Commercial Lab JVs With Hospitals Are Declining In Number

Are These Joint Ventures A “Dying Breed”?

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CEO SUMMARY: There are many reasons why a properly-designed and well-managed laboratory test joint venture (JV) between a commercial lab company and a hospital should succeed. But no matter how strong such concepts look on paper, the real world has proven to be a harsh environment. A handful of promising JVs took root during the 1990s, but closures have thinned their ranks during the past two years. In fact, so many of these joint ventures have closed down in recent years that it might be accurate to declare commercial lab-hospital lab test joint ventures a “dying breed.”

IT’S TIME TO RECOGNIZE THE FAILURE of the business model which paired a commercial lab company with a hospital in a laboratory testing joint venture.

In concept, the idea made sense. Most hospital labs have unused capacity during evening and early morning hours—prime time for testing specimens from physicians’ offices. Commercial lab companies have expertise in sales, marketing, billing, collections, and other operational functions that complement the strengths of the hospital laboratory.

On paper, such a joint venture would seem well-positioned to profitably service the outreach market—those physicians who typically lease offices in the medical campus surrounding the hospital.

The merits of this business model were certainly obvious to the nation’s large public laboratory companies. Throughout the 1990s, these lab companies openly declared they would like nothing better than to develop joint ventures with hospitals and integrated healthcare systems.

Looking For Hospital Partners

To find willing partners and develop these deals, lab companies invested lots of money in flying sales reps and executives all over the country to meet repeatedly with hospital administrators.

However, after more than ten years of intense efforts to develop these joint ventures, commercial lab companies were unable to develop more than a handful of projects. And frequently the actual financial performance of these joint ventures disappointed both partners, but for different reasons.

To justify their involvement in the JV, the commercial partner needed regular distribution of profits generated by the venture. However, this often conflicted with the financial goals of the hospital partner, whose goal was to have profits used to lower the hospital’s cost for inpatient laboratory tests.

It was this inherent conflict over the use of profits, as well as the lackluster financial performance that caused a number of lab testing joint ventures between commercial laboratory and hospitals to unravel after a few short years. This usually occurred when the operating agreement came up for renewal.

End Of An Era

THE DARK REPORT believes that, if there ever was an era of the “commercial lab- hospital lab joint venture,” it has certainly ended with the acquisition of Dynacare, Inc. by Laboratory Corporation of America. That’s because Dynacare was most closely identified with these types of lab testing joint ventures.

Originally based in Canada, Dynacare entered the United States around 1994 with a specific goal: to build a profitable laboratory business based on doing laboratory testing joint ventures with hospitals. As most hospital lab administrators and pathologists can attest, during the balance of the 1990s, Dynacare sales people were frequent visitors to larger hospitals, always probing and trying to interest administrators in a laboratory joint venture.

Growth By Acquisition

One reason Dynacare decided to sell to LabCorp and cease operations as an independent company is because it was never able to develop enough profitable lab joint ventures with hospitals to generate the revenues needed to sustain its business operations. In fact, most of Dynacare’s revenue growth in the United States was actually from its acquisition of small independent lab companies in various regions of the country.

Dynacare did develop some notable joint ventures with hospitals and health systems. But it should be noted that Dynacare spent an inordinate amount of money flying its people all over the country to identify likely partners and develop deals from interested parties during the 1994-2001 period. If these marketing costs over seven years are tallied and divided into the handful of JVs which resulted from this marketing, Dynacare probably had a prohibitively expensive “marketing cost to acquire a new JV.”

Joint Venture Concept Like Mixing Oil & Water

WHENEVER THE SUBJECT of a joint venture between commercial lab companies and hospital labs comes up among hospital laboratory administrators, it stirs up lots of debate.

For whatever reason, putting hospital lab administrators together with commercial lab executives is like mixing oil and water. They have different business priorities that continually tug them in conflicting directions. This makes it difficult to find the common ground necessary to organize a lab testing venture that will be mutually profitable and long-lasting.

A well-conceived lab testing joint venture can provide many benefits to both partners. Through the years, THE DARK REPORT has toured a number of such JVs. It has observed, first-hand, significant achievements and happy partners. The mystery is why even some of the best-of-class JVs, after years of sustained success, are terminated by one or both lab partners.

Similar Business Plan

But Dynacare’s experience was not unique. Its sizeable marketing effort was mirrored by another Canadian company. MDS Laboratory Services entered the United States shortly after Dynacare with a similar goal: to develop collaborative lab testing ventures with hospitals and health systems.

MDS came to the joint venture concept differently. In the mid-1990s it had tried to sell its total laboratory automation (TLA) system to hospital labs in the United States and found no takers. Unable to sell its TLA system, MDS decided to create a collaborative business model where it would partner with a health system.

In this business model, MDS would build a state-of-the-art laboratory incorporating its automated equipment. MDS would manage the lab and, where possible, increase specimens into the JV’s new lab through a laboratory outreach marketing program. The hospital partner would contribute trained technical staff, inpatient specimens and other resources. The two partners would split profits and costs according to a pre-agreed formula.

Limited Number Of JVs

Like Dynacare, during the remainder of the 1990s, executives and sales reps from MDS criss-crossed the country hoping to interest hospitals and health systems with their collaborative lab testing business model. As was true of Dynacare, MDS spent scads of money on travel and salaries over several years, but was only able to develop a limited number of collaborative projects with hospital partners.

It was a similar story at Quest Diagnostics Incorporated and Laboratory Corporation of America during the 1990s. Each of the two blood brothers invested considerable sums of money attempting to develop joint ventures or collaborative lab testing agreements with hospitals and health systems.

In fact, in 1998, Quest Diagnostics signed a partnership agreement with Premier, Inc., the nation’s largest group purchasing organization. The objective of both partners was to develop partnerships with Premier member hospitals to improve their laboratory testing operations. (See TDR, May 26, 1998.) At the time, the news generated lots of excitement in the lab marketplace, but THE DARK REPORT is not aware of a single Premier hospital that entered into a collaborative lab testing agreement with the Quest and Premier consortium.

Similar Business Plan

Each of these examples supports the contention of THE DARK REPORT that the era of the commercial lab-hospital lab joint venture, if there ever was one, ended with the sale of Dynacare to LabCorp. The four big lab companies mentioned above invested disproportionate money into developing only a limited number of actual joint ventures with certain hospitals.

That is certainly confirmation that hospitals are generally hostile to the idea of partnering with a commercial laboratory company. Further confirmation of this fact comes from an analysis of those lab testing joint ventures which did become operational.

Dynacare is a good place to start, since its entry into the United States was predicated on a strategy of emphasizing lab testing joint ventures with hospitals. Its first JV was with Cedars Sinai Medical Center in Los Angeles. This project disappointed both partners and was not renewed after the three-year contract expired in 1997.

Lab Outsourcing Contract

One big financial success for Dynacare was its acquisition of Laboratory of Pathology (LOP) in Seattle. Acquired in 1995, LOP was an independent commercial laboratory owned by pathologists. Although Dynacare-LOP is closely identified with Swedish Hospital, the business relationship is not a joint venture. Dynacare-LOP holds a contract to provide inpatient laboratory testing to Swedish Hospital.

Another big win for Dynacare was its joint venture with Hermann Hospital in Houston, Texas, launched in 1996. Despite some early mis-steps, the Dynacare-Hermann venture did quite well in the outreach market. However, several years later Hermann Hospital was acquired by Memorial Health System.

Memorial, with 12 hospitals, wanted to integrate Hermann Hospital’s lab into its already-standardized regional lab division. First, it excluded Dynacare from participating in Hermann’s inpatient lab testing. It then declined to renew its outreach testing agreement in 2001, thus terminating the last elements of the original lab testing JV.

Several JVs Launched

During these same years, Dynacare entered into lab testing JVs with Ellis Hospital in Schenectady, New York; Froedtert Memorial Lutheran Hospital in Milwaukee, Wisconsin; University of Tennessee Medical Center in Knoxville, Tennessee; and Allegheny General Hospital in Pittsburgh, Pennsylvania.

At the time Dynacare announced its sale to LabCorp, it also disclosed that it was terminating its contractual relationship with Ellis Hospital and Allegheny General Hospital. This leaves it with only two operational joint ventures after almost eight years of non-stop efforts to develop such joint ventures.

It’s a similar picture at MDS. Since 1995, it developed two collaborative lab joint ventures with HCA Corporation, the for-profit hospital company. These are located in Atlanta, Georgia and Miami, Florida. It also has partnerships with Baptist Memorial Hospital in Memphis, Tennessee and a lab outreach JV with Duke University Health System in Durham, North Carolina. MDS also had a joint venture in Poughkeepsie, New York that was established with two hospitals back in 1988, known as MDS-Hudson Valley Laboratories, Inc.

For the marketing effort expended by MDS over the past seven years, this is not a large number of partnerships. One of these joint ventures was terminated. In 2001, the hospital partner of MDS-Hudson Valley Labs asked to cash out its partnership share and recast the relationship as an outsourcing contract.

Change In JV Status

MDS is thus the sole owner of MDS-Hudson Valley Labs and provides inpatient testing services on contract to Vasser Brothers Hospital and Northern Duchess Hospital. These hospitals were the two equity partners in the original MDS-Hudson Valley Labs venture organized back in 1988.

It should be noted that rumors regularly surface that the MDS-HCA relationship is strained due to the “disappointing” financial performance of the consolidated labs in Atlanta and Miami.” But these are long-standing rumors and neither partner has publicly disclosed any changes or proposals to alter the original joint venture agreement.

For Quest Diagnostics, the failure of the Premier partnering agreement to generate joint ventures has been accompanied by a couple of other set- backs. It had announced a collaborative relationship with Unity Health System in St. Louis, Missouri. However, this relationship ended within a few years.

Collapse of Long-Lasting JV

Of more interest is the recent collapse of a long-standing joint venture with multiple hospitals that Quest Diagnostics had in Lincoln, Nebraska. Clinical Laboratories of Lincoln, Inc. (CLL) was formed in the late 1980s when pathologists from the major hospitals in Lincoln proposed forming a for-profit lab company to run an integrated lab services company.

From a central core lab, CLL managed all inpatient testing for its hospital owners and maintained a thriving lab outreach program. Nichols Institute purchased CLL in 1986 and CLL became a Quest Diagnostics lab when it acquired Nichols Institute in 1994.

In the last six months, Quest-CLL has been dismantled. Several of the hospitals served by Quest-CLL did a cost analysis of the inpatient testing services provided by Quest-CLL. In the case of one hospital, it was determined that savings of $6 million per year could be realized if that hospital reconstituted its inpatient laboratory and managed it directly.

Quest-CLL’s hospital partners broke up the long-standing lab testing joint venture. Each hospital has pursued inpatient lab testing options it believes to be cheaper and more effective than what it received from Quest-CLL.

Disappointing Performance

In the late 1990s, American Medical Laboratories, Inc. (AML) developed a lab testing joint venture in Fairfax, Virginia with four hospital/health system partners. Called Shared Laboratory Services, Inc., the venture built a core lab in the late 1990s and had high hopes. But service problems and dissatisfaction with the operational execution of the venture caused one health system partner to pull out in 2001. Another health system partner is preparing to leave SLS soon as well.

Another notable and long-standing lab testing joint venture existed in La Jolla, California. It was started in 1994 by Scripps Healthcare and Pathologists Medical Laboratories, Inc. (PML). Based on its sustained success, the partnership was expanded in 1996 to include operation of the labs in hospitals newly-acquired by Scripps. However, two years later, new administration at Scripps summarily ousted PML and brought in Dynacare to manage its labs on contract. PML’s owner later won a multi-million dollar lawsuit against Scripps for its arbitrary actions in terminating the joint venture.

International Clinical Labs Mastered Hospital JVs During Decade of 80s

MAYBE THE HIGHWATER MARK for lab testing joint ventures between commercial laboratories and hospital laboratories was the 1980s.

Laboratory executives with long memories recall that International Clinical Laboratories, Inc. (ICL) had a knack for developing lab testing joint ventures with hospitals. ICL had more than 40 active JVs with hospital laboratories prior to its acquisition by SmithKline Beechman Clinical Laboratories in 1988.

Because of its success in developing joint ventures with hospitals, ICL was much-admired by its commercial laboratory competitors. One of its earliest joint ventures continues today. CompuNet Laboratories, Inc. of Moraine, Ohio is a three-partner joint venture. Equity participants include Miami Valley Hospital and Valley Pathologists, the pathology group affiliated with the hospital, and Quest Diagnostics Incorporated.

CompuNet Laboratories was originally formed in 1987 by ICL. The first general manager for the joint venture was Bill Pesci, who is still in the lab business and is Executive Director of the Carolina Laboratory Network in Charlotte, North Carolina.

Over the past two decades, CompuNet survived a series of acquisitions involving its commercial laboratory partner. ICL was sold to SmithKline Beecham Clinical Laboratories. In 1999, Quest Diagnostics purchased SBCL and thus inherited SBCL’s equity stake in the CompuNet joint venture.

Two Important Points

This rather long litany of collapsed lab testing joint ventures in recent years makes two important points. First, despite the substantial money spent by commercial laboratory companies to market this concept to hospitals, there have been few takers.

Second, a high proportion of the joint ventures developed during the last decade did not survive. In most cases, the hospital partner moved to terminate the joint venture.

Based on these facts, THE DARK REPORT concludes that the concept of a lab testing joint venture between commercial labs and hospitals is impractical. Despite the obvious mutual bene- fits to both parties on paper, in the real world the needs of hospitals to lower costs and improve inpatient testing services seem to conflict with the needs of commercial lab companies to generate and distribute profits from the joint venture.

However, this is not the end of the story. There will always be a small slice of the hospital industry willing to experiment with commercial labs to find a business formula that works. These evolving experiments may guide the lab industry to a new lab testing joint venture business model that actually delivers substantial benefits to both hospitals and their commercial laboratory partners.

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