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The new generation of joint ventures.

Pathologists and their management teams, hospitals, and physicians are discovering the benefits of co-sponsoring new lab operations.

We have heard over and over again how changes in government regulations, intensified competition, and the rise of HMOs and other managed care systems are placing increased pressure on laboratory profit margins. While causing turmoil in the health care marketplace, these developments have also created unparalleled opportunities for pathologists and the rest of the laboratory management team.

For example, managed care systems often require wide geographic coverage in order to meet the needs of all their members. Laboratories that serve these systems get a chance to test patients from a larger area and increase their revenue. In addition, the move toward preadmission testing and ambulatory surgery creates opportunities for growth in freestanding laboratories. As a result of these trends, laboratory management has changed its focus from internal operations to external market factors, such as price competition and service orientation.

Pressure on physicians to supplement income losses, from rate freezes and reduced patient utilization, has spurred laboratory testing in office practices. Laboratories, however, are largely a fixed-cost business, requiring a large volume of tests to be successful. Most laboratory analyzers have ample capacity and can easily handle the volume necessary to generate significant profit margins.

Limited in the amount of profitable testing they can generate on their own and concerned about quality, primary care physicians have begun to approach hospital and freestanding laboratories with requests to set up joint lab ventures. Besides the financial benefits, physicians also gain from having efficient, conveniently located labs that issue reports they can quickly understand and save their patients trips to the hospital.

The redirection of laboratory business has also changed the objectives of joint ventures and the form of legal structures used to direct them. Joint ventures of the early 1980s were developed to obtain capital for new equipment, improve management expertise, or reduce overhead.' Current ventures aim more at securing referrals and expanding market share.

Previously, joint ventures were for the most part hospital/hospital or hospital/pathologist arrangements, usually with two to five players: commonly one hospital, sometimes two, and one or more pathologists (partner-level pathologists if a pathology group was involved). Current ventures include not only hospitals and pathologists but also significant numbers of hospital medical staff or private physicians in the community.

When a pathology group or laboratory organization initiates a joint venture, it concentrates on strengthening referral sources, service, and payer mix. For example, to change its payer mix, the lab may seek to provide tests not in high demand by Medicaidand in some cases, Medicarepopulations. Laboratory management evaluates services the lab provides, those it could provide, competitors for current and prospective services, and potential referral sources.

Joint venture partners, such as hospitals and physicians, are identified by their ability to provide a solid referral base in a noncompetitive manner. Laboratory management attempts to identify the strongest players in the marketplace based on their service capability, geographic accessibility to the laboratory, turnaround time, and cost to the laboratory of providing service, as well as other providing service, as well as other factors.

Then an evaluation is performed to determine the laboratory organization's own strengths and weaknesses. The venture should lead with the former and protect the latter. For example, a laboratory providing excellent service at higher than average cost would promote service as the primary reason to belong to its network and deemphasize the fact that potential partners could get testing done more cheaply elsewhere.

When narrowing the field to the best prospects as partners, laboratory management should look for those who possess a good consumer image, provide an adequate volume of service and adequate geographic coverage, recognize the needs of all partners, and agree with the financial strategy of the venture.

It's logical to start the search for partners with physicians who already refer work to the laboratory organization, either as part of a hospital medical staff or in private practice. Next, the pathologists can consider the hospital with which they are affiliated and other hospitals in the area. Additional sources of referrals, and thus potential venture partners, are medical groups in the area.

Hospitals and medical groups will already have varying levels of laboratory service. However, a high-volume, freestanding lab in a joint venture may furnish the procedures they need at substantially lower cost. Efficient specimen pickup by couriers and electronic transmission of results should lay to rest any fears about moving testing off-site.

Another benefit to partners in the joint venture will be a marked reduction in work sent to reference laboratories. The venture should produce enough test demand to support a fuller range of laboratory procedures than most hospitals and medical groups can afford to perform on their own.

A joint venture can be set up in many possible ways. The legal structure will depend on the strategic direction of the venture and the objectives of the panners. Whatever the structure, investors' ownership rights and the pathologists' compensation program must always provide incentive for increased market penetration, innovation, and creativity.

If the aim is to have primary care physicians involved financially but not operationally-so that they don't tell pathologists how to run the lab-a sister corporation holding title to the equipment can be established. Owned primarily by the referring physicians, this entity would lease equipment to the operating corporation (the laboratory organization), which would be owned by the pathologists. As a financial incentive to build up physician referrals to the joint venture laboratory, lease payments might be scaled to increase as test volume increases.

Frequently, alternative structures may be somewhat limited by the environment in which the laboratory currently exists. For example, if the pathologists are operating in a hospital-based lab, the hospital may not want to sell or lease its space and equipment to the new joint venture.

If the hospital has excess space available, however, it may be willing to lease space to the venture to expand current capabilities while improving the productivity of the hospital staff. In addition, the joint venture may arrange to purchase new or existing hospital laboratory equipment and lease it back to the institution as part of a contract to operate the hospital laboratory.

In any of these scenarios, the pathologists and other venture partners would have a management contract to run the laboratory for the hospital. This contract would include incentive clauses based on such standards as higher test volume and increased laboratory efficiency-more tests performed per full-time equivalent, for example.

Although satisfactory arrangements can usually be implemented, some incentive plans are precluded by Federal guidelines related to Medicare fraud and abuse statutes and internal Revenue Service regulations covering tax-exempt operations, including hospitals. The Medicare guidelines bar kickbacks for referrals. The IRS regulations limit incentives by prohibiting private gain for individuals in their dealings with taxexempt hospitals; hospital payments must be reasonable for the services provided.

There are many advantages to working with freestanding laboratories. These labs can contract to manage a hospital laboratory on an incentive basis, enter into a sale/leaseback agreement with the hospital, lease hospital lab space or both space and equipment, or simply enlist hospital and physician partners in a reference testing operation.

A laboratory venture composed of physicians has many opportunities to creatively invest in or manage businesses. In the rare instance when a hospital is fully occupied, the institution can free space for any desired purpose by reducing its laboratory operations to a level of Stat service only and obtaining an equity position in a freestanding reference laboratory.

The venture partners can participate in the operating contract or one or more investments in equipment. In addition, the physician partners' offices can be used as drawing stations to increase geographic coverage for either the hospital-based or freestanding lab model.

In each of these examples, all of the participants should improve their position. The pathologists gain by strengthening their affiliation with referral services, making their operations more profitable through increased volume, expanding their service capability, and improving their marketability to managed care systems.

Referring physicians share in profits from testing for their own patients and from other test work done by the joint venture-without spending any time managing laboratory operations. They also receive more input for the care of their patients.

The hospital can obtain more efficient laboratory service, develop stronger relations with the medical community, expand its market presence through the increased productivity of a freestanding rather than hospitalbased laboratory, share in the profit of outside reference lab operations, and possibly improve space utilization.

The largest stumbling block to the success of joint ventures is difficulty in setting up the right operating structure for management. All of the venture partners should provide input to the organizational structure and financial strategy of the venture, but experience has shown that those most familiar with the operations-pathologists and other laboratory professionals-should be responsible for day-to-day management.

Pathology management reports to the board of directors, which should consist of no more than seven partners, representing each of the major participating groups. The board should develop overall strategy and policies and review operating policies and results.

Success will depend on the ability to join together venture partners with common goals in a structure that has well-defined lines of authority and best meets investor needs.
COPYRIGHT 1988 Nelson Publishing
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1988 Gale, Cengage Learning. All rights reserved.

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Title Annotation:co-sponsoring new lab operations
Author:Porn, Lou; Price, Laura
Publication:Medical Laboratory Observer
Date:Jul 1, 1988
Previous Article:Developing better lab supervisors.
Next Article:Launching a hospital-based 2 + 2 MT program.

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