Outsourcing lab services can save money, but it's not that simple

When executives at 65-bed Brooks Memorial Hospital in Dunkirk, N.Y., go over the draft of next year's budget, they likely will discuss whether to outsource laboratory services.

Doing so would reduce annual lab costs by about 20%, according to hospital consultants and market analysts. But it could mean longer turnaround times for lab results and the hospital's loss of control over lab services.

Brooks recently outsourced its inpatient pharmacy and is selling its dialysis center. While contracting out lab services would reduce labor costs—mainly because the hospital could lay off some unionized employees—the hospital has to think about the impact of losing experienced staffers, said Jarrod Johnson, vice president of hospital operations at the independent facility in rural western New York. Also, Brooks would no longer have direct control over the quality of lab services.

“There's a lot to consider,” Johnson said. “The big question on the table for any organization is, why do you keep your (own) service?”

As hospitals face a squeeze on payment rates and margins, there are few types of clinical services, purchased services and medical-supply categories that aren't facing a ruthless bottom-line evaluation. Hospitals increasingly are outsourcing nonclinical services such as laundry and food to save money. Now, some are turning the cost spotlight on clinical services such as labs and diagnostic imaging.

Ratings agency Standard & Poor's said in a recent report that more hospitals are willing to sell their labs, create joint ventures and establish lab management agreements with lab services companies. “As hospitals strive to become more efficient, these types of lab transactions could be a way for some hospitals to redirect scarce capital away from labs to core activities,” S&P analysts wrote in the Aug. 4 report.

A hospital's “lab business is not a core asset,” said Bryan Brokmeier, an analyst for Maxim Group. “Historically, it's been looked at as a cost center, not a profit center.”

The trend has accelerated thanks to aggressive moves by major lab companies seeking hospital customers looking to outsource lab services. Publicly traded

Laboratory Corporation of America and Quest Diagnostics, two of the biggest lab services providers, are making a play to purchase hospital labs, contract with hospitals to manage their labs or form joint ventures with large health systems. They currently provide lab services to about half of U.S. hospitals.

Quest said in a securities filing that it plans to expand its business through strategic partnerships with hospitals and independent delivery networks. About 60 hospitals have outsourced lab services to Quest. “We believe that continued price and utilization pressure, as well as evolving payment models in healthcare, will drive demand for our expertise in a range of strategic partnerships, including lab management outsourcing, outreach acquisition and joint ventures,” the company said.

But outsourcing clinical services requires hospitals to evaluate service and quality issues. Hospital leaders have to think about whether the vendor may seek to boost revenue by encouraging unnecessary or more expensive tests. And in a continuing tough job market, executives may think hard about laying off staff lab workers.

Experts say hospitals also should carefully consider whether outsourcing will generate the kinds of savings they are looking for, and how it could affect patient care and hospital operations. “Outsourcing of lab services is not always the answer,” said Rick Conlin, managing director of spend performance solutions at the Advisory Board Co.

The hospitals where outsourcing works best are small or midsize and work with a commercial partner—such as a national lab services provider—to outsource routine lab services, Conlin said.

Hospitals of that size can save between 8% and 20% on lab services, mainly because large lab companies are more efficient and have the data and analytics tools as well as the capital assets to identify and implement best practices.

A hospital with between 300 and 500 beds can save about $15 million over five years by outsourcing lab services, said Dr. Jon Cohen, Quest Diagnostics' chief medical officer. In an outsourcing model, Quest usually handles about 30% of the tests typically performed in a hospital lab. Time-sensitive tests, such as those performed for patients in the ICU, would continue to be run in the hospital.

Cohen says that along with lower costs, other benefits for hospitals from outsourcing include faster turnaround times on receiving lab results, freeing up of space that previously housed the lab, and access to Quest's strategies to improve admissions and discharge processes.

Midsize hospitals may perform certain lab tests one or two days a week, while Quest labs handle those tests several times a day, Cohen said. “Our quality and turnaround times are better than the hospital,” he asserted.

Quest, based in Madison, N.J., has made a number of deals to acquire hospital outreach labs, (which provide services to doctors and patients outside the hospital) such as buying Dignity Health's lab-related clinical outreach service operations and the clinical outreach and anatomic pathology businesses of UMass Memorial Medical Center, a financially struggling hospital in Worcester, Mass.

Earlier this year, it closed an acquisition of Steward Health Care System's outreach lab, stating that it will provide testing services to doctors, nursing homes and others previously provided by the Boston-based health system.

In an April 2013 written statement, Dignity said selling that service line allows the health system to “invest more strategically in its core business of acute and ambulatory clinical care.”

One reason why lab services providers—whose industry had estimated U.S. revenue of $74 billion last year, according to G2 Intelligence—are increasing marketing of outsourced services to hospitals is because the rates insurers are paying for lab services are decreasing. Medicare rate reductions in 2013 were considered “unusually large” by S&P analysts, who said the rate cuts were a significant contributor to lower profit margins reported by most publicly traded lab companies in 2013 and early 2014. The rate pressure from Medicare and private insurers is expected to continue. In addition, lab companies have been losing business from physician practices as hospitals buy more practices.

Hospital labs make up about 60% of the total testing revenue in the U.S. Analysts estimate that Quest and Laboratory Corporation of America. have slightly less than 25% of the lab market and may have lost some market share as hospitals have bought up physician groups. When doctors are employed by hospitals, they are more likely to send lab work to the hospital's lab than to an independent lab company.

The Advisory Board's Conlin said that while hospitals have to think about quality in deciding whether to outsource lab services, most currently are relying on outside providers such as Quest or Laboratory Corporation of America. for some testing. “There's a 50/50 chance you're working with them already,” he said.

But many hospitals and health systems have sought to achieve comparable cost savings without outsourcing to lab services companies. Some large systems have centralized lab services into a single facility and have satellite labs at individual hospitals.

In addition, independent hospitals in some markets, such as Pennsylvania's Lehigh Valley, have joined together to form for-profit lab companies to handle lab services for their hospitals and the community at large. Under this model, each hospital generally maintains its own satellite lab for services that require immediate turnaround, such as for ICU patients.

William Mosser, vice president of materials management at the Franciscan Missionaries of Our Lady Health System in Baton Rouge, La., said that his system is considering its options, including outsourcing to a lab services company or establishing a partnership model featuring a centralized lab. “We're all looking for ways to lower our total costs,” Mosser said.

About 15 critical-access hospitals are in the same geographic region as Franciscan hospitals in Baton Rouge and Monroe. Building a centralized laboratory that can also service healthcare providers outside the Franciscan system is one way to bring in revenue and better coordinate care.

“Linkage from a care perspective is going to happen sooner or later,” Mosser said.

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