Hospital, Heal Thyself

By Figliuolo, Michael L.; Mango, Paul D. et al. | The McKinsey Quarterly, Winter 2000 | Go to article overview

Hospital, Heal Thyself


Figliuolo, Michael L., Mango, Paul D., McCormick, David H., The McKinsey Quarterly


The authors thank Martin Barkman, a McKinsey alumnus, for his contribution to this article.

Hospitals bought up the practices of primary-care physicians to gain additional patient referrals, but instead they transformed those physicians from entrepreneurs into salaried, complacent bureaucrats. The damage can't easily be undone, but it can be mitigated in the present and avoided in the future.

Seeking a profitable and steady source of patient referrals, in the early 199 Os US hospitals and hospital systems began hungrily acquiring primary-care physician practices (Exhibit 1, on the next spread). [1] By 1998, they owned roughly 10 percent of such practices, yet this strategy has done little, if anything, to increase their supply of patients. Moreover, proprietary primary-care practices have become a drain on their parent hospitals, which in 1998 lost a net average of roughly $80,000 per physician from them. [2] That adds up to more than $1 billion in losses, roughly 30 percent of the net revenue these doctors generated.

Such deals are not easily undone. But by thoughtfully applying two practical ideas from the world of marketing--segmentation and sound channel management--hospitals can increase the number of patients referred to them and turn this channel into a source of competitive advantage. [3]

A postmortem

Hospitals failed to improve their economic performance through the ownership of primary-care physician practices for several reasons. In the first place, most of the hospitals overestimated the ability of affiliated physicians to change their referral patterns. In a recent study of a large system-owned network of primary-care practices, for example, we found that even several years after the network had been acquired, referrals to it had actually increased by less than 10 percent. In absolute terms, fewer than half of the patients seen by the system's primary-care physicians received follow-up care from affiliated specialists or hospitals.

About 75 of 100 physicians in recently acquired primary-care practices told us that there were four main barriers to changing their referral patterns. Often, neither the doctors nor their patients were familiar with the affiliated specialists. Patients were unwilling to travel unusually long distances to see them. Payor incentives or policies sometimes encouraged primary-care physicians to refer patients to unaffiliated hospitals and physicians. And affiliated hospitals suffered from shortages of critical technologies (such as CAT scanners) or surgical facilities, thus causing excessively long waits for patients and physicians alike.

The second reason hospital systems could not improve their economic performance by purchasing practices of primary-care physicians was their new mode of compensation. Traditionally, primary-care physicians ran their own businesses and were paid for each patient they saw. Because every dollar they saved went straight into their own bank accounts, they had every incentive to keep their support staffs lean, to control other expenses, and to monitor billings and reimbursements closely. But hospitals encouraged primary-care physicians to join hospital systems by offering lump-sum payments over and above the value of the assets of the practices. The hospitals then put the physicians on salary. Assured of a certain income regardless of performance, the physicians' productivity declined by 15 to 20 percent in the two years after acquisition.

Finally, hospitals tended to overestimate the value of direct referrals from primary-care physicians into hospital systems--referrals that actually generate relatively little income (Exhibit 2). More than three-quarters of an average hospital's net income is derived from referrals by specialists. Specialists refer not only more patients than primary-care physicians do but also patients requiring more elaborate care--thus generating higher hospital bills and, potentially, more profit. …

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