Hospitals Saw Several Benefits In Forming Laboratory Joint Venture

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CEO SUMMARY: For the past eight years, growing numbers of hospitals and health systems have launched laboratory outreach programs. Hospital CEOs are recognizing that laboratory outreach programs generate worthwhile operational gains, along with steadily-increasing revenues. However, laboratory outreach programs also require a significant capital investment, because the hospital laboratory needs to match the service levels of other laboratory competitors in the community. At MountainStar Healthcare Network in Salt Lake City, Utah, senior hospital administrators decided on a business strategy of partnering with Pathology Associates Medical Laboratories (PAML) of Spokane, Washington. PAML would bring the necessary capital and management expertise to the laboratory joint venture. MountainStar would provide the laboratory testing resources.

“We expect our lab venture with PAML will help us realize several goals. By expanding the number of physicians utilizing our lab, not only will we enjoy more specimen volume and greater revenues, but the laboratory relationship also gives us the opportunity to encourage these same doctors to refer more patients to our other hospital services.”
—Matt Dixon, COO, St. Mark’s Hospital, MountainStar Healthcare Network

FOR MORE THAN 25 YEARS, the overwhelming majority of hospital CEOs and administrators have proven decidedly resistant to the concept of laboratory joint ventures involving their hospital laboratories and outside lab companies.

Among the nation’s 4,800 hospitals, examples of a laboratory testing joint venture involving a hospital laboratory and an independent lab company are scarcer to find than the proverbial “hen’s teeth.” Despite the excellent service and financial performance sustained by a handful of successful laboratory joint ventures, it is a business opportunity that hospital CEOs and their administrators are reluctant to embrace.

That’s why the recent decision to launch a laboratory joint venture by leaders at two of the hospitals in the MountainStar Healthcare Network in Salt Lake City, Utah, deserves closer study and understanding. MountainStar is an eight-hospital health sys- tem owned by Hospital Corporation of America (HCA), of Brentwood, Tennessee.

Called MountainStar Clinical Laboratories LLC, the new laboratory joint venture consists of the labs of 297-bed St. Mark’s Hospital of Salt Lake City, Utah, and 116-bed Lakeview Hospital of Bountiful, Utah, in partnership with Pathology Associates Medical Laboratory, Inc. (PAML) of Spokane, Washington. In the interview that follows, hospital administrators from MountainStar discuss how they evaluated the opportunity and why they supported the creation of the laboratory joint venture. This complements an earlier interview that THE DARK REPORT conducted with executives from PAML about the joint venture. (See TDR, December 10, 2007.)

Participating in the interview from St. Mark’s Hospital were Matt Dixon, Chief Operating Officer, and Jane Newhall, M.T., Director of Laboratory Services.

EDITOR: What was it about a laboratory joint venture that caught your attention back in 2003? Also, what triggered the momentum that sustained the joint venture concept through a proposal and into a working venture?

DIXON: Initially, we saw two significant opportunities. First, we recognized that a growing outreach program would feed steady increases in specimens to our clinical laboratories. Obviously, that had the potential to generate economies of scale, particularly because our lab instruments could be used more productively.

EDITOR: Was the fact that this increased outreach volume would lead to a lower average cost per test for both inpatient and outreach tests considered to be a direct benefit?

DIXON: Yes. Further, we knew our lab had excess capacity and our instruments were available to handle the outreach testing as it came in later in the day and in the evenings. Second, we knew that the outreach volume would translate into increased earnings. Both of those factors made the laboratory joint venture an attractive proposition.

EDITOR: Were there any other important factors that helped in this decision?

DIXON: One other big opportunity helped sell the deal and it was probably just as important as the direct financial advantages. This other opportunity was the chance for the hospital to sustain and improve physician relations and to have a presence with those physicians in their offices that we did not have at the time. We did not have a dynamic outreach program and so were losing out on the opportunity to have that daily relationship and establish electronic links into the physicians’ offices.

EDITOR: It is widely recognized among hospital lab directors that the outreach lab program is usually the hospital’s first clinical service to establish these electronic ordering and reporting bridges, and the daily relationship the lab has with office-based physicians strengthens the relationship the physicians have with the hospital.

DIXON: We agree with that point. In our area, the national lab companies have used connectivity as a competitive edge. We knew our hospital would have to do better. Plus, we knew that we could not develop a state-of-the art informatics and connectivity solution on our own. We placed significant value on PAML’s connectivity services to physicians’ offices.

EDITOR: Is another primary goal in this joint venture is to use the outreach lab program as a bridgehead to build stronger relationship with physicians?

DIXON: Yes. We believe the joint venture will help us achieve this in several ways. For example, the joint venture’s sales reps will be gathering intelligence on what the physicians need and we want to react in ways that meet those needs. As physicians look at our hospital, it is easier for them and their patients if they have a one-stop shop. That eliminates the cost and confusion of attempting to coordinate patient care across four or five different entities. We want to provide all those services in a seamless fashion from one hospital. That is all part of a broader strategy that we our hospital is looking to execute. We believe a successful laboratory outreach program can support this primary business strategy.

EDITOR: This is good background for your interest in laboratory outreach. Describe how you evaluated the laboratory joint venture proposal.

DIXON: Well, we see two opportunities in lab outreach. One, we have 600 physicians on staff. We serve their inpatients very well. The real growth opportunity is to expand our laboratory outreach services to those 600 physicians’ offices and to physicians who are not affiliated with our hospital. The new lab joint venture is focused on these two opportunities.

EDITOR: Besides the income generated by the lab outreach program, is the hospital’s more global strategy to use the laboratory to build inpatient admissions?

DIXON: Definitely. We want these physicians to see our hospital as a partner for their needs. If our lab serves them effectively and efficiently, it makes them confident that they can refer their patients to our hospital. We want to leverage that relationship with our lab to generate more outpatient referrals and inpatient admissions. This is one way our lab outreach program can benefit other areas of our hospital.

EDITOR: As you describe this, it sounds like you were wrestling with a fundamental decision, should you build the outreach program by yourself, or should you ally with a partner, like PAML, who can contribute capital and expertise?

DIXON: That hits the nail on the head. However, this decision included one more dimension, because our hospital is owned by Hospital Corporation o f Am e r i c a ( H CA ), of Brentwood , Tennessee. HCA is a large company and owns more than 160 hospitals nationwide. At any one time, there are numerous projects competing for resources at the corporate level. When PAML approached us in 2003, many of the issues associated with a laboratory joint venture had to be addressed at the corporate level. As you can imagine, it is difficult at the hospital level in our company to simply say, “Let’s go out and develop a lab interface that we can use to link with a physician-office EMR.” If that’s our goal, it has to be proposed to corporate and reviewed. Corporate must determine whether they want to fund it, which requires time since our request for resources is jostling for attention with other important initiatives and priorities that HCA is pursuing.

EDITOR: This is interesting, because many of our readers know that HCA is a for-profit company. Thus, how and why they favorably reviewed this laboratory joint venture will be of high interest.

“We want to leverage that relationship with our laboratory to
generate more outpatient referrals and inpatient admissions.”
–Matt Dixon

DIXON: That is true, because, as your readers know, labs don’t always get a lot of attention, since clinical laboratories lack much visibility within a hospital. For lack of a better word, it’s not as sexy as some other services we offer, such as outpatient imaging or the ambulatory surgery center.

EDITOR: So what made the difference at HCA corporate?

DIXON: Administrators here realized that PAML was offering an opportunity for St. Mark’s to address several challenges it had in its local market. These included an existing outreach program that had the potential to produce much more, plus the lack of a connectivity solution for office-based physicians.

EDITOR: What was attractive about PAML’s laboratory joint venture proposal?

DIXON: PAML has a track record in building outreach business, as demonstrated with other hospitals in other places. In many ways, PAML was offering to help us address some of our own weaknesses. We already had in-house lab testing facilities that have turnaround times that can’t be beat. We already had the equipment and we are a well established hospital with a long history of more than 130 years in Salt Lake City. PAML offered to give us some of those missing pieces, among which is the ability to interface with the physician office EMRs. And PAML already had effective systems to handle the couriers, the ordering, and the logistics. In effect, PAML had all the ingredients to energize our laboratory outreach program and help it achieve a much higher level of success.

EDITOR: Having recognized the potential benefits from a laboratory joint venture, what were the next steps in selling this idea up the line to HCA?

DIXON: At that point, we needed to introduce the idea to the different departments. PAML had developed the concept of the lab joint venture and it did pro forma financials about our current market. So, we took the financial pro forma and business concept to a number of corporate departments for their review. The goal was to ensure that the laboratory joint venture structure was sound and legal. We also had to introduce it to our billing and compliance departments to make sure that we could operate within the design of the joint venture.

EDITOR: Was this a complicated process?

DIXON: No, rather, it was a healthy give-and-take. HCA has smart, experienced, and well-qualified individuals in these departments. As we described how we intended to make the joint venture work—from an operations point of view—the idea was met with a healthy dose of skepticism. As questions were answered and due diligence took place, it was seen that the laboratory joint venture was a good idea. It was also recognized that the upside benefits from capturing more business in our market far out-weighed the downside risks.

EDITOR: What other elements helped in this evaluation process?

DIXON: Another important factor in helping to sell this idea to corporate was PAML’s experience with hospital laboratory joint ventures. PAML’s history of having done this in multiple markets and having a track record of success adds to the argument that this venture would succeed. We visited several of the other joint ventures that PAML developed to see their operations and get a feel for what to expect going forward. That certainly helped in getting the approval from corporate.

EDITOR: Changing course, who were the internal champions of the idea at St. Mark’s and what specific benefits did they recognize that kept the proposal moving toward implementation within HCA?

“PAML was looking for a joint venture partner and they were going to find one in Salt Lake City. My biggest concern was that, if we did not join with them, they would become another competitor. ”
–Jane Newhall, M.T.

DIXON: Our laboratory director, Jane Newhall, championed it from start to finish. She was integral in keeping it in front of everyone. About two years ago, I joined St. Mark’s as Chief Operating Officer. Along with other members of our administrative team, we took the time to study the laboratory joint venture proposal and understand its upsides and downsides. Throughout this time, Jane, as the director of our laboratory, did a very good job of explaining the strengths of the idea and pitching it to us as we went through our skepticism and did our due diligence. So, she should be the one who addresses that issue.

NEWHALL: Basically, from start to finish, from when PAML first approached us about four years ago, it was a matter of explaining it to everyone who was involved. We started discussing the possibilities of the lab JV with our previous administration before they moved the proposal to the division level. That was to our benefit, because then we had people at the division level who understood the issue and this understanding helped us in the long run. When Matt came on board, it was my job to push it from the lab standpoint. HCA has furnished our lab with top of the line equipment, including dual analyzers in every department. So we had analyzers with plenty of capacity that were not being fully used. Utilizing this capacity was another reason we found the lab joint venture to be advantageous.

EDITORS: Did any other factor play a role in these decisions?

NEWHALL: We also recognized that PAML had the marketing and sales capability to more than double the specimen volume that we have now. We can accommodate those specimens without adding people because of the equipment in our fully automated lab. When you look at it from that perspective, it makes perfect sense. We said, “Let’s get these machines running at full capacity and make them pay for themselves.” In the lab business, the more work I do, the less it costs.

EDITOR: How did St. Mark’s view its ability to compete against other labs?

NEWHALL: That question needs to be answered in two ways. On one hand, the Salt Lake Valley is a unique market and I was concerned about our ability to compete against Quest Diagnostics and LabCorp. They have a strong presence here. On the other hand, we recognized that PAML, which had recently acquired a lab in Salt Lake City, is an extremely aggressive company in a good way.

EDITOR: Explain that, please.

NEWHALL: PAML was looking for a joint venture partner and they were going to find one in Salt Lake City. My biggest concern was that, if we did not join with them, they would become another competitor. So, if you look at it realistically, that means we really would have had three competitors: Quest Diagnostics, LabCorp, and PAML.

EDITOR: I can see how this assessment of the competitive balance in the Salt Lake Valley would encourage further discussions with PAML.

NEWHALL: Certainly. I like to say that, “It’s important to keep your friends close and your enemies closer!” Not that PAML is our enemy, but we knew they could easily be our competitor and we would rather have them on our side. We decided early on that we didn’t want to let them partner with any other hospital in our region. But that was not the major consideration.

EDITOR: What other elements came into play?

NEWHALL: We recognized from the start that PAML offered us an opportunity to work with people who could contribute operational and strategic business services in lab outreach that we could not provide on our own, as Matt explained earlier. In fact, from the time Matt joined St. Mark’s, he recognized the advantages of the proposed laboratory joint venture and was dedicated to the cause. He was constantly in front of corporate pushing this project forward. Plus, at the corporate level, his credibility and commitment helped to bring this business concept to fruition.

EDITOR: We understand that St. Mark’s had done its own studies about the lab outreach market. How did these internal studies influence the evaluation of the proposed joint venture?

NEWHALL: We knew from the PAML projections that we would see increases in our lab testing volume and the St. Mark’s laboratory could accommodate that increased work without adding to staff or adding equipment. In fact, we already had first-hand experience with PAML’s ability to sell its lab testing services in a new market.

EDITOR: Had you done referral testing for them?

NEWHALL: Yes. For two years previously, under a separate agreement, PAML had contracted with St. Mark’s to do all of its microbiology testing for PAML. When this micro arrangement first started, we processed roughly 20 specimens a night. Over the past two years, that number grew to about 100 specimens. That’s a five-fold increase just in microbiology! For our laboratory joint venture, the projections are that our main lab, meaning chemistry and hematology, coag, and urinalysis, will see a
50% increase from current volume.

EDITOR: With increased test volume comes the ability to expand the in-house test menu and improve turnaround time. Did St. Mark’s recognize this as a benefit in the joint venture?

NEWHALL: The answer is yes. The agreement allows us to regularly determine whether it makes sense to set up tests in-house rather than sending them out. This is another big advantage. Not only can we increase our volume, but we can also increase our in-house menu of tests. That is positive for physicians and patient care because, when we do tests in-house, we deliver faster turnaround time for results and have greater control over the tests.

DIXON: To put the issue into context, as we worked with PAML to put this deal together, several market studies were done on lab volumes and where the lab volumes were going. In the immediate vicinity of St. Mark’s Hospital, meaning the five blocks surrounding the hospital, we hold about a 20% market share of the outreach volume. But within this five-block area, many of those medical office buildings are physically attached to the hospital and that’s significant. Few physicians in those five blocks have to walk outside and cross the street to get to our hospital. Their office building is physically connected to our hospital.

EDITOR: That’s quite a built-in marketing advantage for your hospital laboratory outreach program.

NEWHALL: That’s why we believe it is a reasonable goal to capture 80% to 90% of the market share from this medical campus. It gives us lots of confidence that, over the next five years, this joint venture is going to be a big win for us.

EDITOR: Could you speak to the general benefits identified by St. Mark’s that would result from this laboratory joint venture?

NEWHALL: On the revenue side, this laboratory joint venture will make a significant contribution that will increase as our market share expands. From an efficiency standpoint, there will be significant
improvements. One, the lab will enjoy continuous increases in economies of scale because we will get more from our fixed investments in assets such as analyzers and lab equipment. Two, it will make
lab labor more productive. Together, these two items will contribute to reducing the cost of laboratory services, on a per patient basis.

EDITOR: Strategically, I’ve picked up that the decision to develop the laboratory joint venture also stems from a general willingness of St. Mark’s and HCA to use market- driven opportunities to move forward.

DIXON: We believe that to be true. For example the business model developed by PAML is one that involves using healthcare dollars in a responsible way. When you consider some of the macro concerns of the healthcare system—such as the cost of care and how to increase efficiencies in the system—collaborations like this are what the healthcare system needs. These are the types of market-based solutions that can help control the rising cost of care while helping to achieve improved outcomes for patients.

EDITOR: Please continue.

DIXON: As health care administrators, we all have to ask ourselves, is there a need for us to invest in infrastructure and then for PAML to invest in very similar infrastructure, only to have both of use operate at only half capacity? If we can come together avoid duplicate investments, and put these fixed dollars in the system, then we can work together to do what we are both good at. In that way, we will be spending our healthcare dollars more wisely.

EDITOR: That leads to the last question. How do you think HCA corporate will evaluate the success of this laboratory joint venture? Will the success of this laboratory joint venture motivate them to consider the business concept for other HCA hospitals?

DIXON: That is very much a possibility and, of course, it is contingent on how we execute it here in our market. But, clearly we have blazed the trail with the legal, regulatory, compliance, and billing issues that we have resolved with PAML. So, for HCA to do this in another market should be a lot easier. It is possible that if the venture succeeds and generates the earnings that we anticipate in terms of physician relations, then this could be scaled to other HCA hospitals, absolutely.

NEWHALL: And I would add one other comment. The mission statement of the hospital is to provide care for patients in harmony with our long tradition of quality and caring and compassion. To me, it is a big benefit for our patients when their laboratory testing is performed here in our laboratory and not sent hundreds or thousands of miles away. By allowing us to expand and improve our laboratory services, this joint venture will help us further the long-standing mission of our hospital.

EDITOR: Thanks for sharing the process by which you evaluated this laboratory joint venture. It will help other hospital administrators rethink and reassess their strategies for using laboratory services to advance patient care.

NEWHALL: Thank you! On behalf of Matt and myself, we appreciate the opportunity to tell our story.

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