The Market Environment and Investment Opportunities in Teleradiology

Mariusz KociubinskiMohammed H. Petiwala

Mohan NaiduNatalie Raines

June 1, 2006Submitted to Professor Greenstein

MGMT 463 – Management of Technology

Teleradiology

Contents

Executive Summary.....................................................................................................................31. Introduction to Teleradiology..............................................................................................4

1.1 Growing Need for Teleradiology Services..................................................................41.2 Background on the Technology...................................................................................51.3 Benefits of Teleradiology............................................................................................61.4 Major Hurdles and Barriers to Diffusion.....................................................................71.5 Direction of Teleradiology Services Industry..............................................................8

2. Analysis of Key Players in the Teleradiology Service Industry..........................................92.1 U.S. Based Teleradiology Service Providers...............................................................92.2 Global Teleradiology Service Providers....................................................................122.3 Hybrid Teleradiology Service Providers...................................................................13

3. Investment Opportunity.....................................................................................................154. References..........................................................................................................................17

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Teleradiology

Executive Summary

The radiology department within healthcare facilities provides a critical service in

analyzing and reporting on different types of images taken on patients. Although radiology

reports play a critical part in the diagnosis and treatment of patients, the physicians themselves

are often not in direct contact with the patient. By the use of Picture Archiving &

Communication Systems (PACS) & Radiology Information Systems (RIS), radiologists can

effectively perform their duties without a need for direct patient contact. To harness this

separation, a set of new businesses is developing in the recent years called teleradiology.

This paper analyzes current teleradiology market state and the incumbent firms’

strengths, weaknesses, assets, capabilities & strategies to determine which firms are best

positioned to serve these customers. The paper also proposes investment options in this industry

based on this analysis. Even though there is some activity in the international market, this

analysis only examines the U.S. market and service providers. Based on the infancy of this

industry, the following discussion addresses market developments and advantages among service

providers over the next five years.

As a result of a thorough analysis of U.S. teleradiology service providers and their market

environment, our recommendation is to invest in NightHawk Radiology Services (NASDAQ:

NHWK). NightHawk is the biggest and best-known player in the hybrid nighthawk space, has a

strong reputation, and is well positioned strategically to expand its nighttime and daytime

teleradiology services. In addition, the company has strong fundamentals with a solid history of

income and revenue growth and is reasonably priced with the forward P/E ratio of 26.

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Teleradiology

1. Introduction to Teleradiology

Within the U.S. and across the globe, the healthcare industry is experiencing a significant

increase in demand due to an aging population. In addition to increased costs across all channels

within the industry from hospital procedures to pharmaceutical products, there is a constant

shortage in supply of skilled healthcare workers. Each of these factors combine to intensify

demand for improved service, communication, price and quality of care. Improvements in

technology have cultivated the field of telemedicine whereby physicians can videoconference,

transmit images to monitor and diagnose patients remotely. Such technological advancements

reduce costs and allow physicians to spend more time treating patients instead of answering

pages or writing prescriptions.

1.1 Growing Need for Teleradiology Services

Demand for radiology services is expected to increase as a result of the aging American

population. Projections for inpatient and outpatient imaging procedures will grow to nearly half

a billion outpatient and 100-million inpatient scans in 2008.1 With the increased use of digital

technology and workstations within hospitals, the transition to teleradiology has become a

natural evolution as institutions increasingly phase out X-ray films and look to lower their

operational costs.

As the only widely available form of medical care during after-hours and weekends, the

emergency medicine department (ED) currently delivers close to 10% to 15% of the healthcare

in this country.2 With increasing medical care being shifted to the ED, greater demands are put

on radiological services – one of the major support systems to emergency medicine. The

increase in emergency-related scans is applying additional pressure on an already small pool of

radiologists. In fact, a recent survey showed more than 65% of the responding radiologists rated

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being on-call as the most stressful part of their profession. Call scheduling has become a focal

point of conflict within radiological groups, sometimes even exceeding compensation. Further

stretching this pool of radiologists, over 40 percent of emergency radiology scans occur at night

– when fewer doctors are available to read them.3 Small, rural hospitals and clinics with no staff

radiologist can send images to teleradiology providers, making it possible to have images read

within minutes rather than days.4 This technological advancement has produced a major surge in

demand of radiological services.

1.2 Background on the Technology

Although Teleradiology as a technical innovation has the potential to completely reshape

the field of radiology, currently its impact has been rather limited. Unlike many high tech

innovations, the technology required for teleradiology services has been available for over a

decade. Almost every hospital of considerable size already has a PACS* & RIS† that radiologists

use to read and dictate on images. Such systems enable the radiology department to outsource

the interpretation of some of their examinations to remote service providers. Facilities need only

to a high-speed Internet connection (T1 line, DSL or cable), access to a web browser and the

ability to send their DICOM‡ images to the service provider. Most service providers do not

require the purchase of any equipment or software and many provide a full service IT staff in

case of connectivity or network problems.

When an image is taken at a teleradiology-affiliated hospital, it is sent to service provider

across the Internet through their virtual private network. The workflow software at the service

provider then identifies the most appropriate radiologist based on his or her specialization, * Picture Archiving & Communication System† Radiology Information System‡ DICOM - Digital Imaging and Communications in Medicine, a standard in the field of medical informatics for exchanging digital information between medical imaging equipment (such as radiological imaging) and other systems.

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hospital credentials and workload capacity. Upon receipt, the teleradiology provider performs a

preliminary evaluation of the scan and then dictates a report. The patient data and report are sent

back to the originating hospital, and if the evaluation requires immediate attention, the local

physician may be contacted to discuss the findings that night. If the evaluation does not require

immediate attention, the scan undergoes a primary evaluation the following morning by the local

radiologist.5 Some facilities may also outsource the interpretation of their daytime exams to

other U.S. based teleradiology providers. This process simplifies the workflow since the

interpretation is final and does not require another radiologist’s approval; however this practice

is not highly pervasive at the current time.

1.3 Benefits of Teleradiology

From the hospital point of view, there are quality and financial benefits since some part-

time radiologist positions can be eliminated. For the referring clinician, teleradiology provides

more rapid assistance and better patient care. For hospitals without a full time radiologist, it can

supply coverage where none existed and can provide consultation with experts and training at a

distance.6 Finally, because the compensation for nighttime radiologists is shared by multiple

groups in the teleradiology network, the overall cost of the after-hours coverage is far less than

the cost would have been had the hospital hired their own radiologists for this purpose.7

From a radiologists’ perspective, there are several benefits. First, their time is used more

efficiently since one or two radiologists can cover 30 to 40 hospitals within a system instead of

serving as one radiologist on call per hospital. In addition, because they are constantly reviewing

urgent or emergency cases, they become specialists in the field of emergency radiology. This

expertise improves the quality of diagnosis and increases efficiency by which reports are

generated and returned to the hospital and patient. Finally, and perhaps most importantly, the

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quality of life for the radiologists is significantly improved, as they are not awakened in the

middle of the night and can provide diagnoses from home without driving to the hospital.8

1.4 Major Hurdles and Barriers to Diffusion

Several issues regarding billing, licensing, and liability make it challenging for

teleradiology providers to distribute their services to a larger market. While nearly all large

commercial insurers cover teleradiology, the U.S. Medicare system does not allow payment for

services that are outsourced overseas. The only service for which Medicare does permit payment

is for preliminary interpretations, which will pose a significant limitation on the diffusion of the

technology.

The governmental and legal liability of treating patients that are not physically present in

the state has opened the door for considerable problems if a Board Complaint or Malpractice

Suit is filed against the physician. Physicians practicing teleradiology must protect themselves

by obtaining a full medical license or teleradiology license in each state where they will be

accepting teleradiology contracts. Licenses are available at minimal cost, but it is the

responsibility of the service provider to ensure all practicing teleradiologists are properly

accredited.

Finally, the American College of Radiology (ACR) states in its teleradiology standards

that physicians, in addition to the facilities using teleradiology companies, must “have

appropriate medical liability coverage for the state in which the examination was obtained” and

from the state in which the examination is read. This can pose a significant hurdle since

obtaining adequate insurance coverage can be expensive, particularly for smaller health systems.9

At present, these hurdles have kept the technology’s diffusion at bay, with most facilities using

teleradiology only for preliminary interpretations of image studies run during the night.

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1.5 Direction of Teleradiology Services Industry

The pace of development and adoption in the telemedicine industry is driving adoption of

teleradiology services in the U.S. and across the globe. According to a 2003 report from

MedMarket Diligence, the U.S. market for telemedicine products and services is estimated at

$243 million. By the end of 2006, the payments for telemedicine visits are expected to be near

$10 billion. In addition, the proportion of total home telemedicine care visits that are

telemedicine-enabled is expected to grow from approximately 10% in 2004 to 16% in 2011.10

As this technology continues to evolve, telemedicine will continue its diffusion and radiology

services will have the potential to be almost completely outsourced. Since more than 90% of

conventional x-ray, MRI, CT and ultrasound examinations could potentially be handled in this

manner, it is expected that the teleradiology industry will meet and likely exceed growth

estimates for the telemedicine market by 2011.11

In view of the benefits of off-shoring in IT, one may suspect that teleradiology will move

in the same direction relatively quickly. However, most radiology practitioners argue that such

drastic change is unlikely because of such issues as certification, cognitive, market, and cost

factors12. It would require “dramatic change in the regulatory and market situation” before it

becomes feasible to outsource the primary reads to low cost countries where radiology services

cost a fraction of what they do in the United States. Thus within the next five years most of the

action in the teleradiology arena will involve U.S. trained and accredited radiologists providing

“nighthawk” services. Pure foreign competition that would utilize non-U.S. accredited

radiologists will be a non-issue in the foreseeable future.13 14

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2. Analysis of Key Players in the Teleradiology Service Industry

In order to successfully compete in the teleradiology arena over the next five years,

companies must have certain capabilities. The following continue to emerge as most important

in order to achieve a sustainable competitive position:

Ability to comply with stringent U.S. regulations (requires a staff of U.S. trained and

licensed radiologists)

An up-to-date technology infrastructure (largely not an issue anymore)

Reputation and track record of high quality services

Ability to perform nighttime reads at competitive prices

Ability to address patients concerns about quality and privacy

For the purpose of this analysis, we constrained our client market to include only U.S.

radiology practices (hospitals, independent clinics, etc). However, when considering the various

types of teleradiology service providers, we analyzed the prevalent arrangements that cater to our

U.S. market. The following sections discuss the various types of teleradiology service providers,

their assets, capabilities and likelihood of their success in this environment. The service

1http://www.rt-image.com/content=8304J05C487E948640569C724488B0441 2 http://www.imagingeconomics.com/library/200009-03.asp3 http://www.nighthawkrad.net4 http://www.radiologytoday.net/archive/rt_051004p20.shtml5 http://www.nighthawkrad.net/techworkflow.htm6 http://www.mikety.net/Articles/PC-Teleradiology/Teleradiology.html7 http://www.imagingeconomics.com/library/200009-03.asp8 http://www.imagingeconomics.com/library/200009-03.asp9 http://www.radiologytoday.net/archive/rt_051004p20.shtml10 http://www.fortherecordmag.com/archives/ftr_030804p28.shtml11 http://www.diagnosticimaging.com/showArticle.jhtml?articleID=185302932 12 http://www.auntminnie.com/print/print.asp?sec=sup&sub=imc&pag=dis&ItemId=7018013 http://www.diagnosticimaging.com/showNews.jhtml?articleID=5420125314 http://content.nejm.org/cgi/content/full/354/7/661

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providers can be divided into three major categories based on their geographical locations: U.S.

based, global and hybrid providers.

2.1 U.S. Based Teleradiology Service Providers

The U.S. based teleradiology service industry has developed overtime from the need to

cater to remote and rural hospitals15 where it was difficult to staff full-time radiology

professionals due to their high fees and unwillingness to re-locate. Teleradiology service

providers in this space are sub-divided based on the value proposition and expertise they offer.

The first sub-category are the incumbent established urban hospitals like Massachusetts

General Hospital16, Children’s Memorial Hospital17, and Arizona College of Medicine18; with a

full-time specialized radiology staff that provide teleradiology service to neighboring county and

state healthcare facilities and hospitals. These providers do not compete on the cost of service

but offer the expertise of their practitioners. These services are used mostly as value-added

second opinions or in emergency cases where it is difficult to transport the patient to the urban

facilities. The radiologists providing this service have accreditation from the incumbent

hospitals and are certified by the ACR and Joint Commission on Accreditation of Healthcare

Organizations (JCAHO19).

Another sub-category of U.S. based service providers are the 3rd party specialized

teleradiology centers like Quality Nighthawk20, Reddy Solutions Inc (RSI)21, Virtual

Radiologic22, U.S. TeleRadiology23. Each provider is based in the U.S. and runs radiology and

15 http://www.rurdev.usda.gov/rd/stories/ny-20050103-telerad.html16 http://www.massgeneralimaging.org/Teleradiology_Site/NewFiles/Services.html17 http://tie.telemed.org/programs_t2/showprogram_t2.asp?item=253318 http://www.radiologytoday.net/archive/rt_051004p20.shtml19 http://www.jointcommission.org/

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diagnostics services from centralized locations and facilities. They recruit U.S. based

radiologists that have the necessary certifications and credentials to serve the U.S. healthcare

industry. These service providers address the liability insurance and other legal issues while the

hospitals and healthcare facilities using their services are only responsible to pay for each

diagnosis report. This type of service providers serve as nighthawks and dayhawks for smaller

and remote healthcare facilities that cannot afford to hire full-time dedicated radiology staff on-

site.

The third sub-category of teleradiology U.S. based service providers is very similar to the

one above but is smaller in size and is decentralized. The primary teleradiology provider

employs or sub-contracts the radiology diagnosis work out to other 3rd party radiologists based in

the U.S. This type of arrangement works well for self-employed radiology professionals who

provide their own insurance coverage and accreditation. The main difference between this type

of service and the former centralized category is that the patient scans and images are sent to the

remotely located radiologists work/home site (within the U.S.) as compared to radiologists

traveling to work at the centralized teleradiology service provider location.

In general, the U.S. based teleradiology providers are well positioned to offer “overflow”

and specialized services to radiology practices that are in remote locations, are understaffed, or

do not have the on-staff expertise for specialized cases. However, the current growth of daytime

outsourcing services has not been significant. According to a recent survey by Auntminnie24,

while the “nighthawk” preliminary interpretations are common, there is little acceptance of

daytime outsourcing.

20 http://www.qualitynighthawk.com21 http://www.rsirad.com/index.htm22 http://www.virtualrad.com/page/home.jsp23 http://www.usteleradiology.com/careers.htm24 http://www.auntminnie.com/print/print.asp?sec=sup&sub=pac&pag=dis&ItemId=70806&prin&d=1

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Furthermore, these providers are at a disadvantage to hybrid providers when it comes to

offering nighttime reads, which are currently much more common. In order to provide these

popular services, U.S. based providers require their staff to work during the night, which is

generally loathed by the practitioners. In turn, radiologists demand a 30% premium for their

services performed during unusual hours, which in turn leads to less competitive prices as

compared with hybrids. In short, the U.S. providers are in a strategically inferior position when

it comes to meeting the currently fast growing “nighthawk” opportunity.

Another disadvantage of these U.S. based providers is that they currently don’t have a

large installed base. So, even if the industry turns its attention to the practice of outsourcing the

daytime reads, the hybrid nighthawk providers will be in a better position to offer their clients

those services because they already have established relationships and processes.25 26

25 http://www.medicalimagingmag.com/issues/articles/2005-02_03.asp26 http://www.imagingeconomics.com/library/200510-02.asp

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2.2 Global Teleradiology Service Providers

A number of teleradiology providers located outside of the U.S. have sprung up across

the globe – notably in India, Brazil, Russia, Israel, and China in the last 3 or 4 years. This

service model is very closely based on the success of outsourcing of services in the Information

Technology (IT) and customer support ‘call-center’ industries. The primary benefit touted by

this category of global service providers is the significant cost savings by exporting the work

outside the U.S. For example, a radiologist in India charges $25,000 per year as compared to

$350,000 charged by a certified and approved radiologist based in the U.S. Global teleradiology

service providers have yet to succeed largely due to strict legislation and high importance on

quality of service norms of the U.S. healthcare industry.

Many unsuccessful attempts have been made in the past by global service providers to

enter the U.S. teleradiology market. Most notable is the experiment carried out by Wipro

Industries of Bangalore India, in partnership with Massachusetts General Hospital. In this case,

U.S. patient scans and images were sent for preliminary diagnosis to the Indian radiologists (ones

who did not possess U.S. board certifications and approvals) for a first-pass diagnosis and then

validated and authorized/signed by U.S. certified radiologists. Based on security of information

and other related issues, this experiment was ultimately suspended by U.S. authorities.

The proven track record of outsourcing IT services still has some pundits predicting that

the same will happen in the field of teleradiology. However, the global teleradiology providers

are positioned rather poorly to compete in this field over the next several years. Unfortunately,

the legal, regulatory and licensing hurdles make it impossible for these providers to gain a

foothold in the U.S. market.27 Furthermore, the certification process is lengthy and constrained

27 http://www.diagnosticimaging.com/showArticle.jhtml?articleID=47902001

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by U.S. institutions that are already at or near capacity. Finally, there is very little that these

global providers can do to address the problem. They can neither influence the policy or

regulations, nor can they have all staff members trained and board certified. All of these issues

create a very difficult strategic position.

Another difficulty that the global providers face is the issue of assuring quality and the

perception of quality by the patients.28 When it comes to healthcare, Americans are more

concerned about quality and privacy than about the cost, and global providers would have to

overcome the perception of second-rate quality. Because these providers are not governed by the

rigorous U.S. regulations, patients and practitioners perceive them as lower-cost and lower

quality providers, which is a serious disadvantage. Their biggest selling point is lower costs,

which implies worse quality, yet quality is the primary consideration in this market.

2.3 Hybrid Teleradiology Service Providers

The hybrid category of service providers includes those with headquarters in the U.S.

who are registered as U.S. companies but have external teleradiology operations.29 The most

successful example of a hybrid is NightHawk Radiology Services30 (NASDAQ: NHWK), a

provider of nighttime, weekend and off-hours emergency radiology services to radiology groups

and hospitals across the U.S. Operating remotely from centralized facilities in the U.S.,

Australia, and Switzerland, NightHawk's team of American Board of Radiology-certified, U.S.

state-licensed and hospital-privileged radiologists use a proprietary workflow technology to

provide 24/7 radiological interpretations, or reads, for its customers. The company is able to

28 http://content.nejm.org/cgi/content/full/354/7/66129 http://www.imagingeconomics.com/library/200009-03.asp30 http://www.nighthawkradiologyservices.net

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leverage its highly efficient and scaleable operating model to service nearly 463 customers and

more than 860 hospitals throughout the U.S.

Due to success of NightHawk Radiology Services several other companies (Technology

Solutions31, Radlinx Group Ltd.32, NighHawk Pros33) have copied their business model and

established teleradiology service centers across the globe. These hybrids now compete to some

extent on cost of service but mainly on turnaround time (average turnaround time is between 30

to 60 minutes) of the results as well as efficiency of diagnosis. These service providers do not

claim to compete with the U.S. based radiology professionals but count themselves as

complementors.

By utilizing U.S. trained and certified radiologists, hybrid service providers are uniquely

positioned to compete in the teleradiology field over the next several years. There are currently

plenty of radiologists who would like to live in exotic countries that offer the same or higher

quality of life.34 This allows hybrid providers to overcome the most significant hurdle of

licensing, certification and the “legal minefield.” Their radiologists already have all the

necessary licenses and certifications and can legally perform preliminary interpretations from

distant locations.

Outsourcing nighttime reads is the primary reason why hospitals first consider

teleradiology. Physicians in the U.S. do not want to work at night and such services performed

by U.S. based radiologists usually command a significant premium. In this regard, the hybrid

providers have an advantage over the U.S. providers. They are well-positioned to offer cost

savings because they can capitalize on the time difference. Their radiologists can work during

31 http://www.telradsol.com/index.html32 http://www.radlinxgroup.com/index.html33 http://www.nighthawkpros.com34 http://www.diagnosticimaging.com/showArticle.jhtml?articleID=47902001

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the day at “day prices” but because of the time difference, the reads happen to occur at nighttime

in the U.S. This allows hybrid providers to forego the nighttime premium and offer lower prices.

Because hybrids only utilize U.S. trained and certified radiologists who carry full

malpractice insurance and obey by the U.S. regulations, the quality concerns are usually not a

problem. Some have even made the argument that this arrangement leads to higher quality reads

because a radiologist who is awakened in the middle of the night is not as rested as his

counterpart in Sidney who has just begun work. 35

The strategy of hybrid providers is to first enter the market by offering preliminary reads.

This allows them to claim that they do not directly compete with the staff radiologists and that

their services only complement their local practices. Because of this, nighthawk types of

services have enjoyed a strong rate of acceptance and are currently used in about 10% of nation’s

facilities.36 Thanks to the large existing installed base, hybrid companies will be best positioned

to take the radiology services outsourcing to the next level.

Rather than offering only “preliminary” reads, in time they could offer “final” reads as

well. The prerequisites needed for this step are already in place, the technology infrastructure

would not need to undergo major changes and the existing workflows could easily be adjusted.

Most importantly, once the client hospital is assured of a satisfactory level of quality, the client

would likely take the relationship to the next level. Granted, there are still some legal barriers

that would allow hybrid providers to offer “final” interpretations, but once they are clarified,

which doesn’t seem to be far off, they would be in an excellent position to offer such services.

35 http://content.nejm.org/cgi/content/full/354/7/66136 “Teleradiology Growing” by Henry L. Davis, Buffalo News, 18 January 2005

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3. Investment Opportunity

Out of the three types of service providers, the hybrid nighthawk service providers are

most likely to grow and succeed over the next five years. These providers currently capitalize on

the most prominent trend of facilities outsourcing nighttime reads. Also, because of their

existing relationships with customers, they are most likely to benefit by the impending wave of

outsourcing daytime reads.

One company that is currently the best candidate for investment is NightHawk Radiology

Services (NASDAQ: NHWK). It is the biggest and best-known player in the hybrid nighthawk

space, has a strong reputation of providing quality interpretations and has solid relationships with

a large installed base of client hospitals. NightHawk is also well positioned strategically to

expand its nighttime business as the need continues to grow as well as sell daytime services to its

existing customers. To expand its capabilities into daytime services NightHawk has made a

strategic acquisition of DayHawk Radiology Services in January 200537, thus effectively

increasing its coverage to daytime hours. Finally, the company has strong fundamentals with a

solid history of income and revenue growth. NightHawk is reasonably priced with the forward

P/E ratio of 26. As a result of these quantitative measures in addition to our qualitative analysis

of its opportunity, we recommend NHWK as the best candidate for investment in the

teleradiology field over the next five years.

37 http://files.shareholder.com/downloads/NHWK/35803791x0x24997/b9184b3a-e081-43c8-b23b-be764d418c73/01-04-04.pdf

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4. References

17