Market Assessment Leads Quest To Do Several Deals

Acquires independent Connecticut laboratory while pursuing joint ventures in several cities

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CEO SUMMARY: Quest CEO Ken Freeman is moving rapidly to restructure Quest’s regional laboratory system. Using the financial head-start provided by the January spin-off from Corning, Inc., Quest purchased one laboratory and seeks to do joint venture deals in several cities. Quest’s activities will change the competitive situation in cities affected by these developments.

Competition for laboratory services is about to radically change in several markets. Quest Diagnostics Inc. is altering the status quo with acquisitions, joint ventures and laboratory restructuring.

Connecticut, Arizona, Montana and California will be impacted by Quest’s activities. In some cases laboratory competitors will benefit. In other cases Quest may emerge as a tougher competitor.

The biggest influence will probably be in Connecticut. Quest acquired Diagnostic Medical Laboratories (DML) of Branford, Connecticut. The sale was consummated last month. With an estimated $30 million in revenues, DML represents the largest acquisition by Quest since 1995.

Reasons For Sale

Owned by Joseph Canavan, Diagnostic Med Labs was the biggest independent commercial laboratory remaining in Connecticut. Reasons behind the sale were not made public. However, Connecticut’s aggressive managed care market may have been a factor in Canavan’s decision to sell.

“DML won the laboratory services contract for Physicians Health Services (PHS), a large health plan here in Connecticut,” stated one lab- oratory executive in the Hartford area. “To properly service this contract, I know that DML expanded draw sites, added courier service and hired more staff.

“DML may have not done well financially with the PHS contract,” he continued. “If so, it could have contributed to Canavan’s decision to sell his laboratory.”

Logical Acquisition

DML was a logical acquisition candidate for Quest. Not only are the two labs less than 20 miles apart, which simplifies the consolidation of DML into Quest, but the acquisition removes Quest’s largest competitor from the Connecticut marketplace.

In Arizona, Quest is pursuing a joint venture strategy. Quest operates a regional laboratory in Phoenix that fails to meet Quest’s criteria for operating profit and growth potential. To make the best of a marginal situation, Quest is negotiating to create a joint venture with another laboratory in that market.

Rumors are widespread that Quest and Sonora Laboratory Services are in serious negotiations to pool their laboratory resources and run a common laboratory organization in the state. Neither group will comment publicly at this time.

THE DARK REPORT believes these rumors are true. Further, such a joint venture would be a winner for both laboratories. Sonora and Quest each hold about one-third of the market for outreach testing in Phoenix. Combined, they would have a dominant market share with the added benefit of significantly lowering test costs.

Clients of THE DARK REPORT should recognize that this joint venture would be a tangible demonstration of the regional laboratory strategies discussed in the May 12, 1997 issue of THE DARK REPORT and at the Executive War College in New Orleans.

Sonora Laboratory Services is owned by the Samaritan Hospital System. It is a consolidated laboratory organization with a successful outreach program. This is the regional model we find to be universally profitable throughout the country.

It validates our prediction that consolidated hospital laboratories will play an essential role as regional laboratory systems evolve throughout the country. The fact that Quest is approaching Sonora as a venture partner also reflects the reality of today’s marketplace. The national laboratories no longer have the financial clout to dominate any city where they offer testing.

In Montana, Quest is implementing the same strategy of market restructuring, but in a different way. Quest is closing down the regional laboratory in Billings. Those specimens will be shipped to the Quest laboratory in Denver.

Quest determined that the economics of maintaining the Billings laboratory did not meet corporate targets. Montana is a relatively small market for laboratory services. Estimates are that the Billings lab generated about $4 million in annual revenue with limited growth potential in that market.

Further, in keeping with Quest’s goal of reducing anatomic pathology and cytology, Quest sent a letter to clients of the Billings laboratory notifying them that the facility would no longer offer in-house AP and cytology in Billings after June 18.

Connecticut Lab Network Subcontracts With Quest For Blue Cross Lab Work

PROVIDING ANOTHER SIGN that it is not “business as usual,” Quest Diagnostics subcontracted with the Connecticut Hospital Laboratory Network (CHLN) to provide laboratory services to Blue Cross/Blue Shield patients.

When Blue Cross initially chose Quest to be the exclusive laboratory provider, a number of physicians complained to Blue Cross. These physicians wanted to continue sending laboratory tests to their hospital laboratory. An arrangement was worked out between Blue Cross, Quest and member laboratories of the Connecticut Hospital Laboratory Network.

“It represents a change in thinking by this national laboratory,” said Charlotte Selinger, Sales Manager at Hartford Medical Laboratories. “We believe that Quest would like to build good relations with hospital laboratories and this is one way of demonstrating good faith.”

The arrangement is simple. CHLN member laboratories can provide testing for Blue Cross patients. Information is transmitted monthly to Quest. Quest receives a capitation payment from Blue Cross and remits a pro rata portion of that capitation payment to each hospital laboratory, based on the volume of tests performed by that laboratory. A similar arrangement between Connecticut hospitals and SmithKline two years earlier may have encouraged Quest to follow the precedent.

30-Hospital Venture

Within California, Quest has the inside track to work with Tenet’s 30 southern California hospitals. A final decision on the RFP process has not been announced, but bidders indicate that Quest has the edge. One attraction for Tenet is the close proximity of the former Nichols Institute reference laboratory in San Juan Capistrano.

As market trend indicators, Quest’s activities signal an important shift in corporate strategy. Quest is demonstrating a bias for action. These four situations are just a sample of negotiations Quest is conducting throughout the country. Expect more surprising announcements of unorthodox joint ventures from Quest.

Institutional Indecision

Contrast Quest’s new-found bias for action with the institutional indecision at SmithKline Beecham Clinical Laboratories (SBCL) in similar market situations. In Detroit, SmithKline has an underutilized laboratory facility of more than 40,000 square feet. During the past three years SBCL executives explored various partnership and joint venture models with individual hospital systems in Greater Detroit and the Joint Venture Hospital Laboratory Network.

Participants in these discussions tell THE DARK REPORT that SBCL managers recognize the need to either fill the lab with specimens or downsize the Detroit operation. These same participants say that SmithKline proposed several shared laboratory service arrangements which they found attractive, yet no one at SmithKline could get approval from higher levels to proceed. After three years, meetings and negotiations continue and SmithKline’s Detroit laboratory remains open and underutilized.

Change To Environment

For Quest, this flurry of restructuring provides definite proof of change to the competitive environment for laboratory services. On one hand, Quest is demonstrating a new management culture which emphasizes both profitability and service. Quest is willing to exit markets which do not generate adequate operating profits. Quest is also willing to joint venture with strong partners where terms are flexible for both participants.

On the other hand, hospital laboratories are regaining market clout. Increasingly, the national laboratories will need to include and accommodate hospital laboratories in their regional operations.

What has yet to be determined is whether both hospitals and commercial laboratories can succeed in these joint ventures. In addition, although Quest is the first national laboratory to demonstrate a changed attitude toward market strategies, both SmithKline and Laboratory Corporation of America have yet to weigh in on the same issue.

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