"The Dark Index"

Three Blood Brothers Release Year-End Financial Performance

FINANCIAL REPORTS RELEASED by the three national laboratories for the fiscal year 1998 reveal a definite improvement in their financial performance and cash flow.

One sign of this improvement is the fact that none of the three blood brothers disclosed any huge write-downs similar to those experienced in 1995, 1996, and 1997. Another sign is that revenue per accession increased modestly at both
Laboratory Corporation of America and Quest Diagnostics Incorporated. SmithKline Beecham, PLC did not report the change in revenue per accession for its laboratory division.

Of course, the biggest development affecting the three national labs is the impending acquisition of SmithKline Beecham Clinical Laboratories (SBCL) by Quest Diagnostics. (See TDR, February 22, 1999.) It is expected that, subject to shareholder approval and regulatory clearance, the acquisition will occur sometime this summer.

When that acquisition is completed, the commercial laboratory industry will find itself dealing with new competitive forces. Hospital laboratory outreach programs and independent commercial labs may find new opportunities to improve their market share at the expense of the remaining two blood brothers.

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LabCorp’s Progress

At LabCorp, the battle to convert the legacy billing systems from the former Roche Biomedical and National Health Labs into one workable system seems to be progressing. The company reclassified a significant amount of “net sales adjustments” into “bad debt,” requiring a restatement of financials extending back into 1997. This means they are writing off uncollectible claims which resulted from billing problems during the past 24 months.

Annual revenues for 1998 increased 2% over 1997, to $1.62 billion. Although specimen volume decreased by 1.2% during the year, LabCorp saw a 3.2% increase in revenue per accession.

Quest’s Operating Profit

At Quest Diagnostics, revenue per accession was also up. For fourth quarter, revenue per accession increased 4.2% over the same quarter in 1997 even as specimen volume declined by 4.7% during the same time period.

Annual revenues at Quest Diagnostics were $1.46 billion. This is a reduction of 4.6% over 1997. But both EBIDTA and net income increased for the year, to $158.6 million and $26.9 million, respectively.

Because SmithKline Beecham is divesting its laboratory division and its pharmacy services division, it has yet to release full details on the financial performance of both businesses. It did disclose that SBCL’s 1998 revenues were $1.55 billion and operating profit at the lab division was $179 million.

Lab Pricing Hits Bottom

Collectively, the financial data for 1998 provides evidence that pricing for clinical laboratory services may have hit bottom. Two of the three national labs report increases to the average revenues per accession which are significantly better than the inflation rate in 1998.

This can be interpreted in several ways. One, pricing discipline at LabCorp and Quest Diagnostics is helping to curb the practice of “marginal cost” pricing used by many laboratories to capture incremental business.

Two, managed care companies increasingly have fewer laboratories that are willing to provide testing services at the rock bottom capitation rates of just three years ago.

Collectively, the financial data for 1998 provides evidence that pricing for clinical laboratory services may have hit bottom.

Three, the market process that converts fee-for-service testing into highly discounted or capitated contract arrangements is slowing because the rate of penetration by managed health- care is also slowing.

Four, the internal pain suffered by the three national labs when they actually commit to “marginal cost” pricing arrangements acts as a further check on this type of pricing strategy.

It can be expected that the Quest/SBCL union will further improve pricing for laboratory services in many cities around the United States. However, it will take several years for the full impact of that acquisition to ripple through the marketplace. Repricing laboratory tests occurs most easily when contracts come up for renewal.

If THE DARK REPORT’S assessment of improved financial capabilities at the three blood brothers is correct, then competing laboratories will want to reassess their sales strategies.

There still is overcapacity of laboratory resources in most cities of the United States. The three national laboratories will continue to whittle away at their network of regional, satellite, and rapid response laboratories. They must bring their lab infrastructure into alignment with the incoming flow of specimens if they are to become cost-effective.

Strong Local Competitors

As the three national labs remove local laboratory resources, this opens up an opportunity for local lab competitors. Physicians and patients tend to prefer a local laboratory provider. Hospital labs with professional outreach programs and a well-placed system of draw sites and rapid response labs will find themselves in a strong competitive position.

THE DARK REPORT predicts that the twin market trends of stronger lab pricing and continued consolidation of the national lab’s internal testing system will increase the competitive capability of locally-based lab providers.

Ironically, even as the national laboratories improve their financial health, the very actions necessary to accomplish that strengthen local laboratory competitors. Hospital and independent laboratories should position themselves to take maximum advantage of the opportunities they are being presented.

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