LabCorp Exec Discusses Reasons Behind Its 10-Year Pact with United

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“This 10-year agreement is unique in the laboratory industry. It speaks to the long-term commitment of both parties.”—Brad Smith, Executive Vice President, Laboratory Corporation of America

CEO SUMMARY: It was unprecedented when UnitedHealth Group announced an exclusive, 10-year laboratory testing services agreement with Laboratory Corporation of America Holdings. This is a high-stakes development for both companies. To learn more about the motivations and goals that encouraged UnitedHealth and LabCorp to partner up in this fashion, THE DARK REPORT spoke with Bradford T. Smith, LabCorp’s Executive Vice President for Corporate Affairs. Two key objectives are to lower UnitedHealth’s cost of laboratory testing and to reduce leakage. Several subtle goals align the interests of both parties. Among them is a mutual interest in developing more standardized laboratory test data and using that information to support efforts in disease management and evidence-based medicine. The interview was conducted by Robert L. Michel, Editor-In-Chief of THE DARK REPORT.

EDITOR: There are many implications to the new, exclusive, ten-year national laboratory testing contract between UnitedHealth Group and Laboratory Corporation of America Holdings. In our conversation today, I’d like to explore the fundamental reasons why LabCorp was willing to tackle the challenge of becoming UnitedHealth’s sole national laboratory provider. It would also be helpful to learn how LabCorp believes a national managed care contract like this may represent a shift in thinking by the nation’s largest health insurers.

SMITH: For the past several years, improving our relationships with major managed care companies has been one of LabCorp’s three key strategies. We attempt to do this by highlighting the strengths we can bring to national managed care companies, including our leading-edge esoteric and anatomical pathology test offerings, our standardized computer and lab testing systems, and our national coverage.

EDITOR: How is this new national contract with UnitedHealth consistent with LabCorp’s long-term strategy for working with managed care companies?

SMITH: A large part of the answer is related to the widespread consolidation that has occurred in healthcare over the past decade. Acquisition activity in the managed care industry has resulted in several very large national health insurance firms. For example, WellPoint, Inc. has 34 million beneficiaries and UnitedHealth serves 25 million lives. We can not hope to grow our business without growing our relationships with all of the national and major regional managed care companies.

EDITOR: Please continue.

SMITH: Consolidation within the managed care industry changes LabCorp’s relationship with many of these companies. If you look at our revenue, 40% comes directly from managed care companies. If you add indirect sources of revenue linked to managed care plans, such as physicians who pay us and then bill the managed care companies, or patients who pay us, then more than 50% of LabCorp’s revenue is tied, directly or indirectly, to managed care plans.

EDITOR: It is logical that LabCorp would want to develop strategies to address the source of more than 50% of its annual revenue. What steps are involved?

SMITH: The core of our strategy is basic. In addition to stressing the strengths that I mentioned, we need to find ways that LabCorp can serve managed care companies in ways that meet their needs—while allowing LabCorp to achieve its own business goals.

EDITOR: Let’s discuss this business objective in the context of the UnitedHealth contract. What were the factors that led UnitedHealth to align itself so closely with LabCorp?

SMITH: First, as a health services company, we believe that UnitedHealth wants to become more efficient in the delivery of healthcare in ways that benefit their patients while improving the quality of the healthcare that they receive. That certainly includes improving the cost-effectiveness of laboratory testing. But it is a misconception to emphasize only the pricing components of this contract.

EDITOR: Yet pricing has been a major point of speculation by the financial community. Speculation centers around what level of pricing caused UnitedHealth to exclude Quest Diagnostics and offer the national contract exclusively to LabCorp. What other factors contributed to UnitedHealth’s decision?

SMITH: UnitedHealth has regularly expressed its interest in improving clinical outcomes through the better use of data. It actively manages data and uses it, not just for utilization, but for helping clinicians raise their effectiveness. One example of a UnitedHealth initiative in this area is use of data to support the early identification of patients likely to become diabetic. That’s an effort to make medicine more proactive and preventative. With respect to price, we have said we are not commenting directly, but I will say that I know, based upon the marketplace, what prices have been offered in contracts by our competitors. So I am quite certain that UnitedHealth’s decision to chose LabCorp involved much more than price.

EDITOR: Clearly laboratory test data plays a role in this type of initiative. UnitedHealth has repeatedly made public statements about its strategic objectives to collect better data and use it to improve the delivery of care and health outcomes.

SMITH: Correct. UnitedHealth is interested in developing extensive sets of standardized data that it can use in disease management and evidence-based medicine. Within the laboratory industry, LabCorp is uniquely positioned to support UnitedHealth in its data accumulation efforts.

EDITOR: Please explain.

SMITH: LabCorp believes it has achieved the most standardization of any large laboratory organization. Within our company, we have standardized systems for: test ordering, test reporting, test identification, and test platforms [instrument systems]. Each of these factors is important for a large managed care company like UnitedHealth. It means LabCorp is providing uniform sets of data that can be incorporated with other data sources and used by the managed care organization to guide decision making.

“UnitedHealth is interested in developing extensive sets of standardized data that it can use in disease management and evidence-based medicine.”
—Brad Smith

EDITOR: That implies an ongoing relationship between UnitedHealth and LabCorp, because it takes time to understand the information contained in the laboratory test data from large numbers of people, then use that information to generate operational efficiencies and clinical improvements.

SMITH: That’s true. I can say that UnitedHealth became intrigued with LabCorp as it began to understand our standardization and how that contributed to uniformity in the laboratory test data and other information we are able to gather and provide. To succeed in its efforts with disease management and evidence-based medicine, UnitedHealth must get control of the data flowing in from all types of providers, including hospitals, physicians, and clinical laboratories. LabCorp’s ability to deliver standardized data on lab testing—which is an important part of every patient’s clinical record—was a factor in helping us develop the agreement with UnitedHealth. When these capabilities are overlaid with our extensive geographic reach and comprehensive expertise in esoteric and oncology testing, we believe we offer a compelling solution in one package.

EDITOR: Is LabCorp doing anything internally to generate more value from the lab test data it produces?

SMITH: Yes. We have an ongoing project involving Medicity that uses LOINC (Logical Observation Identifiers Names and Codes) and other proprietary technologies to combine disparate laboratory data from multiple laboratories and other sources and feed it into a standard data set. From that single, standardized set of data, it is then possible to break out information by individual patients, by diseases, or by lab results that meet specific criteria.

EDITOR: That would certainly be of interest to UnitedHealth and other managed care organizations. It is the capability to gather laboratory results from many sources and create a standardized data set.

SMITH: That’s the goal. It’s also an example of how the idea of a partnership and ongoing relationship between UnitedHealth and LabCorp emerged from our years of discussion and business interaction. Our two companies recognized common interests and common opportunities. I’ve already mentioned two of them, which are disease management and evidence-based medicine.

EDITOR: Does this point answer the question about why these two companies decided to make the agreement for ten years?

SMITH: Definitely. I am not aware of any similar contract for laboratory services. This ten-year agreement is unique in the laboratory industry. It speaks to the long-term commitment by both parties. As you know, both parties have a lot at risk. That means each party has something in play. That aligns the interests of both companies and keeps us both looking forward.

EDITOR: Brad, this is a good point to shift the conversation to the risks and challenges in this agreement. My first question is about pricing. Wall Street and the business press are speculating about what level of pricing LabCorp was willing to accept that Quest Diagnostics considered “fiscally irresponsible” to its shareholders and the lab industry collectively. Would you speak to that?

SMITH: Much has been written and said about the statements by Quest Diagnostics that it couldn’t do this contract on the terms offered—and that LabCorp says it can do it, while maintaining the industry’s leading margins. My first observation is that people are likely starting from a false premise, by assuming the contract terms that Quest was unable to accept are ones that we accepted. I don’t know what terms Quest found specifically objectionable. But, based on their public comments, we do not have the same types of terms that they appear to have found to be problematic. Second, the value of a contract and partnership may differ dramatically depending on the relative positions and objectives of the parties.

EDITOR: Would you explain that?

SMITH: Each of these two lab companies has an existing book of business with UnitedHealth. This business is anchored in communities where one laboratory may have more infrastructure than the other. Next, there is established pricing for existing business. That means each of our two companies is going to look at the contracting status quo with UnitedHealth and weigh the impact of various contract terms differently.

EDITOR: Let me speculate for a moment, and use the New York City metropolitan area as an example. It is widely-recognized that Quest Diagnostics is the dominant lab provider in that market. In the physician office segment, it has a market share that probably approaches 70%. Because of this dominance and existing market share, Quest Diagnostics could logically be expected to view certain levels of lower pricing for an existing major managed care contract to be untenable with their cost of maintaining that business in that market. LabCorp, on the other hand, with a different cost structure—and a less extensive service network—may consider that same level of contract pricing to be acceptable, since it creates the opportunity to capture new client accounts and specimen volume.

SMITH: Conceptually, that’s one way to explain why Quest Diagnostics and LabCorp may have viewed the UnitedHealth contract from different perspectives. But again, I do not necessarily accept that LabCorp accepted a lower price than Quest would have been willing to accept. Remember, LabCorp was an active bidder for the Empire Blue Cross Blue Shield contract in New York. We publicly stated our disappointment when we weren’t awarded the contract. New York is a market where we would like to expand our presence. That is one regional market where LabCorp and Quest Diagnostics would view the UnitedHealth contract from very different extremes.

“We have stated, in unambiguous terms, that we are confident we can maintain our current margins while we use the UnitedHealth contract to increase specimen volume and revenues.”
—Brad Smith

EDITOR: Essentially, you are saying that, when both Quest Diagnostics and LabCorp evaluated the United Contract opportunity, both companies had different levels of pricing risk for their existing book of business, and different opportunities to expand their share of the UnitedHealth lab business. These factors guided each company in how it viewed the combination of prices and other terms offered by UnitedHealth.

SMITH: To the degree I can comment on this point, it is consistent with how LabCorp would explain its evaluation of this contract opportunity. We have stated, in unambiguous terms, that we are confident we can maintain our current margins while we use the UnitedHealth contract to increase specimen volume and revenues. Again, our standardization is a key reason for that.

EDITOR: That’s a definitive answer. Now, let’s discuss the challenges that lie ahead in performing as the sole national laboratory provider. In simplest terms, UnitedHealth has beneficiaries located in many regions of the country where LabCorp has little or no existing service infrastructure, including sales reps, patient service centers, rapid response labs, and logistics networks. How is LabCorp planning to serve these regions on January 1, 2007?

SMITH: We’ve publicly discussed certain aspects of our plans. What I would like to stress up front is that, by its very design, this national laboratory testing contract recognizes that achieving the goals of both companies will be a long-term effort. That is why it is a ten-year contract.

EDITOR: However, LabCorp does have a contract clause that calls for it to reimburse UnitedHealth for up to $200 million in transition costs. So there is a big financial incentive for LabCorp to act quickly in moving business and helping to reduce UnitedHealth lab leakage.

SMITH: That’s right. Let me address our implementation plans step-by-step. First is the existing lab networks. In the case of Oxford Health Plans, LabCorp will step into Quest’s shoes and assume management and operation of the existing regional laboratory provider network. There are also specific insurance programs mentioned in the press release for which LabCorp is an existing provider, and will become the exclusive laboratory. These include the HMO benefit plans of Pacificare of Colorado, Neighborhood Health Partnership in Florida, Mid Atlantic Medical Services, LLC (MAMSI) in Maryland and Virginia, as well as specific markets in California and Colorado. In selected areas during the contract term, LabCorp will also create and manage regional lab provider networks.

EDITOR: Will these be similar to the type of regional laboratory provider network used by Quest Diagnostics to serve Oxford Health Plans?

SMITH: Conceptually, yes. The details are under development. LabCorp will be discussing this opportunity with prospective laboratories in these markets. The reimbursement model will be based on RVUs (relative value units). Participating laboratories will be reimbursed under a proportional formula.

EDITOR: What about regions like New York City and Chicago? These are metro areas where UnitedHealth has many beneficiaries, but LabCorp has little infrastructure.

SMITH: First, we do have a presence in these markets but clearly we need to expand access points for United patients and logistical support for their physician providers in areas where patient concentrations require it. We have obligations and commitments to build out these and similar markets where UnitedHealth has beneficiaries. Even now, we are opening new patient service centers, establishing rapid response testing capabilities, developing logistics, and hiring new sales personnel, with an expectation that these resources will be operational on January 1, 2007.

EDITOR: This is an expensive proposition. For example, LabCorp told analysts that 200 new patient service centers were under development in this first phase.

SMITH: I can’t comment on the specific numbers. We’ve announced that in 2006 we will spend about $14 million to $18 million in increased operating costs to support the UnitedHealth contract. There will also be another $15 million to $20 million in related capital costs. But, when you consider how this partnership presents the opportunity for LabCorp to grow its business, we feel the amount of investment is relatively modest.

EDITOR: Now it’s time to talk about the toughest challenge: convincing physicians to switch from their existing laboratory provider to LabCorp. Over the past 20 years, the nation’s largest laboratory companies have generally failed to succeed in one core business skill: the ability to put a sales force in the field and see that sales force profitably generate new accounts over a sustained period of time. What will LabCorp do differently that will allow it to shift tens of millions of dollars of market share away from other laboratories?

“We do recognize that LabCorp must differentiate itself from competing laboratories. To move market share, we can’t rely on the offer of lower prices or the same bundle of benefits that has been shopped in our industry for years. ”
—Brad Smith

SMITH: I don’t think that the problem has been in selling the business. I think the problem has been in keeping the business, or, in other words reducing “churn.” The laboratory testing business is a very competitive business—with many difficult challenges for sales efforts. First, there are many “customers” for the same business. The ordering physician, the patient, the payer—each can sometimes have differing interests. Second, with thousands of tests and thousands of laboratories, historically it has been relatively easy to switch laboratories. What we need to do is to reduce the reasons that cause physicians, payers, or patients from wanting to switch once we get their testing business.

EDITOR: What will be different in how LabCorp uses its sales program to capture increased market share?

SMITH: At the center of our strategy is to partner with major managed care companies like UnitedHealth. Not just to meet their business needs, but rather to work with them to help meet the broader objective of bringing more cost effective, high quality testing to their patients and physician providers. We also recognize that the typical physician is not going to automatically switch from his or her existing laboratory just because a LabCorp sales rep knocks on the door. Physicians need to be convinced that LabCorp offers a different, unique, and useful set of benefits and advantages.

EDITOR: Any specific insights?

SMITH: We do recognize that LabCorp must differentiate itself from competing laboratories. To move market share, we can’t rely on the offer of lower prices or the same bundle of benefits that has been shopped in our industry for years. That’s where our leading-edge science, including our cancer testing and genomic testing laboratories, comes into play.

EDITOR: One truth about this new con- tract with UnitedHealth is that LabCorp’s success in building market share will be directly linked to its success in putting an effective sales program into the marketplace.

SMITH: That is a valid point. However, we also believe that, while the sales effort is a key component, it will only be effective if we continue to offer industry leading service. Our company must execute. As we put the service framework into place, our people need to convince physicians to switch to a LabCorp solution for all their testing needs.

EDITOR: The $200 million risk pool must add motivation to be successful in selling and reducing leakage. This amount is the maximum LabCorp might pay to UnitedHealth during the first three years of the agreement.

SMITH: That’s correct. It is a significant risk factor for us. We have the financial motivation to act quickly to increase market share by enough to generate the savings to UnitedHealth that are specified in the contract.

“Over time, it wants to reduce this number. It was made clear to us that, moving forward, UnitedHealth wants data presented in more detail and in a standardized format, even as leakage on its national contract is steadily reduced.”
—Brad Smith

EDITOR: What role will UnitedHealth play in helping to convince physicians to utilize its network laboratories?

SMITH: There is a commitment by UnitedHealth to proactively help encourage physicians over this point. Remember, both parties have entered into a ten-year agreement. That commitment is unique and speaks to UnitedHealth’s determination to redirect its laboratory testing arrangements.

EDITOR: But how might UnitedHealth actually push physicians to move to a contract laboratory—without causing alienation and resentment?

SMITH: I can’t answer for UnitedHealth, but I can say that we have discussed with UnitedHealth how we incentivize physicians to use their contracted providers, including LabCorp. UnitedHealth has told us they are committed to achieving the goals established in this sole source, ten-year, exclusive national laboratory contract and we expect their full and active support.

EDITOR: You are indicating that UnitedHealth will be more active in this role. Historically, managed care companies have been relatively passive about leakage and continued use of non-contract laboratories by physicians. Until recently, UnitedHealth was soliciting request for proposals (RFPs) from regional laboratories and appeared to be willing to expand its provider panel. Could you explain why the shift away from this approach and its decision to put LabCorp in front as the exclusive national contract laboratory and the primary manager of any necessary regional laboratory provider networks?

SMITH: Although I can’t speak for UnitedHealth on this point, I can say that United has publicly stated their intention to do something with this laboratory RFP that was truly market changing. We take them at their word and are thrilled to be their partner as we work to achieve that goal. I also think it is true that UnitedHealth believes it has too many laboratory providers. Over time, it wants to reduce this number. It was made clear to us that, moving forward, UnitedHealth wants data presented in more detail and in a standardized format, even as leakage on its national contract is steadily reduced.

EDITOR: That is consistent with the long-term goals that are reflected in this ten year contract. Can I be bold enough to say that, certain elements of this contract appear to be structured to help LabCorp establish laboratory testing infrastructure in regions where it currently has little or no presence? Thus, one unexpressed outcome from this contract is that it provides a bootstrap for LabCorp to expand its presence in more communities around the United States.

SMITH: Again, I can’t speak for UnitedHealthcare, but, if we grow and strengthen our infrastructure, this expanded, strengthened infrastructure can be used to win and service other new testing business. There’s also an efficiency aspect to this ten-year pact. UnitedHealth seeks operational efficiencies in how healthcare is delivered. It wants more detailed and standardized sets of data. And it wants to raise clinical quality.

EDITOR: It is easier to do this with partners who effectively support these goals over long periods of time than it is to engage a vendor in a three-year contract, then repeat the process and possibly start all over again with the new contract awardee. I can interpret this 10-year contract as an effort on UnitedHealth’s part to break that cycle and establish a closer relationship with a lab provider, in this case, LabCorp.

SMITH: That is one interpretation.

EDITOR: But isn’t it true that the structure of this contract does create an opportunity for LabCorp to establish a greater presence in existing and new regional markets?

“There’s an efficiency aspect to this ten-year pact. UnitedHealth seeks operational efficiencies in how healthcare is delivered.”
—Brad Smith

SMITH: Yes. That is one benefit we expect to result from this contract. It allows us to build infrastructure in some areas and support our growth in other areas.

EDITOR: That response is another answer to my original question at the start of this interview, when I asked about the fundamental reasons which led LabCorp and UnitedHealth to enter into a sole-source, ten-year contract. You have provided a wide range of insights into the reasons why both companies entered into this contract. Thank you for your time.

SMITH: You’re welcome. In closing, I would emphasize that LabCorp is excited about the opportunities to advance laboratory medicine and help improve health care outcomes by a closer collaboration with one of the nation’s leading health insurance companies. Despite the risks, it is a goal worth pursuing.


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