New Competitive Forces Alter Market Status Quo

Quest Diagnostics announces plans to expand internationally and enter POCT

CEO SUMMARY: January was not kind to Quest Diagnostics, as the company disclosed that it was likely to lose all its UnitedHealth business by year end. It also found itself excluded from the Horizon Blue Cross Blue Shield of New Jersey program. By February 1, however, Quest Diagnostics had acquired HemoCue, a point-of-care testing company with international distribution and annual revenue of $90 million.

EXPECT AN INTENSE CONTRACTING WAR TO BREAK OUT between Quest Diagnostics Incorporated and Laboratory Corporation of America. As this war develops, it is likely to affect the entire laboratory industry.

But that’s just for starters. When LabCorp negotiated its exclusive national lab services contract with UnitedHealth Group, Inc., it set in motion a number of forces that will disrupt the status quo of laboratory testing in the United States. In public statements and presentations at financial conferences, executives at Quest Diagnostics and LabCorp have begun to provide clues as to how they believe the laboratory testing marketplace will evolve.

In managed care contracting, LabCorp has already stung Quest Diagnostics twice. First was the UnitedHealth contract. (See TDR, October 14, 2006.) Second, in January, Horizon Blue Cross Blue Shield of New Jersey excluded Quest Diagnostics (and Bio-Reference Laboratories, Inc.) from its PPO program.

LabCorp was already the exclusive statewide laboratory provider for Horizon’s HMO. It is believed that LabCorp offered Horizon an improved contract to become the exclusive provider for its PPO and other plans.

That strategy would be predictable for LabCorp. The more it can exclude competing labs in the New York/New Jersey area from regional managed care contracts, the easier it is for LabCorp to persuade local physicians to use its services. Based on this strategy, it would not be surprising to see additional announcements from regional players that they are excluding Quest Diagnostics and other regional laboratories in favor of LabCop.

Looking For Opportunities

Quest Diagnostics recognizes this development. On January 25, CEO Surya N. Mohapatra told financial analysts, “We are monitoring the competitive environment. We expect to see competitive pressure play out for the next six to 12 months.

“We are seeing a competitor [Lab- Corp] use lower price for exclusivity over the long term,” continued Mohapatra, “and, more importantly, guaranteeing leakage. And we have a payer that’s protected itself by having $200 million in transaction costs, but has gone out of its way to take choice away from physicians and their patients—basically turning PPO products into [closed panel] HMOs.”

Mohapatra called attention to the relationship between low price and service. “These contracts are not profitable [to our competitor] and service will be affected,” he said. “We will continue to provide service and remain competitive with our pricing.”

Quest Diagnostics believes that its competitor will continue to use a similar pricing strategy with other managed care contracts. This process will play out over the next year. By implication, Quest Diagnostics is indicating that, if the pricing that LabCorp offered to UnitedHealth and other health insurers is truly below the cost of providing services, then LabCorp’s financial performance will reflect this situation at some point.

On the other hand, it may be that LabCorp has developed an operational cost advantage that allows it to offer lower prices to managed care companies and still earn an acceptable margin. Over time, LabCorp’s quarterly financial reports will reflect these facts.

Buying Labs Overseas

Faced with the rapid erosion of 7% of its annual revenues, Quest Diagnostics is adding to its business plan. “There are two new areas for us,” Mohapatra explained. “One is international expansion. We have narrowed down our prospects. We will go to selected countries in the Pacific and South America. The second area is point-of-care testing (POCT). This is a market segment where growth is averaging 8% to 10% per year.”

Quest Diagnostics wasted no time acting on this second business strategy. Several days later, on February 1, it announced that it would pay $420 million to acquire HemoCue AB. This company is based in Sweden and sells a line of point-of-care testing (POCT) products.

In practical terms, Quest Diagnostics faces a simple problem. During the course of 2007, it projects it will lose 8% of its revenue base (7% from the UnitedHealth contract and 1% from the Horizon PPO contract), or about $500 million. It must replace that revenue. One way to accomplish this goal is to acquire other companies. HemoCue is a start.

Quest Diagnostics will be looking for laboratories to acquire in the United States as well as specific countries around the Pacific Rim and in South America. There are laboratories available to be acquired. For the most part, however, these are smaller lab companies that serve healthcare systems for which growth prospects are modest.

The most interesting wild card over the next year will be the managed care contracting strategy Quest Diagnostics implements in response to LabCorp’s coup with UnitedHealth. Over the next 12 to 24 months, there is likely to be intense competition between the two blood brothers as existing managed care contracts come up for renewal.

Quest Buys HemoCue, Enters POC Testing

WITH THE ACQUISITION OF HEMOCUE AB, Quest Diagnostics Incorporated is now a worldwide player in point-of-care testing (POCT).

HemoCue, based in Ängelholm, Sweden, generates about $90 million in annual revenue and distributes its products in 120 countries. It says it has installed “more than 200,000 analysers and photometers globally.”

Among HemoCue’s primary products are the HemoCue B-Hemoglobin system, which it has sold since the early 1980s. It launched the HemoCue B-Glucose system in the early 1990s and a urine albumin system in the early 2000s. Last year, it introduced HemoCue WBC, for total white blood cell count.




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