Joint Venture In Phoenix To Be Copied Elsewhere

Reasons and motives behind this JV exist in markets throughout the United States

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CEO SUMMARY: Look for the Quest-Sonora joint venture to be followed by others in coming months. Competition and marketplace realities are forcing the three national laboratories to respond with groundbreaking strategies. Hospital laboratory partners in these deals can reap significant benefits with savvy negotiations.

SHARED EQUITY VENTURES between hospitals and commercial laboratories are tough to make succeed. Only a limited number of such arrangements currently operate in the United States.

As a joint venture, Sonora Quest Laboratories, LLC breaks new ground for one important reason: it is an attempt to respond to the realities of Phoenix’s advanced managed healthcare marketplace. Both Quest Diagnostics Incorporated. and Sonora Laboratory Sciences hope the joint venture combines the best of both laboratories to create a profitable new competitor in Phoenix.

This laboratory joint venture between Sonora and Quest also establishes a new precedent. Quest will transfer its existing operation to a new facility. The goal is to create a new core lab, under joint management, which is capable of handling the combined specimen volume from both companies participating in the joint venture.

It marks the end of an era when public laboratories dominated most regional markets, set pricing levels and were willing to increase their market share by pricing services greatly below cost.

In reality, the move by Quest to venture with Sonora is a “market partnering” strategy. Quest acknowledges that it failed to accomplish two things in Phoenix: make adequate profits and increase market share.

Sonora Quest Laboratories, LLC breaks new ground for one important reason: it is an attempt to respond to the realities of Phoenix’s advanced managed healthcare marketplace.

From that perspective, Quest’s partnering strategy represents good strategic thinking. As a national company, it decided to put its management time and resources into laboratory partnering models where better potential exists to increase revenue and profits.

By partnering with a strong hospital system, Quest reaps several direct benefits. First, it closes down a marginally profitable laboratory site in Phoenix and may actually gain an immediate increase in operating profit from its share of the joint venture (not counting one-time expenses of the transition).

Second, it gains a capable partner with clout in that healthcare marketplace. Over time, this aids in obtaining managed care contracts as well as improving access to physicians who are affiliated with the system.

Third, and probably the most strategic benefit, comes from the close working relationship Quest will have with the Samaritan Health System (owner of Sonora Laboratory Sciences). This should not be underestimated. THE DARK REPORT predicts that integrated delivery systems (IDS) will anchor healthcare services at the local level.

Invaluable Information

By becoming a partner with Samaritan, Quest accesses invaluable information, experience and insights into the needs and operational opportunities provided by integrated systems. It is a primary corporate strategy at Quest to “become a preferred partner” with integrated healthcare systems. Working with Samaritan is a way for Quest “to go to school” on the needs of integrated systems, then use this knowledge elsewhere.

Like THE DARK REPORT, Quest believes these integrated systems will be power players in every metropolitan area. Quest’s future, indeed the future of every commercial laboratory, depends upon developing profitable business relationships with such systems.

This is why Quest spent two years negotiating with Samaritan to form this joint venture. On one hand, it helped resolve the marginally profitable laboratory division in Phoenix. On the other hand, it made Quest a venture partner with a recognized and respected healthcare system.

One sign of Quest’s commitment to the success of the Sonora-Quest joint venture in Phoenix is their unprecedented willingness to contribute existing outreach testing volumes and revenues to the partnership. Further, Sonora was given lead in both ownership and operation of the joint venture.

Quest’s Priority

Another sign of the priority Quest places on their corporate strategy of joint ventures is the fact that Quest CEO Ken Freeman will sit on the Board of Directors for Sonora Quest Laboratories. This joint venture is receiving attention from the top executives at Quest because they intend to do everything possible to insure its success.

Laboratory executives should realize that the Quest-Sonora partnership is a direct result of marketplace realities. With both reimbursement and test utilization declining, neither laboratory had the potential to expand market share and test volume in Phoenix. By joining forces, they can achieve economies of scale and provide a state-wide level of service which neither laboratory could do alone.

Of equal importance, the fact that Quest is willing to consolidate its existing specimen volumes with Sonora illustrates a point THE DARK REPORT has preached for almost two years: managed care will not subsidize excess laboratory capacity!

Greatest Market Opportunity

The greatest market opportunity exists for those laboratory executives who recognize the truth of this economic fact and are the first in their market area to control how and when they eliminate their excess capacity.

California provides an example. Physicians Clinical Laboratories, Unilab and Meris continue to maintain independent lab systems which have excess capacity. They continue to operate under financial pressure. Layoffs and cutbacks take place at regular intervals.

In Phoenix, Quest and Sonora both chose to break the cycle and exercise market leadership. In theory, they should now prosper relative to their competitors in Phoenix. There is always risk to being a market leader. However, rewards are commensurate with risk and both laboratory organizations are now positioned to earn such rewards.

Regionalization Strategy
Integrated Systems Recognized As Major Force In Managed Care

EMERGENCE OF integrated healthcare systems as a vehicle for clinical and operational integration has a major impact on the way laboratories organize and deliver diagnostic services.

Integrated systems bring two critical changes to the market: how laboratory services are purchased and how laboratory services are used. Instead of individual physicians choosing a laboratory, as was common under fee-for-service, now “buying consortiums” decide which laboratory will be a provider. On the user side, clinical integration requires the laboratory to interact with physicians in non-traditional ways.

Quest Diagnostics Incorporated recognizes the strategic changes now transforming the laboratory marketplace. This led Quest to seek out partnerships with integrated systems in various cities.

“This transaction at Quest builds upon the experience that Ken Freeman had at Corning Incorporated,” stated James Chambers, Vice President, Administration. “Joint ventures were a successful business vehicle for that company. It is reasonable to expect that similar joint ventures can succeed in healthcare.

“We believe that joint ventures are an effective way to build value,” he continued. “However, it is essential that the participants have shared values. When you snuggle up to a partner for the long term, shared values play a major role in the success or failure of the venture. During the two years of negotiations with Samaritan, both organizations came to realize how much was shared in common by both groups.”

Chambers acknowledges that Quest has laboratories which have not performed well. This influences the joint venture strategy. “Of course we have a number of laboratories in our national system which are marked by low profit margins or low market share. As reimbursement decreases and utilization declines, those laboratories become increasingly difficult to sustain over time.

“This made us appreciate the mutual benefits which would follow from aligning with a significant player in these cities,” observed Chambers. “You can expect to see Quest explore similar arrangements throughout the country. We believe there is synergy in combining the things we do well with the individual strengths of locally based integrated healthcare system.”

Don’t expect a cookie-cutter approach with Quest. They appreciate regional differences. “We absolutely see different healthcare structures in different cities,” explained Chambers. “We tailor solutions on a region-by-region basis. Further, we know that rapid evolution in the marketplace requires each unique joint venture to evolve and adapt over time.”

Because of Freeman’s background with quality management principles, one value Quest Diagnostics Incorporated seeks in a potential partner is a focus on process. “This is an important shared value for both of us,” noted another executive with the joint venture. “If a partner understands the importance of process as a way to evolve with changes to technology and the marketplace, it permits the resulting joint venture to successfully adapt as healthcare is transformed from fee-for-service to managed care.”

Another Motive

It is also important to understand another motive behind Quest’s willingness to dismantle the Phoenix laboratory and pool their specimens and revenues with Sonora. Quest understands that “value-added” in the future does not lie in performing diagnostic tests. Rather, it derives from information, knowledge and management contribution.

Why are computers and Nike athletic shoes designed in the United States and manufactured overseas? The added value is in design and information, not in assembly of the final product.

This is why Quest is beginning to strip out the “manufacturing” component of diagnostic testing. It is beginning its evolution into an information-based diagnostic provider. There will be a transition period in the clinical marketplace before this becomes a widespread phenomenon. But Quest is positioning itself early on this curve.

Further Speculation

THE DARK REPORT can speculate further. With Quest’s experience in total laboratory automation at major laboratories in St. Louis and Denver, it may be that Quest also recognizes how rapidly point-of-care and near-patient testing technology could render the centralized laboratory obsolete.

Again, this would be one more strategic reason for Quest to begin evolving from a “laboratory test result manufacturer” toward a “clinical information provider.”

It is precisely this strategy which drives UroCor, Inc. of Oklahoma City. Guided by this vision, UroCor’s revenue and profit growth during the past four years is exceptional, a track record not shared by any public commercial laboratory during the same period. Urocor’s success demonstrates the importance of diagnostic information in a value-added context. (See TDR, June 23, 1997.)

As THE DARK REPORT’s analysis of the Sonora-Quest joint venture indicates, there are several sophisticated management strategies at play. Financial motives may have impelled Quest to solve its Phoenix problems, but the solution is actually a futurist strategy.

Obvious Cost Gains For Sonora & Quest

In combining the two laboratories, these elements represent the immediate financial benefits to both laboratories:
Lower Average Cost Per Test: By combining specimen volumes, a lower average cost-per-test results.
Consolidation of Laboratories: Eliminates duplicate instruments, couriers, excess capacity and redundant staffing.
Managed Care Contracts: Both laboratories have different contracts, so the combined laboratory can serve more physicians.
Service Infrastructure: Combining both labs improves courier route structure and offers improved access throughout the entire state at draw sites and stat labs.
Mass Purchasing: Because of Quest’s buying power, it brings significantly lower prices for instruments, reagents and supplies to the partnership.
Reference Testing: Were the joint venture given Quest’s preferred internal pricing for reference testing, valuable savings could result.

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