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DSO Supplier Briefings

The Rapid Rise of DSOs


September 28, 2012 / Cotton Hawes and Philip Toh

Key Takeaways
1. Dental Service Organizations (DSOs) are companies which offer non-clinical support to dental practices including administrative, financial, and management services as well as assets such as facilities and equipment. A DSO does not directly provide dental services as state laws typically prohibit these companies from doing so. Manufacturers should care about DSOs because they are quietly and quickly taking a major role in dentistry. DSOs have added about 1% of the dental services market to their total share each year which equates to $1 billion of revenue and $160 million in spending with suppliers. The challenge for suppliers is that DSOs are very savvy and cost-driven negotiators with much different buying requirements than solo or group practitioners. To become more competitive and profitable in this market segment, suppliers must adapt their approach to match DSOs goals which are focused on higher revenue from adding new offices, increasing patient and treatment volumes, and improving fees.

2. 3. 4.

Discussion
In 1995, the Internet browser pioneer, Netscape, could look with satisfaction at charts showing that their product held an 85% market share among all computer users worldwide. But they were looking at the wrong charts. That year, Microsofts browser had a 92% market share among new computer owners which meant that Netscapes share was rapidly eroding. Five years later, Netscape had only a 15% market share and in another six years was out of the browser business. The history of the browser wars has a lesson for dental manufacturers as they watch the development of Dental Service Organizations (DSOs). Coincidentally, dentists working alone in their practice or with one other doctor now have approximately 85% of the dental services market while DSOs have about 10% market share. But DSOs have taken about 1 market share point annually during the recession and the pace will accelerate. By 2018, DSOs are expected to have a 20% market share. Projections for the top five DSOs show they will have between 5-8% of the total dental services market and the next ten DSOs will also have a 5% market share. Even more startling are the growth curves for small DSOs. As private equity firms have invested in DSOs with as few as 2-4 offices, perhaps as many as a half-dozen companies have surged from $10 million in revenue to $50 million in the last four years.

What Is a DSO?
The precise definition of a DSO is a company offering non-clinical support to dental practices including administrative, financial, and management services as well as assets such as facilities and equipment. A DSO does not directly provide dental services as state laws typically prohibit these companies from doing

so. What this means, in short, is that DSOs deal with the business aspects of a dental practice so that dentists can focus on dentistry. Because states typically restrict practice ownership to dentists, DSOs must contract with legal entities to be involved in operating dental practices. The standard legal model for DSOs is an exclusive management service agreement with a professional corporation owned by a dentist which, in turn, employs dentists and in many cases hygienists and assistants as well. The agreement with the professional corporation provides income to the DSO based on fee arrangements and cost reimbursement. Other than their legal structure, what makes DSOs different than solo or group practices are their systematic and aggressive plans for profitable growth. While most dentists are concerned with gross production and overhead percentages, DSOs are similar to other major corporations in their focus on EBITDA in dollar and percentage terms. As manufacturers have found, DSOs constantly search for ways to increase EBITDA through direct cost reductions from improved supplier prices and indirect savings from productivity improvements. However, the key driver for EBITDA improvements among DSOs is higher revenue from adding new offices, increasing patient and treatment volumes, and improving fees.

DSO Management, Doctor Ownership, and Business Models


Behind DSO growth plans are savvy management teams with an unparalleled ability within dentistry to transform strategic plans created at the home office into detailed execution in practice locations. At the executive level, DSOs often have managers whove built major businesses in dental or other industries and have strong expertise in areas including marketing, operations, real estate development, and finance as well as clinical leaders with impressive credentials and organizational skills. Regional managers at these companies complement the executive team with hands-on dental office experience and by addressing the DSOs tactical issues as they each lead 6-10 offices with revenues totaling $8 - $20 million. Finally, at the foundation level of DSO management, office managers are completely focused on day-to-day challenges and opportunities such as staffing, production, patient service, and billing and collections. Doctors are attracted to DSOs based on compensation that is 22% higher than the average for solo practice owners. Opportunities for ownership by DSO doctors vary based on three different approaches. Some DSOs are eager to have doctors own the practice in which they work and often encourage those who are successful to invest in and take management responsibility for multiple locations. In contrast, other companies employ doctors and do not offer ownership at all. A handful of DSOs have found a middle ground by employing doctors without practice ownership but instead offering ownership stakes in the entire company through ESOPs. The ownership choices DSOs provide to doctors affects these companies in many ways including their business model which introduces even more variations to the DSO landscape. One factor in DSO business models is whether offices have individual brands which is, for example, American Dental Partners approach or corporate brands which is Aspen Dentals method, while some companies have both. Another aspect is the location of practices in rural, suburban, or urban locations as, for example, Midwest Dental seeks rural offices whereas Pacific Dental Services opens practices in suburban areas. The kinds of patients that DSOs cater to also shapes their business as many Western Dental locations, for example, serve lower to middle-income populations while Heartland Dental offices are geared toward middle and upper middle-income patients. The type of clinical services offered differs widely among DSOs as many provide comprehensive care while others specialize in either dentures, pediatric, orthodontic, implant, or emergency treatment. Payor-type is one more DSO adaptation as they usually tend to rely on one kind of reimbursement source more than others including Medicaid, indemnity, PPO, or HMO.

Why Should a Manufacturing Executive Care about DSOs?

The first reason why suppliers should care about DSOs is that they are quietly and quickly taking a major role in dentistry. DSOs have added about 1% of the dental services market to their total share each year which equates to $1 billion of revenue and $160 million in spending with suppliers. From another perspective, as DSOs take 1 point of market share away from solo practitioners they also add roughly 1% of practicing doctors to their ranks. In other words, about 1,500 doctors went to work for a DSO last year and at least as many more will do so next year. Those doctors will join the 9,000 or so clinicians already working at DSOs. Second, nearly every significant trend in the dental environment favors DSOs. As manufacturers are well aware, the cost and complexity of dental equipment has jumped dramatically in the last ten years making it harder for solo and group practitioners to pay for and master these tools whereas DSOs, due to their size, dont share either of these challenges. Also, because dental student debt has ballooned to nearly $300,000 on average, fewer new graduates can get a loan to buy a new practice while DSOs have plenty of cash and credit available to buy practices from retiring doctors. Under the pressure of repaying their student loans, recent graduates need a higher income than before but have fewer associate opportunities as practice owners arent willing to give up even a fraction of their recession-lowered production, yet DSOs have hundreds of openings each year. Moreover, associates earn more at DSOs because they have as many as ten times the new patient flow as solo and group practices. Another factor that attracts doctors to DSOs is that both new and end-of-career practitioners want to avoid management obligations of owning a practice and appreciate that DSOs allow them to focus on dentistry. Third, DSOs are very different buyers. Manufacturers have found that DSOs dont respond nearly as well as solo and group practices to the sales and marketing strategies created for smaller buyers. From purchasing managers to CEOs, DSOs have teams of savvy negotiators who know how to compare products, bargain with a clear goal in mind, and have the discipline to walk away from table when they dont get what they want. DSOs also have a defined management structure which means that, for example, they generally dont want salespeople calling on their offices based on a manufacturers territory system and instead want one primary point of contact with occasional support from others on the suppliers team. With that one point of contact, DSOs want to have quick answers to spot questions, regular updates on any changes including pricing or turnaround times, and strategic discussions about how a manufacturer can help improve their business rather than how the features of one product are better than another.

Conclusion
With the wind at their backs due to favorable trends, advantages of scale and scope, and access to capital, DSOs are positioned to grow from a significant customer segment for manufacturers to a major one in just a few years. As supplier executives assess how to serve DSOs better, they could ask: 1. 2. 3. Who in our company is responsible for managing our business with DSOs and how is their approach specifically designed for these customers? How does our approach to DSOs differ from that of our competitors? How have we leveraged our dealer as a partner in growing our DSO business?

About the Authors Cotton Hawes is Vice President of Corporate Strategy in Levin Groups Baltimore office and has led the firms DSO & Large Group Practice since 2006. Founded in 1985 by Dr. Roger P. Levin, DDS, Levin Group is the leader in dental practice management consulting with 125 employees serving corporate clients and over 1,400 dental practitioners in comprehensive programs that improve business operations for the benefit of patients, employees, and owners. Philip Toh is the Director of Strategy and Development for Henry Schein Special Markets and has assisted many large customers grow and improve their businesses since 2004. Henry Schein Special Markets is the market leader in

serving large accounts by offering world-class products, services and insights fueling thousands of locations for customers around the country and the world.

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