This case has two main purposes. First, it offers students an opportunity to ponder and resolve the issues involved in designing a performance measurement and incentive compensation system for highly skilled professionals, in this case, doctors. Second, it stimulates students to carefully consider the links between an organization’s mission, goals, and its incentive system. The goal of this medical group is not just maximization of owner value. The organization also aims to achieve patient service and doctor training goals. There are conflicts inherent in this complex set of goals.
Suggested Assignment Questions
1. What purposes are served by the FCS physician compensation system? Must some of the doctors’ compensation be made performance dependent?
2. Is the current system an improvement over the QIIP that it replaced? Explain why, listing the major strengths and weaknesses of both plans.
3. Are the incentives provided by the existing system “balanced” or are some forms of initiative rewarded more generously than others? In particular, compare the average reward for seeing additional patients during regular sessions to that for seeing additional patients during “extra” Saturday sessions. How might the existing system affect FCS physicians’ allocation of effort?
4. What are the major constraints on the design of any physician compensation system for FCS? In particular, how should FCS decide the appropriate reward, if any, for higher performance?
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructor’s Manual
5. What changes to the FCS physician compensation system, if any, would you recommend to Dr. Samaniego?
Case Analysis
1. What are the goals of FCS?
a. Make money.
b. Provide quality care to patients in an underserved community, many of whom are covered by the government’s Medicare and Medicaid plans, which provide more limited coverage than private insurance plans.
c. Train young doctors through a residency program at White Memorial Hospital. d. Provide a desirable workplace for the medical practitioners.
All of these goals are important, but to some extent they conflict.
It is important to highlight the fact that the goal is not maximization of profit (value). Finances are important because they help to attract and retain good doctors, and they provide an operating safety cushion. But finances are a constraint rather than a primary goal.
To highlight the trade-off, ask the students which type of patient FCS would rather have: a. One from outside the neighborhood, who has a premium private health care insurance
plan; or,
b. One from the neighborhood on Medicare (funded by the US federal government), which pays at rates 30% lower than the private plan. (To make the point more explicitly, the instructor could change the example to a Medi-Cal patient. Medi-Cal, the health insurance plan funded by the State of California for indigent patients, pays on the order of 70% less than private plans).
Serving the second patient is more consistent with FCS’s mission, but serving some of the first type of patient helps pay the bills. Ideally, the practice will have a mix of patients.
2. The old plan (QIIP)
Clarify the key elements of this plan, including the points allocated to specific areas of performance and the payout potentials (20–25% of total compensation, which is the same as 25–33% of base salary).
Points to raise or to let emerge in this discussion:
a. The plan is quite subjective. Only the “meetings” measure can be captured objectively. The other items must be judged subjectively.
b. Any weight assigned to clinical efficiency or total clinical hours was limited to a portion of the 35% allocated to the Site Medical Director’s evaluation. There was little provision for individual physicians to pursue higher total compensation in return for greater effort or greater commitment of hours other than through moonlighting outside of FCS.
c. Patient satisfaction depends as much on the performance of the clinic as that of the doctor. Studies have shown that patients are generally unable to judge the quality of care they are receiving.
d. This plan does provide guidance to the doctors as to what is expected. e. Are the weightings of the various factors set properly?
3. The new plan
Points to raise:
a. Doctors can work weekends if they want.
b. They get pay for being on call (first and second call).
c. Productivity incentive (target = 14 patients per half-day session). d. No bonus if only teaching duties.
Issues:
a. Why is the target set at 14? Doctors can still earn a bonus if they see fewer patients than target, but nothing for seeing more than 14. (Exhibits 5 and 6; see also below for detailed calculations).
b. The productivity bonus appears not to be working (Exhibit 5). Only one doctor has met the target. Moreover, the number of patients that can be seen in any given time frame varies significantly by specialty.
4. What purposes are intended to be served by each of the FCS compensation plans?
A. Generically
Incentive compensation systems can be designed with some or all of the following purposes in mind:
a. Motivation, which includes two elements: i. Direction
ii. Effort b. Wealth sharing:
i. Signals that “we’re all in this together.” Can lead to social/cultural control.
ii. Makes cash flows and profits more variable with performance. When performance is down, so are cash outflows and expenses.
c. Tax efficiency: increase participants’ after-tax income. d. Attraction and retention of valuable personnel.
e. Perceptions of fairness, which can increase morale and motivation. f. Save cash (e.g., use of stock options).
g. Retain top management power (e.g., through the heavy use of subjectivity).
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructor’s Manual
B. The old (QIIP) plan
The old plan was aimed primarily at motivation—informing the doctors about what was expected of them and rewarding them for doing what was expected. But it seemed not to provide incentives necessary to attract and retain staff. In the Los Angeles area, Kaiser was the largest employer of doctors and tended to set the market for pay. Kaiser offered doctors significantly more money than FCS. The case says the differential is about 20%. Instructors can assume that the base salary at FCS was $140,000, while at Kaiser it was $168,000. An interesting point of discussion that energizes many students is regarding the issue as to whether doctors are motivated by money. There is evidence in the case that they are. Doctors gravitate toward the higher paying specialties; they often have large student loans they need to pay off; and they are leaving FCS to work at places like Kaiser, which pay more money.9
Would any doctor be willing to work at FCS for less money? The answer to this question is yes. They might be attracted to the FCS mission. They could value serving the community. They could value the teaching mission, which is noble (intrinsic) and provides more work variety and flexibility. Places like Kaiser are medical “factories” where the doctors just see one patient after another. But the concern for FCS is that they might only be able to attract less qualified doctors, those who would not be hired at Kaiser.
C. The new plan
The new plan was designed, first and foremost, to help improve FCS’s ability to attract and retain good doctors. It provided the doctors with opportunities to earn more money. Doctors can earn more money by working more hours or by working more productively (seeing more patients per session). The plan also provides the benefit of allowing doctors who want to earn more to reduce the burden of other doctors who wish to work fewer hours.
Some students will rightly be concerned that clinical efficiency of individual physicians is not independent of the quality of care delivered. As noted in the case, some patient encounters are more complex and time consuming than others. Thus, the objective must be to motivate achievement of an optimal level of efficiency, which the structure of the current plan suggests should be 13–14 patients per 3.5 hour session, or roughly 15 minutes per patient encounter.
There are two primary quality control mechanisms in place that are not explicitly included in the incentive compensation system. One is the Hippocratic Oath that doctors take to serve their patients. They want to serve their patients well and be perceived as good doctors. The other is the peer reviews of files. Regarding these reviews, Dr. Samaniego said: “We don’t need to provide incentives based on the provision of quality care. We are all highly motivated to provide quality care.”
5. Evaluation
The current system is arguably superior to the QIIP on nearly every one of the objectives developed in the prior analysis. However, the current system may not be the best system for achieving the objectives. The most obvious feature of the current system is that it focuses almost exclusively on patient volume, whether through clinical efficiency or total scheduled hours. In this sense it is clearly unbalanced. Yet, as discussed in the case, few other practical measures are
9 A short article that briefly discusses these “tensions” can be found in Van der Stede, Wim A. (2007). "The Pitfalls of Pay-for-
Performance". Finance & Management, 150, pp. 10–13.
available to provide a basis for a more balanced system. Further, the other dimensions of physician production, (e.g., education, patient satisfaction, quality of care) have difficult to quantify direct impacts, if any, on Group revenue.
Nonetheless, the current system is imbalanced even with respect to the narrow dimension on which it does focus. This can be seen by considering the financial incentive for clinical efficiency with the incentive to take extra shifts on dollars per patient encounter. The strongest per patient encounter incentive for clinical efficiency is that for increasing the average encounters per session from 12 to 13. If eight sessions per month is considered the full-time clinical load, a physician must see roughly an additional 31 patients per month (= 1 patient per session 8 sessions per week 46 weeks /12 months) in order to qualify for the $500 per month incremental bonus, or about $16 per encounter. Note that the incentive for increasing efficiency from 11 to 12 or from 13 to 14 per session is half this amount and zero otherwise. By contrast, Saturday sessions above the minimum number are compensated at the market rate of approximately $500 per shift. Even at maximum efficiency, on a per encounter basis this comes to more than $35 per patient. Further, this additional pay is essentially guaranteed, whereas the bonus for increasing average patients per session is merely expected. Progress toward the goal early in the month can be mitigated by a slow session late in the month. Likewise, a slow session early in the month could impair the power of the incentive for the rest of the month. Clearly the existing system can be improved.
In order to attempt to optimize the system we must first consider the constraints on any possible changes. The overriding constraint is what can be achieved through incentives. Only effort and the allocation of effort can be directly affected by incentives. Particularly for highly skilled knowledge workers, effort is only one factor contributing to productivity. Ability, skill, and experience are important factors unaffected by incentives. In settings where intrinsic motivation is already high, the amount of additional effort that can be induced by incentives may be limited. In extreme cases extrinsic incentives and intrinsic motivation can act as substitutes rather than complements such that relatively weak extrinsic incentives, especially monetary incentives, may actually reduce rather than increase effort. This is called the “crowding out” effect of incentives.10 Consequently, any incentive-based compensation must be directed toward those aspects of production conducive to additional effort.
The second major constraint is the Group’s requirement to maintain generally positive net margins. That is, FCS cannot afford to pay more for an additional unit of output, however defined, than that additional unit of output provides in contribution. In practice, the contribution provided by any additional unit of output can only be estimated. In most cases for FCS, the additional contribution is likely to be zero. Education, administration and most services provided to manage care patients produce no direct contribution. However, market rates for moonlighting physicians provide a reasonable estimate of the upper bound for the marginal patient encounter. In order to support the stated market rate of $500 per shift given productivity of 12–13 patients per shift, the upper bound can be no higher than $38–$42 per additional encounter. Considering the large percentage of Medi-Cal and managed care patients in the FCS patient mix, these market rates should be reduced by 35% or more. Not surprisingly, this yields a figure consistent with the level of per patient incentive provided for additional Saturday sessions.
10 See, for example, Frey B., and Jegen R. (2001). "Motivation Crowding Theory". Journal of Economic Surveys, 15(5), pp. 589–611.
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructor’s Manual 6. Suggestions
The best student suggestions usually involve combinations of the old and the new systems. They recognize that FCS must allow the doctors to earn more money to serve attraction and retention purposes, and to be able to pay the doctors more, FCS must generate higher revenues. An ideal incentive system should also motivate the doctors to engage in the behaviors that FCS values.