BUSINESS PLANNING & TECHNOLOGY DEVELOPMENT
Going into 2007, growth and advances in the medical device industry show no signs of slowing. Likewise, the myriad pressures weighing on company executives show no signs of abating.
Whether an emerging medtech start-up or an established industry leader, manufacturers in all sectors of the medical device industry must cope with challenges related to pricing, expanding global markets, industry consolidation, and evolving regulatory requirements. At the same time, company executives must also manage a variety of pressures specific to their individual sectors.
To find out more about market challenges facing medical device manufacturers in the coming year, MX recently spoke to five experts in the field (see sidebar). In this roundtable discussion moderated by MX editor-in-chief Steve Halasey, these industry experts discuss issues surrounding global competition, sector-specific developments and their broader implications, and current market dynamics for both small and large manufacturers.
MX: More than one analyst has made note of the relentless pricing pressures that are stressing profit margins in the medical device industry. Is the situation as bad as they make it sound?
John J. Viscogliosi: Raymedica Inc. (Minneapolis) does not currently sell products to the U.S. market, but several of the portfolio companies of Viscogliosi Bros. LLC (New York City), such as Small Bone Innovations Inc. (SBI; New York City), do have products available in the United States. Based on that experience, we haven't seen pricing pressure to the extent that you've heard being discussed by some analysts.
The parties experiencing far greater pricing pressures than medtech manufacturers are the hospitals and the surgeons performing the procedures. Surgery centers that are physician-owned and more profit-oriented than normal hospitals have passed some of this pricing pressure along to SBI, and I do expect to see this trend grow in 2007 and 2008. In order to better their bottom lines, hospitals and doctors will start putting more pressure on device manufacturers to reduce their prices.
Thomas J. Gunderson: I'm not witnessing any new pricing pressure in the cardiac sector or, for that matter, from a global perspective. We're not seeing anything particularly new. But it's a big world out there. In parts of Europe, we are seeing increasing pricing pressures due to socialized medicine and the winner-take-all reality for companies that come in with the lowest bids. On the other hand, the market in Japan is very price-inelastic. The country has some of the highest prices worldwide. Also, I recently visited some cath labs in China and was surprised to discover that Johnson & Johnson (J&J; New Brunswick, NJ) is the number-one supplier of drug-eluting stents in the country. While the pricing is lower than it is in the United States, it is higher than it is in Europe.
Viscogliosi: Raymedica does sell products in China, and the end-user prices there are as high as they are in Europe, if not higher. They are lower than they would be in the United States, however.
In Germany this year, surgeons staged about two weeks of rolling strikes to protest the nation's crackdown on surgical fees. The German surgeons actually stopped performing surgeries and went on strike. So obviously there's a lot of pressure on hospitals and surgeons to reduce their fees.
In general, medtech companies have become more aware of the importance of reimbursement and reimbursement planning. Is that how manufacturers are addressing the pricing pressures that exist in the United States and internationally?
Alexander K. Arrow, MD: Pricing pressure has been a constant feature of medical device markets. It is a reality in the European market for medical devices, and it is a threat that hasn't actually affected manufacturers as much as expected in the United States. In our opinion, the idea that there's been more pressure recently has been overplayed, especially in the United States. Manufacturers can avoid this pressure because they tend to launch new models of existing devices at higher price points. Therefore, they can concede to lowering the price on their existing models to gain favor with hospitals. They thereby can keep the average selling price constant by continuing to launch newer versions at the higher price points.
Manfred Scholz, PhD: I speak primarily from the perspective of the in vitro diagnostics sector, in which there has been a lot of rationalization and competitive shakeouts over the last several years. Pricing pressure isn't as prevalent as it once was in areas such as immunoassay testing and clinical chemistry. Pricing in these areas has settled down. However, we see a lot of price pressure in serology and nucleic acid testing for infectious diseases. These segments include international markets in which there is no patent protection for certain blood viruses. Entrants come into these markets with new and old technologies that compete on price. We often see that in China. However, China doesn't have a lot of molecular testing yet. But the tests that have become available have started at a much lower price point than in Japan, the United States, and Europe.
Rising healthcare costs and the aging population bulge that is expected to overburden Medicare and private reimbursement sources will continue to pressure manufacturers to become more efficient and lower their own production costs. How do manufacturers respond to that challenge?
Richard S. Cohen: They respond to that challenge by seeking to automate many of their domestic production operations. But the big trend has been to outsource production where there is labor intensivity. Outsourcing initially focused on low-wage countries, particularly Mexico and some nations in Eastern Europe. But now the Chinese market has opened as not only a vast customer market but as a very prolific production market with low-wage opportunities. But it's a complicated situation. Although production costs may be low, quality control and quality assurance must still be maintained. There are logistical issues as well as intellectual property piracy issues. There's also a whole array of infrastructure that needs to be put into place to make production in China and elsewhere effective.
John, you've had experience in China as well. What has been your experience?
Viscogliosi: We don't currently do any manufacturing in China, but it seems less expensive to set up operations there. However, what has been communicated to me is that some surgeons perceive the quality that comes out of China as being less attractive than the quality that comes out of other places around the world. With orthopedics and other medical sectors being so heavily instrumented, it's important that doctors are comfortable with the instruments. So quality is still a primary concern.
Gunderson: You might have phone banks in India. You might have some manufacturing in China. But more than likely, it's manufacturing in China for the Chinese market.
For the first time since World War II, a whole new middle class is rising in that part of the world. This shift may create global demand for medical devices that hasn't been seen before in that region. If medical device manufacturers want to look at this issue through rose-colored glasses, the current situation in China might be something that partially offsets cost pressures and U.S. and European reimbursement issues. There may be a giant new market out there for everything from hips and knees to stents and implantable cardioverter-defibrillators (ICDs) to glucose meters.
The United States has waited a long time for the Chinese market to open. And now there is also some movement in the Indian market, in the Eastern European markets, and to some extent in Latin America. What are your thoughts about the opening of those markets for medical device manufacturers?
Arrow: We don't spend a lot of time looking into the dynamics of India and Latin America, but we have also done some research in the Chinese market, and some of the devices that we've evaluated in that market are domestically produced versions of U.S. products that are being offered at a fraction of the U.S. price point. I'm talking one-tenth the price. This effectively shuts U.S. companies out of this market. That has happened with some lower-tech cardiovascular devices and with breast implants. I wouldn't be surprised if a similar dynamic is occurring in other developing nations, but I can't say for certain that this is happening in India or Latin America. These markets are obviously enormous in population, but they're probably at least five years away from having a material effect on the revenues of publicly traded U.S. medical technology companies. They're not top-of-mind for our investing clients yet.
Scholz: In China there is a lot of local competition. Locally produced technology is catching on quickly, and very few U.S.-based companies are competing effectively. More and more products that are produced in China are being developed specifically for the Chinese market. These products are beginning to be exported to other markets in South and Southeast Asia, especially Malaysia, Indonesia, and, to a lesser extent, India. Exports to South American markets are also starting to be seen. That is adding to global pricing pressures.
Is that phenomenon specific to the in vitro diagnostics (IVD) sector or does it apply to multiple sectors?
Scholz: I only can speculate about other sectors, but the phenomenon is certainly occurring in the IVD sector.
It seems the IVD sector is more globalized than any other sector in the medical device industry.
Scholz: The IVD sector exhibits global standardization with a few variations. Essentially, the same products that are sold in China are sold in the Middle East, in Southern Europe, in Central Europe, and in Latin America. It's the same companies making these products; they're multinational companies.
Chinese companies often develop their technologies based on the patent blueprints of Western companies. These Chinese companies are very skilled in manufacturing, and they are becoming competent in quality assurance. So there are new entrants to the landscape of global competition. But in terms of absolute dollars, the Chinese market is not quite on par with Western nations.
IVD products are fundamentally the same everywhere, with one exception: molecular testing. That is due to the cost difference. These technologies are not very developed in secondary markets such as Asia. For example, blood bank testing is still only done with serology, not with nucleic acid testing.
Is there anything that manufacturers can do to help build these new markets or to prepare themselves for the markets when they do emerge?
Cohen: The first phase of involvement by manufacturers in these developing markets has been on a contractual and strategic alliance basis. It involves identifying reputable, high-quality third-party vendors in these markets. But the process of training these companies is a long one, and manufacturers must often work through intermediaries. Larger companies such as Medtronic gain more control over the process by developing company-owned facilities in developing markets.
The process requires manufacturers to build infrastructure, approach the market through a combination of company-owned facilities and reputable outside vendors, and develop an effective distribution network. Such a network would likely involve alliances with other sales organizations rather than salespersons employed directly by the company. The process is one of trial and error. Like in any developing country, a manufacturer may run into parties seeking graft, bribery, and other types of opportunism.
Viscogliosi: It is a unique world out there. Europe and the United States are closely tied together, meaning some U.S. companies are successful selling products in Europe and some European companies are successful selling products in the United States. However, it is difficult for smaller U.S. companies to compete in Asian markets and especially in South America.
The major markets are generally broken down into the United States, Europe, and the rest of the world. And the rest of the world is quite different in terms of doing business. There are very few small orthopedic companies based in Asia and South and Central America that are able to gain any traction in the United States. A lot of European companies are successful in Asia and in South and Central America because they are governed by different laws. U.S. companies can't do certain things that European companies are allowed to do. European orthopedic companies have done well in establishing presences in those rest-of-world countries.
Do you see any disruptive activities taking place around the globe that are going to significantly change the balance of markets, open new channels, or cause problems for medical device manufacturers selling in a particular area?
Gunderson: No, I don't see any disruptive technologies. The United States is still the largest market, and the U.S. market still has its own barriers and issues that international companies must navigate. These include dealing with FDA, payers, and the high cost of distribution in the United States. As far as technology goes, the status quo should be maintained in the near term.
Arrow: Heightened global security is an impedance that has stopped or slowed the pace of international commerce in every sector, including medical devices. That's a relatively recent development. There also is the existing problem of counterfeit, low-priced domestic entrants in the industry, but that's not a new issue.
Are there any rising international challenges related to intellectual property (IP)?
Arrow: If anything, the global issues surrounding intellectual property have slightly improved. Many nations have recognized that they must respect IP if they're going to have a robust domestic market. The two components go hand-in-hand, and as more countries recognize that link, international commerce will improve.
Scholz: The only disruptive trend that I see is the approach of global pricing. Price differentials are declining from country to country, and markets around the world will have to implement the same pricing principles. New entrants from various geographies might reset the price point for any given product.
The cardiac sector has had a difficult year. ICDs are having problems. Stents are having problems. All of the companies in the sector have seen a falloff. Medtronic has announced a big campaign to try to rebuild the ICD business. What do you see coming for the sector over the next year?
Gunderson: It's a quandary in the cardiac sector. Cardiac may be at the end of its run for now, at least in terms of big, new technologies. Drug-coated stents and resynchronization defibrillators have been the key innovations as well as the key controversies on Wall Street over the last 10 years. A decade ago, people were arguing over whether resynchronization would work. They were arguing as to which company would be first to market drug-coated stents, and what size was that market? How was it going to split among the players? Over the past 10 years, Wall Street has had all those discussions.
In the meantime, I don't see any innovation of that magnitude on the horizon in the cardiac sector. Those types of breakthroughs are going to have to come from somewhere else. The cardiac sector is a mature market. It's certainly going to have smaller innovations that will reduce pain and increase longevity. But I just don't see any of those big, easy-to-bite apples of innovation in cardiac over the next two to three years.
Arrow: The greatest achievements in the cardiac sector were made in the 1990s when interventional cardiology emerged as a renewed field due to the angioplasty balloon and all the other inventions that took patients away from cardiac surgeons. What's left for value creation in the sector now are incremental improvementsanything that will allow interventional cardiologists to take even more patients away from surgeons by increasing the scope of what they can do at the end of a catheter.
The cardiac and orthopedics sectors are the fields that have made the biggest strides in the past 15 years and now are left with room for incremental improvements. We believe other medtech sectors, such as neuro and gastrointestinal devices, still have their biggest strides ahead of them.
The turf wars among physician specialty groups seem to be affecting several sectors now, including imaging, orthopedics, and oncology. Are such struggles inevitable when technology starts to change practice?
Arrow: We view turf wars as one of the leading indicators of a device that is going to be a real hit. It takes a turf war to produce results that are far above expectations.
When there is one interest group that's motivated to take a patient population away from another group, the device that allows them to do that is going to be very popular. We've seen that happen with traditional cardiologists and surgeons, with neuroradiologists and spine surgeons, with interventional neuroradiologists and neurosurgeons, with interventional cardiologists and vascular surgeons over abdominal aortic aneurysm repair devices, and with interventional radiologists and neurologists over stroke-treating devices.
This will be a continuing and useful theme for investors. Turf wars allow investors to identify devices that have the most disruptive potential. In the imaging sector, the graphic capabilities of today's magnetic resonance imaging systems and computed tomography scanners that allow for imaging of the coronary arteries on a beating heart have very much changed the diagnosis of cardiovascular disease. Diagnosis can be achieved without an angiogram now. This could represent another turf war, and as a result, patient treatment will likely shift.
From a manufacturer's point of view, does a turf war make your job harder when addressing all your potential target customers?
Viscogliosi: Sure it does. Raymedica and some of the other portfolio companies of Viscogliosi Bros. target innovating surgeonsthose who want to be on the forefront of a new technology. We are fortunate in the fact that we still go to surgeons. But we are faced with the challenge of determining which groups of surgeons to target due to the ongoing turf wars. We try to be friends with and accommodate as many groups as possible.
The Department of Justice (DoJ) investigations into antikickback violations in the orthopedic and cardiac sectors seem as though they will likely come to fruition in the next six months or so. What is your sense of what the Department of Justice is looking for and what it's likely to find?
Cohen: The department is likely to find some unfair trade practices between device companies and surgeons or other providers. Some of the relationships may be holdovers from the not-so-recent past when gift giving, favors, and trips were the norm. But now such relationships have been pulled into the spotlight by New York Times investigative reporters and other newspapers, Congress, the Federal Trade Commission, and the Department of Justice.
It's a function of the pendulum swinging. The need for orthopedic and cardiac devices is significant, and the population bulge is just beginning to hit. Overall, the Department of Justice investigations will have some effect but will not create major impediments to selling these devices.
Gunderson: I agree. Although the investigations are an issue, the companies I monitor are taking appropriate actions. But from a Wall Street standpoint, the Department of Justice is like a giant cone of silence. We can't cold-call somebody at DoJ and have them explain what they're going to do and why they're going to do it. Therefore, the topic is subject to a lot of conjecture.
The marketing practices of five, six, seven years agoand certainly 10 years agoaren't the same as the marketing practices of today. Companies can't take providers on big ski trips or cruises that involve 15 minutes of work within four or five days of play. I don't know any major companies that do that anymore. The investigations will take a historical look at what practices were, and companies will respond by pointing out that those aren't the practices they currently use. Everyone will move forward from there.
Viscogliosi: Is the Department of Justice really going after manufacturers? Investigating companies may be the easiest way to unearth the doctors. When it comes down to it, how badly is the elimination of such kickbacks hurting manufacturers? If anything, it's allowing them to boost their bottom lines by not having to host elaborate events for surgeons.
Emerging Information Technologies
The federal government has been demonstrating support for the growth of information technologies (IT), but the government programs seem to be limited to those promoting electronic health records. Little thought is being given to how information technologies are used in medical products or how those medical products connect with other systems. How do you see this issue developing in the coming years?
Arrow: I am surprised that there hasn't been wider implementation of information technologies. Hospitals could benefit greatly from it. There's so much waste in paperwork. Yet companies like Healtheon-WebMD, which had a terrific mission, have either failed or been substantially delayed because the healthcare system is so slow to adopt information technologies.
There are some promising start-ups in healthcare IT. One that comes to mind is Visicu Inc. (Baltimore), which recently went public. The company produces remote monitoring devices for intensive care units. In addition, GE Healthcare (Chalfont St. Giles, UK) has been integrating its electronic health records into a lot of operating room equipment and other devices. The Socrates system by Intuitive Surgical (Sunnyvale, CA) enables a surgeon to remotely communicate with another surgeon located in an operating room anywhere in the world.
These products represent only a small fraction of what could be done in healthcare IT, and it's puzzling to me why this trend hasn't spread. In fact, I'm surprised by this situation outside of healthcare as well. I'm puzzled as to why businesspeople continue to fly around to see clients rather than using teleconferencing. I wish I knew why we aren't putting the same kind of resources and infrastructure behind IT that we do behind other aspects of innovation.
When will that logjam break? Do you have any thoughts on when we will see a major push for truly smart products?
Cohen: A major driver is the push to shorten hospital stays by moving patients into home healthcare and other ambulatory settings. With devices such as vital-signs monitors, ambulatory infusion pumps, and implanted insulin pumps, there's a need to communicate device data to the patient as well as to a provider or other monitoring service. The aging population, enhancing home healthcare, and catering to patients' desires to control more of their healthcare will propel new information technologies to report data to patients and providers, as well as information technologies to interpret those data.
Is there money waiting for those types of products to emerge?
Gunderson: If you're referring to Wall Street, I'm not certain that I'm able to address broader healthcare services that go beyond medical devices. But when I think of information technologies, I think of all the very cool smart devices that could be usedthe little chips that we'd all walk around with that would have everything and do everything. Clearly the technology is available. Nothing has to be inventedit just has to be implemented.
A couple years ago, there was a great policy debate on ICD payments between the Centers for Medicare and Medicaid Services (CMS; Baltimore) and ICD providers. In the process, the players decided that they could mine CMS data to determine whether the technologies work. This example illustrates that it doesn't require a big jump in technology, and it doesn't require a new company. But it might take a change in policy to enable the healthcare system to determine on whom these myriad technologies will work best.
I haven't met a baby boomer yet who says, ‘Oh, count me out. I don't need that technology.' They're all going to want it. They're all going to expect it. But the healthcare system has to become more efficient, and such efficiencies might be achieved simply by using the available information better.
The IVD sector has been pretty much moribund for the last decade. But recently, there has been tremendous movement in the sector in terms of mergers and new entrants. How do you see these shifts changing that market?
Scholz: Many of the changes are being driven by the integration of financial and clinical data. It is important to understand that individual patients and physicians are not the customers for healthcare. The primary customers in healthcare are the payers and the provider organizations. The information flow between these two parties comes with high costs. There are significant inefficiencies in the communication of the information that makes way for good healthcaremaking the right decision for the right therapy. I assume this is the same for cardiovascular diseases as it is for infectious diseases. It is particularly important in neuropsychiatric diseases, an area in which recent studies suggest that initial treatments are only correct for about a third of the patients. The rest must be treated through a process of trial and error.
Siemens, Philips, and GE are trying to move toward integration in their business models. They have patient information. They have payer information. Integrating those two components might be the first step toward the merger of healthcare services and healthcare technology. Integration is a big motivator for the big-three healthcare companies to add IVD technology to their business. It brings an important information component to the larger therapeutic picture.
The big challenge is that the medical device industry is overly diverse, with many different positions that now need to be integrated. Everyone's going to have a lot of fun trying to sort this out, and it won't happen in 2007. There will be ripples, but it will be years out before this is really completed.
There's been a lot of talk about the goal of personalized medicine, and diagnosticsboth imaging and IVDsplay a key role in that. Does the joining of IVDs with imaging and information make this goal more attainable?
Scholz: It will happen, but it's not happening overnight. As with all aspects of healthcare, most improvements take 25 years to come full circle. A generation of physicians must come out of medical school and replace old habits. But this is occurring, and personalized medicine is happening.
The transition will happen at a steady but slow pace, and it will start in a few critical care areas. It has already happened in cardiovascular diseases, where diagnoses today are made very quickly. It is also happening in infectious diseases, and I think it will happen in the field of neuropsychiatry within the next five years.
Arrow: Combining in vitro diagnostics with imaging will allow some personalized medical therapies and will certainly help with medical and surgical decision making. However, the most important progress in personalized medicine rests with the use of genetic testing, a subset of IVD that holds both therapeutic advantages and ethical dilemmas. The other meaning of IVD, in vivo diagnostics, is also being applied now. An example is in vivo ultrasound in the coronary arteries. If in vivo ultrasound were going to reshape therapeutic protocols in the United States, it probably would have done so to a greater extent by now, particularly given that it is so well penetrated in Japan. In the United States and in other geographies, only about 5% of angioplasties are accompanied by this technology. In the United States, it's not seen as a necessary diagnostic modality.
As major markets like joint replacement and stenting mature, more emphasis will be placed on more specialized markets, like small bone and joint, and peripheral vascular disease. Carotid artery disease and lower-limb peripheral occlusions are quickly becoming new stenting frontiers. There is also a lot of talk about neurostimulation as a field with a lot of potential. Which of these markets are going to see some big achievements in 2007 and 2008?
Gunderson: I think you're right on peripheral arterial disease (PAD). As mentioned earlier, cardio companies have had a tough year. It's hard to have a good year in interventional coronary procedures simply because it's a well-penetrated, fairly mature market. Price reductions and unit growth seem to balance out. However, peripheral is growing 1015% annually. Some argue that pain in the legs is as serious as pain in the heart and deserves to be treated equally.
Some of the same technologies used in coronary procedures can be used quite successfully in treating peripheral arterial disease. In addition, companies are now tailoring the technologies specifically for PAD. Fox Hollow Technologies (Redwood City, CA) has essentially reinvented atherectomy. In addition, ev3 LLC (Plymouth, MN) has put together a considerable number of peripheral products and has made the area its main focus. I attended the Vascular Interventional Advances meeting in Las Vegas this year, and I was impressed with the number of interventional cardiologists who are switching the focus of their practices from coronary to peripheral.
On the neurostimulation side, it seems as though stimulating various nerves in the brain or the body can cure almost anything—at least theoretically. The show 60 Minutes just did a segment on deep brain stimulation. In a study of a very small number of patients, stimulation of Brodmann area 25an area in the cerebral cortex of the brainseems to be a cure, or at least a partial cure, for serious depression. In addition, Cyberonics Inc. (Houston) has gone through various trials and tribulations in order to launch a neurostimulation product on the market for the treatment of depression. Other companies are looking at neurostimulation as a treatment for everything from migraine headaches to obesity to other mental illnesses. However, beyond pain management and other areas with existing treatments, I don't think neurostimulation is really going to take off in 2007. But it's certainly a sector to watch over the next three to four years.
Arrow: The neuro sector is in a state of immaturity similar to that of the cardio sector 15 years ago. We believe neuro is "the next cardio"a phrase we agree with but did not coinin terms of commercial potential for emerging devices.
Viscogliosi: Since we launched Small Bone Innovations in early 2005, about 25 to 30 new companies have been formed that focus on this area, which was formerly referred to as extremities. The main reason we launched the company is because we saw the opportunity to reach an underserved surgeon segment. Surgeons working in this area have not received much attention from device manufacturers. The segment hasn't seen much new product innovation, and the only companies focusing on the segment were smaller ones that didn't have the financial wherewithal to deliver new technologies similar to those being brought to other orthopedic surgeons.
In 2007, I think there will continue to be more focus on specialty surgeons, such as hand surgeons. In the past, these groups have not been targeted as aggressively as total joint surgeons and sports medicine surgeons. In July, for example, Warburg Pincus acquired a majority interest in Tornier (Grenoble, France), a firm with a focus in extremity prostheses. So just as Warburg has followed Viscogliosi Bros. investments in total disk replacement and other areas of orthopedics, now they're following us into this new space.
Is there enough funding in the investment community to support the development of emerging companies in these new areas?
Cohen: Yes. There's an overabundance of funding when compared to meritorious opportunities. As the larger-joint replacement and cardiac markets matured, both established and developing companies looked for specialized niches. Whenever that happens, it attracts newcomers to the market, along with significant Wall Street investment activity.
When companies start to mature and appear on the industry's radar screen, larger companies tend to either develop their own technology organically or to acquire the emerging companies that have reached certain milestones of success. As with any developing market, it won't be broad enough to support all of the participants. But the market will certainly attract great interest from Wall Street and other investing sources looking to take advantage of new frontiers.
Will these emerging sectors consolidate fairly quickly as the big players identify new companies as acquisition targets?
Gunderson: The big companies are already playing in some of the emerging areas. Medtronic and Boston Scientific are both in the neurostimulation area, as is St. Jude Medical with its acquisition of Advanced Neuromodulation Systems Inc. So consolidation is already starting to happen.
On the peripheral side, there will be a lot of small companies that develop their own embolic filters or carotid stents. The one-off companies that build a better mousetrap will also consolidate, but they will likely funnel into existing big companies.
Recently, though, the industry has seen the creation of a little bit of a middle ground. This counters the usual routine in which small companies rise up and are taken over by the Medtronics, Boston Scientifics, and J&Js of the world. An example of this middle ground is Edwards LifeSciences, which was spun out from Baxter. This also could be the case with ev3, but that's probably a little bit farther off. But essentially, we are seeing the rise of a small mid-cap world that can also absorb some of the emerging companies.
There's very little new technology that the big guys aren't watching, and many of these companies are starved for growth. They are watching entrepreneurs, who can move faster and get to markets more quickly. Then the big guys can come in and leverage their worldwide distribution.
What does that mean for the valuation of these small companies?
Viscogliosi: There is less venture capital money flowing into orthopedicsprimarily the spinein recent years. A lot of people initially thought that huge exits were easily obtainable. But with the change in reimbursement for total disk replacements, these small companies now essentially have to pay the full freight on their trials.
Valuations at companies are a little high. Such high valuations are going to continue to be paid by the J&Js and other very large companies of the world because it's important to buy growth. The big companies have the distribution and can pay that higher multiple. But lately, venture capitalists have been saying that the valuations that a lot of these companies are talking about are very frothy.
There's a lot of money being tossed around in the IVD sector, in which a lot of mergers are happening. Will this affect the prices that small companies can hope to garner when they are purchased?
Scholz: I don't think there is much bargain pricing going on in the sector. There has been a long depression on valuations in diagnostics, and that depression is coming to an end. The IVD sector is a recovering market. In the past 15 months, valuations have improved. The highest valuations are derived from assay content providers, as evidenced by BD's acquisition of GeneOhm Sciences. But the portfolio acquisitions that Siemens has been making hint that the prices will continue to inch up. Good technology at reasonable prices is very important. So we have two components that are key drivers: falling costs and a market that is being expanded by content.
What trends should manufacturers be watching over the next year to 18 months?
Cohen: Competition is growing, and due to group purchasing organizations (GPOs), it's increasingly difficult to reach operating room and hospital call points. Over the past couple years, the market loosened up due to legal issues surrounding antitrust-type concerns. But now the market is beginning to close up again. Group purchasing organizations initially felt they had to include small companies. But now we're witnessing more concentration and more bundlingthe same dynamics that we've seen before. Although there are some smaller companies participating, when GPO contracts are renewed, these companies must prove they have penetrated the GPO member hospitals. This is hard to do without the sales forces employed by larger manufacturers. I think the market may be contracting from a year or two ago when this issue was initially spotlighted.
The Senate has been examining this issue. Do you believe there will be legislation to restrict GPO activities in the coming year?
Cohen: I don't know whether legislation will be enacted or, if it is, under what time frame.
GPOs have contracted with certain smaller companies because their products were worthy of such a contract. How a manufacturer gets its devices to market, whether through GPOs or a long chain of distribution, is a major issue. GPOs highlight the issue because they are funnels. GPOs have significant power as gatekeepers into the hospital.
John, what are your thoughts for the next 12 to 18 months?
Viscogliosi: The medtech industry will continue to see the larger companies look to acquisitions to fill out their product portfolios. When you have a good technology and a good company, you're always an acquisition candidate.
New small companies will continue to be formed, and surgeons and the overall medical community will continue to be disenchanted with some of the larger companies.
Doctors want to help people, and they'll continue to work with smaller manufacturers to turn their thoughts and concepts into products and procedures. It's difficult for large companies to spend appropriately to satisfy surgeons who have good ideas for revolutionary technologies.
Scholz: In 2007, the medical device industry will see a trend toward more global pricing. There will be IT integration within the healthcare service industry rather than technology companies. There will be more consolidation within the industry, and competitors that have subpar technologies will disappear. In addition, the industry will see more novel, personalized content in the diagnostics field, especially in areas like neuropsychiatry that have not been adequately served and will greatly benefit from improved diagnostic technologies.