Chi Chronicles A Laboratory Thought Leadership Blog

Three Reasons Hospitals “Divorce” National Labs

A recent article by Robert Michel of the Dark Report highlighted two out of the three top reasons national laboratory partnerships with hospitals fail:
1. Service issues
2. Lack of local control

Over my consulting career, I have been called many times to help hospitals and health systems resolve “partnership issues.” The most common problem is physician dissatisfaction with turnaround times for results. This is no surprise since the lab partner has an incentive to consolidate testing at other owned facilities in the region to reduce cost. The trade-off is longer turnaround times for the local hospital.

This is often aggravated by the fact that the hospital no longer runs the lab. It has conceded local control to the national lab partner and is therefore unable to easily rectify service issues. It can take months to years of monitoring and negotiation.

The third reason that these partnerships fail is a dirty little secret. In fact, it is the common thread to why relationships, in general, fail. You guessed it—it’s about the money. How many marriages split up over different views about money? Lots! Money is one of the most common reasons for break-ups. The same is true with the national lab partnerships.

During the “dating” period, the national lab partner emphasizes its low cost structure and how it can save significant money for the health system. Over time, a different story emerges: “fee creep.” Health systems realize that they are paying more to outsource than to manage the lab on their own. In addition, they now must share profits for outreach. They start to ask themselves why they entered this relationship in the first place. So, if we’re not getting the same service, we’ve lost local control, and the relationship is no longer financially viable…


…that’s three strikes and you’re out!

Kathleen A. Murphy, PhD
Senior Advisor
Chi Solutions Inc., an Accumen Company

1Michel, Robert, “Quest Diagnostics Exits 31-Year-Old CompuNet Lab Venture.” The Dark Report, June 26, 2017.

    What Do Operating a Clinical Laboratory and Sea Kayaking Have in Common?

    One of the things on my bucket list—or as I prefer to call it, my “life list”—was to go sea kayaking. I’d been kayaking on inland bodies of water, and even on a river at the mouth of the ocean, but never out in the open sea. I checked that one off my list last week, and oh my, what an experience!

    I went out of Essex, Massachusetts, with my local Audubon Society to see a heron rookery off the coast of Boston’s north shore. When we got to the site, I thought it looked a little windy and rough. This trip had been canceled twice due to thunderstorms. We were determined to make it that evening. How cool would it be to see herons (black-capped and small blue), ibis (glossy), and egrets (both snowy and great) fly back to their nests on Kettle Island at sunset? Nothing was stopping me.

    We donned our gear and set off from shore, gradually getting the rhythm of paddling with some waves and small chop. It seemed quite manageable. We paddled to the island and stayed on the side closest to shore where the water was more protected and basked in the glow of the sunset while the birds flew overhead. Their nests were on the other side—the really rough side. Of course, we wanted to go over there to view the nests and chicks. Our leader decided we could “test the waters” (pun intended). They told us to keep paddling no matter what. We started around the far end of the island, and it was more than rough. The swells were so deep that I couldn’t see half of the kayaks in front of me. All of a sudden, this big wave came out of nowhere. It almost swamped me! I felt myself tipping, and I was sure I was going down. From all around me, I heard “keep paddling,” and I sat up straight and dug in with everything I had. A moment later, I had turned myself around and was actually surfing the waves back on the protected side of the island. Whew! The rest of the evening was beautiful, and I made it back to shore unscathed and happy that I finally tried and survived sea kayaking.

    So, what does this have to do with running a clinical laboratory? Haven’t we all been in situations at work that we thought we could handle when the wind blew up and suddenly we were drowning, reaching for a life preserver that wasn’t there? Someone (or maybe that voice from within) told us to hold our own—to keep paddling (swimming or even treading water)—and we got through it.

    The rate of disruption and change is the greatest we have experienced in our careers thanks to accelerated consolidation of hospitals and systems, accountable care, reimbursement declines (such as PAMA), and the most competitive outreach markets to date. It will not end at this. We must continue to find ways to offset declines in reimbursement, increase revenue streams, and deliver higher-quality, patient-centered care.

    During even the most blissful of times we are bound to encounter some waves, but if we paddle through it, we will make it back to safety. We must believe in our capability to improve performance, seek expertise from outside resources to lower the risk of execution, accelerate the time to market, and keep paddling to increase speed to outcomes.

    Kathleen A. Murphy, PhD
    Senior Advisor
    Chi Solutions Inc., an Accumen Company

      Laboratory Outreach Financial Considerations: Risk-Part 8 in a Series

      Reasonable folks would agree that most hospitals in today’s environment, especially the not-for-profits, are risk adverse.  So what is the downside of making a mistake?  Of failing to execute?  Of disappointing results?  Not much.  Honestly!

      It’s because the vast majority of investment for outreach is in operating expenses.  The capital costs are very modest.  The five-year capital requirements are shown in the table below for a range of program sizes:  $10 million, $25 million, and $50 million.  The first-year capital ranges from $397,000 to $1.0 million and includes the cost of IT connectivity, computers, interfaces, courier vehicles, and upgrading and/or outfitting patient service centers.

      Outreach Program – Capital Requirements over 5 Years

      graph1

      Most of the cost of outreach is labor (additional FTEs for the unique outreach infrastructure).  The following chart shows a five-year estimate of FTEs required for the same size businesses as above.  The range is from 45 to 179 FTEs as shown in the chart below by job title and in total:

      Outreach Program FTEs

      graph2

      Should business conditions or strategic priorities change at some point in the future, the business can be monetized for roughly 1.0 to 1.5 times revenue.  The multiple can be higher for specialty laboratories, but this number is typical of what we have seen in the industry over the last three to five years.  And there are always willing buyers—both Quest Diagnostics and LabCorp have grown mostly by acquisition over the last few years.

      The last step in exiting the business would be to right-size staffing for reduced volume and eliminate outreach-specific FTEs (sales, couriers, phlebotomists, specimen processors, billing, and client services).  No doubt, reductions in force are emotionally challenging but fairly straightforward from a management perspective.  In this context, I view the risk associated with an outreach strategy as low.  With a thoughtful analysis of options and good execution, it is easy to exit the business.  The ability to monetize without timing constraints further supports a low-risk strategy.  Does that surprise you?  I think it would surprise many executives who view outreach as difficult, complex, and risky.

      See other entries in this blog series for information on additional financial issues that laboratory outreach program leaders must consider.  You can also learn more in my book, The Profit Machine in the Hospital Basement: Turning Your Lab into an Economic Engine.

      Kathleen A. Murphy, PhD
      Senior Growth Advisor
      Chi Solutions Inc., an Accumen Company

        Laboratory Outreach Financial Considerations: Performance Management-Part 7 in a Series

        The three biggest opportunities for maximizing revenue in order of priority are:

        • Reimbursement as a hospital or independent laboratory.
        • Sales performance.
        • Billing efficiency.

        Reimbursement and sales performance have been addressed in previous blog posts.  With regards to the third opportunity, there are six ways that you can reduce the amount of money left on the table by billing inefficiencies or just bad business practices.  In order of priority, they are:

        • Maximize the use of online order entry systems on the front end (to eliminate errors such as missing or incorrect information).  The most successful laboratories use online order entry for 80 to 90 percent of their client base.
        • Ensure that your billing service is working all denials.  A laboratory with 1,000 patients per day can have a denial rate as high as 30 percent.  Not working those claims has a material impact ($5.3 million annually).
        • Confirm that the laboratory follows through on missing billing information within 24 to 48 hours.  Collections are disproportionate to the length of time to follow up, and it is possible to miss filing limits (as little as 90 days for most commercial payers).
        • Use a low write-off balance for laboratory in the $3 to $5 range.  This is tenfold less than the typical write-off balance for general hospital services.
        • Do not take “cast off” business from the national laboratories!  If they dumped a client, it is likely because they were not profitable or too high maintenance.
        • Don’t be afraid to fire “bad” clients.  All business is not good business.  Do not confuse volume with profitability.  A client profitability analysis of a Midwestern outreach program revealed that eight of its highest volume clients were not profitable. 

        Stay tuned to this blog series for information on additional financial issues that laboratory outreach program leaders must consider.  You can also learn more in my book, The Profit Machine in the Hospital Basement: Turning Your Lab Into an Economic Engine.

         

        Kathleen A. Murphy, PhD
        Senior Growth Advisor
        Chi Solutions Inc., an Accumen Company

          Laboratory Outreach Financial Considerations: Financial Transparency-Part 6 in a Series

          All businesses require a profit and loss statement (P&L) to determine profitability.  Yet, according to our research, only 41 percent of outreach programs are provided with periodic profitability reports.  More than half are not.  Forty-six percent do not get reports, and the remaining 14 percent are uncertain.  There is an astounding lack of transparency for this business line.  Seriously, how can anyone run a business without a P&L?  Why would any hospital allow that in this day and age?  To put this into context, we are talking about a median and average business of $11 million and $19 million, respectively.  These are substantial businesses that are run like a mom-and-pop or, perhaps more appropriately, worse than a mom-and-pop.  At least the local family business knows whether they are making money!  This is a case of the not-for-profit mentality gone haywire, or alternatively, a view into the surprisingly unsophisticated financial management of hospital business lines.

          Everyone knows how to construct a P&L, but not everyone knows what costs to include and exclude.  The most common problem we encounter with P&Ls is the misallocation of costs. Misallocation inadvertently makes the outreach program look like a loser.  Our philosophy is that the P&L should only contain costs that are specific to outreach:  costs that would go away if you decided to exit the business.  Therefore, hospital and laboratory overhead should be excluded; those costs would not go away if you got out of the business.  Likewise, facility costs and laboratory equipment are required to support hospital patients.  There are specific, unique outreach costs that are appropriate to include such as courier vehicles, patient service centers, physician connectivity software, interface costs, and new labor costs (outreach manager, phlebotomists, couriers, client services, sales staff, extra specimen processing FTEs, and incremental technical FTEs in labor intensive disciplines like microbiology or cytology).

          This past year, a client with a $12 million outreach program contacted us because the profitability of its program was diminishing, and it was reluctant to make a required upgrade to its IT connectivity if the business was not sustainable.  The client wanted to know whether to invest in the business for future growth or to exit.  We looked at its P&L as a combined hospital/outreach entity shown on the table below under “Total.”  The operating margin was a paltry two percent, one tenth of the expected margin.

          octoberchart

          Next, we analyzed cost allocations between the hospital and outreach and developed separate proformas for each.  Not surprisingly, the outreach program was profitable at 19 percent (very close to the expected range of 20 percent for an independent laboratory billing on the commercial laboratory fee schedule).  It was actually the hospital laboratory that was unprofitable at a 19 percent negative operating margin.  This makes much more sense since the hospital has a required investment in laboratory facilities, equipment, and staffing for a 24/7 operation to support the acute, inpatient business.  These costs should not be viewed as part of the outreach business since they would remain even if the hospital decided to exit the business.

          Our analysis represented a major turnaround in thinking.  Outreach was truly accretive; the new revenues helped cover fixed overhead costs and provide $2.3 million in new operating margin that would be foregone otherwise.  Seeing it in this new light, the same executives who originally questioned the IT investment now want to accelerate growth.  We also solved a common conundrum for the laboratory.  They did not have a competitive IT offering.  Growth stagnated.  The laboratory asked for capital to upgrade IT which, in turn, was not approved because the laboratory wasn’t growing and was viewed as a low margin business—a veritable catch-22 for the laboratory.

          I would be remiss if I did not point out another important advantage of outreach:  lowering unit costs overall.  The blended cost per test of $13.30 distorts the picture.  The cost per test for hospital patients is actually 23 percent higher than outreach ($16.72 versus $10.75 for hospital and outreach, respectively).  In a similar study conducted two years ago, we estimated that the cost of testing would increase by 30 percent if the system monetized a $42 million outreach program.  There are important, unintended consequences of exiting an established business that are not always readily apparent nor appreciated.  With volume decreases, the test menu would be pared down and turnaround time would suffer.

          Stay tuned to this blog series for information on additional financial issues that laboratory outreach program leaders must consider.  You can also learn more in my book, The Profit Machine in the Hospital Basement.

          Kathleen A. Murphy, PhD
          Senior Growth Advisor
          Chi Solutions Inc.

            Laboratory Outreach Financial Considerations: Billing-Part 5 in a Series

            After IT, billing is the second biggest challenge of outreach programs. Laboratory billing is the most complex, regulated, and risk-prone of all medical billing. Laboratory claims are also often perceived as a nuisance since they are small-dollar compared to other hospital bills (think inpatient stays, surgery, sophisticated diagnostic testing, and interventional treatments). The average laboratory claim of $45 is often less than the write-off amount for hospital bills! It is not uncommon for us to encounter hospital billing departments that do not follow up on laboratory denials. Here are some facts from our 2014 Comprehensive National Laboratory Outreach Survey to substantiate these statements:
             66 percent of outreach programs do not know their bad debt rate.
             77 percent do not know their days sales outstanding (DSO).
             Only 23 percent are confident that they are collecting everything they can.

            blog box 9-6-16
            Every single day, hospital billing departments leave money on the table that is critical for a business based on a large volume of small-dollar claims. For this reason, it is strongly recommended that outreach billing be outsourced to a company that specializes in laboratory billing. One note of caution: do not confuse outsourcing with abdication. You can have laboratory billing experts perform the billing for you, but you still have to manage their performance.

            Beware of skimming from less-than-stellar companies. They submit claims and take the easy money without following up on denials or chasing down claims with incomplete or inaccurate information. That’s your problem. Your responsibility is to submit “clean” (complete and accurate) claims. The billing company sends out the bills and collects the money. A good specialty (laboratory) billing company will provide upside in collections merely by chasing down bills of a much smaller balance than a hospital billing department (down to the $3 to $5 range). The one caveat is that the billing company must be good, and you have to manage performance. You can’t be profitable if you pay seven percent of collections on average to outsource billing and have unworked denials and aged accounts receivable. This results in a triple whammy: lower than expected collection rates, subsequent write-downs, and lower profitability. I know this seems like common sense, but remember the quote from Thomas Greeley: “Common sense is very uncommon.” Based on my experience, this definitely applies to billing.

            There are two additional advantages to outsourcing billing: it is a great way to segregate outreach revenues from hospital business, and it allows you to determine a specific collection rate for laboratory. Most payments are bundled. Laboratory might be paid as part of a bill covering other hospital services. It is possible to do line-item posting of payments, but very few hospital billing departments take this cumbersome step. As a result, collection rates are an aggregated rate for the hospital overall and may not accurately reflect laboratory collections. Segregation of revenues and knowledge of actual collection rates are key building blocks for the profit and loss statement (P&L).

            Stay tuned to this blog series for information on additional financial issues that laboratory outreach program leaders must consider. You can also learn more in my book, The Profit Machine in the Hospital Basement.

            Kathleen A. Murphy, PhD
            Senior Growth Advisor
            Chi Solutions Inc.

              Laboratory Outreach Financial Considerations: Reimbursement and Profitability-Series Part 4

              Hospitals have a distinct reimbursement advantage over independent laboratories. This is based on the higher cost to provide around-the-clock services: seven days per week for hospital patients. In contrast, independent laboratories operate on one shift five days per week, a 21/5 work ratio for hospital versus independent laboratories. Our 2014 Comprehensive National Laboratory Outreach Survey found the average and median reimbursement to be $16.87 and $19.51, respectively, for hospitals. Using an average of 3.5 tests per requisition or patient encounter, the average and median reimbursement per requisition is $59.05 and $68.29, respectively. Comparing these hospital rates with $44.00 per requisition for independent laboratories shows a 34 to 55 percent higher reimbursement for hospitals. This represents a huge advantage for hospitals.

              The reimbursement advantage of hospitals transfers to the bottom line. In our 2014 survey, pre-tax operating margin for independent laboratories was 11 percent compared with a contribution margin for hospital outreach of 28 percent. The largest of the nationals, Quest Diagnostics and LabCorp, had higher margins than independent laboratories as a group (18.9 percent for Quest and 15.8 percent for LabCorp) but still well below hospital laboratory performance.

              When we look at subsets of hospital-based businesses, we find that the contribution margin can range as high as 50 percent. What other service business do you know that sports this kind of margin? Typically, system core laboratories outperform stand-alone hospital laboratories. We have not seen any slippage in operating margin over the past few years despite declining reimbursement. We believe this to be due to the simultaneous focus on cost reductions.

              Stay tuned to this blog series for information on additional financial issues that laboratory outreach program leaders must consider. You can also learn more in my book, The Profit Machine in the Hospital Basement: Turning Your Lab into an Economic Engine by clicking here.

              Kathleen A. Murphy, PhD
              Senior Growth Advisor
              Chi Solutions Inc., an Accumen Company

                Benchmarking: What is the Blood Pressure and Pulse of the Lab?

                benchmarkbloodpressure
                When is the last time you have taken or had your blood pressure checked? Was the reading representative of past readings? Did you find that it was elevated when you were in the doctor’s office and leave with a prescription or intent to pay more attention to keeping it in check through diet and/or exercise? If you aren’t checking your blood pressure or pulse regularly, you may be at risk for a major health event that actually could be prevented.

                Most patients report that their blood pressure is only a snapshot of that moment because they compare it to other readings taken over time—it may be higher or lower in comparison. While most people blame elevated results on “white coat syndrome,” in the patient world, this is a form of benchmarking. Benchmarking laboratory costs and productivity is closely related to taking your blood pressure. One benchmarking report is a dynamic snapshot in time of your laboratory, but subsequent reports show trends and opportunities to effect positive change.

                If you work in a clinical laboratory and have not benchmarked its costs and productivity, how do you know what the pulse or “blood pressure” of the laboratory is in comparison to peers? How is it performing? After all, if you benchmarked the laboratory and saw opportunities for improvement in the health of the laboratory, you would be more aware or research ways to make improvements, right? In a climate of cost reductions, staff reductions, and the like, it is much more prudent to know where you stand and support it with data.

                The value of benchmarking is achieved at the highest level when a clinical laboratory decides to complete a baseline benchmarking analysis to determine its health in comparison to peers. The value continues to be driven by ongoing analysis and trending generated at intervals of three months or more. These ongoing reports provide practical management guidance and insight into performance improvement progress or setbacks that may signal the need for a “comeback.” The comeback is achieved once the laboratory has identified the largest opportunities for improvement and then drills down deeper into the data to determine action steps to make them happen!

                Dori Cheng
                Business Analyst
                Chi Solutions, Inc., an Accumen company

                  The Value of Input for Clinical Laboratory

                  Over the course of my 45-year career in the medical laboratory field, I’ve had the good fortune to meet many of the successful leaders in our industry and visit many of their labs.  This has given me the opportunity to study the common attributes of successful leadership.

                  The leaders who stood out were not successful because of their personal knowledge, but rather the expertise they gathered and cultivated from their management teams, colleagues, and others.  All good laboratory leaders assemble teams, over time, who are capable of delivering quality and service in a cost-effective manner on a day-to-day basis.  Those leaders have successful careers.

                  dt_150708_value_800x600

                  The leaders I’ve met who have developed break-through strategies and produced exceptional results have something in common:  they seek knowledge and expertise from outside their own organization.  They understand that organizations need to be pushed, challenged, and stimulated to consider new ideas, develop new strategies, and create the kind of positive change that keeps their operation at the forefront of achievement in the industry.

                  Where do they get outside knowledge and expertise?  There are a number of resources.  Those in common use are:

                  • Reading professional journals and publications.
                  • Formal education in a related field.
                  • Attending national meetings and seminars.
                  • Talking to other leaders within the organization but outside the lab.

                  Those leaders in our industry who have really stood out and created a reputation for themselves and their organization go beyond the common resources as they seek that external stimulus to improve their organization.  They do the following:

                  • Identify labs that are considered top performers and arrange for visits to those labs or visits of the key leadership of those labs to the local organization.
                  • Seek input from one or more industry consultants and many times contract with one or more of them to provide advice regarding the same challenge.
                  • Try new strategies and tactics to determine if they can deliver long-term value to the organization.
                  • Recognize that assuming some level of risk or being an early adopter of a new strategy or service can provide benefits that keep the lab organization on the leading edge in the industry and differentiate it from competitors.

                  The question for you today is, “What kind of leader do you aspire to be?”  Are you satisfied with the status quo of your operation, or are you seeking to lead growth and efficiency to be the best in the industry?

                  If you are the latter, my recommendation to you is to make sure you include the expertise of those resources outside your organization that is essential to providing the stimulus necessary to help you achieve that highest level of success.

                  Earl C. Buck
                  Advisor and Senior Consultant
                  Chi Solutions Inc., an Accumen Company

                    Laboratory Outreach Financial Considerations: Pricing-Series Part 3

                    It is common knowledge that hospitals have higher reimbursement rates compared to commercial laboratories. This gives hospitals a distinct advantage on the revenue side, provided that their pricing is not egregious. Recent movement towards pricing transparency is making it more and more difficult for hospitals to justify or sustain this advantage. After all, there is no real rationale for an outpatient test performed by a hospital laboratory to cost more than a similar outpatient or nonpatient test performed by a commercial laboratory. The rationale only applies to inpatient testing which has to be done quickly on a 24/7 basis versus being batched once per 24 hours. There is a much higher cost for inpatient testing.

                    For years, pricing has been one of the top five obstacles for laboratory outreach programs nationally (as measured annually in Chi’s Comprehensive National Laboratory Outreach Survey). In 2014, it became the hottest issue. There are four primary reasons behind this:

                    • There is a push for greater pricing transparency for all types of health care pricing.
                    • The Affordable Care Act is driving prices lower.
                    • More costs are being shifted to patients in the form of higher deductibles and co-pays.
                    • National laboratories are using fees as a major differentiator from hospitals.

                    A recent article in the Wall Street Journal addressed how pricing transparency emphasizes vast differences in pricing within and across markets. This will most likely drive competition based on cost—something that is new to health care. According to the article, “doctors and hospitals have rarely competed on cost. Third-party payers still foot the bulk of the bills, and many players in the health-care industry benefit from keeping their costs and profit margins murky.[1]

                    There is another trend afoot in health care that places pricing under the microscope. Employers are asking employees to share the burden of the rising cost of health care insurance. This cost shift comes in the form of increased employee premiums, individual and family deductibles, physician office co-pay amounts, and co-insurance, all of which raise out-of-pocket expenses for individuals. According to the Wall Street Journal, the number of patients with deductibles of $1,000 or more rose from 10 percent in 2006 to 38 percent last year. The Affordable Care Act applies family deductibles of $6,000 and $10,000 for Silver and Bronze plans, respectively.[2]

                    The table below demonstrates how higher prices charged by hospitals become a deterrent for patients to use their local hospital rather than Quest Diagnostics, LabCorp, or a regional independent laboratory:

                    Chart 6-1-16 blog

                    The table illustrates that the disincentive involves both a pricing disincentive (i.e., the hospital charge is almost double the average commercial laboratory charge) and a reimbursement premium that is often paid to the hospital-based laboratory providers. This premium comes in the form of increased health care costs for individuals.

                    The current gap between hospital and independent laboratory reimbursement may be short-lived. At some point in the future, all outpatient and nonpatient laboratory work may be reimbursed under one fee schedule. Some hospitals recognize this and are trying to decide whether to ride the wave for as long as they can under the provider reimbursement model or adopt the lower independent laboratory fee schedule to be more competitive. While they recognize that their patients are unhappy, they choose to maximize revenues in the short run or exit the business and get maximum value for it. Others have chosen to adopt the independent laboratory fee schedule as a defensive move to prevent a loss of business. Real entrepreneurs have adopted independent laboratory fees to continue to grow and capture new market share.

                    Depending on your goals, you may have to adjust your pricing. If you want to become a regional laboratory and compete head-to-head with the nationals in an open marketplace, then adopting the independent laboratory fee schedule may be required. If you want to develop a modest business from physicians who are employed or affiliated with your organization (what we call “inreach”), then you may be able to maintain a modest pricing advantage over the nationals. For years, I have predicted that this difference will disappear and reimbursement for all outpatient/nonpatient testing will be standardized. Surprisingly, this has not happened as of this writing, but you would do well to plan for it in your financial models.

                    Stay tuned to this blog series for information on additional financial issues that laboratory outreach program leaders must consider. You can also learn more in my book, The Profit Machine in the Hospital Basement: Turning Your Lab into an Economic Engine.

                    Kathleen A. Murphy, PhD
                    Senior Growth Advisor
                    Chi Solutions Inc.

                    1 Beck, Melinda, “How to Bring the Price of Health Care Into the Open,” The Wall Street Journal, February 23, 2014.
                    2 Ibid.