cases, “product line development” is driven primarily by the reimbursement that is available, but there are many other factors such as patient demand, internal operational considerations and competition that may play a role in determining the direction of development.

The product line approach is common among the numerous for-profit companies that have entered the industry. Some of these companies are involved in inpatient services and offer the “hospital within a hospital” concept where they operate disease-specific units. More companies have applied this concept to outpatient services where they look to capture market share in a defined geographic area, derive economies of scale by rolling up mom and pop providers or exploit a (usually temporary) reimbursement advantage. After the spate of Medicare fraud settlements and skilled nursing home bankruptcies, the for-profits are beginning to realize that product and niche development must be based on sound service delivery principles.

There are many sound business reasons for physicians to look at some form of product line development. New ancillary services are one approach to this type of practice expansion. An increasing number of specialties are experiencing physician shortages. Adding services that are different from core physician services may be a simpler approach to growing a practice than adding doctors. This is especially true in those practices where it is not entirely clear that there is enough work to make a new doctor feasible. Another consideration in specialties with a shortage is that salaries are increasing and adding another doctor may mean a substantial upfront investment with an indeterminate payback.

Depending upon the service and practice, offering expanded ancillary services may present operational advantages, including the following:

1. Many ancillaries can be scheduled independently and operate independently from a physician. Thus, once they are established, they may run on their own. (Note: certain ancillary services must be performed under the supervision of a physician, with a doctor’s onsite presence required when patients are receiving the service).

2. Depending upon the service, it may be easier to recruit clinical or technical employees as compared to a nurse or other type of office employee. Or, adding ancillaries may present an opportunity to more fully utilize existing employees by cross-training them.

The economics of ancillary services are another factor. They may offer a higher profit margin than physician services. Increasing physician salaries and malpractice expense, coupled with flat or decreasing reimbursement, especially for surgical procedures, is reducing the margin on physician services. Ancillary services, particularly diagnostic services, present an attractive alternative because one of the largest components of their operating expense, the equipment, is often fixed through a lease.

In the period 1997 through 2001 there has been a substantial change in Medicare reimbursement for ancillary services. Reimbursement for major surgical procedures has decreased by as much as 20 percent, while payment for some diagnostic tests has increased in the range of 10 to 18 percent. The reason is linked to continued revision of the RBRVS reimbursement mechanism, particularly as it relates to practice overhead or operating expenses. Reimbursement should not be the primary consideration for adding services, but it is an important consideration in the overall feasibility of expansion.

Practice expansion should not be taken lightly. The health care industry is highly regulated and, as doctors already know, there are regulations that pertain to physicians’ business dealings. These include the Stark regulations, the antikickback regulations and, in some states including Pennsylvania, regulations that require disclosures when patients are referred to a service they own or invest in.

While the regulatory environment may control many aspects of how ancillary services can be provided out of your office, it should not discourage you from moving in that direction. Ancillary services can be a beneficial addition to the other services available in your office and comply with the various regulatory requirements at the same time. If the ancillary service is structured so that it doesn’t encourage overutilization and there is no value- or volume-based compensation paid to providers, it can become a positive aspect of your practice, both for your patients and your bottom line.

Generally, the intent of Stark II was to remove financial incentives that would otherwise encourage a physician to over-utilize certain health services. In general, the law and its regulations say that a physician may not refer a patient to an entity in which the physician or an immediate family member of the physician has a financial interest for any Designated Health Service (DHS) that is payable by Medicaid or Medicare. In addition, the entity performing the DHS may not bill for a service so referred. There are a number of exceptions to this general prohibition, however, they are narrowly drawn and maintain the requirement that the physician remain financially neutral in the referral process. DHS’s consist of:

• Clinical laboratory services.

• Physical therapy services.

• Occupational therapy services.

• Radiology, including MRIs, CAT scans and ultrasound.

• Interventional radiology services and supplies.

• Durable medical equipment and supplies.

• Parenteral and enteral nutrients, equipment and supplies.

• Prosthetics, orthotics and prosthetic devices.

• Home health services and supplies.

• Outpatient prescription drugs.

• Inpatient and outpatient hospital services.

Although the legislation was enacted in 1993, only half of the final rules have been published for this highly complex and hotly debated legislation.

The other federal legislation that is implicated in expanding the services you offer to your patients are the anti-kickback provisions of the Social Security Act. This law provides criminal penalties for offering, asking, paying or accepting remuneration, in cash or in kind, for referring a patient for services payable by Medicare. Simply put, no compensation of any type (including discounted or free services, equipment, office space, support, etc.) can be paid if patients are being referred. In this situation, if the ancillary services are structured through a separate entity, you can very easily run afoul of the federal anti-kickback provisions. As with Stark II, there are several narrowly drawn exceptions to the general prohibition known as safe harbors.

Finally, many states also have anti-kickback provisions that are similar to the ones contained in the Social Security Act. Some states also have anti-referral legislation in varying degrees. For instance, while Act 66 in Pennsylvania allows a doctor to refer a patient to an entity in which he or she holds a financial interest, the financial relationship must be fully disclosed to the patient.

Physicians need to be aware that the regulations are out there and that, at the very least, they will influence ownership structure and how profits are allocated. However, due to the complexity of the regulations, it is advisable that you consult with an attorney who has extensive experience and knowledge of the regulations before implementing the arrangement.

Thomas Reinke is the manager of Healthcare Advisory Services at Kreischer, Miller & Co. in Horsham, PA. John Hobson, M.D., is a health care consultant and practicing internist in Bryn Mawr, PA. Adrian Scipione, Esq., is a health care attorney at Wade, Goldstein, Landau & Abruzzo, P.C. in Berwyn, PA.

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