Diagnostic industry – In a take-off stage

The diagnostic industry continues to evolve; companies that can address challenges while providing innovative solutions are likely to succeed in the years to come.

India’s healthcare industry has been steadily growing, and the diagnostics space is no exception. Estimated at ₹78,004 crore in 2022, the Indian IVD industry is expected to grow at a CAGR of 15 percent over the next 5 years.

2022 was quite a tumultuous year for diagnostic centers. The labs at large have experienced operating deleverage in the financial year FY23 due to sharp decline in Covid and Covid-related revenue. The decline in Covid business has been to the extent of 80 percent to 85 percent, compared to last year in general. While it was not very clear last year, but deeper analysis also suggests that even non-Covid revenues were favorably, as well as unfavorably, impacted in some quarters due to Covid, thereby resulting in extremely uneven quarter numbers in FY22. For meaningful analysis on top line and bottom line, one needs to look at CAGR pattern of non-Covid sales over three to four years on an annualized basis, that is the comparison with pre-Covid times. Also, one needs to look at trajectory building on sequencing pattern that is quarter-on-quarter trends over the last three to four quarters instead of year-on-year basis. The industry also experienced in these couple of years, entry of many players coming from pharma, hospitals, and e-commerce as well. Most large players in the industry also have not taken meaningful price increase in the last five to six years. On the contrary, while bundling of tests may have led to higher realization per patient, it resulted into effective decline in realization per test. So, far, this has been possible due to operating leverage, mainly driven by higher number of tests per patient. It would be very interesting to see how this pattern takes shape, given very high inflation scenarios in times to come.

This is an inflexion point for the sector, and performance improvements, in terms of growth to double-digit revenue growth that will lead to the valuation rerating back, are expected.

The laboratories will have to widen their footprint geographically, because this is a very asset-light business, the supply side is abundant, and you will always have somebody just entering the business, whether it is a hospital side or pharma or even smaller players. So, technically, one company having a very high market share in one market is probably a difficult thing to achieve. So, you need to widen the footprint. And that footprint will have to be done both organically and inorganically.

Also, there will need to be a shift in the business model. Patients post-Covid are looking for a higher level of convenience. They are no longer prepared to stand in the queue and wait for 30–35 minutes for their turn to come and give blood sample. They expect collection to be done near them, which could be in the format of a collection center or a home collection. Now more centralized labs are needed and a lot of spokes in the format of collection centers.

In 2022, as Covid receded, and the diagnostics industry started to see normalized growth, due to intense competitive activity, the growth started to split amongst many players. The large pile of unorganized market continues to lose its market share and increasingly customers are preferring organized players, with accurate results, faster TAT, and most importantly outcomes, which are accepted by the medical fraternity. It is the trust of the doctors and the consumers, which is becoming a key factor for selection of labs much more than just the price point, especially when people are unwell. Convenience, use of technology, and brand premium built by the larger credible players over decades are being preferred over standalone labs, and trust and medical expertise and large test menu of the credible larger players are winning over healthcare players and aggregators. The lab chains witnessed consistent low- to mid-teen growth of non-Covid revenues for the four quarters of calendar year 2022, not only by continuing to be very respecting by doctors across the country, but also by introducing technology and consumer connect that makes life easier for consumers.

Two distinct segments have emerged. Direct-to-consumer, where the focus is on preventive, lifestyle, chronic illness, a segment that sometimes does not depend on prescription, or if depends on one prescription leads to multiple visits to a lab. The USP here tends to be mostly price, which gives them some momentum over large amounts of cash, but the business itself does not always have strong unit economics. And servicing cost is the largest cost in the P&L in a pathology company. It becomes very difficult to become profitable in this business, with high discount and volume growth, as the cost of servicing is only increasing.

New competition is coming largely from hospitals and pharma companies or pharmacy chains. Here the idea is to build a large cluster of labs and many franchise collection centers, and focus on B2C and B2B business, by getting doctors to recommend patients and business from unorganized labs, customers of semi-specialized and specialized test category, which is B2B. Again, price is being used as the main USP for doing this business. While B2C is showing very low traction for these new entrants, all are focusing on B2B. At the current price points many may never make money. In the best-case scenario, even with total volume increasing, unit economics may be a challenge over 10-year period for these new entrants. While this competition is putting a lot of pressure on the entire market, we are seeing that while B2B lab customers value price, they also value strong logistics, sales team, technology, quality of reports, connect with doctors, and good support and large lab infrastructure from new and old companies.

And this is what is making it harder for the new lab companies to scale. What attracted most of these competitors to this market is the attractive financial metrics of low capital and high return, but the way the business is being built by most in an urgency to scale is low capital and low return. While the investor worry is that this big pricing pressure will cause low growth and low revenue growth and margin pressure, B2B businesses are facing some pricing pressure and pressure on sales talent. Since the lab chains business is never built on price as the USP, their customer loss is less it is more linked more to the execution of services.

With working toward excellence in these services, the incumbents like Metropolis and Dr Lal PathLabs, who have built a moat, using scientific expertise and strong brand connect with B2B and doctors and consumers, will not only be able to withstand the onslaught of competition and the human capital and pricing pressure it brings, but also be able to grow the core diagnostics business well and make good returns.

The other model is a very institutional hospital pick-up business, a high-end business, and not a direct-to-consumer one. Here, the labs need to work with the medical fraternity and do companion diagnostics work with pharma companies to see how the high-end portfolios, which are very, very specialized, can be tapped. These include electron microscopy, cytogenetics, and gene sequences.

For lab chains, while there are as many as 20 deals possible at one given time, with lots of diagnostic firms wanting to sell their businesses, the average asset quality is not high. And therefore, it is not very attractive to go into a place where they wind up paying a high value and then need to spend so much time in cleaning up the core practices of the past that revenue is lost while doing so.

Players, who have entered the industry and are focusing on wellness as a core, are making severe losses and the revenue growth is not so high. The monthly active users are falling. Wellness was more of an outcome of Covid and while the wellness category has got developed during Covid, and not that it will not grow in the future, it will. But the real profit and the real growth continues to be in the illness segment. And even in the wellness segment, unless the sales team knows how to sell plans, which are unit economic viable, getting profitable growth is improbable. The concept of wellness growing on its own at 20 percent, 25 percent a year is not actually what we are seeing happening on the ground.

There is some impact because of dollar too. The dollar appreciated against the rupee in 2022, and since most of the reagents are imported, the dollar appreciation does have some impact on pricing charged by vendors to lab companies in the industry. The labs at their end do try to balance the cost increase with operational efficiency on the back end and cut down the impact on the P&L.

With growth in technology and increase in demand, most of the labs can plan for automation in all wings of clinical testing like hematology, biochemistry, immunoassay, and molecular diagnostics testing. Labs are inclined to switch from semi- to fully-automated analyzers. And this is where manufacturers come to provide solutions that meet the rising demand for speed, quality, affordability, and accuracy.

The Indian manufacturers have acquired technologies, such as molecular diagnostic tests, next-gen sequencing, and other novel technologies for infectious diseases. The ability to manufacture most of the products in-house by upgrading technology, skills, or in collaboration with world leaders has not only helped the Indian companies to offer their products and services at an affordable price but also support the Make in India initiative of the Government of India. The RT-PCR test for SARS CoV-2 is a glaring example.

The industry is embracing new technologies, artificial intelligence (AI), machine learning (ML), and automation to enhance the accuracy, efficiency, and speed of diagnostic tests. This has led to the development of innovative products and services.

These include:

Emergence of digital pathology. Digital pathology will continue to play a key role in pathology, albeit much of this was necessitated by the demands of the Covid-19 pandemic requiring remote review and signing out of cases. This was digital pathology’s proof of concept.

There remain multiple barriers to widespread adoption, including regulations, the high cost of equipment, training, validation, and workflow. Despite these obstacles, the value of digital pathology in allowing rapid remote second opinions and consultations, shorter sign-out times, enhanced data retrieval and integration, as well as the opportunity for AI assistance for enhanced analysis, are helping to drive the process forward.

Expansion of POC testing. POC testing has been gaining popularity in India, particularly in rural areas where access to laboratory testing is limited. The Indian diagnostic industry has been responding to this demand by developing new and innovative POC testing devices that are affordable, accurate, and easy to use.

Rise of telemedicine. With the increasing availability of high-speed internet and mobile devices, telemedicine has become a popular option for patients seeking medical advice and consultation. The Indian diagnostic industry has been leveraging this trend by offering telemedicine services that enable patients to receive diagnostic test results and medical advice from the comfort of their homes.

Consolidation of the industry. The Indian diagnostic industry has been witnessing a consolidation of players as larger companies acquire smaller ones to expand their product portfolios and geographic reach. This trend is expected to continue, leading to a more concentrated industry with fewer players but larger market share.

Increased focus on preventive healthcare. There is a growing awareness of the importance of preventive healthcare in India, and the diagnostic industry has been responding by offering a wide range of preventive health checkup packages and wellness programs. This trend is expected to continue as the Indian healthcare system shifts toward a more patient-centric and preventive care model.

Technological advancements are enabling the industry to move beyond just the diagnosis stage. The IVD space now plays a key role in not only identifying symptoms and diagnosis but also in patient monitoring, personalized medicine, hospital management, and supporting physicians, clinicians, and patients.

The government has initiated collaboration to set up MedTech parks. These parks help strengthen the IVD industry with products and services that can help healthcare service providers offer better healthcare facilities. The Telangana State MedTech Park is one such example.

With the introduction of Indian Certification for Medical Devices (ICMED) in 2018, India is now poised to bring quality-assurance system for India-manufactured medical devices at par with multinational companies. It is proving to be a boon for IVD manufacturers in bringing down the substantial time and monetary investment to obtain globally accepted quality certifications and in-turn it is helping in assuring standardized products. It also helps Indian manufacturers to compete against recognized products, which are equipped with certificates like CE and USFDA certifications.

In recent times, collaborative efforts of the industry and the government have led to opening of new avenues for the IVD industry. For example, the states of Bihar, UP, MP, and Rajasthan have allowed participation of private pathology service providers on private-public-participation (PPP) model.

Overall, the Indian diagnostic industry is rapidly evolving, and companies that can adapt to these new trends and technological advancements are likely to succeed in this growing market.