National Labs Cut Costs Using Radical Strategies

Big three use proven management techniques to control costs and maintain service levels

CEO SUMMARY: All three national laboratories are dumping unprofitable accounts and unprofitable lines of testing. It ends the era when commercial labs “gave away” testing to any client willing to open an account. The three national laboratories are enacting stiffer requirements for new accounts. This significant trend will radically alter sales and pricing strategies for all competitors throughout the United States.

EACH OF THE three national chain labs is currently dropping unprofitable clients or unprofitable lines of testing. This important marketplace change will alter sales and pricing strategies among competing laboratories throughout the United States.

Within the commercial laboratory segment, this is the most significant trend since the consolidation wave ended in early 1995. It will force changes upon the sales programs of independent commercial laboratories and hospital laboratory outreach programs everywhere.

Each national laboratory seems to have a different strategy, but the market impact will be similar. Quest Diagnostics Incorporated is repricing physician accounts which generate small volumes of tests. SmithKline Beecham Clinical Laboratories is releasing long term care accounts in selected markets around the United States. Laboratory Corporation of America is sending specimens from regions with high production costs to be processed at regional laboratories with lower costs.

A common theme links the individual strategies of the three national laboratories: profit per account. If the individual client account does not generate sufficient income to cover direct costs and administrative overhead, then the laboratory pursues one of two strategies. It either declines to provide service or it alters the terms of service with the client.

“This is the first evidence I have seen of rational business decisions concerning money-losing client accounts,” said Mark Smythe, Principal of Management Mentors in Wilsonville, Oregon. “I am encouraged to learn that the national laboratories finally want to look at profitability per individual account. The laboratory industry must learn that it is good business to offer testing only at prices that fully cover costs and generate a profit.”

Fear of Competitors

Since the early 1990s, laboratory executives feared giving competitors an advantage if they priced small-volume physician clients differently than large- volume accounts. Also, with fat operating profit margins of 15% to 30% for the total laboratory, lab executives felt no pressure to change the way unprofitable accounts were serviced.

Today the picture is different. With laboratories struggling to maintain financial stability, any source of cost savings is undergoing scrutiny.

Probably the most rigorous effort to evaluate and reprice individual client accounts is now under way at Quest Diagnostics. Quest retained Booz-Allen & Hamilton, a national consulting firm, to study the profitability of client accounts.

THE DARK REPORT learned that Quest is using parameters developed by Booz-Allen to revamp pricing and service policies for individual client accounts. Quest quietly sent letters early in May to physicians whose small volume accounts fail to cover costs. These letters put the clients on notice that, after a specific date, service terms will change.

Clients serviced by Quest’s central laboratory in Teterboro, New Jersey were among the first to receive registered letters dated May 7. The letters announced changes to the terms of service. Similar letters were mailed to clients in Ohio and Pennsylvania. In the coming months it is expected that Quest will send these letters to clients in every regional market. One criteria used to identify money-losing accounts is the monthly net revenue generated by those accounts. Apparently Quest is restructuring service arrangements for accounts generating less than $500 per month in average net revenues.

For Quest’s Teterboro clients, service changes will become effective on June 9, 1997. Quest’s affected client accounts will see several important differences. First, courier services to the client’s office will cease. Patients can continue to be drawn at Quest patient service centers. Quest also noted to the physician that “any transportation and/or shipping costs to our facilities will be the responsibility of your office.”

Second, Quest will limit the collection supplies it provides to “a select list of non-blood work testing.” Further, Quest will monitor the specimen volume referred by that client and only ship sufficient supplies to maintain the customary volume of specimens.

No Office Teleprinters

Third, results will be reported by fax or by mail. This means that Quest will not offer teleprinters or computers for test requisition/reporting to physicians receiving this letter.

Fourth, all client and patient bill work for tests referred by the physician will be priced at the current Client Fee Schedule and current Patient Fee Schedule, respectively. All special discounts or prices will be discontinued.

Fifth, custom test profiles designed for that physician will be discontinued. Testing will be limited to those assays published in Quest’s Reference Manual.

Laboratory executives should recognize that Quest’s five key service changes directly reduce the cost of servicing the accounts categorized as unprofitable. In fact, should Quest successfully implement these policies, it will be doing the entire laboratory industry a service. By stopping wasteful and money-losing practices, Quest aids all laboratories which would like to similarly improve the cost/revenue performance of marginal client accounts.

In Quest’s case, it directly targeted courier and transportation costs, clients who abuse “free” collection supplies, office printer/computer costs and discounted pricing to clients whose volume does not justify it.

THE DARK REPORT believes that Quest will successfully implement these new policies, with two outcomes. First, Quest will see a significant, even substantial, gain in overall operating profit at any laboratory site where these new policies are implemented. Second, Quest will see no competitive
disadvantage or loss from changing service terms.

Physicians are undergoing the same reimbursement and financial pressures as clinical laboratories. So long as Quest communicates effectively what it is doing and why, THE DARK REPORT predicts most physicians will understand and accept the changes.

Unlike Quest and SBCL, however, LabCorp does not yet appear to be releasing existing client accounts which are considered unprofitable…

Contrasting Quest’s strategy of directly attacking unprofitable accounts through changes to discounting, supplies and service, SmithKline Beecham Clinical Laboratories (SBCL) chose another course of action.

SBCL is simply terminating service to accounts it considers unprofitable. Apparently SBCL decided to exit the long term care market in selected regions. Florida and California seem to be the first states where such efforts are under way, but others are involved.

SmithKline’s decision to withdraw from the nursing home business reflects several strategic decisions. First, profitability per individual account is probably marginal at best. This is directly attributable to the high cost of providing phlebotomy, infection control programs and the other numerous features that competition made standard in the nursing home segment.

The second reason is probably SBCL’s experience with increased federal regulation and scrutiny of testing for Medicare patients. Add to that the coming Medicare DRGs for skilled nursing facilities, and SmithKline probably sees long term care as a distraction from their core business.

Sources indicate that SmithKline negotiated with regional laboratories to
take over nursing home accounts in San Diego, California and Jacksonville, Florida. Similar activity seems to be unfolding in Tampa, Florida and southern Louisiana. In these markets SBCL simply gave the clients notice and stopped service on a specific date.

At Laboratory Corporation of America, profit per account is being addressed in different ways. For new business commitments, LabCorp is pricing contract RFPs and new accounts to more accurately recover full costs.

Unlike Quest and SBCL, however, LabCorp does not yet appear to be releasing existing client accounts which are considered unprofitable. Instead, it is pursuing a policy of moving testing to laboratories within its system which have low costs.

One example of this strategy is LabCorp’s cost-cutting moves in New York City. During March and April, LabCorp’s Mitchell Field lab facility, their anchor laboratory in New York state, laid off 12 customer service representatives. This was followed by lay-offs of eight cytotechnologists.

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$1 Million Savings

In salaries, LabCorp saved a minimum of $25,000 per year per customer service rep, along with $65,000 per year per cytotechnologist. With benefits, this represents payroll savings of $1 million per year.

But that is not the whole story. LabCorp will be sending Pap smears to locations outside New York City, where costs are up to 40% cheaper. Assuming that quality and turnaround time can be maintained, LabCorp will reap significant savings by moving work outside the Mitchell Field lab site. It reduces LabCorp’s losses on Pap smears originated in that market. As discussed earlier in THE DARK REPORT, all three national labs lose significant money on Pap smear testing. (See TDR, April 8, 1996.)

LabCorp’s initial strategy is to leverage low cost locations to perform tests which are unprofitable at current reimbursement levels. For this strategy to succeed, LabCorp’s service implementation must be flawless so clients perceive no change in how their Pap smears are handled.

Industry Consequences

The fact that all three national laboratories now emphasize the profitability of individual accounts creates consequences soon to be felt throughout the clinical laboratory industry. There will be changes to the way diagnostic testing is priced. There will also be changes to the package of services offered physician clients. For example, not only will Quest cease courier service to small accounts, but Quest will no longer install a printer and dedicated phone line in such accounts. Multiplied by hundreds of accounts, these savings are considerable.

Further, the importance of this new trend is that it is based on a cost management strategy which uses principles established in manufacturing and distribution. In particular, it utilizes two management principles: profit/cost per account and the 80/20 Rule, also called Pareto’s Law.

Competition Must React

Laboratory competitors will need to learn these management principles and apply them in their own laboratory if they are to maintain their competitive position in the marketplace. Laboratories will also need to revamp sales compensation plans to emphasize operating profit, not net revenue, as the basis for sales commissions.

As predicted earlier by THE DARK REPORT, it is becoming increasingly important for laboratories to manage profit, not process. That alone represents radical change for many lab executives.

Ken Freeman Fulfilling Innovator Prediction

As CEO of Quest Diagnostics Incorporated, Ken Freeman is taking a decidedly unlaboratory view of the industry. It is no coincidence that Quest is first in the marketplace with a major management project to address the profitability of individual accounts.

As you will read here, Mark Smythe explains that successful businesses outside healthcare pay close attention to the profitability of individual accounts. Management principles and techniques are well-established and easy to use. Freeman, drawing on his earlier experience with Corning Incorporated’s industrial businesses, is importing these successful principles into Quest.

THE DARK REPORT picked Freeman as one of 1997’s Laboratory Innovators To Watch. He has not disappointed. We believe Quest will continue to emphasize quality management principles. Compared to its two national competitors, Quest should move to the head of the pack.

Clients of THE DARK REPORT will also be interested to know that Quest is engaged in some very atypical behavior. Laboratorians tend to hire only laboratorians. We believe that one source of problems for the lab industry is that the major commercial labs sim- ply reshuffle executives from one company to another. Old practices and bad habits simply perpetuate themselves at the major laboratories because new executive blood is not infused.

Sources tell THE DARK REPORT that Quest directs its headhunters to recruit executive candidates from outside the laboratory industry. If this is true, it is more evidence that Quest may become a good laboratory model to observe and emulate. Outside executive blood will bring new ideas and new energy to a tired lab industry.

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