“State of Lab Industry” Reveals Radical Change

Throughout 1998, expect continued pressure to restructure and reengineer lab operations

CEO SUMMARY: Pick your trend: declining reimbursement, consolidation, clinical integration, downsizing, and capitated reimbursement. These trends all continued to shape the way laboratories organized to provide services. But 1997’s wildcard was the federal government. Between investigations and new regulations, laboratories were hit hard.

FOR THE clinical laboratory industry, 1997’s biggest surprise was both unexpected and unpleasant: stifling government intrusion into laboratory operations and business practices.

Whether deserved or not, during 1997, clinical laboratories became the whipping boy of government regulators. Healthcare regulators and federal prosecutors found castigating laboratory billing practices was a good way to earn points with Congress and the American public. Three important outcomes emerged from this process.

First, government regulators were encouraged to expand their investigation of laboratory billing practices to include hospital laboratories and smaller commercial laboratories throughout the country.

Second, to close existing “loopholes” and prevent further abuses of federal healthcare programs, HCFA decided to tightly regulate the laboratory industry.

Third, after successfully extracting almost $1 billion in Medicare fraud and abuse settlements from clinical laboratories, government investigators found motivation to search out fraud elsewhere in healthcare. Now hospitals, home healthcare agencies and long term care facilities are undergoing the same investigative scrutiny as was formerly directed only at the laboratory industry.

Against this backdrop of intensified government involvement in clinical laboratory operations, it can be said that the “state of the laboratory industry” is troubled. The government is only one important dynamic acting upon the laboratory industry at this time. Other dynamics impacting the laboratory marketplace have equal potential to radically alter the organization and operation of clinical laboratories as we know them today.

In this exclusive “state of the industry” analysis, THE DARK REPORT identifies seven key areas of sweeping change. During 1998, it will be essential for laboratory organizations to develop a management strategy in response to each of the seven trends.

Separate Paradigms

What is important to understand is that each key area represents a separate paradigm. Taken collectively, these seven paradigms are shifting simultaneously. At no time in the history of the laboratory industry has change come in such a diffuse and widespread manner.

Consider the range of key trends identified in this article. Some of these trends directly alter the organization of laboratories. Consolidation, regionalization, and clinical integration are processes which restructure and re-engineer existing laboratory business models.

In contrast, government regulations create arbitrary responses which may require laboratories to handle testing and billing in burdensome ways. Declining reimbursement levels and alterations to payers’ reimbursement procedures similarly impact the organization and delivery of laboratory services.

THE DARK REPORT predicts that laboratory executives will find one particular trend to be most challenging at a personal level. The coming revolution in management philosophy will force laboratory managers and administrators to develop new skills.

This new management philosophy places a strong emphasis on managing people and processes, with a focus on meeting and exceeding customer expectations. It will supplant and eventually replace the old “top-down” authority structure which business borrowed from the military.

Instead of a hierarchical chain of command, this new management philosophy will require laboratorians to become leaders of people. Formerly, most laboratory administrators could succeed simply by maintaining the stability of the laboratory’s technical processes. For this reason, the impending paradigm shift in management philosophy will be difficult for many “old guard” laboratory managers to accept and embrace.

Because there is a simultaneous shift of seven different paradigms, laboratory executives are faced with unprecedented challenges in how their laboratories are organized and managed. The coming years will bring accelerated change in multiple dimensions. This accelerated change will be accompanied by sustained levels of high stress.

Whether these seven elements are labeled as “market dynamics” or “marketplace trends” matters little. We recommend that you convene your management team and discuss how each of these seven elements may interact upon your laboratory organization during the next five years. Use these discussions to cue strategic thinking within your laboratory organization.

Seven Paradigm Shifts

As these seven paradigm shifts interact upon the laboratory industry, there will be winners and losers. Based on extensive site visits to laboratories throughout the United States, THE DARK REPORT identifies two basic qualities which separate winning labs from their peers. First, winning laboratories have a leader capable of motivating people and nurturing change in a proactive, innovative way. Second, winning laboratories have an accurate strategic picture of their marketplace. They understand the importance of evolving “ahead of the change curve” if they are to remain viable and competitive.

State of the Laboratory Industry-Key Trend #1
Clinical Integration

CLINICAL INTEGRATION of healthcare services is evolving at a steady pace. At some undetermined point in the future, it will become the dominant organizational model for healthcare.

During 1998, most laboratory organizations will see this trend as neither fast-moving nor threatening. After all, clinical integration is currently more of a concept than a reality.

One important premise to managed healthcare that sets it apart from the previous fee-for-service system is the goal of providing a continuum of care for an individual.

Fee-for-service was good at providing episodic and acute care. But fee-for-service frequently failed to achieve two worthwhile objectives: 1) providing continuity of care to an individual; 2) practicing preventive healthcare.

Managed care is partially a market response to the failure of fee-for-service to provide either of these two benefits. However, in order for managed care plans to provide total “cradle to grave” healthcare in an effective manner, they must create a clinically integrated healthcare network.

Integrated delivery systems are forming in cities throughout the United States. As hospital labs find themselves merged into a healthcare system, consolidation is one of the first organizational changes to occur. For commercial labs, the formation of an integrated delivery system may mean that they see a shrinkage of business. As physician practices are acquired by the emerging system, commercial labs are excluded from providing testing services. The integrated delivery system gives preference to its internal laboratory organization.

Given the fact that most of these integrated delivery systems (IDN) are in early stages of organization, their capabilities are limited. Currently neither integrated delivery systems nor managed care plans have yet to organize a true, clinically integrated healthcare service.

One impediment to clinical integration is the lack of effective information systems. Current IS technology inhibits effective clinical integration. Another impediment involves provider attitudes. Physicians and other providers still want independence to practice medicine as they see fit.

Both these impediments will be overcome with time. Clinical integration will occur because it is a rational, economic and effective way to deliver high quality healthcare services.

Laboratories will be required to play a different role within a clinically integrated healthcare system. Business practices and organizational models that were acceptable in the old fee-for-service world will prove inappropriate.

For laboratories, it is critical to understand why clinical integration will occur. Laboratory executives should begin to position their laboratories to provide the type of services which add value to an integrated healthcare organization. There is a window of opportunity to develop such services ahead of competitors.

State of the Laboratory Industry-Key Trend #2
Consolidation

PROBABLY THE MOST VISIBLE trend in 1998 will be consolidation of hospital-based laboratories. This is a direct result of the phenomenal number of hospital mergers, acquisitions, alliances and joint ventures which occurred during the previous three years.

Economics drives laboratory consolidation. High volume laboratories can perform tests more cheaply than low volume laboratories. Hospital administrators, under pressure to reduce costs wherever possible, quickly recognize the benefits of consolidating laboratories. Compared to other clinical services, laboratory consolidation is relatively easy to accomplish. Fewer political issues are involved, and it does not require moving patients between facilities.

Since 1995, laboratory consolidation has moved from being an exceptional event to a common industry activity. This trend will continue for several more years.

There is a two-fold impact upon the laboratory industry. First, most savings in hospital laboratory consolidation come from staff cutbacks and layoffs. This reduces the number of available jobs for med techs and laboratory managers. It also reduces the demand for med techs in the cities where laboratory consolidation occurs.

Second, laboratory administrators who remain in charge of the consolidated laboratory face a new challenge: managing multiple laboratory sites. It requires a different set of skills to provide leadership and management across two or more geographical locations. Most laboratory administrators have only been required to manage a single site laboratory. When selected to manage a multi-site consolidated laboratory operation, they must acquire the necessary leadership skills to be effective at this new position.

The consolidation wave which engulfed commercial laboratories ended in 1995. Now hospital laboratories are undergoing a similar wave of consolidation. As this trend works its way through the marketplace, it is beginning to transform the laboratory industry in fundamental ways.

Consolidation removes excess or unused laboratory capacity from the marketplace. But it also creates a new type of laboratory provider, with regional capabilities. In so doing, the consolidation trend creates new opportunities for partnering. Commercial laboratories recognize this. They maintain extensive sales and marketing programs to promote partnering arrangements with hospital laboratories.

Because a consolidated laboratory represents a different class of buyer for instruments, reagents and other laboratory supplies, there will be changes in the way vendors package their products and contract for services. Additionally, hospital laboratory consolidation encourages consolidation among vendors. Expect to see more mergers similar to that of Beckman and Coulter.

Consolidation of hospital laboratories is the necessary precursor to full-blown laboratory regionalization. It is already one of the most influential trends of the 1990s.

State of the Laboratory Industry-Key Trend #3
Regionalization

EARLY ATTEMPTS TO CREATE regional laboratory networks were not overwhelmingly successful. Yet the future of the laboratory industry lies in regionalizing services.

Early successes of Pittsburgh’s Reference Laboratory Alliance and San Francisco’s Bay Area Hospital Network were widely reported during 1995 and 1996. Their example caused regional laboratory networks to sprout in a variety of cities and states.

But it is no coincidence that the regional laboratory network movement disappeared from center stage. Political, economic, and management difficulties of organizing such networks are daunting. The process of creating a viable regional laboratory network is proving more difficult than organizers imagined.

THE DARK REPORT predicts that regionalized laboratory service organizations will eventually be seen as the single most important business model to emerge during the 1990s. Despite the high profile of regional laboratory networks, we believe the successful business models of regionalization will emerge from the consolidated laboratory organizations now operational in several cities.

Further, commercial laboratories continue to push development of regional laboratory models. It is an essential strategy for them, since integrated delivery systems tend to exclude them by definition.

Regional laboratory systems will emerge because managed care is squeezing excess capacity out of existence. It is widely recognized that we have too many hospital beds in the United States. It is also true that we have too much laboratory capacity.

THE DARK REPORT believes that regionalization will be the method used in local markets by existing laboratory providers to better align existing laboratory resources with the local demand for laboratory testing and services.

That is the reason we believe regional laboratory organizations will emerge from the 1990s as the predominant business model. A properly-designed regional laboratory system eliminates excess capacity and wasteful duplication. It can provide services and access points across the same geography covered by managed care plans in that metropolitan area.

One intrinsic strength of the successful regional laboratory provider is that it will not build “new” laboratory capacity. Rather, the regional laboratory organization will incorporate existing laboratory assets into the delivery system.

That is why we predict these regional organizations will be a consortium comprised of hospital laboratories, commercial laboratories with facilities in the region, specialty laboratories and even physician office laboratories. Early evidence from the marketplace leads us to predict that these regional consortia will evolve from consolidated laboratory organizations, not regional laboratory networks.

State of the Laboratory Industry-Key Trend #4
Reimbursement

DURING THE COURSE OF 1998 and beyond, adequate reimbursement is the critical success factor for laboratory survival.

Reimbursement is listed as a separate trend from government regulation because it is a distinctly different market dynamic. Reimbursement relates to all the sources of money flowing into the laboratory.

THE DARK REPORT sees two critical aspects to reimbursement. One aspect involves the actual reimbursement schedules posted by managed care plans and government healthcare programs. The other aspect deals with the contractual form of reimbursement, such as fee-for-service versus prospective payment.

In terms of actual reimbursement schedules, it is no mystery that reimbursement for laboratory services declined steadily in recent years. This decline will continue into the foresee- able future. To respond, laboratory managers must develop business plans which allow the laboratory to synchronize cost reduction efforts with expected reimbursement declines.

However, the more insidious impact on the management of laboratories will be prospective payment arrangements, such as capitation. The majority of laboratory managers do not yet comprehend how capitation revolutionizes the management of laboratory operations.

When reimbursement was based on fee-for-service, laboratory managers were required to keep expenses in line with expected revenues. Sustaining test volumes above the break-even level was probably the easiest way to maintain a financially viable laboratory. This was a relatively straightforward process. In fact, the generous reimbursement fee schedules of that era almost guaranteed that any laboratory could make adequate profits. Thus, most managers focused on technical challenges, such as maintaining testing at a high quality and with a consistent level of reproducibility.

Now comes the era of prospective payment, centering around capitation arrangements. This transforms the way a laboratory must be managed. Payment for testing is fixed, against an uncertain range (possibly even uncapped) of expected utilization.

Prospective fixed reimburesment means managers must operate the laboratory differently. Management now needs to get accurate cost data, utilization information and productivity measurements on a timely basis. Management must use this data to keep laboratory expenses in line with the prospective reimbursement.

If utilization climbs beyond expected levels, management must learn this fact as soon as possible, because it is essential to respond by both cutting costs and learning why utilization rates jumped upwards.

The net impact of prospective payment is that it greatly complicates the management requirements for financial stability. It means that laboratory executives must closely scrutinize variables which previously were received little attention or priority.

State of the Laboratory Industry-Key Trend #5
Government Regulation

MORE APTLY DESCRIBED as government intervention than regulation, this is one area which will receive the most time and attention by laboratory management throughout the upcoming year.

After analyzing the government’s influence on healthcare in general and laboratories in particular, THE DARK REPORT believes that government intervention will increase during the next few years. If true, this is a critical point.

It is our opinion that government regulation will take the form of micro-management. From this point forward, expect to see an unending cascade of guidelines for clinical practices and regulations concerning reimbursement procedures.

Within the laboratory segment, the four organ panels represent the first tangible sign of this heightened government involvement in healthcare. The organ panels are less about preventing Medicare fraud and abuse and more about constraining test utilization. Expect to see a steady stream of directives and guidelines concerning clinical practices.

Although the requirement that all laboratories implement a compliance program is attracting most of the headlines, we think it is important that laboratory executives understand that the real battleground between healthcare providers and government healthcare regulators will center upon regulation of clinical practices.

Because the clinical laboratory industry was the first healthcare segment to become tainted with Medicare fraud, it will be the most visible target of new directives.

The financial impact of these clinical practice directives will be significant. But it will be difficult to oppose them on the basis of how they affect reimbursement, since the government issued them to “improve clinical practices,” not to affect reimbursement.

Therein lies the reason why regulators will focus less on reimbursement guidelines and more on clinical practice directives. They can lessen utilization, reducing the dollars paid out for these procedures, without having to cut the designated reimbursement for the procedures. This avoids political debate on reimbursement levels.

Another crucial point relates to government micro-management of healthcare. This involves private payers such as Blue Cross, Aetna/US Healthcare, Cigna, Prudential and others. Increasingly, these private payers are adopting HCFA’s guidelines and directives as their own.

Thus, another result of increased government intrusion into healthcare is to spread the government’s complicated, contradictory and obtuse regulations into the private sector. For the laboratory industry, it represents a double dose of very bitter medicine.

During the next two or three years, government involvement in the day-to-day management of healthcare will increase. Clinical laboratories should understand the subtle philosophical changes now altering the way their activities are regulated.

State of the Laboratory Industry-Key Trend #6
Technology

TO REMAIN A VIABLE PROVIDER, laboratories must quickly evaluate new technology and introduce worthwhile offerings into the clinical marketplace ahead of the competition.

New technology has the potential to improve the competitive position of laboratories. But it will also influence and change the organization and operation of laboratories. A variety of innovations and discoveries will drive these changes.

Automated cytology systems represent a good example of how new technology can potentially transform the laboratory. The first generation of automated cytology systems is currently entering the marketplace. As this technology proves its clinical value, there will be radical changes to the way Pap smears are prepared and evaluated.

Potentially, monolayer technology could become the gold standard for preparing Pap smears. On the diagnostic side, subsequent generations of automated cytology instruments could replace cytotechnologists completely.

Assume, for a moment, that both technologies achieve this potential. To incorporate this technology, clinical laboratories need to organize themselves differently. There is a precedent where radical technology shifts affected a large segment of laboratory specialists. Remember hemotechs? They became extinct with the arrival of automated hematology machines.

Because of the potential for new technology to transform laboratory operations, THE DARK REPORT regular- ly covers new developments in the field. If most laboratory administrators fully understood the vast amount of tangible research which will soon be introduced into clinical practice, they might well decide to pursue a career outside the lab industry.

Laboratory automation technology is directed towards combining related instruments into automated modular clusters. Miniaturization of test instruments is creating a new class of smaller instruments which can be used for point-of-care and near-patient testing. Micro-miniaturization technology, combined with electronic chip technology, is striving to create silicon microchips which use microscopic amounts of bio-sample and reagent to perform the test on the chip itself, at a cost of pennies per procedure.

Genetic research is leading directly to the development of diagnostic assays which are not phenotypic-based, but are genetic-based. The explosion of PCR testing demonstrates how quickly this technology can find extensive clinical application.

Competition will force laboratories to stay abreast of this technology explosion. As clinical efficacy is demonstrated, early innovators will be rewarded by the marketplace. This is one reason why the three national labs quickly acquired automated cytology systems when they earned FDA approval two years ago.

In order to maintain a cost and service advantage over their competitors, all laboratory organizations will need to introduce innovative technology as early as possible. Because the pace of change and speed of introduction for new technology is accelerating, laggards may well find themselves locked out of the game.

State of the Laboratory Industry-Key Trend #7
Management Philosophy

HERE IS THE ONE AREA of clinical laboratory operations which gets short shrift. Management philosophy and style underpins the success of any service organization in the world.

The entire healthcare industry starts with a handicap. During the fee-for-service days of the 1980s, business management was not a critical success factor in the financial performance of any healthcare provider. It was easy to “make money” as long as a provider could keep expenses aligned with generous fee-for-service reimbursement schedules willingly paid by private payers. Even Medicare/Medicaid reimbursement levels where considered acceptable in those days.

Most healthcare providers were organized as the traditional hierarchy. It was management from the top down. With everyone doing well financially, there was little incentive to change the management style of healthcare organizations.

Meanwhile, in the real world of business, management was undergoing a revolution. Japanese car manufacturers invaded the United States and captured huge market share. (Remember Chrysler’s near-bankruptcy?) Japanese televisions and electronic goods swept American products off the shelves. Japanese mini-mills dominated the steel industry.

To survive, American businesses were forced to change the way they were organized and managed. W. Edward Deming, Joseph Juran, Philip Crosby and Tom Peters expounded new ways of managing people and producing products and services.

Keystones to this philosophy are an emphasis on meeting customer needs, a focus on “process design” to produce products and services free of errors, and empowering employees to respond with their own knowledge and initiative.

While American business was undergoing this transformation, healthcare continued in its isolated world. Then came the arrival of managed care, accompanied by declining reimbursement, which eroded the financial security of hospitals, physicians, laboratories and other categories of providers.

Nowadays, sustained success for any healthcare organization, including clinical laboratories, will only come from effective implementation of the new management philosophies which have achieved worldwide validation and acceptance.

One can debate the merits of TQM (total quality management), CQI (continuous quality improvement), re-engineering, ISO-9000 and other various acronyms for management paradigms. But one cannot deny that these represent a new philosophy of management which will not disappear.

The new generation of executive leaders in the clinical laboratory industry will be those managers and administrators who understand this fact, and develop the knowledge and expertise to manage people using these new philosophies.

For better or worse, the former way of organizing and managing a laboratory is no longer viable. The future belongs to those individuals willing to incorporate the new management philosophies into their personal style.

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