Dental Support Organizations

UCL Letter #4 - March 22, 2020

Mar 22, 2020

Welcome to the fourth letter of Undirected Cyclic Thoughts. I previously wrote that my goal is to bang out one letter each week and on the fourth week… well, I’m no longer doing that. Writing (clearly) isn’t a high enough priority for me to sustain that. The main reason I write is to organize my thoughts around a topic I want to explore. I think the better way to achieve that is through less frequent, more thoughtful posts.

In any case, the topic this week is Dental Support Organizations, or DSOs. And, apologies for the healthcare theme this newsletter is taking on - it may go on for a while, but I promise not to talk about COVID. There’s enough of that going on.

Taking care of business

Think of a dentist, or a doctor, or any licensed professional. Now try to imagine what their normal day looks like. You’ll probably focus a lot on like, cleaning teeth, or taking a patients blood pressure, or installing light fixtures or whatever electricians do. Now, if I asked you to think a bit deeper, you’d realize that they have to deal with some amount of paperwork (especially in healthcare) and some amount of billing. Then, if I asked you to go further down that road, you’d probably realize that there’s a lot of “admin” work for licensed professionals, especially those who own their own practice or business. There’s a lot of work required to take care of business.

Unsurprisingly, these activities take a lot of time and your typical dentist did not slave away for years in school and residency programs to be dealing with accountants and suppliers and attorneys. (I guess they slaved away to hear you lie about your flossing habits?)

Wait, that’s annoying…

Dentists agree!!! In fact, a recent study by the Levin Group found that 95% of dentists DO NOT ENJOY these aspects of running a practice.

As history has it, a few dentists started realizing this many decades before the Levin Group survey. They realized that a lot of their time was spent negotiating with suppliers, hiring and firing the people behind the front desk, their dental hygienists and their dental assistants, filing claims for insurance, processing payroll, yada yada yada. For consistency’s sake, let’s call these business support activities.

And after they came to this first epiphany, they had a second one shortly thereafter. They found that not only do they spend a lot of their time on these business support activities, but also that these activities were more or less the same practice-to-practice. With some minor per-provider discrepancies (e.g. would this hire be a good fit culturally?), what success looks like is pretty much the same across all practices. Success at processing payroll or filing insurance paperwork isn’t some secret sauce that’s practice-specific.

So what did they do? They banded together and created a company. A company of the dentists, by the dentists and for the dentists… or something of the sort. The idea was that this company could handle all of these business support activities for those dentists. It would not only be able to be more efficient by sharing learnings across providers but it would also gain some economies of scale when negotiating leases, reimbursement rates with insurers, or discounts for supplies.

This was the initial form of what would be called a dental support organization (DSO). It was pure and natural and good.

It also made economic sense! If you look at rent, suppliers, advertising, etc, they add up to a double digit percentage of gross billings. Being able to optimize any one of these functions could make a meaningful impact to the bottom line.

Are dentists really the best people to be running this?

Well, if on the first day God introduced a dentist-owned DSO, on the second day he introduced Private Equity-owned DSO.

After the first dentist-owned DSOs came about in the 70s, it wasn’t long before they caught the attention of private investors. Each DSO was relatively small and would be owned by and serve a few practices in a town or region. But the functions of these DSOs were all more or less the same.

The private investors looked at all these small, dentist-owned DSOs and thought, hey, why not consolidate all of these into one big DSO. Instead of serving a handful of dentists, this one big DSO could serve dozens or hundreds of dentists. Instead of getting some small amount of economies of scale, the one big DSO could get a large amount of economies of scale.

This is how the the investor-owned DSO was born. And on that day of birth, the incentives were invariably changed. Rather than being a corporation wholly owned by dentists, where the financial interests of the practice and the service group were nearly one-and-the-same, the financial interests of the service group was separate from those of the practice.

And, the structure and functions of a DSO started to change:

Rather than helping dentists negotiate purchasing equipment, the DSO would buy the machines themselves and lease them to the practice.
Rather than helping negotiate leases, the DSO would buy the property and lease it back to the dentist.
Rather than helping with the hiring of administrative staff for the practice, the administrative staff would work for the DSO.
Rather than helping with marketing and advertising for the practice, the DSO would have practices convert to using its brand.
Rather than being one of a few service providers for a practice, the DSO would require 20 to 40-year exclusivity clauses in their business services agreements.

Soon, DSOs’ affiliation with practices became murky. Some DSOs were “acquiring” practices, for all intents and purposes. Others took Paul Graham’s advice to heart:

Paul Graham @paulg

If your technology is better but potential customers are too set in their ways to switch, use it yourself and compete with them.

And these DSOs began to open de novo practices that were funded and serviced exclusively by them. It wasn’t long until regulators started asking some tough questions.

One second: Who owns whom?

It became increasingly unclear whether DSOs were truly “support” organizations. Were they there to assist a dental practice with administrative and management work? Or were they a PE-funded wolf in sheep’s clothing?

The context for these questions, or why they would matter to a regulator, is found in the ban on the practice of “corporate dentistry.” It originated from a court case in the 40s, U.S. vs American Med. Ass’n, which held the following:

Where a corporation operates a clinic or hospital, employs licensed physicians and surgeons to treat patients, and itself receives the fee, the corporation is unlawfully engaged in the practice of medicine. This is true because it has been universally held that a corporation as such lacks the qualifications necessary for a license, and without a license, its activities become illegal.

Practically, this means that a non-dentist corporation cannot receive fees for the rendering of dental services that are in the scope of a licensed dentist. The goal of this ban is to prevent a focus of “quantity of care over quality of care.”

In the abstract, there are two forms of corporations: a business corporation (an LLC or C-corp) for the DSO and a professional corporation (a PC or PLLC) for the dentist. As the regulators would have it, the professional corporation is owned by a dentist, it owns all of the patient records, and it is free to exercise control over all clinical decisions. If this professional corporation chooses to partner with a DSO to have services rendered, they would do so through a business services agreement. In theory, this agreement would compensate the DSO for services provided while allowing the PC to maintain clinical autonomy.

In the context of DSOs, there are two cases when this setup looks concerning. For existing practices that partner with the DSO, the business services agreements may call into question the ability of the dentist be in full control of clinical decisions. For de novo practices that are opened by the DSO, the professional corporations (PCs) are only nominally owned by dentists calling into question if a true PC really exists.

A case brought against Aspen Dental by the New York Attorney General puts the business service agreements and corresponding autonomy of the provider under a microscope. Here’s the AG’s big takeaway:

Rather, ADMI has facilitated the development of dental practices owned by individual dentists, but which, in violation of New York law: (a) are subject to extensive involvement of ADMI, (b) share profits with ADMI, and which (c) are marketed under the “Aspen Dental” trade name creating an impression of common ownership, treatment goals and philosophies, policies and procedures, and standards of care

Their findings included that the DSO was…

Incentivizing staff to increase sales of dental services and products
Implementing revenue-oriented patient scheduling systems
Hiring and overseeing clinical staff
Accepting patient and insurance payments in a single consolidated account to which the practice owners did not have access
Requiring that the dentist purchase ALL of their prostheses from them
Binding dentists by a non-compete and non-solicit that prevents them from owning dental practices that are competitive with ANY OTHER practice affiliated with the DSO
Training clinical staff on how to increase their offices’ revenue through dental care
Creating policies and guidance documents used in operation of clinic
Awarding bonuses to office managers (who were employed by the DSO) based on the practice’s gross profits
Implementing performance bonuses for dental hygienists without formal approval from practice owners
Assessing fees that in-effect are an agreed upon percentage of each office’s gross profits (45-50%)

With increased scrutiny from regulators, DSOs are now forced to become more creative with their legal arrangements with affiliated practices. But Private Equity never let regulation slow it down too much, especially when it has a nominal cause it’s fighting for.

Enter Obamacare

There are a number of drivers of DSO growth over the past decade. Some are market dynamics that make sense:

Rising student-debt makes the setup costs of starting your own practice daunting
Aging dental population leaves more dentists looking for exit opportunities
An increasing share of female dentists makes work-life-balance a larger concern

But one big driver has been the Affordable Care Act. The ACA increased enrollment in state Medicaid programs, especially for adult population, and has the potential to lower the number of children without dental benefits by 55%. The fact that benefits vary by state makes having a partner responsible for navigating the changing policy landscape useful. Hence, the boom in DSO affiliation since the ACA was passed.

Outside of being on top of maximizing reimbursements, DSOs are obviously ideal for optimizing expenses. This makes serving lower income populations economically feasible - a differentiator that lobbyists for DSOs will be sure let you know about.

The numbers are showing this to be true. A policy brief from 2012 estimated that over 20% of dental services to children in Medicaid were provided by DSO-supported dentists. Moreover, a study performed by Laffer Associates in Texas found that dentists associated with DSOs performed fewer procedures per patient than those not affiliated with DSOs. They also found a lower cost per patient per year ($350-480 vs. $700) for those treated by DSO-affiliated dentists vs those treated by dentists not affiliated with DSOs.

Clearly, the opportunity for DSO-affiliated dentists to provide care to underserved populations is not to be scoffed at, but that doesn’t absolve the industry of facing up to the charges of corporate dentistry. In an ideal world, economies of scale are leveraged while a dentist maintains autonomy over clinical decision making. Whether this is possible remains up for debate.

Where to next?

Outside of the ACA, the market dynamics listed above show no sign of letting up any time soon, pointing towards continued growth of DSOs. Moreover, most DSOs that have faced regulatory investigations have gotten off without much more than a slap on the wrist. This leads me to believe that aggressive business service agreements will continue to be the norm and the ownership and autonomy of practices will remain murky. However, it’s important to remember that the overall % of dentists affiliated with DSOs is still in the single digits. So, what’s going to happen in the next decade? Here are some spitballs:

First, I think that most dentists will not want to sell their practice and work for a large corporate. What does that mean? It means there’s probably room to build out DSOs that have the scale of PE-backed giants like Aspen Dental but leave the autonomy over finances and clinical decisions in the hands of the practice owner.

Second, consolidation is a very dominant force. I believe that there will be more and more consolidation of small- and medium-size DSOs. If the pitch to dentists is allowing them to run a more profitable operation, it’ll be hard to compete against DSOs with a large economy of scale in their back-office.

Third, the winning DSOs will have a very proactive approach towards technology. From payroll to marketing to patient financing, software is eating everything and even the biggest DSOs are still a decade or so behind Silicon Valley. I think technology will be a differentiator in both the service that can be delivered to providers and patients as well as the profit margin and scalability of DSOs.

Food for thought

One thing that I couldn’t get out of my mind is the lack of analogous plays in other industries. I think there are a few factors at play for an industry to see a rise in support organizations:

Non-trivial regulatory or licensing burden (e.g. for dental/medical, insurance complicates back-office)
Relatively high-volume of transactions (e.g. code for high use of backend services)
High upfront costs required to get started (e.g. normally $500K-1M to set up a dental practice)
Large number of small providers

That being said, while SV hopes to automate lots of front- and back-office tasks with software, I wouldn’t be surprised if we see Wall Street start to make similar plays in other industries (e.g. construction, transportation, etc). Even if you have a bunch of slick tech at your disposal, you still need someone to help craft the right basket of tools and hire a team to use them.

Sources:

Undirected Cyclic Thoughts