CEO SUMMARY: Efforts by national laboratories to improve profit margins will affect all laboratories. Consequences of this initiative will actually benefit competitors. It provides all laboratories with the opportunity to increase profits. Mark Smythe demonstrates how this can be accomplished.
STRATEGIES USED by the three national laboratories to improve “profit per account” will change the competitive marketplace. These changes will be to the benefit of all laboratories.
It is essential that competing laboratories respond in three ways. First, they must understand what the national laboratories are doing. Second, they must understand how these new changes will alter the competitive marketplace for laboratory services.
Third, competing laboratories must respond with their own “profit-building” strategies if they are to take advantage of the market opportunity now unfolding. That is the purpose of this story. Mark Smythe, Principal of Management Mentors in Wilsonville, Oregon, describes two simple techniques which boost profits.
“As I study the actions of the three national laboratories, I can see the first applications in the clinical laboratory industry of two management principles consistently used by well-managed companies. First is ‘profit per account’
analysis. Second is proper use of the 80/20 Rule.
“Both management principles can greatly increase the operating profits of your laboratory,” continued Smythe. “This is just as true for a hospital laboratory as for a commercial laboratory.
Easy To Learn
“The wonderful thing about these management principles is that they are easy to learn and easy to apply. As I explain how to use them, I want laboratory executives to recognize that they gain an advantage over competing laboratories when they are first to introduce these profit-building techniques into their own lab organization.
“First, let’s look at ‘profit per account.’ I am heartened to see that the national laboratories finally want to pay attention to profit per account,” stated Smythe. “The fastest way to lose money is to accept business which costs you more to service than the revenue it generates. Although this common sense precept is widely understood among manufacturers and distributors, for some reason the clinical laboratory industry ignored this truth.
“The concept is simple: each individual client account of the laboratory should generate enough revenue to cover the full cost of providing the service,” he explained. “It sounds easy, but two things generally prevent this from happening. First, few labs accurately know what it costs them to service individual accounts. Thus, they don’t know how much money they lose on specific accounts. Second, lab managers allow sales reps to pressure them to accept money-losing terms as a way to acquire or retain individual accounts.”
“It is unfortunate that the clinical laboratory industry has long neglected to copy successful management techniques used outside the healthcare industry.”
-Mark H. Smythe
“To evaluate profit per account, the first step is to develop a cost figure for each element of an account. Besides the cost of performing the tests themselves, this typically includes the cost of providing courier and logistics services, the cost of placing and maintaining a remote printer or test-ordering computer system in the physicians office, requisitions, supplies, catalogs, etc.
“However, the cost analysis should not overlook expenses incurred by the laboratory to maintain the account internally” stated Smythe. “For example, it costs something to track billing and reimbursement activity for the account. Client services may communicate daily with the account. Service reps may make weekly or monthly calls to the account. These items should be costed and added to the expenses necessary to maintain the account.
“This information is required to develop a reasonable figure for expenses. On the revenue side, the laboratory needs to develop a basic formula for calculating operating profit,” noted Smythe. “Regardless of how the numbers are calculated, operating profit should be a measure of how much income is generated by the account over the allocated direct and administrative costs.”
Calculate Operating Profit
“Once these two sets of numbers are determined, it is necessary for management to evaluate the existing cost/operating profit performance of the account. Obviously, every account which incurs more costs than the revenue it generates is a target for management action.”
Smythe believes that the letter sent by Quest Diagnostics Incorporated to clients in the East and Midwest (see letter on page 4) represents good execution of the “profit per account” principle. “A careful reading of that letter indicates that Quest has done their management homework. Quest apparently did a rigorous cost analysis of servicing specific accounts. They matched those costs against actual revenues and decided on strategies to eliminate money-losing accounts.”
Quest Changing Services
“Look at the specific service terms Quest is changing. For low volume accounts, they are dropping regular courier service and encouraging the physician to send patients to the Quest’s phlebotomy sites for collection. Not only does this eliminate courier costs, but specimens collected by Quest are more likely to have complete patient and billing information. Specimens collected this way can also be preaccessioned before arriving at Quest’s regional laboratory.
“Just changing courier arrangements can trigger a cascade of cost savings beyond simple courier expenses,” declared Smythe. “Results reporting is another big money-saver. Quest will fax or mail reports to the affected accounts. This eliminates three expense items: the dedicated telephone line, the line printer and possibly a test-ordering computer. Balance these monthly costs against the operating profit generated by an account referring less than $500 per month of tests. Quest will harvest significant savings from these changes.
“Savings from collection supply policies and client/patient list fee discounting is probably not equal to the changes I’ve already mentioned. However, spread across thousands of client accounts in Quest’s system, even these savings are considerable.”
Quest Did Basic Math
“Remember that Quest had to do the basic math on the cost to service an account versus the operating profit and revenue generated by that account before they could intelligently decide which accounts would be affected,” said Smythe. “Once that was done, it was obvious where the cut-off levels were and which accounts would receive Quest’s letter changing terms of service.
“For those laboratory executives who are interested in doing this same ‘profit per account’ analysis,” I want to add some advice. Don’t let the naysayers in your laboratory tell you that it can’t be done. There are two common objections I hear when I am brought in to help implement this project.
“The first objection is ‘we can’t get accurate numbers to properly cost these items.’ That is a bogus objection. Even a ballpark estimate of costs is better than no estimate at all. If your laboratory is like most others, no one has ever tried to collect this information. You will be surprised at how easy it is to develop a relatively precise measure of individual account cost and operating profit… once management decides it has to happen!”
“The second objection is the same one that originally contributed to the problem. ‘If we do this, the physicians will become upset, our competitors will take the account from us and people will say we have financial problems.’ My response is ‘hogwash.’ When you make a sound business decision for the right reason and communicate your decision effectively to your clients, they understand and support your efforts. Besides, under existing terms of business, these are precisely the accounts which suck money out of your laboratory. You are better off without them.
“I can prove that both these objections are straw men,” continued Smythe, “by predicting that Quest Diagnostics will successfully implement this project on a national scale and it will result in a significant percentage increase to their operating profits within two quarters. If Quest can do it, why can’t your laboratory?
“Now it is time to look at the other management principle, the 80/20 Rule. Also known as Pareto’s Law, the 80/20 Rule simply says that in any distribution or population, a small number of items have a disproportionate impact.”
“The examples are abundant,” said Smythe. “In your laboratory, 20% of the assays in your catalog generate 80% of the billable tests. 20% of your revenues come from 80% of your clients. 20% of your sales reps generate 80% of the new business. In the hospital, 20% of the physicians order 80% of the tests.
“The 80/20 Rule is your management secret weapon, if you will use it. It is simple to learn and quick to apply. You start by looking at information in a different way. Typically, when you ask accounting or systems for a study or report on client revenues, test volumes or expenses, they provide a lengthy report which is sorted by account number or alphabetically.
“For serious managers, these formats are completely useless,” declared Smythe. “Insist that your reports hence-forth be submitted in an 80/20 format. You want to sort the information in descending order of the financial or volume variables. For example, a study of revenue by client would rank the largest volume client at the top, the second largest, then third largest and so forth.
“It would be the same for test volumes. Rank your highest volume test at the top and then descend to lowest,” he continued. “If you can get columns to represent cumulative volume, percent and cumulative percent, then you can quickly identify the 20% of your accounts, tests, expenses, etc. which affect 80% of your total volume.
“The chart on page 13 is an example of an 80/20 Report. If you use this format, you will discover several benefits. First, it is easier and quicker to make decisions. Second, you have confidence that these decisions are correct. Third, you find it easy to establish priorities for you and your staff, because you focus work on the 20% of the accounts/tests/expenses which generate 80% of the results.”
80/20 Rule Is Secret Tool
“Does it sound too simple? It is. But the 80/20 Rule is the secret used by management experts skilled in turnarounds and accelerated growth situations. They use the 80/20 Rule to focus their time and energy on only those elements which promise huge benefits.
“If it is this easy and this effective, why wouldn’t you want to begin using this management tool?” asked Smythe. “Quest Diagnostics certainly has. After analyzing their account costs and operating profits, they probably ranked clients by three parameters: net revenue, monthly service costs and operating profit generated by the account.”
“From these three rankings, they determined where their break-even points were for making money versus losing money. It was a simple matter to identify accounts below breakeven, then develop a strategy to either reprice or release the account.
“Having explained these two management principles,” added Smythe, “I want to make it clear that these tools are guides to management decision-making. Someone still has to make choices that affect how the laboratory services individual client accounts.
“Someone within your laboratory must make the executive decision to address the problem of unprofitable accounts. Further, once specific accounts are determined to be unprofitable, management must make decisions about how to fix that situation, taking into account marketplace quirks, political relationships and competing lab activities.
“Until recently, no laboratory seemed willing to take the lead in emphasizing profit per account. Now that Quest, SmithKline and LabCorp are taking the initiative, laboratory competitors who lag behind will find their profits negatively affected.
“By contrast, any laboratory which takes the initiative to utilize these principles will find a big boost to their profits. In my 35 years of management experience, I find rigorous application of account profitability, the 80/20 Rule and deliberate methods change techniques cause operating profit to increase by upwards of 30%. The same can happen to your laboratory.”
Challenge And Opportunity
“You face a challenge and an opportunity. The challenge is that your three national competitors are finally using proven management principles to boost operating profits. If your laboratory does not respond in a timely manner, you may find yourself losing market share.
“The opportunity is for you and your laboratory to rapidly incorporate these management principles into your organization,” recommended Smythe. “By moving faster than the competition, your laboratory can increase operating profits and market share. Plus, your laboratory may just implement these management principles with more skill than your three national competitors. If so, it is a great chance to turn the tables on them for a change!”