Busy Year Demonstrated By Top Ten Lab Stories

Lab industry’s Top Ten Stories for 2007 point to accelerating change in coming years

CEO SUMMARY: As it turns out, 2007 has been an action-packed year with lots of events, plenty of changes, and the promise of even faster evolution across all sectors of the lab testing marketplace. THE DARK REPORTS “Top Ten Lab Stories of 2007” show the full intensity and pace of activity within laboratory medicine. One big driver in these events is the tidal wave of investment money flowing into diagnostics and lab testing. It is a time of high expectations and confidence in the future of lab medicine.

WHAT A YEAR FOR LAB MEDICINE! Big things happened in every corner of the lab industry. Billions of dollars changed hands as every sector involved in laboratory testing consolidated, grew larger, and transformed.

Our list of the “Top Ten Lab Stories for 2007” backs up this observation. It ranges from an obvious pick—UnitedHealth Group, Inc.’s 10-year exclusive national contract with Laboratory Corporation of America—to an overlooked, but important development: Procter & Gamble’s $325 million dollar investment to form a joint venture with Inverness Medical Innovations, Inc., involving what the two companies call “consumer diagnostics.”

P & G is betting that consumers will walk into retail stores and readily purchase self-test diagnostic kits. In fact, the joint venture, named SPD Swiss Precision Diagnostics GmbH, immediately became the world’s largest seller of home pregnancy tests and fertility/ovulation monitoring products. The brand names include Clearblue, Persona, AccuClear, Fact Plus, and Clearplan.

Will retail sales of diagnostic test kits to consumers rapidly develop into a major market? No one knows. The point of this top ten story is to alert clients and readers of THE DARK REPORT about this new joint venture so that laboratories can respond as appropriate to any marketplace threats and opportunities.

In fact, collectively, our picks for the “Top Ten Lab Stories of 2007” have a compelling message for laboratory administrators and pathologists, which is that progress across the length and breadth of laboratory medicine is unfolding at a faster and faster pace. This pace has several business implications.

For one, sustained consolidation activity across the clinical lab, anatomic pathology, in vitro diagnostics (IVD), and molecular sectors means that existing companies in these spaces must be nimble and responsive. New competitors pop up and existing competitors grow bigger in unexpected ways. For example, early last year, Siemens AG had a negligible presence in IVD. Today, it is the world’s second largest IVD company, trailing only Roche Holdings.

So, in just 16 months, companies competing against Diagnostic Products Corp. (DPC), Bayer Diagnostics, and Dade Behring now find themselves competing against Siemens Medical Solutions Diagnostics. That shift is a radical one in the marketplace.

It’s a similar story in the clinical laboratory sector. At the start of 2005, Quest Diagnostics Incorporated and Laboratory Corporation of America were the two huge national lab companies. Now, at the end of 2007, Sonic Healthcare Ltd. is the owner of regional labs in the United States that collectively generate almost $500 million in annual revenues. Sonic is not only an active bidder against the two blood brothers for laboratory companies that come to market, it is a well financed competitor in regions where it has laboratories.

Rapid Changes In Market

As these examples show, in less than 24 months, radically different market dynamics have emerged in both the IVD sector and the clinical lab sector! And it doesn’t stop there. Our top ten story list identifies other lab industry sectors evolving in similarly swift fashion.

Another business implication identified in this year’s top ten lab stories is the significant role government plays in the financial stability of the laboratory profession. Two of the top ten stories illustrate this trend. One top ten story involves the implementation of new federal rules that restrict how physicians can mark up work for certain diagnostic procedures. It is an attempt by federal healthcare regulators to control the rising costs and increased utilization connected to in-house pathology and radiology services that office-based physicians have established. The other top ten story addresses the steps Medicare has taken to implement the “Demonstration Project For Competitive Bidding of Clinical Laboratory Services,” including the selection of the San Diego area as the first demonstration site.

Lean And Six Sigma “Arrive” 

One top ten story that deserves attention is the burgeoning support among hospitals, health systems, and laboratories across the United States for quality management systems. In response to pressures to reduce and eliminate medical errors while boosting healthcare outcomes, providers are turning to Lean, Six Sigma, and other process improvement techniques.

As noted in our coverage on page 7, this year’s Lab Quality Confab not only was able to assemble 60 presentations on the use of quality management systems in labs and pathology groups, but attracted a large crowd from seven countries around the globe. These results would not have been feasible just 24 months ago, illustrating how swiftly this trend is taking root within the laboratory industry.

As in past years, we encourage laboratory directors and pathologists to use this “Top Ten Lab Stories of 2007” list as the basis for a strategic review session with their management teams. It is a powerful tool to expose weaknesses in the business plan and identify emerging opportunities that might otherwise go unnoticed amid the crush of daily activities. The clear message from this year’s top ten list of lab stories is the need to be proactive, not reactive! 

Top Ten of 2007

1.  UnitedHealth Deal with LabCorp Upsets MC Contract Status Quo

PROBABLY NO SINGLE NEWS EVENT during 2007 captured the attention of the entire laboratory profession as did the decision by UnitedHealth Group, Inc. to grant Laboratory Corporation of America an exclusive, 10-year, national contract, while excluding Quest Diagnostics Incorporated as a national contract provider. (See TDR, December 10, 2007.)

It was a story that everyone watched closely because it clearly upset the long-standing status quo in managed care contracts for laboratory testing services. For almost a decade, there had been little change in how the nation’s largest health-care insurers granted contract status to the two blood brothers.

Following UnitedHealth’s decision, Aetna, Inc., signed an exclusive national contract with Quest Diagnostics and shut out LabCorp as a national provider. Cigna Corp. decided to renew multi-year national contracts with both LabCorp and Quest Diagnostics.

Many lab directors and pathologists are concerned that intensified competition between the two national lab companies for exclusive national contracts will unleash a wave of heavily discounted pricing. THE DARK REPORT does not believe heavy discounting will happen in a way that is destructive.

Rather, it is likely that evolving business strategies at LabCorp, in particular, could lead to a different contracting model that puts LabCorp in the lead role in managing regional lab networks organized to serve specific payers. That scenario could negatively affect local labs.

2.  New Investors Drive Up Valuations for Laboratory Testing Companies

ONE IMPORTANT TREND in the laboratory industry is the steady increase in the prices buyers will pay for laboratory companies that provide testing services to referring physicians. A number of lab company sales during 2007 demonstrated the power of this trend.

The year’s single biggest deal is a dramatic illustration of these higher valuations. Quest Diagnostics Incorporated proved willing to pay $2 billion for AmeriPath, Inc., which had revenues of $750 million in 2006.

Similarly, Sonic Healthcare Ltd. of Sydney, Australia, another new competitor in the U.S. market, has pulled out its checkbook and paid strong prices for selected laboratory acquisitions. One recent example was Sonic’s acquisition ofSunrise Medical Laboratories of Hauppauge, New York. It paid approximately $148 million for Sunrise, which posted revenues of about $75 million in 2006.

New buyers for labs continue to emerge. One example is Laboratory Partners, Inc., of Palo Alto, California. It acquired three lab companies during the year. Another buyer is Aurora Diagnostics, Inc., of Palm Beach Gardens, Florida, which bought a number of pathology groups and labs in 2007.

These events signal a shift in the buyer mix. Relative to just a few years ago, Quest Diagnostics Incorporated and Laboratory Corporation of America were the primary buyers for lab companies. Now there are additional buyers willing to bid for lab companies that come to market.

3.  Medicare Competitive Bid Demo Moves Toward Implementation

SINCE MIDYEAR, when Medicare officials conducted an informational conference on the “Demonstration Project For Competitive Bidding of Clinical Laboratory Services,” progress toward implementation has been steady.

In October, federal officials announced that the San Diego-Carlsbad-San Marcos MSA (metropolitan statistical area) would be the first demonstration site. (See TDR, October
29, 2007.) Last week, the Centers for Medicare and Medicaid Services (CMS) conducted the first bidder’s conference in San Diego.

These are significant developments for the laboratory industry. First, whether the demonstration project succeeds or not, it represents the efforts of healthcare policy makers to move the Medicare program forward in ways that constrain spending and utilization. If not competitive bidding for lab testing services, then another scheme to achieve these goals would soon take its place.

Second, competitive bidding strikes at an interesting Achilles’ heel for the lab industry: the fact that private payers are given lower prices by labs in exchange for access to large patient volume. In some cases, it is Medicare work, reimbursed at higher levels, which subsidizes the pricing of these private contracts. Will Medicare officials succeed in using competitive bidding to bring down the prices it pays for lab testing? If so, that could lead to major upheavals in how the private sector sets prices for lab testing services.

4.  IVD Industry Attracts New Players Prices for Molecular Firms Skyrocket

NEWS THAT SIEMENS AG had spent $14.1 billion to become the world’s second largest in vitro diagnostics (IVD) company was just one of several major developments in the IVD industry. (See TDR, August 6, 2007.)

To achieve this, Siemens bought its way to the top by acquiring, in order, Diagnostic Products Corp. ($1.9 billion),Bayer Diagnostics ($5.2 billion), and Dade Behring Corporation ($7 billion). These three acquisitions were done over a 16-month period.

Not to be overlooked is the $8.3 billion acquisition agreement that would have seen General Electric acquire most of the diagnostic businesses of Abbott Laboratories, Inc. The deal, announced in January 2007, was voided by the two parties in July 2007.

There was equally significant news from Roche Holdings. In June, Roche made a hostile tender offer for Ventana Medical Systems, Inc., offering to pay $3 billion for a firm that posted revenues of $282 million. Then, weeks later, in July, Hologix, Inc., agreed to pay $6.2 billion to acquire Cytyc Corporation (which had 2006 revenues of $602 million).

These transactions send a message: big labs and investors alike are bullish on the future of in vitro diagnostics and molecular test technology. In context with other top ten lab stories for 2007, it affirms the importance that lab testing will play as healthcare evolves.

5.  Lean/Six Sigma Techniques Gain Mainstream Acceptance by Labs

ITS ALWAYS DIFFICULT TO IDENTIFY the specific moment in time when an emerging trend reaches a tipping point and becomes mainstream.

For hospital and laboratory acceptance of quality management methods, such as Lean and Six Sigma, that moment was 2007. It’s when the use of quality management systems moved beyond first mover and early adopter hospitals and labs and went mainstream. (See TDR, October 8, 2007.)

As proof of this development, THE DARK REPORT offers the Lab Quality Confab conference, which took place in Atlanta on September 19-20, 2007. A sold-out crowd of 275 people showed up, including lab directors from Argentina, Australia, Brazil, Canada, Sweden, and the United Kingdom. More than 60 sessions focused on the use of Lean, Six Sigma, ISO 15189, and similar quality management programs in hospitals, health systems, clinical labs, and pathology groups.

Moreover, the collective lessons provided by these sessions demonstrated that these quality management methods are extremely effective at unlocking gains and improvements in reducing errors, boosting productivity, raising quality, and lifting patient satisfaction.

THE DARK REPORT expects to see a steadily growing number of hospitals, health systems, and laboratories embrace Lean, Six Sigma, and other process improvement tools. As they do, they will gain competitive advantage.

6.  EMR’s in Doctors’ Offices Trigger New Demands on Competing Labs

ITS A TREND THAT THREATENS the strong competitive successes many hospital laboratory outreach programs have enjoyed in recent years.

As larger physician groups take steps to implement electronic medical record (EMR) systems in their practices, they are fundamentally changing how they demand to interact with their laboratory providers. Quite simply, the EMR is a major step toward a paperless office and that motivates physicians to approach their laboratories and request electronic interface gateways that supports electronic test ordering and lab results reporting.

Should the laboratory provider drag its feet on implementation of such an interface gateway between the LIS and EMR, then the advantages are significant enough that physicians will talk to competing laboratories.

When this year’s Executive War College conducted a one-day program on LIS–EMR Electronic Gateways, a full audience of 300 lab executives and pathologists packed the room to hear from early-adopter labs, EMR firms, and laboratory informatics vendors. Most attendees freely admitted that their laboratory was already responding to requests from larger clients to install gateways to enable electronic test ordering and result reporting between the LIS and the EMR.

The message for lab directors is that it is time to craft a strategy for electronic connections to clients’ EMRs.

7.  Speedy Change in Six Lab Sectors Points to Accelerating Evolution

ONLY THE DARK REPORT HAS IDENTIFIED a remarkable development within the world of laboratory medicine. It is compelling evidence that the pace of evolution is accelerating across six identifiable sectors of the laboratory industry.

This analysis provided the facts and evidence to demonstrate how, within the past 24 months, each of these six lab industry sectors had undergone changes that were rapid, if not revolutionary! (See TDR, August 6, 2007.)

The sectors are: 1) managed care contracting for laboratory test services; 2) acquisitions of clinical laboratories; 3) new business formations and acquisitions within anatomic pathology; 4) new business formations and acquisitions of firms with molecular diagnostic technologies; 5) consolidation among the 15 largest in vitro diagnostics (IVD) companies; and, 6) consolidation and integration within the healthcare IT industry. Each sector involved companies serving the laboratory industry.

For laboratory directors and pathologists, this insight has important strategic implications. It demonstrates that a tidal wave of new technologies—ranging from molecular to software to automation—and fueled by a river of venture capital dollars, are creating an accelerating rate of change in laboratory medicine. That raises the stakes for any lab that adopts a “do nothing” or “wait and see” business strategy. Tomorrow’s lab winners will be those that respond proactively to the market.

8.  TC/PC Batters Anatomic Pathologists, New CMS Rules Offer Some Relief

IN 2007, PATHOLOGYS BIGGEST STORY was the accelerating erosion of specimen referrals as many office-based physicians took steps to capture, for themselves, revenues from anatomic pathology (AP) services generated by their patients.

TC/PC is the term often used to describe a variety of arrangements that allow referring physicians to profit from either TC (Technical Component) or PC (Professional Component) or both. Over the past four years, THE DARK REPORT has regularly reported on this important trend. (See TDRs, July 19, 2004; July 23, 2006; September 17, 2007.)

In its simplest form, it involves urologists, gastroenterologists, and similar specialists deciding to build their own pathology laboratories as a way to capture anatomic pathology revenues for themselves. Since these are the high-referring specialists for most pathology groups, loss of these case referrals can be financially devastating.

Some relief may be on the way. Effective January 1, 2008, new Medicare rules take effect that will restrict the circumstances under which physicians can mark up anatomic pathology services provided to their patients. (See TDR, November 19, 2007.)

It is unlikely that this round of new federal regulations will completely stamp out TC/PC arrangements. But it does put physicians on notice that federal health officials are concerned about this situation.

9.  Hospital CEOs Realize Capital Value By Selling Lab Outreach Businesses

FOR YEARS, MOST HOSPITAL CEOS have failed to recognize the capital value that is created by a profitable lab outreach program. However, that may be changing.

During 2007, two very successful hospital laboratory outreach programs were put on the market and sold so that the parent hospital or health system could tap the accumulated capital value of the revenue stream and apply those proceeds to other uses.

Coincidentally, Laboratory Corp- oration of America was the buyer in both sales. In June, it acquired DSI Laboratories, Inc., of Fort Meyers, Florida, from NCH Healthcare System, followed in September with the purchase of Pathology Associates (PA Labs, LLC) of Muncie, Indiana, from the joint venture which included Cardinal Health System.

The sale prices paid were not made public. But it is estimated that the sale price of DSI Labs was as much as $75 million. That is a big chunk of change for NCH Healthcare System, which, at the time the sale was announced, projected losses of as much as $20 million for 2007.

Of course, it shouldn’t be overlooked that Carilion Health System of Roanoke, Virginia, has a strategy to build its outreach testing business—and is bidding for these acquisitions as they come to market. These are all signs that hospital CEOs are learning that lab outreach can be a lucrative endeavor.

10.  Procter & Gamble Positions Itself To Retail Diagnostic Tests in Stores

PROBABLY ONLY CLIENTS and regular readers of THE DARK REPORT are aware that, during 2007, Procter & Gamble invested a third of a billion dollars to position itself to sell diagnostic test kits to consumers in retail stores.

On the same day last May that Inverness Medical Innovations, Inc., announced that it was the successful bidder forBiosite, Inc., Inverness and Procter & Gamble announced the formation of a joint venture between the two companies. In this joint venture, called SPD Swiss Precision Diagnostics, GmbH, Inverness and Procter & Gamble will cooperate to develop and market what they call “consumer diagnostics”—self-test kits to be sold to consumers in retail outlets. (See TDR, June 4, 2007.)

This development is important and is one that pathologists and laboratory executives should not overlook. That is because Procter & Gamble is one of the world’s most respected consumer products companies. When it selects a product category to develop, it invariably succeeds.

Thus, P&G’s interest in positioning itself to have access to diagnostic technology that will allow it to create and sell diagnostic test kits to consumers in retail outlets is significant for two reasons. First, it shows that P&G expects diagnostic technology to develop rapidly to support accurate, off- the-shelf test kits that consumers can use with confidence. Second, it shows that P&G believes that demand by consumers for such test kits will grow steadily.

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