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Building a business with unwanted customers

FORTUNE — Diego Cobo was trying hard not to cry when he returned to his family in the waiting area at the dentist’s office. The three-year-old just had just had a cavity filled, and it hurt. “Maybe you shouldn’t eat so many candies,” his mom said to him. Diego thought for a minute, then pointed to the teeth on the side of his mouth that wasn’t numb with Novocaine, and said, “Maybe I can eat candies with these teeth?”

If Diego is like the majority of patients at Newark, N.J.-based Dental Kidz, he will be back soon enough with more cavities. Dental Kidz targets patients on Medicaid and other subsidized health care. The practice is jointly owned by husband-and-wife team Chris and Lezli Harvell — he handles everything outside of the clinic, and she’s a dentist.

Most dentists don’t want to touch kids on Medicaid with a 10-foot pole, much less a dental scraper. But Chris Harvell believes that treating the underserved can make for good business. And in New Jersey, which has one of the worst records for pediatric dental care in the U.S., kids have so few options that a good provider, even to those with little income, can make a profit.

“I used to be deathly afraid of the dentist. I used to have tons of cavities,” says Harvell, a former Booz Allen consultant turned business student turned entrepreneur.

Harvell tries to keep Dental Kidz’s office inviting.  It’s brightly lit, with an open floor plan, Crayola-colored seats for small patients, high ceilings, and mock hardwood floors. Mariah Carey’s power pop version of “All I want for Christmas” is playing. Kids in the back squirm into their examination chairs, some are crying.

Despite his early fear of dentists, Harvell married one, and recognized a serious shortage of quality care in the Newark area. In 2008, before launching Dental Kidz, he crunched numbers that he requested from the state dental board and department of human services and found that there were about 210,000 children within a five-mile radius of the city, 40% of which receive Medicaid benefits, and only 15 pediatric dentists.

Medicaid’s ups and downs

Nationally, dentists shy away from treating Medicaid patients. Many complain that this patient population has a far higher no-show rate than patients with private insurance, according to a May 2011 report called “The State of Children’s Dental Health” from the Pew Center on the States. Those empty chairs eat at profits.

Medicaid compensation often falls woefully short of the cost of care: 33 states reimbursed under 60.5 cents for every dollar a dentist charged, according to the Pew study. The study also graded individual states’ progress providing adequate pediatric dental care. New Jersey was one of five states to receive an F.

There is money in treating these patients, Harvell says, but getting it is a hassle. Dentists must wade through red tape for Medicaid reimbursement, says Richard Green, the managing director of public affairs for the American Dental Association. Many dentists, including American Dental Association president William Calnon, will treat Medicaid patients pro bono to avoid the inconvenience. “It’s just not worth the headache,” Green says, and many dentists figure that“it’s better to get 100% of nothing, rather than working really hard to get 15 to 80% of something.”

But 75% of Dental Kidz clients receive some kind of state subsidized dental care. This is not charity work; it’s the foundation of the company’s business. “In terms of having a practice like that,” Green says, “the more you do, the easier it is.”

Volume is the answer. Harvell sees opportunity in the same facts that deter so many dentists. He sees a group of patients who need care but aren’t getting it. What’s more, these patients tend to have more and more expensive problems than what is typical. The average age of the kids is four,” Harvell says, “and the average number of cavities is eight. They only have 20 teeth!”

Dental Kidz patients have their first dentist visit much later than they should — the American Dental Association recommends a child visit a dentist before the age of one. Because of this, along with poor education about proper nutrition and eating habits, patients often have advanced dental problems that require expensive procedures, which Medicaid does reimburse.

The key to profiting with patients who receive Medicaid or other subsidized care is getting enough of them in the door, then making sure those patients come back. Since Dental Kidz opened its doors in 2009, its patient population has grown from zero to roughly 6,600.

The limitations of the ‘volume business’

While volume might be the key to financial success, this model has sunk other dental practices. In 2010, company Forba Holdings LLC, which owned a nationwide dental practice called Small Smiles, agreed to pay $24 million over five years to settle charges that it had advocated unnecessary procedures. Families of patients filed lawsuits claiming that dentists in Small Smiles offices were pulling healthy teeth and performing unneeded root canals for the sake of Medicaid money.

Many Medicaid patients have received sub-par treatment at clinics, Harvell says. Diego Cobo’s grandmother, who was in the waiting room with Diego’s mother and two siblings, told a couple of horror stories about other family members who had traumatic dental experiences. “This place is better,” she says.

The office has a room to educate parents on oral care and nutrition. But does that kind of educational effort actually work? “After about the fourth or fifth visit, they get it,” Harvell says. This gives enough lead-time to pull a substantial profit, while the information absorbs and before the patients’ permanent teeth come in.

Harvell’s business model is not for the faint of heart. “The first year, I called it ‘Obama’s ground game,’” Harvell says. “I Googled every competing office in the region. I visited 60% of them.”

The pace is more manageable now, but business is booming. The clinic sees between 180 and 200 new patients per month. The company made $1.6 million in revenue for 2011, up from $500,000 at the end of 2009. Profit margins have also increased, up from 24% in 2009 to 47% this past year.

The most expensive part of the business is actually its staff, which accounts for 40% of Dental Kidz’s overall expenditure, Harvell says. To attract talent to work so hard in a demanding environment, Harvell has set up a student loan forgiveness plan for his staff, the only one in the state for a private practice, he says. The state will pay $120,000 towards staff members’ dental school loans over four years. Hiring can be a challenge, Harvell says. You can’t be a tough guy with a heart of gold. You have to be outgoing, to love kids – you have to be able to handle noise.