"CHAPTER TWO"

Strategic Business Failures Of The Laboratory Industry During the 1990s

Important To Understand Reasons For Failure

If analysis is to be accurate and objective, it must recognize and praise successful accomplishments while at the same time recognizing and criticizing failures. Human nature being what it is, however, criticism of failed business decisions is painful and bound to generate denials by the parties involved.

One key element of a White Paper review of the laboratory industry is an assessment of where the industry failed in its responsibilities to patients, physicians, payers, and owners—either hospitals or stockholders.

I believe it is fair and reasonable to define the period of 1985 through 1999 as the beginning and end of one major business cycle for the clinical laboratory industry.The mid-1980s were the time that Medicare DRGs were having full impact on hospitals and hospital-based laboratories. Meanwhile, independent commercial laboratories were starting to acquire small labs owned by local pathologists.

As these main trends played out during the 1990s, consolidation was completed within the commercial lab segment. Hospital mergers and acquisitions fueled widespread consolidation of hospital laboratories. By 1999, both trends were played out. It was a 15-year period of unprecedented change in the clinical laboratory industry. Not surprisingly, the collective laboratory industry failed in a significant number of important ways.

It is important to identify and recognize these failures. If the new decade of the 2000s ushers in the era of genetic and molecular testing, it will be easy for the lab industry to repeat the mistakes it made during the 1990s, when managed care wrought substantial changes to the healthcare system and the clinical laboratory industry responded quite ineffectively.

What follows is my list of significant industry failures. The purpose in identifying strategic business failures is to determine whether the lab industry has been successful in attacking the root causes of these failures. Many of the same economic and social trends present in the 1990s still influence the healthcare marketplace today. Unless the lab industry learns from its experience in the last ten years, it will repeat many of the same strategic business and management mistakes in this new decade.

Failure 1: to anticipate the impact of managed care upon the operation and organization of laboratory testing services. Compared to traditional indemnity health plans, managed care companies contracted for laboratory services in a different ways. HMOs wanted to exclude all laboratories but a select few to provider panels. HMOs also wanted to only contract with laboratories capable of servicing larger geographical areas, including statewide coverage. The lab industry was slow to recognize that the way managed care companies contracted for laboratory services would profoundly alter the financial stability of all laboratories within a given region.

Failure 2: to recognize the financial threat of capitation and limited or exclusive provider panel contracts. This is a separate strategic business issue from failure 1. The managed care industry changed the economics of laboratory testing by introducing capitated (prospective) payment for lab services and by requiring labs to assume utilization risk. Commercial lab companies eagerly offered discounted capitated rates at levels which eventually drove almost all of them into merger or bankruptcy. By rashly establishing capitated rates at unreasonably low levels early in the 1990s, these commercial lab companies accelerated widespread declines in laboratory testing reimbursement by almost all types of payers.

Failure 3: of the lab industry to speak with one effective voice to the government on matters of reimbursement and regulation of laboratory testing services. Heres a major business battle which the lab industry ceded to the enemy. Since the late 1980s, there is almost an unbroken record of funding declines for laboratory reimbursement. When compared to other medical provider categories, laboratory testing has been the eternal whipping boy for budget-cutters. Why? Because of a lack of unified action by the collective lab industry. National commercial lab companies lobbied Congress on their issues of concern. Hospital labs did no lobbying, since they were just one of many ancillary services within the hospital industry. With no unified voice representing the interests of clinical laboratories and anatomic pathologists, the consequences were tragic.

Failure 4: of the diagnostics industry to introduce Total Laboratory Automation (TLA) products in an open, objective manner. The large diagnostics manufacturers should not escape their culpability in failing to honestly disclose the disappointing productivity and financial performance of the earliest TLA installations. By the end of 1995 and 1996, it was common knowledge among diagnostics vendors that their TLA solutions were not meeting the performance standards of productivity and return on investment required to encourage significant numbers of laboratories to acquire and use such technology. In the eyes of many lab customers, this lack of candor also eroded the credibility of many diagnostics companies on a whole range of product issues.

Failure 5: of clinical laboratory and pathology associations to respond to their members’ needs with effective education, lobbying, and leadership. Within any industry, it is trade groups and professional associations which have the lead role in responding to political issues and providing education on competitive changes in the marketplace.

If the success of professional associations can be measured in terms of both political lobbying and helping companies stay financially solvent, then the decade of the 1990s was not a golden age for the various professional associations supporting laboratory medicine. In the political arena, Congress has sustained 12-year track record of reducing overall reimbursement for laboratory testing. This unbroken string of funding bills is undisputable evidence that the lab industry has failed to effectively state its case to Congress.

In the business and management area, professional associations have been slow to recognize that, although the science of laboratory medicine is paramount, the application of science must be supported by effective business, financial, marketing, and management expertise.

Moreover, laboratory professional associations have virtually ignored the management gurus whose techniques have transformed the way business is conducted worldwide, and whose names and methods are hailed in business publications from Fortune Magazine to the Wall Street Journal and the Harvard Business Review. Information about innovative management thinking from outside the lab industry that would have direct application and benefit for laboratorians has been notably absent in the seminars, educational programs, and publications offered by lab industry professional associations.

Failure 6: to adapt principles of accepted professional corporate management into the clinical laboratory marketplace. For many reasons, some inexplicable, during the 1980s and 1990s most laboratory industry executives and pathologists believed there was little value in searching outside the lab industry for innovative management thinking and new business ideas. This left the lab industry unprepared for the challenges it faced during the last ten years. Even today, many lab managers and pathologists maintain a belief that techniques of business administration, information management, and other business functions that are successful in other industries have no useful application for laboratories. For example, during the past two decades, Federal Express and UPS both developed sophisticated ways to track packages from the moment their drivers picked up a package at the customer’s office. Yet today, it is nearly impossible to find an example of a laboratory using similar systems to track the specimens picked up daily by their couriers.

Failure 7: to understand, acquire, and apply established techniques of sales and marketing to physicians and other users of laboratory testing. All business organizations must grow profitably to survive. A laboratory with increasing volumes of specimens, priced at profitable levels, has the cash flow and operating margins necessary to invest in both its people and its operational infrastructure. In the Fortune 100 world, corporations use professional sales and marketing techniques to generate profitable growth. However, within the laboratory industry, only a handful of laboratories (both hospital outreach programs and independent commercial labs) and pathology group practices maintain and support effective sales and marketing programs.

Failure 8: to recognize the economic effects of excess (unused) laboratory capacity in regional markets throughout the United States. This failure is insidious. Because fixed overhead is such a large component of laboratory costs, the economics associated with additional specimen volume are attractive. During the 1990s, many lab companies decided to accept new lab testing contracts at prices based on the marginal costs (reagent and tech time per test) of those additional tests. For any individual lab company with excess lab testing capacity, this was rational. But with so much unused lab capacity available, it was a business decision that led to widespread financial problems once payers adopted marginal cost-based pricing as the norm. Within the hospital industry segment, hospital lab consolidation made sense because there was so much unused lab capacity and duplicate instrumentation. But after a decade of consolidation, there still exists significant amounts of excess lab capacity. The Two Blood Brothers now recognize this fact and changed certain of their business practices to avoid this problem. However, many hospital lab administrators have yet to acknowledge the problem of excess lab capacity in their own community, let alone act upon it.

Failure 9: to invest and develop effective laboratory informatics products and services. The basic product produced by all laboratories is information. Thus, appropriate investment in sophisticated information management systems is essential. But the lab industry has generally lagged behind such industries as insurance and banking in the proportion of their annual revenues which they invest in information services. It is also generally acknowledged that hospitals and other categories of healthcare providers have underinvested in information technologies, so laboratories are not alone on that count. However, as noted elsewhere in this White Paper, the single biggest critical success factor for laboratories in the years ahead is their ability to offer enhanced information services to hospitals, physicians, payers, and patients. This will require laboratories to invest substantially more funds into lab information systems than has been true in past years. Enhancement of information systems will probably become the single most important strategic business priority at many labs.

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