Biggest Lab Firms Diverge on Hospital Lab Strategies

Public lab companies want new agreements to acquire or manage labs owned by hospitals

CEO SUMMARY: Almost half of the nation’s hospitals and health systems are rethinking how to use their clinical labs to support clinical and financial strategies. Options range from outright sale of their lab outreach businesses to lab management agreements or joint ventures with one of the nation’s three billion-dollar public lab companies. Each of the three big companies—Laboratory Corporation of America, Quest Diagnostics, and Sonic Healthcare—has a different approach to these deals.

ONE COMMON STRATEGY THAT EXECUTIVES VOICE regularly at the nation’s three largest public lab companies is to expand their management or ownership of the clinical laboratories in hospitals and health systems.

National lab companies discuss this strategy during conference calls with analysts and at conferences with Wall Street investors. Their oft-repeated message in recent years is that significant numbers of hospitals and health systems are willing to explore how they can cut lab testing costs by engaging with commercial lab companies.(See TDRs, Feb. 21, 2017, and Aug. 20, 2018)

Hospital Lab Transactions

Regularly, THE DARK REPORT has assessed the most significant agreements between hospitals or health networks and commercial lab companies. Most often these agreements involve either a sale of a hospital’s laboratory outreach business or a contract for the public lab company to manage the hospital’s inpatient lab.

When viewed retrospectively, however, only a small number of such sales and management agreements are negotiated each year. And, most such transactions involve a financially-strapped hospital or health network selling its laboratory outreach business to raise capital.

Raising capital was one goal when PeaceHealth System of Vancouver, Wash., sold its substantial lab company, PeaceHealth Laboratories, to Quest Diagnostics in 2017 and when Providence Health/CHI decided to sell their PAML lab company to Laboratory Corporation of America that same year.

Timing was a factor in each sale because each seller expected the profitability of their respective outreach lab companies would decline when Medicare cut what it paid for Part B lab tests as of Jan. 1, 2018. (See TDRs, Feb. 21 and Mar. 13, 2017).

Some hospitals and health networks, however, view their inpatient, outpatient, and outreach laboratory activities as valued points of clinical advantage that can and do contribute revenue to the parent organization. ProMedica Health of Toledo, Ohio, held this view when it announced a laboratory joint venture (JV) last month with Sonic Healthcare USA.

ProMedica wants the new lab JV to support its operational and clinical integration with other hospitals and office-based physicians in the three states it serves. An integrated clinical laboratory service is a key element in ProMedica’s effort to deliver precision medicine and improve patient outcomes to support value-based payments from health insurers.

After ProMedica and Sonic announced their lab joint venture, THE DARK REPORT interviewed Sonic’s Vice President of Hospital Affiliations Noel Maring. Almost half of the nation’s hospitals and health systems are rethinking their lab-testing strategies, he said, and many are considering ways to work with or sell outreach testing operations to one of the big three lab-testing companies.

Each of the three companies— LabCorp, Quest Diagnostics, and Sonic— works with hospital labs differently, he said, and it’s useful for lab directors and pathologists, to understand each approach.

“From a strategy standpoint, with each deal these companies make, I can see the dividing lines among the three billion-dollar public lab companies,” Maring commented. In discussing the various objectives, he started with Quest Diagnostics, followed by LabCorp, and Sonic.

“Quest seems to want to both buy out-reach programs and—where possible— manage the hospital’s inpatient laboratory,” explained Maring, “It will off load all the outreach testing business it acquires to a Quest facility. Additionally, in past inpatient lab contracts it has aggressively moved as much of the less time-dependent testing volume to a Quest facility offsite.”

In Massachusetts, there’s a recent example of this strategy where Quest acquired the outreach lab testing business of Cape Cod Healthcare last year and now manages the inpatient laboratory, he added.

During a conference call with Wall Street analysts on July 24, Quest Chairman, President and CEO Steve Rusckowski explained Quest’s plans to accelerate growth. “The first element of our growth strategy is to grow 1% to 2% through strategically-aligned accretive acquisitions,” he said. “We completed our previously-announced acquisition of the outreach laboratory services business of Cape Cod Healthcare in Massachusetts.”

That system includes Cape Cod Hospital in Hyannis, which has 283 beds, and Falmouth Hospital in Falmouth, with 95 beds. Quest runs what it calls the ‘lab of the future’ in Marlborough, Mass., a new, state of the art facility of 200,000 square feet about 95 miles from Hyannis. In an arrangement announced last year, rapid-response tests are done in the hospital labs in Hyannis and Falmouth, and other tests go to Marlborough.

Lab Costs Are Triple

At the time, Michael Lauf, CEO of Cape Cod Healthcare, said, “The costs of providing lab services to our patients is roughly three times that of Quest.”

For LabCorp, its strategy differs slightly. “LabCorp also wants to acquire hospital lab outreach businesses,” Maring said. “At the same time, LabCorp is providing services under technical service agreements (TSAs), in which LabCorp helps with reference testing and couriers. However, compared with Quest, LabCorp seems less interested in managing hospital labs.

“Both public lab companies seem to be avoiding joint ventures—at least for now,” he added. “While each company has existing JVs, they do not seem to be actively pursuing new joint ventures, possibly because they do not want to cannibalize existing revenue they currently control around a prospective JV partner’s medical campus.

“At Sonic, our approach is more varied,” continued Maring. “We’ll consider agreements that call for us to manage inpatient labs. However, we prefer a more comprehensive partnership with healthcare systems that have a strong strategic position in their communities.

“Because our goal is a long term strategic partnership with hospitals and health systems, we are more willing to contribute our existing lab testing volume into those joint ventures when it makes financial sense to do so,” Maring commented. “That’s what we did with ProMedica by shifting about two million lab tests per year to the joint venture lab, which is the ProMedica Pathology Laboratories (PPL) core laboratory.

Contributing Lab Test Volume

“To date, I am unaware of arrangements where Quest and LabCorp have contributed significant outreach lab volume into a joint venture with a hospital, and I’m not sure they will,” he said. “At this time, therefore, there is a clear delineation of where these two lab companies are willing to go.”

Maring affirmed that the CEOs of many hospitals and health networks are considering options for their clinical laboratories. “These hospital leaders are reacting to the changes in how they are reimbursed, the slowing growth of inpatient admissions at the same time that outpatient services are increasing, and the need to further integrate care delivery.

“These factors motivate them to seek the highest and best use of their laboratories,” he added. “For example, they’re asking if their lab outreach businesses will be profitable in the future. They know that lower reimbursement is coming from Medicare and other payers, that cuts in lab test payments are in place under the Protecting Access to Medicare Act (PAMA), and that the cuts under PAMA will accelerate in the coming years.

“In addition to asking if their outreach businesses are profitable, health system administrators also want to know if they should remain in that business,” he commented. “Some hospitals have no choice but to sell their outreach lab businesses. They have short-term financial needs and the outreach business is an asset they can sell easily. When they sell that asset, they gain capital right away.

“Both Quest and LabCorp are talking to the administrators at those hospitals, and Sonic is too, but to a lesser extent,” he explained. “From our conversations with these same administrators, we know they will sell their outreach businesses and consider some form of a lab management deal. They will do so because a lab-management deal can save them 10% to 20% on inpatient lab expenses.

“On the other end of the spectrum are the large, well-run health systems—such as Northwell Health on Long Island— that have their own lab strategies,” added Maring. “Because of their strong finances, these systems are least likely to consider a joint venture, a lab management deal, or a sale of their lab outreach businesses. Certainly not in the near future.

“In between those two extremes, as many as 40% of hospitals—or about 2,000 facilities—in the United States need to refine their lab strategies,” he added. “These hospitals know they need to cut costs and to either improve or exit their lab outreach businesses. And many recognize they may need help achieving these goals.

Stable Finances

“Then there are hospital systems that are relatively large and do not have short-term financial needs that require them to sell their lab outreach businesses,” continued Maring. “But they want to reposition themselves strategically and they want that repositioning to happen in a stepwise fashion over time.

“Instead, these hospitals have an interest in other options for their labs, such as a joint venture,” noted Maring. “If they can, they want to keep their lab outreach business and grow it with the help of someone who’s savvy about how to do that.”

Contact Noel Maring 509-220-9872 or nmaring@sonichealthcareusa.com.

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