Mayo Move Breaks Vertical Integration Model

When the Mayo Clinic (Rochester, MN) undertook a project to produce a magnetic resonance imaging coil under its own brand, the move represented the first time a research-oriented healthcare delivery organization had created a medical device and brought it to market under its own name. Now, with more than 100 MRI coil sales under its belt, Mayo is looking to expand its offerings in medical devices.

At first glance, the clinic's move would seem to represent the emergence of another competitive force in the already crowded medical device field. But what first appeared to be a threat to established medical device vendors may in fact be a boon, providing a new business model that could challenge medical device firms' longstanding allegiance to vertical integration.

The Mayo Model

Delivering healthcare while maintaining a commitment to research is a daunting task. University teaching hospitals are constantly looking for ways to generate revenue to fund new research. Most large university hospitals have technology commercialization offices that seek to monetize the fruits of their research. According to Steve VanNurden, vice chair of technology commercialization for Mayo Medical Ventures, his office gets a new commercialization candidate from Mayo's researchers every day. The traditional approach of the office has been to license the intellectual property (IP) to a vendor, which then commercializes it and plows royalties back into the institution. Although the vendor assumes all the business risk, the institution loses control and most licensing deals end up returning little revenue.

In 2003, Mayo researchers developed an innovative way to generate MRI images of the hand and forearm. Rather than licensing the technology to a modality vendor, the researchers developed a prototype and contracted with IBM's Engineering and Technology Services group (Rochester, MN). In collaboration with Mayo engineers, IBM developed the MRI coil and produced the first manufacturing prototype within eight months. Named the Mayo Clinic BC-10 MRI coil, the final manufactured version was completed four months later and is currently being sold through MRI manufacturers Philips, Siemens, and GE Healthcare. The device is branded with the Mayo name and sold through catalogs and as an accessory in a new MRI sale or upgrade.

Mayo is also developing another product with IBM's Engineering and Technology Services group. Called the interactive breath monitor, the device is intended to improve lung biopsy methods. The product went from Mayo prototype to engineering prototype in just 10 weeks and is currently undergoing the FDA premarket approval process.

Commercializing research at this level entails different risks and rewards compared to simply licensing the technology. By outsourcing product development and manufacturing, Mayo assumes the regulatory risk associated with becoming a medical device manufacturer—regardless of the fact that it outsourced development of the product to IBM. And because the outsourced product carries the Mayo brand, the company assumes risk associated with the product's safety and effectiveness. This is not to mention the costs that Mayo assumed in underwriting product development and manufacturing costs.

But with such risk come rewards. By becoming a medical device vendor, Mayo receives a much higher margin on the sales of its BC-10 coils than it would have received if it had simply licensed the technology. And as a manufacturer, if it is not satisfied with its distributors, it can find new ones.

“Our customer is the finished-product manufacturer that sells to end-users and deals with group purchasing organizations (GPOs), but we could go through distributors in the future,” says VanNurden.

“This is now one of technology commercialization's established strategies for new products. We look at the product and market first to determine the best approach,” he adds. “The commercialization strategy is evaluated on a per-idea basis.” Not surprisingly, VanNurden has received several calls from peers regarding this new business model.

Industry Implications

Founded on proprietary technologies, the medical device industry has pursued a strategy of vertical integration for many years. Vendors have held their secrets tightly, bringing distribution and manufacturing in-house to maintain margins in the face of price pressures. Vertical integration has fostered proprietary hardware platforms and communications protocols, increasing customer's costs for changing vendors and helping to lock in the installed base.

In most other high-tech industries outside healthcare, the vertical integration business model has been replaced. Using outsourcing, industry standards, and open-source technology, other industries have given up purely proprietary solutions, allowing more resources to be focused on core technologies and competitive differentiators.

Several key factors are contributing to the breakdown of vertical integration among medical device vendors. The growing pressure to adopt healthcare information technologies (IT) is forcing the use of more-standardized technologies like bar code readers, wired and wireless local area networks, and standards like Health Level 7 (HL7) and d igital imaging and communications in medicine (DICOM).

The integration of medical devices with clinical information systems continues to affect medical device vendors. Such connectivity necessitates the adoption of general-purpose computing technologies to analyze data, generate diagnostic reports, and improve surveillance and therapy delivery.

As healthcare IT, telephony, and medical device vendors increasingly focus new products on the point of care, proprietary solutions break down simply because no single vendor can offer all of the relevant products and services. A nurse views surveillance and alarm notification quite differently from the way an infusion-pump or patient-monitor company views them. Once nurse-call systems, wireless phones, and messaging middleware are added to the mix, there's little room left for proprietary systems. Fortunately, with this increasing complexity, the research and development (R&D) outsourcing industry has matured and is making early inroads with medical device vendors. Mayo's new business model is a prime example.

Medtech Outsourcing

Few medical device manufacturers seem threatened by Mayo's move onto their turf. According to VanNurden, original equipment manufacturers are increasingly outsourcing R&D, and interest in leveraging research done at places like the Mayo Clinic is increasing. Now research organizations can not only generate ideas, but validate and advance product concepts to the point at which they are ready for sale.

Medical device vendors have been slowly adopting outsourcing for some time. According to Samuel Prabhakar, director of medical solutions for IBM's Engineering and Technology Services group, IBM started providing R&D services related to product development 15 years ago. In 2002 the company created the Engineering and Technology Services division, which now has 1500 employees and is one of the fastest-growing divisions of IBM.

In the case of the Mayo Clinic, the use of outsourcing enabled it to execute a business strategy it would otherwise have been unable to pursue. Medical device manufacturers are using outsourcing for a variety of other reasons as well. Outsourcing also allows vendors to reduce time to market by quickly adding ‘virtual' staff—without being burdened with incremental employees once the project is complete. Many vendors also look to outsourcing for products or portions of projects that are outside their core competencies. Market requirements for new features, such as wireless enablement or systems integration, are frequently outside the core focus of medical device vendors. In addition, a common consideration toward the end of a product line's life is the cost of sustaining engineering, which includes both opportunity costs and budget dollars. Offshore outsourcing can reduce sustaining engineering costs, providing additional life to older products.

Outsourcing and IP

A key concern related to outsourcing centers on IP and the desire of medical device firms to keep such property proprietary. Many outsourcing firms, including IBM, can contribute their own IP to customer solutions. “What each company brings to the table is its own,” Prabhakar says. “But what develops from the collaboration is up for negotiation.”

Typically, clients negotiate for ownership of the collaborative IP, and IBM is allowed to license the IP for noncompetitive uses, according to Prabhakar. To protect a client's IP, outsourcing firms are organized in client silos so that engineers have little or no contact with peers who may be working on projects for a client's competitor. An outsourcing firm's engineers share processes and have equal access to the firm's own IP—but no access to other clients' projects or the collaborative IP that results from other engagements.

For many years, vertical integration and proprietary solutions have been the dominant business strategies for medical device vendors. But both vertical integration and proprietary product strategies are under tremendous pressure due to changing technology and market requirements. The concept of a ‘virtual' medical device company, embodied by Mayo Clinic, represents a unique example of the breakdown of such strategies. According to IBM's Prabhakar, other institutions similar to Mayo are expressing interest in following in the clinic's footsteps.

New strategic options are available to both established vendors and new entrants. Success with these new business strategies could significantly change the face of the medical device industry.

Tim Gee is the principal of Medical Connectivity Consulting (Beaverton, OR). For more information, visit www.medicalconnectivity.com.

© 2006 Canon Communications LLC

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