Increased Competition For Hospital Lab Referrals

It’s getting tougher for national reference labs to win new clients and expand market share

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CEO SUMMARY: It’s a buyer’s market for hospital send-out testing because the supply of such tests exceeds demand. To fill excess capacity in their labs, some reference/esoteric lab companies are willing to offer rock-bottom prices to new clients. This situation is also motivating national lab companies to develop and offer additional services to clients as a way to differentiate themselves.

THERE ARE PLENTY OF SIGNS that the supply of reference and esoteric tests exceeds demand. That is a situation which favors hospital labs, many of which enjoy lower prices and more “extra” services as national reference lab companies compete for their send-out testing.

This situation continues to validate a prediction made by THE DARK REPORT back in 1999. At that time, Quest Diagnostics Incorporated had just acquired SmithKline Beecham Clinical Laboratories and American Medical Laboratories, Inc. (AML) had become a new competitor for hospital send-out testing. These developments were disrupting the status quo, to the benefit of hospital laboratories interested in negotiating a better contract for the reference and esoteric test referrals. At that time, THE DARK REPORT wrote that “during the next 24 months, there will be outstanding opportunities to shop these six reference/ esoteric testing providers and negotiate a winning package. Like the television game show, it’s a good time to declare ‘let’s make a deal’.” (See TDR, August 30, 1999.)

Not only was that an accurate prediction, but seven years later competition in this market segment remains both sustained and intense. Many hospital labs have benefited from this situation by shrewdly negotiating contracts that lowered their cost of reference send-out tests, sometimes by substantial amounts.

Recent events provide evidence that the supply of reference and esoteric testing continues to exceed the testing continues to exceed the demand for such testing from hospital laboratories. As long as this situation remains unchanged, it is a buyer’s market and hospital laboratories will benefit.

Aggressive Test Pricing

What is true of today’s marketplace for hospital send-out testing is that the major competitors are willing to be aggressive on the pricing they offer hospital laboratory clients.

Thus, the national reference/esoteric laboratory companies face a classic business conundrum: when all your competitors are selling at identical prices, how do you differentiate yourself with customers? Recent actions at ARUP Laboratories, Inc. of Salt Lake City, Utah, provide evidence that it is taking steps to differentiate itself in the market.

In July, it was widely reported that ARUP Laboratories had announced an agreement with Mednet Services of Allen Park, Michigan to provide consulting expertise in managed care contracting and similar outreach development issues to hospital laboratory clients of ARUP Labs, upon request of such labs. What went unremarked is that no ARUP clients were “in the queue” to engage Mednet in this fashion, nor have any clients been known to enter into a consulting agreement with Mednet since the relationship was made public.

Resource Pool of Experts

Rather, the motive in this business collaboration seems to be that ARUP Laboratories is assembling a resource pool of experts it can introduce to its laboratory clients to help those clients with different operational and management projects, including laboratory outreach programs. This is a strategy to differentiate itself as a reference/esoteric testing laboratory that can bring more than just a full menu of tests and low prices to the negotiating table. ARUP Labs believes it can win new business by offering packages that include competitive prices for the send-out tests, as well as assistance in bringing specific resources to the client laboratory.

Other national reference/esoteric laboratory competitors are similarly working to develop services and products that allow them to offer more than just low price to hospital labs—and at the same time differentiate themselves in the marketplace. These are rational business responses to a marketplace where there is excess testing capacity among the leading competitors.

Thus, the national reference/esoteric laboratory companies face a classic business conundrum: when all your competitors are selling at identical prices, how do you differentiate yourself with customers?

Two examples demonstrate why the market for hospital send-out testing continues to be intensely competitive. In December, 2004, Specialty Laboratories, Inc. relocated into its new laboratory facility in Valencia, California. At the time of the move, Specialty was already posting red ink because its expenses exceeded revenue.

The cost of the relocation and the operating expenses of the new facility were additional reasons why Specialty Laboratories needed to bring in new accounts, increase specimen volume, and gain new revenue. As most laboratory directors and pathologists know, Specialty has continued to compete aggressively for new business and it is willing to offer attractive low prices to win new client accounts.

Just four months after Specialty Laboratories moved into its new laboratory, a start-up laboratory company entered the national reference/esoteric testing marketplace. American Esoteric Laboratories, Inc. (AEL) of Nashville, Tennessee, commenced operations in April 2004. Its declared goal is to offer reference and esoteric testing services to hospital laboratories and certain specialists.

Built New Lab In Dallas

AEL added to the supply by building a new laboratory in Dallas and has sent sales reps out to beat the bushes for new business. The company has not said much publicly about the success of its sales program. On the other hand, it has acquired four lab companies since the fall of 2004. What makes these acquisitions interesting is that three of these labs provide routine testing services to office-based physicians.

The fact that AEL has acquired routine testing labs may be a sign that competition for new reference/esoteric specimens from hospital laboratories is making it tough for AEL to achieve its internal growth goals on the planned timetable. In order to have the specimen volume needed to produce the necessary economies of scale, it is acquiring regional laboratories that primarily offer routine testing to office-based physicians.

Supply Has Not Declined

There has been no major reduction to the supply side of the reference/esoteric testing marketplace since THE DARK REPORT made its 1999 prediction. In 2002, Quest Diagnostics purchased American Medical Laboratories. But no labs were closed and Quest converted AML’s main lab facility in Chantilly, Virginia into an east coast reference/esoteric testing center.

In 2005, Laboratory Corporation of America acquired Esoterix, Inc., which operated specialty testing labs in a number of cities. LabCorp has redirected and consolidated some of this testing. The other significant change during these seven years was the entry of American Esoteric Laboratories into the market, which was a further expansion in the available supply of reference and esoteric testing.

It should also be noted that the supply of reference and esoteric tests has been expanded by the regular entry of smaller lab companies which offer a limited number of specialized reference and esoteric tests. Individually, these increases to the supply are relatively small. It is the cumulative addition of this supply which creates more pressure on the national reference/esoteric laboratory companies.

Continued Supply Glut

Collectively, the experience of the past seven years indicates that the over-supply of reference and esoteric tests is not likely to disappear in the coming years. Such a situation benefits hospital laboratories. It means they can continue to shop competing reference laboratories against each other. Because of the economics of laboratory testing, reference labs with excess capacity will have an incentive to bid work from new clients at marginal costs, as well as bundle other value-added services into their bid.

Is there a downside to this test supply glut for lab directors and pathologists? After all, any time a reference laboratory underprices its tests, it will generate insufficient revenue to cover its costs. Over time, service levels may erode, to the detriment of that lab’s clients.

That is an acknowledged risk, with an offset. Over the past 15 years, whenever a national laboratory provider found itself in financial difficulty, it generally sold itself to a stronger laboratory that corrected the problems and maintained service.

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