A confluence of critical issues in the medical device and technology markets is changing the way medical device vendors and global medtech firms do business, especially in building cost-effective strategies for innovation and R&D.

Those influences include the uncertain effects from the Patient Protection and Affordable Care act, greater global competition, shareholder anxiety, reduced reimbursement rates, and an overall tighter regulatory environment.

In such an environment, original development manufacturers (as opposed to contact manufacturer or outsourcers) can become valued vendor-partners with medtech firms, who might choose to offload R&D for critical, non-core technologies.

This strategy enables OEMs to focus more critically on and excel at their own core products and technologies, which include higher-value implantables and interventional therapy devices.
 

R&D Trends and the Threat of the Device Tax

There are considerable advantages in moving toward outsourcing for R&D. Among them is a more economical way to maintain innovation at acceptable cost levels for medical technology companies that once thought of their vendors as mere suppliers.

Public companies are finding this vendor-partner strategy to be necessary, given the current economics of the MedTech industry. Margins are decreasing from record-setting highs, while OEMs simultaneously try to reign in operational expenses by downsizing property and people even as they aggressively push to drive more sales and buoy shareholder expectations and returns.

A recent Accenture report, Achieving High Performance: Reinventing Medical Technology for a Dramatically Different Future, concludes that “after years of strong and steady growth, the medical technology industry is facing a wave of pressure that is forcing companies in the industry to reexamine the fundamentals of how they compete.”1 The report goes on to state that “while growing overall, [the industry] has experienced a dramatic slowdown in the rate of growth over the past several years. Accenture research shows a reduction of approximately 15 percent in annual growth about six years ago, to just 3.5 percent a year ago.”

The same report noted that “enterprise value dropped in 2010 to 17% below the prerecession peak of 2007 and, for the first time, future value for the industry became negative.”

Looming on the horizon is the excise tax threat of the new federal healthcare act, forcing OEMs to more closely scrutinize non-core research and design budgets. Under provisions of the Patient Protection And Affordable Care Act, beginning in 2013, manufacturers, producers and importers of medical devices will pay a 2.3 % excise tax on all sales of medical devices. According to PricewaterhouseCoopers analysis, “The tax, authorized by the 2010 Health Care and Education Reconciliation Act (P.L. 111-152), is estimated to cost the industry $20 billion over the next 10 years.”2
Given that daunting figure, one of the nation’s largest med-tech trade associations, Advanced Medical Technology Association (AdvaMed), reports in a study by researchers at the Manhattan Institute and Hudson Institute and commissioned by AdvaMed that “Innovation could be stifled, as the new tax must be paid by companies regardless of net income.”3

The report says the pending 2013 excise tax on industry revenue of $20 billion will help pay for the new healthcare legislation. But the law’s effects could undermine the industry, resulting in significant job loss and innovation and increase medical device costs for healthcare, among other effects. AdvaMed makes the following arguments:

The new 2.3% excise tax will roughly double the device industry’s total tax bill and raise the average effective corporate income tax rate to one of the highest effective tax rates faced by any industry in the world. Moreover, the new tax will be paid both by firms that have net income and those that do not. The tax will be especially harmful to companies that innovate and tend to suffer losses in the first years or when investing in research and development for a new product.

Under the tax, U.S. manufacturers will be more likely to close plants in the United States and replace them with plants in foreign countries. Foreign manufacturers will improve their competitiveness relative to American firms, and U.S. leadership in this industry could be threatened.

The Joint Tax Committee estimates that the tax will raise $20 billion in revenues between 2013 and 2019, a cost to device companies and consumers. According to AdvaMed, the economic impact of the tax on wages and output will be significantly higher.4
 

Ripple effects from the health tax are already being seen in the world of venture capital, where risk-averse investors have stepped away from start-ups where such innovation is often found. Young companies are perceived as too costly and too risky in the current climate. Or, as the Accenture report indicates that, “Concerns over regulatory reform and future returns on innovation are already having a dampening effect on venture capital funds directed at small innovative start-ups.”
 

However, the decreased venture capitol interest has actually made such start-ups attractive to the development manufacturers as either viable sub-contractor-partners, or acquisition targets. Through such partnerships, development manufacturers can provide greater value to medtech brands that want an outsourcing strategy for R&D and innovation.
 

Regulatory Pressures Underscore Need for Proven Partners

Besides economic pressures, the medical technology sector has also seen more competitive products introduced into the European market prior to introduction into the U.S. market. Many in the United States argue that these foreign-made products have gotten to market faster in Europe because of tighter FDA approvals for devices and technologies targeted for commercialization in this country. That situation is exacerbated by an increasing number of recalled products, and threatened and ongoing litigation in the courts around recalled products. In addition, congressional scrutiny on the 510(k) process has considerably slowed product development life cycles while increasing costs.

A recent study of 350 medical device professionals at Northwestern University, funded by the Institute for Health Technology Studies, underscores the industry’s perceived view of the current U.S. regulatory climate. Roughly two-thirds of those surveyed in the study felt Europe’s regulatory system was more predictable than FDA in the United States.5

The constricted regulatory environment adds to the pressures of the vendor-partners to provide assistance and direction in navigating regulatory channels. Thus, highly experienced companies with longevity in the industry are in demand, as long as they can ensure total grasp of the regulatory system and can guarantee productive, longstanding FDA relationships.
 

Strategic Rationale for Outsourcing

The advantages for outsourcing R&D to development manufacturers with a well-established track record should be clear, especially given the multiple pressures facing the medtech industry. Strategic partnering with such vendors can result in reduced time-to-market while enabling OEMs to focus on core competencies.

Development manufacturers are improving their research and design capabilities and increasing clinical experience in the field to optimize a vendor-partner arrangement. The goal is to complement a medtech firm’s R&D efforts to drive next-generation products. Some vendors are also focusing on specialty areas such as development of minimally invasive delivery systems and components and leveraging those specialty services to optimize production (see the sidebar, “Designing an Embolic System.”). They have the ability to quickly move products through the development cycle and scale up manufacturing to match geographic product launch plans.

Specialized skills provided by development manufacturers can condense product development and launch timelines, while reducing overall internal R&D investment. In an industry in which patient outcomes are of paramount concern along with high performance and shareholder value, the outsourcing model justifies itself at many levels.

For OEMs, the development of non-core manufacturing capacity is capital intensive, slow, and results in lower long-term return on investment (ROI). With optimized systems and a wealth of experience in the development and manufacture of non-core, as well as specialty products to draw on, development manufactures can lower costs, speed time to market, and help OEMs realize long term ROI.

Development manufacturers provide OEMs access to specialized expertise and potentially exclusive IP without distracting from their focus on their own development of future core technologies.
 

Getting the Most Out of Outsourcing

Partnering with a development manufacturer is a sound and strategic business model for the rigors of the 21st century medtech industry. The benefits of doing so can include increasing efficiencies and leveraging of external networks, which are sources for R&D innovation that may often be overlooked.

The right development partner can provide the expected level of overall project management to enable more efficient communication and ensure that internal customer R&D, quality, documentation, and other internal engineering resources are minimized over the life of the project and into manufacturing.

Today, development manufacturers have begun to invest resources in their own new technologies and complementary products by working more closely with clinical practitioners. By focusing these efforts on emerging device delivery procedures themselves, rather than on the device therapies, such manufacturers can develop their own intellectual property — and eventually share that equity with their medtech partner —by establishing up-front agreements around proprietary technologies or processes. These agreements can increase shareholder value for both parties and more importantly can improve patient outcomes in the delivery systems used for emerging clinical procedures.
 

Conclusion

In an age of economic uncertainty and the myriad pressures on OEMs to innovate, compete, and protect IP, while also delivering shareholder value to the bottom line, the development of vendor-partner relationships for R&D should be on the top of every medtech company’s list. R&D innovation can be enhanced by forming external partnerships as follows:

Smart OEM companies will already be engaged in or planning for such a strategic partnership. Development manufacturers must be able to prove longevity to navigate multiple processes, the vision to bolster the future of the industry, and the capacity to deliver life-saving technology.
 

References

1.Accenture, Life Sciences Report 2011, “Achieving High Performance: Reinventing Medical Technology for a Dramatically Different Future,”
2.PricewaterhouseCoopers, MedTech Focus, August 16, 2011.
3.AdvaMed News, Release, “Study: Device Tax Could Cost Jobs, Stifle Innovation.”
4.Diana Furchtgott-Roth and Harold Furchtgott-Roth: “Employment Effects of the New Excise Tax on the Medical Device Industry,” AdvaMed/Manhattan Institute and Hudson Institute, Executive Summary (September 2011).
5.Janet Moore, Star Tribune Business Section, “Study Calls FDA Drag on Innovation,” (May 24, 2011)
Jim Mellor is vice president of sales and marketing for Lake Region Medical.