Ten Myths of Lab Management That Led the Clinical Lab Industry Astray

Is this popular wisdom that proved false?

Part One of a Special Series

CEO SUMMARY: One of our most popular series ever was the “13 Perilous Parallels” of laboratory management. This four-part story appeared in 1996 and chronicled similar management strategies used by various national laboratories during the ten years leading up to 1996. It was a revealing look at how commercial lab executives tended to copy each other’s failed strategies and generally ended up with the same failed results. THE DARK REPORT now takes a fresh look at ideas which continue to shape the thinking of both hospital lab and commercial laboratory executives. With just a little tongue in cheek, we offer our “Ten Myths of Laboratory Management.” These are widely-accepted axioms of lab management that surely misguide more than a few laboratory executives in their decisions. Unfortunately, the consequences are not always positive for laboratories, their employees, and their customers.

EVERY INDUSTRY HAS ITS LORE and legends which shape the decisions made daily by its managers and executives. The laboratory industry is no exception.

Yet, how often do executives question the lore and legends which consciously and unconsciously influence their decisions? Probably not often enough. Consequently, they may be basing important decisions on collective or popular wisdom which is actually wrong.

That is why it’s time for the clinical laboratory industry to recognize and debate the truth about the management precepts which seem to frame the thinking of so many managers and executives.

THE DARK REPORT believes it has identified ten management myths which continue to lead laboratory managers astray. In this first installment, we take a detailed look at the first three myths.

Original Facts Often Distorted

We use the word “myth” for a reason. Myths frequently are based in truth. But the original facts often become distorted as the story is retold time and time again. That seems to happen a lot in the clinical laboratory business.

Our motive in presenting these myths is to provoke thoughtful discussion. Yes, myths have their roots in truth. But is the original truth relevant in today’s healthcare marketplace? Laboratorians should not be building business strategies around destructive or false management precepts.

One way to recognize these management myths in your own laboratory is to listen during meetings and conversations with co-workers. Management myths tend to be offered in defense of a position, without supporting documentation. The advocate who repeats a management myth is relying on the fact that it is “popular wisdom” and thus should not be challenged.

That is actually a lazy defense. For, as you will read, many of the popular wisdoms bandied about during meetings are actually based on false information, outdated circumstances, or just plain bad management thinking!

It’s amazing how long bad advice can remain credible. Hopefully this series of articles in THE DARK REPORT will cause our clients and readers to rethink their own opinions about these management subjects.

More importantly, in declaring these common lab management precepts to be myths, we hope that laboratorians everywhere can root out bad management practices and replace them with effective management thinking.

Without further ado, here is the beginning of our list. Despite our numbering system, these ten management myths are not presented in order of priority.

MANAGEMENT MYTH #1
Lowest cost per test gives a laboratory unbeatable competitive advantage.

FOR MANY YEARS, IT WAS A SHIBBOLETH among commercial laboratory executives that the laboratory with the lowest cost per test in a market would hold an unbeatable advantage over its lab competitors.

Thus, achieving the lowest cost per test became a persistent goal for ambitious laboratories. After all, here was a management myth that said, “if my lab could become the lowest cost producer, it would achieve market dominance.”

Therefore, if low cost per test equals market dominance, then the proper business strategy for an ambitious laboratory was to create huge laboratories which tested high volumes of specimens. This was true for two reasons.

First, because fixed costs within a laboratory represent as much as 80% of total total costs, high volumes of specimens would serve to drive down the average cost per test.

Second, if a laboratory company could deliver high volumes of tests, it could negotiate more favorable prices for instruments, reagents, and service agreements. This would further lower its cost per test.

Add up both results, and a laboratory which succeeded in building high-volume testing centers could achieve the lowest cost per test. But, did having the lowest cost per test actually make that lucky laboratory the dominant competitor in the markets it served?

If this management myth was true, then we would see an unquestionably dominant laboratory in city after city. Whichever laboratory boasted the lowest cost per test (based on high test volumes) would have emerged as king of the mountain in that region.

For example, in California, Unilab Corporation operated laboratories in the state which were acclaimed as having some of the lowest costs per test during the 1995-1998 period.

Yet, despite this cost advantage, it lost several hundred million dollars during those years and did not eliminate such competitors as Laboratory Corporation of America or SmithKline Beecham Clinical Laboratories from the marketplace.

Laboratory Industry’s Ten Biggest Myths

Here are the first five management myths on our list. Upcoming installments will review each in depth:

  1. Lowest cost per test gives a laboratory an unbeatable competitive advantage.
  2. Bidding for additional specimens using marginal cost pricing is a viable business strategy.
  3. Getting a managed care contract guarantees that pull-through business will follow.
  4. Lab automation is an automatic way to access cost savings.
  5. The best way to cut costs.

Maintain Viable Operations

A similar example can be made for New York City and Long Island. All the national laboratories operate high volume routine and esoteric testing centers within a reasonable distance from New York City. Yet, the Big Apple remains an intensely competitive marketplace and independent laboratories continue to maintain viable operations in competition with the three blood brothers.

City after city provides similar examples. Independent laboratories continue to offer stiff competition to national labs, even though their average cost per test is higher than that of the national labs.

So how did this management myth come into being? THE DARK REPORT believes it originated in the fee-for-service system of the 1980s. Two things contributed to the creation of this myth.

First, the advent of sophisticated and increasingly automated test instruments made it much easier to create a laboratory that could test tens of thousands of specimens per night.

Second, fee-for-service reimbursement placed a non-discounted “retail” price on individual tests. If, for example, a 12-test chemistry panel was reimbursed at $20, then the amount of prof- it earned by the laboratory was directly proportional to its cost per test.

If a cost per test was $10, then a $20 chem panel would generate $10 in profit for the lab. But if the cost per test was only $5, then the lab could earn $15 on the same test.

Here then, was the rational economic incentive for lab executives to drive cost per test down to its lowest possible level. In the fee-for-service world, every penny shaved off the cost per test was an extra penny of profit for the laboratory.

Acquisition Frenzy

It was this combination of economics which fueled the laboratory acquisition frenzy of the late 1980s and early 1990s. Buy someone else’s laboratory. Consolidate their specimens into your lab and lower your cost per test. That increases your profit on all specimens reimbursed by fee-for-service plans.

This type of business strategy was rational for that type of healthcare system. Commercial laboratories booked record profits during those years and were the darlings of the investment community.

But all was never well with the lab industry’s client service performance. When lab A bought lab B and consolidated its specimens into the core lab, it often lost 10%, 20%, 50% or more of those acquired client accounts within 12 months. Because profits were ample even after such levels of client turnover, no one paid much attention to this phenomena.

That is why the management myth that says “lowest cost per test equals unbeatable competitive advantage” is misleading. It is rooted in the fee-for- service economics of the 1980s.

Competitive success in the lab industry remains linked to the level of service provided by a laboratory to its physician clients. Physicians, and even many managed care plans, will take a higher cost per test if they perceive that the laboratory services that come with it are superior to competing laboratories.

MANAGEMENT MYTH #2
Bidding for additional specimens using marginal cost pricing is a viable business strategy.

IT IS LOGICAL TO FOLLOW management myth number one with our management myth number two. Probably the most crippling financial decision ever made by laboratory executives during the early 1990s was their willingness to bid for managed care contracts using a marginal cost pricing scheme.

Why did lab executives believe this was a good strategy at the time? Because their laboratories had excess capacity. At the enterprise level, it seemed like a sensible thing to bid for specimens currently going to a competitor by pricing that work based on the direct cost of testing.

If the contract was won, the incremental work would fill up unused lab capacity and help lower the overall cost per test for all specimens in the laboratory. Further, it was believed there was the opportunity to get pull-through business as a result of getting that managed care contract. (For more on this, see Management Myth #3).

Crushing Financial Pain

Time alone has proved that bidding for additional specimens to fill the unused capacity of laboratory is not a viable business strategy! During the past five years, all classes of laboratories, from national labs to independents to hospital labs, have endured crushing financial pain from the managed care reimbursement levels established by laboratory testing bidders in the late 1980s and early 1990s.

It should be added that one factor compounded the already bad decision to use marginal cost pricing to acquire managed care contracts during these years. THE DARK REPORT was first to identify and describe how lab industry overcapacity was responsible for causing below-cost bidding strategies.

In every city, there was much more laboratory capacity than there were specimens to fill that capacity. Thus, again at the enterprise level, it was rational for lab executives to decide to bid for specimens currently tested at competing laboratories by using a “below marginal cost” pricing scheme.

Utilize Laboratory Capacity

Capturing these additional specimens could contribute to better utilization of the laboratory’s capacity. Pull-through specimens at fee-for-service reimbursement would hopefully generate enough income so that the lab could at least recover costs on the full mix of incremental tests.

How far below the marginal cost of testing were labs willing to bid? An example from the editor’s experience at Nichols Institute provides a perfect example. At the beginning of 1994, a two-year contract covering 5,000 lives came up for renewal in Southern California. Since the Nichols lab already had the contract, actual utilization data was available. The IPA indicated it wanted to move the contract from fee-for-service to capitation.

Remarkable Difference

When Nichols ran the numbers, the revenue difference was remarkable. Under fee-for-service, Nichols had averaged $3.80 per member per month (PMPM). The IPA was looking for a 60¢ cap rate. Whereas this lab testing contract had generated $230,000 in fee-for-service reimbursement during 1993, at a 60¢ cap rate, it would generate only $36,000 for all of 1994.

This example illustrates how much money laboratories denied themselves when they deliberately bid for these con- tracts using a below-cost strategy. As if the 60¢ example was not enough, Nichols Institute lost a contract that same year when Unilab bid 22¢ PMPM.

Has the lab industry learned its lesson? Not totally. THE DARK REPORT is aware of a recent contract in the Northwest where a well-known laboratory bid 17¢ PMPM to get the work! Folks with knowledge about existing exclusive national HMO lab contracts say that the national labs which won them gave away significant price concessions for the privilege of exclusive provider status.

For these reasons, Management Myth #2 remains alive and well, flourishing despite an almost ten-year history that should have taught laboratory executives otherwise.

MANAGEMENT MYTH #3
Getting a managed care contract guarantees that pull-through business will follow.

THIS IS ONE OF OUR FAVORITE laboratory industry management myths. It was probably foisted onto administration by sales reps who wanted easy entree to the doctors’s offices.

Myth #3 is closely linked to Myth #2. It was a common belief among laboratory industry executives that, by winning the big managed care contract in the area, doctors would be more inclined to use their lab for 100% of their testing.

It was believed that the lab’s preferred relationship with the managed care plan would mean something. It was also believed that no doctor would want to disrupt his office by sending specimens to more than one clinical laboratory. (See Management Myth #4.)

There are still laboratory executives who believe that, if their lab can get the managed care contract, doctors involved in that insurance plan will refer them the Medicare and fee-for-service specimens as well.

That is wishful thinking. In its travels, THE DARK REPORT regularly queries the sales and marketing managers who participated in bidding and working these managed care contracts throughout the 1990s.

Seldom do any of these lab sales veterans admit that winning the managed care contract actually caused all the docs to immediately steer their fee-for-service work to the winning laboratory.

To the contrary, most relate a far different experience. Once a managed care contract was won, it took six to nine months of diligent sales effort to capture the fee-for-service work from a portion of the physician offices. Typically, we are told that the winning lab never got more than between 5% and 20% of potential pull-through, even after that kind of intensive sales effort.

Were there pull-through successes? Certainly. But they seem noteworthy precisely because they happened so seldom. In the real world, winning the managed care contract did not unleash a flood of pull-through work for the lucky laboratory. To the contrary, it had to spend months, lots of money, and expend lots of sales effort to capture only meager amounts of the potential pull-through testing business.

Common Thread

These first three management myths for the lab industry are definitely linked. The common thread among them is that filling unused laboratory capacity with more specimens would be beneficial.

In other words, just to have a flow of increased specimens would trigger a variety of benefits for the lucky laboratory. Obviously, the actual experience of the collective laboratory industry during the 1990s demonstrates that the wisdom in these precepts was misleading at best, and financially corrosive at worst.

The more challenging question is whether current managers in your own laboratory still use these management myths to justify their position on various management options under consideration. The 17¢ cap rate recently bid in the Northwest proves there are still lab executives who continue to use these strategies in today’s laboratory marketplace.

As reimbursement for laboratory testing continues to decline below even today’s levels, it becomes imperative that laboratory administrators and pathologists make well-informed decisions about their laboratory’s direction.

The margin for error continues to shrink. If a laboratory administrator bets on the wrong business strategy, the result is now a rapid descent into bankruptcy or acquisition of the lab by financially stronger hands.

Do these first three management myths teach us any lessons? Certainly the one important lesson which jumps out is that there is no substitute for offering a client top quality service.

Cutting draw stations, eliminating stat labs, and reducing client service people may reduce cost in the short term, but it certainly encourages clients to take their testing business to a better-performing laboratory in the long run.

Have You Got Other Myths?

Each issue of THE DARK REPORT always contains collective wisdom and experiences from clients and readers throughout the country.

Readers are invited to contribute their own management myths about the laboratory industry. Contributions can be sent directly via: email–labletter@aol.com or fax–503.699.0969.

These management myths should represent the popular wisdom and current thinking of most laboratorians, whether accurate or not.

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