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Commercial labs benefit from competitive testing market.

As companies look to lower costs, and more sophisticated technology continues to produce increasing amounts of data, many laboratories are turning their testing over to commercial labs. While outsourcing has become a popular way to trim expenses, the capabilities of commercial labs also serve to ease the burden during particularly extensive research trials, and given the increasingly stringent regulations placed on material testing, independent laboratories can provide reassurance by supplying a second opinion.

The multibillion dollar commercial lab market can be divided into four sections: clinical labs, environmental labs, broad-based testing labs and contract research organizations, or CROs. Among the largest companies in these groups, 2002 sales proved especially strong; and, if the first half of 2003 is a faithful predictor, sales this year look to be even more robust.

Within clinical labs are two distinct types of testing: clinical testing, which involves the examination of body fluids, and anatomic pathology testing, which involves tissues and human cells. Among the largest labs, Quest Diagnostics and Laboratory Corporation of America are dominant. In 2002, Quest reported $4.1 billion in sales, while Lab Corp. pulled in just over $2.5 billion.

While a large portion of the companies' revenues can no doubt be attributed to the wide array of tests that they conduct (Quest lists among its routine tests blood cell counts, pap smears, HIV-related tests, urinalyses and substance-abuse and blood-cholesterol tests), they have also grown significantly larger in recent years, namely through acquiring competing labs and equipment companies. In April 2002, for example, Quest bought American Medical Laboratories and a subsidiary, LabPortal, for $500 million; in February 2003, the company bought Unilab, a California clinical lab, for 7.4 million shares of Quest stock, $297 million in cash and the assumption of Unilab debt. LabCorp also purchased a pair of testing companies during the previous two years: Dynacare and DIANON Systems, which had combined 2001 revenues of $363.7 million.

Smaller labs, such as Specialty Labs, which reported $140.2 million in sales in 2002, admits that they cannot compete with the clinical behemoths. To remain competitive, Specialty has focused on the more expensive esoteric testing market, and has made an active effort to develop unique technologies, such as its proprietary assays. In addition, Specialty has worked to forge relationships with hospital labs, which are the company's largest client.

The consolidation that has occurred in the clinical market has appeared in the fragmented environmental lab market as well. With more than 1,300 labs offering pollutant testing, UK-based Severn Trent Laboratories (STL), the leader in the market, has had its veritable pick of companies to acquire. Between 1997 and 2001, STL bought 18 environmental labs, and has been looking to develop new business in the US, where hazardous waste is the largest segment and direct industry is the largest customer segment. In response to the possibility of reduced testing demand from the UK water sector, STL has expressed interest in exploring business generated by new European environmental regulations. Among the US markets it is targeting are perchlorate, toxic mold and drinking water testing.

Analytical and Environmental Services, a subsidiary of Northumbrian Water, works mainly in the UK and has the advantage of Northumbrian's extensive network of water and sewerage companies to support it.

As a result of their wide-ranging services, broad-based testing labs, not surprisingly, show some of the strongest sales growth among their peers. Both Eurofins Scientific and LGC, for instance, each reported an over 30% increase in revenues from 2001 to 2002. While some of this may have stemmed from reduced industry spending in the last quarter of 2001, Eurofins and Caleb Breu, a subsidiary of Intertek, have both exhibited strong results for the first hall of 2003 (first-half 2003 sales numbers for LGC had not been released at presstime).

Because broad-based labs serve such an extensive number of markets--petroleum, chemical, agricultural, food, environmental, pharmaceutical, consumer and forensic science industries are all represented--it is difficult to narrow the driving trends to only a few. Caleb Breu cites outsourcing from oil and chemical companies as one growth opportunity; the company's outsourcing business accounts for approximately 25% of its total sales. The mapping of the human genome, in addition to significant advances in genetic screening, have led broad-based labs to bolster their DNA and gene expression offerings. In the food and agriculture market, outsourcing has increased as a result of the testing of crops for genetically modified organisms (GMOs) and of cattle for Mad Cow disease. Also, an aging population, compounded by growth in the generic dugs market, has created expanded testing sources within the pharmaceutical market.

Despite annual growth rates of more than 10% over the last two years, Eurofins reports that it has been harmed by poor exchange rates. As a result, the company has announced a strategic restructuring in which it will close 25 of its 62 laboratories and reduce staff by approximately 10% by 2005.

CROs provide drug discovery and development for the biotechnology and pharmaceutical industries. Many, such as Quintiles Transnational, Covance and Pharmaceutical Product Development (PPD) offer services throughout all clinical trial phases. Although laboratories' in-house laboratories have typically carried out tests for their own products, growing numbers have favored outsourcing work to commercial labs. As biotech and pharma companies try to move drugs to market more quickly, CROs, which are familiar with government regulations, can help speed the approval process and provide laboratory management services. In April 2002, Covance, PPD and Quintiles, along with CROs PAREXEL International and Kendle International, formed the Association of Clinical Research Organizations, or ARCO, to lobby for the drug development in the US and other countries.

As CROs consolidate (Quintiles, for example, acquired 39 businesses between 1995 and the end of 2002), their expertise and geographical reach has also expanded. Where in the past CROs lacked the technological offerings and ability to perform multinational trials that some pharmaceutical companies desired, now they are viewed as able partners. While large CROs do offer diverse services, they also tend to have larger overheads, and thus higher prices, than their smaller counterparts.

Because commercial laboratories should continue to focus on productivity and keeping their costs low, trends toward outsourcing show little evidence of slowing. Certainly, consolidation, and the resulting price competition, should transform independent labs into an attractive alternative to in-house research. As the quality of outsourced research has steadily improved, the deciding factor, it seems, will come down to fundamental economic considerations.
 First Half 2003 % 2002 Revs.
 Revs. ($M) Change ($M) Change

Clinical Labs
Quest Diagnostics $2,312.7 14.7% $4,108.1 13.2%
Laboratory Corporation
 of America $1,455.9 21.1% $2,507.7 14.0%
Specialty Labs $59.3 -23.8% $140.2 -20.0%

Environmental Labs
Severn Trent
 Laboratories (Severn
 Trent) N/A N/A $277.1 * 13.1%
Analytical & Env.
 Svcs. (Northumbrian
 Water) N/A N/A $17.5 12.9%

Broad-Based Testing
 Labs
Caleb Brett (Inlertek) $134.4 15.4% $257.9 5.7%
Eurofins Scientific $85.7 28.1% $155.5 33.3%
LGC N/A N/A $78.0 * 30.7%

CROs
Quintiles
 Transnational $1,031.6 4.0% $1,992.4 5.8%
Covance $467.2 9.2% $883.1 3.2%
Pharmaceutical Product
 Development $327.7 24.9% $562.6 30.4%

* FY2003 sales ending March 31, 2003.
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Publication:Instrument Business Outlook
Date:Nov 15, 2003
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