CEO SUMMARY: Every regional laboratory network in the United States is unique. Regional variations in healthcare and business objectives are different in every case. But the management problems of network structure, governance, marketing and finance are always the same. Here are some useful lessons learned by the Middle Tennessee Healthcare Network.
PROBABLY NO OTHER laboratory industry trend has disappointed as much as that of regional laboratory networks. When the concept exploded onto the scene in 1995, it was rapidly adopted by many hospital laboratory administrators throughout the United States.
Two pioneering networks were widely promoted in 1995. Both failed to live up to their potential. In San Francisco, Bay Area Regional Laboratory Network (BAHLN), continues to operate. At launch, it numbered 18 hospital laboratories. But the pioneering network has yet to make any significant impact with managed care companies in the region.
In Pittsburgh, 40 hospitals joined the Reference Laboratory Alliance (RLA). It had a well-designed operational plan and was successful in acquiring provider status with the region’s largest managed care organization. But the rapid evolution of two competing hospital systems caused a reversal in RLA’s finances. The regional laboratory network ceased operations in early 1997.
Despite these setbacks to the regional laboratory network movement, there is still widespread activity in all areas of the United States. Two primary goals fuel networking activity: achieving provider status with managed care plans and lowering laboratory costs through shared testing.
Potentially Powerful Model
Last week THE DARK REPORT was on site at the Middle Tennesse Healthcare Network (MTHN) in Nashville. MTHN represents a potentially powerful business model for regional laboratory networks. Since 1995, its organizers have been diligent and thorough at attacking the same problems which derail or defeat other regional laboratory networks.
During the site visit, MTHN CEO and General Manager JoAnne Schroeder discussed how MTHN developed its solutions to the challenges of creating a viable regional laboratory network.
Probably the most important issue is financing. Many regional laboratory networks are under-capitalized from the start. Their business plans also fail to provide a source of cash flow to fund ongoing operations of the network.
“At MTHN we recognized the crucial role of money,” said Schroeder. “Case studies presented by regional laboratory networks at the Executive War College in 1996 and 1997 made us appreciate, in advance, that sufficient capital and operating cash flow were critical success factors.”
Solve This Problem
“It was our goal to solve this problem while giving our participating hospitals an incentive to invest the necessary funds,”? continued Schroeder. “Thus, we decided to fund the network in three ways.
“First, initial capital funding was obtained by having the equity participants purchase shares in the network,”? she explained. “Each share cost $50,000. Four hospitals purchased two shares each. The other hospitals purchased one share each. That provided us with start-up capital of $750,000.”
Did hospital CEOs hesitate to make this kind of investment? “As you would expect, any level of investment asked of our participating CEOs was not automatically accepted,”? said Schroeder. “However, we made it easier for them. We had already negotiated lower reference testing fees through a centralized contract with one national reference laboratory. Service under that contract had commenced in May 1997.”
“Money saved from send-out work at their hospital laboratory offset this $50,000 investment. So, we were really asking them to shift funds already budgeted for the laboratory. This turned out to be a good selling point,”? she stated. “The CEOs were comfortable with this investment when they realized it was simply redirecting money from their existing laboratory budget.”
The second source of capital is actually a clever aspect to MTHN’s business plan. Schroeder explains, “We minimized our capital needs up front by getting agreement from the equity participants to make ongoing capital contributions from the collected revenues of the laboratory network.
“A percentage of MTHN’s ongoing revenues are designated as a capital contribution by the equity participants. In year one, 45% of revenues are designated as a capital contribution and retained by the network. This percentage declines and zeroes out at year six,”? she noted. “Administrative fees are 30%. The network will pay 25% of revenues back to each participating hospital for their testing. This will increase to 62% by the start of year six.”
“…we recognized the crucial role of money,”? said Schroeder. “Case studies… made us appreciate, in advance, that sufficient capital and operating cash flow were critical success factors.”
This appears to be an elegant solution to the funding of the regional laboratory network. By negotiating lower reference testing fees for its 12 hospital laboratories, on the front end, MTHN’s hospitals could designate the resulting savings to be the initial equity investment. Ongoing capital needs are then funded from the actual cash flow generated by the network’s laboratory testing.
It is also important that the network is billing and collecting the money. Many regional laboratory networks are not organized this way. Revenue dollars flow first into MTHN. A fee is deducted for network administration. The remaining funds are then distributed to the participating hospitals.
Joint Venture Hospital Laboratory Network (JVHL) in Detroit is another regional laboratory network where revenues flow first to the network and are subsequently distributed to the participating hospital laboratories. JVHL is one of the few lab networks which is flourishing. (See TDR, January 16, 1998.)
Another issue which MTHN thinks it has solved without a major investment of capital is laboratory information systems. “It goes without saying that every hospital laboratory in our network operates a laboratory information system (LIS) which cannot connect with the others,” commented Schroeder. “Incurring the expense to convert each hospital laboratory to a common LIS was out of the question.”
“Given the reality of reduced staffing in laboratories today, it is unreasonable to expect laboratory administrators will have enough free time to manage a regional laboratory network on the side.”
“Our chosen reference laboratory partner provided the solution,” she added. “We use microscript application modules run from PC workstations. Our reference laboratory partner maintains an Oracle database repository. We will have a single entry LIS arrangement which collects, formats, sends out, retrieves, and reports laboratory data.”
Although MTHN is gaining a variety of service supports from its reference laboratory partner, Schroeder pointed out that another goal of the network was to internalize its existing send-out work. “Based on a centers of excellence model, three of the equity hospital laboratories in Nashville will do reference testing for other hospital laboratories in the net- work. This gives us four reference laboratories to support MTHN.”
To accomplish this and comply with appropriate local, state and federal laws and regulations, MTHN is organized as a joint purchasing entity. “This means that we hold the contractual responsibility with Speciality Laboratories, other reference laboratories and any managed care companies where we are a provider,” said Schroeder.
Outside Billing Service
“MTHN is also using an outside billing service,” she added. “It was recognized that coding and billing for outreach laboratory services is detailed and specialized. It was determined that MTHN could do a better job of billing outreach laboratory services than the hospital billing departments. We can offer better service, do it at less cost, and improve our compliance. The more administrative services we control, the more responsive we can be to our physician clients. We need flexibility and freedom of action if we are to successfully compete against commercial laboratories in our market.”
Another area where MTHN learned from the experience of other regional laboratory networks is staffing and manpower. MTHN wants to avoid the problems caused by relying on volunteer administration.
“Given the reality of reduced staffing in hospital laboratories today, it is unreasonable to expect laboratory administrators will have enough free time to also create and manage a regional laboratory network on the side,”? said Schroeder. “Our start-up budget includes funding for three full-time positions: an administrator, a marketing director and an LIS director. We are also budgeted to hire service staff as the need arises.”
Joint Venture Hospital Laboratories (JVHL) of Detroit also recognized this weakness of volunteerism. In order to maintain adequate services and expand market share, the network eventually replaced volunteers with paid administrators handling administration, marketing, and finance. Since the change-over to paid administration, JVHL has found it easier and faster to respond to market developments and implement management projects.
Organizing the network has not been without its pitfalls. Like most regional laboratory networks, it took several years to move from concept to operation. “It is inevitable that our 12 hospitals needed time to trust each other. Historical relationships, institutional politics and a changing marketplace all compound the decision-making process,”? said Schroeder.
Equity Ownership Structure
“One key issue carefully studied by our CEOs was how to structure the equity ownership of our regional laboratory network,” she added. “What legal arrangements were needed to determine how new hospital participants can be admitted? How would an equity member withdraw from the LLC? These are important concerns, because MTHN was a competitive market response to Columbia/HCA. This is why determining how hospitals could get in and out of MTHN was a major issue.
“Another little surprise which delayed us by three or four months were the attorneys,” commented Schroeder. “CEOs and administrators from the hospitals understood what we were doing. But once it was time to execute the legal documents, lawyers for each hospital now entered the picture. Since they hadn’t participated in the development process, they didn’t understand the laboratory business.
“It took us three months to educate them about the laboratory business and the marketplace. Once they understood it, they were very supportive of the network and their hospital’s participation. In hindsight, it would have helped if the lawyers had accompanied their hospital CEOs to the planning meetings.”
THE DARK REPORT came away from this site visit impressed by some of the sophisticated business thinking contained in the business plan for MTHN’s regional laboratory network. It appears that MTHN has solutions to the most intractable of problems confronting organizers of such networks.
If true, this is an important development. Regionalization of laboratory services must occur in response to the growth of managed care and integrated clinical services. Regional laboratory networks are an effective market strategy. Any business plan structure that proves successful will aid the national movement towards regional laboratory networks and systems.
But as proved by the disappointing failure of Pittsburgh’s Reference Laboratory Alliance, even a sophisticated, well-designed business plan is no guarantee of success should management inadequately respond to marketplace changes.
That is why a successful regional laboratory network must accomplish two things. First, it needs to develop a viable business plan which provides appropriate working capital. Second, it must field a capable management team to implement the business plan.
To avoid the disappointments of failed regional laboratory networks, management of the Middle Tennessee Healthcare Network will need to be good with their implementation of the business plan and timely with their response to changes in the marketplace. If they can accomplish both, they may well become a major laboratory competitor for physicians’ office business in Central Tennessee.