Clinical Management
The profit potential of Hospital LabsOutreach programs expand services to physicians, employers and insurers with relatively modest added investment
Opinions about what strategic value hospitals derive from their laboratories have zigged and zagged during the last 30 years: from cash cows to “necessary evil” cost centers; from something of an afterthought to mission-critical drivers of data and decisions. Now, perceptions are changing again. Hospital leaders increasingly see so-called laboratory outreach programs as a true business opportunity.
Outreach expands labs’ traditional role beyond quickly turning around tests for emergency cases and inpatients. Hospitals market their labs’ services to physician offices, employers and insurance companies, no longer conceding most of that business to independent commercial labs.
The business case is clear. “Hospitals are able to leverage that lab asset, and not have to put in a significant amount of cost, to do lab outreach,” says Jack Shaw, executive director at Joint Venture Hospital Laboratories, Allen Park, Mich. “You have an asset, you may as well use it. It’s an incremental activity.”
The business model is simple. A hospital already must spend a lot of money to staff and equip its laboratory 24 hours a day; in economics, this is called the sunk cost. Since the cost of performing additional tests [variable costs] is relatively low, most of the revenue generated from lab outreach theoretically goes straight to the bottom line.
“Hospital lab structure is basically 50 percent fixed costs and 50 percent variable costs, so if you do twice as many tests, your average costs come down 25 percent on all tests,” says Rodney Forsman, administrative director of Mayo Medical Laboratories, Rochester, Minn.
The “sunken” nature of fixed laboratory costs is a critical concept. “So many hospitals get really tied up on the fact that their costs are high and they think, ‘Lab is a cost center, that’s all it ever can be,’ ” says Mike Snyder, principal of Clinical Lab Business Solutions, a consulting firm in Readington, N.J. “But if you don’t do outreach, your costs remain more or less the same. Since you’re stuck with the fixed costs anyway, any revenue you make from lab outreach is almost pure profit.”
While up to 90 percent of hospital labs now do some form of outreach, most do it only on a piecemeal basis—a few tests here and there for affiliated doctors at the clinic across the street, for example. “It’s hard to ‘dabble’ in the outreach business—if you’re only going to dabble, it’s not really outreach,” Shaw says. “If you want to be out in the market and gain a fair amount of revenue, you need to put resources behind those things.”
Some hospitals are doing just that, with good results. Carilion Clinic of Roanoake, Va., has run an aggressive lab outreach for several years. Joint Venture Hospital Laboratories, a consortium of 123 Michigan hospital labs that was formed in 1992, captured several prominent managed care contracts, including a big one with United Healthcare. And Mayo Medical Laboratories—one of the pioneers of lab outreach back in 1971—has consulted with other hospitals for years on how to improve operations.
Controlling Billing
From a practical standpoint, a proper lab outreach program starts with billing—and all the successful players use a similar approach.
“The biggest problem that lab outreach businesses have is that the billing and collection is usually performed by the hospital’s main billing department,” says Jondavid Klipp, editor of Laboratory Economics, a monthly newsletter for laboratory managers. “The typical lab bill may be $30, and that’s not a significant amount of money compared with a $10,000 inpatient stay, so those lab bills often get overlooked. If more information is needed for the test to be billed correctly, the main hospital often won’t follow up on it.”
Outreach billing, therefore, is best handled by the lab itself. “It’s not impossible for hospitals to do billing, but in the best practices, the billing will be managed by the lab,” Forsman says. “They’re the closest to the situation, they’re the closest to clients, they’re the closest to the specimens where the information lies.”
In addition to a separate billing function, lab outreach programs need all kinds of supporting functions that are scaled down or even unnecessary in a “traditional” hospital lab—things like customer service representatives, an outside sales staff and a dedicated courier service.
“Hospital labs have to be competitive with the commercial labs if they want to sell themselves outside their walls,” Snyder says. “You need to field a customer service group that can answer doctors’ inquiries on a timely basis, you have to enhance your IT system, you have to work on sales and marketing. It takes a lot of nurturing.”
It also takes money. While increasing volume to lower average costs is an effective model, it works only to a certain point.
“One misconception that some hospitals have is that the marginal cost of bringing in the next test is inexpensive—and that’s true when you’re talking about the supplies and labor involved in actually performing the test,” says Bud Thompson, executive vice president of Carilion Clinic and CEO of Carilion Labs. “What is underestimated are all the other costs—a billing system, the technical and nontechnical labor you’re going to bring in. As you build up your outreach business, you have to be prepared to dedicate capital to allow the growth to continue.”
Hospital Advantages
An aggressive laboratory outreach means hospitals must be ready to go toe-to-toe with commercial labs. Once a competitive industry with hundreds of small local and regional players, commercial labs have been consolidated into two major players—Quest and LabCorp. Hospital labs would seem to be at a distinct disadvantage based on size, market penetration, economies of scale and scope. Quest and LabCorp should always be able to undercut hospital lab prices in the same markets.
But hospital labs have their own strengths. “We don’t try to compete purely on price because our hospitals can do so many other things well—we can integrate results into an electronic health record, we offer better continuity of care, and so on,” says Shaw of JVHL. “We think that has value, and we try to reflect that value in our pric-ing. That said, our pricing is somewhat higher than commercial labs, but it is still competitive.”
The diversity of services is also an advantage in negotiations with insurers. “Payers are trying to push hospitals down on high-ticket items—the per diem stay, the surgeries,” Snyder says. “What gets left over are small things like laboratory, and the payers allow those to be kicked up in return for other concessions.”
Hospital lab outreach can also bring benefits to their communities—the doctors, employers and insurers in those communities—that commercial labs are hard-pressed to duplicate.
“Through outreach programs, your lab is doing more tests yourself, you’re doing tests more often, so you’re more responsive to physicians’ needs,” Forsman says. “The added volume means quicker turnaround time, quicker decision-making and better decision-making. And that leads to cost savings, cost avoidance, and physician and patient satisfaction.”
The Next Step
Some hospital labs are going further with outreach, becoming large regional players that can compete with the big commercial labs on an even footing.
To accelerate its growth, Carilion Labs was incorporated as a separate, for-profit subsidiary of Carilion Clinic in January 2006. Carilion purchased the Chi Solutions lab consulting business and two labs, Rockbridge Medical Laboratory in Lexington, Va., and Presbyterian Reference Lab in Charlotte, N.C. Carilion’s lab business has grown from $63 million in 2006 revenues to $81 million last year; it projects $114 million in revenues for 2008.
“When we do an acquisition, we prefer to leave the seller organization with some equity instead of an all-cash acquisition; this structure would allow equity to be held by the selling organization,” Thompson says.
Not all hospital labs have the resources or muscle to replicate Carilion’s strategy—but they can still become regional players if they find the right partners.
“One model involves getting separate entities to jointly affiliate and bid successfully on managed care contracts for a region, city or state,” says Mayo’s Forsman. “The labs maintain their identity. They have access to managed care lives, which individually they wouldn’t have had the strength to bid on alone. And they provide enhanced service levels by doing certain esoteric tests for one another instead of farming those out commercially.”
JVHL used that model when it formed its Michigan network in 1992. “This started as a survival business,” Shaw says. “One local managed care plan said, ‘We’re going to have a sole-source contract,’ and we asked, ‘What do we need to look like to compete with a Quest?’ The plan needed to look at us as if we were a commercial laboratory.”
JVHL originally represented four health systems with 20 hospitals; it now includes nine systems and 123 hospitals. It serves as an administrative clearinghouse for billing and claims, and leverages the unified strength of those hospital labs to compete for managed care contracts.
The organization made headlines in late 2006 when it signed a contract with United Healthcare, which had previously dropped Quest as an approved lab. JVHL made $60 million in revenue for its affiliated health systems in 2007.
“The payer only has to deal with one person, they get the advantage of the wide area our hospitals cover, they get claims from a single source, and the plan only has to think about paying JVHL,” Shaw says. “It’s an efficient way of doing this. They don’t have 123 individual hospitals knocking on their door and saying, ‘I want to do outreach.’ ”
Sleeping With The Enemy?
Once a hospital lab has built an outreach program into a major regional player, there’s another step to consider: “flipping” the program by selling out to one of the national players. In late 2007, for example, LabCorp purchased three hospital outreach programs—PA Labs, Muncie, Ind., partially owned by Cardinal Health; Midwest Clinical Laboratories, a for-profit lab owned by Wheaton Franciscan Healthcare, Glendale, Wis.; and DSI Laboratories, owned by NCH Healthcare System of Naples, Fla.
“Hospitals have been able to realize value from these laboratory business ventures,” says Klipp of Laboratory Economics. “Even though some of them have been pretty marginal businesses, they wound up being sold for good prices.”
Some people may disdain the idea of selling something they’ve worked hard to build into a viable, revenue-generating business, especially to a fierce competitor. But Snyder says hospitals with viable outreach programs owe it to themselves to at least evaluate the situation.
“Most hospitals are constantly looking for capital,” Snyder says. “Given the current multiples being paid, a lab outreach program can be a great investment vehicle.”
Better yet, Snyder notes, most of those purchases don’t involve any real assets; the acquirer is buying the hospital’s outreach customer list, while the hospital inpatient lab continues to run. After a standard noncompete period (usually five years), that lab can start doing outreach again.
“If you’ve got a mature lab outreach program and you need the capital more than the revenue stream, this is the perfect time to sell it; then you can restart it later,” Snyder says. “This could be the start of a magical cycle with respect to hospital outreach programs.”—Chris Serb is a freelance writer in Chicago.
Clinical Management is a quarterly series that looks at specific disease or treatment areas. Clinical Management aims to uncover trends in technology, staffing, financing and other issues of concern to senior hospital executives. . Our next Clinical Management article will look at behavorial health
This article 1st appeared in the January 2008 issue of HHN Magazine.
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