Hospitals in Michigan Build Unique Shared Lab

Use of “co-tenancy” business model benefits participating hospital owners

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CEO SUMMARY: This operational model for a collaborative regional laboratory organization makes “profit” irrelevant. Serving 30 hospitals in four Midwestern states, Michigan Co-Tenancy Laboratories is consistently expanding lab testing services, lowering costs, and emphasizing the laboratory’s contribution to better patient care in participating hospitals.

WORKING QUIETLY and without much fanfare during the last 17 years, a group of hospitals in Michigan created the nation’s most unique collaborative regional laboratory organization.

No, it’s not Joint Venture Hospital Laboratories (JVHL), the thriving and well-known regional laboratory network based in Detroit. It’s Michigan Co-Tenancy Laboratories (MCL—which operates in parallel with Warde Medical Laboratories), based in Ann Arbor, Michigan, only 45 miles from Detroit. MCL is owned by 17 hospitals and involves 30 hospital laboratories.

Three noteworthy attributes mark this collaborative regional lab venture. First, it delivers sustained yearly reductions in laboratory testing costs. Second it provides participating hospitals with an enriched menu of reference and esoteric testing, accompanied by high quality and fast turnaround times. Third, it operates as a “co-tenancy” and is believed to be one of only three co-tenancy laboratories in the United States.

This successful co-tenancy laboratory is posting impressive numbers. It performed more than 1 million esoteric tests for fiscal 2002. In the past five years, MCL reduced its cost-per-RVU (Relative Value Unit) by 21.7%, declining from $7.47 in 1997 to $5.85 in June 2002.

What is particularly intriguing about the Michigan Co-Tenancy Lab story is that, despite its successes, it has escaped the notice of other hospital laboratorians seeking to create collaborative regional lab networks.

That surprises two MCL executives who believe this business model is well-suited for hospital labs wanting to develop collaborative testing operations within a region. Paul N. Valenstein, M.D., Chief Operating Officer and Dennis R. Hodges, Manager of Business Development, are both convinced that co-tenancy is an ideal business model that can be easily replicated by hospitals throughout the United States.

“Co-tenancy, in which owners share assets as tenants-in-common, is a longstanding business concept,” explained Hodges. “There are plenty of examples outside the healthcare industry, such as laundry services firms owned and operated by competing hotels. The premise is that you are willing to cooperate with your competitors to achieve a common goal.

“MCL evolved out of Warde Medical Laboratories to meet the changing needs of the hospitals it served,” noted Hodges. “It was David Keren, M.D., Warde’s medical director, who recognized that Warde had only begun to tap the regional demand for specialized testing services. Many hospitals did not want to completely outsource a service as critical as laboratory testing. Co-tenancy was a solution that allowed these hospitals to achieve economies of scale while maintaining control of their laboratory operations.”

Reduce Lab Testing Costs

“The original intent of Warde Medical Laboratory was to consolidate esoteric testing to lower the cost to hospitals in one healthcare system,” continued Dr. Valenstein. “Pathologists held a one-third share of the partnership. Mercy Health System owned the remaining two-thirds. Not all Mercy hospitals were part of the original partnership. Of the participating hospitals, some used Warde Medical Labs as their primary reference lab. Others used it for just a portion of their send-out testing.

“Because we offered a high level of service and good turnaround time as a local lab provider, we were competitive with the national reference labs,” he said. “Growth was steady from our founding in 1985 through 1997. In that year WML’s partners decided to recast laboratory operations as a co-tenancy.

Changing Healthcare Market

“Participating hospitals, responding to a changing healthcare market in Michigan in the 1990s, wanted to refocus laboratory services,” stated Hodges. “They recognized that, despite the substantial economic benefits that WML was delivering, there was yet more unrealized opportunity for savings.

“Hospital CEOs asked our pathologists a fundamental question. ‘WML still has excess lab capacity despite our past growth. Doesn’t that excess capacity mean that our hospitals are not realizing all the benefits of higher productivity and lower costs that would come from a fully-utilized laboratory?’,” recalled Hodges.

This question launched an intense period of study and strategic planning in the mid-1990s. During the evaluation process, pathologists from all Mercy Hospitals in Michigan met and considered a variety of options. The strategic decision was to create a regional “superlab” that would operate in support of original owner hospitals’ laboratories and would also allow new owners to use the facility on an equal footing. The assets of Warde Medical Laboratory were transferred to the four Mercy owner hospitals and operated under a co-tenancy arrangement.

“Thus was born Michigan Co-Tenancy Laboratories,” stated Dr. Valenstein. “Because only non-profit entities can participate in our co-tenancy agreement, only hospitals would hold equity. New hospital owners have joined the shared lab operation since its inception. However, the Warde Medical Laboratory partnership still exists. Warde leases excess capacity from the owners of the co-tenancy and sells it to smaller hospitals that are not yet ready to become co-tenants.”

CEOs of the participating hospitals were not put off by the fact that a co-tenancy laboratory was an “untried” concept. “This was not a lab organized to generate profits,” declared Dr. Valenstein. “It was organized to serve the hospitals’ mission to provide quality care to hospital inpatients and outpatients.”

To meet this objective, the hospital CEOs wanted an operational form that encouraged hospitals to feed specimens into the regional “superlab.” This growing specimen volume would generate lower overall lab testing costs while supporting a steady expansion in the menu of tests done locally.

“Co-tenancy allows the owners, all of which are not-for-profit health systems or hospitals, to share a cost center in common,” continued Dr. Valenstein. “What the hospital owners choose to charge their customers for the lab testing services is beyond the scope of the co-tenancy. Our job is to run the shared lab operation with high quality and efficiency.”

“This is an important concept,” emphasized Hodges. “Michigan has a law called the Laboratory Purveyor’s Act that forbids a provider, including a laboratory, to mark up the price of a test performed by another laboratory. However, under the co-tenancy agreement, all participating hospitals are owners of the shared lab operation. Because testing done in the central reference lab is an intrinsic part of a hospital’s own operation, it can price tests based on its own business economics. This feature preserves competition between participating hospitals.”

In the MCL model, each co-tenant owns an undivided interest in the assets formerly held by WML. There is a minimum capital contribution of $50,000 to secure an ownership position. This is placed in the shared asset pool.

“Testing on behalf of each co-ten- ant occurs on what is legally considered to be that co-tenant’s share of the equipment, using its share of the reagents and its designated share of the staff. Both the marketing and the billing for such testing is the responsibility of the co-tenants under their own names,” said Hodges.

“All shared assets are carried on the books of the participating hospitals,” observed Dr. Valenstein. “MCL is an agreement, not a corporation. Therefore it has no ‘corporate books.’

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Shared Assets

“Each MCL co-tenant lists its ownership interest in the shared assets on its books as a single line item designated ‘Investment in Michigan Co-Tenancy Laboratory’,” he continued. “The initial capital contribution is deposited in a tax-exempt checking account and the co-tenants receive interest on the assets they’ve contributed to the shared lab operation, in the form of a credit subtracted from their cost allocation.

“This credit represents the opportunity cost of each hospital’s capital contribution and equitably recognizes those hospital-owners that contributed larger amounts of capital. The co-tenancy checking account is used to pay for approved capital purchases, supplies, and external reference lab services. Payments from co-tenants are deposited into this account.”

The governing body of MCL is the Administrative Committee. It meets quarterly and is chaired by the COO, Dr. Valenstein. Each co-tenant has two representatives on the committee. The Administrative Committee oversees the shared operation.

New owners are admitted following the approval of existing co-tenants. “To date, no interested hospital has been refused entry into the co-tenancy,” noted Hodges. “We cover Michigan, Northern Ohio, Northern Indiana, and we even have one owner in Des Moines, Iowa.”

Owners have complete autonomy in how they make use of the shared lab facility. Some send a higher proportion of tests than others. All owner-hospitals continue to operate their own on-site laboratories. MCL offers its owners a full menu of reference and esoteric testing. This menu also includes some routine assays because several hospital owners want to use the shared lab facility to lower costs for more commonly-performed tests.

There is no predetermined or expected test mix for participating hospitals. However, each hospital is expected to send at least $50,000 worth of testing to the shared lab facility each quarter.

“What makes MCL work is the collaborative attitude among the hospital owners,” said Dr. Valenstein. “This type of operation requires a high level of trust, because some owners compete with other owners. Operations are conducted openly and the finances are laid bare every quarter for all to see. As a result, our co-tenancy laboratory is delivering substantial benefits to our hospital owners.”

Simple Formula Used For Sharing Test Costs

COST ALLOCATION FOR EACH OWNER is straightforward. Each test performed in the co-tenancy lab is assigned an RVU (Relative Value Unit) based upon in-house micro-costing principles. Interim payments are made by each owner on a monthly basis, based on the volume and types of tests the owner has sent. At the end of each quarter, the total cost of the shared lab operation is divided by the total RVUs in that quarter to arrive at a cost per RVU.

Each individual co-tenant’s total RVUs for the quarter are calculated and multiplied by the cost per RVU. The resulting number is a particular hospital-owner’s allocated cost of testing. A rebate is sent to the co- tenant for the difference between the amount of the owner’s interim payment and their actual allocated cost for the quarter.”

What happens when a new test needs to be added to the menu? Dr. Valenstein responded. “Keep in mind that the co-tenancy makes no profit. The test is assigned an RVU based on its complexity. The test is not brought in-house unless the RVU is equal to, or less, than the cost to send the test to an outside reference lab. Our volume of esoteric testing is so high that most of the tests we can bring into the shared lab operation have already been moved in-house.”

United In Common Purpose

Michigan Co-Tenancy Laboratory is a remarkable example of a collaborative regional laboratory organization. It demonstrates what motivated hospital CEOs, laboratory administrators, and pathologists can create when united in common purpose.

However, THE DARK REPORT believes the most notable aspect about MCL may be how the participating hospital CEOs created a subtle and sophisticated laboratory testing tool to support their institutions. By its very design, it encourages participating (and often competing) hospitals to willingly feed larger numbers of specimens to the regional core laboratory as a way of expanding the local test menu and lowering overall laboratory costs.

The contribution made by pathologists and lab administrators in these hospitals should also not be overlooked. They supported the co-tenancy operational model. The creativity of this group and its willingness to strike into unknown territory must be recognized. Most laboratorians would consider it unnecessarily risky to be first in the United States to build a sizeable laboratory around the co-tenancy organizational model. The willingness of these Michigan hospitals CEOs and their laboratory leadership to pioneer this concept is commendable.

Sophisticated Strategy

The Michigan Co-Tenancy Laboratory is also an example of a very sophisticated business strategy. It is not organized to generate and distribute profits from the sale of laboratory tests. Nor does it hold assets which can grow in value as the lab test volume increases. To the contrary, MCL neither reports profits nor holds assets. It is organized for the exclusive purpose of enhancing the laboratory testing services each hospital owner provides to its inpatients and outpatients. MCL is an organizational tool that generates higher productivity, a broader test menu, and lower costs for its hospital owners.

Since its founding in 1997, Michigan Co-Tenancy Laboratories has delivered measurable value to participating hospitals. There is ongoing growth in its test volume and test menu. MCL is demonstrating that the concept of co-tenancy is a viable operational model for developing collaborative regional laboratory organizations.

More Hospitals Want In

The merits of this co-tenancy laboratory model continue to attract hospitals. “Currently we have seven new owners reviewing paperwork,” stated Hodges. “Four currently buy some testing from WML, but Warde is not their primary reference lab. Our last owner was added in July. We expect to add more new owners soon!”

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