This section of the White Paper deals with the marketplace for laboratory services. For brevity and clarity, I will address five components: 1) independent commercial laboratories; 2) hospital-based laboratories; 3) esoteric, reference, and specialty testing laboratories; 4) anatomic pathology lab- oratories; and 5) diagnostics manufacturers and suppliers.
These groups represent the basic divisions within the competitive laboratory marketplace. Each group has characteristics that differentiate it from the other groups. However, identical economic, demographic, and clinical trends are impacting each group.
Industry segment #1
The most visible laboratories in the United States are independent commercial laboratory companies. These include the two blood brothers, Laboratory Corporation of America and Quest Diagnostics Incorporated, several public lab companies, and regional independent laboratory companies.
The heyday of the independent commercial laboratory passed early in the 1990s. Mergers, acquisitions, and bankruptcies caused widespread consolidation throughout the decade. As a result, the number of sizable commercial lab companies that survived is relatively small. If you take a cut-off point of $5 million in annual revenues, there are probably less than 100 independent commercial lab companies which meet or exceed that figure.
Widespread consolidation of commercial laboratories created some interesting consequences. First, independent commercial lab companies no longer dominate the physicians’ office testing segment the way they did in 1990. In response to this diminished sales competition, growing numbers of hospital laboratory outreach programs are building competitive and profitable footholds among physicians’ offices in their regional service areas.
Second, intense sales competition among public lab companies in the first half of the 1990s actually benefited the handful of surviving independent regional laboratories during the second half of the 1990s. In most major cities, there was financially-ruinous sales competition among national lab companies, such as Damon, MetPath, MetWest, Nichols Institute, National Health, Roche Biomedical Labs, SmithKline Beecham Clinical Labs, and the others. To generate new business, these companies offered unbelievable deals to physicians and payers. In client-bill states, test prices where heavily discounted to doctors. Labs provided phlebotomists in physicians’offices and offered offered rock bottom capitated rates to payers.
Such intense competition for new lab testing business literally ruined the market for all labs. It proved financially ruinous to all the large lab companies. The exception to this situation was a handful of pathologist-owned lab companies which never joined in the competitive, price-discounting frenzy. Instead, they emphasized good service to their physician clients, walked away from money-losing HMO contracts, and stayed focused on the needs of their local clinical community.
These pathologist-owned lab companies survived the financial turmoil of the 1990s in relative comfort. Few lost money and most have done quite well in recent years. With the benefit of hindsight, their pathologist-owners’ common sense in emphasizing good service and refusing to engage in loss-leader pricing allowed them to survive even as public lab companies were forced into mergers or bankruptcy.
During 2000, the commercial laboratory segment of the lab industry seemed to achieve a quiet status quo. LabCorp and Quest Diagnostics maintain focused sales and marketing efforts in the field. Both lab companies declare they are committed to only acquiring new business which is profitable. Moreover, the Two Blood Brothers are in a strategic race to reconfigure their lab testing services. Each company wants to shift away from a dependence on routine testing and its inadequate reimbursement.
In practical terms, this means that the commercial laboratory segment is in transition. The business model developed during the 1980s is no longer valid in the 2000s. The individual physician is no longer the major “buyer” of lab testing services. HMOs co-opted much of this responsibility during the last decade. The emergence of integrated healthcare networks (IHN) brought another class of lab testing “buyer” into the market. And of course, increasing numbers of consumers want control and influence over their laboratory testing.
So it remains unclear what business model will be adopted by commercial laboratories during the next market cycle. Important advances in diagnostic technology and how information is collected, stored, and accessed will create new opportunities for commercial laboratory companies. These technologies will probably allow commercial laboratories to offer a new menu of added-value lab testing services.
Until this happens, the current status quo is unlikely to change much. Lab testing will still be primarily a “local’ product, delivered by labs which are relatively close to the ordering physician. That means the national lab companies will be strongest in cities where they operate a large regional lab. Independent commercial labs will remain a viable competitor in their specific service areas.
Industry segment #2
Like the commercial lab segment, the hospital-based laboratory segment underwent widespread consolidation during the years 1995-1998. By the year 2000, hospital systems controlled more than 60% of the nation’s 4,800 non-government, acute care hospitals.
Consolidation of hospital ownership and management directly led to hospital laboratory consolidation and restructuring. Thus, in most urban markets across the country, the primary business model for hospital laboratories is the core laboratory. It is supported by rapid response labs in those outlying hospitals which are part of the health system. There may also be a laboratory outreach program which serves physicians’ office clients.
As a trend, hospital laboratory consolidation was rooted in an undeniable fact: almost every hospital had a significant amount of unused laboratory capacity, supported by redundant instrument systems to guarantee testing throughput. This “excess lab capacity’ was low-hanging fruit when hospital administrators looked for ways to cut the cost of lab testing.
But once this wave of lab consolidation passed, the need to further reduce lab testing costs did not go away. Today, hospital laboratory testing is directly influenced by two major forces. First, parent hospitals want sustained reductions in the cost of laboratory testing from year to year. Second, as integrated healthcare networks (IHN) take tangible steps to integrate both clinical care and healthcare operations, the hospital laboratory must respond to the changing needs of clinicians.
Harried lab administrators are devoting the greatest part of their time and effort to developing ways to further slash expenses in the laboratory. Precious little time has remained for these same lab administrators to develop innovative strategies for enhancing the value of laboratory services for the IHN and physicians that it serves. At some point, the lack of management resources devoted to improving lab testing services will have widespread impact across the hospital industry.
There was another interesting trend which began in the 1990s and will have profound impact on hospital laboratories during the early years of this decade. This is the trend of laboratory regionalization. The earliest regional laboratory networks were formed in Detroit, Pittsburgh, and San Francisco. Between the years 1996 and 1998, at least 35-40 regional lab networks were formed throughout the country.
Issues of control and trust among participating lab administrators made the organization and operation of regional lab networks a frustratingly slow process. However, a significant number of these lab networks remain active. More importantly, the most successful of these lab networks are proving that the business model works. Regionalization of lab services through collaborative effort can both reduce costs and lead to enhanced lab testing services.
At least two lab networks now exist which offer statewide coverage and have credibility with payers and clinicians alike. In one case, a lab network recently captured its state’s largest managed care lab testing contract. In another case, a lab network is in its second year of assembling statewide HbA1c test results on diabetes patients in a clinical repository. This data base of lab test results is helping clinicians more accurately measure their diabetes patient outcomes and improve their clinical treatment pathways.
These are two of the most impressive successes from the regional laboratory network movement. They demonstrate that regional laboratory networks still have the potential to deliver enhanced lab testing services to clinicians while reducing the cost of providing those services. Economic forces and the more sophisticated lab testing needs of clinicians will create the opportunity for regional lab networks to expand their role and importance to their local healthcare community.
During the current business cycle, the organization of hospital laboratory services will undergo radical change as a result of new technologies in diagnostics and information management. These changes will mirror the needs of the parent hospital or IHN, which will be undergoing its own path of radical change. Expect lots of testing to migrate out of the core lab into near patient, point-of-care, and patient self-test settings. Information management systems will be the glue that binds this new scheme for lab testing services.
It is tough to predict, with precision, how these new technologies will change the way hospital laboratories are organized and how they deliver testing services to clinicians. The capabilities of these technologies are still unknown. Moreover, the technology improvement curve is so rapid that what was definitely impossible in 2001 may turn out to be easily attainable in 2002.
Industry segment #3
Esoteric & Reference Labs
This is probably the most interesting segment of the laboratory industry. In the year 2000, it looks very different than it did in the year 1990. I consider this segment to include the national esoteric and reference labs which provide referral testing services to hospital labs and commercial labs.
Examples of national esoteric and reference testing labs would include ARUP, Mayo, Specialty, and AML. Both LabCorp and Quest Diagnostics maintain a substantial reference testing business for hospital labs. Niche, or specialty testing companies such as Esoterix, Inc., with its seven different specialty labs, would be another example. I would also include academic centers that offer specific reference and esoteric testing, as well as small niche labs closely tied to scientists responsible for developing specific diagnostic technology.
Ten years ago, it was relatively uncommon to find niche labs offering a menu of specialized esoteric tests to a national market. Typically, promising new esoteric or reference tests were licensed to national lab organizations. National labs had the resources to invest in educating the clinicians about when, why, and how to order new tests. They also had the sales and marketing team to call on the doctors, educate them about the tests, and convince them to start referring specimens.
What changed that situation over the last ten years is the growth of the overnight package delivery industry and the increased sophistication of long distance communications. These were the preconditions that make it increasingly easier for companies to develop a proprietary test and then market it directly to clinicians nationwide.
Also, developments in molecular and genetic science are creating a new class of research specialists who are experts in their specific niche. What niche labs offer to clinicians is not just a diagnostic test, but interpretation and follow-up by the researcher who developed the test. This specialized knowledge resource is tough to match for a national reference testing company offering literally thousands of different assays. Niche laboratories are using this benefit to their competitive advantage.
Another reason for the burgeoning numbers of niche testing laboratory companies is the venture capital industry. Simply put, there are lots of investors, with lots of money, who want to back promising diagnostic testing technology. They know the story of PCR and hope they can hit a similar financial home run in the diagnostics industry. These investors provide both capital and management expertise to researchers. They also prefer to directly market their proprietary esoteric tests, rather than license them to any of the national reference laboratory companies.
It is logical to expect continued growth in niche, or boutique, lab companies which offer a limited menu of proprietary reference and esoteric tests. Continued improvement in laboratory information capabilities will further reinforce this trend. It will become increasingly common for clinicians to refer both patients and lab tests to any specialist anywhere in the country. Advances in telemedicine, imaging, and information exchange will make this possible. (State and federal laws will be changed to accommodate this shift in clinical practices.) Widespread acceptance of out-of- area patient and test referrals will support the niche laboratory segment.
Industry segment #4
Several interesting things are happening within the profession of anatomic pathology (AP). Competition for AP specimens is increasing and the role of pathology subspecialists appears to gaining importance in the marketplace.
Both trends work against the continued success of a small pathology group practice serving a single hospital. For that reason, there will be be continued pressure on small pathology group practices to merge and consolidate.
This process of consolidation has been ongoing since the mid-1990s, when large numbers of hospitals formed integrated healthcare networks (IHN). As several hospitals came under joint ownership and management, eventually the pathology groups at the individual hospitals were asked to form a unified contracting and operating entity.
In most cases, pathologists formed a single, consolidated group practice to serve the needs of their IHN. It is interesting to note, however, that pathology group consolidation generally was a slower process and occurred after major consolidation and restructuring was done to the hospital’s clinical laboratory.
Also, several cities saw the formation of regional pathology practice “supergroups.” Participating pathologists recognized the business and professional benefits from a larger practice setting and voluntarily agreed to pool their AP practices.
Even as this consolidation trend was taking root, a new phenomenon emerged. This was the arrival of pathology-based physician practice management (PPM) companies. Inspired by the early financial success of PPM companies like MedPartners, PhyCor, and PhyMatrix, entrepreneurs believed anatomic pathology was ready for PPMs.
At least six pathology PPMs launched in the marketplace. AmeriPath, Inc. was first, and went public in the fall of 1997. During a two-year period, American Pathology Resources, Inc.; Pathology Consultants of America, Inc.; Pathology Partners, Inc.; PathSOURCE, Inc.; and USLabs, Inc. all received substantial venture capital funding. By the end of 2000, only AmeriPath, Pathology Partners, and USLabs remained independent. The other pathology PPM companies had merged or been acquired.
The second half of the 1990s also saw the emergence of national anatomic pathology companies. DIANON Systems, Inc.; IMPATH, Inc.; and UroCor, Inc. made anatomic pathology services a major component of their product mix. They sent sales people into every area of the United States to generate case referrals from local physicians.
Another notable effort was the formation of Pathology Service Associates LLC, a national organization of independent state pathology networks. Its business model is to support local pathology group practices, while giving them access to sophisticated business services necessary to be competitive in their regional market.
Taken collectively, these different business trends are reshaping the anatomic pathology profession. Pathologists are being asked to do several things simultaneously. First, both hospitals and payers want pathologists to upgrade their business skills and the management sophistication of their practice setting. The economics and structural changes to healthcare make this important for financial survival.
Second, the integration of clinical services means that pathologists must pay closer attention to the needs of their customers. This goes beyond the referring physician. It includes the patient, the payer, and the hospital. “Meeting customer needs” properly will require a comprehensive range of anatomic pathology services, complemented by the business tools needed to deliver and support AP clinical services.
In other words, just being good at anatomic pathology will no longer be enough. A successful pathology group practice must offer the necessary range of AP clinical services, then deliver reports and deal with the needs of different customers’including billing, clinical data repositories, etc.
There are also early signs of a growing division in the marketplace between local pathology resources, best typified by community hospital-based pathology group practices, and the increasing number of companies providing anatomic pathology services nationally. These national AP companies are financing national sales teams to visit local physicians and solicit their business. Since most local pathology groups do not support any sales reps, this puts them at a competitive disadvantage if a local doctor decides to refer his AP cases to a national company.
When taken collectively, all the trends and forces now reshaping the anatomic pathology marketplace do send one clear message: Successful pathology groups will be those that wrap their AP services with professional business services. This allows pathologists to emphasize their pathology skills, while insuring that their pathology group practice competes effectively in the competitive marketplace for healthcare services.
Industry segment #5
Diagnostics Manufacturers & Information Vendors
It is important to consider the changes taking place among vendors serving the laboratory industry. These companies must anticipate the needs of clinical laboratories several years in advance of their customers.
It is their products which enable labs to meet the evolving needs of hospitals, physicians, payers, and patients. Historically, there has been little product crossover between the companies which produce instruments and reagents and the companies which sell software and other lab information products.
In the market for diagnostic instruments and reagents, there are several new priorities affecting the design and operation of laboratory equipment. First, the widespread shortage of trained med techs is increasing the demand for a new class of diagnostic instruments one that is “load and walk away.” In response, both large diagnostics manufacturers and smaller companies are developing a host of instruments to meet this demand. It will be easier to find instruments which place little technical demand on the operator, whether a high-volume machine in the core lab or smaller instruments used at the point-of-care or in physicians’ offices.
Second, laboratories will have more choices when considering instrument systems. It is now easier for start-up companies to compete against the billion-dollar diagnostics giants. The reason is miniaturization. It is becoming increasingly cheaper and easier to build automated, stand-alone instruments that sell for a fraction of their high-volume cousins. One consequence of this trend is that the economics associated with smaller diagnostic instruments are changing. Not only will these instruments become easier to operate, but their QA/QC and cost per test will become more competitive with core lab testing systems. This will give laboratory administrators more options to meet the lab testing needs of clinicians in all settings within the integrated healthcare environment.
Third, clinicians continue to demand faster lab test turnaround times. They want lab test data to feed directly into integrated data repositories and be reported in real time. These changes in marketplace expectations have already caused diagnostics manufacturers to rethink the design of their instruments and how they feed data into the laboratory information system (LIS). Expect to see rapid enhancements to the information management capabilities of all classes of diagnostic instruments.
Changing expectations by clinicians and their laboratories are pushing diagnostics manufacturers to swiftly incorporate new technology and features into their instrument systems and test kits. But laboratory information service vendors face a more daunting challenge. The information revolution, as typified by e-healthcare commerce services, is about to make existing “fat client” software products obsolete. “Fat client” describes the business model where customers buy the software, run it on their hardware, and maintain it with their staff.
The information services market is shifting to “thin client’ and ASP (application service provider) business models at an accelerated pace. The reason is simple. ASP-based, thin client information solutions are cheaper and easier to use. In the short term, it is the problem of converting from fat client systems to thin client systems which will impede the introduction of these products in hospitals and laboratories.
For these reasons, the biggest healthcare and laboratory information system companies are at great risk. They must maintain revenues from the existing base of installed users (of fat client products) while simultaneously moving these same customers to cheaper, thin client products and services. In effect, they must cannibalize their own revenue streams if they are to survive.
Moreover, there will be new competitors entering the marketplace for lab information services. These new competitors will include diagnostic companies (which can accumulate the test data generated by their instruments) and reference laboratories (which are also generating test data). Even pharmaceutical companies may have an economic incentive to provide lab information services and improve their access to lab test data.
One consequence of the changes underway among diagnostics manufacturers and laboratory information service companies will be tighter supplier/customer relationships. The emphasis will shift away from purchasing based on cheapest price. Instead, it will shift to purchasing based on the overall package of added-value services a particular vendor can provide a particular laboratory. This shift is closely tied to economic transition from an industrial economic to an information economy.
In order to bring full value to clinicians, payers, patients, and hospitals, both laboratories and their various vendors will have to collaborate much more intensely than ever before. These customer/supplier relationships will grow more complex, but will will yield more value.