IVD test platform consolidation, laboratory standardization & lab automation

CAP Today, August 2002 Cover Story
by Anne Paxton

Bolstered by the consolidation wave, laboratories with some of the country's largest healthcare 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 the vendor.

Could clinical laboratory cost reduction 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, Texas.

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 analyzers."

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 7200s on a trial basis in an 850-bed tertiary and pediatric hospital.

Pros and Cons of standardized laboratory equipment

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."

One way of risk-sharing: pricing based on cost per reportable tests

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 arrangement."

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 of time."

"But laboratories almost always come to the administration with non-controversial 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.

The market for laboratory consolidation and laboratory standardization is undersaturated

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 automation 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 good will 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," Bauer says.

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.

We need more test platform consolidation of chemistry and immunoassay analyzers

"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 and automation."

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 deal with."

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 user-friendly.

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 lost something."

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.