Medical Services
Clinical labs, in a fix a few years ago, thrive on price hikes, advanced tests
By Gloria Lau
Investor's Business Daily
investors.com
Industry Snapshot
Monday, August 13, 2001
The medical services industry — traditionally a commodity business — is fast turning into a specialty business. Until a few years ago, lab tests could help doctors figure out only whether you had a disease.
With advances in genomics, new gene-based lab tests help doctors choose treatments and then gauge the results in patients with diseases such as HIV and hepatitis.
Doctors use HIV resistance tests, for example, to find out whether a certain drug cocktail will work in an HIV patient or if a different mix might be better. The tests also tell whether the patient will become resistant to the drug within a few months.
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These complex gene-based tests are just the latest attempt by the industry to boost margins and raise prices.
In 1997, the biggest clinical lab company in the country raised prices and canceled its exclusive contracts with managed care insurers. That has worked well. Prices have risen in the mid- to high-single digits across the industry. But how long can labs raise prices on the same old commodity tests? Realistically, insurers will pay only so much for a Pap smear.
That’s why the lab companies have turned to gene-based tests.
“These kinds of tests weren’t available four or five years ago to help doctors manage disease,” said Thomas MacMahon, chairman and CEO of Laboratory Corp. of America (LH). “We’re seeing the use of these tests as critical to disease management by physicians.”
At least one major lab has also started selling tests directly to consumers — yet another way to boost profit. To boot, consumers pay cash. The lab company swipes a charge card and doesn’t have to fill out a stack of documents for Medicare. That’s an immediate payment vs. a month’s wait.
1. BUSINESS
Today’s biggest clinical lab companies — Quest Diagnostics (DGX) and Lab Corp. — benefit from new technologies. They get to sell new tests for higher prices and at higher profit margins than their bread-and-butter commodity tests.
“Not only does it tend to be a higher-growth, higher-margin business, but esoteric testing cannot be done by most hospitals, and commercially available kits don’t exist,” said US Bancorp Piper Jaffray’s Bill Bonello. “Most hospitals can’t generate enough scale to justify the costs involved.”
Bonello estimates gross profit margins from molecular test approach 50%. That compares with Quest’s overall gross margin of 41% and Lab Corp.’s 43.8% in the second quarter.
Quest is also entering the consumer business. It opened 20 storefronts in strip malls in Colorado, Utah, Montana, Missouri and Kansas where anyone can walk in, plunk down $45 and get an osteoporosis test, a cholesterol test or two dozen other tests.
“We think we’re tapping into a megatrend here,” said spokesman Gary Samuels. “People are getting more interested in their health care, and they’re willing to spend a lot of money for information.”
Name of the game: Boost prices and grow margins. Commodity tests may still be the industry’s core business, but margins are low. Smart labs find high margins tests like gene-based ones — or even new business lines.
Analysts can’t pin down why Lab Corp. has higher margins than Quest, but Lab Corp. brought in pretax margins of 11.1% last year. Quest had pretax margins of 7.4%.
“Unfortunately none of us gets that level of detail or look into their business,” Bonello said. “I’m speculating, but (maybe) Lab Corp. is more profitable because . . . esoteric (gene-based and other) tests make up a bigger percentage of their total revenue.”
2. MARKET
Big labs like Quest and Lab Corp. are relieved that hospitals don’t offer gene-based tests. Quest, Lab Corp. and most of the publicly traded labs are among the “independents” that make up 25% to 30% of the entire $34 billion lab test business. Hospitals control 60% to 65% of the lab business. Doctors handle 7% to 8%.
Of the $9.3 billion independent lab sector, Quest controls 41% and Lab Corp. 20%. The rest is controlled by smaller independents.
Analysts say Quest and Lab Corp.’s fiercest rivals aren’t other independents, but local hospital labs. Quest and Lab Corp. get the bulk of their business from doctors’ offices. The local hospital labs also compete for that business.
Besides, hospitals interpret a lot of their own lab tests in-house. Bonello says the Quests and Lab Corps. of the world may not be able to win a lot of this business because it’s internally processed.
3. CLIMATE
The mid-1990s were a low point for the industry. Managed care companies had slashed reimbursements for five straight years. But in 1997, Quest acquired its biggest rival — SmithKline Beecham’s lab unit — and this gave it muscle to battle the HMOs.
“We really focused on ensuring that we were reimbursed appropriately,” said Quest’s Samuels. “We didn’t really have a choice because we were losing money, and we couldn’t continue to operate as an independent company that way.”
For instance, Medicare and insurers usually gave labs just $7 to $8 in the mid-1990s to interpret Pap smears.
“It cost more than that for us to just do the Pap, but labs were using them as loss leaders just to bring in other business,” said Quest’s Samuels.
Quest strong-armed its biggest managed care clients into accepting price hikes. Clients including giants Aetna Inc. (AET) of Hartford, Conn., and UnitedHealth Group (UNH) of Minnetonka, Minn., agreed to pay more per lab test analyzed by Quest. The managed care insurers send millions of lab tests a year to Quest. In exchange, Quest gave up being their exclusive clinical lab.
The result of Quest’s move was a trend of price increases across the industry this year. Today Medicare pays about $15 for a Pap test.
Analysts say that thanks to Quest’s efforts, all of its rivals — especially its biggest rival Lab Corp. — have raised prices.
The pricing strategy succeeded. Prices per order at Quest jumped 5.8% last year and even more this year.
Lab Corp.’s MacMahon says the company enjoyed overall price increases in the second quarter of 7%. By his estimate, a third of that came from selling higher-priced, higher-margin gene-based tests. The other two-thirds came from price hikes.
4. TECHNOLOGY
New technology drives margins. One example is how the low-margin Pap smear is slowly getting replaced by the far higher margin Thin Prep test, made by Cytyc (CYTC). The Thin Prep is more sensitive and can determine the cervical cancer status of the 2% of women on whom the Pap doesn’t work.
Even better, Medicare and insurers will pay labs about twice for the Thin Prep what they’ll pay for the traditional test.
Although cervical cancer rates have plunged by 70% since the Pap smear was introduced in 1941, nearly 13,000 American women still will get the disease, and 4,400 will die from it this year.
At Lab Corp., MacMahon says the “thin layer” tests — which include the Thin Prep and Digene Corp.’s (DIGE) HPV test — make up 45% of all Pap-type tests the company handles a year. Next year, MacMahon says he expects that to rise to 53% of the 7.5 million paps.
5. OUTLOOK
In the last 18 months, testing volume as well as Medicare and insurance payment rates have risen. Higher-priced, higher-margin tests and industry consolidation also have improved the outlook for the industry.
Upside: Lab tests not only detect disease, but also help monitor the effectiveness of treatment. This will boost doctors and patients’ reliance on them and boost lab volume.
Risks: It’s unclear how long prices will continue to rise. If they start to stall, labs will have to make up for it by selling more tests. |
