CEO Summary: In third quarter earnings reports, both national lab companies posted modest gains in specimen volume, revenue, and net profit. More telling is the relative quiet in the current market for lab testing services. With no obvious opportunities to fuel double-digit rates of growth, the two blood brothers are pushing forward with similar business strategies. However, each lab company is pursuing those strategies with uniquely different tactics and emphasis. Here’s an in-depth comparison of events unfolding with Quest Diagnostics and LabCorp.
IT’S BEEN TWO YEARS SINCE ANYTHING as dramatic and disruptive as the 10-year exclusive national contract between Laboratory Corporation of America and UnitedHealth has shaken the laboratory testing marketplace. (See TDR, October 16, 2006.)
As the consequences of this development rippled across the lab testing industry, there were new threats and opportunities for independent labs and hospital laboratory outreach programs. That made 2007 a busy and interesting year. By contrast, 2008 has lacked that level of drama and disruption. With things relatively quiet, it seemed like a good time to check on the two blood brothers and see what business strategies each lab is pursuing. Because of sheer size, the actions taken by either company can have consequences to almost all laboratory testing providers in this country.
Last month, Quest Diagnostics Incorporated and LabCorp each announced financial performance for the third quarter. Confirming the rather quiet state of the current laboratory testing marketplace, neither earnings announcement contained news of dramatic improvement in specimen volume, revenue, or net profit.
At Quest Diagnostics, revenue was up 3.4%, to $1.8 billion. Net income for Quest grew by 13%, from $98 million in Q3-07 to $110.8 for Q3-08.
LabCorp experienced faster revenue growth. Its $1.1 billion in revenue represented an 11.2% gain. By contrast, net earnings were flat. Its $111.9 million in net earnings for Q3-08 was up just 0.6% from net earnings of $111.2 in Q3-07.
During conference calls with analysts, both companies discussed the state of their respective businesses. These comments provide useful information about the laboratory testing marketplace, along with insights into their different business strategies. Not only do the overall comments by executives of the two lab testing companies indicate a relatively quiet time in the laboratory marketplace, but each company is pursuing similar strategies—while using different tactics—to increase revenue and improve net profit.
Fast-Growth Areas Of Testing
Quest Diagnostics stressed five specific strategies or growth opportunities during its earnings call. First was to call attention to its fastest growing areas of testing. “Gene-based and esoteric testing revenues grew by almost 10% during the quarter,” noted Surya N. Mohapatra, Chairman, President, and Chief Executive Officer at Quest Diagnostics. “Testing volume for Vitamin D, testosterone, chlamydia, gonorrhea, and HPV all grew at double digit rates.”
Mohapatra also mentioned that areas of routine testing with strong growth included food allergy testing and non-food allergy testing, up 25% and 20% respectively. Testing for celiac disease increased by 25%, and orders for the its branded colorectal screening test were up 15%.
The second strategy targets healthcare’s shift from acute care to emphasizing wellness, prevention, and early detection. “As you have heard me say before, as we enter the decade of diagnostics, healthcare is moving from a focus solely on curative care to a recognition of the value of detection, prevention, and personalized care,” he said. “Consider our collaborations to drive awareness of the value of early detection of colorectal cancer. To date, payers including Aetna, Cigna, Independence Blue Cross, and the State of Tennessee, have given hundreds of thousands of our convenient InSure tests to their members, employees, and residents.”
That wellness theme continued in a discussion of Quest’s initiatives in employer health and wellness programs. Mentioned by name were Domino’s Pizza, Jeld-Wen, and the Houston Independent School District. It was noted that the Google Health relationship was being expanded by allowing Google Health users to order, on their own, a limited menu of laboratory tests.
“We think wellness is a great opportunity,” explained Mohapatra. “We have built up a business line called Blueprint for Wellness… Going forward, you will see us focus on this area… I consider wellness testing as important as illness testing.”
Overseas Lab Revenue
Next came the third business strategy. Quest Diagnostics has big expectations for revenue growth from its overseas laboratory operations, particularly in India. “In the next three to five years, we expect enormous growth from India, which has a middle class of 300 million people,” observed Mohapatra. “We have built a state-of the art laboratory and expect to develop business, not just from physicians and hospitals, but also from pharma companies for clinical trials and from life insurers.”
The fourth strategy centers around opportunities in hospital laboratory testing. Of particular interest to hospital laboratory directors were statements about Quest Diagnostics’ hopes for increasing its presence in the hospital lab testing segment. “I have had discussions with many hospitals which would like to have somebody manage their laboratories with high quality tests,” said Mohapatra. “Then they don’t have to spend extra capital to update their laboratories. We see that, going forward, we will work with hospitals to manage their labs and also to update their labs.”
Hospital Lab opportunities
In answering an analyst question on this point, Mohapatra noted that “I’m talking about doing high quality, innovative tests for hospitals—which we are very well positioned to do, either by managing their laboratories or providing them tests because we have the volume and the expertise… with our strength in the hospital business, I look forward to deeper market share…and gaining more presence in the hospital market.”
Mohapatra also had some specific views about hospital laboratory outreach programs and their limitations as competitors. “As far as the outreach business is concerned, I think there will be 10 or 12 outreach businesses, but once you go above a certain region and above certain dollars [revenue], an outreach laboratory has the same costs as everyone else. It must have managed care contracts, logistics, billing. What we have seen over the past 18 months is a number of outreach laboratories for sale.”
The fifth business theme discussed was improving operations and eliminating costs. “Our cost reduction program, announced last year, is on track to reduce our cost structure by $500 million,” noted Mohapatra. “We expect to have delivered $300 million in annualized savings as we exit this year, with the balance in 2009.
“Mohapatra noted that “I’m talking about doing high quality, innovative tests for hospitals— which we are very well positioned to do, either by managing their laboratories or providing them tests…”
“Last quarter, I outlined the major elements for our program, which include using Lean Six Sigma to increase productivity in our labs,” he continued. “Driving more of our purchasing through master contracts to take advantage of our scale. Better alignment of our service capacity with patient and sample flows. Optimizing logistics routes and using more fuel efficient vehicles. And deploying enhanced connectivity to our customers, patients, and service centers to reduce specimen data entry, improve billing, and lower our bad debt.”
During the Quest conference call, two other aspects of the laboratory market were discussed. One involved managed care pricing and the other was bad debt trends from the patient-pay segment.
Quest Diagnostics has not seen strong downward pressure on pricing by managed care companies this year. However, it has felt the effects of contract pricing negotiated during the previous 24 months. “…At the beginning of the year, some of the price concessions that we made last year—when we renegotiated managed care contracts— kicked in,” said Robert A. Hagemann, Quest’s Chief Financial Officer. “And that’s certainly been one of the things that put downward pressure on the margins this year, which are being offset by some of the cost reduction programs. Pricing is much more stable than it was a year ago because all of those contracts were negotiated for multi- year periods.”
Patients Paying Lab Bills
When asked about bad debt related to patient self-pay, Quest’s Chief Financial Officer, Robert A. Hagemann answered, “[Self-pay revenue is] between 5% and 6% of our total revenues. It has not changed dramatically… and that’s mostly uninsured that we classify as self-pay. Embedded in our third party [segment] is the portion associated with [patient] deductibles and co-pays, which is about equal to that amount. So, in total, there is probably 10% of 12% of our revenues that we collect from patients and that has not changed dramatically.”
At LabCorp, the strategic business priorities are similar in nature to the five elements discussed by Quest Diagnostics. But LabCorp has a different focus and market execution, as indicated in the assessment which follows.
During its third quarter earnings call, LabCorp executives stressed the company’s drive to expand the volume of esoteric testing, currently at 35%, to 40% of the company’s revenues. That strategy is part of a more comprehensive effort to position LabCorp as a player in health- care’s shift from acute care to early detection and wellness.”
That strategy is centered around personalized medicine. “Many of you have heard me say I believe healthcare will always be physician-centric, but that increasingly patients will expect and require treatment based on their specific personal characteristics, including their genetic makeup,” stated David P. King, LabCorp President and CEO. “…the three drivers that will move us forward for personalized medicine are esoteric testing, our outcome improvement programs, and companion diagnostics.”
As the first primary growth driver, “our goal is to increase esoteric testing to 40% of our revenues in the next three to five years,” he continued. “…We will continue to introduce new esoteric tests to respond to scientific discoveries, such as the importance of the K-ras gene for colorectal cancer drug selection, to improve patient care and outcomes, and to satisfy unmet medical needs.”
LabCorp’s second growth driver strategy is to expand its testing presence in outcome improvement programs. The current push is in the area of chronic kidney disease (CKD). Some 26 million Americans suffer from CKD and it is the ninth leading cause of death in the United States. Also, because these patients have a chronic condition, testing to support management of each patient’s disease will be regularly performed for years.
In November 2006, LabCorp acquired Litholink Corporation, a laboratory specializing in kidney stone analysis. LabCorp has broadened Litholink’s products and services for CKD. “The Litholink program for kidney stone management has been extremely well received, and we are seeing double-digit revenue growth, uniform acceptance from payers, and premium reimbursement,” stated King.
“Litholink’s CKD program focuses on identification of patients who have reduced or deteriorating kidney function,” he continued. “Through collaboration with local nephrology groups, we focus on educating primary care physicians about the importance of identifying CKD through laboratory testing of EGFR, albumin, parathyroid hormone, and other accepted measures of kidney function. Our sophisticated report, developed with input from an international panel of CKD experts, guides the physician on how to use appropriate medication, dietary modifications, and procedures to slow the process of the disease and prevent further damage to the kidneys.”
Positive Physician Reaction
According to King, physician reaction to this specialized lab testing has been “enthusiastic.” He stated that LabCorp now has several nephrology groups doing collaborative outreach with LabCorp to help primary care physicians identify patients with diminished kidney function and to launch appropriate care.
Some payers have also responded favorably. “One of our managed care partners has assigned internal resources to assist us in physician and patient recruit- ment,” noted King, “Furthermore, the Medicare Improvements for Patients and Providers Act of 2008 instructed CMS to establish demonstration projects to improve the treatment of CKD in the Medicare population. We are working to have our CKD outcome improvement program qualified for this important CMS and Medicare demonstration project.”
The third growth driver discussed was companion diagnostics. To position itself in this market, in December 2007, LabCorp acquired Tandem Labs, a contract research organization (CRO) headquartered in Salt Lake City, Utah. As King explained, “Our clinical trial division continues to help pharmaceutical companies develop diagnostic tests that provide guidance on administering the proper dose of the proper drug to the proper patient at the proper time. Our Tandem division is a leader in biomarker discovery, and is seeing strong growth year-over-year as pharmaceutical companies seek markers to assess drug safety and efficacy.”
King then addressed a market development that has major positive implications for the entire clinical laboratory industry. “Drug repositioning has emerged as a corporate strategy with companies such as ARCA Biopharma and Vanda Pharmaceuticals,” noted King, “[They are] focused on in-licensing existing compounds that have not performed well in broad trials, then developing tests to target patient populations in whom the drugs are effective. We have entered into relationships with both of these companies to develop companion diagnostics, and are excited about these and other opportunities in this rapidly-growing field.”
Another sign that the concept of companion diagnostics is gaining traction within the healthcare system is the relationship that LabCorp is developing with Medco Health Solutions, Inc., a pharmacy benefit manager. LabCorp is collaborating with Medco on Tamoxifen and Warfarin. “A significant number of employers who secure their pharmacy benefit management from Medco have enrolled in this innovative program,” declared King, “which provides specific lab testing to assess the safety and efficacy of these drugs prior to dispensing them to patients.”
Like Quest Diagnostics, LabCorp does not see strong downward pressures on pricing with its managed care contracts at this time. In answer to an analyst’s question, King noted that most price reductions realized in last year’s contracts have had their effect. “Also positive, we are contractually going to receive escalators from a couple of the contracts that we renegotiated at the beginning of 2008,” he commented. “….We are cautiously optimistic we are not going to see the kind of pricing reset that we saw in 2007. So generally I would agree with the comment that [managed care contract] pricing seems to have stabilized, and we should see some real price improvement in 2009.”
Along with pricing for managed care contracts came a discussion of how aggressive payers had become about controlling leakage. “I think there has been increased focus on it [reducing out-of-network lab testing] among our managed care partners,” said King. “On the other hand, …managed care has had a lot on its plate this year, so increased focus has not necessarily led to increased activity. But in general, we do see a strong desire from our managed care partners to move out-of-network business into a network. And even to move in-network business from higher-cost [lab] providers to lower-cost providers.”
LabCorp 2010 Initiative
Cutting costs is a constant theme with the two national labs and LabCorp has told Wall Street about its LabCorp 2010 Initiative, which King described as “a comprehensive plan to drive service quality and operational improvements, and to optimize our growth platform.” One cost control measure is to close the LabCorp laboratory in Herndon, Virginia, by year’s end.
LabCorp is also watching bad debt from patients, because of enrollment growth in high-deductible health plans (HDHPs). During the conference call, LabCorp executives estimated that patient pay represented about 17% of revenue (including uninsured, self-pay, deductible, co-pay, and out-of-pocket sources).
This side-by-side look at the strategies and specific business initiatives under way at LabCorp and Quest Diagnostics demonstrates the similarities in how both companies view the current lab testing marketplace. With no obvious opportunities for a “big-hit” business strategy, each laboratory seems focused on improving its day-to-day performance and the services it offers to its customers.
Sales Force Targeted To Support Objectives
WITH FEWER LAB ACQUISITION OPPORTUNITIES available to support revenue growth, the national labs are turning more attention to using their respective sales forces to achieve corporate growth targets.
During the recent call with analysts, LabCorp Chairman and CEO David King noted that his lab company was using its sales force to help offset the impact of any declines in patient visits to client physicians. “We have a sales force that we can direct to customers and specialties where we think they are going to see less impact from patients not coming to the doctor,” he stated.
King also discussed how LabCorp could target its sales force. He noted that LabCorp can provide its sales team with information about which doctors are likely to see chronically ill patients (and thus likely to be a heavier user of laboratory testing), as well as what types of esoteric tests will be of highest interest in such specialties as oncology, endocrinology, and rheumatology.
This indicates that LabCorp is developing its capabilities in database marketing. Outside of healthcare, a number of Fortune 1000 corporations have been quite effective at using database marketing to improve the productivity and sales performance of their sales teams. When used effectively, data- base marketing can allow a company to significantly increase the revenue generated by its existing customers.