CEO SUMMARY: Business strategy does make a difference. However, it sometimes takes years to appreciate the wisdom of choosing one strategy over another. In the case of SmithKline Beecham’s lab division, the decision to become sole-source provider to the nation’s largest HMOs may eventually prove to be a masterstroke. In coming years, sole-source arrangements may give SBCL a dominant national market position.
IN THE SECOND HALF of the 1990s, SmithKline Beecham Clinical Laboratories may be quietly carving a dominant position in the national marketplace.
Since 1995, it has notched sole-source laboratory testing contracts with three of the giant HMOs: Cigna, Prudential, and Aetna U.S. Healthcare. These three companies insure more than 9 million lives in their various HMOs and managed care plans.
Most laboratory executives fail to appreciate how SBCL’s managed care business strategy will alter the market- place for laboratory services. If SBCL continues to successfully bag sole- source managed care contracts with the nation’s largest HMOs, the competitive position of both national and local laboratories will change.
Should SBCL’s sole-source managed care business continue expanding, it will create two separate outcomes. One impacts its two national lab competitors. The other affects local laboratory providers in most urban areas of the United States.
Alone of the three blood brothers, SBCL is carefully building a book of managed care business which is predicated on sole-source, long-term relationships with individual HMOs. The terms of these relationships will make it increasingly harder for competitors Laboratory Corporation of America and Quest Diagnostics Incorporated to break them apart.
The reason is simple. Once a big HMO like Cigna or Aetna commits to a sole- source relationship with SBCL, a tight working relationship develops between the two companies. Each year brings about tighter business bonds.
Such an entrenched business relationship is difficult for any outside company to overcome. Thus, the effort required by LabCorp and Quest to wrest this business away from SBCL becomes tremendous.
Keep in mind that SmithKline’s sole source strategy comes with great risk. If SBCL ever fails to effectively serve its customer, then it will be quickly kicked out the door. Doing business with a big customer is great for increasing sales. However, if that customer ever goes elsewhere, the financial hit is huge.
But is SBCL at risk in this way? Probably not. The Cigna contract is now finishing its second full year. There is no market scuttlebutt which says Cigna intends to replace SBCL or bring in new laboratory providers. Neither Prudential or United Healthcare are sending signals that they want to radically downsize SBCL’s role in their provider networks.
Given this marketplace evidence, it must be assumed that SBCL is performing acceptably where it has sole- source laboratory responsibilities. In fact, it must also be assumed, with the announcement of the new Aetna contract, that SBCL is becoming increasingly proficient at serving the needs of national HMO companies.
“Think of the 1996 Cigna contract as SBCL version 1.0,” said a managed care specialist from a competing laboratory. “Two years later, SmithKline is probably on SBCL version 3.0 with Cigna. Each version gets better, both in performance of basic testing and at including new features which Cigna likes.”
“I would bet that SmithKline is benefiting from its ongoing experience at Prudential and United Healthcare in the same fashion,” he continued. “This means SmithKline is developing experience, capabilities, and services which don’t exist at the two other national laboratories.
“This is important to the managed care companies for a simple reason,” said the executive. “If you want the benefits of going to a sole-source laboratory provider for your national network, wouldn’t you want a laboratory that’s already done it… more than once? Or, would you want to bet your corporate career on a laboratory which has yet to have that responsibility?
“That’s why it’s a safe decision to pick SmithKline Beecham,” this executive answered, “Among other reasons, that probably contributed to their winning the Aetna contract last month.
“If this pattern continues with other HMOs, it spells danger for LabCorp and Quest,” he explained. “The national labs need these national contracts to survive. Such contracts justify their existence.
“The three national laboratories need access to the patients of the national HMOs if they are to maintain their market presence in urban areas,” concluded this executive. “That is why this is a critical battleground for them.”
The next big laboratory services contract award is Oxford Healthcare. Quest is currently perceived to be the leading candidate for that contract. However, SBCL is also knocking on that door attempting to wrest the Oxford contract away from Quest.
Quest has a lot at stake, because Oxford’s beneficiaries are mostly located in the Northeast, traditionally a strong market for Quest. If SBCL were to win that contract, it would pick up a significant volume of specimens, at the expense of Quest.
SBCL’s Early Decision: Embrace Managed Care
EARLY IN THE 1990S, SmithKline Beecham Clinical Laboratories made a critical busi- ness decision concerning managed care.
“As managed care began to appear in various cities, we realized that we needed to reexamine our business strategy,” said Vijay Aggarwal, Ph.D., Vice President and Director, U.S. Reference Laboratories, SBCL. “After much reflection, we decided to embrace managed care.
“At the time, our studies indicated that managed care would continue to expand its influence upon healthcare,” he added. “As managed care grew over time, SBCL would need to be more than just a producer of lab- oratory test results. We would need to become a full partner with both managed care companies and the clinicians.
“Integrated healthcare and prospective payment fundamentally change the way laboratories operate,” said Aggarwal. “Once SBCL made the decision to embrace managed care, it required us to begin transforming our laboratory company toward a new business model for the future.”
Impact On Local Labs
Local laboratories will find themselves impacted by SBCL’s sole-source contract victories. During 1996, many labs saw their Cigna lab specimens disappear to SBCL and its contracted laboratory network. In certain cities the Aetna contract will similarly redirect laboratory specimens away from local labs and directly to SBCL.
However, the equation is not that simple. Healthcare remains a local business. THE DARK REPORT sticks by its prediction that most laboratory services will be delivered locally by regional laboratory systems anchored in that area.
The economics of testing, combined with ever-lower reimbursement, will work against transporting lab specimens hundreds, if not thousands of miles. This is particularly true in any city where unused laboratory capacity exists.
New Lab Business Model
A surprising new business model for laboratory operations may be emerging as a result of the sole-source laboratory contracts that SBCL is winning. That business model calls for SBCL to be the “network operator.”
SBCL is the responsible entity, the supplier of laboratory testing to the HMO’s physicians. As the “network operator” SBCL will utilize the best combination of laboratory resources necessary to deliver testing services to that locality.
In cities like Philadelphia and Miami, where SBCL has large regional laboratories, testing will be done internally. But in cities where SBCL lacks the infrastructure, it will contract with local laboratory resources to get the work done.
In fact, this was how SBCL cobbled together the laboratory resources needed to serve the Cigna contract back in 1996. It will use a similar approach to create the provider network required for the Aetna contract.
As the operator of these laboratory “networks,” it is SBCL’s responsibility to supervise the testing, respond to problems, bill for tests, and report results. In addition, and very importantly, SBCL will aggregate the test data from all regions and feed it to the HMO. It can also provide clinical outcomes studies that involve laboratory test data.
Incentives Motivate HMOs
Laboratory executives should understand that operational and economic incentives motivate national HMOs to do sole-source, national contracts. SBCL, LabCorp, and Quest have similar incentives to bid for that business.
For these reasons, national deals will not disappear. But at the physicians’ office level, the need for superior service, delivered day after day, will never disappear. The clinician’s need for value-added laboratory information will continue to increase.
This is where opportunity for local laboratories can be found. All three national labs lose business to local laboratories which compete intensely for the business. This is the dichotomy between a national contract and local service.
That is why aggressive local laboratories will continue to hold their own. And remember, SBCL’s contracts for 9 million people nationally still leave another 262 million people who require laboratory testing. It remains a big market with plenty of room for tough competitors.