Business principles for plastic surgeons

Synopsis

■
This chapter provides a broad overview of the essential principles that characterize what a business does and how a business does its work.
■
The ability to apply business concepts is of paramount importance if plastic surgeons are to become and remain leaders in healthcare.
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Plastic surgeons should understand and use strategy, accounting, finance, economics, marketing, and operations to help guide decisions about their practice.
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Innovation, entrepreneurship, and human resource management are three areas where plastic surgeons can add value to their practice and distinguish themselves from their competition.

Introduction

Make everything as simple as possible, but not simpler . Albert Einstein

Not only is healthcare business, it is big business.

The healthcare–industrial complex incorporates multiple sectors to deliver health and depends on an expanding group of interdisciplinary teams, services, and institutions to achieve this value proposition. Business sectors involved in the delivery of healthcare include not only professionals such as doctors, nurses, and administrators, but also hospitals, nursing homes, and home healthcare groups; drug manufacturers and developers; manufacturers of medical equipment and instruments; diagnostic laboratories; biomedical researchers; and biotechnological entrepreneurs.

Recent estimates from 2020 place healthcare spending at 19.7% of the United States' gross domestic product, an increase from 17.7% in 2017. For every dollar spent in the US on healthcare, 31% goes to hospital services, 21% to physicians, 10% to pharmaceuticals, 6% to nursing homes, 4% to dental services, and 28% to other categories, such as diagnostics laboratories, medical equipment, and medical devices. Of note, 7% of total spending is assigned to administrative overhead costs.

If healthcare provided by physicians is not business, then physicians are certainly surrounded by business; they must navigate a complex environment that is full of paradoxes, inefficiency, and bureaucracy. Unfortunately, physicians receive no formal education in business but must learn on the job, through mistakes and successes, often one patient and one business problem at a time. Although many critics argue that healthcare has been tainted by the intersection with big business, which places the bottom line at the top and undermines the physician–provider relationship, many other thought leaders contend that healthcare needs business, to help solve problems of inconsistent quality, rising costs, limited access to care, and disparities in outcomes. Indeed, business thinking and business processes are desperately needed to transform our current system, so that healthcare can be available to all people, at fair-market prices, to improve the health of our community.

Why should plastic surgeons care about the business of healthcare? From an individual perspective, every plastic surgeon must either run a business or be part of a business, if the surgeon’s practice is to thrive, grow, change, and continue to provide high-quality care. Whether one works for oneself, for a hospital or health maintenance organization (HMO), for an academic institution, for a non-profit or non-governmental organization (NGO), for a free community clinic, or for an overseas volunteer mission trip, plastic surgeons are involved with organizations that utilize business principles and interface with business entities.

From a broader perspective, however, plastic surgeons are uniquely situated to serve as leaders of healthcare systems and healthcare businesses. Given our extensive training, our collaboration with multiple specialties, our diverse portfolio of services that we provide, our problem-solving skills, and our entrepreneurial spirit, plastic surgeons have the leadership skills, influence, and positioning within the healthcare system to effect real change. Just as the Greek word plastikos , which means to shape or to mold, was chosen to describe what we do as surgeons, this word could also impart upon us the ability to shape or mold our systems of healthcare delivery.

The knowledge and application of business principles is of paramount importance if plastic surgeons are to become and remain leaders in healthcare. The purpose of this chapter is to provide a broad overview of the essential principles that characterize what a business does and how a business does its work. Each section offers a topical overview, and readers are strongly encouraged to explore in more depth the following components of this chapter:

1.
Strategy
2.
Accounting
3.
Finance
4.
Economics
5.
Marketing
6.
Operations
7.
Innovation
8.
Entrepreneurship
9.
Sustainable enterprise
10.
Human resource management
11.
Legal and regulatory considerations
12.
Negotiation
13.
Ethics
14.
Leadership

The end of each section will spotlight an “Idea Watch”, as a forum to present novel, emerging, and occasionally controversial topics related to business and healthcare. Featured topics will be drawn from cutting-edge articles published in the Harvard Business Review , with the goal of promoting further reflection, analysis, and inquiry by the reader.

Plastic surgeons, at the very least, must learn the language of business, to have meaningful interactions with hospital administrators, insurance carriers, salespeople, and marketing firms. Hopefully, though, plastic surgeons can utilize the principles of business to improve the care that we provide, and in the end, to transform the industry in which we practice our science, and our art.

Strategy

Long-range planning does not deal with future decisions. It deals with the future of present decisions … Significant competitive advantage lies with those organizations and individuals who anticipate well in turbulent times . Peter F. Drucker

Competitive advantage begins and ends with strategy ( Box 5.1 ). Nearly all of the components of business are affected by strategy, from finance to operations, from marketing to managing human capital, and therefore a review of business principles should commence with an understanding of how strategy guides decision-making within an organization.

Box 5.1

Idea watch: Strategy

Reference: Wade M, Joshi A, Teracino EA. Six principles to build your company’s strategic agility. Harvard Business Review , September-October, 2021. https://hbr.org/ .

Over the past few years, business leaders have been reminded of the interconnectedness and unpredictability of commerce, economies, and societies. Humanitarian disasters such as the coronavirus pandemic, the war in Ukraine, and climate change have impacted geopolitics, trade, energy, supply chains, and markets in ways not anticipated. Although many companies have succumbed to these crises, some businesses have survived and even thrived in these conditions. Agility and resilience may not only protect companies from black swan events, but may offer a strategic advantage in such times of volatility. The key to navigating these challenges and adapting to rapidly changing environments may be due to three qualities:

Staying nimble enough to avoid the worst impacts of a crisis
Remaining robust enough to absorb direct hits from an overwhelming challenge
Being resilient enough to accelerate forward, while competitors fall backward

To achieve these qualities, the authors recommend the following six principles:

1.
Prioritize speed over perfection
2.
Prioritize flexibility over planning
3.
Prioritize diversification and “efficient slack” over optimization
4.
Prioritize empowerment over hierarchy
5.
Prioritize learning over blaming
6.
Prioritize resource modularity and mobility over resource “lock-in”

These principles do not apply to all businesses in all markets but may provide a roadmap for corporate survival in turbulent times. Sometimes, perfection is the enemy of good.

Strategy can be characterized as the art of inducing your competitor to do something else, while you focus on doing what you do well. In more academic terms, strategy is the process of forming, implementing, and evaluating decisions that enable an organization to achieve its long-term goals. Strategy is dictated by (and, in turn, can influence) the organization’s mission, vision, and values, which serve as a foundation to guide policy, projects, and programs. Furthermore, strategy is about competing on differentiation – creating a value proposition – in which a firm provides the consumer with a product or service of greater quality or at less cost than its competitor, deliberately choosing a different set of activities to deliver a unique mix of outputs.

Before examining specific strategic principles, one should become familiar with how the business environment affects the flow of inputs to outputs, along the supply chain . Because value is added at various points along this process, the entire axis, from supplier to consumer, is called the value chain . Primary activities of the company, which include inbound logistics, operations, outbound logistics, marketing and sales, and ultimately customer service, each create value that manifests in the final product; these processes are guided by strategic priorities and are coordinated by support activities that include technological development, human resource management, and firm infrastructure.

The most established and respected model of the business environment is Michael Porter’s 5-Forces model of competition ( Fig. 5.1 ). Each industry contains: (1) previously established competitors; (2) the potential for new entrants; (3) the threat of substitute rivals, who often compete on price; (4) suppliers, who can have significant bargaining power; and (5) buyers, who create demand for the outputs. Understanding the environment of a specific industry, such as healthcare, can strengthen decision-making and help with strategic planning. For example, how should an academic plastic surgery practice respond to the influx of recently graduated residents into the community? How should the solo private practitioner attract new patients in a fixed market, when a group practice dominates the landscape? How should surgeons challenge scope of practice with non-surgeon physicians and non-physician providers? What is the optimal portfolio of services, specifically the mix of reconstructive surgery, cosmetic procedures, and skin care, to achieve the goals of the organization?

Figure 5.1, Strategy: Porter's 5-Forces model of competition. HMOs, Health maintenance organizations; PPOs, preferred provider organizations.

Once the dynamics and landscape of the business environment are defined, specific decisions can be made regarding change in operations, marketing, investment in new assets, alliances, or supply chain. Most mature industries, such as the automotive industry or the personal computer industry, settle into a competitive scenario in which one firm dominates with 60% market share, while a second firm contains 30% of the market share, and the remaining competitors occupy 10%. Because of barriers to entry, new entrants may not be able to successfully compete, unless disruptive technology lowers production costs or the market shifts, due to cultural, social, economic, or political forces. In fact, significant competitive advantage is conferred to small, nimble firms that focus their product line or services and offer a unique selling proposition, to a targeted segment of the market. When executed correctly, this activity, termed “ judo strategy ”, has the power to undermine dominant businesses and increase market share substantially.

A major limitation of competitive strategy is that most efforts deal with gaining a larger portion of a fixed market or attracting new customers via the “rising tide” of a slowly growing market. If companies in search of sustained, profitable growth compete with multiple rivals, then differentiation becomes difficult, price wars may ensue, and the total profit pool shrinks. Instead, companies may pursue a “ blue ocean strategy ”, in which uncontested but related market space is discovered, rendering rivals obsolete and generating new demand. Previous “settlers” will “migrate” to this new market space and become “pioneers”. Apple has done this over and over with the personal computer market, introducing new devices that expand the functionality of their operating system and hardware, evidenced by the transition from desktop to laptop to iPhone to iPad.

True value innovation comes when a company jumps out of its industry and creates an entirely new market, often in a different industry. This foray into uncharted territory, which is referred to as “white space”, typically occurs when a company develops a disruptive technology that permits the use of core competencies to produce a radically different product or service. Apple was successful in capturing the dominant position in the digital music market by designing and offering iTunes, despite being a computer company. Inherent to this success was the fact that Apple also changed the business model for purchasing music; consumers could buy singles or albums, listen to samples, and of course, use the website for free. As the music industry shifts again, from purchasing content to subscription services as a major revenue model, Apple is determined to remain the dominant player. The acquisition of the Beats music platform will allow Apple to compete with Pandora and Spotify, but also serve to stream video content for gaming and on-demand viewing of television and film.

In summary, strategy involves the following steps:

1.
Industry analysis – assess industry profitability today and tomorrow.
2.
Positioning – identify sources of competitive advantage.
3.
Competitor analysis – study current competitors, future entrants, and substitutes.
4.
Assessment of current strategy – predict effectiveness and sustainability.
5.
Option generation – search for new customers, new segments, new markets.
6.
Development of capabilities – planning now for future opportunities.
7.
Refining strategy – assess uniqueness, trade-offs, compatibility with vision and values.

Accounting

Nowadays, people know the price of everything and the value of nothing . Oscar Wilde

Business management must be based upon a common language that is used to objectively communicate information related to the quantitative metrics of an organization. That language is accounting ( Box 5.2 ). This section will review the tools that accountants use to assess the financial health of a business: income statement , balance sheet , summary of cash flows , and financial ratios . The nuances of accounting are beyond the scope of this overview, but healthcare providers must have a basic comprehension of these instruments and how they represent the financial standing of their practice, their hospital, and their healthcare system. Furthermore, these instruments are used in budgeting to construct pro forma predictions of future performance.

Box 5.2

Idea watch: Accounting

Reference: Gallo A. Contribution margin: What it is, how to calculate it, and why you need it. Harvard Business Review , September-October, 2017. https://hbr.org .

Although hospitals and healthcare systems typically cite profit margin and operating income as some of the most important indicators of the financial viability of the organization, contribution margin provides more granular information about value created by products or services. Amy Gallo reminds us that contribution margin allows analysts to determine the profitability of a specific product or service, independent of overhead and fixed costs (real estate, debt repayment, administrators’ salaries, marketing), which are often allocated incorrectly, based on faulty assumptions, and subject to manipulation.

Contribution margin, defined as revenue less variable costs, permits us to compare different products or service lines within a portfolio of offerings. As long as a product or service has a positive contribution margin, and the system is not at capacity, that product or service brings value to the enterprise, which can be used to pay down operating expenses. When the system is at capacity, then the product or service with the highest contribution margin creates the most value.

For surgical procedures, ranging from abdominal wall reconstruction to facial rejuvenation, contribution margin can be significantly affected by the cost of the materials used, as well as direct variable overhead from capital equipment and labor. If procedures have a negative contribution margin, then the institution faces three choices: (1) improve efficiency and decrease costs to obtain a positive contribution margin, (2) eliminate the procedure, or (3) continue the procedure as a mission-critical “loss leader”. Procedures with positive contribution margins can be ranked according to importance and prioritized based on the financial needs of the institution and clinical needs of the patients.

The field of accounting is governed by generally accepted accounting principles, also known as GAAP , which are rules used to prepare, present, and report financial statements for various entities, such as non-profit organizations, publicly-traded companies, and privately-held firms. Although the government does not set these standards, the US Securities and Exchange Commission does require that public firms follow these rules. Managerial accounting, which is used to allocate cost and assign overhead, does not follow GAAP and is dependent upon institutional culture and practice.

Income statement

The income statement, also known as the profit/loss statement, describes financial transactions within a defined period of time, which may be quarterly or annually. Revenue refers to the gross income that a company receives from normal business activities, typically the sales of goods or services, but may also include rent, dividends, or royalties. In accrual accounting, revenue occurs at the time of the transaction, not when receipts are collected. Net income is expressed as a profit or loss, after deducting expenses, which usually include operating expenses (cost of goods sold, variable overhead expenses), depreciation of assets and amortization of leases, fixed overhead (selling and administrative expenses, research and development), interest expenses, and taxes.

\begin{matrix} Revenue \\ \underline{less Operating costs} \\ = Gross profit \\ less Fixed overhead \\ \underline{less Depreciation (assets) and amortization (leases)} \\ = Operating income (E B I T) \\ \underline{less Interest expenses} \\ = Pre - tax income \\ \underline{less Income taxes} \\ = Netincome \end{matrix}

$\begin{matrix} Revenue \\ \underline{less Operating costs} \\ = Gross profit \\ less Fixed overhead \\ \underline{less Depreciation (assets) and amortization (leases)} \\ = Operating income (E B I T) \\ \underline{less Interest expenses} \\ = Pre - tax income \\ \underline{less Income taxes} \\ = Netincome \end{matrix}$

Balance sheet

The balance sheet is a snapshot of what the company owns and owes, at a single point in time. On one hand, the balance sheet summarizes the cumulative impact of all transactions, but the balance sheet does not provide much useful information on the operational performance of the firm. The net worth of the company, referred to as owner’s equity, is defined as the difference between the assets and the liabilities.

Equity = Assets - Liabilities

$Equity = Assets - Liabilities$

However, balance sheets usually frame this relationship slightly differently, but again, the following equation must always balance:

\begin{matrix} Assets = Liabilities + Equity \\ or \\ Assets = Debt + Equity \end{matrix}

$\begin{matrix} Assets = Liabilities + Equity \\ or \\ Assets = Debt + Equity \end{matrix}$

The actual worth of a company, the equity, is difficult to ascertain, but one method to calculate value is market capitalization, which is (share price) × (shares outstanding); this represents the public consensus of the value of the firm’s equity.

Assets are defined as resources with probable future economic benefit, obtained or controlled by the entity, as a result of past transactions, that are expected to contribute to positive net cash flows. Examples of assets include cash and cash equivalents (pre-paid expenses, bonds, stock), accounts receivable (the money that is owed but has not been collected), inventory (raw materials, work-in-process, and finished goods), property/plant/equipment (purchase price less depreciation), goodwill (intangible value of brand), and intellectual property.

Liabilities refer to what a company owes, or from a different perspective, how the assets were obtained. Liabilities include short-term loans (credit lines) current portion of long-term debt, accounts payable (the money a company owes its vendors), and long-term debt.

Owners' equity – the difference between assets and liabilities – can be allocated into several categories: preferred shares (which usually receive periodic dividends), common stock, and retained earnings (accumulated earnings that have been reinvested into the business, instead of being distributed as dividends).

Summary of cash flows

An assessment of a company’s cash flows is critical in determining the financial viability of the firm, because profit is NOT the same as cash. This disconnect is due to multiple reasons: (1) cash may be coming in from investors or loans; (2) revenue is booked at time of sale, not collection; (3) expenses are matched to revenue, not when they are actually paid; and (4) capital expenditures do not count against profit (because only the depreciation is charged against revenue) but require cash or debt to pay for the assets. As a result of this discrepancy between when a good or service is provided and when cash is exchanged, following the flow of cash can be very complicated. Fortunately, we have accountants. For mature, stable, and well-managed companies, cash flow does approximate net profit. But for younger, growing, and poorly managed companies, profit can occur without gaining cash (resulting in bankruptcy, because bills cannot be paid) or cash can accrue without being profitable (which bodes poorly for long-term success, if expenses cannot be controlled).

Overall cash flows are further subdivided into three categories – operations, investing, and financing – based upon the conduit for the flow. Cash flows from operating activities (CFO) indicate how much cash was generated from operations: selling goods and services. Cash flows from investing activities (CFI) indicate how much cash the company spent (or received) from buying and selling businesses, property, plant, and equipment. Finally, cash flows from financing activities (CFF) indicate how much cash the firm borrowed, received from selling stock, or used to pay down debt or repurchase stock.

Total cash flow represents the true flow of money through a firm and is a composite of the operations, investing, and financing, represented by the following equation:

Total cash flow = CFO + CFI + CFF

$Total cash flow = CFO + CFI + CFF$

Many financial analysts believe that total cash flow myopically focuses on earnings while ignoring “real” cash that a firm generates and retains for future investments. Therefore, another measure of the ability of a firm to create value is free cash flow (FCF), which is defined numerically as:

\begin{matrix} Free cash flow = CFO - capital expenditures \\ or alternatively: \\ Free cash flow = net income + amortization + depreciation - \\ change in working capital - capital expenditures \end{matrix}

$\begin{matrix} Free cash flow = CFO - capital expenditures \\ or alternatively: \\ Free cash flow = net income + amortization + depreciation - \\ change in working capital - capital expenditures \end{matrix}$

In other words, free cash flow represents the total cash that a company is able to generate after laying out the funds required to maintain or grow its asset base. FCF is very important to investors because this allows a firm to pursue opportunities that increase shareholder value. This is the best source of capital for development of new products and services, acquiring new companies, paying stock dividends, and reducing debt. Cash really is king, and this is why.

Financial ratios

Because companies even within a single industry can vary in size and maturity, such instruments as the income statement, balance sheet, and summary of cash flows may not permit a valid comparison of those companies. Instead, financial ratios – the numerical relationship between two categories – can provide powerful insight into the financial health of a company. Jonathan Swift observed that “vision is the art of seeing what is invisible to others,” and financial ratios provide that vision.

Four types of ratios help managers and stakeholders analyze a company’s performance: profitability, leverage, liquidity, and efficiency. These ratios can be used to follow the performance of a firm over time or to compare several firms across related industries.

Profitability ratios

\begin{matrix} Gross margin = gross profit / revenue \\ Operating margin = operating profit / revenue \\ Net margin = net profit / revenue \end{matrix}

$\begin{matrix} Gross margin = gross profit / revenue \\ Operating margin = operating profit / revenue \\ Net margin = net profit / revenue \end{matrix}$

\begin{matrix} Return on assets = net profit / total assets \\ = (net income / revenue) \times (revenue / assets) \end{matrix}

$\begin{matrix} Return on assets = net profit / total assets \\ = (net income / revenue) \times (revenue / assets) \end{matrix}$

Return on equity = net profit / shareholders' equity

$Return on equity = net profit / shareholders' equity$

\begin{matrix} Contribution margin = revenue - variable direct costs \\ (technically not a ratio, but \\ loved by CFOs everywhere) \end{matrix}

$\begin{matrix} Contribution margin = revenue - variable direct costs \\ (technically not a ratio, but \\ loved by CFOs everywhere) \end{matrix}$

Leverage ratios

$\begin{matrix} Debt-to-equity ratio = total liabilities / shareholders' equity \\ Interest coverage = operating profit / annual interest charged \end{matrix}$ $\begin{matrix} Debt-to-equity ratio = total liabilities / shareholders' equity \\ Interest coverage = operating profit / annual interest charged \end{matrix}$

Liquidity ratios

\begin{matrix} Current ratio = current assets / current liabilities \\ Quick ratio = (current assets - inventory) / current liabilities \end{matrix}

$\begin{matrix} Current ratio = current assets / current liabilities \\ Quick ratio = (current assets - inventory) / current liabilities \end{matrix}$

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