Market Trends Prompt Need for a Better Operating Model

Four significant market trends will dramatically affect the future of medical device companies. The next generation of medical device winners will be those companies that heed these trends now.

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Tom Hodson, Tom Beattyand 2 more

January 1, 2008

14 Min Read
Market Trends Prompt Need for a Better Operating Model

MARKET TRENDS

Photo by GETTY IMAGES

Over the last five years, the medical device industry has averaged gross margins of 60%, which is 15% higher than the average gross margins of the S&P 500. Additionally, the growth in earnings per share (EPS) of 18% is 34% greater than that of the S&P 500.1 A bidding war erupted over Guidant and the growth potential of its primary market—selling $22,000 implantable cardioverter defibrillators (ICDs) and $5000 ICD leads to patients with irregular heartbeats. A host of competitors such as Danaher, Perkin Elmer, Intermagnetics General Corp., Teleflex, and OSI are growing their positions in the segment, lured by the attractive returns.2

Furthermore, the underlying demographics appear to paint a rosy picture for the future. More than 60% of industry sales are heavily weighted toward two treatment areas: cardiovascular disease and orthopedics.3 In the United States, which accounts for roughly 43% of total industry sales, medical device companies view the hips and hearts of the 78-million-strong baby-boomer generation with an accountant's green eyeshade.3,4 Globally, the trends are equally compelling. In developed nations, the percentage of the population older than 60 years will climb to 33% in 2050, up from 19% in 1999.5

So why, exactly, should medical device companies be concerned? This article explores four significant market trends that will dramatically affect the future of medical device companies. It also discusses the reasons these trends call for pointed questions and a holistic approach to anticipating the future, formulating appropriate responses, and executing in a way that provides clear direction and flexibility to address changing market conditions. The next generation of effective medical devices will be those provided by companies that take action now—while profits are flowing and resources are available—instead of waiting for certainty in an ever-changing future.

TREND #1: Traditional Lines of Business, Technology, and Competition Are Blurring

A convergence of information technologies, telecommunications, biotechnology, robotics, optics, sensors, materials science, physics, chemistry, and nanotechnology will increasingly play a major role in the innovation of medical devices and create new opportunities for companies to fill their product pipeline. Possible examples include:

  • Cell phones capable of holding personal health records or serving as glucose monitors.

  • Sensor nets—wireless networks of distributed sensors to monitor physical or environmental conditions such as temperature, sound, motion, etc.—that can monitor the elderly and thus enable them to remain in their homes rather than move to assisted-living facilities.

  • Handheld devices that combine nanotechnology, chemistry, and biology, and that are capable of early disease detection.

However, new competitors from within and outside the healthcare industry have entered the medical device market with product pipeline goals of their own. These include traditional manufacturing companies, such as Danaher, Perkin Elmer, Intermag-netic General Corp., Teleflex, and OSI; healthcare distributors such as Cardinal Health Inc., which are now manufacturing generic versions of devices; and information technology (IT) powerhouses, such as Intel Corp. and Microsoft, that offer the technology infrastructure that can blend with devices to help solve complex industry issues involving information exchange.2,6

Although pharmaceutical companies traditionally have not been involved in medical device design and manufacture, small biopharmaceutical firms are developing combination devices that must meet market and regulatory requirements for both pharmaceutical and device products. Concurrently, medical device companies that have concentrated solely on diagnostic devices are beginning to broaden their focus to encompass the entire life cycle of patient care.

Medical devices of the future likely will be an amalgamation of mechanical, physical, chemical, and nanotechnology inputs that are developed and marketed by established and emerging competitors. The blurring of traditional lines of business, technology, and competition should prompt device company executives to ask and answer a series of strategic questions:

  • How might the future evolve, and what might it mean for our business?

  • Do we want to be a company that addresses therapeutic needs or one that manufactures products?

  • Should we be organized around therapeutic areas or product models?

  • Do we have access to the assets (people, intellectual property, etc.) necessary to compete and win in a converging industry?

  • Where are we most vulnerable to disruption from an unforeseen competitor?

TREND #2: The International Market Is Big . . . and Getting Bigger

Our research indicates that the international market will continue to offer great business opportunities—and challenges—to U.S.-based medical device companies looking to increase sales or expand their research, development, and operations beyond country boundaries.

In less than 40 years, the economies of Brazil, Russia, India, and China combined could be larger than the G6 (United States, Canada, UK, Germany, Japan, and France) in U.S. dollar terms.7 All four countries have the potential to be strong markets for U.S. medical device companies. With their large, untapped population bases, demand generation should be easier than in the saturated North American and European markets, and steady growth in these emerging regions could help erode their commercial differences with more-­established markets. Additionally, both India and China offer low-cost skilled labor for manufacturing and, increasingly, other value-chain activities.

Yet the challenges to achieve results in an international marketplace can be considerable. For instance, healthcare systems in several countries have implemented competitive bidding for the procurement of medical technologies, which can reduce the treatment options available to patients (as well as sales opportunities for device firms).8 Emerging markets also come with significant price pressures. Almost certainly, U.S. device companies will have to significantly lower their products' prices to remain competitive with lower-cost manufacturers that have already established footholds in these markets. U.S. companies likely will need to source alternative locations (probably in the Far East) to manufacture their products to hold down production and distribution costs.

Medical device companies should think globally from the first steps of product development through customer service. Important questions to ask as part of the planning process include the following:

  • How do we offer fewer products for less cost and still meet the needs of emerging markets?

  • What are the physiological differences of patients outside of the United States that may necessitate design changes to tailor our company's products to local markets?

  • Do we have the right talent to get the results we want in the complex international marketplace?

  • How can we protect our intellectual property in emerging markets, as well as reduce the likelihood that counterfeit products produced there do not make their way into U.S. distributorships?

TREND #3: The Definition of Customers Is Changing

For most of its history, the medical device industry has viewed clinicians as its primary customers, spending significant resources, including time, money, and sales personnel, to develop and maintain their loyalty. However, we have observed that as other stakeholders are becoming more influential in the buying process, device companies are increasing their focus on payers, purchasing directors, employers, and patients as important customer groups.

Private payers, the Centers for Medicare and Medicaid Services (CMS), and employers are increasing their demands for transparent data on healthcare product and service quality and performance.9–11 We expect this to affect medical device pricing negotiations and customer-segmented pricing strategies. Also, health plans are developing new product lines that require their members to assume more of the cost burden.12

Aging Americans are requiring more high-acuity care, which should increase demand for medical devices in specialty areas such as cardiovascular, orthopedics, and certain diagnostics.13 In addition, the growth of consumer-­directed healthcare should increase the importance of direct-to-consumer (DTC) advertising as a tool to increase consumer awareness of medical devices and to educate them about quality care.

Serving one customer is easy; serving the web of diverse stakeholders who will increasingly influence the buying decision is much more complex. Important questions include the following:

  • How do we manage and interface with our key customer accounts?

  • Have we made conscious choices about which organizational resources (time, money, and people) we want to dedicate to specific customer audiences?

  • Have we adequately addressed questions and concerns from payers, who ultimately decide whether to reimburse for specific devices?

  • What is our consumer strategy?

TREND #4: Regulatory Scrutiny Is Increasing

The medical device industry is regulated or influenced by numerous third-party forces, including FDA, the European Agency for the Evaluation of Medicinal Products (EMEA), the International Conference on Harmonization of Technical Requirements for Registration of Pharmaceuticals for Human Use (ICH), AdvaMed, providers, payers, patient advocacy groups, and the media. Criminal penalties can be devastating (if not fatal for a company), which is the reason that enterprise compliance is so important. The industry can expect increased regulatory scrutiny in the coming years, particularly because FDA is receiving pressure from the public to protect patients from unsafe devices.14 This trend highlights the need for medical device companies to implement comprehensive quality systems and the need for postmarket study organizations to significantly increase the integrity of both existing products and those in the pipeline, whether they are produced in the United States or abroad.

Traditional sales and marketing practices are under scrutiny by the Office of Inspector General (OIG), as evidenced by OIG's investigations of orthopedic vendor marketing practices. In addition, group purchasing organization (GPO) arrangements are being brought into question. Industry groups such as AdvaMed have developed a code for sales representatives (similar to the PhRMA code in the pharmaceutical sector) that establishes ethical guidelines for interaction with healthcare professionals.

We expect the increased regulatory pressures on providers to affect the medical device industry as well. Pay-for-performance and value-based purchasing are growing realities, forcing providers and physicians to develop active, coordinated, and transparent reporting of their prices, error rates, and safety standards. This makes the adoption of vigilant product performance and safety standards by life sciences companies more important than ever.

To effectively manage increased regulatory scrutiny, medical device companies should ask these questions:

  • Are we taking a broad view of our regulatory and compliance responsibilities and looking for ways to combine similar threads of activity to avoid duplicating compliance efforts?

  • Do we have mechanisms in place to keep abreast of the latest regulations in the markets in which we participate?

  • Do our compliance and regulatory processes allow us to rapidly comply with new statutes and requirements?

  • How can we work effectively with local officials in emerging markets without running afoul of the Foreign Corrupt Practices Act?

Think Ahead and Be Flexible

Many medical device companies are beginning to experiment with different organizational structures in response to one or more of these emerging trends. While many retain a functional operating model, some that are further along the Six Sigma curve are managing their business as a set of core processes, such as Demand Generation, which span multiple functions. Still others are organizing around specific disease states and therapeutic areas. Although interesting and perhaps appropriate, organizational form must follow function, and sweeping changes are usually not a cure-all for questions of business strategy.

However, pointed solutions also are not a panacea. Too often, medical device companies with a problem in one operating area assemble a focused team to address it and dig in. One company, for example, assembled a team of operations and R&D employees to “determine whether we need a plant in China,” as if that were a separate and distinct question from the organization's overall business strategy. Similarly, deciding whether a DTC campaign makes sense cannot be divorced from questions regarding reimbursement strategy and clinical relationship management. Self-contained projects and initiatives may be well-intended, but time dedicated to cross-functional strategic alignment should yield greater results.

A better approach is to couple a comprehensive, bottom-up assessment and inventory of discretionary projects with a top-down, flexible strategic-planning process. Determining where a company spends its time and money from the bottom up can be more complicated than it sounds and often yields surprising results: Is it focused on new products for new customers, or on internal process improvements? What is the right balance?

Many of the trends addressed in this article point to several general and industry-specific drivers of change, including economic growth, regulation, the role of payers, and patient demand. These key drivers represent sources of uncertainty. It is the job of senior management to understand these uncertainties and to develop and execute flexible, top-down strategies that help manage them. The traditional strategic-planning process rarely accomplishes this task.

It makes sense to understand the relationships between key drivers and define several, equally plausible, future-state scenarios based on those drivers. Then, for each scenario, management should determine the appropriate response strategies, identifying the capabilities the organization would need and how it would secure them. After repeating this exercise for each scenario, a fairly clear picture should emerge of the common strategies that, regardless of the future, should be executed to effectively compete in the marketplace. One example of a common response in each scenario might be to allocate additional financial and human resources to educate hospital buyers about the company's value proposition.

For one-off strategies that fit one or more scenarios, a more nuanced approach is required. In some cases, it's not good enough to wait and see, especially if the lead time for acquiring or developing a capability is lengthy. We expect healthcare IT, for example, to dramatically affect the medical device sector. By the time that effect is apparent, however, it might be too late to respond. In instances such as this one, it's appropriate to make investments, whether in strategic partnerships, building infrastructure, or other areas, to hedge against a particular uncertainty.

The final step to prepare for an uncertain future is to broker reconciliation between top-down scenario planning and the bottom-up project inventory. No company lives in a world of unlimited resources, and choosing the right things to do must be balanced against executing actual projects. For example, the decision to allocate resources to educate hospital buyers must be weighed against its trade-offs: Should you have fewer sales reps calling on doctors, or one less IT project? Addressing these decisions at the board level can be the difference between an interesting theoretical exercise and an actionable plan that can help provide comfort in the face of ambiguity.

Medical device companies should begin now to plan for an uncertain future. This process may not yield an answer to every question raised in this article, but it may help an organization to become better positioned to respond to changes when they come.

Tom Hodson is a principal in the life sciences industry practice of Deloitte Consulting LLP with an emphasis on the device and diagnostic segment. Hodson can be reached at [email protected]. Tom Beatty is a manager in strategy and operations for Deloitte. Beatty can be reached at [email protected]. Ohad Ludomirsky is a manager in strategy and operations for Deloitte. Ludomirsky can be contacted at [email protected]. Kelly Fischbein is a manager in strategy and operations for Deloitte. Fischbein can be reached at kfischbein@ deloitte.com.

References

1. Reuters Research Inc., (London: One-Source Information Services, 1983–2006) [online]; cited September 29, 2006; available from Internet: http://about.reuters.com/productinfo/reutersresearch.

2. Pete Lawyer and Rob Alford, “Industrial Revolution: The New Medical Device Acquirers,” In Vivo: The Business & Medicine Report 6 (2005): 2–8.

3. “Healthcare: Products & Supplies Industry Survey,” Standard and Poor's (February 23, 2006): 3, 8.

4. “Oldest Baby Boomers Turn 60,” U.S. Census Bureau, Special Edition [online] cited January 3, 2006; available from Internet: www.census.gov/PressRelease/www/releases/archives/facts_for_features_special_editions/006105.html.

5. World Population Prospects: The 2004 Revision by the United Nations Population Division. Referenced in “Healthcare: Products & Supplies Industry Survey,” Standard and Poor's (February 23, 2006): 9.

6. Joris Evers, “Microsoft, Intel Team to Target Healthcare Market,” Info-World (March 11, 2005), available from Internet: www.infoworld.com/article/05/03/11/HNmsintelhealthcare_1.html.

7. Dominic Wilson and Roopa Purushothaman, “Dreaming with BRICs: The Path to 2050,” Goldman Sachs Global Economics Paper no. 99, October 2003.

8. “Competitive Bidding,” position paper by Global Medical Technology Network, July 2005 [online]; available from Internet: www.advamed.org/MemberPortal/Issues/International/paper_bidding.htm.

9. “BTE in the Current Pay-For-Performance Landscape,” Rewarding Quality Quarterly Physician Newsletter (April 2005): 1.

10. Katy Henrickson et al., “Health Plans Pursue Provider P4P Programs: Case Studies of Leading Plans' Quality Incentive Efforts,” Forrester [online] July 29, 2005; available from Internet: www.forrester.com/go?docid=36806.

11. Kaveh Safavi, “Moving Pay-for-Performance to Pay-for-Value,” Solucient Healthcare Technology 3 [online] November 2005; available from Internet: www.hctproject.com/document.asp?d_id=3585#.

12. Leslie Berenstein, “Insurance Ills Put Squeeze on Consumers,” San Diego Union-Tribune (August 22, 2004).

13. L Mion, “Care Provision for Older Adults: Who Will Provide?” Online Journal of Issues in Nursing 8, no. 2 (2003); available from Internet: www.nursingworld.org/ojin/topic21/tpc21_3.htm.

14. Richard A Devo, “Gaps, Tensions, and Conflicts in the FDA Approval Process: Implications for Clinical Practice, Health Care Policy,” The Journal of the American Board of Family Practice 17, no. 2 (2004): 142–149.

Copyright ©2008 Medical Device & Diagnostic Industry

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