What Is Theranos's Business Model, Anyway?

[This post originally appeared on Forbes.com on October 22, 2015.]

Lost in the ongoing kerfuffle over Theranos, the embattled diagnostics newco, is a more basic question: What does it take to win in clinical diagnostics, let alone “disrupt” it?

This isn’t a simple question, because on the whole, lab testing is a well-served sector. Clinical questions arise, samples are taken, tests are run, results are reported, decisions get made – and it all happens pretty quickly, cheaply, and reliably, millions of times each day. That’s not to say there’s not room for improvement, but in general, the system works pretty darned well.

That means – at the risk of being Captain Obvious – that Theranos, or any new player in the clinical lab space, needs to answer three questions: What's the need in the market? How does the company plan to meet it? And, what's the potential reward for succeeding? Any other details – technologic novelty, intellectual property, FDA compliance, and so forth – are only worth investigating after you've addressed these fundamental questions about the company's business model and strategy.

So, what is Theranos's business model, anyway?

There are basically three ways for a new lab company like Theranos to succeed:

  1. Satisfy an unmet clinical need. A new lab company can win by meaningfully addressing a diagnostic problem that affects patient management. Is the problem lack of speed? Be faster. Is it insufficient sensitivity or specificity? Solve that problem. Is it the lack of appropriate analytes? Discover and test for them. There’s no “one solution” for all clinical needs – but each clinical need has a specific solution that one could provide.
  2. Satisfy an unmet business need. Lab testing is a service industry, so like all service industries, there’s almost always an opportunity for better/faster/cheaper/higher-touch/lower-friction options.
  3. “Disrupt” the market. It’s also possible to win by somehow changing the entire way the diagnostics business operates – by eliminating a middleman, reaching new classes of customers, or some other means – and coming out on top in the new world order.

On the clinical side, there are certainly unmet needs in lab testing – but it's not clear Theranos is addressing them. The company’s “nanotainers," which reportedly run multiple tests off a single drop of blood, could help patients who currently avoid big needles and cumbersome blood draws – but needle-phobia doesn’t strike me as a significant unmet clinical need per se. (No patients with serious medical needs forgo lab tests just because they require a conventional needle stick, and I haven't found any published studies showing that fear of needles impacts adults' compliance with routine preventive testing.) Absent compelling data, providing a new option for needle-phobes is more of a business opportunity (see below) than a clinical one.

Similarly, the faster turnaround that Theranos reportedly delivers isn’t a burning clinical need for the routine clinical lab tests the company is running. If you get the results of your basic metabolic, hematologic, or lipid profile back a day earlier (or a day later), it won’t change clinical management – which is the main thing that matters in diagnostic testing. (There are some limited data on anxiety from delayed or ambiguous test results in specific settings, but their clinical impact and relevance to Theranos are unclear.) Sure, there are situations where diagnosis speed affects patients' outcomes, but they’re mostly in the inpatient or emergency settings (where time is measured in minutes and hours, not days), which are not areas where Theranos appears to be focusing.

What about succeeding on the business side? Being cheaper is a reasonable strategy – as long as your total costs (including consumables, labor, equipment, administration, customer sales and support, etc.) are low enough to enable you to beat giants like LabCorp and Quest, with their tremendous economies of scale. (And remember: just because Theranos has set cheaper prices so far doesn't mean they’re sustainable in the long run.) Price is unlikely to trump other key qualities in lab services – most patients and physicians wouldn’t trade analytic accuracy and reliability for lower cost, for example – but if diagnostic performance is equivalent, undercutting competitors on price is certainly a viable business approach.

There’s also a business case to be made for gaining customers by improving the whole experience of getting one’s blood drawn. That includes not just the company’s spa-like “wellness centers,” but also the nanotainer technology (which, as discussed above, is more of a market differentiator than a clinical need), easy scheduling, rapid and simple results reporting and so forth. I'm not sure how big or attractive this general strategy is, but in theory at least, it's a potential option for Theranos as well – again, provided one can meet basic standards of accuracy and reliability.

Finally, there’s the opportunity to “disrupt” lab testing – which, to Theranos, seems to mean offering tests, results, or both directly to patients, without physician intermediates at either end. Personally, I question whether allowing healthy folks to test their own cholesterol ad libitum (and ad nauseum) is a large, clinically meaningful, or socially transformative opportunity – that’s a whole other discussion, beyond the scope of this post – but it’s not illogical for Theranos to make a bet on that future state, and for investors to back it.

Theranos is far from the first company that has sought to unseat the main lab testing players – and for all of them, the questions are the same: What is the need you’re addressing? How do you plan to address it? What is the reward for success?

If Theranos hasn’t figured out the company’s key value proposition and business strategy, the company needs to do so, and quickly. Not for the public, mind you – after all, if you’ve raised as much money as Theranos has, who cares what the nattering nabobs say? – but to know where to focus efforts and resources. And "all of the above" isn't the best answer. Clinical labs are a tough business, and to beat its entrenched competitors, Theranos needs to figure out its “killer app” – needle-free blood draws, low-priced tests, patient empowerment, quick turnaround, high-touch service, whatever – and then the team needs to focus, put their heads down,\ and crush it.

Importantly, only some of Theranos's strategic options depend on any differentiated technologic advances per se. If the "killer app" is delivering faster results directly to patients, for example, and this can be accomplished using standard equipment, then it doesn't matter whether the company has is using a new machine, let alone how that machine compares with the established platforms. In that case, all considerations of Theranos's so-called "Edison" technology would be an irrelevant distraction – not only for the the public and the media, but more importantly, for the company itself.

Regardless of what path the team takes, though, there’s one more critical thing Theranos needs to do besides nail its business model: Nip in the bud any lingering doubts about the company’s ability to provide high-quality lab data. Day after day, established labs provide reliable results to patients and doctors within established standards of performance that impact clinical decisions. And if you can't nail that in diagnostics, you’re finished – no matter whether you're using a new technology or an established one, whether the test is ordered by a doctor or provided self-serve, or whether you drew five milliliters of blood from a syringe or 50 microliters from a fingerstick. Whether through hubris, ignorance, or incompetence, Theranos has led folks to question whether they can be trusted analytically – and that's a disaster in this industry, because at its core, lab testing is a trust-based service business: send me your sample, and I'll send you a reliable, clinically actionable answer. So my advice to Theranos is: Release data, publish papers, partner with independent academic or clinical centers, whatever – just fix this perceived analytical quality issue. Otherwise, all the microtainers, wellness centers and online results in the world can't help you.

Addendum (10/23/2015): Theranos has issued a detailed rebuttal to the Wall Street Journal's coverage of the company - and as a public service, I've posted it on Genius so folks can provide line-by-line annotation / comments. Visit the Genius site here and contribute your insights!

Thanks to Matthew Herper and Danielle Newnham for inspiring me to write this piece, and to Matt for reviewing it and providing feedback. On Matt's recommendation, I sent a draft of this post to Theranos's PR team, a member of which provided informal comments (related to the "clinical value proposition").