Keys to Growth of the Medical Device Market

Originally Published MDDI August 2003

R&D Roundtable

Research expenditures continue to grow steadily. But are the dynamics of medical device development shifting?

Gregg Nighswonger

The medical device industry has continued to enjoy generally healthy market growth despite the sluggishness of the national economy. Looking at industry in general, industy support of R&D efforts is expected to top $194 billion in 2003—roughly the same as 2002. Government priorities are likely to continue to be influenced by a focus on defense and biological sciences, according to many industry observers.

To examine some of the current trends in medical R&D, MD&DI invited five representatives from industry to discuss current funding levels and factors that are shaping R&D.

The selected participants were: William Buckley, Business Development Manager with Foster-Miller (Waltham, MA); Jules Duga, PhD, Senior Researcher at Battelle Memorial Institute (Columbus, OH); Bill Inman, Senior Chemist/Technical Service Representative at Dow Corning (Midland, MI); Gary Smith, Director of Marketing at Battelle; and Dean C. Winter, PhD, Director of the Bioengineering Department at Southwest Research Institute (San Antonio, TX).

MD&DI: Who is funding R&D today?

Inman: The government, at least here in the United States, supports the National Science Foundation (NSF), the National Institutes of Health (NIH), and through the university programs. That's where a lot of the new, cutting-edge research seems to be happening. 

Buckley: Government agencies and individual firms fund most current R&D. Other significant sources of R&D funding are industry consortiums. Our experience with industry consortiums has been primarily within energy production and distribution. 

Duga: The government doesn't do a lot of work, as near as I can tell, directly funding device work. But they have provided an awful lot of the background from which industry then can pick up in terms of identification of diseases, and ways in which various medical treatments can be assisted with the development of appropriate diagnostic and therapeutic delivery systems. 

I think the government provides a platform from which others can launch various types of incentives. But the primary source for performance of medical device R&D is in the industry. 

Namely, government organizations such as the Veterans Administration have a very distinct interest in the welfare of their clientele and to the extent that specialty medical devices are required for people who come under the jurisdiction of the Veterans Administration, there would be a small amount of R&D that would go into that. Actually, the R&D budget for the Veterans Administration isn't particularly large—I think it's scheduled to be something on the order of $800 million, which is a real drop in the bucket—but, nevertheless, it is something that can act as a catalyst. 
I also get rumblings that representative organizations that have a significant clientele that may need various types of medical devices, such as AARP, would be a reasonable place from which to get either seed funds or influencing funds. That is, they go through such organizations as AARP to identify what the needs of their clientele are, and to use them as a lobbying force for either government or industry to help influence expenditures in R&D. 

Winter: Well, I think there are a couple of major players. One is certainly the federal government and NIH. And I think a fair amount of that goes on through the SBIR program within NIH. And the other area that we see is really the small medical device companies that may be angel or venture funded. 

From our end, we see less and less being done by the larger established medical device companies. They're still a major component, but it's less and less. 

MD&DI: In what device sectors are the most active R&D efforts found?

Buckley: There is much R&D activity in the areas of minimally invasive surgical procedures, semi-invasive diagnostic procedures, and improved methods of blood glucose monitoring.

Inman: Right now, the ones that seem to be really hot are tissue engineering (that would include stem cell research and such), wound care and wound healing—how to promote ideal wound healing and minimize scarring and such. 

Drug delivery is another big one as well, trying to get focused drug delivery so that less and less of a drug can be used but still get to the site. Use of patches is getting to be really big. And they are looking to roll in more of the standard drugs that people would take orally and put them into patch forms. 

Smith: I think the big three are still cardiovascular, oncology, and orthopedic. And close behind that would be endocrinology driven primarily by diabetes management. 

Winter: I would mention drug delivery too. I think that's a big area. The technology that goes with drug development, which I guess peripherally relates to medical devices, is a really big area. 

And there's cardiovascular support—anything from electrophysiology, like defibrillators, to the vascular stents and things like that. We see a lot of activity in that area.

MD&DI: Is funding still available for medical R&D, or is it becoming harder to locate?

Inman: I would think it's still available. The way I see it, if you want to go out there and get R&D dollars, you need to have some real, focused objectives in mind. You can't just say you want to go out there and see what you can find out. Nobody's really willing to support the kind of research that doesn't seem to be tied into some kind of viable end results anymore.

Buckley: There is a large amount of funding available for medical R&D. It is not necessarily easy to locate and never has been. The most effective way to locate R&D funding is direct contact with industry and agency decision makers. However, establishing and maintaining this direct contact can be challenging and time consuming. To qualify for funding from government agencies such as NIH, one must usually bring an innovative technology to the problem being addressed.

Duga: Looking at some of the areas we deal with here at Battelle—surgical and medical instrumentation and apparatus areas—the history suggests a relatively steady growth in R&D expenditures by industry. 

The projections are for about 4% per year in current-dollar expenditures, which is a pretty good growth rate considering that inflation is relatively small. 

There was a somewhat smaller growth rate in industries that deal with orthopedic and prosthetic devices, but it's generally still positive. I think the monies will continue to be there, and we're talking about 3 or 4% there as well. 

Now these data are based upon surveys and reports that have been put together by a company in Illinois. They take data that are available to the Securities & Exchange Commission, reports from publicly traded companies, and they extract the R&D data from these and do a variety of analyses on them. The data are always subject to question, especially when you're talking about individual companies. However, when you're looking at industry as a whole, things are reasonably accurate and the projections are fairly good. 

And I think that the industrial availability of money will continue to grow at about the same rate as it has in the past, outpacing inflation by two to three points per year for the foreseeable future. 

Smith: As a gross generalization, when we take a look at the healthcare sector in its broadest sense, we divide research from development in trying to analyze it. Again, as a simplification or generalization, government supports research, industry supports development. Government dollars, whether they are federal or state or local, will support research—disease research, diagnostic research, therapeutics research, health and life science research in the most nascent forms, including the funding going to national laboratories. It is this early research that industry is unwilling to sustain. It's too early, it's too unpredictable, and too risky. So industry then can afford to wait and see what happens with that government-funded research. At that point, the government dollars typically won't support it once product commercialization starts to take place. Once a product and commercial opportunity are identified by a researcher, they begin to look for funding from industry—and that industry funding can be corporate, venture, angel, family and friend, and so on.

Duga: And that applies not only to medical devices, but to almost every other area as well. It is somewhat of a fallacy to talk about industrial research when it is, in fact, much more a case of industrial development. To some extent, industry does do what they refer to as fairly basic research, but it is certainly directed basic research, not the kind of truly fundamental research that the universities are accustomed to, or that groups like NIH and NSF are accustomed to supporting.

Winter: I think the venture capital has tightened up quite a bit. I think that's pretty obvious. It seems, at least we hear, that it's loosening up a little bit in the biotechnology area, but not necessarily medical devices. So I think that is where the biggest economic impact that we've seen is. Smaller companies are finding it hard to get financial backing. 

MD&DI: What types of organizations are most involved in R&D? Small, large, multinational firms?

Buckley: All three general sizes of organizations are actively involved in R&D. The differences between them are in the scale of the R&D effort and funding. Small companies are often start-ups using private and/or government agency funding to commercialize new technology. Large firms often have permanent R&D staff and departments to generate new technologies and extend existing technologies. Multinational corporations do not necessarily do more or less R&D than large national firms. Large pharmaceutical companies sponsor large-magnitude R&D on an ongoing basis.
Inman: All three are really doing it—small, large, and the multinationals. As far as cutting-edge R&D, I think the smaller companies out there are doing a lot of the advanced research. It's mainly just to try and establish themselves in an industry that's pretty large. They are the ones that seem to be taking the most risks. 

With the larger companies and the multinationals, most of them now have risk programs where they actually meet, maybe in a boardroom, to see what inherent risks are associated with a type of research and whether they want to do it or not. They're considering whether it is worth potentially losing everything they have to lose. On the other hand, the small company can usually get things done relatively cheaper than the bigger companies. And, relatively speaking, they have less to lose.

I think the smaller companies are risk takers more so than the larger companies. And you know a lot of the larger companies, at least from what I've seen on the device side, they simply sit back and keep a close eye on these smaller companies. And if they see something they like or something that's likely to pan out, a lot of times they'll just purchase the company.

Smith: We see research as a continuum with different mechanisms and different “producers” along the curve. At the research end, there are national labs, academic and clinical research centers, and emerging companies—all funded by a variety of federal, grant, and private resources. 
Development is happening in more established firms where technology has been in-licensed or acquired from the aforementioned sources. These firms typically have strong sales and marketing capability and will often contract outsource development to ensure timely delivery of products to their market constituents (customers). I would say the trend continues toward small companies taking on the R&D risks. More so than ever in the past, the big companies are now realizing that they are sales and marketing and distribution organizations. 

The Johnson & Johnson models, the Medtronics, and the Guidants clearly have a strategy where they would rather wait and acquire a company that is either past some key milestones, such as FDA approval, or well beyond feasibility. They're comfortable with seeding a small dollar volume into the research company at a point where they know they can garner equity later on, even total ownership. But rather than risk their own dollars in that front end, I see them seeding lots of companies, building strong franchise development organizations—organizations that are responsible in core technology organizations for surveying the market and looking for start-ups that have certain capabilities that will fit their pipeline. Sprinkling the infield, so to speak, to be able to pick the best flowers later on.

So, would that cause a decrease in their R&D expenditures? I don't know that it has. But it shifts dollars into business development.

Duga: I would add that the larger companies in general over the past decade have gone through a very significant restructuring of their internal R&D activities and the extent to which they maintain laboratories that are necessary to deliver services for their customers. A lot of their R&D has been outsourced and has been going down through the supply chain. So they've let their suppliers undertake the kind of R&D that's necessary to get a finished product. Now in the long run, this shifts the R&D budget from the major corporation down to the next level. 
That doesn't necessarily mean that the major corporations are saving a lot of money because they are now buying it from their suppliers with a higher value added to it. But they have reduced some of the risk, and they have a lot more flexibility when it comes to outsourcing to that supply chain. 

MD&DI: How much R&D is still handled in-house versus outsourced programs, collaborations, and others?

Buckley: This is a difficult question to answer because most in-house R&D is proprietary to the organizations that perform it. Our perception is that the great majority of commercial R&D is performed in-house. Government-sponsored R&D often involves collaboration between multiple research organizations, academic consultants, and the sponsoring agency.

Inman: There's more outsourcing, very much so. It's quite a paradigm shift for Dow Corning because, in the past, we've always thought we had to build our own expertise. It's taken a lot of time and a lot of money. 

And there are some instances where that doesn't necessarily pan out. So what we have done is started to look outside to see if there is a product that we would like to bring to market. And if there isn't, and it's not within our own core capabilities, who could we work with to bring it to market? 

An example of that would be where we've had customers come to us and ask for reinforced tubing. Now that's not something we typically have done, and we don't really have a true core competency in that area. But we partnered with a fabricator to bring a new line of reinforced tubing into the marketplace. 

I think you're seeing that everywhere really. People are finally realizing that from an economic standpoint, they can't do everything. It just doesn't make sense if there's somebody out there that's already skilled and has the capability to help a company as a partner to do what they want. Ideally, it's a win-win situation for both sides of the partnership. 

Duga: That depends a lot upon the particular industry. For what I know about the medical device area, it would appear to me that there would be less outsourcing within the device industry because of the highly proprietary nature of the eventual product. However, there is an increasing move toward outsourcing, not only domestically but also on an international basis. And I think this is something that is going to be continuing. Again, this would be at different levels for different types of industries. 

Smith: I would add that in the past 18 to 24 months, there's been a moderate contraction in the outsourcing trend due to the economic conditions. Companies have had to defend their own staffs, as dollars dried up for them both in the public markets as well as in venture and angel funding. So they were forced to drop some programs to focus on recurrent engineering needs and problem-solving within their own organizations. 

I think when the market comes back around to a healthy state, we'll see a reestablishment of a trend that we started to see clearly in the 1997–98 time-frame, which was, “My commitment to Wall Street and my investors is larger than I can handle alone, and so I'm willing to outsource some key programs.” 

Winter: This may reflect the economic situation, but we find that companies are more risk averse when it comes to developing R&D programs. First of all, they are not reluctant to outsource manufacturing, for example. 

And they're not reluctant to outsource things that don't necessarily involve the development of an actual product. They tend to want to keep that in-house for a couple of reasons. One, they don't want to share the intellectual property (IP), which you can understand. But, secondly, they want to have the people inside who develop the IP. 

I've heard one of our consultants describe this medical device industry as, in this sense, an immature industry compared to the automobile industry, or some long-established industry that had learned to deal with this and to outsource their R&D in certain areas. Medical device companies don't know how to do this. 

MD&DI: What impact is global outsourcing having on R&D programs?

Buckley: Global outsourcing has resulted in a significant amount of R&D now being done outside of the United States and Western Europe. For example, a large amount of software development is being done in India.

Inman: I don't really think so yet—at least on a really wide scale. But there is huge potential. You look at countries in Asia. In countries like China and India, for example, you have a very highly skilled, intelligent population that is more than capable of doing a lot of this R&D. And the price is right. So I see a lot of that shifting now. We've seen it from a manufacturing standpoint already with many OEMs going down to Mexico to get their assembly done. I think it's just a matter of time now before they look to shift the R&D over to some of the Asian countries.

Duga: I see this as a very significant factor in various sectors. I don't know the extent to which it's a factor in the medical device industry. However, there has been a very strong increase in the amount of outsourcing, both to captive laboratories—those that are subsidiaries of U.S. companies—as well as to noncaptive ones. 

But before anyone gets terribly excited about this, you need to take a look at the total statistics on it. U.S. industry does spend several tens of billions of dollars in supporting R&D programs overseas. 

But for every dollar we spend supporting their R&D, foreign companies spend a dollar and half to two dollars supporting R&D performed in the United States. So we have a positive balance of trade relative to the performance of R&D.

I think that the globalization of R&D efforts is something that probably will continue when companies are attempting to establish themselves in those markets. They have to undertake R&D that is going to be more specific to the regulatory and cultural environment in which they want to market their goods. So there's every good reason to undertake R&D in places like India and Bulgaria, Mexico, or wherever else they choose to expand their business. 

Smith: I would add that the medical industry interestingly lags behind the consumer product industry in product development and R&D. Product lifecycles are typically longer in the healthcare industry, and costs have not been that much of an issue traditionally. Only recently have we seen interest from the medical device industry in looking overseas for outsourcing resources. Typical interest includes software development and manufacturing.

Winter: We see a couple of things. One is software, say run-of-the-mill software, that is outsourced overseas. And we've been seeing more and more things like rapid prototyping and packaging going to places like China. 

Certainly it's all driven by cost.
 
Again, this goes back to what I said before, to the companies that are willing to outsource things that are not IP related—and packaging tends not to be, and run-of-the-mill software tends not to be. And it's driven a lot by bottom-line cost.

MD&DI: What factors are influencing R&D?

Buckley: Medical R&D is partially insulated from normal business cycles, as the need for medical care and its funding by insurance (for most patients) are relatively constant. The major factors that have influenced R&D over the recent past are the need for cost reductions in devices, procedures, and care related to procedures; minimally invasive surgery technologies as a way to reduce patient trauma, discomfort, and the cost of care; increased concern about contamination and infection for both patients and medical professionals; and increased use of disposable devices and components in response to cost (of disinfection or sterilization procedures) and contamination concerns.

These factors influence the selection of medical procedures and associated device technologies to be developed. The need to reduce trauma during medical procedures, and therefore save costs and improve the patient's comfort, has spawned a variety of new devices.

Inman: Right now, on the spot, I'd have to say it is economics. Companies are really still doing some of that long-term research, but they're looking for shorter-term opportunities—maybe two to four a year—where they can really get some bang for their buck, and relatively quickly. They're looking at customer-focused opportunities where they're trying to listen more to their customer to bring to market faster what the 
customer needs. 

With development of our Class VI high-consistency silicone rubber (HCR) elastomers and liquid silicone rubber (LSR) elastomers, you have a good example of customers telling us that they needed these more-cost-effective materials and that they needed them quickly. Within a year, we had HCRs on the market, and we had LSRs within two years. And they've really taken off since then.

It's really customer-driven development. There's still some core research that's happening, but right now it seems to have been cut back quite 
a bit. I think companies are still doing it. But, again, it's more focused and they have certain goals in mind. For example, we're looking at things such as photonics, and we're trying to focus our efforts and deliver some long-term gains in those areas. 

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