College of American Pathologists
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Pitfalls and payoffs of a cooperative core laboratory

August 2000
Anne Paxton

TriCore Reference Laboratories, a merger of three integrated health care systems’ laboratories, may not seem unusual in an industry grown accustomed to consolidation. But since 1998, when the Albuquerque-based core laboratory was formed, consolidation has been dealt a rude reality check. In San Francisco, where health care publications only last year proclaimed "Consolidation is king," the merged UCSF Stanford Health Care was forced this year to a complete split, amid huge operating losses widely blamed on culture clashes. All of the health system’s services, laboratory testing included, were divorced in the process.

Nevertheless, TriCore intends to prove that it has successfully merged disparate entities-academic research laboratories, hospital-based testing, and commercial laboratories-into a cooperative, not-for-profit company. "With the unwinding of the UCSF Stanford merger, I think we all need to think about the culture issue. A very important part of the model we have at TriCore is getting that to work," says Linda Cole, PhD, president and chief executive officer of TriCore.

Dr. Cole described the laboratory as a case study in consolidation at the Executive War College on Laboratory and Pathology Management, held in May in New Orleans. One of her messages: Forming a core laboratory on a cooperative model can bring large savings to sponsors by providing them with testing at cost, but there is plenty that can interfere with the best-laid business plan.

In recounting TriCore’s history to date, she pointed to three key challenges: integrating the information systems, consolidating the technical services for anatomic pathology at a single site, and coping with the different cultures of each stakeholder in the merger.

The day it officially opened, on July 1, 1998, TriCore instantly became the largest laboratory in New Mexico. But the market it serves is not all that unique, said Robert Michel, editor of The Dark Report, which sponsors the Executive War College. He compares TriCore’s market, covering eastern Arizona, southern Colorado, and west Texas in addition to New Mexico, to a number of smaller urban markets around the United States, in which consolidated laboratories can successfully reach out to serve an extended, relatively rural area.

TriCore brought together Presbyterian Health Care Services and the University of New Mexico Health Sciences Center, both in Albuquerque, and St. Vincent’s Hospital in Santa Fe. Included in the merger were three hospital-based laboratories, two independent laboratories doing commercial work, three pathology groups, and four academic-based, highly esoteric testing laboratories: a hematopathology service, a cytogenetics molecular diagnostics laboratory, an immunogenetics transplant laboratory that provides transplant services for all of New Mexico, and a virology laboratory.

Why a cooperative structure? Cooperatives are useful for sponsors who are less interested in equity buildup or dividends and more interested in achieving direct savings, Dr. Cole says. She cites four key features. First, a cooperative’s members have equal voting power, or unequal voting power requiring a majority or supermajority of members to assent to bylaw amendments. Second, economic benefits are distributed on an equal basis in proportion to the use made of services. Third, the return on capital is limited. Finally, cooperatives do most of their business with their own members.

"The primary push of a cooperative is not to provide a return on equity, but immediate savings to owners or users as you get more efficient," Dr. Cole explained in an interview with CAP TODAY. TriCore’s goals were threefold: to reduce unit costs, to improve market competitiveness, and to provide at-cost testing to its sponsors. "Like everyone else, we were losing market share to the national laboratories," she adds.

The business plan was ambitious. It included a high-production core facility in Albuquerque, rapid-response laboratories in the hospitals, staffed and managed by TriCore, plus the specialty labs, six branch laboratories performing waived and moderate-complexity testing, and six patient centers. In the plan also were the integration of information services and an aggressive marketing blueprint projecting 12 percent growth in years 1 and 2, and 10 percent growth in years 3 through 5.

Those were overly ambitious targets, Dr. Cole concedes, mainly because of TriCore’s No. 1 challenge: implementing the information system. "The business plan called for an interface engine to be installed by October 28, 1998, which would provide communication with all our sponsors’ interface engines and their systems. But we very quickly found out that was impractical."

Instead, TriCore contracted with a new LIS vendor and was able-although beset by unscheduled Y2K issues-to go partially live with the system in December 1999, with the remaining systems to be added on soon. "Dealing with multiple computer systems has been very difficult," she says. "It’s really what has prevented a lot of the cost savings from occurring."

A close second on the list of challenges was the consolidation of histology and cytology to a single site off the hospital campuses. Dr. Cole says, "In the first six months there was a plan to consolidate all these activities, and we went along really comfortably; we built a state-of-the-art lab and moved everybody over there. But a year and a half later, we are still trying to make this work at a level that satisfies patient needs and our pathologists’ practice patterns."

Dr. Cole, who was part of a pathology group for 13 years, attributes the difficulties to the complex logistics. "If you’re in academic pathology, you practice a little bit differently from a community-based pathologist. You have residents you have to sit down with; you have a careful mechanism by which they screen slides first and then sit down with a senior-level pathologist. And all of this has to be accommodated in the scheduled turnaround time for these slides. And within pathology groups themselves there are a lot of differences of opinion; they are very independent in their thinking."

The logistics of transferring slides and tissues and returning them to the pathologists were much more complex than the logistics of the clinical laboratory, she adds. "What we really had to do when this was not working is something we should have done beforehand. Now we have carefully mapped out the process, developed clear goals and standards for turnaround time, and gotten all the pathologists to agree on it."

In fact, TriCore generally sought to develop an aggressive atmosphere, Dr. Cole says. The company culture emphasized getting things done, not being satisfied with mediocrity, not withholding information, and promoting continuous learning. "But as the textbooks say, culture takes years to develop. We found there were some disparities in this culture development, and we’re still dealing with them."

The stakeholders were varied, she stresses. For example, "We had some groups that asked before they did anything. We had other groups that had a lot of autonomy, and there was allowance for mistakes within that autonomy." Some groups were cautious about information sharing, and others willingly shared information. Chain of command was clear in some cultures, not clear in others. Some stakeholders focused on education and research, while others were primarily interested in business objectives-"just give me the numbers."

On the overall strategic issues, there was good communication among the different sectors-the hospital CEOs, the academic department chairs, the research pathologists, and so on-she says. "But when you get down to the details, it’s a lot tougher. You really have to go at it in multiple ways to make sure communication occurs. And the rumor mill is a little harder to control in these settings."

When St. Vincent’s executive leadership changed completely in 1999, Dr. Cole faced an added challenge. "You find yourself in the role of constantly communicating and coming back to what your mission and vision is and why it really has value. And it’s very important to continually do that. I’m very impressed with how other networks can accomplish it dealing with more than three stakeholders."

She views her role as coordinator of information for the sponsors, and she cites several communication channels TriCore has adopted. Among them is a Laboratory Agenda Planning Group for each sponsor, a group that meets at regular intervals and includes the CEO, the laboratory administrator, the medical directors, and key managers who oversee the site. In addition to attending separate quarterly meetings with the sponsors’ executives, she goes out on "town hall" meetings every quarter, holding 12 to 17 meetings with employees on all shifts at all locations. Employee sessions include the same financial indicators presented to the finance committee of TriCore’s board, she notes.

Another feat at which TriCore has been successful is managing transfer pricing, Dr. Cole says. Transfer pricing-that is, the prices charged for intra-firm transactions like those between the sponsors and the cooperative-may be market-based or cost-based. Many laboratory executives have been interested in TriCore’s model, she points out, because "in consolidated entities where you have integrated health care systems, a big part of the value of a core lab is in reduced costs per test." By pricing services at cost to sponsors, TriCore is able to drop the prices as efficiency improves.

The sponsors’ transfer pricing consists of two components: the costs of the rapid-response labs, which are passed through to sponsors, and core lab transfer pricing. By re-evaluating direct costs every six months, TriCore tries to keep pricing fair and equal for all sponsors. The company’s pricing model is distinct, Dr. Cole believes. "We’re actually giving them testing at cost; therefore, our methodology is a little bit more complex, because we are dealing with three different integrated health care systems and we’re reflecting differences in test complexity."

A complication for TriCore is New Mexico’s 5.1825 percent tax on medical services, one of only a few such taxes in the country. "New Mexico’s economy depends on this source of revenue," she says. The sponsors didn’t have to pay this tax on laboratory services before the core lab was formed. "Now, when we do this cost-based testing, we must then add on this tax." As a result, for the sponsors to save money on testing, they have to have a volume that gets them beyond the tax.

Is it worth it? The sponsors believed they could justify the additional tax because their savings would add up to more than the loss on the tax, Dr. Cole says. "We did a pre- and post-TriCore year 1 study, and two sponsors, even with the tax add-on, showed savings, and one showed neither a gain nor a loss. We’re confident that sponsors can realize savings once we complete the IS integration."

Tests performed on site at the core laboratory are charged to sponsors using an "80/20" rule, Dr. Cole says. "If a sponsor sends over 100 tests, we take 80 of those with the top volume, like metabolic panels or CBCs, and do an actual cost per test. For the remaining 20, which might contain some rarely ordered or esoteric tests we do not individually price out, we do a blended rate, or an average cost per test."

Added to this price is a base cost per test, which covers the cost of providing a processing area in the core laboratory, and an overhead allocation. "The overhead allocation is the controversial part of transfer pricing," Dr. Cole contends. Since 60 percent of TriCore’s revenues are from commercial testing, the sponsors’ overhead allocation does not include commercial overhead costs such as patient draw sites or the statewide courier network charges.

The formulas for allocating overhead in the rapid-response laboratory are still evolving, Dr. Cole notes. Initially, each sponsor was assigned one-third of the cost of human resources, a fourth of the cost of information systems, a third of accounting costs, and so on. Now, however, for a transitional period, she says, "we have two methods that we’re averaging." This helps compensate for one sponsor’s information system not being completely integrated yet. Eventually, TriCore plans to calculate prices using a relative value unit, which, in simple terms, will be the direct cost per test, divided by the total volume, times the sponsor volume.

While cost per test is the most important figure at TriCore, the company regularly compiles other financial indicators, Dr. Cole says. Each month, TriCore analyzes its budgeted volume, the budgeted variable cost, and fixed cost. "We dissect this to see what our cost per test is and what our variance is. This is a very powerful tool-both for budget compliance and as a productivity tool."

One figure that did not look good in 1999 was DAR, days in accounts receivable, Dr. Cole reports. "In the middle of all this culture development and implementing a new computer system, we had a major operational problem, causing our AR to be down for six to eight weeks." This failure required double staffing of the billing office and had a profound effect on average age of receivables, but the situation has improved, she says.

Among other financial indicators TriCore calculates, "we find average volumes per business day to be very useful, and we look at salaries and benefits as a percentage of net sales in a cumulative fashion." All of these have been helpful in letting TriCore focus on the real costs incurred by consolidating laboratory services.

Dr. Cole adds, "I think everyone in the industry has the concept that you push everything to the core lab and that’s how you’ll drive costs down." In many cases, that’s true, Dr. Cole says, but it’s not guaranteed. "We’ve all been on the bandwagon of the core lab for so long that we need to stop along the way and realize some price structures have changed."

Toxicology is one area where sending tests to the core laboratory was not effective, she says. With one sponsor, a level-one trauma center, the necessary turnaround time on certain toxicology tests was not met by sending the tests to the core laboratory, and a few tests were moved back to the rapid-response lab. In another case where retrenching was required, under the original business plan, Presbyterian Health Care Services was supposed to download to the core lab all the routine testing like CBCs and metabolic panels that the physicians require for first morning rounds. "One day in late 1998 we tried to do this and we did it for about eight hours." It didn’t work, she says; "we pulled it back."

Presbyterian now does about 20 percent of its volume on site and sends the rest to the core laboratory, while the University of New Mexico, which hasn’t yet integrated TriCore’s information system, does 60 to 70 percent of its testing on site and sends only about 30 percent to the core laboratory.

One of TriCore’s success stories, Dr. Cole says, is the separation between the university’s research and education costs and the true costs of laboratory testing. "In discussions before the formation of TriCore, the sponsors agreed to the guiding principle that the commercial entity would not subsidize the research needs of the university." All the medical directors meet in a technical council, she says. "Anybody desiring to do research brings a format to the council for that research. And if it involves a direct benefit to commercial activities, it can be approved and funded through TriCore. If it does not, we find other ways to fund it, and the universities support us in that regard."

As TriCore starts its third year, Dr. Cole maintains, many of the early stumbling blocks have been overcome, but the meshing of business needs with education needs continues to be challenging.

"Can an aggressive independent laboratory successfully merge with an academic-based laboratory? This is where the whole culture thing comes into play, and also the need to serve the education and research mission in an academic institution," Dr. Cole points out. "In two more years, we’ll see what the real answer is." She predicts it will be "yes."

Anne Paxton is a freelance writer in Seattle.