Running a medical device company has never been for the faint of heart. Yet it has become more difficult over the last two years as the industry has been bombarded with stiff new challenges. Major changes at the FDA, an increasingly complex insurance reimbursement climate, the passage of healthcare reform legislation, and the evaporation of venture capital funding have each become daunting issues. And all these developments have occurred at virtually the same time.

Lisa Suennen

December 15, 2010

8 Min Read
Device Industry Can Weather Tough Times

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Lisa Suennen

New modes of doing business must emerge in response to these drastically changed market conditions. Meanwhile, medical device company executives should make sure they are fully abreast of all the changes that have occurred. Below is an overview of those with the most impact, with suggestions on how to weather the difficulties.

A Time of Change at FDA

Getting a product approved by FDA has never been easy, but traditionally the process has at least been somewhat predictable. Not anymore. The federal agency is significantly altering the way it operates, leaving many companies in limbo. While the changes are being driven by good motives—FDA, after all, is charged with ensuring patient safety and the release of quality products—it is creating an environment in which innovation cannot readily flourish.

The regulatory process has become so onerous that some medical device company executives specifically intend not to seek U.S. regulatory approval. Instead, some are choosing to focus their efforts in easier-to-penetrate overseas markets and avoid the U.S. market altogether. This is bad for the American medical consumer as well as for American innovation.

One reason that some medical device industry executives have begun sidestepping the U.S. market is that FDA is reformulating the 510(k) approval process and more carefully scrutinizing PMA applications. The result is that medical device companies say they simply cannot predict what data will be considered acceptable. They also don’t know how long it will take to work through the FDA approval process or whether FDA will change their requirements in the middle of clinical trials. AdvaMed points out that these changes have been increasingly underway for at least eight years, with the average 510(k) decision time rising more than 20% since 2002.

This backdrop obviously makes it difficult, and sometimes almost impossible, for medical device manufacturers to know how to navigate their way through the FDA process. Trial designs become a moving target, leaving sales and operations in the lurch while key issues swirl unresolved.

The Uncertainty of Healthcare Reform


The Patient Protection and Affordable Care Act (PPACA) has created massive uncertainty about how products and services will be adopted, reimbursed, and taxed. More people covered by healthcare insurance should result in some increased medical device revenues in select areas. However, many PPACA provisions have put medtech executives on edge, most notably:

  • Excise tax increases. Medical device manufacturers will soon be subject to an excise tax of 2.3% on revenues. The tax will be levied regardless of the size of a company or its profitability and will be particularly burdensome to smaller companies that have not yet achieved positive cash flow. The new tax is likely to drive up medical device costs to the healthcare system as companies struggle to meet the tax burden and do so by increasing prices.

  • Reductions in government healthcare reimbursement rates. PPACA relies on significant reductions in Medicare fee-for-service (FFS) and Medicare Advantage payment rates. In part, these will come out of the pockets of medical technology manufacturers. In addition, plans to institute bundled payments, reimbursement for Accountable Care Organizations, and pay-for-performance models all raise the level of uncertainty about whether current device pricing models will be sustainable over the next 10 years.

In addition, the PPACA established the Independent Payment Advisory Board (IPAB), which is authorized to make binding recommendations on Medicare cost-cutting without going through normal congressional channels, representing another potential risk to the bottom lines of medical device manufacturers. An unexpected or significant drop in Medicare coverage or reimbursement levels can spell doom for a company almost overnight, so it is important for companies to have a diversified base of reimbursement channels.

  • The implementation of comparative effectiveness. With a $1 billion budget, the Patient-Centered Outcomes Research Institute (PCORI) will perform clinical research to help physicians and consumers make more informed choices among available therapeutic approaches. Yet the validity of research, as most people know, lies in the eyes of the beholder. If the PCORI decides, for instance, to focus research on coronary stents or obesity products, does that mean that one vendor’s products can ultimately be deemed “the best”? Is there even enough personalized medical evidence to truly help individuals make the best healthcare choices? Many companies fear that their products will have an unfair disadvantage in the marketplace if the research isn’t clear about meaningful differences. Very few medical device makers are represented on the PCORI board. It’s virtually impossible for a medical technology executive to know how PCORI may impact his business over the next decade.

The Complexity of Government Reimbursement

Understanding whether public and private payers will reimburse the cost of a product and how they do so has always been a critical consideration for companies considering investing in new medical devices. Unfortunately, the reimbursement process has become so burdensome as to induce virtual paralysis as companies consider whether to invest in new product development.

Amid unrelenting market pressure to cut healthcare costs, the ability of medical device companies—especially new industry entrants—to qualify for reimbursement has become increasingly uncertain. For instance, while somewhere between 50 and 100 new CPT-1 Codes are published by the American Medical Association every year, no more than a handful are for new technologies achieving “reimbursable” status for the first time. More often than not, companies are being directed into the experimental CPT-3 coding process, and it can take as many as three to five years before they graduate to the far more rewarding CPT-1 code level.

The private insurance side, in particular, is becoming increasingly challenging. Only a handful of new technologies get approved for coverage at private carriers every year, notwithstanding hundreds of new medtech product introductions annually. Any product that is clinically or financially controversial in any way may never be reimbursed in the private carrier market.

The best way for a company to combat this risk is to understand and plan for reimbursement from the very beginning of product inception. When they get to the point of performing clinical trials, companies must build in cost-effectiveness metrics. They should also spend serious face time with the professional societies that affect their destiny and be responsive to them in reimbursement studies and make a point to meet with private carrier medical executives to get their feedback along the way.

The Paucity of Venture Capital


New small companies, in particular, are facing daunting challenges and the pursuit of capital is among the most formidable of all. Venture capital investment in medical devices and related equipment has dropped precipitously since the beginning of the recession in 2008, in tandem with the decline in venture capital liquidity. In 2007, for instance, more than $3.7 billion was invested in more than 398 young medical device companies. By 2009, venture capital investments plummeted to $2.5 billion in 315 companies, and 2010 investment is looking similar to 2009.

As VC firms consolidate, there are simply fewer dollars for emerging companies. Furthermore, since regulatory and reimbursement risks have risen and the resulting capital requirements of young companies have grown, risk aversion has risen considerably among venture capitalists. Even companies that raise venture financing face greater hurdles, as they are now often required to meet various clinical milestones to get further financing support. This situation is amplified by the increasingly longer route to regulatory and reimbursement approval, which often takes much longer than originally anticipated. It is extremely difficult for CEOs and boards of directors to plan for such contingencies, making capital formation a challenge.

Financing issues affect big companies, too. It is common for the largest medical device entities to view smaller VC-backed companies as their virtual R&D pipeline. They have enjoyed the luxury of watching young companies grow and then acquiring them or at least their technology after much of the clinical and regulatory risk had passed. Since this pool of promising young companies has shrunk so markedly, big medical device companies have to increase their own internal R&D efforts or look overseas to find the innovative medical device technologies they are seeking. They can find these opportunities flourishing in Europe, India, and China, but U.S. innovation suffers in the process.


Grasp of Healthcare Economics Required

As we see, it is a brutally challenging time in medical device development and manufacturing. The days when a great technology almost ensured a great future for a company are largely over. Instead, technology must today be coupled with a firm grasp of healthcare economics and nerves of steel to navigate the reimbursement and regulatory landscape.

To cope, medical device company executives must become more creative and flexible than ever, finding new paths to market and capitalizing on relationships that may have previously lain outside their realm. Creative distribution relationships and joint development projects with larger companies, for example, can provide young companies with early revenue, offsetting some fundraising requirements. Medical device companies should also more actively develop close working relationships with private insurance carriers. This approach can establish faster routes to reimbursement for products that demonstrate meaningful cost savings. More patience will also be required. CEOs and the boards of start-up medical device companies must accept that they may be working together for up to a decade before their goals are ultimately achieved.

Clearly, the challenges for medtech companies are daunting, but we must continue to bring innovation forward in order to continue to improve health for our nation’s citizens. Given the market realities, companies must in invest heavily in long-term strategic planning and commit themselves to understanding the intricacies of healthcare economics in order to survive and thrive.

Lisa Suennen is a cofounder and a managing member of Psilos Group (Corte Madera, CA), a healthcare-focused venture capital firm. She is the head of the company’s West Coast office and specializes in medical devices, healthcare IT, and healthcare services. Suennen may be reached at 415/945-7010 or [email protected]. Her healthcare VC blog is http://venturevalkyrie.com.
 

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