Opportunities for Testing Equipment Companies Abound

Growth in the diagnostic lab testing industry offers a lucrative opportunity for companies that supply lab equipment and materials (PDMSN, Aug. 28). However, equipment and materials suppliers must also be aware of trends in who performs these tests, who pays for them and where they’re conducted.

Industry experts generally divide the diagnostic testing market into three segments. Routine blood and urine testing is the largest component with 67 percent of revenues, but also the slowest growing, with 3.5 percent annual growth. Anatomic testing — Pap smears and other tissue analytical techniques — is the next biggest segment, accounting for 23 percent of the market with an 8 percent annual growth rate.  Esoteric testing, which represents the newest modalities such as genetic diagnostics and advanced cancer screenings, makes up just 10 percent of total market revenues, but has the fastest growth rate at 13 percent per year.

Diagnostic lab tests play a role in 75 percent of all treatment decisions in the U.S. As such, the statistics on who pays what portion follow the same trends as the healthcare industry overall. To be exact, Medicare pays for 28 percent and Medicaid covers 16 percent, bringing the combined government share of the costs for diagnostic testing to 44 percent. Insurance companies cover 45 percent of the costs, leaving out-of-pocket costs to fill the gap at 11 percent.

Reimbursement Arithmetic

Companies involved in routine testing don’t need to worry too much about how the payments are divvied up. Routine tests are such a basic part of the clinical setting that these sources of funds are relatively stable. For companies working on cutting edge technologies, however, it’s important to pay attention to the mechanics and politics of funding.

In general, diagnostic tests don’t represent a major component of the budget and are likely to face little resistance in the reimbursement process. But advanced esoteric tests are expensive. An increase in the number of diagnoses for conditions that require high-cost therapy could face an uphill battle in funders’ decisions about reimbursement.

Insurance companies are not likely to balk at funding their share of diagnostic lab testing. As a rule, they tend to be receptive even to expensive tests that lead to early diagnosis because their goal is to get members to 65 in a healthy condition and then let Medicare assume the risk of payment from that point on.

The segment of patients who do not have health insurance and must pay the full cost of testing out of their own pockets obviously will resist paying for anything beyond what is absolutely necessary. The other major out-of-pocket players — smaller in numbers but paying a disproportionate share of the costs — include wealthy people who place a very high premium on health. They’ll pay for tests even when insurance companies refuse.

Testing Site Numbers Can Be Deceiving

The following table shows the different venues for diagnostic testing in the U.S.

Nearly 95 percent of these tests are performed in one of three settings: hospitals, stand-alone clinical labs and physicians’ offices.  Although there are obviously more physicians’ offices than any other kind of testing site, they account for only 5 percent of annual testing spending — the classic “mile wide and inch deep” scenario. Sheer economics dictate that it makes more sense for all but the largest physicians’ offices to outsource anything that requires specialized equipment to a facility with higher patient volume. Therefore, physicians’ offices do not represent the most promising target audience for makers of diagnostic testing equipment.

In contrast, hospitals account for the largest portion of overall spending — 54 percent — and the average hospital spends $3 million annually on diagnostic testing, exponentially more than the $21,700 the average physician spends. While this is clearly a very important market, stand-alone labs actually represent the most productive diagnostic testing market, raking in $3.4 million annually per facility. With stand-alones, however, there are caveats to keep in mind.

Stand-Alone Monopoly

While there are more than 5,000 stand-alone labs in the U.S., 64 percent of these are owned by just two companies: LabCorp and Quest Diagnostics. This backdrop has major marketing implications. With purchasing decisions made at the corporate level and then filtered through the system, the purchasing offices of these two companies have enormous power to extract favorable terms from suppliers. The process also makes for a long buying cycle that must be handled by a very qualified sales team. On the positive side, these companies have very deep pockets and see advanced diagnostic tests — while costly — as a way to grow their businesses.

Although the testing revenues of hospitals are slightly lower than those of stand-alones, they may be easier for equipment suppliers to do business with. Hospitals have independent decisionmaking units as a rule, and while their purchasing offices are adept at contract negotiations, suppliers can usually walk away with better terms than they get from the major lab companies. However, most hospitals are paid by insurance companies and through Medicare using a diagnosis-related group method, which means the hospitals will get a flat fee regardless of the tests they run. In this environment, advanced testing equipment is likely to be viewed more as a cost than as an investment.

Mixed Bag of Options

In addition, some hospital chains have essentially the same buying characteristics as big lab firms, with decisions influenced by corporate offices, tough contract negotiations and long buying cycles.

Apart from the major lab firms, diagnostic testing is highly fragmented, with some 100 companies each sharing well under 1 percent of the total market. Marketers should view these kinds of labs as being in a similar vein as the non-chain hospitals, with independent decisionmaking units and relatively little aggregate buying power.

In the end, growth in the diagnostic industry offers ample opportunity for suppliers of testing equipment and materials, but only for companies that know precisely where to look to make the most of it. — Todd Clark

“Clinical Lab Industry,” an Aug. 14, 2007, report from investment analysts at Credit Suisse, is the source for most data in this article unless otherwise noted.