Carilion Health System joined the ranks of U.S. healthcare providers putting their own twist on outsourcing by selling rather than buying services. But the Roanoke, Va.-based hospital system is gearing up to market its services on an ambitious, even national, scale.
Carilion's not-for-profit laboratory outsourcing business has flourished, growing from $7.1 million in revenue in 1996 to $43 million with nearly 700 clients in 2004. Too big and "far enough afield from our mission in our core market," to sustain as a tax-exempt operation, Carilion's President and Chief Executive Officer Edward Murphy said it's time for the sideline business to expand as a for-profit venture.
The not-for-profit health system acquired Laboratory Services Group, a consulting division of Park City Solutions, Alpharetta, Ga., in April. And last week, Carilion officials announced plans to launch a wholly owned, for-profit laboratory services subsidiary with an eye on markets across the eastern United States.
It's not Carilion's first for-profit subsidiary. The new company, named Carilion Labs, will be the health system's eighth for-profit corporation, but it's an enterprise that Murphy says has significant potential. "I wouldn't want to rule out the possibility we'd expand west of the Mississippi," he said.
The health system appears to have the financial footing needed for the enterprise. It acquired Laboratory Services, now called Chi Solutions, for an undisclosed amount in cash. New York ratings agency Moody's Investors Service rates Carilion an Aa3 and revised its outlook in February from negative to stable, in part because of Carilion's healthy cash reserves, improved revenue growth and a record $111 million in operating cash flow last fiscal year.
Moody's analyst Bruce Gordon said Carilion's cash position has been one of its strengths. "From a financial and credit standpoint, it's a strong entity," he said.
To start, Carilion Labs will seek to acquire or build three to five additional laboratories, all financed with cash, Murphy said. Building each laboratory would cost roughly $10 million, where acquiring a laboratory and its existing business operations would exceed $10 million, he said.
Its purchase of Chi Solutions gives Carilion Labs the expertise and infrastructure it needs to expand, Murphy said. "We bought Chi so we could get into this business in a more deliberate way," he said.
It's not uncommon for not-for-profits to own all or part of a for-profit subsidiary. Tax-exempt healthcare providers typically expand into for-profit ventures to co-opt competition, boost revenue or when a business line strays from the not-for-profit's mission, said Standard & Poor's Director Lisa Zuckerman.
However, such aggressive for-profit ventures have been the subject of federal and state regulatory scrutiny over whether they violate the charitable mission that qualifies them for a tax exemption.
Certainly, the ties in Carilion's case are close. Bob Thompson, Carilion's executive vice president, has been named CEO of the fledgling laboratory company, though he'll retain his position within the health system.
Murphy is the for-profit laboratory services company's board chairman. Two of Carilion Health System's officers have been named to the laboratory company's board. The company is recruiting two outside directors, as well as a chief operating officer and a vice president for sales and marketing, Murphy said.
Company spokesman Eric Earnhart said Murphy is not concerned that Carilion's for-profit subsidiaries will jeopardize its tax-exempt status. For-profit subsidiaries support Carilion's not-for-profit mission, he said. The health system must be careful to keep for- and not-for-profit operations separate and pay appropriate taxes.
Such hybrid business models raise concerns that not-for-profit management may be strained by the demands of for-profit ventures, though whether that's the case is unclear, said Bradford Gray, a principal research associate for the Urban Institute's health policy center. The marriage of not-for-profit and for-profit also raises concerns about the potential for accounting manipulation, he said.
Carilion isn't the first to enter the laboratory services business. UMPC Health System, Pittsburgh, launched a joint venture with clinical testing giant Quest Diagnostics, Teterboro, N.J., in 1998.
The value of mergers and acquisitions among laboratory, dialysis and MRI providers skyrocketed in 2004 to $3.1 billion from $392 million in 2003, according to the Irving Levin Associates Health Care Acquisition Report.
Murphy said Chi Solution's consulting expertise will allow Carilion Labs to market management outsourcing and consulting to hospitals, as well as sell itself as a potential owner of local hospital laboratories. Chi Solution's national client base could result in Carilion Labs' national expansion, though such deals would be attractive and appropriate, he said.
Health systems have previously made successful forays into the consulting business, such as Susquehanna Health System, Williamsport, Pa., which recently began outsourcing information technology pioneered by Siemens Medical Solutions (Sept. 16, 2004, p. 6).