Unprecedented Times Lie Ahead For Labs

Start with the huge financial hit to hospitals, which has slowed capital spending by laboratories

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CEO SUMMARY: Here’s a lab industry first: insight and analysis about why hospital/health system laboratories are already feeling the financial pinch as their parent organizations scramble to conserve and accumulate cash. That’s bad news for IVD vendors and other lab industry suppliers. And that’s not all! Healthcare reform proposals carry the potential to further hamstring the finances of clinical labs and pathology groups.

IT’S A TIME WITHOUT PRECEDENT for clinical laboratories and pathology groups in the United States. Unfolding events will challenge pathologists and lab managers in serious ways.

The first, and most immediate, development is the collapse of equity values and the stock market following the mortgage crisis and widespread failures of banks and financial companies over the past six months. These events significantly damaged the financial integrity of most hospitals and health systems. However, this remarkable development has generally been unreported by the media and healthcare publications.

With this intelligence briefing, THE DARK REPORT is first to alert the laboratory industry of a broad trend that has direct impact on hospital laboratories, along with the industry vendors who sell them analyzers, reagents, and supplies. Simply put, hospitals and health systems are reining in spending as they strive to rebuild cash reserves. Consequently, hospital labs are facing unexpected demands to curtail scheduled capital spending. That allows hospitals and health systems to move that capital into cash accounts.

As well, hospital labs—along with other clinical departments—are also being asked to prune spending below budgeted levels and deliver that additional cash back to the parent hospital. Again, hospitals and health systems are using this cash to increase total cash-on-hand.

For the immediate future, this puts many hospital laboratories in a “cash preservation mode” so as to support the financial priorities of their parent hospitals or health systems. The implications of this situation for the greater laboratory industry are unclear.

However, it is easy to understand why this spending roadblock occurred. These actions are a direct consequence of one single development: the collapse in the value of equities and financial instruments during recent months. Headlines have screamed the news that investors and individuals in the United States have seen the value of their investments fall by 30%, 40%, 50% or more!

50% Drop In Portfolio Value

Like investors and individuals in the United States, hospitals and health systems have seen equally devastating reductions in the value of their endowments and investment portfolios. A health system with an investment portfolio valued at $1 billion in January 2008 may have only $500 million or $400 million in value today.

This has created an unexpected financial problem for any hospital and health system with bonds or debt that must be serviced (and that means almost every hospital in this country). Typically a bond issue requires the hospital to maintain a cash reserve that equals a specified number of days of average revenue—often as high as 180 days. If the hospital does not maintain the required cash reserve, it violates its bond and/or debt covenants. Once declared in default of that covenant, the lender can assess financial penalties and raise the interest rate. This increases the amount of money the hospital/health system must pay to service its bonds and debts.

Loss Of $60 Million Per Year

Take this example: assume a $1 billion investment portfolio for the hospital during 2007 that earned an 8% return. That hospital received $80 million in income during the year (or $6.8 million per month). This income was available to keep cash-on-hand at the level required by the hospital’s bond covenants.

Now, since last fall, assume this investment portfolio dropped in value by, say 50%. Also, assume the return fell from 8% to 4%. Thus, the $500 million portfolio now produces only $20 million per year in income (or $1.7 million per month) to the hospital.

In this example, the hospital has seen a $60 million reduction in annual income, in just over the past six months. It needs to replace this lost cash flow from other sources. One fast way to do that is to defer capital spending and to ask hospital departments to cut discretionary spending below budgeted amounts wherever possible.

This dramatic setback in hospital finances has gone unremarked by the press for a simple reason. At the same time that hospital investment portfolios have lost 50% of their value, most of these same hospitals continue to experience a constant rate of inpatient admissions.

Reporters usually check hospital admission rates to see if rising unemployment and/or consumer spending cutbacks are causing a decline in inpatient admissions. Thus, by watching inpatient admission rates and not the financial condition of hospitals’ investment portfolios (and income from investments), reporters have missed this story.

Parsimonious Lab Spenders

There will be no quick and easy recovery from this situation. That’s because hospitals/health systems, having lost 50% or more of the value of their investment portfolios and endowments, will not soon recover that value. As a result of this situation, THE DARK REPORT predicts that hospital laboratories will be parsimonious spenders during the next 24 months.

The next trend which bears watching is consumer response to the deteriorating economy. Will consumers cut back on healthcare spending? Will growing ranks of unemployed cause bad debt levels to increase—not just for hospitals, but also for laboratories and pathology groups?

Unfortunately, signs point to tougher times ahead. The most obvious factor is this nation’s worst economic downturn since 1982-83. Every week brings another round of bad news about economic indicators. It was last fall when years of over-stimulation in the real estate and mortgage industry finally caused the bubble to burst.

In the months since then, major companies in the banking and financial sectors collapsed. Unemployment rates began climbing as companies laid off employees in response to falling demand for their products and services.

Stock Market Declines

Even the inauguration of a new president and a new Congress last January brought little good news. In response to the first economic stimulus bills passed by law-makers, stock market values collapsed, falling to levels not seen in 12 years!

For that reason, THE DARK REPORT considers the free fall of the Dow Jones average from 13,000 to under 7,000 over the past year as an inauspicious development. The world’s smartest economic and financial minds—who are paid to put money where it will earn the highest return—are avoiding the stock market. That is their vote of “no confidence” as to the expectation that recent federal actions will “stimulate” the economy.

Business Strategies For Labs

It is necessary for laboratory administrators and pathologists to establish an accurate perspective of current and future economic and political issues. That context then guides efforts to develop appropriate business, financial, and clinical strategies for their clinical laboratories and anatomic pathology group practices.

What will make the coming economic times particularly challenging for many younger lab managers is that they have never worked in a laboratory during an economic recession. It was 1982-83 when the last deep recession dogged the American economy. For this reason, these younger lab executives and pathologists lack the experience and perspectives accumulated by their older colleagues during that time.

Crystal Ball Gazing

Knowing the dangers of consulting its crystal ball, THE DARK REPORT offers some predictions about how the laboratory industry is likely to fare during the next couple of years. These prognostications are offered as a basis to stimulate discussion among the management teams of clinical laboratories and pathology groups. Every city and every region will have a different experience to the unfolding economic and political events. (And, that is TDR’s first prediction!) For that reason, it is important that individual labs craft business, financial, and operational strategies that are appropriate for their regional service area.

Prediction: this nation is entering an economic and political cycle without precedent. Since last October, actions taken by Congress and the federal government have dwarfed, in spending scale and adjusted for inflation, anything seen since federal spending during War War II. Thus, using past experience as a guide for future actions is not likely to be productive.

Prediction: Baby Boomer and Generation X patients will continue to demand access to healthcare services and the newest technology, whether genetic lab tests or new, expensive therapeutic drugs. It will be difficult for lawmakers to limit consumer access to such health services, because these consumers vote!

Strong Labs To Prosper

Prediction: Clinical laboratories and pathology groups led by strong, visionary individuals will perform surprisingly well and are likely to emerge from the end of this economic cycle as profitable, larger organizations.

Prediction: Economic forces already in motion will cause the financially weakest hospitals to restructure, file bankruptcy, or sell themselves to stronger health organizations. Buyers will try to keep these weak hospitals open and operating, but if the economic malaise lasts long enough, many of these hospitals will be closed.

Prediction: If hospital labs defer capital purchases long enough, this will put financial stress on smaller in vitro diagnostics (IVD) manufacturers and suppliers. That will trigger further consolidation among lab vendors as strong companies acquire these financially-weakened companies.

Prediction: The longer that economic activity in the United States stays flat or declines, the more opportunities progressive labs will have with private payers. In partic- ular, labs will find private payers more receptive to programs that help physicians do a better job of ordering and using lab tests that produce improved patient outcomes while lowering the overall cost per healthcare episode.

Prediction: There will be no slowdown in the introduction of advanced molecular technologies, particularly in laboratory medicine. During this economic cycle, a rapid pace of technology introduction will be sustained because of: 1) demand by patients; 2) opportunities for profit; and, 3) ready acceptance by clinicians. This is a another positive factor for innovative laboratories that continue to exploit strategic opportunities during this economic downturn.

Strategic Planning

Lab administrators and pathologists should use these predictions as a launch pad for strategic planning and crisis anticipation within their respective laboratory organizations. THE DARK REPORT is optimistic that laboratory testing’s vital role— and huge leverage as an added-value service—will help the majority of laboratories survive whatever is to come.

However, the more important responsibility for lab administrators and pathologists is to prepare their laboratories for the worst, while positioning their labs to prosper from the opportunities that continue to exist, even in difficult economic times.

“Crises Strategies” for Labs At Upcoming War College

THIS ECONOMIC DOWNTURN is already being compared to the Great Depression of the 1930s! Many veteran lab administrators and pathologists are preparing their labs and pathology groups for tougher times ahead.

That makes this year’s Executive War College in New Orleans on April 28-29 the first major laboratory event to provide intelligence and analysis about these remarkable trends. Speakers and special sessions to help lab directors and pathologists respond to these new challenges are a core part of this year’s curriculum.

For example, Alan Mertz, President of the American Clinical Laboratory Association (ACLA) of Washington, DC, will provide an important perspective on the expected healthcare reform legislation. He’ll offer an “inside the beltway” perspective, identifying the new powerbrokers in healthcare reform and how legislation currently being drafted is likely to either benefit or disadvantage lab testing services.

Another important ‘inside the beltway” perspective will be provided by Peter Kazon, Attorney at Alston & Bird in Washington, DC. Kazon is one of the nation’s recognized authorities on legal, regulatory, and legislative issues in laboratory medicine. He will identify evolving new legal threats. He’ll also handicap the new powerplayers in Washington and how they may help or hinder the fortunes of laboratories in the political dealmaking now commencing.

In the midst of the first serious, extended economic downturn since the first half of the 1980s, this Executive War College is designed to be every laboratory manager’s single most valuable resource. It will prepare lab leaders to weather approaching financial storms. It will provide powerful strategies that laboratories and pathology groups can use to protect cash flow and win profitable new business.

 

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