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By Don Howard
10/09/07
Thriving in a Competitive Environment: A Tale of Three Pathology Groups Becoming
One
Faced with increasing competition from large national labs and marginalization,
smaller pathology groups need to put their stake in the ground and develop
partnerships to expand their market share. This article illustrates how three
pathology groups merged to establish a strong presence offering high-quality
service in Northwest Washington.
Makings of a Merger
CellNetix (WA) was formed roughly two years ago by the merger
of three established companies. The pathology group occupies the corridor up
and down Interstate 5 in western Washington, which is the most highly populated
part of the state, and extends about 120 miles. CellNetix has 32 pathologists
at four sites and serves 10 hospitals. “We have more than 110,000 surgical
specimens—about
half of those are located in Seattle and the other half are spread out among
our different sites,” says Don Howard, MD, PhD, Chairman, CellNetix Pathology
and Laboratory (WA). “While we are geographically non-competitive, the
sites are in striking distance from each other and this enabled us to create
a centralized technical and administrative operation.”
The merger was
the result of the changing landscape in pathology. “Twenty
years ago, pathology was very different. Pathologists ran the show, life was
good, and everyone was happy—except it was expensive and then the competition
began,” he says. “Since that time, pathologists have been increasingly
marginalized and we’re on the verge of becoming obsolete. While many
businesses have merged to compete effectively in today’s market, doctors
in general, and pathologists in particular, are slow to adapt and take risks.
Because of this, we are being beaten up and losing the battle.”
Competition from national pathology labs is strong, particularly in the more
lucrative outpatient market with technical business. “In addition, physicians
and clinicians are building their own technical operations, hospitals are trying
to employ pathologists, and payers are squeezing pathology groups on costs.
And while some might consider other pathology groups as a threat, we see them
as out biggest asset and ally.”
Howard notes that most pathologists don’t
give thought to their competitive advantages. “Primarily, we have personal
relationships and the physicians that we deal with are not only clients, but
we know them as friends and colleagues with whom we attend conferences. This
kind of connection makes it very difficult for an outside organization to come
in and marginalize you—unless you
want to be marginalized.”
Quality is another competitive buzzword. “One
of the things that we’ve
been able to do in the course of our merger is to improve quality. We’ve
been able to monitor, measure, and show improvements in quality, and I think
that’s critical.” He also counts sub-specialization as a driving
force behind the group’s centers of excellence.
“By merging and
forming a larger group, we’ve also been able to
achieve economies of scale—in other words, save money,” he says. “That
money is not going into our pockets but is being reinvested into the company.
We have also been able to centralize our business and support operations, and
are in the process of purchasing a number of practice enhancers. Our size allows
us to buy the best-in-class IT system for anatomic pathology and to place it
in every hospital in every lab that we own. This has also created increased
productivity among pathologists. For example, we now have three dermatopathologists
in our centralized site. Our pathologists were spending a huge amount of time
consulting with the dermatopathologists. We have become more efficient as dermapathologists
can do 60 or 70 cases a day, freeing up the pathologists to do other things.”
The
size of CellNetix has also helped the group to attract top talent. “We
are increasingly seeing pathologist applicants from the top universities in
the country, and it is becoming much more competitive to get into our group
than it used to be,” he says.
In addition to being an offensive strategy,
a merger is also a defensive strategy against competitors. “It helps
with payer contract negotiations, for example. Before the merger, the payers
were paying each of the groups at a different rate. The two lower groups went
up to the top group after the merger and that brought up our bottom line up,” he
notes.
“We have also created brand identity and have been able to manage
risk better with a consequent savings in malpractice insurance,” Howard
continues. “One
of the groups was paying $60,000 per pathologist a year in malpractice. By
merging with the other groups, the malpractice insurance carrier dropped that
to $15,000—a huge savings in malpractice alone.”
In addition to
having an excellent billing company, Howard notes that one of the fundamental
things about his practice is its ability to implement joint ventures with just
about any other organization—lab, hospital, etc.
“We’ve
created a corporate structure with real value,” he
elaborates. “We don’t just have a professional organization where
the money flows in and out. We are creating a company that has real value for
its stakeholders. In addition, larger organizations have an advantage by having
more potential for political influence at the local, state, and even national
levels.”
Finally, Howard notes the 110,000 surgical samples that the labs
holds and the potential of growing that number. “We have a critical mass
of esoteric testing, which is advantageous for a whole variety of reasons.”
The
Results Are In
The merger has resulted in measurable results. “Most
significantly, we improved our financials in just one year. We have increased
total revenues and decreased operational expenses. However, the pathologists’ income
has not changed. In fact, it went down for a while after the merger because
we were reinvesting in the company,” Howard relates. “We’ve
also been able to improve our payer contracts with better rates for some of
our groups and we consolidated and eliminated a lot of waste in the organization.”
Howard
also notes that a quality committee, comprised of members from all the sites,
has been able to demonstrate improvements, which resulted in significant reductions
in their malpractice insurance premiums. In addition to the IT system that’s
being put in place, he adds that a telepathology system is being implemented
at its peripheral hospitals to provide access to CellNetix’s
specialists for consultations.
“Finally, our organizational structure
is quite attractive to large clients,” Howard
adds. “In fact, we recently had a hospital approach us and ask that we
take over its lab work—in 24 hours! Believe it or not, we were able to
do it—albeit with a few bumps along the way. Nonetheless, having three
different groups with so much expertise and capacity enabled us to do this.”
Success
Factors for a Merger
Key success factors of a merger include the following:
• Designate
pathologist leaders. “You need at least one from each site, and more
if they are available,” Howard says.
• Hire
expert assistance. “You need a great legal team, accounting firm, and
a consultant. You need someone to drive the whole process—it could be
a pathologist, your legal team, or a consultant—regardless, you need
someone to organize things and keep everything on track. Pathologists tend
to get lost in the day-to-day activities of the practice and profession, making
it difficult to keep the process going,” Howard says.
• Develop
trust. “A certain amount of trust has to be developed among pathologists,” he
notes. “We made the smaller groups equal partners in the company and
we shared the pie with them; and once they saw this they came on board 100
percent.”
• Willingness
to compromise. “A certain amount of compromise is inevitable and necessary.
You have to be realistic about your goals and what you can achieve.”
• Understand that control is a two-edged sword. “You can gain control,
but also you have to give up some control in doing a merger of this type,” Howard
points out.
• Establish
governance. “We have a board of seven directors, representing each of
our sites. You need to make sure that everyone is represented and has a voice
in the merger.”
• Stay
on top of the details. “In terms of malpractice insurance, for example,
you should contact the carrier and explain how the merger will be beneficial,
resulting in cost-savings and higher quality.”
• Provide
a strong benefits package for staff (health insurance, retirement funds, as
well as peripheral benefits).
• Emphasize
consistent quality assurance throughout all the practice groups.
• Establish
a buy-in structure. “Young pathologists coming out of training could
buy in with a relatively modest amount and still become full partners in the
company. We did not want to create a pyramid scheme; we wanted to create a
structure that was fair to everyone,” Howard says.
• Account
for and value the assets of each company before the merger.
• Develop
a timeline for the merger that establishes a date for full integration.
• Keep
your partners in the loop. “I suggested that we keep our hospitals in
the loop from the very beginning. You want open, full disclosure with your
hospitals and clinical lab partners,” he adds.
A Team Process
“The merger was almost a two-year process for us,” Howard says.
You need to consider a wide array of issues, including anti-trust, and whom
you select for your team. “In our case, we first hired a local attorney
who didn’t work out—he was unable to give us the creative ideas
and energies that we needed to take the company to the next level. We replaced
him with an excellent multi-specialty law firm on a local level and also hired
a couple of national attorneys for focused projects that enabled us to create
a state-of-the-art corporation in terms of structure.”
Howard also notes
that hiring a strong accounting firm and billing company are key. “In
fact, our billing company helped us implement clinical Part B billing, which
we were the first to do in our state.” In addition,
a business consultant was brought in to drive the process and provide advice.
Finally, Howard tapped into the pathology groups for leaders who would be able
to step up to the plate and put in the extra hours to make the merger happen.
Reasons
to Fail
From his experience, Howard bumped into a lot of issues that
could potentially lead to failure in a merger, including:
• Change
is scary. “For pathologists that are very risk-adverse, the idea of doing
something that is out of their comfort zone is very difficult. Getting people
beyond that takes a bit of education and it’s a process.”
• Loss
of control. “There are people who have built their mom-and-pop operation,
been in business for 30 years, and are a few years away from retirement. Ultimately,
they do not want to give up control.”
• Inertia
and vested interest. “If individuals have money invested in the practice,
they are going to be concerned about how to get that money out.”
• Aging
partners. “Having a couple of very senior, very strong partners could
result in them nixing the whole thing.”
• Different
cultures. “You need to pick groups to merge with that are like-minded
in culture,” he notes.
• Adverse
reactions. People are afraid of the reaction from hospitals and clinical lab
partners and, of course, the potential consequences.
• Legal
aspects (and costs) and corporate structure.
• Anti-trust
issues.
• Financial
issues (i.e., expenses and buyouts). “Some of the groups
had different corporate structures; they had buy-in/buy-out types of practices
and that was a challenge we had to overcome,”
Howard says. “Two
were S corps and one was a C corp; while the buy-in for two was minimal, the
third was substantial.”
Success Factors
Howard makes note of a few factors that were
critical in the success of the merger that resulted in CellNetix.
• Align
goals. “We set up not only a pathologist compensation program, but a
compensation program for executives, senior executives, and all employees.
This aligns goals for everyone,” he states. “We are also in the
process of developing a structure where we can offer participation in ownership
of the company to our technical people.”
• Set
a fast track to full integration. “The longer you ‘hang out there’ as
independent pods, the more you’re likely to develop a them-versus-us
mentality. We put a time limit of one year for full integration,” he
notes.
• Bring
in a great billing company to capture revenue.
• Hire
a strong leadership team. “We chose a CEO who was not from the lab world,” Howard
relates. “We went after someone who was very entrepreneurial, tech savvy,
IT-oriented, and had a strong business sense. This individual is well-compensated—something
that you can’t do if you’re a small group.” You also need
support-services managers and technical managers.
• Establish
an efficient courier system. “We have courier systems that, within one
hour, can take a difficult case to a pathologist who is a specialist and get
an answer,” he relates.
From Courtship to Honeymoon
Howard likens the merger process
to a relationship, where you invite a number of potential partners to a dance
and move from courtship to marriage to honeymoon.
“One
year before the merger, we invited six potential partners to the ball,” Howard
elaborates. “We thought about whom we wanted to invite
and where they were geographically located. We also didn’t want them
to be directly competitive. We entered a courting phase with four groups and
held eight meetings over a year. This was a process of turning skeptics into
believers—and it didn’t happen over night. One dropped out and
we then went through eight months of due diligence and intense work with three
until the merger resulted.” Since the merger, the partners have been
on a “honeymoon.
Long-Term Prognosis
“I think the merger model is one that could spread across the country
and allow pathologists and pathology groups to take back pathology for themselves
and for future generations,” Howard says. “We went from a conglomeration
of pathology groups to CellNetix Pathology. We spent a lot of time on branding
and choice of logo. We feel that we have a great corporate identity that has
captured the imagination of many people in our state. In fact, we’re
being approached by a number of groups regarding merging into our practice.”
According
to Howard, the lab’s guiding principle is pathological excellence
based on sub-specialization, based on a centers-of-excellence model. “Our
market position is based on quality, as well as providing value at competitive
pricing. We also believe it’s very important to demonstrate quality—actually
measure it, and show it to our clients, the hospitals, and insurers. We have
exceptional business leadership and we are also willing to make investments,
in staff and technology, because we believe this is the future of pathology.”
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