Diagnostics Companies React To Changing Lab Marketplace

CEO SUMMARY: During the last five years, extensive consolidation among in vitro diagnostics (IVD) manufacturers has created a new class of industry giants. Their increased dominance of the IVD marketplace promises significant change to how laboratories acquire and use reagents, test kits, and new IVD instruments. Here’s how and why the IVD industry transformed itself through consolidation.

Part One of an ongoing series

MOST LABORATORIANS FAIL to appreciate how consolidation reshaped in vitro diagnostics (IVD) companies during the decade of the 1990s.

In 1990, the ten largest IVD companies had only 62% of the total market. By 1998, the ten largest IVD manufacturers controlled 80% of the international market for in vitro diagnostics.

Concentration Of Power

This concentration of power is now changing the way diagnostics companies provide products and services to clinical laboratories. As market power concentrates in the hands of fewer and bigger IVD companies, it leaves clinical laboratories with reduced options for purchasing new instruments.

It also increases the risk that clinical laboratories might buy the “wrong” technology when purchasing new instruments. This is because THE DARK REPORT predicts a stratification of the diagnostics industry into two categories of companies.

One category will be the IVD powerhouses. These might be described as the behemoths of the industry. They are huge, offer a broad array of instruments, and have extensive sales and service resources. The three largest IVD firms, Roche, Abbott Laboratories, and Johnson & Johnson, provide good examples of companies in this category.

Innovative Products

The other category will be IVD companies offering innovative products built upon emerging technologies. Generally, these companies will be developers of new technology that has the potential to bring increased value to clinical procedures. Examples in this category are Affymetrix, Idexx Laboratories, Ventana Medical Systems, and Epitope.

Dealing with companies in s second category entails a greater risk for laboratories. These companies must demonstrate the clinical and economic value of their diagnostic technology. Since most are start-up companies, they only have a limited capital base to accomplish this goal.

Without Service Or Support

That means laboratories which are early adapters of such new technology might find themselves without service and support if their vendor fails. A recent example of this was the bankruptcy in April of Neuromedical Systems, Inc., maker of the PapNet system for Pap smear diagnosis. Labs using PapNet now must get service and support through other means.

Three fundamental market trends caused the IVD industry to consolidate and evolve into this two-tier structure. The trends were a logical consequence of widespread consolidation among hospital and commercial laboratories.

One, IVD manufacturers used mergers and acquisitions to achieve economies of scale. Larger production runs mean lower manufacturing costs. This allows the IVD company to maintain competitive pricing as GPOs (group purchasing organizations) and integrated healthcare networks seek to drive down prices when acquiring new diagnostics systems.

Two, by offering a unified product line of instruments, IVD companies gain an advantage over firms which only offer a limited number of instruments. The growing interest in automated workcells and upcoming generations of total laboratory automation (TLA) systems further reinforce this trend.

This strategy was clearly at work when Beckman purchased Coulter Corporation in 1997. This combined Coulters’s respected portfolio of hematology instruments with Beckman’s line of chemistry instruments. (See TDR, October 6, 1997.) Bayer’s acquisition of Chiron Diagnostics last year was another example of using an acquisition to broaden a product line.

Increase Capital Base

Third, it takes increasing amounts of money to research and develop new diagnostic instruments. This was recognized by the largest IVD manufacturers. It was an important reason why they used acquisitions as a way to increase capital available to fund research and development.

These three consolidation trends are rooted in an important fact about the IVD industry. Like the commercial lab- oratory industry, in vitro diagnostics is considered to be in a mature phase. Growth prospects are limited.

Financial analysts predict that the entire IVD industry will see growth of just about 1% per year through 2002. Even the top ten IVD companies, as a group, are expected to average sales increases of only 5% per year during that same period.

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IVD Growth Projections

Compare IVD growth projections with those for sales of personal computers, where analysts see annual revenue increases of 25% to 50% per year. IVD companies must compete for capital. Laboratory executives should understand that IVD companies are under constant pres- sure from Wall Street to increase sales and earnings.

That does not mean, however, that growth prospects for the IVD industry are totally glum. Specific technologies are expected to deliver rapid revenue gains as clinical usage increases.

In fact, these are technologies which laboratory executives should watch with interest. Because of their potential to enhance clinical outcomes, laboratories will want to add these assays to their offerings as early as possible in the market introduction curve.

Four areas of diagnostic testing are expected to grow rapidly. DNA probes are already a $616 million market for IVD companies. It is projected to grow at 20% per annum.

Whole blood glucose testing is currently a $2.8 billion market and should grow at 12% per year. Increased point of care and home testing kits mean the clinical laboratories will not see as much benefit from this segment.

Point of care testing is currently worth $400 million to IVD companies. This is an area of diagnostics which directly impacts the number of specimens moving away from core laboratories. Estimates are that this segment will grow at 20% per year.

In situ hybridization, currently at $300 million per year for diagnostics companies, is expected to grow at a yearly rate of 15%.

In contrast to these four high-growth technologies, IVD companies still generate substantial sales from technologies considered mature. These are the slow-growth products for which demand is flat or even shrinking.

Technologies considered mature, are cell counting, clinical chemistry, microbiology, and immunoassay. Clinical chemistry is the largest segment. It is estimated that clinical chemistry comprises nearly 40% of the $18.3 billion IVD market. On a unit volume basis, between 50% and 60% of all IVD procedures involve clinical chemistry.

IVD Firms Serve Four End-User Segments

In vitro diagnostics companies provide products to four distinct types of end-users. They are:

  • Central Laboratory–Includes all centralized sites in the hospital or reference laboratory.
  • Ambulatory–Includes all decentralized testing sites in physician offices, clinics, and at the point of care.
  • Patient Self Testing–Includes all testing performed by the patient such as pregnancy or ovulation monitoring.
  • Blood Processing and Screening– Includes all screening sites of donor blood and blood products for quality control purposes.

Mature Technologies

IVD companies with the biggest stake in mature technologies are not expected to see strong year-to-year increases in revenues from such technologies. This is one reason for the steady flow of acquisitions by leading IVD manufacturers.

For example, Bayer’s acquisition of Chiron Diagnostics last year gave it access to a strong intellectual property position in nucleic acid diagnostics. Of particular value was access to Chiron’s HCV technology, its high volume immunoassay system (the Centaur), and a number one market position in the blood gas market.

Bayer’s access to Chiron’s products helped it diversify away from mature products such as clinical chemistry, immunoassay, and hematology. It demonstrates how selective acquisitions are necessary if IVD companies are to field a competitive mix of products which have high growth potential during the next five years.

Another interesting example of how IVD companies are restructuring their product mix is Dade Behring. during 1997 and 1998, Dade Behring’s sales declined by 9% and 5%, respectively.

According to Scott Wilkin, a healthcare analyst at Warburg Dillon Read, Dade Behring’s revenue declines are actually a sign of postive developments at the company. “It is not surprising that sales [at Dade Behring] have declined over the past two years,” he wrote last fall. “as the company has been judiciously eliminating unprofitable product lines and redeploying resources in higher-growth, higher-margin businesses.”

Wilkins continued “while sales growth has been lacking, management has delivered impressive operating margin and cash flow results.”

Wilkin’s comments about Dade Behring illustrate how the major IVD manufacturers are juggling their product lines to drop money-losers and add breadth to the products they offer laboratories.

To summarize, during the 1990s, several trends dominated the IVD industry. These trends are changing, in fundamental ways, how diagnostics companies and clinical laboratories interact with each other.

Predominant Trend

The predominant trend has been consolidation. IVD firms used acquisitions to build size, increase volume, and generate economies of scale in manufacturing and sales.

Second, the largest IVD firms have used acquisitions to build a broad offering of products. As the chart above demonstrates, the larger IVD companies are able to offer a broader menu of products as a single source.

Third, consolidation of laboratories is changing the way IVD companies sell their products. The emergence of integrated healthcare systems and stronger GPOs caused IVD firms to concentrate on meeting the different needs of this new class of buyers.

Coming issues of THE DARK REPORT will provide profiles of the leading IVD companies. The fortunes of clinical laboratories and the IVD industry go hand-in-hand. It is important for laboratory executives to understand the market forces now transforming the IVD industry. Such knowledge makes it possible to make more informed purchasing decisions.

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