CEO SUMMARY: Expect the Tenet-SBCL contract announcement to trigger similar deals during the next 18 months. Competition and the need to gain economic advantage will drive some hospital CEOs to turn their laboratories over to commercial laboratory partners. The number of such joint ventures and contract management projects will increase rapidly.
BY ALL MEASURES, the laboratory management contract between SmithKline Beecham Clinical Laboratories (SBCL) and Tenet Healthcare is a milestone event for the lab industry.
It is an important wake-up call to hospital-based laboratory administrators, both in California and throughout the country. A respected hospital operator is choosing to place laboratory operations in the hands of an outside company. A careful reading of the circumstances leads to the conclusion that more such arrangements will occur between hospitals and commercial laboratories.
A more detailed understanding about why this contract was negotiated develops after sifting through the public comments of the two companies and combining that with market knowledge of circumstances in Southern California.
The goals are indeed about cost reduction and improving laboratory services. But that simplifies the more complex market dynamics which validate the premise behind this laboratory management contract.
Certainly cost reduction was a factor. But read carefully the public comments about this contract. Tenet realized that its internal cost-cutting capabilities had reached the point of diminishing returns. On their own initiative, most laboratory directors at the Tenet hospitals in Southern California had used the obvious techniques to squeeze costs out of the laboratory.
Fractional Cost Reduction
On a go-forward basis, Tenet was only going to get fractional cost reductions with the existing management arrangements. To create a quantum leap in cost-cutting capability, Tenet would need to radically change the status quo. Further, Tenet had to go outside the organization to access management techniques and knowledge that none of their existing hospi- tal laboratory directors possessed.
By selecting an outside partner to drive its laboratory restructuring, Tenet accomplished both goals in one move. It is using the knowledge of an outside resource to introduce and implement radical change to the status quo. From the perspective of senior management and stockholders, this is a good strategic decision.
But where does that leave the other primary goal: improving clinical laboratory services? Again, Tenet recognized that existing laboratory arrangements at the smaller hospitals limited the service capability of that laboratory to meet the needs of physicians and other users.
Tenet also understood that physician users of the laboratory continue to under-go their own paradigm shift. The demands of integrated healthcare, declining reimbursement and better use of clinical information are forcing physicians to alter their clinical practice procedures.
“It is noteworthy that the Tenet-SBCL contract is happening in California. The state is a bellweather for healthcare trends which later migrate to other cities and states.”
Director, Hospital Alliances
This has a direct impact on laboratories. If laboratories are to meet and exceed the expectations of their physician customers, they must identify those changing needs and alter their laboratory operations to provide new services. Tenet understood this perfectly. For each Tenet hospital to remain a preferred clinical services hub in its region, it must constantly upgrade ancillary services.
THE DARK REPORT believes that senior hospital administrators in Tenet’s Southern California region were ahead of their peers and competitors in understanding this market-driven phenomenon. As a for-profit hospital chain, they have a short window of opportunity to change with the market, or see competing hospitals steal their business.
Thus, the more compelling reason for this laboratory management services contract was the need to redesign a regional laboratory system that could better serve hospitals and physicians. Further, it was essential that this revamped laboratory service organization possess the innate capability of adding additional lab services as required by the changing needs of those physicians using the laboratory. The radical nature of the laboratory services contract between Tenet and SBCL accomplishes both primary goals.
It is also important to separate the “plan” from “implementation.” Laboratory directors are famous nay-sayers. They can predict misfortune for any proposed change to their beloved laboratory.
But in the case of the Tenet-SBCL arrangement, there is sound business strategy underlying the logic of the deal. Implementation is a separate challenge. One or both companies could cause the implementation of this business plan to undergo significant problems, if not fail completely.
Frankly, THE DARK REPORT doubts that this project will run into trouble. There will be the usual potholes and unexpected surprises. But the overall gains to Tenet will far outweigh any implementation problems.
Significant Other Lessons
Now that an understanding of the more sophisticated business reasons underlying this laboratory service contract has been established, it is useful to point out significant other lessons.
First, regardless of the motives of both parties to the contract, the primary effect of laboratory re-engineering will be to remove excess laboratory capacity from the marketplace. Testing will be consolidated among the 30 hospitals. Redundancies in staffing, instrumentation and management will be reduced, if not eliminated outright.
Second, Tenet’s laboratory re-engineering project will effectively create a unified regional laboratory system within Orange County and Los Angeles County. This laboratory system will have both the capability and the motive to pursue outreach business from each medical campus around the 30 hospitals.
Both actions by Tenet illustrate the market forces described by THE DARK REPORT in recent years. It is laboratory overcapacity which feeds below-cost pricing. Laboratory reimbursement will not improve until enough excess capacity is taken off-line.
Regional laboratory systems meet managed care’s need to contract only with providers who have service infrastructure in the same geography where the managed care plan has beneficiaries. Regional laboratory networks are the independent hospitals’ response to this market dynamic. In Southern California, Tenet happens to be big enough to create their own regional laboratory network.
Outreach Program Next
We predict that Tenet will initiate a laboratory outreach program in the later phases of the restructuring. Simple economics makes this an accurate forecast: the easiest way to lower a laboratory’s average cost per test is to increase the specimen volume going through the facility.
Tenet’s Southern California hospitals and their competitors are subject to the same trend: regular annual declines in the number of inpatients. If no action is taken, declining specimen volumes from inpatient testing guarantees that Tenet will see predictable annual increases in their laboratory cost per patient.
They can forestall that event by launching an effective laboratory outreach sales and marketing program. The additional volume of outreach specimens will lower the average cost per test over a multi-year period. That is why Tenet will organize a laboratory outreach program in some future phase of this re-engineering project.
We hope that laboratory administrators now understand the reasons why they should consider the Tenet-SBCL laboratory management contract as a wake-up call. There are sound business reasons why Tenet decided to pursue this project. Other hospital systems face the same circumstances and will consider the same options as Tenet.
A key point to emphasize is this: no matter how good a job any laboratory director feels they have done, it is not enough in today’s managed care world. Developments in Southern California lead THE DARK REPORT to make the following recommendations to hospital laboratory administrators and managers.
First, initiate change in your laboratory that creates lower cost and improves your laboratory’s ability to deliver “value-added” services to the clinicians.
Second, think “out-of-the box.” Tenet realized that its laboratory managers had used up their personal bag of tricks. Radical improvement would not come from inside. SBCL will do what the Tenet’s laboratory administrators failed to do on their own: consolidate testing among the facilities in a rational way, create a regional laboratory capability and begin enhancing those lab services which physicians need in an integrated clinical setting. Many of these management options were known to the existing Tenet laboratory administrators. But the usual excuses as to “why this couldn’t happen” were given. No lab director took a leader- ship role and implemented such projects on their own initiative.
Third, learn management techniques for creating change, helping people become more productive and enhancing services. Become a management asset for your hospital.
Laboratory administrators who survive and thrive in the coming years will be the ones who decided to act upon the three recommendations above. This huge laboratory management contract is the wake- up call which should not be ignored.