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Letter Gordon K. MacLeod Re: Some Proposals for PMS to Use Money as a Measure.

Gordon K. MacLeod, M.D., Chairman

Ad Hoc Committee on Long Range Strategy

Pennsylvania Medical Society

20 Erford Road

Lemoyne, PA 17043

December 15, 1984

Re: Some Proposals for PMS to Use Money as a Measure

Dear Gordon,

Ludwig von Mises, the Austrian economist, won a Nobel Prize for drawing the world's attention to the information value of prices in a market economy. Since a capitalist society measures most things by money, you can learn a great deal about how society values a person, system or product by how much society is willing to pay for him or it. Herein was an academic formulation of the old Calvinist doctrine that if you were rich, it was probably a sign you were beloved by the Almighty. For von Mises, the important issue was not theological, but political, since he maintained socialist economies function badly mostly because they fix prices by a committee and thus deprive themselves of the information system of the "bottom line".

Well, non-profit corporations like the Pennsylvania Medical Society also deprive themselves of the information content of prices and profits, although I here maintain that it is undesirable to do so, that it is feasible to do otherwise, and that our committee ought to try to get the Society to use money as a measure where it can. I intend to use the AMA as an example because it is readily visible to us. The AMA can afford to spend large amounts on management consultants who suggest systems which become entrenched because they work, even though the users of the systems may well not understand them. that sort of entrenchment by effectiveness, too, ought to be one of our goals.

When organizations get to be a hundred years old, they acquire a number of functions which do not readily fit into a crisp mission statement. In the case of the Pennsylvania Medical Society, we have some activities which are typically for-profit businesses, even though the organization as a whole declares itself to be non-profit (hence, tax-exempt) corporation, dedicated to carrying out a number of public- service missions. The most obvious for-profit activity is the operation of the endowment portfolio, which differs in no major wat from the operation of a mutual fund or any other investment activity. In addition, we are in the rental real estate business, the speculation in raw land of our headquarters, the malpractice insurance business, the magazine publishing business, and probably a number of-of other actives which I have not had time to ferret out. Activities of this sort always are applauded as a way of reducing dues (speaking to the members) and of expanding the scope of our benevolent activities (when speaking to the governmental authorities who would like to tax us.) Because of the discomfort of scrutiny by the tax collector, there is always a tendency to conceal or at least blur the discussion of such activities, and out of that tendency may grow slackness of management (as in the case of Blasingame) or unwarranted domination of the organization (as in the case of Fishbein). These two potential evils will cost the Society much more than it could ever pay in taxes, and therefore I make my first proposal:

1. All profit centers of the society should be measured by their return on fair-market equity. It is sometimes described as "conservative" accounting to maintain stocks, bonds and real estate on the books at the purchase price of twenty years earlier; it is no such thing as conservative, it is deceptive.

2. To the maximum feasible degree, activities which should have a major goal of producing profit should be separated from the purely benevolent activities in a special accounting system. To the extent feasible, such activities should become for-profit corporations, the stock of which is contained in the Society's investment portfolio, and whose return on equity is evaluated in conventional terms.. No doubt the Society now maintains its books in other ways for other reasons, and it is not here proposed that the present books need be discontinued for whatever audience reads them. Rather, it is proposed that the membership and the leadership need a new reporting methodology for their purposes. The concept being urged is that our return on pure endowment investments can now be readily compared with the results of other professional investments can now be readily compared with the results of other professional investors, and therefore becomes our gold standard. To the extent that Pennsylvania Medicine, for example, falls short of the return on equity which our portfolio managers can produce with non-medical investment,Pennsylvania Medicineis being subsidized. The amount of that subsidy can be carried over to the benevolent side of the ledger as a cost to the membership dues. At the present time, I believe, only absolute losses are being carried over, and such a system, therefore, does not measure the "opportunity" cost. Because it is desirable to structure returns to take full advantage of the Society's tax-exempt status, determining the "total return" on such investments will depend on our ability to produce accurate estimates of the underlying market value of our subordinate business. Since that goal is to produce estimates of the degree of subsidy from the dues, ranges of estimates would be sufficiently serviceable for the oversight and decision-making function. For example, it should be possible to form a rough estimate of how much the Society Could realize from selling the malpractice insurance company to a commercial carrier, and from this to decide the order of magnitude of the subsidy from dues. It seems possible that the total investment return which we presently realize is much less than we could realize from selling out and investing in the Dow Jones Average. Conversely, it is equally possible that the invisible total return on a growing asset is more than we could realize from any alternative investment. The point is we do own a substantial piece of property and yet have not made such an appraisal, against which subsequently would have to be argued its merits in a non-financial sense, of course.

Turning to the non-profit, or service, side of PMS, we could do worse than to emulate the AMA system. They divide their activities into "missions" and report how much they have spent on political representation, education, member services, etc. If PMS employed the same format, we could at least compare our expense allocations with those of the AMA. Presumably, we spend a much smaller proportion of our money on publications and scientific information than the AMA does, and proportionately more on other things, but it might be illuminating to compare the "pie-chart" of our expenses with their pie-chart, utilizing the same scheme of mission definitions. Other state societies may have thought of the same idea, and we might compare ourselves with other states. Ultimately, of course, we hope to compare our expenditures on each mission with our accomplishments in each mission; the result is a cost/benefit ratio. Within each mission there are projects, and projects have cost/benefit ratios, too. Ultimately, we can put a price on small services. How much does it cost PMS to write a letter? To answer the average member request for information? To process a new member? To hold the annual meeting? To publish one issue of Pennsylvania Medicine?

It might carelessly be said that we already have a good estimate of such costs, but I believe it is not possible to know your costs unless you have constructed a matrix in which every penny you spend is included, and every benefit you produce is defined. If every cost must be allocated somewhere, you find that you have to do something with the cost of unsuccessfully lobbying to have a bill passed. Its cost may well have to be added to the visible cost of successfully lobbying a bill through the legislature, on the win-some, lose-some philosophy. Some credit must be assigned to preventing some unwelcome bill from passing, and some indirect overhead cost must be developed for the general purpose of making the legitimate like us a little more or dislike us a little less. This cost is legitimate, and it must ultimately be added to the true cost of our occasional successes since they are all part of the same process.

There is a dark side, too; since no one likes criticism. perhaps it is costing too much to answer member letters either we find a way to do it more cheaply, or we stop answering letters, or we stop complaining about the cost. Management should always have the first crack at such problems, but ultimately such cost/benefit analyses are the proper concern of the Board of Trustees. The Board must decide whether to seek efficiencies, to drop a program, or to stop complaining about its costliness. The line-item sort of budget and financial summary is probably not terribly useful to the Board, although it is useful to management, and it is essential to prepare it for tax purposes and for financial audit. But there is a question whether the Board would ever even look at a line-item budget if it had a budget by function with which it was pleased.

I guess what I am proposing come down to an elaborate computer spreadsheet program, with all expenses recorded at least three times:

1. By function, as locally defined in response to Board request.

2. By function, as defined at the AMA (for comparability).

3. Byline item, as needed for management, audit, and tax purposes.

Furthermore, I do not see how the overlapping functions, particularly of the higher levels of management, can be allocated without the use of a "lawyer's time-sheet". From my experience with other organizations, I know that employees rebel at such things, since they fear the worst motivations are at work. Therefore, the time-sheet idea (for which inexpensive computer software is readily available for use by lawyers) is only feasible if it starts at the top, and each layer of management is able to assure its juniors that they themselves "have tried it and it isn't so bad".

Let me try to summarize. Where we are engaged in remunerative activities, the profit yield should be compared with the yield on similar resources in our investment portfolio; the investment yield should be compared with the yield of professional investors.

Where we are engaged in service, we develop cost/benefit ratios, making certain that we divide 100% of our costs by 100% of our benefits. Missions, goals, projects, and activities can be defined in many different ways; such redefinitions are legitimate only if they adhere to the 100%rule.

Out of these two measurement schemes, one for bottom-line profits, and one for service functions can come to a heightened appreciation of where we are and where we are going. The Board needs to know this, management needs to know it, and ultimately, the membership needs to know it.

Respectfully submitted,

George Ross Fisher, M.D>

 

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