The Problem

Southern Teaching Hospital (STH) is a major teaching hospital that owns and operates a primary care network (PCN) to serve its local market. The group has large and persistent operating losses, but has been in a rapid growth mode, and these losses are thought to be due to its fast expansion. Is this the case, or is something more fundamental amiss?

The Situation

STH is a major teaching hospital located in the downtown part of a midsized urban center in the South. It serves a 2o-county area with tertiary referral services, but primary care is organized for the more local market, within about 25 miles of its home base. STH competes with two other large systems, with four and six community hospitals in their networks, respectively; all but a few hospitals in the metropolitan area belong to one of the systems. A rapidly growing proportion (now about 60 percent) of the primary care physicians in the metro area are part of a group affiliated either with STH or one of the systems.

STH had few employed physicians two years ago, but as the market began to consolidate, both with the hospitals and in the primary care practices, STH decided it needed a primary care group to remain a relevant market factor in the metropolitan area. STH embarked on a rapid growth strategy for its primary care group, adding 17 physicians to the 22 already in the group.

Encounters grew by 75 percent and admissions from the total group grew 25 percent in the past two years.

Operating losses from the PGN grew proportionate to group size and have been averaging over $200,000 per FTE physician annually. With the increase in the size of the group, the operating losses have become a significant concern, amounting to about $7 million per year. Although the management of the group attributes the larger-than- expected losses to the rapid growth phase and the underperformance of new practices added to the group, others in senior management are not sure this is an adequate explanation. And the CFO has pointed out that the PCN essentially cost the system half its operating margin in the past year.

Although no one questions the basic strategy of having a network, continued losses at these levels will sink the system if the network grows to its projected size of 100 physicians in three years. One senior leader is beginning to advocate for shrinking or disbanding the PCN, and two are suggesting a freeze in its growth for the next three years. But the other five are committed to the original plan, and all agree that more information is needed before proceeding further. The CFO and a small task force have been charged with getting to the bottoni of the situation.

Analysis

The PCN consists of 89 physicians, but only 32-8 total FTEs. Overall losses in the most recent year for which data are available (2008) were $6.8 million.

From an initial analysis that looked at the loss experienced by start-up versus established practices, it is clear that although the start-up practices are contributing more to the overall losses than are the established practices, even the latter are experiencing large losses (nearly $200, ooo per physician) as compared with the national averages, reported to be about $70,000 per physician. If established practices are this far from desired levels and cannot be brought under control, there is little hope for the group's overall financial performance or for a significantly moderated financial impact on the hospital overall.

Highlights of a more in-depth review of the established practices are as follows:

* Established physician productivity, as measured by encounters, is somewhat below benchmarks.

* When measured by net revenue, productivity is 10 percent below benchmarks.

* Payer mix and payment rates are comparable to national medians, but reimbursement levels by payer average 10 to 2,0 percent below national medians and contribute to practice losses.

* Overall expenses for PCN practices exceed benchmarks by substantial amounts (141 percent of the median benchmark) .

* Physician compensation levels are significantly above median levels (about i38 percent of the weighted benchmark), averaging 154 percent of the benchmark for family practice physicians and 134 percent of the benchmark for internal medicine practices.

* Expenses for support staffing (81 percent) are below the benchmark.3

* Expenses for facilities and miscellaneous expenses substantially exceed benchmarks (overall, 152 percent of the benchmark).

* Total operating expenses are $6o3,ooo per FTE for family practice physicians and $497,000 per FTE for internal medicine physicians.

* The bottom line is a loss per FTE physician, per practice, and overall that significantly exceeds benchmark or targeted levels of subsidization for an employed PCN.

* The operating deficits for established physicians are more than 2.5 times the industry median ($70,000 per physician), which includes lower performing new physicians in the process of ramping up practices.

Additional insights yielded from an in-depth practice-by-practice review include findings of suboptimal productivity levels of a number of the physicians and significant variances in operating cost levels among some of the practices.

It is clear that although certain factors are outside STH's control, substantial opportunity exists to materially reduce the losses in the PCN. Although leaders of the group have argued that the focus should be on continued growth and that the PCN could grow its way out of its problems, senior management have begun to believe that growth alone is a prescription for disaster. If you were in STH's situation, what would you do?

The Decision

SWs CFO, the PCN's administrator, and its medical director were charged to lead an initiative to halve the losses in established practices within 12 months and put in place new controls so that as practices are brought in and become mature, they operate in as financially prudent a manner as possible. Initiatives related to physician compensation (e.g., establishing and implementing a physician- and practice-based productivity incentive compensation structure), renegotiation of certain managed care contracts, anda more uniform operating (and cost) model for the group are receiving the highest priority.

a. Lean staffing levels are not necessarily desirable and may be an impediment to physician productivity. Higher performing practices are often rich in staffing. A necessary further evaluation of staffing requires delineating clinical, clerical, and other staffing levels for each practice for comparison with benchmarks.

Author affiliation:

Alan M. Zuckerman, FACHE, FAAHC, is president, Health Strategies & Solutions, Inc., Philadelphia

(azuckerman@hss.inc.com).