Most strategy textbooks tell entrepreneurs they must choose between differentiating themselves with a superior product, great service, or the lowest cost to customers. That trade-off made more sense before software offered a way to achieve it all.

Fulgent Genetics (NASDAQ:FLGT) is bucking the old school approach by offering perhaps the most extensive lineup of genetic testing with unmatched customization. It is also using technology to drive down costs. Over time, this could give the company the best (and cheapest) offerings. So far, Fulgent is following a path that in the past has made a lot of shareholders rich.

Three researchers in a lab, two seated facing away and one facing the camera recording data.

Image source: Getty Images.

1. Low prices

Genetic tests cost hundreds of dollars on average. When Fulgent developed its tests for COVID-19, it dramatically lowered the average price its customers were paying. Despite the drop off in the final three quarters of 2020, prices had already been coming down for years. In the 12 months prior to the pandemic, the average price per billable test hovered between $500 and $600. That dropped below $100 once the pandemic arrived. The good news is, cost declined even faster than price.

Average selling price and cost declining by quarter over the past three years.

Data Source: Fulgent Genetics.

Thanks to several proprietary processes, Fulgent is constantly improving efficiency. Management believes that's giving the company a growing advantage in the genetic testing industry. If 2020 is any indication, they're right.

2. Even lower costs

Fulgent prides itself on its best-in-class cost structure. As the company tells it, its technology platform allows it to gain operational efficiencies, lowering internal costs and passing much of the savings on to customers. That should win the company more business. The cost savings that aren't passed on show up in expanding gross margins. Management has highlighted four ways it is driving costs down while achieving higher margins. 

Year Gross Margins
2018 50%
2019 57%
2020 79%

Data Source: Fulgent Genetics. 

The first is gene probes. These single strands of genetic material help identify a targeted gene. Many companies obtain them from third parties. However, Fulgent is able to design and develop its own proprietary probes that are specifically engineered to produce data optimized for its software. This advantage compounds as the company incorporates data from new genes and develops new tests. 

After being sequenced, genes go through curation. It's a process in which differences are identified between the sample DNA and a reference. Fulgent has developed proprietary algorithms to perform this step using both publicly available databases as well as its own library. This reduces noise in the data leading to faster, more accurate results.

That higher-quality data is automatically incorporated into the company's genetic reference library through its adaptive learning software. The expansion of the library continuously improves the performance of the proprietary gene probes. The software also communicates with its lab systems, facilitating further process automation and efficiency.

Finally, Fulgent's lab management software provides the backbone of its entire workflow. It incorporates the data, monitors quality, and facilitates customer analytics. It is yet another example of how the company has leveraged its technical expertise to design and build an in-house tool that serves its needs, and therefore its customers, better than a vendor solution. 

Fulgent's flywheel

The proprietary tools and subsequent efficiencies have produced a flywheel effect that most business leaders are desperate to create. The flywheel concept describes a cycle in which momentum builds with each subsequent turn, producing more impact from the same effort. For Fulgent, it's a reason to believe in the stock.

The company's ability to leverage data in a way that reduces internal costs has allowed it to continually drop prices. Those lower prices attract more customers, including some with large demands for testing like insurers and other third-party payers. The testing from those customers generates more data to add to the gene reference library, which improves the quality and efficiency of analysis. Those improvements further reduce the costs of testing, beginning the cycle again.

The larger implication is that as costs drop, genetic testing will likely become a routine step in every patient's care. This dynamic of more data improving the product, attracting more customers that create more data isn't new. It's the same one that led to Netflix's advantage in recommending shows, Tesla's lead in autonomous driving, and Amazon's ability to put products you want in front of you before you even search for them. 

Another characteristic of the flywheel is the time it takes to get going. Fulgent has proven its model through the pandemic, but the current conditions and testing volume won't last forever. For it to be a truly great investment, the company will have to prove the model is sustainable even as testing for COVID-19 wanes. If 2020 is any indication, shareholders have a lot to be excited about. Uncertainty about testing volume may cause volatility in the short term, but the business is doing all of the things that should make it a long-term winner.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.