How to do Business Analysis of Diagnostic Labs

 Published: 17-Apr-22

Modified: 17-Apr-22
1. Classification of diagnostics labs
2. Key characteristics of the business of diagnostic labs
3. Summary
The current article aims to highlight the key aspects of the business of
diagnostics laboratories (labs). After reading this article, an investor would
understand the factors that impact the business of diagnostic labs and the
characteristics that differentiate a fundamentally strong diagnostic lab from a
weak one.

Classification of diagnostics labs

There are usually three kinds of diagnostics labs based on their
ownership/corporate structure.

1. Large corporate laboratory chains

2. Standalone labs in the unorganised sector
3. In-house labs for hospitals/clinics
From the functional aspect, the labs are classified under the following segments:

1. Pathology labs: conduct tests on the blood, urine, stool and biopsy
samples
2. Radiology labs: conduct imaging tests like x-ray, ultrasound (USG),
CT scan, MRI, PET-CT scans etc.
3. Integrated labs, which offer all the services including pathology,
radiology, preventive healthcare and wellness segment etc.
While doing the business analysis of diagnostic lab companies, we would
understand them from these perspectives.

Key characteristics of the business of diagnostic labs

1) Low level of cyclicity in demand:

Diagnostics labs perform a key role in the healthcare segment because the
results of the tests produced by them are essential for doctors in deciding the
disease and its treatment. As a result, diagnostics labs are a necessary service
in healthcare. Therefore, just like other key healthcare segments
like hospitals and pharmaceuticals, the demand for diagnostic services does
not fluctuate with general economic cycles of boom and bust.
Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, March
2016 (click here), page 8:
The revenue growth of diagnostic players although not generally vulnerable to
cyclicality due to diagnostics being a necessary and integral part of healthcare
This is because people get sick and visit hospitals for check-ups irrespective of
the phase of the economic cycle and diagnostic tests form an integral part of the
identification and treatment of the disease.

2) Highly fragmented industry:

The Indian diagnostics lab industry is highly fragmented where standalone labs
from the unorganized sector constitute the major portion. These labs are
primarily family-owned with only a regional presence catering to the local
population within small geography.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020 (click here), page 2:
The Indian diagnostic industry is highly fragmented with many small unorganised
standalone service providers. The organised players face stiff competition from
unorganised as well as in-house diagnostic departments of hospitals.
Let us try to understand the reasons for the large size of the unorganized
segment in a sector performing a critical role in the healthcare segment

2.1) Lack of stringent regulations in the operations of diagnostics labs:

Diagnostic services fall under the authority of the state govt. As a result, different
states end up framing different rules for diagnostic labs. Moreover, even in cases
where certain rules are the same across states, their implementation and
enforcement differ across states. Due to a weak regulatory environment,
numerous labs open up near hospitals and in densely populated areas.

In addition, the accreditation with bodies like NABL (National Accreditation Board
for Testing and Calibration Laboratories), which ensures standard operating
procedures, is not mandatory for all the labs. In India, only the labs under CGHS
(Central Govt. Health Scheme) and in govt. hospitals are mandated to take NABL
accreditation.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, March

2016, page 7:

Ministry of Health has mandated NABL accreditation compulsory for only

medical laboratories empanelled by CGHS and the laboratories under
the Centre and State Government hospitals.
Even in the situations where any accreditation is made mandatory, it is claimed
that such accreditations are not enforced strictly.

As a result, in India, unorganized standalone labs and in-house labs of hospitals

and clinics dominate the sector and occupy about 85% of the market share.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 2:

In India, the unorganised format is more prevalent, where privately-owned

standalone labs span metros as well as small cities and towns. Their growth has
flourished because acquiring accreditation is either not mandatory in most states
or not enforced effectively.
Credit rating report of Metropolis Healthcare Ltd by CRISIL, October 2021 (click
here), page 2:
These diagnostic chains face intense competition from hospital-based and
standalone centres, which together comprise a dominant share (about 85%) of
the industry.

2.2) Moderate capital intensity of standalone diagnostics labs:

Most of the standalone diagnostic labs are small in size and service a small
geographic area. This is unlike large corporate diagnostic lab chains, which
establish large reference/central labs that conduct a very large volume of tests
catering to a very large geographic region. In addition, standalone labs usually
restrict themselves to conducting simple standardised tests, which require
technologically simple equipment.

As a result, small standalone diagnostic labs are able to start their business
without a significant investment in their business. Moreover, such labs do not
need to do marketing to a large customer audience via channels like print &
online media or television etc. These labs usually do tie-ups with local clinics to
get business.

Therefore, the fixed capital intensity of small-standalone diagnostic labs is not

high. Moreover, the business of diagnostic labs is not working-capital intensive
because usually customers make upfront payments and their inventory
requirements are also not high.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 7:

working capital intensity of a diagnostic services provider is relatively low,

with less inventory and majority upfront cash receipts,
Further advised reading: Inventory Turnover Ratio: A Complete Guide
Moderate capital intensity has contributed to the growth of small unorganized
standalone labs.

Credit rating report of Metropolis Healthcare Ltd by CRISIL, October 2021, page
2:

The diagnostics industry faces moderate entry barriers on account of average

capital intensity, resulting in the emergence of a large number of diagnostic
centres.
The credit rating report for SRL Diagnostics Private Ltd. by CRISIL, February
2022 (click here), page 2:
Limited capital requirement for starting a diagnostics laboratory has led
to emergence of several diagnostic centres.
Therefore, due to moderate capital requirements and relaxed regulations, a large
number of standalone small diagnostic labs occupy a large portion of the
industry.

3) Non-differentiable, commoditised service, intense competition

with a low pricing power:

In the diagnostic labs, almost all the players whether large corporate diagnostic
chains or standalone labs or in-house laboratories of hospitals essentially provide
the same output to the patient. A sample from the patient is taken and then a
report is provided.

Therefore, unless and until any lab is able to provide any such test or radiology
imaging service, which is not available at any other lab, for a patient, functionally,
almost all the labs are the same. For example, if a patient has to check her
haemoglobin (Hb) level, then any lab is going to take her blood sample and
provide her with a report of her Hb level.

Due to such commoditised nature of service, patients become indifferent to the

lab where they get the test done. Unless there is a specific reference to any
particular lab from the doctor or the hospital, a patient may prefer the lab
charging a lower price.

Moreover, a large segment of the industry is dominated by small standalone labs,

which being unorganized are able to operate at low costs. As a result, they
charge comparatively lower prices to the customers than large organised
corporate laboratory chains.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 5:

Although small, unorganised labs lack infrastructure, technology, skilled

professionals or resources to expand, they are able to garner customers on the
basis of the cost advantage derived from their lean cost structure. This is
especially applicable/true for standardised tests, where a meaningful price
difference  between players can result in the switching of customer loyalty.
As a result, most diagnostics labs end up competing on pricing to gain
customers. This increases the pricing pressure on the whole of the industry.

Credit rating report of Dr Lal Pathlabs Ltd by CRISIL, February 2022 (click here),
page 2:
Intense competition in the diagnostic services market, which has several players
offering similar services, results in pricing pressure.
As a result, in order to gain business, diagnostic labs do tie-ups with doctors and
hospitals as it ensures a steady flow of patients.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020 (click here), page 5:
Referral tie-ups with or on-site labs at renowned doctor clinics and hospitals are
factored in positively, as they assure revenue visibility owing to the credibility of
the doctor or hospital.
Further advised reading: How to do Business Analysis of a Company

4) New asset-light business model of operations:

In the past, whenever any diagnostic lab wanted to gain a large scale of
operations, then it used to focus on a hub-and-spoke model where it would
establish a few large central/reference labs and multiple smaller labs spread
across the country. Nearly all the large corporate diagnostic chains like Dr Lal
Pathlabs Ltd, Metropolis Healthcare Ltd etc. follow this model.

Credit rating report of Dr Lal Pathlabs Ltd by CRISIL, February 2022, page 1:

pan-India network of 231 clinical laboratories (including national reference lab in

Delhi and regional reference lab in Kolkata)
Credit rating report of Metropolis Healthcare Ltd by CRISIL, October 2021, page
3:

As on March 31, 2021, it had a global reference lab in Mumbai, 12 laboratories

(13 regional labs) and 2,731 service centres.
This business model was capital-intensive because establishing large
central/reference labs, which can handle a large number of routine tests as well
as do many special/complex tests, which other labs cannot do, is an expensive
project. In addition, expanding the network of regional labs, which could help in a
quick turnaround time from sample collection to report production, is also an
expensive project.

As a result, previously, establishing large diagnostic labs with wide geographical

reach used to be a very capital-intensive business and companies needed to
raise a lot of capital to build them.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, March

2016, page 2:
Given the high fixed overheads’ nature of the diagnostics industry and their
aggressive expansion plans, organized players have also been fairly active in
raising equity funding either through private equity route or IPOs
However, nowadays, new players use the already present numerous standalone
and corporate labs to build their business. Such players outsource the testing of
samples to existing labs and therefore, do not have to spend money on creating
laboratories.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 3:

Recently, there has been an emergence of players offering diagnostic services

but instead of setting up a reference lab, they outsource the services to existing
organised diagnostic companies. The companies benefit by offering complete
healthcare services to customers and by getting new business without having to
invest in reference labs.
As a result, large corporate lab chains have also started using asset-light
strategies to expand their business. For example, Dr Lal Pathlabs Ltd has
invested money in creating labs; however, it has outsourced its collection centres
to franchisees.

Credit rating report of Dr Lal Pathlabs Ltd by CRISIL, February 2022, page 2:

DRLPL operates its own path labs, while collection centres are run on

franchisee model.
Similarly, another new business model of aggregators is coming up where new
players act as a platform where patients can compare prices of standalone local
labs and get their tests done.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 3:

The competitive intensity in the industry has further increased with the advent
of online diagnostic service aggregators who utilise the facilities of unorganised
single lab diagnostic companies
These diagnostic service aggregators usually have a very limited ground
presence and acquire customers digitally/online. Their business model is
comparatively asset-light because they have a very limited offline presence for
customer acquisition and no investment in setting up labs. As a result, these
aggregators are able to offer discounts to customers by negotiating deep
discounts with standalone local labs. It has further increased the pricing pressure
in the diagnostics labs industry.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 3:

The diagnostic service aggregators offer significant discounts to gain market

share, thereby leading to pricing pressure in the industry. They also benefit from
the fact that they offer a diverse range of tests in the imaging as well as
diagnostic segment. The unorganised labs benefit from a wider reach
The credit rating report for SRL Diagnostics Private Ltd. by ICRA, Nov. 2021
(click here), page 3:
the entry of online aggregators that offer discounts to attract customers has
put significant pressure on pricing
Therefore, the diagnostic labs face strong pressure on their pricing, especially in
the routine standardised test segments.

Let us now see what some labs do to maintain some pricing power in their
business.

Further advised reading: How to analyse New Companies in Unknown

Industries?

5) Continuous investment in technology and supply chain:

One of the ways in which large labs differentiate themselves is by offering

complex tests, which require investing in the expensive latest technology.
Complex/specialized tests provide a pricing power to the labs.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 5:

Labs that offer niche and complex tests and services command premium

pricing and also possess pricing flexibility, thus reflecting product differentiation
It is important to note that tests that are complex and specialized today may
become routine in future and then these labs would lose their pricing power.
Therefore, to maintain an edge, labs need to continuously invest in the latest
technology, which makes their operations capital-intensive.

In addition, large corporate labs also focus on an efficient supply chain supported
by a large number of collection centres closer to customers and investments in
software solutions. The aim is to reduce the turnaround time i.e. time from
sample collection to delivering the report to the customer.

Due to quick turnaround i.e. home collection of samples and online report
delivery, large labs are able to gain customers despite charging a premium
pricing.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 5:

The brand strength of a diagnostic chain is further supported by continuous

investments in technology and supply chain management (through network of
collection centres and reference labs) which facilitates accuracy of tests, a faster
turnaround time and wider reach.

despite the relatively higher price competition in routine test segments, certain
diagnostic labs in Tier I cities, with a strong brand name known for timely,
accurate and standardised practices and hygienic and efficient test processing,
are more likely to get repeat customers.
As a result, due to intense competition, continuous investment in technology and
supply chain becomes essential for diagnostic labs, which aim to grow big and
gain a large market share.

Further advised reading: Asset Turnover Ratio: A Complete Guide for

Investors

6) Large size of operations, economies of scale:

To gain pricing power, diagnostic labs invest in large reference labs, technology,
numerous collection centres, and strong & efficient logistics solutions. This
makes their operations fixed capital-intensive.
As a result, these labs need to achieve a certain level of business operations to
achieve profitability and thereafter, operating leverage comes into play where the
fixed expenses get distributed across a larger business volume.

Having a large business size helps the diagnostic labs in multiple ways as they
can negotiate favourable terms with suppliers, employees as well as customers.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 3:

a higher scale would enable an entity to achieve higher bargaining power to

negotiate favourable rental rates, avail discounts through bulk raw material
purchases (primarily reagents), and attract the most qualified and technically
sound personnel to drive operational efficiency to sustain its leadership position.
Therefore, when any lab starts to invest money in technology and supply chain
systems to improve its competitive advantages and pricing power, then it
becomes important for it to grow its size to benefit from economies of scale.

Moreover, a large business size provides diagnostic labs with the financial
strength to open new labs at prominent locations as well as buy technology for
specialised tests.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 3:

Companies with a large scale are better placed to invest in new diagnostic
centres, technology and equipment while introducing specialised tests/services
in their portfolio… a large diagnostic chain would have greater financial flexibility
to grow fast, establish labs at prominent locations,
Small standalone labs are at a competitive disadvantage as they do not have
sufficient financial strength to acquire technology and manpower for specialised
tests and also do not have higher bargaining power over their suppliers &
customers.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2018 (click here), page 4:
small unorganised companies are unable to offer a diverse range of tests or
specialised tests requiring advanced technology, have limited skilled
technicians and limited bargaining power with suppliers owing to low levels of
scale.
7) Diversification:

7.1) Product mix of diagnostic labs:

To create a differentiation, large diagnostics labs opt for diversification where

they offer services across pathology, radiology, and preventive healthcare &
wellness segments. Once a lab starts providing services across these segments,
then it becomes a one-stop solution for its customers both retail and corporate.

Integrated labs have comparatively higher bargaining power over their customers
because they can offer test packages to their customers, which leads to better
pricing.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 4:

a presence in both pathology and radiology increases the bargaining power and

eventually, the profitability of the entity, as it can bundle offerings to cater to all
customer requirements… Further, ICRA notes the ability of a player to maintain
sufficient depth in each therapeutic test category that enables better customer
service, thereby ensuring repeat customers.
Until now, large corporate laboratory chains had focused on pathology services
and avoided the radiology segment because of higher investment requirements
as well as the usual practice of establishing a radiology segment inside a hospital
instead of standalone labs. As a result, in the radiology segment, standalone labs
had a higher market share.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2018 (click here), page 2:
The share of the unorganised sector is higher in the imaging segment as many
of the organised diagnostic providers do not offer integrated imaging and
radiology services at their diagnostic centres. This is primarily due to the high
capital costs associated with setting up an imaging centre.
Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July
2020, page 2:

This is primarily because the organised players have initially focused more on

the pathology segment to scale up their business while the imaging segment is
more integrated within the hospital infrastructure.
However, nowadays, large corporate lab chains have also started integrating
their operations by offering both pathology and radiology services e.g. SRL
Diagnostics Pvt Ltd.

The credit rating report for SRL Diagnostics Private Ltd. by ICRA, Nov. 2021,
page 4:

SRLD is one of the few diagnostic centre chains offering pathology and

radiology services on a pan India level.
In addition, some large corporate lab chains have also started medical education
programs where they train students in diagnostics skills. It provides these labs
with an in-house talent pool to hire competent employees.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 4:

Recently, some large diagnostic chains have ventured into academia, which

provides an additional source of revenue, by extending courses and fellowships
in advanced diagnostics. These chains can capitalise on this by recruiting quality
students from these courses, thereby aiding talent management.
Further advised reading: Credit Rating Reports: A Complete Guide for Stock
Investors

7.2) Customer-mix of diagnostic labs:

Large labs also focus on a diverse mix of customers as another aspect of

diversification. They focus on both B2C (individual customers) as well as B2B
(corporate customers as well as hospitals & other labs) where companies offer
facilities for preventive health check-ups for their employees and hospitals &
other labs outsource their testing to large labs.

Direct customers (B2C) offer a higher profit margin and make immediate
payments. On the other hand, corporate customers (B2B) negotiate lower prices
as well as make payments after a period.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 5:
The diagnostic chains that derive a higher share of revenues from the B2C
segment have a low customer concentration risk and generally high profit
margins. Tie-ups with B2B players such as hospitals, laboratories and corporate
clients provide a wider reach and higher revenue visibility to diagnostic chains.
While this improves the absolute levels of profits, however, the long-term nature
of the contracts and bulk offerings result in relatively lower prices and lower profit
margins.
When the share of the B2C segment in the overall revenue of any diagnostic lab
increases, then its operating profit margin increases. For example, the operating
performance of SRL Diagnostics Pvt Ltd improved in 9M-FY2022 over the
previous period because the company witnessed a significant improvement in the
share of B2C in the revenues.

The credit rating report for SRL Diagnostics Private Ltd. by CRISIL, February
2022, page 2:

Improving operating performance: This improvement was driven by the

consolidation of DDRC in April 2021 and higher B2C revenue mix of 52%,
compared with 46% a year earlier.
There have been times when a higher share of B2B business impacts the profit
margins as well as receivables position significantly and the diagnostic labs
actively work to reduce its share in their business.

Credit rating report of Metropolis Healthcare Ltd by CRISIL, October 2021, page
2:

The B2B segment has contributed to most of the revenue in the last three years,
resulting in a stretched receivables cycle. While the management has taken
steps to reduce dependence on the B2B segment, it still contributes to ~53% of
the revenue.
Nevertheless, lab companies attempt to have a healthy mix of retail and
corporate customers because the retail customers provide healthy profits and
corporate customers provide volumes leading to higher utilization of their
reference lab.

Further advised reading: How to do Financial Analysis of a Company

7.3) Geographical diversification:

Large corporate laboratory chains diversify across India and even overseas to
mitigate risks associated with any particular region as well as earn better pricing
in foreign locations.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 4:

good geographic coverage (regional, national and international) is a positive

credit factor as it provides access to a larger clientele and reduces the
vulnerability of revenues to disease cycles in a particular region.

The entity diversifying internationally also benefits from better pricing and higher

capacity utilisation of domestic labs via test send-backs.
For example, Metropolis Healthcare Ltd has diversified overseas into eight
countries, while keeping its largest reference lab in India.

Credit rating report of Metropolis Healthcare Ltd by CRISIL, October 2021, page
3:

It also has overseas presence in eight countries, including Sri Lanka, Ghana,

Tanzania, Kenya and Mauritius
Another India large corporate laboratory chain, SRL Diagnostics Pvt Ltd. has an
international presence in the Middle East.

The credit rating report for SRL Diagnostics Private Ltd. by CRISIL, February
2022, page 1:

It also has international presence through subsidiaries in the Middle East,

contributing around 5% of overall revenue.

8) Business Risks:

8.1) Regulatory risk:

Diagnostic labs are a necessity in the critical healthcare segment. Therefore,

governments keep a check on the pricing charged by the laboratories for
essential tests especially during epidemics when a large part of the population
may have to get the tests done. It is visible during the coronavirus pandemic
where the prices of different Covid tests (RTPCR as well as antibody tests) are
controlled by state governments.

The credit rating report for SRL Diagnostics Private Ltd. by CRISIL, February
2022, page 2:

The cap on prices for diagnostic tests (for instance, testing of Covid-19),

introduced by the government, has impacted players adversely.
Still, as the regulation of diagnostic labs is under state governments; therefore,
all the states may not impose price controls at the same time. As a result, labs
with a geographical diversified presence may get less impact than single location
standalone labs.

This again stresses the benefit of diversification in the diagnostics labs’ business.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 4:

Maintaining a high degree of diversification is crucial as it leads to lower revenue

volatility, less susceptibility to regulatory or market changes, provides
competitive advantages and ensures higher profitability on the back of
product/services differentiation.

8.2) Real estate expenses risk:

Rental expenses, as well as the cost of owned premises, are one of the major
expenses for any diagnostic lab. Therefore, any major increase in the lease
rentals for a diagnostic lab may impact its profitability significantly because
diagnostic labs face intense competition and do not have the pricing power to
increase the cost of tests at will. This is especially true in the case of small
standalone labs providing routine/standard tests.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 6:

Apart from the cost of procuring specialised equipment and hiring technically
adept manpower, rental cost is one of the key factors influencing the breakeven
level for a lab.
In addition, delays by developers in handing over commercial premises can lead
to cost overruns while setting up new labs.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, March

2016, page 5:

In India, the growing demand for retail space coupled with lack of proper
infrastructure has pushed up commercial rentals in many locations to
uneconomical levels for diagnostic players… stretched roll-outs due to delays by
developers in case of greenfield expansions. This is a significant risk and can
lead to cost overruns.
Therefore, labs prefer to set up their operations on the premises of existing
hospitals/doctor’s clinics as it protects them from risks related to the real estate
market and also provides them with a business from the outdoor and indoor
patients of the hospital. This is an asset-light strategy of expansion and labs
usually enter into revenue-sharing arrangements with hospitals for it.

Rating Methodology for Healthcare Diagnostic Service Providers, ICRA, July

2020, page 2:

Another format of diagnostic operations encompasses labs operating in public or

private hospitals. These are either overseen by the hospital itself or there is a tie-
up, in the form of a revenue-sharing agreement between the hospital and the
diagnostic service providers. The volume of business and revenue visibility in
hospital labs is relatively higher than other labs due to their linkage to the
hospital’s operations that include the out-patient department (OPD) as well as
the in-patient business.
Further advised reading: How to analyse New Companies in Unknown
Industries?
Summary
Diagnostics lab services are critical for healthcare because they play an
important part in disease identification and treatment. Therefore, their demand
remains almost stable during economic cycles. Indian diagnostic lab segment is
highly fragmented with numerous small standalone laboratories dominating the
sector. Key reasons for a large presence of labs in the unorganized sector seem
to be the moderate capital intensiveness and relaxed implementation of
regulations by state governments.

Almost all the diagnostic labs provide similar, and non-differentiable services;
therefore, customers usually switch to low-cost standalone labs that are
significantly cost-effective when compared to large corporate lab chains. The
emergence of online aggregators and new players with asset-light business
strategies has increased the already intense price-based competition in the
sector.

To differentiate themselves, large diagnostic labs invest in the latest technology

for conducting complex/specialised tests, which provide a high-profit margin and
pricing power. In addition, large labs also spend significant money on improving
the supply chain by establishing collection centres closer to the customers and
reducing the turnaround time between sample collection and report generation.
Such steps are a continuous requirement for large labs and make their
operations capital intensive.

A large investment by a corporate lab chain requires them to achieve a

significant utilization of capacity to earn profits after which operating leverage
comes in. Therefore, corporate labs attempt to expand their business size with
geographical expansion across India as well as overseas. In addition, labs also
diversify into all diagnostic segments like pathology, radiology, preventive
healthcare and wellness. It helps the labs to provide packages to their customers
and ensures repeat business and some pricing power.

Large labs are also able to get a higher bargaining power over their suppliers,
employees and customers. Therefore, economies of scale become an essential
criterion for corporate lab chains to succeed.

Diagnostic tests are in very high demand during epidemics and a large part of the
population needs them. Therefore, governments control the prices of essential
tests directly like recently in the case of Covid tests. Therefore, labs face
regulatory risks to their profits. In addition, any policy measure to mandate
accreditation of labs with the certifying agencies like NABL will impact the
business of small standalone labs significantly.

Rental expense is one of the major expenses for diagnostic labs both for existing
centres as well as new planned locations. Therefore, changes in the real estate
market impact diagnostic labs significantly because an increase in lease rentals
may make their business unviable and delay in builders in handing over new
buildings may lead to cost-overruns and delay the lab’s break-even.

Therefore, an investor should keep in mind these multiple aspects for diagnostic
labs to understand the true picture of their business position.
 Low cyclicity/stable demand
A highly fragmented sector with numerous small standalone labs
Lack of stringent regulations and moderate capital intensiveness
Non-differentiable services, intense price-based competition
New players with asset-light business strategies are putting further
pricing pressure on the sector
 Large labs have capital-intensive business due to continuous
investment in technology and supply chain to achieve differentiation
 Diversified players with good product and customer mix as well as
geographical diversification are better placed
 Regulatory and real estate risks are major concerns for diagnostic
lab companies.
We believe that if an investor analyses any diagnostics lab by considering the
above parameters, then she would be able to assess its business properly.

Regards,

Dr Vijay Malik