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An Operational Model that Transforms Outsourced Reference Testing into an Asset
Co-tenancy laboratory: It’s a simple phrase that represents a remarkable cost reduction concept. Yet the value of laboratory co-ownership has remained illusive to healthcare executives and financial officers. It’s possible that the initial reluctance to embrace laboratory co-tenancy exists because this model brings together competitors to operate as co-owners. In order to receive reference laboratory testing at reduced cost (the fundamental purpose of co-tenancy), a shift in thinking must occur, acknowledging that the benefits derived are not diminished because a competitor enjoys them too. It’s analogous to two organizations that purchase their electricity from the same utility company. There’s no inherent disadvantage to either because both rely upon the same source to fulfill their energy needs.
Lessons Learned in the Laundry The laboratory co-tenancy model is similar to the laundry cooperatives that hospitals created to control costs. Rather than send laundry out to an independent provider, they joined together, becoming the provider themselves. The hospitals acquired a facility, set up operations and devised a mechanism to share the cost. Economies of scale and elimination of independent laundry profit provided cost reduction to the hospital owners. Meanwhile, each institution received an essential service that was needed. Ownership and utilization usually didn’t expand beyond the organizations that formed the cooperative. This limited optimal cost reduction that could be achieved from the additional volume of other organizations.
How the Co-Tenancy Model Works Co-tenancy offers not-for-profit hospitals the opportunity to jointly own, use and govern the assets of an esoteric laboratory. A modest capital investment secures an ownership position, replacing the purchase of reference testing services with the ability to actually own a piece of the laboratory. The hospital owners then in effect perform the esoteric testing themselves at a lower cost and exercise direct control of the laboratory operations. A board of directors made up of representatives from every owner, actively controls all aspects the laboratory.
As a cooperative arrangement, co-tenancy thrives on the trust of its members. This trust is established by the fair and equal treatment of each co-owner. In order for competitors to work together for mutual benefit, an accurate method of cost allocation is absolutely essential.
MCL’s Model of Cost AccountingMCL is a co-tenancy laboratory that performs esoteric testing from its headquarters in Ann Arbor, Michigan. Realizing the importance of a robust cost accounting system, they developed a model to serve their specific purpose. The basic premise was this: the more tests performed on the shared assets, the more money the collective co-tenants could save. MCL’s cost accounting model uses the concept of a relative value unit (RVU). Here’s how it works.
Relative Value Unites (RVUs)Each test performed in the co-tenancy laboratory is assigned an RVU. The RVU is based on total cost of the operation including all fixed and variable components. Testing is billed monthly using an RVU-based fee schedule. At the end of each quarter, the total cost of testing performed in the laboratory is divided by the same period’s RVUs to arrive at a cost per RVU. Each co-tenant’s total RVUs for the quarter are calculated and multiplied by the cost per RVU. The result is the owner/user’s allocated cost of testing. If there is a difference between the amount billed monthly and the allocated cost of testing, a rebate is sent to the co-tenant for the difference. The co-tenants have realized and average annual reduction of 4% in allocated cost resulting in a savings of 23% since the formation of shared laboratory.
Ownership Instead of Outsourcing A hospital typically does a proscribed number of laboratory tests in-house. They are often stat and frequently routine. Though less frequently requested tests could be performed on site, they are usually sent to a reference lab where tests are pooled together in order to take advantage of economies of scale. Since hospitals have to send out tests, the co-tenancy model presented by MCL is imminently practical. It makes sense to release tests that are not routine yet not truly esoteric from one laboratory for higher volume and better pricing.
Unlike relationships with fee-based reference laboratories, MCL co-tenants actually have partial ownership of the assets of a state-of-the art laboratory. Ongoing pursuit of additional co-tenant owners provides additional savings. Testing on behalf of each co-tenant is done using their share of the equipment, reagents and staff. Each co-tenant has the autonomy to utilize the lab assets to meet their own needs, to market the testing under their organization and to bill all testing conducted on their behalf. Co-tenancy successfully addresses the priorities of both pathologists and financial executives, delivering superior quality, excellent service and the lowest possible cost.
Here’s the bottom line. Co-tenancy equals ownership. Instead of buying outsourced laboratory services and showing it as an expense, co-tenants can purchase testing at the lowest cost per unit and reflect the difference on their own profit and loss statement. MCL functions as an extension of each co-owner’s on site laboratory. The profit that MCL creates is now an engine that each member hospital can use for its own purpose; the expansion of facilities, the purchase of capital equipment or the hiring of personnel.
About the author: Steve Zawacki is the Chief Financial Officer at Warde Medical Laboratory.