The MX Q&A: Clyde Pratt, Kinamed

Kinamed’s first overseas sales venture taught Clyde Pratt the importance of offering distinctive merchandise. During that mid-90s foray to Japan, the company’s neurosurgical products faced tough regulatory scrutiny in a device business then rife with consolidation, and Pratt learned an important lesson about its product line, the CEO says.

That focus on “specialty products with their own particular reason for being,” as Pratt puts it, has proved profitable for Kinamed over the ensuing years, according to the executive. The approach attracted an enthusiastic Japanese distribution network, an essential element that has fueled the small company’s successful run in not only Japan but also in China and other foreign markets. Overseas sales account for nearly half of Kinamed’s business, and in 2010 MDDI selected Kinamed as one of its Top 50 companies to watch.

Established in 1987 and based in Camarillo, CA, Kinamed operates partly in a $30-billion orthopedic space that one market research firm says is growing at an annual compound rate of 5% to 7%. Kinamed manufactures instruments and implants for orthopedic and neurosurgery applications. The product line includes the CarboJet CO2 lavage system, the SuperCable IsoElastic Cerclage system, and the KineMatch patello-femoral joint replacement device.

“I think we’re finding that around the world there is a place for premium product that really is demonstrably better than what exists,” says Pratt. One important factor in Kinamed’s success abroad is that the distribution network buys the inventory, giving the company the “critical mass” and order volume necessary to keep its product line fresh while enabling the company to control costs. The set-up gives the company the time it needs to develop and sell the product, he says.

Pratt began his medical device career as a quality assurance specialist. He received a bachelor’s degree in political science from UCLA in 1974 and J.D. in 1978 from Loyola University School of Law in Los Angeles. Pratt is the former director of western operations, reconstructive products manufacturing manager, for Richards Medical, now Smith and Nephew, and the founder, president, and CEO of Techmedica, which developed custom implants for the orthopedic market. He bought Kinamed from Kyocera in November 1993 to become the owner, CEO, and chairman of the privately held company.

As Pratt tells MX, the right product mix, regulatory expertise, and developmental time are all required to have a shot at foreign success. The CEO also discusses the effect of the 2011 Japanese tsunami on the company, his serious misgivings about the new U.S. patent law, his product development philosophy, and what role, if any, medical tourism plays in Kinamed’s overseas business.

MX: Kinamed has had double-digit growth for three consecutive years during a recession. How were you able to accomplish that?

Clyde Pratt: I think the basis for it is product selection and development, coupled with the ability to get that product out into the world. At this juncture our [outside]-USA sales typically are running in the mid-40% [range], and that’s spread pretty evenly around the world, maybe with a bit of a focus in Asia. That would be Japan, China, and now India has come in for us, but also Europe and South America and Australia and some of the other markets.

Is that business strategy allowing Kinamed to grow at the same rate?

Yes, actually both our USA sales and our O-USA sales seem to be growing at about equivalent rates. [There are] some local market anomalies. Last year our neurosurgery product line actually did not grow, and that was due primarily to the tsunami in Japan, which really impacted our Japanese sales. Fortunately for us, the rest of the world sort of picked it up, so we came in at about an even rate.

Can you be more specific when you say double-digit growth?

We did not this year, but typically we have been running right in the mid-teens.

And what happened last year?

Our neuro segment, because of our loss in Japanese sales, was even. It was a zero growth rate. The orthopedic side of the business was right at about 10%.

You bought the company, correct?

I bought the company at the end of 1993 from Kyocera Corporation. Originally, Kinamed started as a total hip company offering ceramics, which was the reason for a Kyocera trying to enter the U.S. market. They spent a lot of money on it then decided it was really not fitting in with what they wanted to see here.

What did you pay for the company?

Not much. We’re privately held, John, but…actually to the credit of the management of Kyocera their primary concern was to find someone or a group that would take care of their patients. Because they had literally thousands of hip replacements in this market, they wanted to be sure that the company would be managed so that those patients could be taken care of when revision components were needed and that kind of thing.

Was that written into the purchase agreement?

No, actually it wasn’t. We negotiated it. As I said, that was their primary motivation. In fact, I know it was. Because they had developed the hip line, the strategics all took a look at the company and really weren’t very interested. By the time we arrived on the scene, let’s just say the focus of their search for a buyer had narrowed considerably.

What are some of the biggest changes you’ve seen in your industry segment since you bought the company?

With regard to the U.S. market, if you look back—and we really started operations in ’94—the first portion of that period and the intervening time was one of a really high level of consolidation. That affected us because it affected the distribution channel. Rather dramatically.

That was the first thing. Then the second element was the onset of contracting by the strategics with hospital groups, where they bundled [services] and really were quite effective in making it difficult for companies that were offering product into the reconstructive space in particular. Finally, [there was] the arrival of large-scale consulting agreements and arrangements. All of that resulted in a competitive environment that reduced the virtues of product features and made it very difficult for smaller companies to operate.

That was pretty much on the U.S. side. With regard to the rest of the world, the biggest change we’ve seen has been more recent, and that is what I’ll term “regulatory fever.” If you look at Japan, for example, it has a very rigid product-approval structure in place, and it’s very, very difficult to get product approved there.

More difficult than in the U.S.?

In my view, much more difficult. And China has put in place a very comprehensive [regulatory] framework; Brazil is pursuing that. We’re seeing that really around the world. Each country seems to see the virtues in creating a regulatory environment both for their citizens in a public health sense and I suspect from a trade sense also.

I just read a report this morning about the French breast implant company that was using industrial grade silicone. They’re out of business, as you know, and FDA didn’t approve the product for the U.S. I’ve spoken with chief executives at other companies who tell me the FDA approval process is pretty rigorous. Some people put that opinion more forcefully, but in this case obviously FDA did the right thing.

Yeah, I think it does illustrate the dangers that are out there in terms of people getting product out, and we don’t know the details; obviously it was a CE-marked product. I don’t know whether they sought regulatory approval here in the States or not.

According to news reports, FDA did not approve the French implants and had warned the company.

Well, then they did, and FDA caught one, which is wonderful.

I point this out because the regulatory discussion here in the U.S. often revolves around the notion that “FDA’s too hard on us.” That sort of thinking.

Interestingly, John, I started my career—and I’ll date myself here—before the advent of the Medical Device Amendments in 1976, and I was working for Richards Medical right when I got out of college and saw the pre-amendment reality, and it was a very, very vibrant time in the U.S. for joint reconstruction. In hindsight some very dumb things were done, but mind you, some brilliant things were done, too.

I think if you look at our industry going back to the ‘70s and look at the impact of FDA, overall FDA was wonderful for the U.S. medical device industry. The regulatory structure forced companies to do what they probably should have been doing if they weren’t, and because of that inspections became better and also were perceived as being better by the rest of the world. It gave us a tremendous advantage there.

But as in all things, moderation is a virtue. The first 30 years of the device bureau were characterized by what I think—although there were missteps obviously—a very pragmatic and balanced view. Having said all that, if the agency decides that devices are the same thing as pharmaceuticals then you will see the industry abandon the United States as a development platform and clearly will go to other parts of the world.

Of your products, which one brings in the most business?

Right now, our largest segment is in our cable and grips business, so that’s our orthopedic side. And as you may be aware, we have a unique polymer cable that replaces metal cable. That’s our fastest growing product, and it happily has met with universal acceptance.

Of that product line or just generally speaking, what percentage of your business comes from foreign sales?

Generally, in orthopedics it is probably—I’ve not looked at all the segments together, frankly—but I would say about 40%. The uptake in the cable [sales] O-USA in the first years was actually faster than in the U.S.

Why was that?

I think it was easier to introduce [because] the product channel was more effective.

Have you ever heard the term “medical tourism”?

Yes, of course.

Do you think that might have any positive effect on Kinamed’s foreign success?

You know, I don’t think so. It’s an interesting question. When I first looked at that I had to really sit back and think. And at this point the answer is “no.” I don’t think that’s had an impact—as yet. I think we’re finding that around the world there is a place for premium product that really is demonstrably better than what exists. The market percentage varies tremendously. But nonetheless, we have the ability to access it, and from my perspective that’s what’s important.

What can other device companies—selling orthopedic products or otherwise—learn from your success in foreign markets?

First of all, the take-home is the strategy that works. Again, from a smaller-company perspective having a mixture of agency and distribution channel is very nice, particularly when you’re rolling out new product, because a distributor, of course, buys the instruments; they buy the implant inventory. If you have a network around the world that gives you critical mass and your order volumes as you’re moving out a new product line can be large enough so that your cost of goods can be controlled, that’s a huge benefit.

Really, the ability to access those markets is there if you have a combination of the right products. You, of course, have to develop the regulatory expertise, and finally you have to have the time to do it. This is not something that can be achieved in six months. We’ve just finally received a product approval in Japan we’ve been working on for over five years.

Which one is it?

It’s our CO2Lavage system It’s not an implant, but for whatever reasons it just took a great deal of time. And if we were a younger company and did not have the variety of different product offerings and were depending upon that it would have been a sad story.

Did you yourself go overseas to pitch business?

I did early on. Now we have just an absolute stellar fellow in place here, who’s been with us most of this time, Bob Bruce. He’s our VP of marketing and sales, and he now handles that, of course, with marketing and sales support here. He’s a busy man.

Do you remember your first overseas contract?

Yeah, actually for Kinamed the first venture was into Japan and that was with our neurosurgery product line. As is often the case we had access to a distribution group that knew of us personally and were very enthusiastic about our product line and picked it up. That was really our first effort [outside] the USA and in those days—because we’re talking about over a decade ago—Japan was terribly difficult in terms of the regulatory side of things. Interestingly, John, because of the consolidation we decided very early on that we had to have, basically, specialty products with their own particular reason for being.

We also at one point due to a huge perturbation of our agency structure in the U.S. went into the supplier side of the business. We were manufacturing product for a collagen corporation and at smaller levels for many of the names that you know today. They all required European approval, so years ago we decided to go out and get ISO registered and inspected. That set the stage for going into Europe with our own products. To us it was a pretty natural step forward. On a personal level my background all those years ago started in quality assurance, and so I’m an absolute believer in quality in terms of complying with your regulatory responsibilities, but that’s a small part of it actually. In the world we live in your products absolutely have to be as good as they can be.

Well, aside from the ethical aspect, businesswise you’d obviously want that to be the case.

Right, well [that’s true] in all respects.

Were any products inspired by your overseas experience? Any medical contacts who gave you an idea for a new product?

A good question. In all honesty I must say most of our product focus and product development have emanated from this market. We’re quite close with a fair number of physicians in an informal way. I’ve gotten many friends out there and whenever we get the chance to yak, we do. So I’ve got an informal sounding board that I can run new product ideas past.

We’ve developed some, we’ve licensed some. Really for me, the criteria are that it needs to be a product that can’t be absolutely revolutionary because we’re a small company, and it’s not a good idea to stage a revolution as a small entity. We need incremental but substantially improved products in our view. We’re very much not a widget manufacturer that makes a little tweak to something. We need a distinctive product with very good intellectual property protection.

Right, you’re not just stamping things out. By the way, does Kinamed manufacture its own products?

It depends, actually. Harkening back to our earlier conversation, one of the big changes in the ensuing years is the development of a very sophisticated supplier base. It just didn’t exist 20 years ago, not in the format that you see today. So we do all our patient-matched device manufacturing in-house. The cable product line is also manufactured in-house. The other product, we outsource the machining.

How important are materials costs?

In our case it’s not terribly significant.

Okay. The price of oil doesn’t cause you to lose sleep, for instance?

No, no, as a percentage of our costs of goods and retail, it’s quite small.

Speaking of percentages, as a percentage of revenue how much does a small company like Kinamed spend on R&D?

Historically, we’ve spent a lot, and typically it runs about 8% to 10% of revenue.

Would you say that’s typical for a company of your size then?

I don’t know. My suspicion is it may be a little higher than some, but that’s what we feel comfortable with. There’s no shortage of good ideas, John. (Laughs.) We’re always working on looking for that next product or technology. We have to winnow through things carefully.

How long is the typical product development process, would you say?

I don’t know if you could say “typical,” honestly. From our perspective if you look at our patello-femoral device, for example, which is both a custom-fitted implant and marking template guide, the genesis for that product line goes back to literally the days when I was running the recon manufacturing for Richards. And when I met [orthopedic surgeon] Marty Blazina he introduced the first off-the-shelf system in the U.S., and I got to know Marty pretty well. So when I started my first company he was having problems with his off-the-shelf device, and we started making customs for him.

Then we learned a lot through the Techmedica experience, and ultimately brought the next iteration to Kinamed. That product development cycle—which is ongoing, I might add—has its roots 40 years ago almost. That’s a little long. But our cable product now, if you look at the very beginning when it was the gleam in the designer’s eye, that effort is over 10 years [long]. I think that’s typical.

How many employees do you have?

We’re just under 30.

Kinamed’s a small, privately held firm. As far as being privately held or publicly traded, what are the advantages and disadvantages of each?

The advantage for a public company, if it’s large enough, is access to capital. I think that’s the rational for it. And very cheap capital. For a smaller company, however, the overhead associated, at least with being a public entity here in the United States, is very high.

There are huge disadvantages. First of all, small companies often end up as public entities, but with no liquidity, and that’s a very bad place to be. You’ve got public stock, but there’s no market in it, and on top of that you’ve got a tremendous overhead to pay in order to comply with the securities regulations. And unlike Europe, in the U.S. we’ve never really evolved a way for small companies to have a public presence in a way that’s just not terribly punitive. Finally, if you’re a public entity and if you actually do have coverage then, of course, there’s tremendous focus on predictability and quarterly progress. In a lot of cases that focus is premature for a small company, and it’s damaging, I think.

Let’s talk about patents for a second. Your name’s on several; one in particular is the ACL arthroscopy device.

Actually, at this juncture I’m a named inventor on 25 patents in the U.S.

So, what’s your take on the America Invents Act?

I think it’s negative. Right now, the old way, which will lapse in due course here as first-to invent in the U.S. versus first-to-file, [in] the American system an inventor can retain rights by virtue of the fact that he actually was the person who invented something. First-to-file, I think, favors large companies, because they have the resources. It’s an expensive process. The earlier you file, the more likely it is that you’re going to have to redo the process because what you end up with is different from what you started with.

I think it inherently favors large companies, and I think that’s unfortunate, particularly for the medical device field because so much of the innovation that occurs here happens with small companies. The classic scenario is: Small company develops a product or a technology and opens up a new marketing niche, and people get together and they risk a lot of money and a big chunk of their lives. If they’re successful, the large company buys them and then delivers this new thing to the world. One of the reasons that that models works and has worked so well is that the small company can actually secure protection… instead of stealing it. I guess imitation’s the sincerest form of flattery, but that’s small solace to somebody who’s just spent 10 years of his life developing something.

How are you guys going to deal with your IP as the law goes into effect?

I think we are going to have to step up our program and spend more money on it. Our patent counsel will approve. [Laughs.] I think that’s the reality, and fortunately now we’re in a position we can do that. The earlier on you are [in product development] with a company, the more delicate the whole process. If we want innovation and we want this segment of our economy to continue to bloom, we have to recognize that innovation is a delicate, hard process that often results in failure. This is just one more way, I think, that we perhaps unknowingly have gone out and may be damaging that process. At least with regard to our industry.

I wanted to go back to the top of our conversation regarding Kinamed’s success in foreign markets. Could you highlight some of the specific aspects of distribution and regulatory schemes, say, in each of your overseas markets?

Let’s start with Japan. As I said, Japan now has a very rigorous regulatory framework. From the standpoint of achieving product approval, it’s quite a challenge there. However, once you’ve introduced a product there that stasis then begins to work in your favor, because, of course, it’s a challenge for a competitor to move in also. Their distribution model is different from ours. They have local distributors. Often, regional distributors that may exist for a single hospital, for example, handle everyone’s product. All the competitors go through this one delivery chute. Interestingly, I think that structure allows companies like ours with singular products to really achieve some success there. That’s a benefit.

The Japanese tend to be pretty conservative, so if something works well for them they tend to be perhaps a little bit more brand loyal than our market here, for example. Japan is a very wealthy market, and margins or returns are good.

In great contrast, China has a bifurcated market. You do have a regulatory apparatus that’s becoming increasingly sophisticated. There is a local market and a market for Western goods. That again harkens back to the respect for the quality programs that exist here and in Europe. There is definitely a portion of that market, which is small but significant, where there’s a thirst for the highest quality product that can be obtained.

What about India?

India’s a bit of a mixed bag; I don’t know how we’ll end up there.

You’re fairly new to India, aren’t you?

Yes, we’re fairly new there. We’ve been selling into India for about three years now, and we’ll see. It’s actually a more tumultuous market compared with China. You have, of course, an English tradition there in terms of the orthopedic community and the surgeon community. So you have high levels [of care] institutionally in some places, mixed with very low levels. It sort of runs the gamut. We’ll see.

You said Kinamed is also selling in South America. Can you touch broadly on your experience there?

We are. We have found that also to be a nice market for us, using country distributors. Of course, Brazil and Colombia and Argentina are in the news now because those economies are growing rapidly, and they’re quite vibrant. The medical segment is the same way. There are problems there.

Regulatory?

It really depends on which country you’re in. As I said, Brazil is very intent on imposing a regulatory framework there, and there might be a variety of different reasons for that. In any case from our standpoint it’s just another obstacle that needs to be overcome. But, again, you have a thriving market that’s growing rapidly, and increasingly it’s a sophisticated market, so we’re happy to be there.