CEO SUMMARY: Chiron is respected for its leadership in branched DNA and viral load technologies. The company had high expectations for its diagnostics group, particularly after its purchase of Ciba Corning. But rapid consolidation of the diagnostics industry changed Chiron’s opportunity to reach the first tier of diagnostic companies. Its experience demonstrates the far-reaching impact of changes to the healthcare system.
IT ONLY TOOK THREE YEARS for Chiron Corporation to enter the diagnostics business and decide to get out. Chiron’s experience demonstrates the rough and tumble side of the diagnostics marketplace.
Laboratory executives and pathologists are familiar with Chiron’s pioneering work in immunoassay and nucleic acid diagnosis (NAD). The company is probably best known for its advances in testing for hepatitis C (HCV) and HIV.
Chiron’s primary business strategy is based upon therametrics. Chiron defines therametrics as the process of taking related technologies for disease prevention, diagnostics, and therapeutics and marrying them into one comprehensive package.
“Therametrics is a comprehensive package that allows both the clinician and patient to work from a unified disease management protocol,” explained Judy Rossi, Director of Communications for Chiron Diagnostics. “The therapeutics strategy is why Chiron began to develop a diagnostics group in late 1994.
“Chiron’s research in the areas of immunoassay and NAD was focused toward identifying disease,” continued Rossi, “but Chiron quickly realized that this technology could also have immense value in monitoring disease states.”
Rossi is referring to the use of PCR and Chiron’s NAD technology in viral load testing, which has rapidly expanded in recent years.Most laboratory administrators and pathologists have become aware that viral load testing, particularly among AIDS patients, is fast-growing, profitable, and has high value-added for both clinicians and patients.
“Consistent with Chiron’s therametrics strategy of marrying prevention, diagnostics, and therapeutics, it was decided in 1994 that the time was right for Chiron to develop a marketing channel for the diagnostics piece of this product line,” said Rossi.
“Two things were needed to accomplish this,” she added. “One was practical experience–managerswho understood the diagnostics business and how to bring Chiron’s technology to market.”
“Second was the need for a worldwide commercial infrastructure and a systems platform for its technology,” continued Rossi. “The acquisition of Ciba Corning from Ciba Geigy (now Novartis) in 1995 provided us with both resources.”
Things did not turn out as Chiron expected. “As the diagnostics group was assembled, certain therapeutic technologies were in clinical trials,” explained Rossi. “Despite high expectations, clinical trials did not validate these technologies.”
Need To Improve Earnings
“This caused confusion among Chiron’s investors about the company’s strategies. Earnings did not meet expectations and that created pressure on the executive team,” she said. “This company’s core competency is in biopharmaceuticals and it was recognized that diagnostics was pulling capital and management resources away from Chiron’s core strength.
“It was also recognized that consolidation within the diagnostics industry was making it tougher for Chiron to build a first-tier diagnostics company,” Rossi stated. “For these reasons, it was decided to pursue a strategic partnership. Chiron explored this possibility with a number of big diagnostic companies during the past year.
“In fact, that is how Chiron Diagnostics became involved with Bayer,” continued Rossi. “During these ongoing discussions, Chiron realized that it would end up with a minority interest in a joint venture with a huge partner.”
Decision To Sell
“Because Chiron was ready to reemphasize biotechnology, and because consolidation within the diagnostics industry had changed the game since Chiron’s entry in 1995, the decision was made to sell the diagnostics business.
“Here is where it gets interesting,” added Rossi. “Joint venture discussions with Bayer had already established a level of trust and mutual understanding about the business philosophies of both companies. That probably was an important reason why Bayer eventually decided to purchase Chiron Diagnostics.”
Bayer paid a strong price for Chiron’s diagnostics business. For $600 million in revenue, Bayer will pay $1.1 billion. Bayer is also licensing worldwide rights to market Chiron’s proprietary research involving HVC and HIV. Bayer estimates that it may pay as much as $900 million in royalties to Chiron over the life of the contract.
This means Bayer will pay about $2 billion to Chiron for a combination of outright acquisition and technology licensing. Since Chiron controls 35% of the market for blood gas analyzers, laboratory executives throughout the United States will see change as Bayer takes over Chiron Diagnostics and begins folding it into the Bayer family of diagnostics products.
Chiron will still have a presence in diagnostics. The company is maintaining its joint ventures with Ortho Diagnostics Systems, Inc. of Johnson & Johnson and Gen-Probe, Inc. These ventures involve blood-screening products and generated $80 million in revenue and operating profit to Chiron last year.
One interesting side note to the Bayer-Chiron transaction adds further perspective about why Chiron divested itself of its diagnostics business. Even though diagnostics accounted for more than half of Chiron’s total revenue, earnings after the divestiture are expected to remain virtually unchanged. The reason: operating profits from the diagnostics division were minimal.
Just as clinical laboratories saw their revenue base squeezed and operating margins shrink to razor-thin margins, so also has a similar thing happened to diagnostics companies. Consolidation within the industry has given big competitors more volume and more clout.
At the same time, consolidation of laboratory buyers (through commercial lab consolidation and hospital system consolidation) now gives buyers more power to drive down prices paid for instruments and reagents.
THE DARK REPORT sees conformation of several key trends from Bayer’s acquisition of Chiron Diagnostics. First, steadily diminishing operating margins among diagnostics companies means that it is becoming increasingly difficult for small firms to expand market share. This is why second-and third-tier diagnostics companies find it difficult to finance aggressive growth.
Second, in the battle for market share, the diagnostics industry giants will continue to acquire lower-tier companies as a way to solidify market position, fill out holes in their product offerings, and obtain valuable new technology.
Third, clinical laboratories will find their vendor choices shrinking as this process plays out in the market. It is the consequence of consolidation of hospital systems and commercial laboratories. Although consolidation has increased the number of “larger” laboratories with buying clout, consolidation in the diagnostics industry means fewer instrument vendors to bid for its business.
Fourth, access to new diagnostic technology is a critical battleground for diagnostics companies. The explosion of viral load testing using PCR and NAD technology shows that future profits will not come from today’s routine testing, but from tomorrow’s value-added assays.
Because these new assays have greater clinical efficacy and value to physicians, patients and payers, reimbursement levels will reflect this value. That is the reason why clinical laboratories should track new diagnostic assays with the same diligence shown by the leading companies in the diagnostics