To evaluate the effectiveness of budget holding by Pegasus Medical Group for laboratory services expenditure and reasons for the successes observed. Two pilot groups and a nonpilot group of general practitioners were formed with the pilots receiving active feedback, educational programmes and test form redesign within the incentive of savings being retained by the group for improved primary care services. Overall savings of 22.7% were achieved within the budget over a 13 month period. There was a highly significant reduction in expenditure per member especially in the mean and standard deviation of cost per consultation indicating a marked narrowing of the variance in cost between members in the pilot groups compared with the nonpilot group. The study illustrates the effectiveness of a comprehensive strategy of education, active feedback and test form redesign and especially the importance of the incentive of retaining budgetary savings for service improvements. It also illustrates the importance of collaborative as compared with competitive strategies in achieving cost control and value for money gains in health services. However, more work is needed to establish the appropriateness of lower laboratory expenditure by linking test requests to diagnosis.