African American female laboratorian in a white coat sitting at a desk with a patient

As clinical laboratories face continued reimbursement pressures from both government and private payers, laboratory leaders of all stripes have ample incentives to become even more financially savvy. Gone are the days when a manager could simply focus on performing tests and leave concerns about money to those higher up in the organization.

Hospital laboratories have traditionally been considered cost centers, but when outreach comes into play, the equation changes and a lab should be evaluated as a profit center, according to Thomas Joseph, MBA, MT(ASCP), president and CEO at Visiun, a laboratory analytics company in Ann Arbor, Michigan.

“You have to look at both incremental (or differential) revenues and expenses, but a lot of outreach directors don’t because outreach revenues are often not easily obtained,” Joseph said. “Lab directors need to know how to do the proper financial analysis on their own because hospitals tend to apply fully loaded costs, which will overstate expenses and make any outreach program look unprofitable.”

Jane Hermansen, MBA, MT(ASCP), director of the outreach consulting program for Mayo Clinic Laboratories in Rochester, Minnesota, concurred, noting that while hospital lab directors know how many tests are run and what is being charged, they rarely know what revenue is collected.

Why should a lab director or manager know their lab’s financials? Because doing so is one way to demonstrate the value of the laboratory to the hospital’s executive leaders, Hermansen said. At a time when hospitals increasingly sell or outsource outreach programs, value is a key metric for the C-suite. In fact, a survey conducted by the Advisory Board in 2019 found that, for the first time, healthcare executives say their top priority is not controlling costs but growing revenues.

“The four commonly used criteria for measuring success are reduction of unit costs, increased productivity, increased net revenues, and profitability,” Joseph explained. “Many managers rely on the first three measures alone, but the first three don’t really matter. Profitability is the only reliable indicator.”

Hermansen cautioned that for the profitability calculation to be meaningful, the allocation and input must be accurate. If a service unrelated to a laboratory is allocated to that lab (such as parking lot construction expenses), any profitability numbers will be way off.

Determining whether a laboratory outreach program is profitable comes down to its balance sheet. Lab leaders need to understand both costs—variable or fixed, direct or indirect—and revenues. Variable costs are those that vary with the number of tests performed, such as reagent costs. Fixed costs are those that do not change with an increase or decrease in the number of tests performed, such as instrument cost and space. Direct costs are those that can be fully attributed to the performance of a test, such as staff time, while indirect costs are not directly related to test production, such as overhead or institutional allocations. Marketing program expenses and outreach-related courier expenses should also be allocated to the outreach program.

“Fixed and indirect costs for the hospital laboratory will exist with or without outreach and should not be fully loaded onto the outreach program,” Hermansen said. “It’s important for a lab director to know how costs are allocated.”

Directors and managers also need to have a firm handle on profitability. In simple terms, revenue minus costs equals profit (or loss), but determining the profitability of hospital outreach testing can be more complex. To deal with these billing and reporting complexities, some hospital labs outsource their outreach billing operations. Alternatively, some are bringing in business analysts to focus on the financial side of the lab.

“Many hospital laboratories are now using the dyad leadership model, where they have both medical (technical) and business leadership for their lab,” Hermansen said. Equipped with meaningful and relevant data, lab directors will be able to take key steps to make their operations profitable.

Reduce Revenue Rejections and Delays

Rejected laboratory claims can cause lengthy delays in payment or in lack of payment altogether, resulting in write-offs or bad debt. Hermansen advised that laboratory directors and managers work with both accounts receivable and billing departments to determine which claims are being rejected, including payer types and the reason for rejections.

“Some hospitals have automatic write-off policies in place. They might not even bother to collect a bill if they feel it is too small,” Hermansen said. “The lab might be really busy doing lots of tests and generating lots of costs, but if the hospital writes off many of those claims, the laboratory won’t be profitable.”

Once the reasons for rejections are known, lab leaders can focus on reducing them. This might mean working with ordering clients to ensure they are supplying the appropriate diagnosis codes with their test requests, working with payers to understand why they are rejecting claims, or working internally to apply modifiers to specific tests prior to submitting claims for payment.

Working with a hospital’s finance department to lower the organization’s write-off threshold is also critical to ensuring that the hospital is collecting everything it can, according to Hermansen. A laboratory with a write-off threshold of $250 will collect very little in lab claims while a write-off limit of $10 or even $5 will result in an increase in collections and revenues. Knowing the hospital laboratory’s bad debt rate and days sales outstanding is the first step to improving collections and increasing revenue, Hermansen added.

Expand Laboratory Services

Hospital-based laboratories typically send between 3%–5% of their tests to reference laboratories. But when volumes exceed a certain threshold for a particular test, it might make sense to add those tests to a lab’s internal testing menu, Hermansen noted.

The evaluation about whether to do so should include immediate revenue opportunities, potential growth in volumes from existing laboratory outreach customers, and the financial impact of not having to purchase given tests from another laboratory. Such a review should recognize other benefits, such as improved turnaround time related to performing a test on-site versus transporting it to a reference lab. Speedier results might provide a quicker diagnosis, allowing for a patient’s earlier discharge and reducing costs related to his or her hospital stay.

Adding new, specialized testing to the menu may also make sense if there is a need. Laboratories should periodically review their test menus to see if any assays should be removed or added.

Increasing volume can also lower overall cost per test because fixed costs—such as capital, labor, and information technology—are spread out over a greater number of tests, noted Hermansen. If a laboratory is not operating at full capacity, the lab director should be looking to increase both outreach and in-reach volumes. “If local physician practices are a part of your system, they should be using your lab,” she said.

Managing Costs

Two of the largest expenses in a laboratory are labor and supplies. Investing in more efficient instruments or installing automated equipment helps reduce the cost of manual labor and allows a lab to leverage technology to make the best use of staff. But to determine whether automation or new equipment makes financial sense, laboratory leaders need to calculate a return on investment, which essentially is net income generated by the equipment divided by cost of the investment.

Patrick Maul, MBA, MT(ASCP), a laboratory consultant and Lean Six Sigma Black Belt, advised looking at both the macroeconomics and microeconomics of financial decisions—in other words, understanding the total cost of use of an item in a lab versus the cost of the individual item.

“You can buy something less expensive, but you might end up using far more of it because of the defect rate in that item,” he explained. “For example, you can buy cheaper microscope slides, but if they stick together and your techs have to spend time separating them and cleaning them before use, the total cost of use, factoring in labor, is much higher. You are better off buying a more expensive slide because the total cost ends up being less.”

Understanding the cost of defects and errors is a critical part of controlling costs in clinical laboratories, he emphasized. “You need to consider the cost savings of the money you don’t have to spend to fix a problem,” said Maul. “It’s about error-proofing the process, which leads right back to Lean and Six Sigma.”

Beyond Dollars and Cents

Considering cost and financial performance should never usurp the importance of performing the right test at the right time, Hermansen said. “We have a responsibility to ensure that our testing is used correctly and managed efficiently.”

All the experts CLN consulted agreed that to ensure that a laboratory contributes to the goals of the larger organization, lab leaders need to focus on effectively managing costs, maximizing revenue opportunities, and demonstrating added value. Honing their financial acumen will go a long way toward ensuring the laboratory is seen as a profit, not a cost, center.

Kimberly Scott is a freelance writer who lives in Lewes, Delaware. +Email: kmscott2@verizon.net