CEO SUMMARY: As a regional laboratory network, PacLab is unusual in one respect: participating hospital laboratories did not meet endlessly to talk about what they should do. Instead, action was the operative word for these network organizers. Since becoming operational in 1996, their bias for action has rewarded all participating laboratories. Test volumes are up and average cost per test is declining. PacLab offers other regional laboratory net works valuable lessons on how to make things happen. PacLab also validates the concept of lab networks.
PART ONE OF TWO PARTS
REGIONAL LABORATORY NETWORKS are probably the most difficult clinical laboratory organization to create and operate. Throughout the United States, many have tried, but few have succeeded.
Yet regionalization of laboratory services is an essential survival step. Without it, few existing clinical laboratories will successfully adapt to the fast-approaching world of integrated healthcare, capitation, and prospective reimbursement.
In Washington state, organizers of PacLab Network Laboratories solved many of the political, operational, and control issues which derail most organizers of regional laboratory networks. PacLab links nine hospitals and one independent commercial laboratory and offers services throughout Washington.
“In hindsight, what made this network come together was a realization by all participants that everybody had something unique to contribute,” said Thomas Tiffany, Ph.D., CEO of Pathology Associates Medical Laboratories (PAML) of Spokane. “Simply put, the network could be more than the sum of its parts. But to realize those benefits, all participating laboratories had to concede some control and work together.”
Tiffany’s remarks were made at the Executive War College, held last May in New Orleans. PAML is the commercial laboratory partner for PacLab and provides a number of contract services to the regional laboratory network.
“PacLab was formed as a limited liability company (LLC) on November 1, 1996,” observed Dr. Tiffany. “It is owned by three member organizations: Catholic Healthcare West, represented by Franciscan Health Services; Sisters of Providence of Washington; and PAML (a for-profit corporation owned by Sacred Heart Medical Center in Spokane. Ownership percentages in PacLab were determined by the amount of revenue brought in by each partner.
“The creation of PacLab was in response to efforts to socialize healthcare,” noted Dr. Tiffany. “Many people remember when the Clinton Administration took office and made it a priority to create their national health insurance plan. But few people are aware that the State of Washington was racing ahead of Washington DC to establish its own comprehensive health plan.
“In 1993, then-Governor Lowery, a Democrat, rammed through a healthcare bill that was going to significantly impact all medical services providers. That law caused people who previously had no desire to talk or work together to begin discussions.
“Even though a new Republican legislature subsequently repealed Governor Lowery’s healthcare plan, by now hospitals, physicians, and laboratories understood the threat,” he continued. “Thus, the first key to PacLab’s success was motivated organizers who recognized the need to act quickly, before the hammer fell on them.”
Second Key To Success
“The second key to PacLab’s success was that we had attention, involvement, and commitment by the highest levels of decision makers in our participating laboratories,” Dr. Tiffany stated. “You have to have the right people at the table. In PacLab’s case, these were the CEOs and COOs of the hospitals, CFOs, laboratory administrators, medical directors, and pathologists. We were fortunate to get all these people together. Over time, these people established a bond of trust.
“This was the foundation for subsequent decision making,” added Dr. Tiffany. “We had all levels of authority involved in the PacLab project from the beginning. As mutual trust and confidence were established, PacLab rapidly took shape.”
According to Dr. Tiffany, the third key to PacLab’s success involved the test mix. PacLab made it a priority to offer value-added services while simultaneously lowering the hospitals’cost of laboratory testing. “Early on, it was decided the best way to accomplish this was to internalize reference testing. At the same time, we wanted to use effective sales and marketing programs to build outreach testing volume at each participating hospital.”
Here is where PacLab’s organizers made a critical decision that insured the rapid growth of the regional laboratory network. “As operators of a commercial laboratory [PAML],” stated Dr. Tiffany, “we know what office-based physicians want from a clinical laboratory provider. In meetings with the hospital laboratory directors, we were able to help them understand that PacLab’s competitive advantage had to derive from delivering high levels of customer service.”
Professional Sales Program
PacLab’s organizers also argued that the network’s success required a professional sales and marketing program. “Provider status with managed care contracts was a major goal at PacLab,” said Noel Maring, Director of Marketing at both PAML and PacLab. “To attain this, we needed to be a significant lab services provider in each market served by our hospital laboratories.
“We determined that, if PacLab had a market share exceeding 20%, this would accomplish two things,” he continued.“First, it meant that managed care companies had to include PacLab at the contract negotiating table. Second, a 20% market share would give PacLab the necessary testing volume to keep costs low and provide the cash flow necessary to support patient service centers and other services needed to be a managed care contract provider.”
Quickly Caught On
“Hospital laboratory directors caught on quickly to the importance of sales programs and pro-active customer service for physician office accounts,” added Maring. “They realized that the three national laboratories spend a lot of money on sales people to gain market share. PacLab needed to make similar investments if it was to wrest market share away from the national labs.”
Another key element in PacLab’s strategic plan was to avoid constructing new laboratory capacity. “We wanted to utilize all existing lab capacity at each network laboratory site,” stated Dr. Tiffany. “By increasing outreach specimen volume and internalizing reference send-out work when ever possible, we could gain economies of scale at each site.”
PacLab’s operational structure sets it apart from most other regional laboratory networks. “Since PacLab is a limited liability company (LLC), it meets the needs of the for-profit and not-for-profit participants,” Dr. Tiffany said. “PacLab acts as an agent for the member hospitals. PAML is the managing partner and provides billing, marketing, finance, information services, and management support to the network.”
Ideally Organized For Role
PAML is ideally organized for this role. It is a commercial laboratory that is owned by a hospital. “We have a 30-year history of working with hospitals on projects similar to this,” stated Lawrence Killingsworth, Ph.D., Chief Science and Technology Officer at PAML and PacLab. “Hospital labs within PacLab can see that we are a commercial laboratory which knows the physicians’ office marketplace, but understands intimately the different needs of hospital laboratories.”
“PacLab is an agency-model network,” stated Maring. “There are no assets and there are no employees of PacLab. PAML provides management services under contract. For example, Stu Adelman is the PacLab Administrative Director, but is an employee of PAML.
“Each participating laboratory contracts to furnish PacLab with specific services,” he continued. “Each participant provides logistics, client services, testing, patient service center support, phlebotomy, specimen processing, and reporting. For the most part, this utilizes existing lab resources.
“PAML acts as the service integrator,” Maring observed. “It provides reference testing and IS links among the participating laboratories throughout the state.
“PacLab divided the state of Washington into logistical service regions,” said Maring. “Each partner manages a specific service area. It gives PacLab a service edge on competitors because each PacLab partner is responsible for servicing its local area. We believe PacLab has superior service capability when viewed against other laboratory competitors.
“For example, in most areas of Washington, PacLab can provide same day results for routine tests,” he added. “That gives PacLab an edge, since most commercial lab competitors require 24 hours to report routine test results.”
Money is a big issue when starting regional laboratory networks. PacLab organized itself with that in mind. “One major goal of PacLab was to minimize the capital requirements for start-up,” recalled Dr. Tiffany. “We did a detailed business plan with revenue projections and expected costs. A return on investment (ROI) was calculated. It was decided to fund enough capital to sustain operations for six months. About $1.4 million in start-up capital was provided to PacLab by its partners.”
PacLab also recognized the benefits of including a commercial laboratory as a partner. Much of PAML’s existing business infrastructure could be used to good advantage by PacLab. Dr. Tiffany explained, “PAML did have a state-wide courier network already in operation. Because we provide reference testing to a number of hospitals, we also had a laboratory information system (LIS) capable of linking individual laboratories.
“In addition, PAML had a billing and collections department, accounts receivable/payable capability. We also had management expertise in budgeting, forecasting, financial reporting, marketing, and sales management,” added Maring. “PacLab had immediate access to these resources without making any upfront investment.”
Another sticking point with many regional laboratory networks is how to reimburse member laboratories for the testing they perform under network contracts. “PacLab uses a simple formula,” said Maring. “Each hospital is reimbursed for the tests it performs using a marginal test cost (MTC) calculation.
“The MTC for each test is based upon its direct cost plus a small profit factor,” he continued. “MTC’s are evaluated periodically, to encourage cost reduction efforts at each laboratory site. As PacLab gets more efficient, MTCs are calculated to reflect this efficiency.
“MTCs reinforce PacLab’s worth to the hospital administrators for two reasons,” observed Dr. Tiffany, “First, they see the cost per test in their lab declining. This lowers their inpatient testing costs. Second, as an agency network, PacLab distributes excess cash flow back to the partners. Lowered MTCs mean increased partner distributions. Hospital administrators see clear benefits accruing from their investment and participation in PacLab.”
Maring pointed out another advantage to using MTCs. “Each laboratory partner is free to choose which tests they will perform for PacLab. To provide testing, member labs must meet criteria for turnaround time in their local market, have state-of-the-art technology, and have expertise in that area of testing. Each laboratory can judge its capabilities against these criteria and decide which tests it will perform for PacLab.”
Oversight of PacLab’s business activities is done by the PacLab Financial Committee. Each partner’s Chief Financial Officer participates. “Having the hospital CFOs actively involved in the network is a big advantage,” stated Maring. “They see the direct benefits the PacLab brings to their individual institutions, plus they have the business savvy to appreciate the economic gains that PacLab is delivering.”
PacLab’s performance since launching operations demonstrates the effectiveness of its business planning and implementation. On the cost side, improvement is dramatic.
“During our first year, we reduced the cost of operation by 12%,” noted Maring. “Projections indicate that we can continue to drive down costs by an average of 7% to 8% per year for the next three to five years.”
Big Sales Increase
PacLab’s revenue performance is equally impressive. “Sales and marketing efforts generated an annualized $3 million increase during our first year,” said Maring. “We are also proud of another fact. Our PacLab sales reps averaged new sales of almost $6,000 per month per rep during this period. That’s about 50% better than industry standards in the Washington market.”
According to Maring, market share for PacLab also increased. “At the time of inception, we estimated that PacLab had a statewide market share of between 12% and 14%. Today, we estimate our market share is now at least 25%.
“PacLab’s sales reps got an extra boost with the addition of four significant managed care contracts,” added Maring. “In total, those contracts represent about 300,000 lives. This is a large number for Washington, where managed care penetration is less than other states.”
More Bang For The Buck
These are impressive numbers. It certainly demonstrates that PacLab’s business model for a regional laboratory network delivers more bang for the buck than the shared-testing model used by many regional laboratory networks.
PacLab’s secret is that it was organized like a business, capitalized like a business, and managed by people who run the laboratory network using established business principles. Six main features contribute to PacLab’s success.
First, PacLab was designed to use existing laboratory resources in more effective ways. As a network, PacLab is more than the sum of its individual laboratories. That brings value to all the partners.
Second, PacLab understood the importance of providing value-added clinical testing services in the marketplace. Physician clients would only switch if they recognized that PacLab’s services were better than those of competing laboratories.
Third, and equally important, PacLab knew that a professional sales and marketing program had to be funded to support the network’s success. PacLab’s testing services would have no value if prospective physician clients were unaware that PacLab was a viable alternative to competing commercial laboratories.
Fourth, PacLab was organized in such a way that it generated income to pay for the ongoing expenses of operating the network. Failure to address this critical business requirement has been the fundamental weakness of regional laboratory networks organized to “lower costs” by shared testing.
Fifth, PacLab’s hospital administrators recognized the value of partnering. Their commercial laboratory partner provided them with a range of business capabilities and management experience, at a very low cost.
Sixth, PacLab understands the importance of leadership. It funds the position of network director, and senior executives from participating hospitals play an ongoing role in guiding the network’s operations.