bargain or breaking point?
Bolstered by the consolidation wave, laboratories with some of the country’s
largest health care systems continue to aggressively standardize more platforms—not
only capitalizing on industry competition to get the best price, but also sometimes
finding new ways to share the risk of these large instrument acquisitions with
Could these tactics backfire?
Some industry analysts warn that laboratories are relying too
heavily on "vendor squeeze," as they put it, to improve their lab
operating costs. "If laboratorians drive prices and margins down
below the levels of other areas of technical medicine, innovation
will dry up," says business consultant Robert Bauer, president of
CaseBauer in Irving, Tex.
While laboratories are making short-term gains, Bauer believes
that lower margins will drive more diagnostics industry consolidation
and starve research and development. "It’s pretty clear that prices
can’t continue to go down and innovation to go up. And laboratorians
aren’t really comprehending that by the time they feel the effects,
it won’t be a reversible situation."
For their part, however, laboratory directors with large systems
can point to millions of dollars in savings on laboratory costs
as a result of consolidation. In negotiating contracts with instrument
vendors, size remains a powerful weapon for laboratories to bring
to the table.
North Shore Long Island Jewish Health Care System is a notable
example. With $3.5 billion in overall revenue per year, it is one
of the five biggest nonprofit hospital systems in the country—and
one of the few not losing money.
"It’s one system that actually makes a profit, and every vendor
wants in," says Thomas M. Sodeman, MD, chairman of laboratory medicine
for North Shore LIJ, located in Lake Success, NY. "When you have
32 blood gas machines scattered across the system and two or three
vendors in that market, that gives you a lot of buying power. It
becomes pretty competitive to acquire this contract."
Because of the range of its laboratory services—which include
supporting acute-care hospitals, serving as a reference facility,
performing nursing home and physician office testing, and conducting
clinical trial laboratory testing—North Shore requires a wide
range of instruments.
"Ninety-eight percent of the laboratory work ordered here gets
done in the system," Dr. Sodeman says. "When you get into the immunoassay
equipment, we have at least one of almost every product out there,
and the reason is the menus are all different and in order to get
the full depth of menu you end up having to get all these different
Negotiating clout isn’t the only advantage of North Shore’s size,
Dr. Sodeman notes. Since there are 18 hospitals in the North Shore
LIJ network, "we also have the ability to experiment and we can
bring in different instruments at different sites, with the idea
of taking a look at them for a period of time, maybe two or three
years, and getting a good feel for whether we want to sustain a
relationship and sign a contract for three years." For example,
the system recently placed two Olympus 2700s on a trial basis in
an 850-bed tertiary and pediatric hospital.
It makes good sense to have standardized equipment across an entire
system, because you can cut a better deal, quality control is more
consistent, and there’s no problem with lack of correlation, Dr.
Sodeman points out. But he cautions that there are disadvantages
too. "The last system I was in we had all one company’s equipment
everywhere, and when we had a chemistry problem, we were up a creek."
"There are always a couple of chemistries on every system that
don’t seem to correlate with what else you’re running," he continues.
"That’s true for all manufacturers, and that’s why some people go
with one line of products across the whole system." The trouble
is that North Shore services 5,400 beds, and like a passenger jet,
it needs redundancy in the system to ensure that any single breakdown
doesn’t grind the system to a halt.
"If we were to have the same chemistry analyzer everywhere and something goes
wrong with the reagents, or something happens with that product—it could
be the calibrators or a variety of things—then the whole system goes down,"
Dr. Sodeman says. "So what we do is maintain a set of equipment at the core,
and another set out in the hospitals, so for main chemistry and main hematology
we can always back up to the other resource."
ACL, the joint operating agreement between Illinois-based
Advocate Health Care and Aurora Health System in Milwaukee, Wis.,
is comparable in size to North Shore LIJ. It is just now finalizing
a contract for hematology equipment with Abbott Diagnostics, following
an extensive and highly structured acquisition process.
Cheryl Vance, ACL’s vice president of Illinois operations, says
having 23 hospitals across two states to some extent puts ACL in
the driver’s seat. "Because ACL is such a large organization, the
vendors are very interested in getting our business. They’ve been
very willing to be aggressive in meeting our time lines with request-for-proposal
information and in the pricing they’ve presented."
That has given ACL room to push for more favorable contract provisions,
she adds—ones that ask the vendor to share some of the risk
of the acquisition. "What we have done traditionally is either purchase
capital equipment and pay for reagents, or we’ve done leases," she
explains. "We are now working with vendors to do a cost-per--reportable
Under this type of agreement, says ACL general manager Jay Schamberg,
MD, "We don’t pay for installation, maintenance, and reagents separately.
We contract with the vendor to supply us with the capital and disposables
and maintenance to pay them on the basis of reportable tests. That
puts them at risk if the instrument doesn’t work well and requires
excessive maintenance or repeat tests."
Since this means the institution pays a fixed cost per reported
test, Vance notes, "when we do a CBC that’s reported back on a patient,
we know we’re paying that dollar amount, and there aren’t hidden
costs for duplicates for proficiency testing, controls, and so on."
Cost-per-reportable contracts are not common yet in the diagnostics
industry, Dr. Schamberg notes. "Laboratories have always been interested
in it, but vendors have shied away because there are no hidden costs"
such as computer paper, added maintenance, or "laptops you didn’t
know you had to buy."
But sharing the risk is not something that manufacturers are eager
to engage in. "We find that because of our size we seem to be able
to get very good pricing," Dr. Schamberg says. "Where we have some
issues is in terms. There are certain things our systems want in
protections that not all vendors are willing to do. If the instrument
malfunctions and causes a patient damage, is the vendor willing
to be responsible for any damage that can be attributed to their
instrumentation? Are they willing to assume some liability? There
are a couple of instances where we haven’t ’gotten to yes’ because
of terms like these."
Vendors often want to talk about being "partners" with the laboratory,
Dr. Schamberg adds. "To me a partner is somebody who shares substantial
risk. We’ve found, when we get down to really saying, Are we going
to share the risk, there’s suddenly a little less enthusiasm. Some
are willing to do it if we standardize on all of their platforms.
But we don’t think a single vendor can [cover all of our needs]."
Although the Abbott Diagnostics contract is far more significant,
ACL actually has a cost-per-reportable arrangement with a couple
of vendors already. Says Vance, "Diagnostica Stago was one of the
first organizations we approached to do cost-per-reportable pricing
for one of their coagulation tests, but it is relatively low-volume."
Two years into the contract, ACL has found it to be working well
and is now in the clinical evaluation process to reach a new systemwide
coagulation contract by the end of the year, to be followed by contracts
for chemistry and immunochemistry.
Vance feels that this risk-sharing creates a stronger partnership with the
vendor because both parties have a direct interest in maximizing the equipment’s
potential. For example, "if the equipment is set up to do automated differentials
with a linearity down to zero, and that was what was factored in the pricing,
we need to work with our clinical people so they accept that they should not
be doing manual differentials or to be running testing in duplicate when it’s
not appropriate in today’s market."
Sutter Health, the largest not-for-profit integrated delivery
network in the country, has found that standardization presents
unique challenges. While Sutter has not written risk-sharing arrangements
into its laboratory contracts, one of the IDN’s strategies as it
seeks to reduce the number of contracts with different vendors has
been to make more gradual transitions.
"Especially as large as we are, one of the significant issues
in contract management is to really try to get one vendor able to
adjust to the different needs of our affiliates. It’s very difficult
to come up with a single-vendor solution," says Robert Stephens,
a contracts analyst with Sutter’s corporate offices in Sacramento,
Calif. "If we were all strictly acute-care hospitals or all outpatient
facilities, it would be much easier."
To ease the transition process, particularly with regard to capital
expenditures, the vendor that Sutter chose recently for its coagulation
standardization "is not pushing us directly for an analyzer conversion
right off the top," he says. "They’re saying rather than convert
X number of analyzers in the next three years, we’ll replace
analyzers with the vendor’s brand just as they come up for replacement
over the next five years."
As Sutter looks toward potentially standardizing immunoassay and chemistry
in the next few years, the longstanding relationships the various affiliates
and vendors have developed pose hurdles. "The issue is not really platform-specific;
it’s just that who the affiliates have been working with goes a long way in
determining who they will be comfortable dealing with in the future. There’s
no perfect analyzer, by any stretch. But most of the affiliates have been working
with their vendors for years; they know the ins and outs of a platform—they
have adapted to or accepted its shortcomings and know how to work around them."
Laboratories make far fewer demands on administrators than
do other hospital clinical departments, Bauer contends. "We’ve had
administrators tell us that on a dollar basis, the laboratory is
the least complicated, controversial, and aggressive part of the
institution they deal with. If you look at other areas, those departments
are coming to administrators with demands and justifications for
making additional expenditures in order to improve. They’re actually
selling them on investments that will improve medicine, decrease
downstream costs, and save manpower or save on supplies over a period
"But laboratories almost always come to the administration with
noncontroversial proposals that are cost-neutral or cost-favorable.
’This doesn’t cost anything—is it okay?’" Rarely will they
sell administration on labor savings, better medicine, or lower
downstream costs. "As opposed to radiology, for example, which might
say we need a million-dollar investment to improve services and
reduce expenditures over the next five years," Bauer says.
The laboratory budget numbers are high, he says, but in terms
of capital expenditures, they’re not high at all. "They’re not competing
for the capital equipment dollar or selling the value of innovation;
they are avoiding that challenge," he says.
In periodic surveys of hospital administrators over the last decade,
CaseBauer has found that administrators have gained little awareness
of laboratory vendors or products. "Most administrators consider
the laboratory as something that almost runs on autopilot; they’re
rarely challenged to make a difficult decision or immerse themselves
in a laboratory product analysis."
This pattern may explain, for example, why total laboratory automation
hasn’t done as well as might have been expected, he says. "Sure,
in small operations the equipment doesn’t cost-justify. But considering
the degree of laboratory consolidation and the size of some laboratories,
it’s clear the market is undersaturated or not at its potential,"
he says. "But laboratory automa-tion is one area where you have
no choice but to go to the administration and sell an investment,
and there just aren’t that many laboratories that are skilled or
interested in doing that."
Bauer says the physical consolidation of laboratories may have
stabilized, if not peaked, because laboratories are asking at what
point the tradeoff is optimized. "I’m not sure more consolidation
is going to outweigh the benefits of reduced turnaround time," he
says. "Lots of proposals on the table for more laboratory consolidation
have actually fallen through. We’ve run into laboratories that have
decoupled or loosened up their consolidation strategy. For more
highly automated processes like clinical chemistry and immunochemistry,
once you’ve thinned your management, what happens when you consolidate?
You just end up putting more instruments in one location with the
same manpower requirement. How much economy are you really getting?"
Bauer is particularly critical of conventional risk-sharing expectations,
which, from the manufacturers’ point of view, is often "risk-shifting"
without an upside benefit. "Is it a partnership if you ask the supplier
to cut the price, broaden the definition of test to include a lot
of ancillary costs, carry the capital equipment cost and risk, cover
any supplies management shortfalls, and, if he really wants the
business, take on some legal liability?"
For their part, laboratories do show manufacturer loyalty, Bauer
says, which might explain why fewer products are being considered
in laboratories’ purchase cycles. "If someone has a relationship
with one specific manufacturer, that manufacturer does things over
the term of the contract to build favor; they’re giving considerable
goodwill going forward. I think that’s generally been the nature
of partnerships: Treat me right and I’ll give you preferential treatment."
And, he points out, the administrators aren’t coming down to the
laboratory people and pressing them to make an exhaustive comparison
of multiple manufacturers. "If they were asking for a million dollars,
the administration would say, ’What are the other options?’"
When asked about risk-sharing’s potential negative effects, ACL’s
Vance concedes, "I think we’re pushing the envelope."
"It’s a new concept," she says, "and some of the vendors are having
trouble understanding what’s included in a cost-per-reportable.
We’re also asking them to give one cost-per-reportable for all of
our locations, whether it’s a 900-bed hospital or clinic seeing
50 patients per day, and because it’s a new concept, the vendors
often have to structure data differently in their own organization."
Both the vendors and ACL are still learning what types of data
are needed to ensure the equipment is being used optimally, she
adds, and the contracts take this into account. "We typically build
in a range, so that if the volumes used for the negotiating process
go X percent over or under, it’s a trigger for either party
to come back to the table and look at the pricing again."
Bauer cautions that if laboratory professionals remain relatively
insensitive to the manufacturers’ tight margins, it will come back
to haunt them. "In the past, some manufacturers have been driven
to ’cave’ during price negotiations and, even though they were bringing
innovation to the laboratory, they felt obligated to make price
concessions," he says. "The manufacturers were trying to compete
too aggressively on consolidation of services, broader offerings,
and cost reduction, so they kind of fed on themselves and brought
the margins down in the industry."
Unlike other technologies such as computers, for which manufacturing costs
drop as technology evolves, Bauer says, "a lot of the innovation in diagnostics
relative to improving laboratory operations is not being delivered on a more
economical basis. "These benefits are coming from increased and costly mechanization,
not better science. These are mechanical products—steel, motors, syringes,
’rust-up’ subassemblies that just cost a lot more money on a per-test basis,"
How will laboratorians, accustomed to an almost unending
stream of innovation, react to a less dynamic diagnostics industry?
Isn’t the need for innovation perpetual?
The industry’s R&D investment level, as a whole, is declining,
as is venture capital interest, according to Bauer. "It’s a trend
that warrants some consideration. The big blood-screening laboratories,
for example, are incredibly strong buyers in the U.S., and very
cost-sensitive, but they have a long history of being careful not
to shop innovation out of the market. They have been careful to
foster innovation and preserve competition in the way they award
contracts and structure their partnerships."
Others express skepticism that innovation is at risk. In fact,
Dr. Sodeman says, vendors may have innovated so much that laboratories
are reluctant to lock into long-term contracts. "Vendors want contracts
to go out five years or more, but we’ll frequently write them in
the three-year range because the technology is changing so fast.
We want to maintain our options out there."
If there is a gap in technology advances, it is for the smaller
hospital laboratory, Dr. Sodeman says. "A lot of manufacturers out
there are driving toward instruments with very high throughput and
very fast speed, and that’s not necessarily a demand in this rapid
response market," he says.
"The small labs that combine chemistry and hematology generally
do 55 or 60 tests, and you end up with multiple instruments sitting
around," he continues. "Sometimes quality control and maintenance
cost more than the tests you run through it. We need analyzers that
combine both straight chemistry and immunochemistry with a small
footprint and where throughput -isn’t that critical, and people
aren’t designing equipment for that environment. I guess there hasn’t
been enough consolidation yet."
Bauer’s research confirms that the diagnostics industry has not
been focused on smaller hospitals. "If you went back in the ’70s,
manufacturers were targeting the 200- to 400-bed hospital because
it was less demanding and more profitable. Now the target institutions
are larger because of consolidation. The majority of work is being
done there, or controlled from the larger laboratories. But will
it be going another step up? I don’t know that I see that in the
near term, particularly with laboratories’ timidness toward robotics
CaseBauer did a study in 1993 that predicted "the economies of
scale beyond what’s associated with a typical 600-bed hospital were
not significant," outside of densely populated cities like New York
or Atlanta, Bauer says. "After that, your size has exceeded the
available instrumentation, and you have transportation issues to
Says Sutter’s Stephens, "I honestly can’t say I take vendors’
research and development into consideration in the development of
our contracts." He believes that R&D occurs in the marketplace regardless
of a specific relationship, and that the market as a whole is going
to determine where various platforms are heading. "I don’t know
that a partnership between an IDN and a specific diagnostic laboratory
company will inherently culminate in anything significantly different
than what might otherwise occur," Stephens says.
Vance feels that ACL has been responsive to many of the vendors’
needs, especially in working with them on developmental projects
or participating in feedback panels to help vendors understand what
the marketplace needs and how to develop products that are more
However, she warns that laboratories may not like finding themselves
on the receiving end of consolidation wherever the number of vendors
dwindles. "As the companies continue to merge, it sometimes impacts
their service levels and product development, and it’s something
we’re always keeping an eye on."
"For example, in the blood bank reagent market, there’s been consolidation
after consolidation, and it’s now down to two vendors," she notes.
"The pricing for traditional blood bank reagents keeps being increased—literally
multiple times on an annual basis, and neither of the vendors now
can handle the entire market, so there’s no negotiation leverage
for any size organization." Vance is not concerned at this point,
though, that the same will occur for the larger product lines. "I
may be very Pollyanna-ish, but I don’t think in most cases the market
will allow that to happen."
"I worry about whether some vendors are going to be around," Dr.
Schamberg says, noting that two computer vendors were acquired in
the last year. Several of the major companies seem to be committed
to the diagnostics industry, but not all of them, he suggests. "As
things get bought and sold, it does change the marketplace. It changes
people’s commitment, and you have to factor that in when choosing
a vendor. You want them to be there."
That commitment factor is one reason why damage to one of the
parties to a laboratory contract can cut both ways. It’s more than
an issue of who holds the most cards, Dr. Schamberg says. "We need
to work with vendors on standardizing a big platform like hematology,
because the reality is the relationship, if it works, is probably
a 10-year relationship going forward. When we negotiate with a vendor
we don’t want either party to walk away feeling beaten up and having
Dr. Sodeman agrees. "I don’t know what the vendors’ margins are,"
he says. "What I do know is that as a purchaser I don’t want to
drive a company to a margin that is not comfortable for them. I
don’t want somebody to come in here and put something in under cost,
because they’ll be unhappy. And there’s nothing worse than having
a piece of equipment and an unhappy vendor."
Anne Paxton is a writer in Seattle.