BUSINESS PLANNING & TECHNOLOGY DEVELOPMENT
In 2007, a number of market trends influenced the business and market planning of medical device manufacturerssome in positive ways, others not so much.
The cardiology sector, for instance, continued to be hit by concerns over the safety and efficacy of its devices, limiting growth in both the heart rhythm management and interventional cardiology segments. Meanwhile, most of the large companies in the orthopedics sector found themselves paying hefty fines to the U.S. Department of Justice over their physician marketing practices. And the in vitro diagnostics sector underwent significant mergers and acquisitions, changing the ownership of the field and bringing renewed vitality and revenue growth.
Illustration by COMSTOCK IMAGES
The performance of regional markets also varied. The mature markets of the United States, Europe, and Japan continued to undergo the pressure of cost constraints from both governmental and other third-party payers. Meanwhile, newly emerging markets in Asia and Latin Americanincluding India, China, and Brazilbegan to show new power.
MX recently called on a panel of industry experts to get their views about how current and future trends are likely to affect the medical technology marketplace (see sidebar). In the following roundtable discussion, moderated by MX editor in chief Steve Halasey, panelists consider the causes of the slowdown in cardiology markets, increasing emphasis on clinical diagnostics, and the effects of the current funding environment.
Hindsight and Foresight
MX: During 2007, what unanticipated market challenges affected the medtech sectors and companies you follow most closely? What kinds of effects will these challenges continue to have in 2008?
Nadim M. Daher: Despite devoted last-chance efforts, the Deficit Reduction Act of 2005 (DRA), including its sections aimed at containing spending on the provision of imaging procedures, went into effect on January 1, 2007. Some of the post-DRA effects were unanticipated, as outpatient providers went on revising their projections or seeking strategic alternatives, as if facing the survival of the fittest. This feeling of uncertainty froze spending on imaging technology in a market that normally accounts for 2025% of opportunities.
Shara Rosen: In the IVD sector, it was anticipated that FDA would continue to allow new molecular and genetic tests to come to market as test services. But this is a case in which government agencies are serving the squeaky wheel.
As more and more companies began to take the test-services route to market, both FDA and the Centers for Medicare and Medicaid Services (CMS) took notice. Now, there is a very distinct possibility that test services and in-lab developed tests will be regulated by FDA.
James X. Laskaris: There are multiple unlike technologies that will compete against each other. One example would be blood tests versus imaging technologies for cancer screening and diagnosis. Companies will no longer necessarily be competing against like competitors, such as imaging companies against imaging companies.
Patients are also more informed and have a greater say in how their dollars are being spent. Because of this, companies will have to market their products to a broader base.
John Viscogliosi: In many ways, the most significant unanticipated change at the large orthopedic and spine companies is the recent change in leadership at virtually all of the major competitors. These executives are in the process of putting their own stamp on the companies they are now leading, which should result in different initiatives and strategies versus those of the previous management.
Roger Zickfeld: One unanticipated challenge we've seen is the effect on home oxygen therapy revenues from the new CMS policies and reimbursement schedules introduced in 2007. Lower reimbursement rates and a protracted competitive bidding process have made it difficult for companies to forecast revenues effectively.
Venkat Rajan: One of the biggest issues causing a buzz was the release of information surrounding the Clinical Outcomes Utilizing Revascularization and Aggressive Drug Evaluation (COURAGE) trial. The study itself was not groundbreaking, and concluded that, when added on top of an optimal drug program, percutaneous coronary intervention (PCI) reduces neither mortality nor heart attack in patients with chronic stable angina.
However, when compounded upon other studies in Europe questioning the cost-efficiency and safety of drug-eluting stents with respect to thrombosis, it had a disastrous effect on one of the largest markets in the medical device industry.
Moving forward in 2008 and beyond, safety and efficacy issues such as these can only be answered by providing solid clinical evidence to counter current market preconceptions. Within the next 10 months, all of the major industry participants are expected to launch a new or second-generation version of their stent in the United States.
The industry may never enjoy growth rates like it did between 2003 and 2005. But over time, as clinicians get a clearer understanding of the trial results and the value of PCI, the market is expected to stabilize.
Richard S. Cohen: The entire area of invasive implantables is under the microscope now. This includes both defibrillators and stents, which are a huge part of the cardiovascular and general medical device market.
Boston Scientific recently reported that it will be laying off 2300 employees and trying to reduce expenses next year by half a billion dollars. This was mostly due to problems related to its acquisition of Guidant, but also defibrillator and lead wire recalls and the challenges related to implanting devices in patients generally.
Drug-eluting stents were introduced to the market with great promise. Initially Boston Scientific leapfrogged over Johnson & Johnson to capture the market lead. But on closer inspection and with data from additional clinical trials, there seem to be some side effects such as stroke risk that have caused interventional surgeons to think twice about recommending these devices in certain patients.
Bill Martineau: Companies must be able to respond quickly to negative publicity challenging product efficacy. A slightly elevated risk of causing life-threatening complications in off-label indications led to a $1 billion decline in the demand for drug-eluting stents between mid-2006 and mid-2007.
The results of the highly controversial Clinical Outcomes Utilizing Revascularization and Aggressive Drug Evaluation (COURAGE) study adversely affected the market for angioplasty products and services by concluding that aggressive drug regimens were just as effective in preventing myocardial infarction in stable heart patients as angioplasty procedures. This conclusion was made in spite of the fact that most of the study was implemented prior to the availability of drug-eluting stents.
In 2008, the key challenge for producers of implants and other advanced medical devices will remain in quickly resolving product defects (such as the recent implantable cardioverter-defibrillator lead-fracture problem), and preventing sales erosion resulting from market overreaction to adverse product publicity.
Thomas J. Gunderson: On the regulatory front, I believe the requirements of postapproval clinical trials and data monitoring will increase. For big companies this is just another layer of bureaucracy to deal with. But for smaller companies, the cost, the delay or reduction in profits, and the need to reallocate scarce resources results in a financial burden that dilutes their efforts to develop new technologies and products.
On the reimbursement front, I am seeing a greater focus on the mortality benefit of a particular product. The best example is the result of the COURAGE trial, which showed that medical therapy and angioplasty with stent usage had no statistical benefit in prolonging lifefor a subset of stable heart patients in a limited-time trial. In the six months since the COURAGE trial released its predictable results, the volume of patients being referred to cath labs has fallen 1012%. The media did not focus on the study's conclusions about chest pain. There was a statistically significant difference in freedom from angina during most of the trial's follow-up periodin favor of angioplasty.
Another example is the area of continuous glucose monitoring. Recent trials have shown even better than expected improvements in lowering the variability of blood glucose concentrations. Yet reimbursement is spotty, awaiting more-definitive trials on the actual clinical benefit. Such trials impose a delay on broader reimbursement coverage.
Some people believe that such efficacy studies have raised serious problems that are likely to keep the stent and ICD markets from growing for several years. Others say we're going to see a rebound next year. What is your view?
Cohen: I'm not a stock market analyst, so I don't have a point of view based on stock price. But it seems to me that these products were introduced into the market with deserved fanfare, and they are extremely beneficial. In their initial use, these products were probably deployed in a too widespread a manner. But the therapeutic value of drug-eluting stents, and implantable defibrillators, and pacemakers, is compelling in many cases. There's no doubt that these are essential, lifesaving technologies.
But as with any new technology, there's a maturity cycle that takes effect. So now some refinements and more critical decision-making is in order. Manufacturers will need to be a little bit more discerning with regard to quality control. And surgeons will need to be more discerning about the types of indications that warrant the use of such devices.
Venkat, you follow the cardiology field fairly specifically. What is your sense of the long-term damage that's been done and how long it will take for the market to recover?
Rajan: It was certainly unexpected for the COURAGE trial to come out against drug-eluting stents. The results pointed out that drug-eluting stents, or stents in general, have little impact on patients with stable forms of angina. But the results didn't devastate the drug-eluting stent market. Instead, what we're seeing is a readjustment and tempering of the high growth rates that were expected in some of these markets. The current trend is more a matter of refining how industry views the benefits of these devices.
When the markets for ICDs and drug-eluting stents started taking off, at the beginning of this decade, the companies' stock market analysts predicted that the market would grow 20% annually for the next 10 years. What we're seeing right now is that the market for both of these devices has reached a saturation point.
But there is no doubt that these devices have lifesaving capabilities. Percutaneous coronary intervention, a minimally invasive procedure, is still the favored approach over open-heart or bypass surgery, which are the alternative forms of clinical treatment for something short of an acute coronary event. And the same is true within the heart. There is no alternative to using an ICD or pacemaker.
So the lifesaving capabilities of these devices are still there. But we do expect to see more-tempered use among stable patients who might not necessarily need these therapies immediately.
Not too long ago, it was reported that the first baby boomer had applied for Medicare and Social Security. As that trend picks up, we're going to see much higher patient loads. And there will be continued emphasis on faster procedure times and quicker recovery, both of which favor PCI and similar implantable procedures. So there will be a stable base for these procedures and technologies. The market for them is not going to collapse, it's just not going to grow at the rates that some industry analysts previously predicted.
The real impact is going to be on new technologies. Clinicians accepted the initial assessments of drug-eluting stents as a great technology, and they really went gung-ho into prescribing their use. But now, many believe that they were in some sense duped, and that they are only now beginning to appreciate the true risks and benefits of these devices.
In the future, new products are likely to meet with a much more skeptical reception. Physicians are going to question what the appropriate niche for a new product is. And we'll see more of that sort of evaluation, instead of physicians just jumping in with both feet.
James, you follow exactly that area of emerging technologies. What do you think is going to be the effect of the cardiology slowdown on the emergence of next-generation technologies such as bioabsorbable stents?
Laskaris: One thing that helped to start the drug-coated stent boom was the excellent reimbursement rate the companies received. Considering that the reimbursement rate for the stent was twice as much as for alternative treatments, it was pretty obvious that hospitals would begin to use drug-eluting stents whenever possible.
Another factor that helped to build that market was the fact that patients are more informed about alternative therapies than in the past. One of the concerns expressed by leading-edge physicians was how to handle patients who specifically asked for a drug-eluting stent, even though it might not be effective for them, or they didn't qualify for one. In that no-win situation, some physicians might surrender to patient pressure in spite of their better medical judgment.
Drug-coated stents are not applicable to all patients, but they have had an excellent impact on reducing bypass surgery. A lot of our client facilities have said that their surgical markets have dropped considerably, almost parallel to the 30% restenosis rate.
There are definitely a lot of different new technologies coming up. Some are looking at ways of regrowing heart tissue and regenerating vascular systems. But those are still a way off.
Closer to realityand supported by funding from the Centers for Medicare and Medicaid Services (CMS) and the National Institutes of Health (NIH)is the approach of keeping coronary artery disease (CAD) from ever happening, or catching it in an early enough phase that statin drug therapy or a change of lifestyle can prevent its effects. That's why one of the primary focuses of current research is on new detection devices or technologies such as cardiac computed tomography (CT). Advanced screening or early-identification applications of positron emission tomography (PET) and single photon emission computed tomography (SPECT) technologies are also being developed to permit clinicians to see cardiac problems before they require intervention.
As a business model for the healthcare system, the preventive and early-detection approach makes much more sense in the long run than the alternative of trying to treat each case of CAD after there's already a problem. Because, even under Medicare, a bypass starts at $22,000.
Cohen: I've heard it said that interventional cardiologists often find it easier to prescribe stenting than to explain lifestyle changes and pharmaceutical therapies that can help reduce cardiovascular risk and maintain wellness, while avoiding surgery.
Wellness, prevention, and early diagnosis deserve greater emphasis. Creating institutional programs to encourage their use can help reduce federal budget expenses and ease the burdens on the healthcare system, which is currently geared to reacting to problems rather than preventing them.. Prevention is not only less expensive, it obviously creates many other benefits to the patient and society.
In this realm of unanticipated events during 2007, were any of you surprised by the M&A activity that's been taking place in the IVD sector?
Manfred Scholz: In diagnosticsincluding both imaging and in vitroone of the biggest surprises of 2007 was that GE Healthcare's announced acquisition of Abbott Diagnostics did not come to fruition. Among the many reasons, FDA trouble and rational valuations were the dominant issues.
Despite the failure of that GE acquisition attempt, the 12-month sum of M&A transactions reached a historic high of $30 billion when Siemens announced its intent to acquire Dade Behring for $7 billion. Now in vitro diagnostic leadership is down to Roche and Siemens. In 2008, the second tier will have to find a way to organize itself.
Similarly, the imaging leaders are GE Healthcare and Siemens, leaving little room for followers.
Cohen: This has been an active area. Siemens bought Bayer Diagnostics and now has a deal in the works to acquire Dade Behring. Roche is seeking to acquire Ventana Medical Systems for $3 billion. And a private equity firm, Madison Dearborn Partners, is acquiring VWR, a diagnostic products supplier.
The diagnostics area has been overshadowed by other sectors of the medical device industry for many years. But now, there is a major trend for diagnostics to identify healthcare problems at an earlier stage than we've been doing, to the point of predicting problems based on genetic markers and other predispositions. This area is called personalized medicine and is a new frontier.
In the future, diagnostics will be more in the forefront, as the federal dollar is better spent on wellness, and as genomic diagnostics make it possible to predict and prevent disease before it starts.
Rajan: Today's emphasis is on prevention, catching diseases before they become acute events. The cost of disability and having patients lying around in hospital beds is enormous compared with the cost of a simple diagnostic testeven if the new diagnostic test costs twice as much as some of the older ones. Recent studies about cervical cancer, for instance, indicate that the new tests for human papilloma virus (HPV) catches twice as many cases as the old form of Pap smears.
We also expect to see a lot more combination devices and integrated technologies, such as medical devices with onboard imaging, or medical devices with diagnostics onboard. As early as last year, for instance, Medtronic was developing an ICD with an in situ sensor for monitoring the fluid status of congestive heart failure patients. In the future, I think you'll see more and more combination systems that provide both diagnostic and therapeutic capabilities, and enable doctors to get faster diagnostic feedback.
Hospitals have traditionally viewed clinical laboratories as cost centers, with the result that there has always been a lot of pressure on labs to reduce their costs. Does this new emphasis on the use of diagnostics as the basis for providing better care represent an opportunity for hospitals to make diagnostics a profit center? How will payer systems respond to these trends?
Laskaris: Legislation to bring about a pay-for-performance approach to reimbursement is on its way, and hospitals have restructured themselves accordingly. Hospitals used to be structured according to functional areas: the surgery department, the radiology department, the clinical laboratory department. Now, hospitals are being restructured in line with areas of clinical specialization: oncology, cardiology, orthopedics.
As a result of this change, hospitals have begun to wrap diagnostics and therapeutics into a single business plan that incorporates a patient's entire cost of care. Thus, it also behooves the hospital to catch the patient's health problems earlier, so that their cost of treatment is cheaper in the end.
The codes for diagnostic-related groups (DRGs) are being restructured similarly, so that they are more specific to a particular disease. These changes will reduce hospitals' margin of error. Hospitals will get x amount of dollars to diagnose a patient's condition and perform the specified procedureand that's all they'll get.
So it will become increasingly important and attractive to use technologies such as ultrasound or optical coherence to diagnose what type of plaque a patient has, in order to determine what type of stent should be usedor whether any procedure should be performed at all. Increased use of diagnostics is going to be at least as important as the selection of a therapeutic device because it can decrease length of stay or keep a patient from being readmitted.
The Centers for Medicare and Medicaid Services recently announced that it would not pay for procedures required to correct preventable complicationsessentially those caused through hospital error or neglect. This policy trend would seem to support the development and use of more imaging and laboratory diagnostics than ever before.
Laskaris: Physicians are also under more pressure, because their reimbursement is getting lower. So for them to make ends meet, they have to diagnose and treat more patients, do it more quickly, and do it right the first time.
This is where there's an extreme opportunity for medical device and diagnostic companiesto commercialize leading-edge technologies that can produce positive results faster and with less expense over the long term. There are tons of opportunities out there for medical device companies.
Emerging medical device companies tend to go through cyclical patterns of funding, growth, maturation, and exit through IPO or acquisition. For the sectors and companies you follow, where do you expect the majority of company activities will be relative to this business cycle during the coming year? What business or technology factors (e.g., investor impatience, completion of clinical trials) will drive companies to take particular actions?
Laskaris: For the past several years, emerging medical device companies have had to compete for investment capital with the defense and homeland security industry. This has driven them to get their technology into the market for whatever intended use is easiest, just in order to start a cash flow. Once the technologies are in place, companies are pursuing additional approvals to widen their applications.
Martineau: Most companies in the medical device segment will focus on bringing improved versions of existing products to market and will streamline long-term efforts to advance medical technologies.
This trend will reflect both investor impatience and the shortcomings of existing products on the market. For example, the introduction of drug-eluting stents with thinner struts will resolve most of the recent safety controversy with the devices, and promote a gradual rebounding of sales and growth opportunities.
Gunderson: I am a believer that the lack of revenue growth at larger companies, and their need for large cash generation, will add up to an acceleration in the rate of medtech mergers and acquisitions over the next 1218 months. Companies with unique products or market caps over $1 billion will be the most likely acquisition candidatesas they have the best potential to bring about a near-term reversal in the revenue growth rates of the larger companies.
Rajan: The healthcare industry in general, and increasingly the medical device industry, is becoming a top-heavy market. Fewer and fewer start-up ventures have been able to take their products to market. As a result of the stringent regulatory process, most companies are never able to cross their technology over into full market clearance. Oftentimes they are forced to alter their focus or even their product in midstream in order to meet the changing clinical environment. This lengthy process, and the high level of losses incurred before any revenues can be generated, can lead to impatience on the side of investors, resulting in sale of the company or even simply shutting down.
The surest road to success is to develop technologies that address emerging markets where there are few commercialized products on the market, yet there is a high clinical need. Good examples of these types of companies on the cardiovascular side include firms like Abiomed, which is developing an artificial heart. That company is playing in a market with a significant clinical need, it has a revolutionary technology, and it is not directly pitted against any of the large market giants.
Rosen: The IVD industry is entering another cycle of intense consolidation. Large companies are in dire need of new tests and technologies. For the most part, such tests have been developed by smaller and start-up companies. But small and start-up companies rarely have the resources necessary to engage in the long-term cost-benefit studies that are needed to persuade payer groups to recognize their tests. The result of this situation will be an increase in the number of collaborations and acquisitions that will continue for at least the next 35 years.
Scholz: In the IVD sector, investors are relearning the lesson that medical devices are more about markets than technologies. During 2007, market-focused companies achieved the highest value in M&A transactions, and this is affecting early-stage investments.
Casey Crawford Lynch: There continues to be high levels of interest in venture investing for neurodevices. For example, CVRx closed the second-largest device financing in 2007, raising $65 million to develop an implantable neurostimulation treatment for hypertension.
In the past, major medical device makers have been quick to acquire innovative neurodevice companies. But Northstar Neuroscience has proven that the initial public offering (IPO) route can be a lucrative exit as well, and that the public markets have a high tolerance for development-stage neurodevice companies. I think we will be seeing more neurodevice IPOs in early 2008.
Viscogliosi: Within the orthopedic and spine markets of the overall medtech industry, we believe that it has recently become somewhat easier to go public versus selling out. Companies with novel technology and products that address niches with significant potential will always be able to choose between these two options.
We expect increased funding will be directed to firms in the orthopedics and spine markets that focus on unmet needs or conditions that are inadequately treated currently. Today's buyers are not opposed to paying large sums of capital for new technology, but are now requiring more long-term clinical results than in the past.
Cohen: Our firm has been very involved in the orthopedics area, and especially with several manufacturers of noninvasive orthopedic bracing products.
In this area, reimbursement policy is favoring more custom-fitted products than custom-manufactured products. Custom fitted products, which start with set sizes and then are fitted to patients with adjustments built-in to the device, are generally less expensive to make, have quicker delivery times and address a wider range of the population. The aging population and the need to address more and more people with orthopedic problems are also spurring an increase in the number of retail medical products available over the counter.
Together, these trends have resulted in the creation of new distribution channels. In the past, a patient in need of an orthosis or prosthesis would have had to visit a traditional orthotist or prosthetist to be fitted for that device.
But now, orthopedic surgeons don't want to give up that source of revenue. So instead of prescribing an orthosis or prosthesis and sending the patient to an outside source, surgeons are hiring their own in-house orthopedic technologists and taking inventory of corrective products. Those in-house employees conduct fittings of patients under instructions from the surgeon, and custom-fit the braces to help prevent the need for surgery or rehabilitate patients after they have been operated on.
Again, reimbursement coverage is tilting toward these kinds of products more now than in the past. And Wal-Mart and other retailers are offering more over-the-counter products that will be sold on a customer-pay basis. There are several orthopedic soft-goods manufacturers that offer products crossing over from pure medical, to quasi-medical, to retail.
Is there enough money in this area to support the ongoing growth of a medical device company, or are the companies in this area likely to be purchased by larger players later in their existence?
Cohen: It's inevitable that there will be a greater emphasis on reducing the cost of these noninterventional medical devices. Considering the potential target populations, not just here but around the world, not everybody can afford a custom brace or some other customized medical device. So there's great pressure and a trend toward reducing the cost of these products and making them more widespread.
But while margins may be going down, volumes are going up. A number of private transactions now in progress are addressing this trend, using both the traditional approach of prescribed medical products and the emerging approach of retail consumerism.
Venkat, what are the key funding and business growth trends in the cardiology realm?
Rajan: In general terms, the cardiology sector is becoming increasingly top heavy.
Five years ago the top leaders in the sector were fueling growth. Boston Scientific and J&J were experiencing tremendous growth, and J&J was even shifting resources away from its pharma units in order to take advantage of the tremendous growth potential on the device side.
And with the growth of the top guys, a lot of people were jumping into emerging companies, start-ups, and early-stage companies. Once a company like FoxHollow Technologies took off, investors actively sought out opportunities to invest in similar artherectomy companies. The same sort of trend resulted in significant investment in drug-eluting stent companies.
But as the cardiology markets have stagnated and started to decline, and as it has become more apparent where the ceiling is for these kinds of products, investment in these early-stage companies has become more tempered.
Many start-up device companies have to change their focus midstream, even before they are able to take a product to market. They start with an idea, and they get funding for it, but midstream they switch to something else because the market needs have changed. A company that started out to develop some sort of metal stent, for instance, now has to switch to bioabsorbable materials, because that's what the market will require six years from now.
To be successful, start-up medtech companies have to look at that long-termsix, seven, or eight years into the future. They have to anticipate what's going to be new and trendy then, and what's going to develop its own niche in the marketplace.
Among emerging companies, the strongest ones are those that are playing in markets where the big guys aren't a force, or in growing areas where the sophistication of the technology represents a barrier to entry by competitors. A good example would be companies like Abiomed, which is developing ventricular assist devices and doesn't have a lot of competition. The company just got approval for the use of its device as a bridge to heart transplant, so it's even stronger than before.
In the cardiology realm, the market for commercial or consumer-health products is limited, because most of the therapies involve interventional devices that are only used if pharmaceuticals failif the patient isn't responding to cholesterol-lowering or clot-busting drugs. When that happens, and the patient is at high risk of having a heart attack, that's when interventional therapy kicks in. So I don't see many opportunities for consumer-oriented products to take off in this area of therapeutic cardiology devices.
However, there may be more opportunities for consumer-oriented products in the diagnostic and imaging areas of cardiology. For instance, it is likely that more companies will release ICDs that incorporate remote home monitoring functions. Such systems can transmit patient data to the doctor automatically or on request, thereby minimizing the need for office visits, enabling the doctor to track the performance of the device regularly, and reducing healthcare costs.
In the near term, we can expect to see more consolidation among cardiology companies, and more of the big companies looking for the next big-growth sector. Candidates may include robotic assist devices and the peripheral vascular segment.
There has already been some consolidation in the cardiology sector, with Medtronic purchasing Thoratec, and ev3 merging with FoxHollow Technologies. Is that the sort of consolidation across the cardiology sector that you envision for the coming year?
Rajan: Yes. The current environment is more tempered than at other times. When Boston Scientific was growing, it was throwing its money around and buying companies left and right. Today's climate favors careful, strategic acquisition rather than just blind buying.
Medtronic's acquisition of Thoratec, for instance, gives the company a foothold in a market it wasn't necessarily playing in. And ev3's purchase of FoxHollow Technologies gives the company a new product segment and a new opportunity for growth.
Part of the reason for this more-tempered climate comes from recent experiences such as J&J's multibillion dollar acquisition of Conor Medsystems last year. That purchase was made in order to acquire Conor's CoStar stent. But within six months, clinical trials of the product indicated that it was inferior to the competition, represented by Boston Scientific's Taxus stent. As a result, J&J announced that it would not be pursuing launch of the CoStar device.
J&J probably expected that acquisition to bring in lots of money for the company. I'm sure it will get some technology that it can transfer to its Cypher stent and future product lines. But I don't know how happy J&J is with that acquisition.
Has J&J now dropped the CoStar stent entirely, or is the company still planning to try it with a different drug formulation, as it was once suggested?
Rajan: I don't know if J&J intends to incorporate some of the CoStar technologies into its next-generation devices. It is a possibility that the company would evaluate the benefits of using CoStar's drug-reservoir format, but I don't know how much of a benefit that would give to the drug.
In the world of drug-eluting stents, bioabsorbable technologies will probably be the next game-shifting technology. A bioabsorbable device co-owned by Boston Scientific and Abbott has just gone into human trials. And Boston Scientific has an investment in and option to purchase Reva Medical, which is also developing a bioabsorbable technology.
If a bioabsorbable technology can be made to work and proves to be clinically safe, it will address a lot of concerns that people have with current bare-metal and drug-eluting stent technologies.
How do these issues related to funding, growth, and business maturation affect emerging technologies?
Laskaris: Our research looks at how these technologies start to appear in the marketplace. Start-up medtech companies often can't afford to go after the large markets that they were initially looking at, so they sometimes end up rolling out their product in stages that enable them to bring in some sort of cash flow.
In the diagnostic arena, the biggest markets would have to be those for screeningscreening for cardiovascular disease, for cancer, and for other diseases with a high incidence rate. But to get FDA approval for a screening technology, a company may have to perform clinical trials involving as many as 15,000 or 20,000 subjects. By contrast, getting FDA approval for a diagnostic or adjunctive technology may require a clinical trial involving only 1000 or 2000 subjects. And, of course, there's a dollar amount associated with those trials, and a big cost difference between the two levels of approval.
As a result, many start-up companies wind up launching their products in stages. They start with approval for diagnostic or adjunctive indications, and later broaden the approval into use as a screening technology. It's a little less costly to do it that way. And as the companies bring in more money, they can afford to hit some of the big-target markets such as screening.
The thrust toward personalized medicine often implies small target populations. Do you see that as a problem for start-up companies that need extensive funding in order to develop products that will inevitably be suited for only a very small market?
Laskaris: For drug companies, use of the cytochrome p450 gene test, which can measure how a particular patient will metabolize certain types of drugs, is causing major excitement in that area. This technology enables physicians to identify appropriate candidates for drug therapies, and thereby to cut down on adverse drug reactions considerably.
But this could mean reduced sales for drug companies, as physicians may be prescribing less of certain drugs. And it may also mean reduced revenues for in vitro diagnostic companies and clinical laboratories, as patients may not need to be tested as often to establish a baseline or monitor their drug levels, as has been the case for certain blood thinning drugs.
In this respect, personalized medicine will enable us to cut down some of these costs in the future.
But correspondingly, companies will make less money.
Laskaris: Yes. Well, the revenue stream shifts in favor of the initial genetic testing and away from later tests. But overall, yes, it would be less money for certain manufacturers.
Richard, do you hear companies lamenting that they have a great therapy, but that it is only suited for a small number of patients each year?
Cohen: On the diagnostic side, target populations probably aren't as limited as they are on the therapeutic side. For instance, if a diagnostic product segments a target population into those at high risk for a particular ailment and those not, it's not necessarily reducing the market. It's just dividing the market according to those who need the specified therapy.
So on the diagnostic side, there are still large-volume opportunities to stratify populations in terms of who needs what. And that goes back to the benefits of identifying problems at an early stage and stressing wellness and prevention, which have undeservedly received less funding but in the long run will save more healthcare dollars and lives.
On the therapy side, however, I think personalized medicine will be more expensive, with much higher market costs and much lower volumes.
Landscaping in Progress
In several medtech sectors, the competitive landscape is changing because of new product launches or recent M&A activity. In the sectors you follow, what new competitive forces (or new competitors) are likely to affect the shape of the marketplace? How are existing companies in the market likely to respond?
Daher: Imaging information technology (IT) is rapidly moving into the enterprise. Makers of enterprise picture archiving and communications systems (PACS) have successfully conveyed the concept and goal of providing 'images and information, anytime, anywhere.'
This confluence of trends is illustrated by the recent wave of consolidation among radiology and cardiology PACS vendors; by the fact that IT vendors are diving further into storage management and healthcare information exchange (HIE); and by the new-found dynamics among vendors in the fields of PACS, radiology information systems (RIS), IT, advanced visualization, and electronic medical records. In the face of changing paradigms, these industries, or their individual participants, might convergebut they could also diverge.
Martineau: The entry of Siemens into the in vitro diagnostic segment and diversification of Abbott Vascular and Medtronic into drug-eluting stents will force existing competitors to focus increased efforts on developing technologically advanced products. Gaining competitive advantages in most medical supply and device segments will become increasingly dependent on developing differentiable products.
Laskaris: One recent trend for new technologies has been to focus on consumables. This strategy provides the vendor with an ongoing revenue stream.
Another strategy is to design technology to perform a procedure in less time. This will help providers to perform a procedure within the limits of capitated reimbursement, while also accounting for the additional costs of the product.
Existing companies will have to change their focus to be able to compete in such an evolving market place.
Rajan: Due to market consolidation, there is little profitability in launching me-too products in established markets. There are several rules of thumb for identifying the next hot market sector. Two of those rules are as follows.
First, find where big pharma has failed. That is, identify what disease states are inadequately being addressed by pharmaceutical treatments alone.
And second, avoid developing me-too products whenever possible. A company launching another metallic drug-eluting stent might essentially go unnoticed, while a firm developing a completely bioadsorbable stent would create significant buzz.
An emerging or established company looking to compete in the cardiovascular space might be better served by launching a game-shifting technology six years from now, rather than a me-too product three years from now.
Viscogliosi: Spine market share is concentrated among a limited number of competitors. This is even more true in the largest areas of the orthopedic market (hips and knees). However, numerous small companies have been funded over the past few years and have had an effect on growth rates.
Existing competitors have placed increased focus on developing new products, in-licensing new devices, and acquiring firms in fast-growing niches. It is logical to believe that the recent acceleration of M&A in the spine market will continue as companies move to build out their product lines and enter new, fast-growing niches within this sector.
Rajan: The largest companies in the industry, I think, are resigned to ignore specialized parts of the market. But for the rest, I think what you're going to see is companies going after more-advanced forms of therapy, including those related to personalized medicine.
For small and mid-sized companies, the real growth opportunities would seem to come through adopting the mission of developing customized devices for women or for pediatric use. We're already witnessing this trend in orthopedics and some other areas, in which companies are specializing in devices designed especially to fit female anatomies or otherwise address gender-based conditions.
For the future especially, industry is moving away from merely saving lives. Many of the opportunities now are more about quality of life, especially as the baby boomers get to the age at which they need orthopedic implants or cardiovascular devices. They've worked hard their whole lives, saving their money for retirement, and they want to be able to visit their grandkids. They want to go hiking. They want to go on that trip to Europe. And they want to be up and running within the week.
So the opportunities in this area are less about maintaining life than about restoring quality of life. In the future, there will certainly be more devices and forms of therapy designed around that goal.
I can't speak specifically about the disposable income available to baby boomers. But when these individuals are willing to spend thousand of dollars for a DLT television, it seems likely they will also be willing to pay out of pocket for products such as home-use diagnostics, healthcare telemonitoring systems, or advanced forms of therapy that are much better than what their insurance would pay for.
Also, there has been a rise in consumer-directed health plans, which give participants more control over how they spend their insurance dollars. In many cases, they are spending more money on these types of quality-of-life treatments.
Consumers have become used to thinking that insurance and third-party payers are responsible for paying the costs of their healthcare. But where do hospitals and healthcare professionals expect the money to come from? Do they expect that consumers will have the deep pockets necessary to stimulate the development and adoption of new therapies?
Laskaris: Patients today have more financial choice because of the rise of medical savings accounts and similar strategies.
That's a whole different structure, where the consumer has saved some tax-free funds specifically for healthcare purposes. That's probably one of the reasons that the number of some elective plastic surgeries has increased in recent years. Even when large dollar amounts are involved, there are quite a few patients who are willing to pay for such procedures.
Consumers are also willing to pay for certain diagnostic tests that can improve their lifestyle or reduce their healthcare costs down the road. I mentioned the cytochrome p450 gene test, which is one example. Another is testing for the genes that can indicate a woman's predisposition to developing breast cancer, or how she may react to a particular treatment. As more breakthrough genetic tests are developed, this kind of personal testing will probably increase.
Some such tests are out there already, and they definitely make matters easier on the patient. They are considerably cheaper than a $2000- $3000 home-use defibrillator, but they can have a tremendous impact on a patient's life.
Scholz: Personalized healthcare and companion diagnostics are in fashion. This fashion has reached the boardrooms' attention. For example, Roche has taken a leadership role through aggressive acquisitions, which have included BioVeris, 454 Life Sciences, and NimbleGen Systems, as well as a bid for Ventana Medical Systems. It will be interesting to see if Roche can resist overspending.
What other competitive forces or new companies are likely to shape the market in the foreseeable future?
Zickfeld: We've seen some continued consolidation in the healthcare services arena. The impact on incumbent companies is that they will increase their roll-up efforts. We should see continued M&A activity.
Cohen: I agree with Venkat's point about the need for new companies to specialize in a niche. Small companies have incredible needs related to getting their products to market.
A constant challenge for medtech companies, especially smaller ones, is distributiongetting their products accepted and sold. The gold standard is for a company to employ its own sales force rather than using distributors or independent manufacturer reps. For small companies, however, investing in and training an in-house sales force can be prohibitively expensive. Companies can incur significant overhead expenses and, if their product line is narrow, they may still be unable to pay a level of commissions that would properly motivate the sales force.
As a result, small medtech companies must often rely on sales and distribution agreements and other exclusive arrangements with larger companies. In these circumstances, it can be a challenge for the small companies to make sure that their large-company partners are, in fact, motivated to sell their products at levels that are beneficial. When setting up such agreements, it is important to establish goals, milestones, and reporting mechanisms to ensure that the required activities are performed.
One other important element of medtech's competitive landscape today is the continuing increase in the number of private equity firm transactions, as illustrated by the private-equity takeovers of Biomet and Bausch and Lomb earlier this year. The subprime mortgage mess has caused a structured-loan hiccup over the past couple of months, but private equity firms are still expanding their appetites for larger deals.
For most medtech companies, the IPO markets are difficult to access and the glare of public reporting can overshadow the benefits of being public. Consequently, when a small company considers an exit, its decision is largely between strategic players or private equity firms. Because of synergies, strategic players can often afford a higher valuation but will generally be more particular about matching up the target company with its own. Private equity firms are more optimistic, but generally pay less up front, offering up a second bite of the apple when the company is grown and sold again. Private equity firms with a willingness to tread into new-technology areas are also showing themselves to be more nimble, less bureaucratic, and more willing to pursue new directions that offer a high return.
Private equity firms seem poised to become new masters of the medtech universe. And, as suggested by this year's large deals, the sky's the limit for such transactions.
Angels and venture capital investors who focus on early-stage investments in this area tend to be fairly savvy and specialized, and they generally understand the medical technology area very well. Do you find that kind of expertise at most of the large private-equity firms?
Cohen: Private equity firms tend to be one of two types: those that are operationally minded, and those that look at a transaction on almost a spreadsheet basis.
Firms that are operationally minded typically have former medical device managers on their staff. These are people who have been in the trenches and understand the technology. They understand how to buy a house that may need a new bathroom or new kitchen. And there are now many such people who are active in the realm of financial sponsors, including venture capitalists.
Overall, I believe, firms that have more operational expertise, with proven managers on staff, will be more successful. They tend to be less stilted and able to navigate industrial sectors better than firms that base their transactions exclusively on a company's earnings before interest, taxes, depreciation, and amortization (EBITDA) or some other such formula.
Governmental authorities in the United States and elsewhere are already working hard to constrain increasing healthcare costs. What challenges do you foresee with regard to such government policies during 2008? How will the U.S. presidential elections affect this area of policy?
Daher: Annual reductions of 5% or more on reimbursement levels for imaging procedures, across the board, are scheduled for the next few years. While procedure volumes are expected to continue increasing exponentially, the providers of imaging services will have to face mounting pressures on profit margins. This could exacerbate the current price erosion on imaging equipment and further delay the introduction of new technologies.
Imaging will likely be a target in any upcoming healthcare policy reforms, as it constitutes one of the fastest-growing sources of healthcare expenditure in the United States.
Scholz: I am always surprised that government policies focus more on the money-in (taxation) and money-out (total cost) aspects of healthcare. A lot of waste exists in healthcare management processes, which are less affected by policy changes. Medical device companies lack control of those processes and are therefore better off focusing on clinical trials and reimbursement strategies. The only certainty is that there will be no relief from policy changes, as the fundamental ills remain to be addressed.
Viscogliosi: It is natural to expect that worldwide healthcare budgets will continue to be under increased pressure. We believe that there will be a greater focus on clinical trial outcomes and evidenced-based medicine. Additionally, payers (insurers and governments) may require that manufacturers show greater proof that a new device is better than existing products.
Zickfeld: The big question and determining factor on the impact of governmental policies will be the outcome of the 2008 election. Most candidates have stated healthcare reform to be a goal. The open question is how radical and how disruptive the prescription will be.
Laskaris: The government plays a major role in the healthcare system, paying more than 40% of every healthcare bill issued in the United States. But there are legislated limits to the amounts that government can pay, and recent reimbursement increases have been just slightly above the government's market basket increases. This limits the amount of capital available to providers.
Among the major factors affecting reimbursement expenditures are the limits imposed by the Gramm-Rudman-Hollings Act, which physicians have successfully lobbied to delay for many years. But within the next year, someone is going to have to decide what we will do about physician and hospital reimbursement. Almost certainly, Congress is going to have to step in. And how that will go, no one can tell at this time.
Another issue that has been much in the news recently is the State Children's Health Insurance Program (SCHIP). It is widely acknowledged that if a disease or condition is detected in its earliest stages, the patient can be treated much more efficiently and with less cost than if the condition were detected later. But if you let a child carry on with an ear infection for six months, then you're talking about some serious costs.
And there is the ongoing issue of the uninsured, whom we permit to use hospital emergency rooms as though they were doctor's offices. And that's not efficient either.
Government is going to have to address these issues quickly, before the limits of the Gramm-Rudman Act take effect. Whatever decision is made, it will affect all medtech companies and healthcare providers. And all of these issues could influence the upcoming U.S presidential elections.
Congress is usually very uncomfortable about taking on anything big like this during an election year. Do you see this being a major policy issue for the election, or is everybody going to try to avoid having to deal with it until after new leadership comes in?
Laskaris: Healthcare has always been the third rail, hasn't it? My hope is that Congress will do something. Otherwise, healthcare costs will soon be well past the $1.1 trillion we spend in United States annually at this time.
In the realm of emerging technologies, the question is 'How can we use technologies to bring these costs down?' And the answers are all in the minds and hands of universities, medtech start-ups, leading-edge technology companies, and organizations such as the National Institutes of Health, that are coming up with such fantastic ideas.
And what it all comes down to is simply this: 'Can we fund the development of these technologies, can we bring them into healthcare quickly, and can we ensure that they enable us to bring down healthcare costs?'
Rosen: I am far from an expert in U.S. politics, but I expect that not much will change, even if the Democrats gain control of the White House. It is easy to put forth grandiose plans when in opposition. But once in power, the former aspirers to power find a situation that is hard to turn around.
It will take more than legislation to control U.S. healthcare costs. Insured Americans are used to a certain level of service that will be hard to curtail. As for improving the lot of the uninsured or underinsured, in the short term this will take an injection of dollars that may see costs increase instead of decrease.
Rajan: Government is definitely shifting reimbursement policy more toward early detectionensuring that hospitals make the right diagnosis, and putting a lid on spiraling costs by reimbursing only for therapies that are necessary.
People have been talking about the baby boomer generation getting older for at least the past decade. But now it's finally here, baby boomers have started to retire. So it will be interesting to see how government agencies are able to manage the healthcare costs related to this aging generation.
And industry will need to keep an eye on the healthcare policies that are proposed during the campaigns for the 2008 presidential election. Those proposals will definitely have an impact on medtech companies.
Martineau: The dual government objectives of extending healthcare coverage to uninsured residents, while keeping healthcare spending under control, will increase the importance of developing products that improve patient outcomes and reduce the need for long-term chronic care. An increasingly price-sensitive marketplace will force medical supply and device producers to improve overall operating efficiencies in order to maintain favorable profitability.
Anticipated trends include the expansion of joint marketing and research collaborations among companies, the streamlining of manufacturing operations, and the adoption of more conservative approaches to product development.
Cohen: The government is still geared toward reimbursing for therapies and treatments rather than for prevention. This is partly because there is no strong lobbying effort in that realm, and maybe also because the benefits of preventive medicine are harder to identify.
But the private sector is picking up the slack to a certain extent. There is already a whole array of disease management and wellness programs that employers are paying foror even incentivizing their employees to participate in: smoking cessation programs, weight management programs, and diabetes management programs, to name just a few. These programs enable employers to reduce premiums, manage healthcare costs, and foster greater organizational stability.
A number of medical service companies provide employers with online health risk assessment programs. The employee completes a survey form and, depending upon the responses and the output of evidenced-based algorithms, the program provides for certain levels of coaching, advice, and health management activities. More-sophisticated programs track outcomes over long periods.
If government agencies could follow some of these leads in the areas of health maintenance and disease prevention on a broad nationwide scale, it might be possible to reduce our massive expenditures on the therapeutic side.
Do you think there is support to move that kind of reconsideration or rethinking of reimbursement policy forward on a national level in the next year, or is this something that's going to take quite a bit longer?
Cohen: In a recent State-of-the-Union address, President Bush mentioned electronic medical records as an area of national emphasis as a means of centralizing healthcare data and making it more accessible and efficient.
Considering that the nation's budget situation is headed toward a crisis situation in the near future, the advantages of wellness programs are becoming more identifiable every day. The challenge is how to fund them and encourage people to use them.
Unfortunately, as was the case with hurricane Katrina and New Orleans, most government policies operate by responding to crises rather than trying to prevent them before they happen.
In closing, what trends in the healthcare market would you suggest that medical device executives keep an eye on in the coming year?
Rajan: Industry is definitely changing, and there is a crisis looming. There's definitely a need for streamlining healthcaremaking it more efficient, emphasizing prevention, and using advanced diagnostics to catch diseases before high costs spiral out of control.
Disability has a high cost for the patient, from both an emotional and economic standpoint. And carrying a large population of bedridden patients has an equally high cost from the standpoint of medical economics. So it's certain that we will be seeing the development of more and more devices to enable people, making it possible for people to avoid or overcome disabling conditions.
Meanwhile, the healthcare industry is also becoming more globalized. Medical tourism is becoming a booming business, with more and more patients going abroad to take advantage of lower costs and forms of therapy not available in the United States. Some other countries may not have the same sorts of safety regulations, but as patients become desperate enough they may still turn to overseas facilities.
There's also a technology boom coming that will involve the integration of robotics with diagnostic imaging and therapeutic systems. Today's hospitals already have the infrastructure to support the transmission of huge electronic files such as CT or MRI scans to local computers almost anywhere in the world. This makes it possible to transfer files from one hospital to another where the patient needs to be. Down the lineperhaps 10 or 15 years from nowusing this capability offers a strong foundation for telesurgery.
But along the way, we're first going to have to deal with the fact that hospitals are now reporting shortages in nursing staff and having to rely on foreign-trained nurses. Hospitals will need to develop a strategy for handling this issue, whether it is by streamlining the ways that patients are diagnosed, greater use of robotic systems, creating alternative sites for the delivery of certain therapies, or something else.
When you consider all of these things, it's obvious that the healthcare industry is going to be vastly different 10 years from now.
Laskaris: How manufacturers present their technologies, and how hospitals go about buying those technologies, are both very important issues.
In the past, hospital purchasing has always been focused on the capital costs, which hospitals scrutinize very closely. But hospital purchases also involve operational aspects, where the costs of consumables, labor, servicing, and similar factors come into play. And hospitals are just beginning to look at their purchasing from this point of view.
Medical device manufacturers are also beginning to address this approach by developing both diagnostic and therapeutic products with an orientation toward consumables. The approach is similar to the way that the information technology industry was structured years ago, where companies permitted the use of their products in return for a licensing fee.
Now, buying a piece of medical technology is really a three-dimensional exercise. Companies are presenting their technologies as including the capital equipment component, the consumable component, and a service component.
This approach is a little bit more complicated for a hospital to get its hands around. But from the manufacturer's point of view, there is much more potential for ongoing revenue if they structure and present their products in this way.
Cohen: Key issues in the marketplace certainly include recent product recalls and clinical studies that have called into question some of the benefits originally touted for certain medical devices. And the same forces are acting on the pharmaceutical sector.
As a result, manufacturers in both sectors have begun to draw back a bit, making sure that their claims are as accurate as possible, and even reining in some of the promotional activities of their massive sales forces. Manufacturers are seeking to be more precise about the products they're offering, and to ensure that claims are in sync with what has been approved and observed in the market and in postmarket studies.
In the future, these trends are likely to force both manufacturers and healthcare providers to become more discriminating about the ways that medical technologies are promoted and deployed. That doesn't mean that providers will retreat from prescribing treatments that are needed by their patients. But I think they will become more discerning about potential safety and efficacy issues, and more aware of the experiential body of knowledge that develops when a product enters the market.
And, as we've said, the use of advanced diagnostics, coupled with health maintenance and disease prevention programs, will save money and lives over the long term. The challenges in this area will be to measure the outcome of diagnoses, to encourage companies and consumers to implement the necessary programs, and to motivate individuals to use the programs and change their lifestyles.