10 Business Value Business Continuity Exit Strategy
John
Sticky Note
I’ve put together a list of 10 business concepts that I feel are most neglected or least understood in medical practice management/ownership. These concepts span all aspects of your business from basic concepts to issues related to revenue generation, expense management, performance monitoring, and exit planning.
The first thing that any entrepreneur must do when starting a new business is to define and vet-out their business model. I’m not sure that physicians typically think about things in the same way as an entrepreneur, but it is critical to understand your business model.
Let’s start with the bombshell – As long as we are talking about traditional healthcare, that governed by managed care, “Medical Care is a commodity.” And while this fact may not be popular, I assure you that payors understand this…and the mere fact that it sends shivers down some of your backs to hear it, plays to their advantage.
Most of you are familiar with the supply and demand curves… This is actually an Industry demand curve. The intersection of the industry supply and demand curves is a static price point that sets the firm demand curve
In other words, the individual firm does not affect the industry price, nor does the individual firm’s supply alter overall industry demand. When you decide to participate in this industry, you effectively agree to the price you are given. From that point on, price is understood to be exogenous (it is beyond your control).
As “price-takers,” we are paid by volume, not quality.
Ourgoodsmustmeeta minimum industry standard (i.e. “standard of care”), but we are not paid beyond that.
John
Sticky Note
Perhaps the most important thing to understand is that we do not compete, nor are we paid based on Quality. This is not say that there are no quality requirements. Our goods must meet the minimum industry-defined standards (in healthcare, this is referred to as “standard of care”), but we are not paid for any quality over and above that standard.
I’m not sure if most of you already know and accept this, or simply refuse to believe it. Let me try to support this with a bit more information. Can anyone tell me how their fee schedule (i.e. prices) are set with various payors? In general, nearly all private contracts are set according to a Medicare base year fee schedule. For example, you may have a fee schedule that is set at 125% of the 2005 Medicare fee schedule. While the exact dollar amounts will vary from Medicare’s, in general, the relative value of specific procedures does not.
To help explain this, let’s look at how Medicare sets their prices: The calculation looks complicated, but it really is not: Every CPT is broken into three relative value units (or RVUs). One is based on the amount of physician work required, one on the office expense incurred by the procedure, and the third is based on malpractice exposure. Each of these RVUs is then multiplied by a Geographic Practice Cost Index, or GPCI, to weight for geographic location. When added together, these component RVUs equal the total RVUs for a procedure. The final step is to multiply the total RVUs by the annual Conversion Factor which turns the RVUs into a dollar value.
Sounds a lot more complicated than it is. Here is an example of the calculation for the 2009 North Carolina Medicare Fee for CPT 99213 => [Work RVU (0.92) * Work GPCI (1.0) + Expense RVU (0.75) * Expense GPCI (0.925) + Malpractice RVU (0.03) * Malpractice GPCI (0.634)] * Conversion Factor ($36.0666) = [(.92) + (0.694) + (0.019)]* $36.0666 = (1.633) * $36.0666 = $58.89 To prove that price is exogenous, we simply need to agree that you accept a fixed price for a procedure and then are paid that price for each such procedure until the agreed rate (or contract rate) changes. There’s no question about that. RVUs show that not only is price pre-determined and fixed, but that (1) quality is not involved in its calculation, and (2) every procedure is normalized to a single underlying unit of measurement (RVU) and then applied to all industry firms (or physicians) consistently.
... the truth is that something as nebulous, sensitive, important, any of a dozen other adjectives, can be reduced as easily… The good news is that once you understand and accept this, the finance and economics of your practice can be much easier to understand and assess.
“Attempts to mathematically capture behavior in strategic situations, in which an individual’ssuccessinmakingchoices depends on the choices of others.”
— Wikipedia
John
Sticky Note
Game Theory. Why am I bringing this up? [Reveal definition]… Sounds a lot like life to me.
How familiar are you with the Prisoner’s Dilemma? So many of our decisions are dynamic and involve the interaction and decisions of others. Just because you don’t think in a calculated manner, does not mean the other “player” doesn’t either. I assure you that insurance companies employ sophisticated game theory models in setting their prices and negotiating their contracts.
[Walk through key take-aways] Something to consider – research shows that when presented with the simple Prisoner’s Dilemma, 40% of participants chose to “cooperate”; which is a losing strategy. ___________________________________________________________ Two suspects are arrested by the police. The police have insufficient evidence for a conviction, and, having separated both prisoners, visit each of them to offer the same deal. If one testifies (defects) for the prosecution against the other and the other remains silent, the betrayer goes free and the silent accomplice receives the full 10-year sentence. If both remain silent, both prisoners are sentenced to only six months in jail for a minor charge. If each betrays the other, each receives a five-year sentence. Each prisoner must choose to betray the other or to remain silent. Each one is assured that the other would not know about the betrayal before the end of the investigation. How should the prisoners act? There is a dominant strategy… which is to say that both players choice’s are not impacted by the choices of the other. To find what the dominant strategy is, we identify it’s Nash Equilibrium.
Pose the question: What is the main goal in owning and running our own business? Is it independence, the freedom to be our own boss and make our own decisions? To do things our way? To have a more enjoyable lifestyle?
[Reveal Profitability] I think these are aspirations that most people have when they start their own business. Nevertheless, while these are desirable characteristics of your business, only one thing ensures your business’ long-term sustainability, and that’s profitability.
Total cost is the sum of fixed plus variable costs. As such, it takes the classic S-curve shape. This shows us what we already know – that to produce the first units of a good is very costly, but that per unit cost drops with volume, up to a certain point.
Maximum profitability occurs at the point where TR is greatest distance above TC… FYI max profitability occurs where the slope of the TR line (also expressed as marginal revenue) is equal to the slope of the TC curve (marginal cost). MR = MC. In other words, as long as the marginal revenue generated by an additional unit is greater or equal to the marginal cost of producing that unit, it adds to overall profitability. The main point is that revenue largely determines profitability, and it is entirely based on your fee schedule. Furthermore, in the production of widgets or RVUs as the case may be, there is an optimal quantity based on both cost and revenue. Great. Your telling yourself, “My fee schedule is critical, but we already established that price is exogenous.”
We are “price-takers,” but which price do we take? Or more appropriately, which price are we given? Private payers use at least 3 different fee schedules, though likely many more. For simplicity sake, we will assume only 3.
Next, there is an improved fee schedule that is given to independent practices that have aligned themselves in a loose affiliation. Our IPA as an example. Our increase can vary as high as a 25% increase over the base contract.
Finally, the best contracts are reserved for the tightly coupled, financially integrated large practices. In our area, that includes the likes of PDC and, increasingly, Novant Medical Group. Their fee schedule may be 50-60% higher than the base fee schedule. Pretty amazing. Regardless of where you find your fee schedule, you are still a “price-taker.” While these differences may seem staggering, I’m not sure you fully appreciate how substantial they are. Let’s look at what happens to profitability… Keep in mind, there is NO change to TC. In fact, more tightly integrated practices SHOULD have a lower cost curve because of both efficiencies and economies of scale. Quality has nothing to with the varying fee schedules. The difference is simply market leverage– the age old determinant in negotiations – how big is your stick? I think anyone looking at this information must ask themselves – What does it mean to be independent? What is “independence” worth? And, given the substantial difference in pricing, are all patients equal?
Opportunity cost, like Game Theory, is a key, recurring economic principle. In general, I think that many people can give a fairly accurate definition of Opportunity Cost.
Let me explain this a little further. Present Value is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money, investment risk and other factors. In other words, all things being equal, you’d rather have a dollar today than a dollar tomorrow.
Net present value is the Total Present Value of a time series of cash flows. When evaluating the economic cost/benefit of a project, NPV expresses the value or cost of the project, taking into consideration all costs as well as all future cash flows.
As such, a project with a positive NPV is typically regarded as one that should be undertaken. If the NPV = 0, then a firm would be neutral as to whether it should undertake. A negative NPV project should not be undertaken. Finally, because we rarely (if ever) undertake a project in isolation, we can express opportunity cost as the value of the NPV of the alternative project not undertaken. In other words, we are constantly dealing in trade-offs. Everything involves trade-offs… As we will see.
The third and final economic principle that I am going to discuss is Sunk cost. Sunk costs are costs that cannot be recovered once incurred. Like Opportunity Cost and Game Theory before it, I think that “loss aversion” or the sunk cost fallacy is one of the most frequently misunderstood, or misapplied concepts in every day business.
The classic example of the sunk cost fallacy is the non-refundable movie ticket. At some point in time, a person purchases a ticket to a movie. The price of the ticket cannot be recovered. The person decides that they do not want to go to the movie, perhaps they heard the film is terrible. Yet, rather than skip the film and spend their time elsewhere (opportunity cost), they choose to go to the movie because they don’t want to “waste” the money they spent on the ticket. The money spent on the movie was lost at the time it was purchased. From that point forward, the money spent on the ticket should no longer factor in any future decision. The choice is really – should I spend 2 hours doing something I am not going to enjoy, or do something else. When framed this way, the choice becomes much easier.
The place that I most commonly see “loss aversion” affecting peoples’ decisions is in the area of technology. Should I purchase a new system? That’s a good, and increasingly important question-- Should I purchase a new system? Well, it depends. First of all, if you decide to purchase a new technology system, say an integrated EMR/PMS, do NOT do so because it improves the quality of care. That is complete and utter nonsense. It’s important that everyone take this in the right vain. I am not saying that you should not be concerned about providing quality healthcare to your patients. You should provide the “standard of care,” otherwise you are doing them a disservice not to mention exposing yourself to both professional and legal censure, but anything more is being paid for out of your pocket. Who has the greatest interest in perpetuating the notion that it is your professional responsibility to do everything conceivable to provide the highest level of care? Who benefits if you spend your money to reduce the incidences of unnecessary ER utilization? Who benefits when you are able to get your chronic disease state patients to be more compliant? … GAME THEORY – it is difficult to negotiate when you care far more than the other player. If we were “all in this together” then clearly the reduction of costs to payers and employers justifies their large-scale subsidizing of these systems… or better, their outright purchase. In my view, the industry as a whole has done the most egregious disservice to technology by pinning its hopes on increased quality. I’ll tell you why you should purchase an EMR. Invest IF it increases your profitability. If managed properly, there is no reason it shouldn’t. Again, technology will not increase your revenue, but it should enhance your cost curve thereby increasing your overall profitability. When evaluating the NPV of the investment, do NOT include prior investments. Such as, “I don’t want to purchase a new system because I already bought this other thing that doesn’t work…”
As much of a proponent and believer in technology as I am, I will not stand here and tell you that it is a panacea. Technology is an enabler. In the right hands, technology can be a powerful ally. In the wrong hands, it can be a costly impediment. The single most important function in the operation of your BUSINESS is revenue cycle management. It is the lifeline that fuels your practice’s operations. If efficiently and effectively managed, it can make up for many other short-comings. To optimally manage your revenue cycle… and you will notice that I use the word “optimize” frequently when discussing billing, collections, and the entire revenue cycle rather than the word “maximize”… you MUST incorporate the proper balance of technology and process.
What do I mean? Well, first let me list out some of the major steps in the revenue cycle management process… Which steps require technology, process, or both? It’s absolutely possible to do everything by process… which many practices do, even those that have poorly deployed technology. The problem with process is that it is EXPENSIVE and difficult to scale. Technology, on the other hand, is great for simplifying repetitive tasks, including those with fairly static but robust algorithms or decision trees, such as claims editing rules. If you asked me which I thought were the most challenging and yet critical steps in the whole process, I would have said – Payment posting, Follow-up, and Pt. Collections. Notice that they are the only ones that I would also characterize as pure process-oriented tasks. Let me break these down a little further– first, Payment Posting is CRITICAL because it is your primary filter to ensure quality data in your PMS. If you do not have tight controls to ensure daily balancing against payment posting, then you will be performing follow-up and collections on poor data. There is nothing more frustrating, or costly. Unfortunately, there are few if any systems that manage this process effectively…. Explain separation of accounting and financial systems. Follow-up and Pt. collections on the other hand, require a great deal of human interaction, and case-by-case judgment.
I love reports. They are essential in understanding what is going on inside your business. Despite what I’ve heard from many people, I do not believe that you can intuit or feel your performance. I frequently ask physicians how their practice is doing. I can probably count on one hand the number of people who I’ve heard openly admit to having difficulty. I understand that people will not be forthcoming about information they believe is sensitive. Nevertheless, I think more people are either defensive – how else would my office be doing than great? – or more than likely, they just don’t know. How many physicians have office managers? How heavily do you rely on them to manage your business operations? What is their education, training and experience? How much do you pay them? How are they incentivized? I don’t mean to suggest that you don’t have wonderful people. There are simple economic factors at work. The complexity of running and managing your office is likely at a threshold that you cannot hire someone with all the skills needed to perform exceptionally. And, even if you are the one lucky person who has a superstar running your office, you still should be knowledgeable enough to (1) know what’s going on, and (2) step in if necessary, because superstars don’t stay put for long. The best way to manage your practice without getting bogged down in the minutia of day to day tasks is to use key reports and metrics. The challenge is which to use… My personal favorite, top-level metric is Staff : Provider ratio. This simple metric is a great proxy for Overhead : Production Capacity. Again, thinking of your practice as a factory, how good do you think this speaks for efficiency? It’s a fantastic measure of efficiency… without knowing actual performance. The average ratio, according to MGMA, for primary care is approximately 4.2 staff per provider. According to the most recent report, other specialties include: Cardiology 5.94 Orthopedic Surgery 5.54 OB/GYN 4.57 Pediatrics 4.18 I find these numbers staggering. Why? People are generally the most expensive component of your overhead. Our office, by comparison, is between 1.5 and 1.9. My preferred metric for overall revenue performance -- $ collected/encounter. It is the purest form of overall production for your practice; however, it is obviously sensitive to: Fee Schedule Payor Mix Practice patterns(?) As such, it really is most valuable for comparing your own internal period to period performance. Why? Because if you assume that your fee schedule is not changing, your payor mix is not changing, and your type of practice is not changing… then any changes are going to relate primarily to revenue cycle management processes. By comparison, if you then look at $ collected/encounter by payor, what is it telling you? The exact opposite is now true. Your internal processes, with few exceptions, should not deviate from one payer to the next. As a result, you can figure out which payers are of greatest value to you… fee schedule aside (you may very well find that high fee schedules don’t match actual collections). If you would like to normalize this information to account for variances in procedure types across different payers, you can figure out $/RVU, and then compare $/RVU by each payer. Another useful internal metric is your collection ratio… I simply look at collections : charges. As you all know, charges is really an irrelevant number. Nevertheless, because you are applying it consistently, it becomes very useful to measure and monitor your own period over period performance.
Questionable Metrics: If a metric is sensitive to interpretation or applied inconsistently, do not use it. It will only get you chasing your tail. Any metric that begs meaningless comparison. For example, you can never compare charges. Not only do different practices have different fees, different physicians within the same practice have different billing patterns that result in different collection ratios. Particular dislikes: Aging reports… if your system is not smart enough to know what the expected payment is, taking into consideration payer specific fee schedules, bundling rules, etc…, then you don’t know what your sales are… Furthermore, you don’t know who is responsible for what component of valid reimbursement… In general, these are rolling numbers. The problem is that it can lead to false conclusions about how prompt a patient is in paying their bills. …And just about any canned report… Know what the reports are telling you, where the underlying data is coming from… the reports strengths and weaknesses. I prefer simplicity. You do not have to have 50 reports to track your practice’s fundamentals.
Key Assumptions:•Maximizeprofitability• Do not want to work forever
What’s going to happen to your practice?
What’s going to happen to you?
John
Sticky Note
Just as I assume that maximizing profitability is your number one business objective, I also assume that you do not intend to work forever. While the term “exist strategy” is typically applied to private equity and venture capital investments, it is a fair description of the planning that everyone of you must do in evaluating when you are going to either retire or leave your practice, and what is going to happen to the business you built. So what is your plan, what is your “exit strategy”?
The single most important thing to understand about the long-term value of your practice is that healthcare is a cash flow business. What does that mean? When you are ready to retire, don’t expect to sell your practice for anything more than book value, or asset value. Even then, don’t expect to get full asset value. Are you telling me that my business isn’t worth anything?
Not at all. Your practice is worth all of its future stream of free cash flows… discounted and expressed in Present Value. This is the most common and the best method for calculating any company’s value – known as the Discounted Cash Flow Method, or DCF Method. Your practice is worth its DCF value… at least to YOU. A buyer will very likely only pay its asset value.
• Plan transition strategy several years in advance.
John
Sticky Note
Vs. Asset Value of $125,000. Implications: Do not expect to capture value at time of exit X% of value occurs in first 10 yrs. Retirement is paid each and every year of practice Plan transition strategy several years in advance
