"NEWSMAKER INTERVIEW"

Specialty Laboratories’ New CEO Reveals How His Company Is Changing

There’s a surprising amount of optimism from a company that some were ready to count out

“You will see a more tightly focused Specialty Labs. We won’t try and do everything, rather we will do what is important for our customers.”
—Douglas S. Harrington, M.D

CEO SUMMARY: In recent months, several events roiled the market for hospital send-out testing. Not the least was the public disclosure of state and federal sanctions against Specialty Laboratories. Hospital labs throughout the country found themselves forced to evaluate the situation and develop an effective response. News that Specialty is again compliant with lab regulations introduces new competitive dynamics in the market for hospital send-out testing. To help hospital lab administrators and pathologists understand today’s altered competitive landscape, THE DARK REPORT presents this exclusive interview with Douglas S. Harrington, M.D., CEO and Laboratory Director of Specialty Laboratories. He intends to aggressively grow and strengthen Specialty. Because he is armed with a $70 million war chest, Harrington has the financial capability to force a response from competing reference labs. As the comments below demonstrate, Specialty Laboratories is showing a positive face to the laboratory industry.

EDITOR: When you became the new Chief Executive Officer (CEO) of Specialty Laboratories, Inc. in April, you found yourself in a high-profile job at a time of high crisis for your company. What was your prior relationship to Specialty and what motivated you to take what many people described at the time as “the toughest job” in the laboratory business?

HARRINGTON: At the time these events unfolded, I had just stepped down as CEO of Chromavision, based in Irvine, California. I remain on Chromavision’s board of directors. During the past six years, I’ve served on the board of directors of Specialty Laboratories. Prior to Chromavision, I was a corporate executive at Nichols Institute in San Juan Capistrano. So I have deep experience in the reference and esoteric testing marketplace. When Dr. Peter made the decision to resign as Chairman and CEO of Specialty in April, the board offered me the position.

EDITOR: Given the pressures on the company at that time, what caused you to say yes? There’s certainly a fair amount of risk in becoming CEO of a lab company which has just been hit with extraordinary regulatory sanctions.

HARRINGTON: I saw that, despite the regulatory problems, Specialty Labs is a fundamentally sound company, although a company in transition. It possessed core strengths in science and medicine, strong customer relations, and one of the country’s most sophisticated laboratory IT capabilities. In my view, the regulatory problems could be resolved quickly if Specialty took the appropriate management actions which I believe we did.

EDITOR: Across the country, the April news of sanctions levied against Specialty Laboratories, Inc. by state and federal regulators triggered serious concerns by lab administrators in hospitals doing business with Specialty. For many reasons, Specialty could not make public statements about details of the regulatory sanctions, leaving a vacuum of information in the marketplace. In June and July, both the California Department of Health Services (DHS) and the Centers for Medicare and Medicaid Services (CMS) determined that Specialty is back in compliance with lab regulations. How would you characterize the problems that occurred and what you’ve done to resolve them?

HARRINGTON: Robert, I was not in the lab during the time these problems were identified. I can best speak about the issues which I’ve addressed since April 22 when I became CEO and Laboratory Director. The primary issues centered around California licensing requirements for the personnel category of “Clinical Laboratory Scientists” (CLS). These California requirements are stricter than those of most states. Specialty, like many labs, had incorporated laboratory aides to assist in the lab testing process.

EDITOR: What type of corrective action was instituted?

HARRINGTON: We went above and beyond the letter of the law to staff all testing procedures with 100% CLS. Wherever we find a “grey zone” we err on the conservative side. We focused not only on quality improvement but process improvement as well, enhancing our regular QA/QC procedures.

EDITOR: Could you describe this?

HARRINGTON: Our regulatory deficiencies did not involve issues of quality at the laboratory but of personnel. It might seem counter-intuitive to consider that a Ph.D., after rigorous scientific training, and managing high complexity testing in specific ways for years, then crosses a state boundary only to find herself unqualified, from a regulatory perspective, to do that very same type of work. To reflect the specific requirements of California’s regulatory code, we instituted a laboratory-wide education program. It has two goals. First, to make people aware of the regulations and why they exist. Second, to teach them to understand our lab’s policies and how to conform to those regulations. To accomplish these goals requires both a strong quality program and a process improvement program.

EDITOR: Effectively, then, your revamped “quality and process improvement program” is teaching what I will characterize as “new” work habits to the highly-trained technical staff so they do work in compliance with California’s stricter regulatory code.

HARRINGTON: Yes. That’s why I am Laboratory Director in addition to my CEO role. The quality and process improvement program director reports directly to me. We are methodically institutionalizing the quality management program.

EDITOR: Does this impact the test protocols used at the bench?

HARRINGTON: That’s one key element of our effort. When a test is validated, that becomes the legal procedure to be followed by technical staff at the bench. It is an integral part of our management system now to insure that the procedure used by individuals at the bench matches the legal practice. That’s required us to inspect every test protocol in the lab and scrub it to bring it into full regulatory compliance.

EDITOR: That’s a daunting job, given the huge number of assays offered by your lab. Could you describe how that is affecting your test menu?

HARRINGTON: This is the reason we took down certain tests and referred them temporarily to other sources. In cooperating with the regulators, we had to immediately concentrate on bringing internal lab processes into compliance with legal requirements. As we implement compliant procedures for specific assays, we are restoring those to our test menu.

EDITOR: What has been the reaction of the state and federal regulators to these efforts?

HARRINGTON: As you know, we announced that Specialty Laboratories is again in full compliance with DHS and CMS, based on their review of our lab’s current operations. I’d like to go further and say that my dealings with officials from DHS and CMS were absolutely stellar. The individuals from both agencies were respectful and professional. Where regulations lacked precision, they worked earnestly to provide us with the clarity necessary to achieve compliance. I have only good things to say about my interactions with both groups of people.

EDITOR: Doug, that’s a revealing and useful explanation of how Specialty restored its regulatory standing. I’d like to next discuss client relationships. Once news of the sanctions affecting Specialty’s standing with the Medicare and Medicaid program became public, many hospital labs had concerns about continuing a business relationship with your company. Although it’s a sensitive subject, it’s one of great interest. Could you candidly discuss the impact the sanctions have had on Specialty?

HARRINGTON: I can make three observations about this. First, we did see a decline in business since April. In our second quarter earnings release, we noted that number of accessions had declined 11% compared to first quarter. We also provided guidance that we expect a 17% reduction in accessions for third quarter compared to first quarter 2002. We attribute these changes to the reductions we made in our test menu as well as certain customers redirecting specimens to other sources.

EDITOR: Can you quantify the impact of each factor?

HARRINGTON: That’s something I cannot break out for you. I can say, most emphatically, that the institution that Jim Peter created here generated a lot of customer loyalty. Throughout this episode we believe we have been successful at maintaining this loyalty by communicating constantly and candidly about the issues. I want to also note that, by no means is our sales force demoralized. They are energized and on the street focused on winning back our customers. Helping in this effort is our new Vice President of Sales, Mark Willig, who recently joined us.

EDITOR: And your second observation?

HARRINGTON: I see Specialty Laboratories as a company in transition. We have always been a science-driven company and did an outstanding job in that regard. Specialty has been good at customer service, but I would not put it in the “great” category. Using our core strength in science, we are now working to evolve into a market-driven company.

EDITOR: What will be different about the “market-driven” Specialty Labs?

“As most lab administrators know, organizational stress is often what triggers profound and positive change. Specialty is undergoing this process.”

HARRINGTON: We are striving to provide measurable added value and set new industry standards for customer service. To accomplish this, we removed a layer of management to make the company more responsive to customers’ needs. In scrubbing our work processes, when we spot an opportunity for improvement, we catalog it. This is generating a prioritized list of improvements that we will implement.

EDITOR: You’ve got a third observation about the impact that sanctions have had on Specialty Laboratories.

HARRINGTON: Post-sanctions, we have specific operational strategies that will make us a different company in the future.

EDITOR: Please explain.

HARRINGTON: As most lab administrators know, organizational challenges are often what triggers profound and positive change. Specialty is undergoing this process and it may be the silver lining to this compliance matter. As we assessed our company, its strengths and its standing in the laboratory testing marketplace, we also identified specific business strategies that we want to pursue. The key strategies will be science, customer service, and information technologies.

EDITOR: How are you repositioning the company to accommodate these goals?

HARRINGTON: To be a market-driven company, we have to be close to the customer. We must also be responsive to rapidly-changing technology. That’s why we flattened our management structure. We intend to better align Specialty’s scientific capabilities with the needs of our clients. We see real value in introducing assays likely to have significant and immediate clinical value and application for our clients.

EDITOR: What about the customer service objective?

HARRINGTON: Customer service encompasses a lot of areas in the laboratory. It starts at the point a specimen is drawn from the patient. If any lab makes a mistake, it influences the course of a patient’s life. That’s why all labs must strive for zero tolerance of mistakes and errors. We are emphasizing the primacy of patient care to our entire staff. Any aspect of our operation that touches a patient or customer is under review for improvement.

EDITOR: What tools are you using to measure improvement in this area?

HARRINGTON: As one would expect, there’s a variety of internal metrics that we closely monitor. This is a long-standing practice and we’ve been exceptionally candid with this quality assessment data, publishing them on an annual basis for the past several years. We’re now planning to benchmark ourselves against the industry to ensure we are, at a minimum, performing at parity. Going forward, our goal is to set the standard for service. I know that sounds ambitious given our recent problems but we are well-prepared, motivated, and off to a good start.

EDITOR: The other strategy you mentioned is information technology.

HARRINGTON: Yes. We consider Specialty Laboratories to be ahead of the marketplace in its effective use of information technology (IT). This is a core competence. For example, we are electronically linked to over 70% of our customers. Because this is a potent core competency and keeps us close to our customers, we will invest more heavily in expansion of our IT capabilities.

EDITOR: All your comments in this interview have a consistently aggressive posture and describe a Specialty Laboratories that intends to compete intensely.

HARRINGTON: That’s true. Competitors should understand this fact. I want hospital laboratories to recognize that Specialty Labs is an evolving company. Despite the regulatory issues which placed it in the spotlight, this company has always had high-quality employees and we intend to maintain that. We are basically building on the best and the past. I personally believe that change is good for a company as it matures. Today in our company we are not destroying good things from the past. We are building upon them.

EDITOR: In making those comments, Doug, you demonstrate a willingness to take a different public profile than founder and former CEO James B. Peter, M.D., Ph.D. What key differences in your management style will become noticeable to hospital lab administrators?

HARRINGTON: Robert, you are talking to a guy who likes to get out and pound the pavement with the sales force. I like to visit customers, to listen carefully, and to find out what is good and what is bad. I like to return to mission control and fix it or make it right.

EDITOR: You personally had a high profile at the CLMA annual meeting in New Orleans five weeks ago.

HARRINGTON: That’s a sign of our increased aggressiveness in pursuing new customers. We sense a significant opportunity here. We’ve dealt with a very intense set of issues and emerged relatively unscathed in a rapid period of time. People will see Specialty Laboratories out there promoting itself, focusing on its service improvements, client responsiveness and other advantages. But it is only by executing in areas that meet and exceed our clients’ expectations that we can expect to build and maintain strong, long-term relationships. This is our goal.

EDITOR: Getting back to your executive style, the assertive display of Specialty Laboratories at CLMA certainly surprised many people.

“Competitors should understand this fact.
I want hospital laboratories to recognize that Specialty Labs is an evolving company.”

HARRINGTON: That was intentional. We want the lab industry to clearly understand that we were confident that our regulatory problem would be satisfactorily resolved. We went to New Orleans to demonstrate that this was not a company defeated, but was a company that was ready to “rock and roll.” In fact, that’s why we chose the House of Blues for our coming out party. We thought a famous rock ‘n roll venue was the right metaphor to reinforce that message.

EDITOR: If I ask you how customers responded, I will probably get the safe answer that it was “great.”

HARRINGTON: Not true. At CLMA, I spent hours in the booth on the exhibit floor to get face-to-face with clients. I listened to the good and the bad. I made no excuses and I am listening. Robert, what I have always found valuable is to talk to customers directly because they usually tell you what you are doing right and what you are doing wrong. The feedback was not always “great” at CLMA, but this did not deter me from making sure clients understand that I’m personally available to listen to their concerns and identify areas of improvement.

EDITOR: You’ve probably gotten an earful from many sources.

HARRINGTON: From the day I assumed my duties, I have either been in front of, or on the phone with, customers. I personally dealt with customer problems. To ensure direct access, I set up a client hotline at extension 636, and I listen to it. I am listening to the customers and I am talking to them.

EDITOR: Doug, your enthusiasm is counter-intuitive, given the impact that state and federal sanctions had on Specialty Laboratories. In the months following the announcement of sanctions, hospital lab administrators had to deal with lots of messy legal issues surrounding licensure, ability to bill Medicare/Medicaid, and the integrity of operations within Specialty. There was the further blow that came when Quest Diagnostics Incorporated announced that it would acquire two of your lab’s larger customers, American Medical Laboratories, Inc. (AML) and Unilab Inc., earlier in the year. This would lead to a loss of specimens at such time that Quest Diagnostics began to direct those specimens to its own reference laboratories.

HARRINGTON: It would certainly be foolish of me to deny the serious problems that have beset Specialty Laboratories this year. No doubt, these have been trying times. But the measure of any individual, and any company, is how they respond to setbacks. To date, I believe Specialty is making a good accounting of itself.

EDITOR: Reference lab competitors report strong flows of new accounts. Along with your decline in accessions, these are specific signs in the market that clients have moved lab testing business away from Specialty. Historically, any lab that has lost significant market share has found it difficult, expensive, and time- consuming to regain that lost business. Why will it be different in your case?

HARRINGTON: I have two answers. First, our largest customers have been very loyal. We’ve maintained close communications with them and we believe that we have strong relationships that will continue. This stabilizes a significant part of our customer base. Second, as most of your readers know, it takes a number of months for large hospital clients to complete the RFP process and switch to a new primary reference laboratory. That allows us to judge the new business that we will be bringing on during the balance of the year. This type of new account activity provides us evidence that we remain competitive in the marketplace.

EDITOR: Your confidence in Specialty’s future certainly is the dominant theme in this interview. However, competition remains brutal in the lab testing marketplace. Specialty will be closely watched to see if it delivers the changes you are promising.

HARRINGTON: That’s a challenge I welcome. Within Specialty, dealing with the regulatory sanctions has allowed us to get everyone’s attention and make deep, lasting changes that make this a better laboratory company. Competition for hospital reference testing has always been intense and we expect to do well defending our clients and expanding our share of the market.

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