CEO SUMMARY: Once again, Ken Freeman and Quest Diagnostics Incorporated is altering the national market for clinical laboratory testing. By acquiring American Medical Laboratories and Unilab, the nation’s largest lab company is expanding its presence in California, Nevada, and Washington, DC. In this exclusive interview with THE DARK REPORT, Chairman and CEO Ken Freeman explains the strategic business reasons why Quest Diagnostics pursued these two acquisitions. He also talks about important trends in the marketplace for clinical laboratory testing. The interview was conducted by Robert Michel, Editor-In-Chief of THE DARK REPORT.
“We are striving to create a full array of products and services that meet the needs of physicians and hospitals.”
EDITOR: Taken together, the acquisitions of American Medical Laboratories, Inc. (AML) of Chantilly, Virginia and Unilab Corp. of Tarzana, California represent an investment by Quest Diagnostics Incorporated of about $1.7 billion dollars. That’s a huge investment. What does Quest hope to accomplish with these transactions?
FREEMAN: Robert, we see four primary benefits. One, it helps us broaden access and distribution for patients and physicians. Two, it’s an opportunity to further accelerate growth in two segments of testing—esoteric and gene-based assays. Three, it expands our access to some highly-desirable geography. Four, both companies bring talented people into our company.
EDITOR: Could you elaborate on the geographical aspects of these two acquisitions?
FREEMAN: The Las Vegas lab facility of AML gives us a sizable laboratory presence in Nevada. Las Vegas is a very attractive market for lab testing because it has been the nation’s fastest- growing metropolitan area since the early 1970s. AML also has extensive lab business in Washington, DC and Northern Virginia.
EDITOR: What about California, where Quest already has a presence?
FREEMAN: According to census data, California has the largest year-to-year increase in population of all 50 states, so it is also a fast-growing market for laboratory testing. Unilab brings us an extensive infrastructure of patient service centers and rapid response laboratories in that state.
EDITOR: Turning to the AML acquisition, you’ve commented publicly that you intend to maintain the company’s reference and esoteric testing activities at the Chantilly laboratory.
EDITOR: You’re on record as stating that gene-based testing at Quest Diagnostics is a fast-growing segment of the business, and AML’s reference testing division is expected to contribute to this growth. Could you provide some details?
FREEMAN: Let me approach it this way. Esoteric testing, including gene-based and non-gene-based, comprises 13% of our revenues, which were $3.6 billion in 2001. Gene-based testing at Quest Diagnostics is growing by 20% per year and totaled about $275 million in 2001. Non-gene-based esoteric testing is growing about 10% per year and totaled $200 million during 2001.
EDITOR: And you expect these growth rates to continue?
FREEMAN: Yes. As individual esoteric assays gain widespread clinical acceptance, they tend to become “routine” lab tests. That is one of the evolutionary drivers to the laboratory business. We believe this same phenomenon will happen to gene-based testing in coming years.
EDITOR: That nicely frames the rea- sons why Quest was interested in AML’s esoteric testing business. You see it as a fast-growing part of diagnostic testing. But I suspect there are other strategic business reasons for the interest in AML’s esoteric division.
FREEMAN: True on both counts. The events of September 11 certainly showed how dependent the lab industry is on the air transport system. For example, about 95% of our highly-esoteric testing is sent cross country to Nichols Institute in Southern California. AML’s esoteric laboratory in Chantilly gives us the ability to perform a full menu of esoteric testing on both coasts. We consider this to be an important strategic growth opportunity for Quest Diagnostics.
EDITOR: That would certainly give you a unique feature in the marketplace. No other national esoteric testing lab currently performs testing on both coasts.
FREEMAN: We expect to use AML’s Chantilly lab facilities to improve the turnaround time for highly-esoteric testing. That will be good for hospital clients, physicians, and patients.
EDITOR: If Quest Diagnostics is to realize the full potential of AML’s reference and esoteric testing assets, it must become more successful in developing send-out business from the nation’s hospitals. Is this true?
FREEMAN: That’s correct. Your readers know that hospitals send out about 3% of their test volume—those tests which are highly-esoteric and are not time-dependent. As Quest Diagnostics moves forward, it has the paradox of being a competitor with hospitals that perform outreach testing as well as a provider of testing. This kind of paradox is not unique to healthcare. It exists in many industries. We understand that we must distinguish ourselves to succeed in this market segment.
EDITOR: When marketing to hospitals for their send-out testing, how will Quest set itself apart from competing reference labs?
FREEMAN: First, we have the opportunity to provide unsurpassed quality. As you know, we are implementing Six Sigma methods to boost the level of performance in all aspects of our company’s services. Second, we offer the broadest menu of testing available in the lab industry. Third, we have over 300 M.D.s and Ph.D.s who are available for physician-to-physician consultation on the most complex cases. Fourth, we have a comprehensive array of connectivity options. For hospitals, our MedPlus division offers an electronic medical record (EMR), called ChartMaxx™ . An Internet-based EMR, called eMaxx™, will be available later this year. Fifth, we are consistently among the first labs to offer the most innovative new tests. Access to such testing is particularly valuable to hospitals seeking to maintain close relationships with physician-specialists.
EDITOR: Certainly that is a full menu of service options. From my perspective, the two key differentiators will probably turn out to be service—once the full impact of Six Sigma takes effect on Quest’s work flow processes—and early access to new lab test technologies. If Quest Diagnostics uses Six Sigma principles to noticeably reduce error rates in logistics, specimen handling, lab accidents, billing mistakes and the like (which are common to most laboratory operations today), that would certainly encourage hospitals to overcome their reticence to send specimens to a lab competing in their outreach market. Equally important, I think, will be the early, sometimes exclusive, access that you and Laboratory Corporation of America, as national lab providers, will have to new diagnostic technology.
FREEMAN: I fully agree. My commitment to improving our basic lab services is such that I personally certified as a Six Sigma Black Belt. This requires four full weeks of training and personally leading improvement projects. Our company goal is to constantly eliminate the sources of errors that are common to all laboratory operations. At the same time, access to new technology is important to differentiate Quest Diagnostics. We’ve seen big changes in this area.
EDITOR: In what way?
FREEMAN: When I first joined the lab business six years ago, our phone in Teterboro was certainly not ringing off the hook with phone calls from innovators wanting to offer us new tests and new concepts for the lab marketplace. What a change in five years! Every week we now get at least one call from a start-up company or institution wanting to explore how Quest might help introduce their product or service into the national marketplace.
EDITOR: Quest’s ability to gain “first access” to new diagnostic technology on favorable terms is certainly demonstrated by any number of agreements already on the books. For example, the 1998 agreement between Cytyc Corporation and Quest which made ThinPrep® the exclusive enhanced Pap test at Quest certainly illustrates this competitive benefit. HIV typing and viral load testing is another area of early-mover advantage.
FREEMAN: Yes. Similarly, we recently signed agreements with Roche Diagnostics to develop and commercialize gene-based tests and with diaDexus, Inc. to license its proprietary technology to detect and monitor osteoporosis.
EDITOR: Clearly one message that Quest is sending to the lab marketplace with its AML acquisition is that it intends to become a more forceful competitor in the hospital send-out segment of lab testing. Can we shift gears now and talk about the Unilab acquisition and its impact on your strategic business plans? Certainly California has proven to be a financially-challenging state for clinical laboratories.
FREEMAN: That’s true. We have no misconceptions about the difficulties which lie ahead. But we believe that Unilab is a great fit with our organization. It has an unmatched service infrastructure throughout the state and strong relationships with the major insurance companies and IPAs (independent physician associations).
EDITOR: However, Quest Diagnostics has its own considerable service infrastructure in California. The need to rationalize and integrate the two lab organizations triggers a different set of management challenges.
FREEMAN: We have two strong cards to play. One, I consider Quest Diagnostics to be battle-tested in this management area, as evidenced by our smooth integration of SmithKline Beecham Clinical Laboratories (SBCL). Two, many members of Unilab’s management team, led by its current President and CEO Bob Whalen, will stay on. They’ve already demonstrated their ability to handle California’s rough-and-tumble lab marketplace.
“My commitment to improving our basic lab services is such that I personally certified as a Six Sigma Black Belt.”
EDITOR: In fact, it should be recognized here that Quest Diagnostics’ acquisition of SBCL and its subsequent integration was, without question, the best job of post-acquisition management seen in the public lab company sector since the mid-1980s. Compared to the go-go lab acquisition wave of 1985-1995, there were relatively few significant problems and very little of the acquired SBCL business was lost in the post-acquisition period. That is certainly good evidence that Quest is capable of smoothly integrating its California laboratory operations with those of Unilab.
FREEMAN: We expect that to be true. Plus, the leadership of both Unilab and AML will remain to help with these transitions. Robert Whalen, President and CEO of Unilab and Tim Brodnick, President and CEO of Unilab, are each strong and capable leaders. Both individuals have demonstrated their ability to create a customer-focused laboratory organization. We are pleased that, going forward, they will continue to contribute as part of the team at Quest Diagnostics.
EDITOR: You’ve mentioned electronic connectivity options between Quest and its hospital customers. Since Unilab had its own connectivity strategy with physicians, what type of strategy will Quest Diagnostics deploy in California?
FREEMAN: We believe that electronic connectivity between our labs and our lab customers, whether hospitals or physicians, is one way we can differentiate ourselves from other lab competitors in the marketplace. We are creating a suite of connectivity products to meet the needs of our customers. Along with our traditional in-house solutions, Internet-enabled and non-Internet-enabled, we’ve acquired a new product. LabPortal.com was part of the AML acquisition. This complements the offerings of MedPlus—ChartMaxx and eMaxx—which I mentioned earlier.
EDITOR: Could you comment on the importance of the electronic medical record and how it relates to laboratory test data?
FREEMAN: Medical records are a traditional problem for the healthcare system. Often they are difficult to retrieve and just as often they are incomplete. Laboratory test data is a major component of a patient’s long-term medical record. We believe there is an opportunity for laboratories to add value by supporting the migration to an electronic medical record (EMR).
EDITOR: Is that why Quest Diagnostics considered the MedPlus acquisition to be strategically relevant?
FREEMAN: Yes. We must be capable of feeding lab test data into EMR systems. As you know, growing numbers of hospitals and health systems are working to implement EMR solutions. Quest Diagnostics wants to be in a position to support this effort.
EDITOR: Does HIPAA play a role in this as well?
FREEMAN: Certainly. Our MedPlus division is developing highly-confidential, HIPAA-compliant electronic medical records designed for use by physicians, physician groups, and hospitals.
EDITOR: Since Quest Diagnostics has taken early steps to introduce Internet-based lab test ordering and results reporting, could you talk a little about how physicians are responding to these features?
FREEMAN: Our experience to date mirrors what most of the lab marketplace has seen. Physicians are much more willing to access lab test results via the Web than to place lab test orders over the Web. However, Web-based lab test ordering is taking hold, albeit at a slower rate than results reporting.
EDITOR: From your experience, then, the steady migration toward browser-based lab test ordering and results reporting is underway?
FREEMAN: That’s true and it is a trend which will help labs add value to their hospital and physician customers.
EDITOR: What about direct patient access to lab test results? With your early implementation of mydailyapple.com, have you seen a steady increase in the number of patients actively retrieving their lab test results from the Web site?
FREEMAN: Based on our experience to date, this is an area of lab services which remains in its infancy. However, enthusiasm expressed by those consumers using the Web to access their lab test results confirms for us that this feature will become very, very important over time.
EDITOR: In other words, although the volume of patients seeking to access their lab test results to date has been limited, there is a growing number of consumers who are quite motivated to have access to their laboratory test data. Could you elaborate?
FREEMAN: You and I both know that the consumerism movement in health care is still in its early days. But I can foresee the day when, with the permission of the referring physician, patients will access their lab test results. I believe that consumer demand for access to this type of information will stimulate changes to state laws that currently restrict such access.
“…we think it is imperative that the lab industry embrace Six Sigma principles and use them to improve the quality of lab testing services provided to all customers.”
EDITOR: What I hear you saying must mean that early-adopter patients, those who were first to access mydailyapple.com to see their lab test results, have been enthusiastic and ardent supporters of this feature. Is that true?
FREEMAN: Yes, that’s right. In fact, I am continually amazed at this phenomenon. Frequently when I speak in public, I ask for a show of hands by anyone who has seen their lab test results. The number who respond is often astonishingly small. This would surprise those physicians who consider lab test data to be “their” information. Our experience with such initiatives as mydailyapple.com indicates that the consumerism movement in healthcare is going to change that situation rather rapidly.
EDITOR: Those are fascinating insights. Could you discuss the role of anatomic pathology in the strategic plans for Quest Diagnostics?
FREEMAN: We consider anatomic pathology to be a very important area of high growth. That is why we are excited about the additional pathologists who are joining us as a result of these two acquisitions. There are a number of subspecialists among them, particularly in dermatopathology and histopathology.
EDITOR: Ken, you’ve been very specific in addressing the various strategic business plans that led Quest Diagnostics to acquire AML and Unilab. Now I’d like to explore, in more detail, the impact that ISO-9000 and Six Sigma management methods are having within Quest Diagnostics. That’s because a handful of laboratories are just starting to learn the power of these techniques to deliver better operational execution in lab testing, accompanied by higher quality and lower costs. This is an important trend in the laboratory industry. It is also one business strategy where Quest Diagnostics has definitely made a major commitment that is far ahead of the lab industry as a whole.
FREEMAN: I’d be glad to, because I am passionate about this subject.
EDITOR: What types of Six Sigma projects are underway and what types of measurable results have been obtained?
FREEMAN: First, over the past two years, all our employees have been through Six Sigma foundation training, which involves a minimum of three hours. So we all know the basic principles. Second, we have trained 130 Black Belts and that number is increasing monthly. They are trained and supervised by 12 Master Black Belts, most of with experience outside healthcare, from major corporations such as General Electric and Allied Signal. Third, we have 200 active projects underway.
EDITOR: And what about measurable results from such projects?
FREEMAN: In Arizona, one project was: 1) to reduce the average wait time required for patients at our service centers to get a blood draw; and 2) to reduce variability in wait time. Following the project, wait times were reduced by 50%. In fact, patients noticed that wait times had improved measurably and told their physicians about this positive improvement.
EDITOR: Other examples?
FREEMAN: We are making a big push to improve billing. Of our 180 Black Belt projects, as many as 30 involve billing. As part of this, we have engaged the payers. After all, when we submit a clean claim, it saves the payer time and money in processing and reimbursing. There are similar projects underway in logistics, accessioning, testing, reporting, and so forth. We believe that Six Sigma is an incredibly powerful tool and, although we view it as a source of competitive advantage, we think it is imperative that the lab industry embrace Six Sigma principles and use them to improve the quality of lab testing services provided to all customers.
EDITOR: That’s a powerful statement. As some of these Black Belt projects at Quest are completed, would you share the results with readers of THE DARK REPORT? It would be a great way to demonstrate to other laboratory executives and pathologists that these techniques have great value for all types of laboratories.
FREEMAN: I’d be happy to do that.
EDITOR: With our time drawing short, I’d like to thank for your candid comments about the two acquisitions, as well as your thoughts on several other aspects of the lab industry.
FREEMAN: Thanks! It was a great opportunity to share perspectives.