A Tale of Two Cities: New York Versus L.A.

One city squeezed out excess lab capacity while the other built unneeded lab capacity

CEO SUMMARY: Here’s a dramatic comparison of the effects of advanced managed care on West Coast laboratories as compared to East Coast laboratories. While Los Angeles labs endured radical downsizing and bankruptcy, New York experienced significant increases to existing laboratory capacity. The consequence could be that some New York laboratories may yet have to undergo radical restructuring.

IT IS TRULY A TALE OF TWO CITIES. In the last three years, the experience of laboratories in Los Angeles was vastly different than those of New York.

In Los Angeles, the theme has been to eliminate laboratory overcapacity. Both commercial laboratories and hospital laboratories endured one round of downsizing and cutbacks after another. This process is still under way.

In California, intense pressures from a highly-competitive managed care marketplace quickly put laboratories in a financial vice. Since 1995, laboratories found themselves literally forced to eliminate excess capacity or go broke.

In New York, it is a different tale. In the Greater New York Metropolitan Area, an expansion of laboratory capacity took place during 1995-1998. Yet no comparable increase in lab testing volume accompanied this new construction.

As a result, operators of these expanded laboratories in New York City watch glumly as the shiny new “totally automated lab palaces” operate at minimal capacity.

For New York, it is proof that the philosophy of “build it and they will come” doesn’t necessarily apply to laboratory services. These beautiful new state-of-the-art laboratories run at 25% or less of capacity. Consequently, none of these projects has delivered the lower cost per test promised by their developers.

THE DARK REPORT writes regularly about the California experience because the state is considered leading edge for healthcare trends. As a result, clients and regular readers know the story of how California’s managed care companies put clinical laboratories into a financial hammerlock.

Reimbursement for lab testing declined so rapidly in California that laboratories literally found themselves at the brink of bankruptcy unless they took radical action and slashed costs by precipitous amounts.

Probably the best example of this situation was Physician Clinical Laboratories (PCL), based in Sacramento. A publicly-traded lab partially owned by two major healthcare systems, it was a $110 million laboratory in 1995.

Both PCL’s former CEO, Nate Headley, and its CFO, Rich Brooks, told THE DARK REPORT a similar story. In a 24-month period between November 1994 and November 1996, PCL saw reimbursement for the same volume of laboratory tests decline by $2 million per month!

This means that PCL, while still processing the same volume of laboratory tests, saw annual reimbursement decline by $24 million in two years. This was a 26.4% reduction in income, with no change in testing volume.

Owners of clinical laboratories in California confirm a similar decline in reimbursement paid to their laboratories. That is why the state has been littered with the corpses of defunct laboratories.

California Sheds Lab Overcapacity

Managed care in California quickly put all laboratories under pressure to slash costs and remove underutilized lab capacity. Huge chunks of laboratory infrastructure have disappeared from the state since 1996. Here’s a partial list:

Physician’s Clinical Laboratories: Chapter 11 Bankruptcy–1996

Bio-Cypher Laboratories: Sale to Unilab–1999

Meris Laboratories: Chapter 11 Bankruptcy–1997; sale to Unilab–1998

BSI, Inc.: Chapter 11 Bankruptcy–1996; sale to Bio-Cypher–1997

Watson Medical Laboratories: Chapter 7 Bankruptcy–1996

Diversified Medical Laboratories: Chapter 7 Bankruptcy–1996
Unilab: Significant operational restructuring–1996-1997

SmithKline Beecham Clinical Labs: Significant operational restructuring– 1996-1997

Laboratory Corp. of America: Significant operational restructuring– 1996-1997

Tenet Healthcare: Regionalization of 30 hospital labs in Southern California–1998

New York Ignored Lessons

Yet in New York, laboratory operators seemed to ignore the lessons to be learned from the California experience. Three significant laboratory expansions took place in recent years.

Probably the best known is Beth Israel Health Care System. Its laboratory administration was very proud of the decision to construct a facility designed around total laboratory automation (TLA).

Yet at the same time, Mt. Sinai Medical Center in Manhattan and North Shore Laboratories on Long Island were similarly building expanded laboratories designed around TLA. During the 1997-1998 period, these three new laboratories were completed and became operational.

Each of these three new laboratories was built by an integrated healthcare system, based upon a similar business strategy:

  1. Premise: an automated laboratory, running at near full capacity, will lower costs and improve turnaround time; thus
  2. the hospital’s existing specimen volume can support the automated laboratory; and
  3. lower cost per test, combined with faster turnaround time for results will cause hospital labs affiliated with the system to refer specimens to the automated laboratory, filling unused capacity; and,
  4. the hospital will launch an outreach sales program to physician offices and fill up unused lab capacity with specimens from this source.

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Competitors Knew Plans

It is interesting to note that all three institutions were aware of plans by their cross-town peers to expand laboratory capacity and fill that capacity with referral testing and outreach specimens.

Insiders tell THE DARK REPORT a similar story about all three automated laboratories. Each runs at between 12% and 25% of capacity. Because of this fact, laboratory costs have actually increased for each lab owner.

More importantly, none of these three facilities has succeeded in achieving a key objective of their pre-construction business strategy: generating additional specimens through both hospital testing referrals and outreach specimens from physicians’ offices.

This tale of two cities illustrates the value of studying the laboratory marketplace in other cities around the country. There are important lessons to be learned from the experience of laboratories in different areas of the United States.

While labs in Los Angeles were furiously eliminating overcapacity, labs in New York City were optimistically expanding their capacity in anticipation of increased volumes of specimens. The question which must be asked now is: how long will hospitals in New York continue subsidizing this unused laboratory capacity?

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