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Is network expansion the booster dose diagnostic firms need?

Experts are bullish about the sector, and cite multiple tailwinds that would help drive growth, including increasing health awareness, potential industry consolidation, and more.

February 25, 2023 / 11:07 PM IST

Diagnostic companies are investing heavily in expanding their networks in a bid to increase their market share and boost post-pandemic revenues.

Companies like Dr Lal Pathlabs, Metropolis Healthcare, Vijaya Diagnostics, and others plan to grow their business both through increased online presence, as well as by setting up brick-and-mortar labs and collection centres.

While Metropolis Healthcare plans to establish 90 new labs and 1,800 new collection centres by FY25, Vijaya Diagnostic aims to expand its presence in the south and east markets.

Krsnaa Diagnostics is also preparing to open new centres in Uttar Pradesh, Delhi, Maharashtra, and Rajasthan. Meanwhile, industry leader Dr Lal Pathlabs is focusing on expanding its presence in Tier II and Tier III cities to strengthen its geographical reach, while targeting a higher market share in the west and south markets.

Economics of expansion

As Covid-related business wanes, diagnostic companies face the challenge of sustaining their revenues. This triggers the question: are the plans for network expansion economically viable? Will the unit economics be similar to that of Tier I cities?

Kunal Randeria, Director of Equity Research at Nuvama Institutional Equities, sees network expansion as a natural progression for diagnostic companies. He notes that the metropolitan market is saturated, and while revenues from Tier II and III locations may not match those from Tier I cities, the lower operating costs and reduced competition would offset this disparity.

Randeria explains that diagnostic chains are primarily focused on expanding their collection centres in these locations as part of their network expansion strategy.

Aditya Khemka, Fund Manager at Incred PMS, shares Randeria's bullish outlook on network expansion by diagnostic companies. He believes that the strategy should work given the immense scope for expansion in the industry, as 80 percent of India's diagnostic segment remains unorganised.

Khemka thinks that although diagnostic companies generate revenues from high-margin products in Tier I areas, they will attract much larger volumes in Tier II, Tier III, and rural areas. He expects that revenue growth in Tier I areas will be price-driven, while that in Tier II, Tier III, and rural areas it will be volume-driven. Khemka believes this trend will continue to fuel higher growth for diagnostic companies, along with sustainable margins.

New-age disruption

The emergence of competitively priced, new-age online players was expected to disrupt the diagnostic industry. However, these concerns appear to have been overstated, as incumbents have only been marginally impacted by the newcomers.

Also Read: Price hikes are changing the game for diagnostic cos; here's how analysts see it

According to brokerage reports, several new-age players have started to raise prices on certain diagnostic tests, including preventive packages, as they shift their focus toward achieving profitability.

"This aligns with our view that a low-price model cannot be sustained in the long term, and competition from low-price providers is not a structural risk for incumbents. Given their cash burn, we believe another round of price hikes cannot be ruled out," wrote Sriraam Rathi, Analyst – Healthcare and Pharmaceuticals, BNP Paribas India.

Rathi added that new-age firms should focus on the preventive health segment, which is not dependent on doctors’ recommendations and only accounts for 10 percent of the total organised diagnostics market.

Due to these reasons, Rathi is bullish on large, organised companies and expects them to return to 12-15 percent revenue growth levels in the quarters ahead.

The future

Most analysts are optimistic about the prospects of the diagnostics industry as there is ample headroom for growth since a significant portion of the sector remains unorganised.

"Given that India has the world's largest population of people around the age of 30, who will turn 40 in the coming decade, and become more careful about their health, volumes in the preventive wellness segment will only go up," said Khemka.

He also believes that the growth in volume will be beneficial for the entire healthcare ecosystem, including pharmaceuticals, insurance, diagnostics, and hospitals.

Also Read: Our focus remains on driving organic growth, says Metropolis Healthcare's Ameera Shah

Rathi also shares this view, and cites multiple tailwinds working in favour of the diagnostics industry, particularly organised chains, that will help maintain double-digit growth. These include a faster shift in business from unorganised to organised diagnostic chains, potential industry consolidation, possible continued upside from Covid-related tests, and an increase in health awareness.

Vaibhavi Ranjan