"NEWSMAKER INTERVIEW"

LabCorp’s MacMahon Provides Insights About Lab Marketplace

LabCorp positions itself to offer more anatomic pathology services

CEO SUMMARY: Pathologists will be particularly interested in what Thomas MacMahon has to say about the evolution of laboratory medicine. As Chairman, President, and CEO of Laboratory Corporation of America Holdings, he has continuous access to some of the best strategic analysis about the laboratory testing marketplace and its evolution. MacMahon has several surprising predictions to make about the future of laboratory medicine. In this exclusive interview, conducted by THE REPORT’S Editor-In-Chief, Robert L. Michel, MacMahon talks about the impact of 2002’s laboratory acquisitions, specialty esoteric testing, and why more hospital laboratories are entering the laboratory outreach business.

“Molecular pathology has the opportunity to be the cutting edge of medicine as we move forward.”
—Thomas MacMahon

EDITOR: Laboratory Corporation of America Holdings is a different company today than it was one year ago. During the past 12 months, it paid $1.3 billion to acquire Dynacare, Inc. and DIANON Systems, Inc. These companies had annual net revenues of $238 million (U.S. revenues) and $190 million, respectively. Why was LabCorp willing to make such a big investment?

MACMAHON: Each acquisition supports a core strategic objective within LabCorp. Although Dynacare and DIANON Systems were very different types of laboratories, we viewed their component pieces as good complements to our existing laboratory system.

EDITOR: It may help, then, for you to describe the attributes of LabCorp which you believe makes it unique. What differentiates it from other laboratory companies in the marketplace?

MACMAHON: LabCorp is a large reference laboratory with 47 major laboratory facilities across the United States. Essentially, LabCorp is a series of regional laboratory business units. Over the past five years, we’ve worked to standardize our billing systems. To accomplish this goal, we had to also standardize operations and testing services across these regional laboratories. As a result, today we can move specimens throughout our national system.

EDITOR: How does this standardized network of 40+ regional laboratories help LabCorp differentiate itself from other lab companies?

MACMAHON: I think what separates LabCorp from other competitors is that we have a focused regional effort supported by the consistent quality standards of a national laboratory with standardized billing and lab systems. In the United States, healthcare remains highly regionalized. Most of us recognize, for example, that the needs of physicians and patients in Seattle, Washington may differ from the needs of physicians and patients in Miami, Florida. LabCorp considers it important to have a base in each region of the United States and to understand what is required to best meet the unique healthcare needs of different regions around the country.

EDITOR: What business advantage do you realize from this strategy?

MACMAHON: We think it gets to the crux of the competitive issue. LabCorp is capable of serving the nation’s largest managed care organizations (MCOs) in a consistent manner, while meeting the specific lab testing needs that differ from region to region. By holding these important managed care contracts, it gives us an anchor in physicians’ offices. This anchor provides us the opportunity to convince the physician to refer his other lab testing business to us.

EDITOR: But using managed care contracts to provide access to office-based physicians is only one competitive objective. Could you speak to how LabCorp wants to develop its business relationships with physicians?

MACMAHON: Our over-arching goal is to offer as many testing capabilities to a physician as we can. Whether it’s an ob-gyn, family practitioner, or internist, we want to convince physicians to use LabCorp and its testing services in a manner that may be unavailable to them from other laboratories in the region.

EDITOR: To sum up this point, one key attribute that differentiates LabCorp is its national system of 47 regional laboratories, which helps it be a “local provider” in nearby communities. This complements LabCorp’s ability to win and hold national managed care contracts, which provide it with a foothold in physicians’ offices for upselling more lab testing.

MACMAHON: Yes. But this attribute must be seen in context of how the laboratory industry has changed during the past five years.

EDITOR: Because LabCorp is responding on several other levels?

MACMAHON: Definitely. Another factor which has changed our laboratory industry over the past five years is the clinical value of new information that can be gleaned from the human body. Whether that information is about an infectious disease or a genetic disorder, laboratories can now provide physicians with diagnostic information that was unavailable just a few years ago.

EDITOR: How has this affected the laboratory industry?

MACMAHON: Within the market for laboratory testing services, we believe two business industries are emerging and must be addressed by every laboratory. The first business industry is the routine testing done by all laboratories to support office-based physicians. Just as it has during the 1970s, 1980s, and 1990s, this will continue into the future. However, new science is contributing to the creation of a second business industry that I will describe as “sophisticated esoteric testing.” Examples are enhanced Pap tests, HPV tests, the cystic fibrosis test for family planning, phenotyping and genotyping. I see progression in this business as different from that of the regionalized, routine testing business.

EDITOR: In what ways?

MACMAHON: Today specialty esoteric testing is a relatively small part of the lab testing pie, but is evolving rapidly. There are only a handful of established companies offering these types of tests, such as LabCorp, Quest Diagnostics, ARUP Laboratories, Mayo Medical Laboratories, and Specialty Laboratories. At LabCorp, we want to be unique and bring lab customers tests from both of these business segments. There are not many laboratory companies which can compete in both the routine and the esoteric segments. For example, we don’t see much competition in the areas of phenotyping and genotyping from non-profit hospital laboratories.

EDITOR: Tom, that comment indicates you have distinct views about the evolution of routine lab testing compared to sophisticated esoteric testing. What roles might hospitals and hospital-based laboratories play in this evolution?

MACMAHON: That question strikes to the heart of our profession’s competitive evolution. In both the short term and long term, chronic disease will be treated in outpatient settings. More of the testing, whether for cancer, for infectious disease, and for other illnesses, will be done in support of outpatient treatment.

EDITOR: This has major ramifications for hospitals.

MACMAHON: Certainly. The growth of outpatient activity has been well-documented since the early 1980s. To me, here is the interesting dilemma for laboratories that you write about all the time and about which I am constantly asked. What will be the relationship of the hospital laboratory and the independent laboratory like LabCorp?

EDITOR: It sounds like you expect more hospitals will develop laboratory outreach programs. Explain the dynamics behind this trend.

MACMAHON: Actually, I don’t. My premise is that existing hospital laboratories which are already vigorous competitors against commercial laboratories have done so because they recognize this fundamental shift away from inpatient treatment in favor of outpatient treatment.

EDITOR: It’s a case of following the patients.

MACMAHON: Look at how healthcare has changed the way the important diseases are treated, such as cancer, infectious disease, and cardiovascular disease. In the 1970s, it was common for a patient to be admitted to the hospital for between one and four weeks. Because of advances in medicine, better technologies, and new drugs, it is now unnecessary for a patient to spend weeks in a hospital undergoing treatment. Today, most patients stay only a few days in the hospital as a result of efforts to minimize inpatient stays as a way to control costs. These developments are steadily transforming hospitals into short-term healthcare facilities.

EDITOR: That is certainly true.

MACMAHON: Take infectious diseases such as HIV, hepatitis B and C, chlamydia, and others. Fifteen years ago, we couldn’t think about treating these infectious diseases. Today there are outpatient treatments that minimize hospitalizations. Collectively, these factors bode well for continued growth in non-hospital sources of healthcare. It also bodes well for the laboratory industry, because almost all of these medical advances require laboratory testing to support diagnosis, therapy, and patient monitoring.

EDITOR: Is that why you see growing numbers of hospital laboratory outreach programs that are viable and professionally managed?

MACMAHON: Yes—and that shouldn’t surprise anyone! These hospital outreach programs know how to identify business opportunities in laboratory testing and capture specimen volume.

To me, the greatest opportunity for a pathologist, moving forward, is to get control of molecular diagnostics.

EDITOR: Moving past the impact of the shift toward outpatient services, is there another strategic market driver that you believe will have great influence on laboratories?

MACMAHON: If any company wants to be in the testing business, it’s my strong belief that tissue-based diagnostics is the place to be. I read each issue of THE DARK REPORT and you seem to be strongly convinced that tissue will play the major role in reshaping diagnostics as we know it today. I concur with equal conviction. I believe any laboratory seeking to be a leader in laboratory medicine must be a leader in cancer diagnostics. And if a lab is to be a leader in cancer diagnostics, it must have a tissue business and work closely with pathologists to evaluate those tissue specimens.

EDITOR: That certainly mirrors my thinking. It’s an opportunity that few pathology group practices recognize, and even fewer have decided to pursue.

MACMAHON: To diagnose cancer requires tissue. To me, the greatest opportunity for a pathologist, moving forward, is to get control of molecular diagnostics. Pathologists should be expanding both their skill base and their business base, not only to read tissue, but to read tissue as it relates to molecular biology. Molecular pathology is expected to be the cutting edge of medicine as we move forward. Ongoing scientific advances in genomics and proteomics guarantee this will be true.

EDITOR: That’s an unqualified recommendation to the pathology profession. We both read the tea leaves the same way.

MACMAHON: Absolutely. Those who predict that tissue will not be important as we go forward are short-sighted. In our strategic planning efforts at LabCorp, we consistently recognize that we must develop and maintain a significant tissue business.

EDITOR: That is certainly a change! In past years, commercial laboratories invariably farmed out anatomic pathology (AP) services to local pathologists.

MACMAHON: This is different from ten years ago. At that time, it seemed commercial labs wanted to run away from anatomic pathology. That’s reversed at LabCorp. We want to be a leading company in tissue-based diagnostics and recognize the need to develop our capabilities in anatomic pathology.

EDITOR: Tom, you’ve just provided me a great segue into our next topic. Let’s talk about the acquisitions of Dynacare, DIANON, and the Northern California lab assets during 2002. How are these transactions changing LabCorp? In particular, let’s start with DIANON, because of its emphasis on anatomic pathology.

MACMAHON: DIANON Systems boosted our capabilities in anatomic pathology. This fits our second core strategy, of providing sophisticated esoteric tests. DIANON stood apart from the other anatomic pathology companies that were out there.

EDITOR: In what ways was DIANON different?

MACMAHON: First, it is organized to provide AP services to office-based physicians throughout the United States and has an established base of clients. Second, it has a proven ability and corporate system already providing uniform anatomic pathology services. Third, DIANON has an effective in-house anatomic pathology system along with its CarePath system for reporting to physicians, patients, and payers.

EDITOR: What “holes” did you hope DIANON would fill for LabCorp?

MACMAHON: Go back to our national system of regional laboratories. Anatomic pathology services in LabCorp were always provided at the regional level. For example, AP services in Texas were done as the pathologists in Texas wanted and that might be different from how pathologists in North Carolina handled similar cases. LabCorp never had a national system to handle anatomic pathology. Nor did it have a national strategy to develop anatomic pathology. Although we will always have relationships with many pathology groups and pathologists, DIANON gives us the framework to support our molecular diagnostic testing. We hope the pathologists who work with us see the DIANON model as an opportunity to enhance their relationship with us.

EDITOR: In lacking both, LabCorp would not be best positioned to develop opportunities in molecular diagnostics.

MACMAHON: True. What LabCorp actually had was a variety of regional AP capabilities that supported a range of regional anatomic pathology strategies. That’s why we seized on DIANON to be the focus of a consistent national strategy in AP, as well as a standardized program of anatomic pathology services within our regional laboratory facilities.

EDITOR: So DIANON forms the backbone of your developing national strategy in anatomic pathology, plus it supports your second strategy of providing sophisticated esoteric testing services.

MACMAHON: That’s right. We intend to funnel many of our cancer-based products to customers through the DIANON channel. It is also a way to funnel services from our relationships with companies like Myriad Genetics, Correlogics, Celera Diagnostics, and Exact Sciences as we launch those esoteric testing products to customers.

EDITOR: Let’s now look at the Dynacare and Northern California acquisitions. How do these support LabCorp’s strategic plans?

DIANON Systems boosted our capabilities in anatomic pathology. This fits our second core strategy, of providing sophisticated esoteric tests.

MACMAHON: This returns us back to the first core strategy I discussed with you. That was to have coverage across the United States. To be a national resource with regionalized lab services, we can’t have geographical gaps. As an acquisition, Dynacare brought us a sys- tem of routine testing laboratories located in some of the fastest-growing areas of the United States. It had a strong lab in the Northwest. In the South, it filled in areas where we weren’t as strong as we wanted to be.

EDITOR: How does the acquisition of Immunodiagnostics Laboratory and the Quest/Unilab assets in Northern California help fill in gaps?

MACMAHON: We’ve always wanted to be a major factor in California, but on business terms which meet our criteria for market share and profitability. LabCorp has infrastructure in Southern California. These Northern California acquisitions now give us a business foundation from which to grow in that part of the state.

EDITOR: What are your plans for Northern California?

MACMAHON: We’ve expanded our routine business in the Bay area with these acquisitions. In particular, the IPA (independent physician association) contracts compliment our strategy of having a contract anchor with office-based physicians. We can now use that anchor to convince physicians to refer us more of their laboratory testing business.

EDITOR: That also supports your strategy of using this access to sell more esoteric testing, correct?

MACMAHON: Yes. The San Francisco Bay Area generates a lot of esoteric testing, particularly in diseases like HIV and hepatitis. We now have access to physicians in this regional market. For example, by year’s end we will have 60 patient service centers in this area. We expect Northern California to be a big source of esoteric testing for us.

EDITOR: Can we talk more about esoteric testing? Patent-protected, branded diagnostic tests are growing in number. LabCorp is doing partnerships with a number of companies that have developed these tests. How does this fit your strategic vision?

MACMAHON: At LabCorp, our fundamental business is to create information from laboratory tests and deliver that information to our physician-clients. In that sense, we are a distribution and information company. We are not in research and development.

EDITOR: Thus, you want to align yourself with companies that develop tests to provide them a channel to the clinical marketplace.

MACMAHON: Yes. Once a diagnostic test is developed, these companies recognize they can get their test to market much more rapidly through companies like LabCorp without having to spend enormous amounts of money to educate physicians and do their own marketing. This change has come about during the past three years.

EDITOR: But what about reimbursement for these high-priced assays. That is always a hurdle.

MACMAHON: LabCorp has sophisticated expertise in reimbursement issues along with extensive working relationships among payers. Part of our value-added to diagnostic test developers is our ability to persuade payers to provide adequate reimbursement to launch diagnostic tests that are supported by good science.

EDITOR: That describes a symbiotic relationship.

MACMAHON: We need their technology. They need our distribution channel and reimbursement expertise. It’s a natural complement, which is why LabCorp gets the opportunity to see lots of promising technology while it’s still in the development phase.

EDITOR: I’d like to shift gears now to another topic. During the past few years, the two blood brothers have posted strong profit gains. Public laboratory companies have sold at impressive multiples of earnings. There is plenty of optimism about opportunities in laboratory testing. Why don’t we see existing lab companies building new laboratory facilities from scratch to open up “new” regional markets and compete for physician’s office testing? Why don’t we see lab entrepreneurs building a new laboratory from scratch to enter that business and compete for market share?

MACMAHON: I have two answers to that question. First, there continues to be a feeling among the investment community that the laboratory industry still has exposure to low profitability and risk. It can be called a fear factor among investors. That makes it tough to get the necessary start-up capital.

EDITOR: And your second reason?

MACMAHON: It requires uniquely experienced people to successfully construct a clinical laboratory and launch the business from a standing start. Creating a new laboratory company to service office-based physicians requires a deep roster of talent: from the CEO through the executives required to support operations, testing, sales and marketing, logistics, and billing. There’s not a lot of those types of individuals available. And because of the difficulty of running such laboratory companies, many shy away from the challenge.

EDITOR: That’s an interesting response. Over the last ten years, there have been only a handful of attempts to launch, from a cold start, a laboratory company organized to provide lab test services to office-based physicians. Let’s finish with your thoughts about laboratory information and LabCorp’s response to changes in this field.

MACMAHON: In simplest terms, LabCorp is an information company. What we do is take human specimens and develop information that we report to clinicians. We are electronically linked to more than 100,000 physicians’ offices. Our information capabilities are a critical success factor for LabCorp. That is why one of my biggest disappointments during my six years at this company is that the information technology which is available to us every day has not been converted into useful tools that help clinicians manage their practices.

EDITOR: Please explain.

MACMAHON: For example, physicians still do not use the Internet to the degree that we expected. In the area of disease management, which links together information on therapeutics with information on laboratory testing and patient demographics, greater use by clinicians has been hampered by many factors.

EDITOR: You sound a bit frustrated.

MACMAHON: That’s because we know the value of laboratory medicine to help clinicians achieve better outcomes.

EDITOR: Do you have examples of payers using enriched laboratory test data sets from LabCorp to drive changes in clinical practices?

MACMAHON: That’s a tough question. Few of the nation’s health insurance companies have devoted resources to assemble information from a variety of sources, including laboratory test data, and then use it with physicians to improve clinical outcomes. However, physicians are beginning to demand better information sets that will help their practice of medicine.

EDITOR: Then you do see growing interest among physicians, but no instances where this is happening?

MACMAHON: In general, yes. However, the clinical laboratory profession has yet to do an adequate job of converting diagnostic information into useful outcome data, then use this outcome data to demonstrate the cost-benefit of diagnostic tests to the clinical community. The pharmaceutical industry does this.

EDITOR: That’s true.

MACMAHON: It’s an obvious opportunity for our leaders in this industry. As we do a better job of demonstrating the cost effectiveness of our laboratory testing services, not only will laboratories get more recognition for their contribution, but it will make it easier to get fair reimbursement for laboratory testing services.

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