College of American Pathologists
Printable Version

  Owning, rather than buying, reference lab





cap today



March 2006
Feature Story

Tony Sullivan

In most medical circles, "MCL" is short for medial collateral ligament, that powerful band of human connective tissue that links the upper and lower leg and helps stabilize the knee. But for a group of 23 not-for-profit hospitals in the Midwest and East, MCL stands for something different—the Michigan Co-Tenancy Laboratory.

As a uniquely structured esoteric reference laboratory, the MCL is far from a band of human connective tissue, but it serves a purpose similar to that of the ligament. It provides a beneficial connection, but in this case it’s a bridge between the hospitals that belong to the MCL and the opportunity to reduce the cost of offering esoteric lab tests. And by making that connection, the MCL helps these hospitals stabilize—in fact reduce—laboratory costs.

The concept behind the MCL is this: Economically unrelated not-for-profit hospitals jointly own and use the assets of an Ann Arbor, Mich.-based regional esoteric reference laboratory—Warde Medical Laboratory—through an arrangement known as "co-tenancy." They do so to reduce the cost of testing services through economies of scale created by pooling their testing volumes.

As a co-tenancy, the MCL provides each owner with an equal and undivided interest in the MCL’s assets. An owner makes a modest capital contribution to secure an ownership position, and the testing that is done for each owner is performed on that owner’s share of the equipment, with that owner’s share of the reagents and by that owner’s share of the staff. Each owner bills for the testing under its own name. And all owners have representation on a governing body, with voting power determined by the same method used to allocate testing costs: A co-tenant that incurs a certain percentage of testing costs will have that same percentage of votes at the governing board level. In other words, voting authority is directly proportional to usage.

Cost allocations are determined by assigning a relative value unit, or RVU, to each test performed in the MCL, and each owner is charged an interim fee for each test and billed monthly. The fees are deliberately set above what the actual costs of the tests are expected to be to provide operating cash for the MCL. At the end of each quarter, the total number of RVUs performed in the laboratory is divided by the same period’s total costs to arrive at a cost per RVU. Each owner’s total RVUs for the quarter are calculated and multiplied by the cost per RVU. The result is that owner’s allocated cost of testing. A reconciliation is then done for each owner, which receives a rebate or refund for the difference between what it paid in interim fees and what its allocated costs were for the quarter.

This volume-based operating concept has proved to be a financial winner for the 23 not-for-profit hospitals—located as far west as Des Moines, Iowa, and as far east as Silver Spring, Md.—that have combined their purchasing power in the MCL. They have saved from five percent to 20 percent on a cost-per-test basis when compared with the cost of having the same tests performed at commercial, for-profit reference laboratories.

By charter, the MCL includes only not-for-profit hospitals, a decision made not because of the legalities associated with the co-tenancy operating structure but because of practicality, says Dennis Hodges, manager of business development for the MCL. "If for-profit hospitals were involved it would have different and greater tax implications," he explains. "By restricting it to not-for-profits, we avoid that. But there is nothing illegal about for-profit entities forming a co-tenancy."

Hodges and the management team of Warde Medical Laboratory and MCL’s not-for-profit hospital members are sure there are no legal pitfalls for the MCL and its owners to step into because they conducted a thorough due diligence study to make sure of that. Unlike condo or pod labs, which typically involve physician ownership, are operated as profit-making ventures, and can run afoul of physician self-referral prohibitions, the MCL steers clear of potential legal pitfalls because of its strategic decision to include only not-for-profit hospitals among its members. "It allows hospitals to gain no particular benefit relative to what the payers pay," Hodges says. "It only allows them to gain benefit on reducing their own costs."

The MCL’s only potential exposure to liability relates to running afoul of laws governing tax-exempt entities, Hodges adds. But the MCL’s legal counsel has ensured that no exposure exists for the MCL in that arena.

Hodges and other members of the MCL believe the co-tenancy concept has been one of the best-kept secrets in laboratory operations. And it offers hospital laboratory managers important benefits that can help them confront the challenges they face each year with orders to slash their operating budgets to cope with declining reimbursement. "In my view, co-tenancy is a relatively risk-free opportunity," Hodges says. "It’s an opportunity for hospitals to join together in a spirit of cooperation and gain benefit."

Among the key benefits the MCL offers its co-tenants: an ownership position in the assets of a regional esoteric reference laboratory; esoteric testing done at cost; use of a reference laboratory’s assets to fit a hospital’s individual needs; shared and equal governance with other owners; and direct billing for all services performed in the shared lab.

Though many prospective co-tenants in the MCL say it sounds too good to be true, it’s no fairy tale, says Craig Killingbeck, an executive with Novi, Mich.-based Trinity Health, a member of MCL since its inception in 1997. Trinity, the fourth largest Catholic health care system in the U.S., has several system hospitals participating in the MCL. Killingbeck is the system’s representative on the MCL’s administrative committee, which serves as the governing board.

"The real advantage of the model," he told CAP TODAY, "is that we can operate at cost, so no matter how low somebody else can set their pricing in the for-profit world, when we set our pricing for the co-owners we are operating at our own cost."

"If you’re not a volume model like this one, that equation doesn’t work," he adds, "But if you bring enough people into the model, it works extremely well."

A second advantage is that every hospital involved in the MCL is a part owner of the co-tenancy, says Killingbeck, executive director of capital asset management and strategic sourcing in Trinity Health’s supply chain division. "So each hospital has a board seat and an equal role in governance. There aren’t very many models where you actually get to control the way the lab does its work. So it’s truly an advantage to the owners." Quarterly board meetings are held at which all issues related to quality and cost— "in that order," Killingbeck says—are discussed.

No. 3 is the quality of the operation itself, Killingbeck says. "We’ve had a long time to get it right. We’re in an area in the southeast corner of Michigan that is a rich environment to draw on as far as quality pathologists and laboratorians. It’s an extremely well-run lab that Trinity is lucky to be associated with."

Worries about quality arise often among prospective co-tenants who are on the fence about whether to shift their esoteric testing from a commercial vendor to the MCL, Hodges says. So do concerns about severing established ties with an existing vendor and having to set up new computer interfaces and reporting systems with a new vendor. "That in and of itself is a major undertaking and something not to be taken lightly," he admits.

But worries about losing control over the testing stands as the chief obstacle to attracting new co-tenants for the MCL, Killingbeck says. "Everyone wonders if they will lose control of the quality of the work that is being done," he says. So the first thing Hodges does to overcome that is to explain the MCL financial model and, more important, get them out to the lab to look at it. "And then let them talk to any of the MCL members about their experiences. It’s usually a pretty easy sell after that," he says

What makes it such an easy sell? "They get inside the lab and see the quality of the work being done and the level of the staff involved," Killingbeck says. Some of the pathologists and laboratory professionals at Warde Medical Laboratory have national prominence, among them the lab’s medical director, David Keren, MD. "They quickly understand the level of the quality they’re looking at because they are laboratorians too. They know what it takes to run the lab, and they know a well-run lab when they see one," Killingbeck says.

The site visit usually seals the deal, Hodges agrees. But he says a side-by-side cost analysis, comparing the cost of a set of tests conducted by the lab’s existing reference lab with the cost of the tests if they were done at MCL, works well too. With that evidence in hand, the decision to join the MCL usually comes down to a simple choice of paying the prices commercial labs charge or becoming an owner and getting the testing done at cost. "We assure them there will be absolutely no sacrifice in the quality of work because we are a first-rate lab run by a first-rate medical director, and there will be no compromise at all in the level of service," Hodges says. "So it comes down to a matter of whether they want to own it and reap the rewards of lower cost and get a seat on the board of directors or whether they want to buy services at market prices."

Killingbeck says potential co-tenants are often skeptical at first because "it sounds too good to be true."

"They usually have to run the numbers a couple of times to convince themselves that the savings the MCL says it can generate for them are accurate," he says.

David Eilers, director of laboratory outreach at Mercy Medical Center, Des Moines, Iowa, an MCL owner since 2002, was one of those skeptics of the MCL and the co-tenancy concept when he was introduced to it. "None of us were terribly excited about it before making a site visit," he admits.

Most of the Mercy team’s unease came from the unknown. "We had never heard of the MCL or the volume-based model," Eilers says, "and we had never heard of Warde Medical Laboratory."

But after visiting the MCL and speaking with the medical and operations staff there, their reservations disappeared. "On the plane ride home we were all trying to figure out how quickly we could make the change," he says. Most appealing about MCL? "The customer service and the willingness to serve our patients like we do," Eilers says.

Mercy’s decision to become an owner in the MCL was a good one. The hospital saw a 17 percent decrease in its outsourced esoteric lab testing costs on a per-unit basis in its first year as an MCL owner, says Eilers, and it has had similar savings every year since.

MCL’s aim is to operate at cost and to bring in new members so it can add volume and reduce its fixed costs, Killingbeck says. "So we expect year-over-year savings on a cost-per-relative-value-unit basis."

MCL has achieved that expectation every year it has been operating except for the years in which it made a financial investment to create greater efficiencies or generate improved returns, Killingbeck says. "Except for a couple of years when we had to do an expansion of physical space, we’ve had the ability to steadily decrease costs year-over-year." In hospitals, he adds, nearly every department is asked to cut its costs because its reimbursement declines. "Here is one way where all of our hospital members can actually expect to receive savings every year. I run very few other things in the hospital arena where I can say that."

Tony Sullivan is a writer in Wheaton, Ill. Direct questions about the MCL to Dennis Hodges at 800-876-6522 or