I know medical devices. And I had opinions about which device might be best for my daughter when her sports injury required a surgical pin. But the choice of pin had little to do with what I hoped and expeced for my child—to be able to play volleyball again, to dance, to live a normal life. And it had nothing to do with what really mattered for most of my daughter’s surgery - the months of physical therapy and lack of mobility. I was shut out of the decision process I was a consumer who was ignored – treated as though my opinions in a highly personal matter simply didn’t have any value.
Under the old healthcare model, there was nothing wrong with that experience. My daughter, as a patient, received quality care. The device performed as the doctor expected. My daughter did, and continues to do, just fine.
But that’s no longer good enough in today’s healthcare economy. Driven initially by changes in reimbursement policies under Medicare, and enshrined by the Affordable Care Act (ACA), the traditional money flows in healthcare have changed. It’s been said there’s a new healthcare motto, “No outcome, no income’.” Outcomes are becoming key to reimbursement and are increasingly measured on the basis of the experience and satisfaction of people who are no longer just patients, but also healthcare consumers. All of this is happening at the same time that payers and care providers are driving manufacturers to reduce costs.
Today, the value of a medical device is ultimately linked to patient satisfaction and no longer simply dependent on the successful sale into hospital inventory.
This situation has created a quandary for established medtech companies. Until now, their old, incremental improvement business model has been a good one. Healthy gross margins have meant that medtech shareholders and investors have enjoyed happy returns. They’ve built their expectations around the healthy cash flow growth that was thrown off by device makers’ historical ability to keep raising prices, linked to the addition of new features and slightly improved device models.
But the old order is changing, and fast. The new health economy is introducing new funding flows. Who pays for the device is quite different now; it creates multiple threats to the comfortable margins and business model that the device manufacturers have enjoyed.
It’s an axiom of business that fat margins attract competition. For medtech, competition itself was not a disruptive issue so long as everyone competed on the basis of the same incremental improvement business model. But today, the vast size of the market opportunity in devices and diagnostics, -estimated to approach $350 billion globally -, is attracting new entrants. Meanwhile, advances in technology, especially social, mobile, and wireless, are creating whole new categories of health-related products at price points that appeal directly to consumers. Reminiscent of comparisons between the computing power of today’s tablet devices and the computers onboard a space shuttle,the shrinking gap between the information value generated by a $150 exercise-monitoring wristband and a $5000 hospital room monitor is a caution flag for medtech. In our smartphone and Bluetooth-enabled age, the pace and magnitude of medtech innovation is being relentlessly driven toward the business models of the consumer electronics manufacturers.
At PwC, we’ve tracked 18 companies including five U.S. Fortune 100 companies and four Global Fortune 100 companies that have entered the medtech space – notably from telecommunications and consumer electronics. This groundswell is one sign of a market that has outrun its incremental innovation model. The door is opening to disruptive innovation.
The approaches these new entrants take toward innovation are mirrored in what Andrew Atwell, senior manager at the Samsung Open Innovation Center, told us for PwC’s recent Health Research Institute report, “We go to a health organization and say, ‘If you had a clean sheet of paper and you were going to design a device that was going to remotely manage a patient’s chronic illness from their home, what would that look like, what would you wish it would do, and what kind of features do you wish it had?’ They are caught off-guard and say they have never been given carte blanche to design that themselves.”
What’s a medtech company to do? Value is no longer simply in the device itself. How do you make an implantable device deliver a better customer experience when being FDA compliant isn’t enough anymore?
Simply put, the meaning of the word “innovation” has to change for medtech companies. It’s a different way of thinking about success. Medtech innovation has to become faster and reflect the kind of step-change innovation employed by disruptive innovators.
Doing Business in the New Healthcare Economy
Savvy device makers are shifting their approach toward innovation in the new economy. At PwC, we’ve codified this new mindset in three recommendations:
1. Be ambidextrous by creating an innovation operating model that separates breakthrough and radical innovation from the incremental innovation necessary to support the core business.
2. Collaborate to get closer to the patient by integrating into the broader patient experience, the larger health ecosystem, and new payment models.
3. Measure innovation in new ways by using forward-looking metrics and connecting the dots for shareholders, who need help understanding the changing role and nature of innovation.
The solution for medtech involves overcoming the traditional fear of failure. The established industrial company mindset that improved efficiency, won by wringing failure out of the manufacturing process, is the key to margin improvement. Instead, medtech innovators need to embrace the attitudes of lean startups and pursue fast, frequent, frugal failure as an innovation model. It’s a way of thinking that was summed up by new medtech entrant Qualcomm Life, whose senior director of business development Clint McClellan told PwC’s Health Research Institute, “I think innovation is when you find something that is disruptive—ten times the value or the efficiency at one-tenth of the cost…to me, that’s innovation.”
The paradox is that medtech needs to create a whole new value proposition, while at the same time continuing to meet high shareholder expectations. The good news is that the industry as a whole is aware of this growing need. While 64% of executives surveyed by PwC’s Health Research Institute (HRI) view innovation as a competitive necessity today, 81% believe it will be in five years.
If this sounds like a call for a completely different way of developing new products and services, it is. But practicality needs to prevail as well. Simply put, companies need to keep flying the plane while they build the new engine. They can’t afford to shut off or disrupt the revenue streams generated by the current business. And many believe they can’t risk upending their enterprise by forcing a culture shift through the entire organization at once. One proven technique is to ring-fence a new operating model to let it mature before integrating that model into the rest of the business, to implement innovation incubators inside a mature organization.
Such solutions have been adopted by several companies finding their way forward in this brave new world. Medtronic took the incubator approach at its European operations after concluding that meeting customer needs and adding value to hospitals and patients involved a greater focus on innovation and a higher tolerance for risk and failure. The company realized it needed to expand its role in the care continuum by integrating information and services for diagnosis, treatment, and disease management. Medtronic studied how it could improve the efficiency of technology delivered at the point of care, and it established a new business unit called Hospital Solutions. Soon the unit launched the catheterization laboratory (cath lab) management program in which Medtronic and hospital systems build in risk sharing for efficiency, savings—guaranteed and underwritten—and clinical outcomes. The contract for the partnership outlines benefits and cost savings for both parties, and hospitals pay per procedure. “Our Hospital Solutions group is clearly a business model innovation incubator that is now growing to become a business unit delivering these services,” said Rob ten Hoedt, senior vice president and president, Europe, the Middle East, Africa, and Canada.
The innovation challenge for the medtech industry is to convert the one-off successes of a handful of players like Medtronic into a new industry business model. The industry needs to embrace the healthcare customer and deliver on patient expectations while also rewarding shareholders.
It won’t be easy, especially for established players. But as I look back at my daughter’s surgery, I see my family’s experience as a cautionary tale of how the healthcare industry, including device makers, needs to adapt to a new health consumer and an outcomes-focused economic reality.
Ed Yu is principal of PricewaterhouseCooper’s Health Industries Innovation & Growth.
Interested in learning more about trends in medical device development? BIOMEDevice San Jose will be hosting seminars on designing with a focus on quality control, safety, and effectiveness, Dec. 4-5, 2013.