The Impact of Physician Organizations on the Healthcare Industry

Value Drivers Specific to a Physician Organization

The value of a physician organization is not black and white.   The nuances related to healthcare industry can cause confusion and debate around methods utilized to determine value.  Defining value can be very industry specific, to account for the nuances within an industry, and provider healthcare is one industry that has more than any other.  Due to the increased M&A activity and non-traditional financing models, there has been more discussion around value drivers for physician organizations.  According to HealthcareMandA.com, “the number of physician medical group acquisitions increased to 48 in the first quarter, a 78{7656ca219931958fe15db644f5e70e9855a8d6dc7ecf752fd1b70e2be3385646} jump from the 27 publicly announced acquisitions in the fourth quarter of 2016, and a 109{7656ca219931958fe15db644f5e70e9855a8d6dc7ecf752fd1b70e2be3385646} increase from the 23 announced deals in the year-ago first quarter.” (PR Web, 2017) In this analysis, we will discuss the value drivers’ specific to physician organizations, which include scope of services and capacity, revenue stream and payor mix, operating expense, capital expenditures, and market conditions.

Scope of Services

For a physician organization to thrive in today’s market, diversification of services can have significant impact on revenue. Physician organizations with multiple service lines, like a multi-specialty practice, have the capabilities to easily add additional specialty services over a single specialty organization.  Only an incremental expense would be incurred because space and equipment can be leveraged and readily shared.  Due to the declining and flat reimbursement rate for the professional fee of an encounter, many specialty groups are looking to add ambulatory services, which are a much more profitable service line.  The discount rate applied would take into account the ability to add additional specialties services and revenue streams.

Capacity

Capacity in a healthcare organization refers to the resources available to treat patients and manage throughput.  For a physician organization, outside of the obvious appropriate number and mix of providers to treat the patient population, these include provider resources, building and office space, support staff, and technology.  This driver is important because it can hinder or facilitate growth.  With the trend in mergers and acquisitions, it is a necessary component to understand fair market value of a healthcare organization.  When assessing future capital expenditures and working capital needs, capacity will be considered as it could impact the amount of free-cash flow available.

Revenue Streams and Payor Mix

Revenue generation for a healthcare organization, as with many other industries, is driven by the volume of services provided.  Physician organizations are heavily dependent on volume of patient encounters and the reimbursement rate for those encounters.  Reimbursement rates vary by the type of payor, commercial, government or self-pay, and acuity level of the encounter.  Consequently, payor mix, is another important driver in the value of a healthcare organization.  Payor mix is the percentage of gross revenue (or some other metric such as net revenue or encounters), where reimbursement payments are received. The payor mix is dependent upon factors such as type of services provided, and the community services being rendered.  A pediatrician will not have a high volume of Medicare patients where a cardiologist will have a larger number of Medicare patients. Because revenue is community specific, utilizing Guideline Public Companies (GPCs) is not an effective method in valuing a physician organization.

Another revenue stream for physician organizations is the engagement in Provider Services Agreements (PSAs).  These are contractual obligations between the physician group and another health care provider where professional services are rendered for a fee.  These types of arrangements have become popular in the midst of healthcare payment reform because hospital systems, in an attempt to contain cost, can predict expenditures with some level of certainty and eliminate overhead.  These contracts are valuable for physician groups in that revenue projection can be predicted with reasonable certainty over the contract period.

Operating Expenses

The largest operating expense for most healthcare organizations is human capital, salaries, wages and benefits.  As we look at physician organizations, provider compensation comprises most of this expense and is under the most scrutiny.  There are several compliance statues associated with physician compensation and how incentives are calculated.  There needs to be assurance that physicians are not incentivized to send or receive volume to and from affiliate organizations.  To determine FMV compensation to ensure compliance with various statues, a benchmarking exercise would occur based upon local, state, and national data.  If these agreements are below fair market value, it could be perceived as an incentive for business.

Another cost area that is a value driver in healthcare for an outpatient services and physician organization is building and equipment lease agreements. These agreements are generally entered into with other healthcare organizations and must be at fair market value to ensure compliance.  Similar to physician compensation, if these agreements are below fair market value, it could be perceived as an incentive for business.

The other major driver in healthcare valuation is supplies.  This may not be an issue for smaller practices that do not perform procedures, but it does come into consideration for outpatient services such as same day surgeries, infusions, and dialysis.  Group Purchasing Organizations (GPOs) are extremely popular in the healthcare industry.  Not every healthcare provider is large enough to achieve the buying power necessary to negotiate pricing.  A GPO solves this problem by serving as the intermediary between suppliers and healthcare organizations, leveraging the total number of orders as bargaining power.  The value in this driver is the cost savings generated from this relationship. Additional volume can only increase the bargaining power, and thus result in cost savings which are passed onto the healthcare provider.  The cost savings from the GPO would impact the value driver selected, as the organization grows, there is potential cost savings due to the increased volume.

Market Conditions

The aging population is a market condition affecting healthcare. Between 2005 and 2030, the population over 65 will double in size resulting in an increased demand for preventative services and chronic disease management.  In addition, the general health status of the US is on the decline due to the increase in chronic diseases.  Because of healthcare payment reform, focused on value over volume, and market conditions, there will be a greater need for multi-specialty practices to provide services to support these individuals, increasing the value of professional physician organizations overtime.  If the future demand was considered in the growth strategy of the organization, it would impact management’s forecast and the discount rate.

The value of a physician organization is significantly tied to the above, in addition to the rapidly evolving US Healthcare Industry and Healthcare Reform, some of which is an unknown.  We do know that value over volume has become the focus; shifting the risk to the provider who must offer services that provide the best possible care, quality, and outcomes, while achieving the lowest possible cost. Due to this, there has been, and will be, a significant amount of M&A and Integration Activities that will require a proper valuation approach to ensure fair market value compliance under the governing statues.

 

Amel Hammad brings over fifteen years of diverse healthcare experience with the primary focus on providers across the continuum of care.  Ms. Hammad is currently pursuing an Executive MBA from the University of Denver with an expected completion in August 2018 and holds a Masters’ in Health Administration and Bachelors’ in Finance from Saint Joseph’s University in Philadelphia, Pennsylvania.
 
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By |2017-08-03T22:01:07+00:00August 3rd, 2017|Financial, Healthcare|Comments Off on The Impact of Physician Organizations on the Healthcare Industry