Diagnostic Testing Growth Spells Good News for Equipment Suppliers

For suppliers of equipment used in diagnostic testing, business is booming and likely to get better as the industry continues to grow at a steady clip.

Fueled by demographic and technological trends, diagnostic lab testing has become a multi billion dollar industry, reaching the $48.5 billion mark in the U.S. in 2006, according to “Clinical Lab Industry,” an August 2007 report by financial analysts at Credit Suisse. Lab testing represents 2.3 percent of overall healthcare spending and has been growing at a rate of 6.5 percent for the last three years.

At present, diagnostic lab tests play a role in approximately 75 percent of all treatment decisions in the U.S. Population growth trends and the demographics of aging are set to further expand the market. In addition, the testing industry has benefited from heightened recognition of the value of early detection. As a relatively small portion of the country’s overall health bill, and one that offers potential savings in other areas via early diagnosis, the lab segment is positioned to avoid the cost containment efforts aimed at other components of the healthcare system. This represents a well-funded opening for companies that supply equipment and materials used in lab testing.

First, however, the industry should understand the characteristics of the major market segments as well as some of the regulatory and political risks faced by makers of advanced tests.

Three Key Categories

Industry experts generally divide the diagnostic testing market into three segments: routine, anatomic pathology/cytology and esoteric. Routine testing includes standard blood and urine screening for conditions such as high cholesterol, diabetes and pregnancy. This category makes up the largest portion of the market, accounting for 67 percent of all revenues. Routine testing is also the most mature segment and exhibits many of the characteristics of a commodity market. Population and demographic factors — rather than new technology — are the primary sources of growth. That means suppliers must compete mostly on the basis of price rather than differentiated products, which translates to thin profit margins and the need to rely on high volume sales to generate profits. For the established players, this is a lucrative market but it would not be attractive for new entrants.

The anatomic pathology/cytology testing segment includes microscopic analysis of tissue samples, such as cancer biopsies and Pap smears, and accounts for 23 percent of diagnostic testing revenues. While representing a smaller share of the market, this segment is growing much more rapidly than routine testing — 8 percent per year compared to 3.5 percent. In this case, population factors play a role but improvements in technology are also fueling growth.

Unlike routine tests, anatomic diagnostic evaluations have not lent themselves to automation and continue to rely on a high degree of human analysis. As a result, the techniques are slower and more subject to human error than more automated methods. In this sector, there’s a clear advantage for providers who can up the ante with technological improvements to reduce processing time, increase accuracy or expand the range of diseases that can be tested.

The third segment of the diagnostic testing market is esoteric testing. This includes gene-based diagnostics and cancer screenings that require sophisticated instruments and highly skilled personnel. This segment accounts for just 10 percent of total revenues, but is the fastest growing, with annual increases of 13 percent. New technology and increased usage are driving most of this growth, with population trends playing only a peripheral role. As a rule, suppliers of esoteric tests have considerably more pricing power than makers of routine or pathological tests, because generally only a handful of companies are competing in subsections of the market and these companies are racing to come up with new and better products.

More Growth Ahead

The following table shows 2006 values and share for each segment of the diagnostic testing market. The 2010 estimated sales and share assume growth rates will continue at their current levels, yielding a total testing market worth more than $60 billion. Since this ignores the possibility for major technological advances, these estimates should be considered conservative.

As shown, at the end of this decade routine tests will represent a smaller and slower-growing, but still dominant share, while anatomic and esoteric tests will capture an increasing portion of the market.

Regulatory Cautions

Historically, diagnostic tests have been only loosely regulated. Unlike drugs or medical devices, there’s no established system for evaluating their safety and accuracy. While this is likely to still be the case for makers of more established and routine tests, the rules may be changing when it comes to the high-growth esoteric testing segment.

In September 2006, the FDA published guidelines on in vitro tests which indicate the agency make take a more active role in regulating this testing. Besides being subject to more regulatory oversight, some kinds of esoteric tests may also face political risks that could undermine business expansion. For example, one of the biggest market opportunities for gene-based testing is screening for health insurance policies. This is another instance of technology getting ahead of society’s ability to answer the questions it raises. In any case, it is highly likely that screening for employment or health insurance will be regulated or banned.

Fortunately, makers of equipment for genuine diagnostic purposes are unlikely to face this type of legal problem. For the industry as a whole, the bigger risk is that the FDA will begin to apply a higher degree of scrutiny to new tests with the result that product introductions face slowdowns. On the upside, there are some forms of new technology that would actually benefit from the FDA’s “stamp of approval” to help ease buyer concerns about quality and safety. At any rate, the largely unregulated environment will prevail for the next several years at a minimum.

The FDA’s 2006 publication on in vitro tests, “Draft Guidance for Industry, Clinical Laboratories and FDA Staff - In Vitro Diagnostic Multivariate Index Assays,” can be seen at www.fda.gov/cdrh/oivd/guidance/1610.html. — Todd Clark