Pathology quietly shifting its strategy on GP co-located collection facilities might be a bigger existential threat to practice viability than payroll tax.
Health Services Daily has sighted a communication between a major pathology provider and a big GP practice in which the pathology provider states unequivocally that they are unlikely to be interested in participating in an upcoming tender for a lease on an existing co-located collection centre because they are changing their business model to focus on “standalone” collection centres.
It’s a one-off communication but the implications of this one message, if the pathology provider is serious and not just negotiating, is likely to be seismic over the next few years for most GP practices with co-located centres in terms of overall practice income profile.
Where a practice has a co-located pathology collection centre, the rent on that centre can make up to a third of the total practice income.
Since the deregulation of collection centres in 2010, there has been a significant increase in co-located pathology centres within medical practices, driven by fierce competition to lock up the GP “reselling” channel to patients.
Income per square metre for the major pathology labs as a result of this competition has grown to be huge over the years – up to $30,000 per full-time equivalent (FTE) GP per year.
The outsized rental returns have been driven largely by competition between the three major providers (mainly two providers) to lock up “reselling” of their tests by having testing conveniently on site. Although there have been court cases testing the outsized rents, the competition between the major pathology providers has largely made the high yield a reasonable commercial transaction.
Essentially, if you have pathology testing onsite then a patient won’t make a choice to go to a different provider once they leave the practice. They will also be much less likely to simply not bother and going to get the test. So, locking up a site with one pathology provider has been worth a big premium in the past 15 years or so.
Until now at least.
Times are changing in Pathology Provider Land with two key dynamics likely to be at the heart of the message of a change of strategy to this GP practice:
- Of the two major pathology providers, Sonic and Healius, one of them – Healius – suffered a post-covid slump in a cash flow near-death experience prompting the sale of one its major imaging divisions, the firing of a CEO, significant restructuring, a $2 billion loss in enterprise value, and two years of losses. Overall, this has significantly shifted the competition dynamics between the two top players to a point where both players are weighing up the potentially significant bottom-line benefits of reining in the cost of their co-located pathology collection centres.
- The federal government is gunning for all the pathology providers in terms of getting them to reduce overall testing volume significantly over the coming years through much better sharing of testing and patient data between all the providers ordering testing. The government consistently quotes a figure of an up to 25% drop in testing volume over time by cutting out unnecessary repeat testing and tests that were never needed in the first place. The pathology groups obviously dispute this figure, but even if the goal is 10%, that’s pretty much going to convert to 10% less income for these companies if it all pans out. All the pathology businesses are doing strategy with some figure in mind for less volume, and all the cost associated with increasing government demands that they share their data much more freely digitally. This includes new legislation that will force them all to upload all their test results in near real-time by the end of this year to the My Health Record. All of this possible future revenue pressure is also causing a rethink on structure and business models, and co-located rental income is part of the review.
The problem for GP practice owners is, with the above two dynamics in play, all the logic is there for the major pathology providers to do what one of them is threatening to do to the GP practice communication sighted by HSD – walk away from their co-located centre and set up next door or nearby with a significant rent reduction. Or use that threat at least to drop the rent back significantly – some rent is better than none after all.
With Healius significantly depleted in terms of available capital to deploy in conducting a co-located facility turf war with Sonic, the savings from reducing their co-located rental liabilities at scale are too tempting.
And if Healius pursues this path, the market for outsized rents at GP practices will collapse. After all, Sonic doesn’t have a competitor anymore – at least like it used to have – so why would it keep paying high rents?
As so often happens in Australia the two major market players, while not formally colluding, are looking increasingly like they see the value to both businesses of moving in lock step: that is, if they both walk away from their past fierce competitive position on co-located rents at more or less the same time the return to both businesses will be very big.
How big?
Usual loose HSD back of envelope maths here, but of the often quoted $30,000 per FTE GP per year in rental income, if the major pathology companies could manage to get their rent down to what someone would be paying next door at the fish and chip shop (even upstairs to that), or what the GP practice owner actually pays for their space, they would be paying something in the range of 50-80% less in rent on that location.
As an example for a net number saving on one practice, if you have 10 FTEs your annual co-located rental income could be up to $300,000 per annum, and that now is in danger of being re-negotiated down to something in the realm of $60,000 to $150,000, a saving to the pathology company of $150,000 to $240,000.
There are something north of 5000 GP practices with a co-located collection facility so a reduction in rent on each of those facilities is going to be substantive, remembering a lot of them are far in excess of 10 FTE GPs per location.
If all 5000 practices had 10 GP FTEs each – they don’t of course but there is an average which someone has calculated – then the potential saving to the pathology groups if they converted every facility (they won’t do this either) would be over $1 billion, all of which would largely fall to the bottom line.
Related
Regardless, that one message HSD has sighted saying that one of the big two at least have changed their strategy focus to “standalone” collection centres, should make us all pretty confident that the numbers people within Healius and Sonic have done the sums and its adding up to good business moving forward.
If the communication sighted by HSD starts rolling at scale over the next year or so across the country then what GP practices might expect is that they will need to either reduce their rents significantly in the next lease agreement or have the tenant pull up stumps and find some space somewhere nastily close by for a lot less anyway – “standalone” like.
GP practice owners need to start wargaming on this scenario as it’s a classic “boiling frog” type problem. You don’t know you have no bargaining power left until the day you realise you don’t. And then you have a horrible step change in income profile.
In the case of the example we’ve seen, that practice must be worrying a lot about what could happen if their existing high-paying tenant is nonchalantly expressing disinterest in tendering for the next lease deal because if they don’t, the single competitor (which might or might not be Healius, which is in financial distress) isn’t likely to put in a high bid.
One thing owners can do now is check their current lease agreement for things like an “uneconomic agreement” get-out-of-jail clause, which apparently exists in a lot of deals now, especially recent ones.
These clauses are like those clauses you see in superstar footballer contracts when they change clubs: if things aren’t working out at the new club – like maybe they’ve promised to be a top-four side and they are in the bottom four – the player can kill the deal and move to another club.
In a pathology rent lease this clause essentially says that if the tenant can prove the rent is “uneconomic” they can break the lease and move on. Good luck trying to take either Healius or Sonic to court to prove that they’re just using this clause as a negotiating tactic.
There is an increasing amount of anecdotal evidence that the shift associated with this significant change in channelling strategy is already underway.
In a survey conducted by Healthed recently of 500 practice owners on pathology rents 10% said that they had already been asked by their pathology provider directly to reduce their rent. If that doesn’t seem like a lot, think again. It looks like things are only just starting. We are redoing the survey next month to try to get some gauge of speed of possible change for everyone.
Thirty-four percent of survey respondents said that a reduction in pathology rent would significantly impact the profitability of the business.
That feels low and might suggest this potentially major issue is yet to get on the radar of a lot of owners.
In the bigger scheme of things, if big pathology is making a big lefthand strategy turn on their attitude to investment in GP co-located facilities, it’s not just owners who look like they could be quickly caught short here.
The federal government has staked a lot of the election on their new investment in bulk-billing incentives, suggesting they are significantly increasing the income of any GP who shifts behaviour away from mixed billing.
Putting aside that the government’s modelling doesn’t seem to add and up and, so far, most of the profession’s peak bodies have rejected the modelling and logic of the government, most practices will still get some jump in income from the ability to increase what they get on what bulk billing they do.
The problem with our story here is that, if it pans out, pathology rents – which are in play in over 5000 practices across the country – make up on average a third of a practice’s income today, but that 33% income stream might get hit by up to 80% over the coming few years.
That would obliterate any good that the new bulk-billing incentives might provide to general practice, if they end up providing any.
PIPs won’t be going up to address the problem so those owners running practices will only be able to do one of two things: increase their commission (which won’t be very popular with GPs working at their centre) or increased their mixed-billing ratio.
Both strategies blow up the whole bulk-billing election position of both parties.
The government has already proven itself willing to get heavy-handed with Big Pathology in terms of trying to rein in perceived inefficiencies in the number of tests being ordered.
And while there is a limit to how far the government can push Big Pathology before more than just Healius starts looking shaky and the whole system becomes unstable, it may need to get its head around this emerging problem on behalf of the GP sector and re-examine its whole funding approach.
It looks like it could be worse than the sort of damage payroll tax threatened to cause, and to some extent, has caused the sector.