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Articles from 2012 In January


Inside Look—Startup Sees Need for Autism, Mental Illness Devices

Vayu, Vest, Autism, Therapeutic Systems, Deep-Pressure TherapyWhile such inventions may provide relief for people with autism, they’re not reimbursable through Medicare or Medicaid and often aren’t covered by insurance. Therapeutic Systems, an Amherst, MA–based startup, hopes its Vayu deep-pressure therapy vest will achieve what those other devices have not: 510(k) clearance.

“Our goal is to develop a reimbursable medical device, not a homemade solution,” says CEO Brian Mullen. “I think [people with autism] deserve the same level of quality and safety as those with any other illness or diagnosis.”

Vayu is a vest that can be inflated with air to apply pressure to the body—a technique that has gained acceptance since autism advocate Temple Grandin, who has high-functioning autism, invented a squeeze machine to alleviate her sensory overload in the 1960s. Since then, occupational therapists have used other devices—neoprene wraps, weighted blankets, and weighted vests—to provide deep-pressure therapy to patients with autism.

Mullen says Vayu improves upon those options in a number of ways. Weighted blankets don’t allow for a lot of activity, therapists must have weighted vests in various sizes to accommodate different patients, and none of those options can easily be customized to the wearer. The Vayu vest, on the other hand, is low profile enough to be worn under clothing, can be adjusted to fit patients of various sizes, and can be inflated or deflated depending upon the needs of a particular patient or situation. It also gives therapists the option to allow patients to adjust the pressure themselves, or the handpump can be removed if a patient isn’t capable of doing so.

Mullen came up with the concept while conducting research on weighted blankets while earning his PhD in mechanical engineering at the University of Massachusetts at Amherst (UMass Amherst). After the Boston Globe ran a story on an early prototype in 2006, Mullen received calls from parents and therapists across the country wondering where they could get one.

That’s when he realized there was an opportunity for commercialization. Diagnosis of autism spectrum disorders is on the rise, increasing 600% over the past two decades, according to the advocacy group Autism Speaks. The U.S. Centers for Disease Control and Prevention now estimate around one in 110 children fall somewhere on the autism spectrum.

Brian Mullen, Therapeutic Systems, Vayu vest, Autism, Deep-Pressure TherapyThe Vayu vest is currently classified as a Class 1 exempt medical device. It sells for $2000, though there is also an option to rent the vests for $100 per month. Next, the company hopes to obtain 510(k) clearance, paving the way for the device to be covered by insurance and reimbursed through Medicare and Medicaid.

“Our goal moving forward is to make specific claims about the benefit of deep pressure as applied by the vest for autism,” Mullen says.

Mullen says Therapeutic Systems is also looking at other uses for the Vayu vest, including as a treatment for mental illnesses such as posttraumatic stress disorder. 

Jamie Hartford
 

Correction: An earlier version of this story stated incorrectly that "the U.S. Centers for Disease Control and Prevention now estimate around 300 million Americans fall somewhere on the autism spectrum." The correct statistic is around 3 million, according to Autism Speaks, or about 1 in 110 children, according to the CDC.

FDA Releases 2012 Medical Device Priorities

FDA's Center for Devices & Radiological Health has announced its strategic medical device priorities for 2012. The device center said it will focus on the following four key areas this year: implementing a total product lifecycle approach, enhancing communication and transparency, strengthening its workforce and workplace, and facilitating innovation and addressing unmet public health needs. CDRH also plans to finalize all guidance documents related to boosting the premarket programs, make the recall process more efficient, and develop a postmarket surveillance strategy.

CDRH's medical device priorities for 2012 can be accessed at FDA's website.

-Richard Park

Editorial: Nothing So Uncertain As Taxes

In his State of the Union last week, Barrack Obama made special mention of advanced manufacturing (by extension medical device manufacturing) as the linchpin of rebuilding the economy, and focused on ensuring that those jobs are not lost. He proposed tax code amendments to ensure that firms no longer get tax breaks for relocating overseas while lowering taxes for companies that choose to retain manufacturing in the United States.

What Obama didn’t mention was healthcare reform and the impending device tax. And, as unpopular as the device tax might be, no one seems to have the right answers on how to fight it. In fact, Nick Woods recently suggested that some of the arguments against the device tax (e.g., it would lead to offshoring, lost jobs) aren’t really resonating. Perhaps it is time to revise our tactics.

To that end, in the fight against the Device Tax, MedCity News outlined an action plan, based on SOPA resistance that the medical device industry could follow. Is it time for a civil action? 

Heather Thompson

Exclusive: Survey Finds Hospital Execs Gloomy about Coming Year

Exclusive: Survey Finds Hospital Execs Gloomy about Coming Year

Nearly half of hospital executives expect business conditions for the U.S. hospital industry to worsen over the next 12 months, according to the most recent “Hospital Executives” survey commissioned by ITG Market Research. A total of 85% of the executives reported being “very concerned” about how reduced reimbursement rates would affect their facilities’ bottom line in 2012. Nearly one-third reported the same level of concern about how President Obama’s healthcare reform would affect their facilities' performance. Added to that is a sense of overall anxiety about the U.S. economy.

Image courtesy of Flickr user Yogendra174


Some degree of optimism persists, however. Many hospitals, for instance, continue to invest in new technologies. While electronic medical records (EMR) may be the most obvious examples, the study found that many hospitals are making large capital acquisitions such as purchasing robotic assisted surgery systems.

A total of 70% of the executives stated that their hospitals' financial performance in the fourth quarter of 2011 was better than expected. The key phrase here is “better than expected,” said Graeme Christianson, vice president of healthcare market research at ITG in an exclusive interview with MD+DI. It is not necessarily the case that hospitals’ earnings were better than they were a year or two earlier. “But I think part of it is that many of the cuts that were anticipated haven’t happened yet—or hadn’t happened in the fourth quarter of 2011,” Christianson says. “A lot of hospitals had tightened their belts already and looked for ways to eliminate extra cost.”

The survey also found that patient volume continued to be strong in 2011. “Some hospital executives were expecting it to go down more than it did,” Christianson says, explaining that they had feared high unemployment rates in 2011 would lead many people to avoid or put off hospital visits unless absolutely necessary.

Adjusting to Market Trends

The survey indicates that relatively small hospitals are expected to have the most trouble adapting to the changing market conditions. Not surprisingly, one of the more pronounced trends relating to hospitals is consolidation. “There have been a lot of mergers,” Christianson says.

The trend of consolidation of hospitals, private practices, and clinics will likely continue to be a common trend throughout 2012. “Large hospitals and [their] networks are getting even larger, and some of these smaller hospitals are joining or are partnering with other groups to try and get economies of scale,” he says.

“Large hospitals and [their] networks are getting even larger.”

This consolidation also increases hospitals’ leverage in negotiations with providers of healthcare-related services and products. A network of ten hospitals, for example, can demand lower prices and more extensive service from device manufacturers.

Hospital executives are adapting to the changing marketplace using a number of strategies, Christianson says. Vendor consolidation is one of the prominent trends. “So rather than having five or six different vendors providing a type of implant, for example, and giving the surgeons a choice between them, they are saying to the manufacturers, ‘We are going to stock two types and you need to submit tenders and we will decide which companies to go with,'” he explains. “They are playing the manufacturers off on each other, and the manufacturers are having to compete on price, obviously, as well as on clinical factors. But a big part of it is going to be price.”

Another strategy to cut costs is capitation. “So they are saying you can continue to provide our hospital with your implant, but we are only going to pay x amount or y amount. So if you can meet that, great, we’ll continue to stock, if not, we’ll use whoever does make that.”

Pay-for-Performance and Accountable Care Initiatives

The study indicated that pay-for-performance and accountable care initiatives are moving forward, but the relatively large hospitals are implementing these programs more aggressively than smaller institutions. “Pay for performance is, in many ways, easier to implement. It has been around a bit longer, so there are more hospitals that claim that they have at least some degree of pay-for-performance in place,” Christianson says. “But accountable care has also grown within the past year in terms of the number of facilities indicating that they are participating.”

Transitioning at least part of their business away from a fee-for-service model could be a challenge for some institutions. A fee-for service model is relatively easy for the hospitals to understand and manage. “Whereas with accountable care and pay-for-performance, suddenly it is not as clear how to improve hospitals’ profits and revenues,” Christianson says. “You might think, well, the solution is to just take better care of patients.” But that is not as easy as a hospital deciding, for instance, that they should try to do more of certain profitable procedures and try to avoid doing other ones. To come up with answers to these questions, hospitals are dedicating a lot of resources determining how to best manage costs. “But it is still something that they are not sure how to do yet,” he says.

Many hospital executives, it seems, are left scratching their heads trying to figure out the best way to move their business forward amid a rapidly changing marketplace. 

Related Content:

A free executive summary titled “Hospital Executives Syndicated Report Series” examines the needs of 100 executives employed at US hospitals in Q4 2011.

Value Plastics’ bag-port technology improves material transfer in biopharmaceutical apps

Value Plastics recently introduced an advanced series of ports for the single-use bags used to transfer media and drug compounds in the biopharmaceutical industry. The benefits offered by the products include animal derivative-free qualification, USP Class VI certification, guaranteed heat sealing and conformance with polyethylene bags, and 24-hr. resistance to alcohol stress cracking, a feature that’s critical when processing materials that can cost thousands of dollars per liter.

The new bag ports also incorporate two features that reduce process time and potential damage to expensive media.  Parabolic lead-ins on the ports save time by shortening the time required to drain a bag by up to 24%, while  alignment ribs improve fluid flow dynamics by reducing shear impact as material exits the bag.  For widespread industry compatibility, the new ports are designed to work with common tubing sizes, as well as industry-standard fittings, filters and other devices.

Richard Nass

Future Risks: How Biomedical Companies Navigated Turbulent Economic Times

After five relatively good years, the medical device industry faces a more challenging future, with significant risks to growth and profitability. Regulation of medical devices is growing, with new certifications and testing required in the United States by FDA, many under the terms of the 510(k) process. This issue has already raised costs and extended time to market and realization of revenue for several firms. As implants increasingly include elements of pharmaceuticals in them (e.g. drug coated stents, joint replacements), or components designed to promote tissue growth, regulatory review will lengthen. Nevertheless, if the value delivered reflects in pricing, there may be some recompense for the delay.
 
Figure 4. National expenditures on Healthcare by country. Click figure for larger image.
The second major risk is simple: Reaching the limits of what people and countries are willing and able to spend on healthcare, with consequent controls and limitations, or behavior changes that turn patients into active shoppers for medical devices. Figure 4 shows the increase in share of gross domestic product (GDP) spent on healthcare, with the United States increasing by 10 points, from 7% in 1970 to 17.4% of GDP in 2009, the most recent year surveyed. This places the United States at the top of the world heap in share of GDP spent on healthcare; Germany, in contrast, seems able to deliver high-quality care for a substantially lower share of GDP, 10.5% in 2008, while Switzerland expends 10.6%. Even the UK, famous for its National Health Service funded from tax revenues, delivers high quality care for 8.5%. The question is, when will countries and individuals run out of the ability to pay? While it not clear exactly where the spending wall lies, it is clear that a limit is approaching.
 
There is also the potential for substantial consolidation in this industry, which as noted is relatively nonconcentrated at this time. The pharmaceutical industry is emerging from a series of mergers that have created pharmaceutical giants; and consolidation has occurred in many other industries, even those with high technology, high value add products, such as computers and software. It is hard not to look at the many large- and mid-sized firms in this business, some with complementary products or geographic markets, and not see the potential for a strong period of consolidation into a few large powerhouses. An early sign of this potential is the recent offer by Danaher Corp. to buy Beckman Coulter.
The final danger lies in the prospect for low-cost products and consumables offered by businesses focused on supply chains and production efficiencies. There appears to be some potential to save on costs by moving production from

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North America and Europe to countries with lower wage costs. While an individual consumer might not want to have a hip replacement from a low-cost bidder, eventually the insurance provider may start to push for lower costs for comparable quality. This substitution of lower cost alternatives has started in pharmaceuticals, where there is growing pressure to replace branded drugs coming off patent with approved generics. If medical device technologies begin to stabilize and the quality of both imported substitutes and their local regulation increases, the possibility of the perfect storm of stringent reimbursement requirements, and more competitive R&D and manufacturing landscapes could squeeze U.S. medical device industry profits. The industry sector will need to rely on its resilience, durability, creativity, and innovation to face and overcome some very challenging years ahead.
 
Conclusion
Across the developed world, companies developing medical devices face multiple challenges. These hurdles include increased regulatory scrutiny, more severe reimbursement requirements, global talent and innovation wars, and aggressive new procurement practices. In search of top line growth, manufacturers are all looking to Brazil, China, and India, while cutting-edge innovations are gradually moving to Germany, France, Israel, and Japan.
 
Today, the United States is the acknowledged world leader in medical technology, but that leadership is being challenged. In order to preserve America’s leadership, there needs to be a focused and concerted effort by industry and government to making innovation in the life sciences a top priority. In addition, the U.S. R&D structure must be sustained and enhanced. Furthermore, there needs to be a close examination of the FDA review process in order to achieve a process that is predictable, consistent, and timely similar to what European biomedical device companies experience.
 
The U.S. medical device industry has many groundbreaking and transformational products on the market and under development today due to a continuous focus on R&D and changing consumer needs. These companies ask the U.S. government to look out for their interests in both the domestic and overseas markets through ongoing efforts to lower tariffs, streamline and simplify regulations, and ensure a level playing field against foreign competitors based in countries throughout the world. Despite the steady growth seen in the largest medical device markets (the United States, European Union, and Japan), the most promising markets for these products are located elsewhere, including China, India, and markets in Southeast Asia and Latin America, most notably Brazil. Through bilateral and multilateral forums, the U.S. government must be ready to help the medical device sector further develop and enhance its global competitiveness and make a meaningful contribution towards improving public health worldwide.
 
Companies face many risks, from public policy uncertainty to regulatory pressures, and payer pressures, which in aggregate are placing unprecedented challenges on medical device innovation. It is affecting the investor sector, with funding going towards the later stage and more mature companies. Yet even with all these challenges medical device companies have a lot of potential growth ahead.
 
To take advantage of these potential opportunities, medical device companies take the following actions:
  • Emerging companies must ensure that they can survive and sustain innovation through the challenging funding climate.
  • Companies of all sizes will need to continue exploring ways to leverage OUS (Outside United States) markets to offset domestic challenges from emerging markets. The opportunities must offer high growth potential to European countries and provide more efficient and effective routes to launch new products and expedite early cash flow.
  • As companies continue to grow it will be critical for them to maintain a focus on operational efficiency and effectiveness.
  • Companies must realign into a consumer-centric future where providing successful outcomes is paramount. In other words, innovation that goes beyond the product to include the support services and data analytics.
  • Companies will be required to evaluate and potentially reinvent parts of their business models to ensure that what they are offering is what the customer wants, and that these offerings are developed as efficiently as possible.
Going forward, biomedical device companies will need to demonstrate that a particular intervention improves patient outcomes and enhances the efficiency of the healthcare system. The need to offer a complete product—including the addition of services and data as part of the complete offering and solution—exists. Real-time patient diagnostic data could prove as valuable as the newly developed medical device for some product categories. In tandem, a new device, with rich patient diagnostic data and a full array of supportive services might prove to be the key for the future success of the medical device industry.
 
Reference
1. A Hirschman, "The Paternity of an Index". The American Economic Review 54, no. 5 (1964): 761.
 
Yair Holtzman is director and global life sciences leader at WTP Advisors (White Plains, NY). Tom Figgatt, Sr., is an associate at the firm.

Key Challenges: How Biomedical Companies Navigated Turbulent Economic Times

 
Key Challenges to Continued Success
 
Lack of Focus. As a result of the ongoing acquisitions and continuing investment in R&D, many firms  struggle to continuously define and refine what they are and their core focus. There is a steady stream of spin-outs or sell-off of divisions, subsidiaries, or business lines that are perceived as no longer fitting with the core strategy of the firm. The result is ongoing trading of business units between the major and mid-tier players; examples include Boston Scientific selling off its cardiac and vascular surgery businesses to Getinge in 2007, the further sale of the Boston Scientific Neurovascular division to Stryker in January of 2011, and the Abbott spin out of Hospira in 2004. This corporate restructuring allowed Abbott to focus on pharmaceuticals, and the medical supply business of nonpatented products was spun out as a stand-alone corporation. In another recent move, Medtronic announced plans to spin out its defibrillator business, comprising the Physio-Control division; this is a second attempt to spin out the division after the first attempt failed following the 2006 FDA recalls on the product line. Tyco Corp., following their CEO governance scandals in 2002, spun out their medical products organization in 2007 to form Covidien as a stand-alone business; it ranks 10th on the BioMed 25 list for 2010 revenues.
 
High Rate of M&A. One downside to the extensive practice of growth and extension by acquisition is that many small plants get picked up and added to an existing infrastructure. Often those plants are located next to the R&D teams that develop and push the products into the marketplace. The result can be a mish-mash of small facilities, each with its own overhead, management, and cost structure, often spread out at locations that make no sense for optimal product distribution and have high labor costs. The need to co-locate manufacturing work with product development leads to additional challenges. While plants and manufacturing functions can be moved for parts and technology manufacturing, it is much harder to move a research staff and keep intact its intellectual core. As a result, some firms have been reluctant to address the inherent inefficiencies of their physical structure and personnel locations, because a move often causes severe losses of important intellectual capital.
 
However, a counter pressure that emerges is the need to host key customers for education and training at a centralized, key campus. A core component of the marketing is training the doctors and other medical professionals on how to use and deploy the products. However doctors will not travel to many small facilities; it makes more sense to build one central research campus with a co-located education facility. Terumo has made major investments in its Japanese home market education facilities; B. Braun has made similar investments in its core campus in Melsungen, Germany.
In response, many firms have launched restructuring plans to consolidate facilities for both manufacturing and research. Medtronic launched a One Medtronic campaign in 2008 to reduce the number of locations and trim duplicative headcount, both in the U.S. and key European markets, recording charges of $742 million in 2008, $1 billion in 2009 and $374 million in 2010. Boston Scientific, a serial acquirer in earlier years, has launched several rounds of restructuring to reduce plant locations, in addition to its serial sales of divisions to competitors. Baxter restructured product lines and facilities in 2005 that set the base for profit growth through the Great Recession. A review of the facilities and locations supporting other firms in the Top 25 reveals ample opportunity for rationalizing and optimizing manufacturing and distribution facilities and research locations.
 

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During early 2011, the BioMed Top 25 was reshaped by major M&A activity. Looking to diversify into medical products and reduce its dependence on a shrinking drug pipeline, Swiss pharmaceutical giant Novartis acquired Alcon. Johnson & Johnson, after a rumored pass at Smith and Nephew, closed on the acquisition of Synthes. Within the Top 25 list, Danaher Corp. added to its base of instrument and technology businesses by acquiring Beckman Coulter. With the closing of these acquisitions, the BioMed Top 25 will shrink to the Top 22.
 
One company stands in contrast to the growth through acquisition and expansion strategy. Terumo, using Japanese GAAP for reporting, draws revenue from two primary lines—a variety of general hospital products including disposable devices, infusion pumps, continuous ambulatory dialysis, and hemodialysis care items, for 47.4% of revenue; cardiac and vascular products that include vascular grafts, and related neurological and cardiovascular systems, comprising 43% of revenue; and a variety of blood transfusion and processing systems, making up 8% of revenue. While 55% of its 2009 revenue came from Japan, the European market comprised 17% and the Americas 18% of revenue, with the balance from the rest of Asia. Growth was strongest in the home Japanese market (+7.3% year to year), compared to essentially flat revenues from Europe. Terumo manufactures its products regionally, with core manufacturing and pilot production in Japan. Local production takes place in factories in the United States and Europe, and new investments are strengthening manufacturing in China. In contrast to the U.S. and European firms that have boosted growth by acquisitions, Terumo has driven its growth through organic extension of existing product lines and addition of new products driven by internal R&D, complemented by new offerings from joint development partnerships with peer Japanese firms such as Olympus Medical Systems. The customary exchange of cross-shareholdings that mark a Japanese partnership left Terumo as the largest single shareholder in Olympus at the time of the recent discovery of long-hidden losses and irregular dealings that has materially damaged the value of the Olympus investment.
 
Figure 1. Sales & Marketing expenditure levels. Click figure for larger image.
Key Characteristics Lead to Success
Increased Marketing Efforts. The high and increasing levels of marketing expenditures are a notable feature of the biomedical device sector, which increased from a 26.2% of revenue to 27.5% of revenue across the five years from 2006 to 2010. Furthermore, the aggregate dollars spent grew by 59% over the time period, against revenue growth of 48% (see Figure 1). Marketing expenses usually decline as revenue and volumes increase and efficiencies of scale begin to kick in. Thus when marketing expenses grow faster than revenue, something unusual is afoot—either a massive and mutually self-destructive foot race to grab share is underway, or something about the nature of the business is causing firms to invest more in marketing and sales. There are very few businesses that spend as much on marketing and sales as the biomedical device industry. In contrast, the IT business, generally noted for making complex products requiring long sell cycles, spends only 15% to 20% of revenues on sales and marketing.
 
Why is marketing and sales expense so relatively high? In general the nature of the products and services offered demands a high touch level in the selling process. Almost all the firms in this business heavily use high-cost direct sales forces, working in high-cost markets with little opportunity for extensive productivity gains. A few use distributors for products in some more remote developing markets, but one theme between many companies is the steady stream of acquisitions of partners or  distributors as they grow their presence to reach sustainable levels in new country markets.
In the selling process, individual medical specialists, often doctors, surgeons, and their support teams must be met, convinced, coached, and trained to use the products. Many firms invest heavily in education, bringing doctors to seminars and training sessions, and vice versa; some have invested in training facilities and supporting staff. Further expenses are incurred for consulting fees, to fund doctors who have used the products to exhort and train other doctors to join them as users. Key hospital staff must also be contacted, cajoled, encouraged, and entertained. We have referred to the costs of this highly hands-on marketing as an investment because it so expensive and intricate, with benefits so far beyond the current period that, although accounting may treat these as items to be immediately expensed in the current period, the clear reality is that the multiperiod payback makes these sales and marketing activities more of an intermediate term investment.
 
In reaction to the practices of this sector and the pharmaceutical sector, some medical schools have begun to either ban their faculty from accepting drug and biomedical device consulting contracts, or forced them to disclose the extent and nature of their support. Similarly, some firms post the names and amounts paid to consulting physicians and other researchers online. These actions may slow the escalating arms race of sales expenditures, but they are unlikely to materially lower the level of spending relative to sales.
 
Some firms have made particularly large increases in their ongoing investment in sales and marketing:
  • Covidien increased sales and marketing spend by 9.3 percentage points from 2006 to 2010, a 55% increase in dollars spend against a 6% increase in sales. The cause is a shift in product mix from lower margin, lower sales touch pharmaceutical products to a new set of medical devices for bariatrics and hernia repair, which required a more hands-on sales approach. As a result, the company hired about 2000 sales representatives between 2007 and 2009.
  • Tornier also increased its sales and marketing spend by 9.1 percentage points, from 46.7% in an early start-up year to an astonishing 55.8% of revenue in 2010.
  • Zimmer Holdings increased S&M spend by 6.9 percentage points to 41.6% of sales in 2010.
  • However, some firms managed to cut their percentage spend on S&M:
  • Wright Medical Group cut from a high level of 56.8% of sales to a 54.4%, for a 2.4 percentage point cut in relative spend.
  • CR Bard cut spend from 31.1% in 2006 to 27.9% in 2010, a savings of nearly 3.1 percentage points over the period, based on the realignment and restructuring of their non-U.S. marketing functions in 2009. Relative to its medical device peers, Bards sells a large share (33%) of products primarily through distributors.
There is logic to the high levels of marketing spend, which can be demonstrated by grouping the S&M spend into relative brackets and then looking at the product-market strategies for firms in the bracket (see Table II).
 
Very High: 40% to 55% of revenue spent on S&M.  This includes (at 2010 levels) Smith & Nephew (46.9%), Tornier (55.8%), Wright Medical (54.4%), and Zimmer (41.6%). The common thread here is that these firms focus on joint replacement products, for core body joints (hips and knees), or extremities (wrists and ankles); and all have high costs for selling to, training, and supporting surgeons.
 
Medium High: 20% to 40% of revenue spent on S&M. This larger group includes, inter alia, Abbott Labs (29.5%), Alcon (28.8%), Baxter (22.6%), Beckman Coulter (30.2%), Biomet (38.6&), Boston Scientific (33.1%), Getinge AB-B (21.5%); Medtronic (34.2%), etc. This group contains firms with complex products that demand a high-touch sales approach to reach heart surgeons and internists, but not the ultrahigh expense levels required to reach and support orthopedic surgeons.
 
Medium Low: 5% to 20% of revenue spent on S&M. This smaller group includes Varian Medical (14.2%), Hospira (12.2%), and Fresenius (16.7%). These companies either sell lower-value services along with devices and consumables, and also sell them to labs, nurses, and other medical users, or go to market through distributors with higher volume, lower margin products where the system element is sold by its sales force. The high-dollar revenue consumables move through the distributors (e.g. Hospira).
 
The common elements here are that the level of marketing spend required is set by the earning power of the key decision maker and the time and effort required to reach and influence the decision makers to favor and use a particular firm’s products.
 
The larger question raised by this high level of sales and marketing expenditure—Are these businesses technology focused, or are they focused on the customer? These businesses invest a lot in R&D, and it is a critical factor facilitating their ability to keep up in the marketplace. But it is also increasingly clear that their customer is the medical professional who makes decisions about which brand or product to use for which application. The acquisition strategy for many firms in this business is to complement their existing offerings with complementary products targeted to extend their array of offerings to the medical professional they already reach, or to those closely related. In short, the high cost of marketing is, for many firms, driving the strategy for growth and acquisition as they search for more products to sell to the same decision makers, in the search for improved sales efficiency.
 
Strategic Development: Winners and Losers. There are some clear winners and losers to be found in this group. The following companies are the best performers (see Figures 2 and 3):
  • Abbott Labs leads with top profit growth, up 169% from 2006 to 2010, on revenue growth of 56%, based in part on the performance of its biomedical device businesses that focus on cardiac stents and related vascular instruments, and in diagnostic products.
  • Fresenius grew profits 83% over the five-year period, on a 32% revenue gain, based on extending its sales of consumables and devices to the dialysis service centers.
  • Alcon grew profits by 64% on revenue gains of 47%, based on extending sales of devices and consumables for eye surgery and care.
Figure 2. Profit trends in medical devices versus all U.S. durable manufacturers index. Click figure for larger image. Figure 3. Sales growth in medical devices versus all U.S. durable manufacturers index. Click figure for larger image.

The following companies were poor performers that either reduced profitability or sustained losses:

  • Biomet, taken private in 2007, was saddled with a large load of debt in a sector that usually runs on low or no debt, and struggled to cover interest charges and pay down debt. With revenues up 19% from 2006 to 2010, profits declined some 323%.
  • CareFusion, spun out of Cardinal Health in 2008, saw low revenue growth from 2007 to 2010, and a profit decline of 66% on the costs of transitioning to a stand-alone company after the spin-off from Cardinal, and the expiration of one-time tax benefits that will raise tax rates going forward.
  • Terumo, based in the slow-growing Japanese home market, saw the lowest revenue growth in the group, a mere 14% from 2007 to 2010.
  • Finally, the perennial loser of the group is Boston Scientific, which lost money in all five years from 2006 to 2010, and after several ill-fated acquisitions (Guidant) and divestitures to Getinge and Stryker, saw essentially flat growth in revenues and a 70% decline in annual profits.

Next: Future Risks and Dangers

Yair Holtzman is director and global life sciences leader at WTP Advisors (White Plains, NY). Tom Figgatt, Sr., is an associate at the firm.

R&D and Investment: How Biomedical Companies Navigated Turbulent Economic Times

 
Investment in R&D and New Products
Over the past few years the way the medical devices industry assesses innovation and new technology has changed. The old dynamic of the physician as judge of value has been replaced with the government, private insurers, and consumers increasingly determining what sells and at what price point. Consumers refuse to pay for incremental enhancements that add bells and whistles that do not improve health or reduce cost. The faster, better, smaller, cheaper innovations in medical devices are the devices that will maintain a sustainable advantage. We have witnessed a similar metamorphosis in the electronics industry over the past decade, and it will be the future of the medical device industry. Smaller and cheaper devices will dominate.
 
Recently, emerging-market countries such as China, India, and Brazil have been taking the lead in developing lean, frugal, and reverse innovation. This type of innovation simplifies devices and processes, retaining essential functions, while applying new technologies that are more versatile, mobile, and adaptable to consumer’s needs and are less expensive.
 
We see three primary trends in the R&D environment for medical device technology:
  • The medical device innovation centers dominated by the United States are gradually moving offshore. Increasingly, medical device innovators are going outside the United States to seek clinical data, new product registration, and the initial streams of revenue.
  • U.S. consumers are not always the first to benefit from advances in medical technology. Innovators already have a preference for countries like Germany, the UK, France, and Israel. By 2020 they will likely move into emerging countries before entering the United States, due to growing complexity of regulation and reimbursement limitations in the U.S. market.
  • The geographical locus of innovation has changed. Non-U.S. developed nations have become leaders in the medical device space. Outside of the United States, there are six countries with very strong R&D capacities and capabilities—Germany, the UK, France, Japan, Israel, and China.

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Medical technology R&D has often been an outside-in approach. Iterative innovation has often originated at the bedside, as physicians provide feedback that sows the seeds for the next generation of product. Today, sunshine laws, which effectively limit a company’s access to physicians, could potentially place some of this process at risk. With a new health environment there exists a need to cast a wider net. Medtronic for example, had begun crowdsourcing some of its innovation with the November 2010 launch of Medtronic Eureka, a European web-based portal that allows physicians and medical technology innovators to submit new product ideas.
 
During the past 40 years, the United States has provided an ideal and robust innovation environment that has facilitated significant advancements in medical technology. The U.S. dominance of this space has stemmed from its strength in the five innovation pillars—powerful financial incentives made up of market incentives and financial incentives; innovative resources; the regulatory approval process; healthcare demand and price sensitivity; and a supportive investment environment.                                                                                                                                                            
 
In order to develop the type of medical technology environment required for success in 2020, countries and companies will have to adapt to what we view as the following new five pillars of innovation:
  • System-oriented and value-based incentives.
  • Global networks of medical centers and medical professionals.
  • Competing regulatory systems.
  • Individualized solutions and price sensitive customers and
  • Global financial networks.
The industry is shifting from U.S.-centric to a global span. Although we expect the United States to continue to play a leading role in medical device R&D for years to come, the country will most likely no longer dominate the industry. The supportive U.S. environment that created this dominance brings with it limits to change and encourages an incremental rather than a disruptive path to innovation. The radical innovations that are more likely to permanently change the cost curve are ikely to emerge from developing countries such as China, India, and Brazil.
 
During the past few years and through the Great Recession, companies in the medical device industry have continued to increase spend on R&D. An anemic 2% increase between 2008 and 2009 was followed up by a 7% increase in R&D spend between 2009 and 2010. Overall R&D investments were up by 11% over two years (2007-2009) and up from $11.6 billion in 2009 to $12.4 billion in 2010.
 
One of the reasons that this industry segment weathered the storm of the past several years relatively well is because it continued to incrementally increase R&D spend. The companies that consistently did so had a more robust pipeline of potential products, another key ingredient to survival and success of the industry. The companies best positioned for success are those that will develop new products that are most relevant to this changing ecosystem. Medical device companies have always taken on the risk to innovate with new technologies. Going forward, one of the most significant risks may be the failure to innovate beyond the product and develop new technologies and services.
 
Industry Strengths
High Rate of Mergers & Acquisitions (M&A). Compared to many established industries, today’s medical device business is characterized by strong topline revenue growth in the top firms, generally highly profitable, and not concentrated. The fact that there are 25 top-playing firms in a related sector focused on a common set of problems—human health—is testimony to the lack of concentration. While the largest firm in our Top 25 (Abbott) is roughly 130 times the size of the smallest (Tornier, a recent IPO), there is a large group of firms, 17 of the 25 companies, with revenue in the $2 to $7 billion range, and another group of 8 firms with revenue in the $7.5 billion to $15 billion range. The overall concentration ratio for the top 4 among the 25 firms covered in this study is a low 35.2%; the top 8 make up 47.6%, which is still in the low range of concentration ratios. Using the Herfindahl-Hirschman index, a more complex measure that weights for the size of all the firms in the sector, yields a concentration index of .08, which places this sector in the range described as “unconcentrated”.1 While there has already been a small increase in the concentration of this sector in the years from 2006 to 2010, the low level of concentration present points to ample opportunity for further mergers and business combinations.
 
Barriers to entry for new startups are moderate when compared to large capital intensive businesses, consisting largely of the need for regulatory approval, to gain access to decision makers such as doctors and hospitals, and to distribute through the medical supply chain. There is evidence of continual new starts by new companies with novel ideas, usually based either on a lab-based development of a new technology, or sometimes the concept and development of a particular doctor that gets funded and gains traction with other medical specialists. Within our Top 25, this ongoing rate of formation is demonstrated by the high rate of acquisitions of smaller firms; taken across the full set of 25, acquisitions of small, nonpublic start-ups runs about five to 10 in any given year.
 
Examples of start-ups and small firms acquired abound. Picking one large firm, Medtronic (2010 revenue $15.8 billion) made purchases in 2010 of ATS Medical for $370 million, Invatec for $350 million plus contingent payments, Arbor Surgical for $11 million; and acquisitions in 2009 of CoreValve for $700 million, Ablation Frontiers for $225 million, CryoCath Technologies for $352 million, Restore Medical for $28 million, and Ventor Technologies for $308 millino. Other examples of frequent and ongoing acquisitions abound and display ongoing evidence of a steady start-up rate of new firms with new technologies, treatments, or relationships.
 
Organic Growth in New Markets. Companies also drive for organic growth through more intensive coverage within existing markets, usually by expanding direct sales force coverage, or by acquiring established business partners in growing markets or local firms in growth markets that can provide a fast extension in distribution and sales reach. Organic growth is also fed by adding complementary products to existing product lines. The R&D section below will provide further examples of how R&D is used to extend product lines.
 
Companies in the Top 25 have taken successful several approaches to growth, including growth through product line extension by acquisition and geographic expansion to sell existing products to new markets. (Organic, internal new product development will be discussed in the R&D section.) Here are some examples:
  • Hospira. Drove geographic expansion via purchases of Mayne Pharma (Australia) in 2007, and Orchid Pharma (India) in 2009.
  • Fresenius. Acquisitions in Malaysia and distribution agreements to expand reach in Japan, Korea, and Russia in 2010. The firm’s 2011 annual report clearly stated their intent to “continue growth through acquisition of small and mid-sized companies.”
  • B. Braun. Acquisitions of partners to extend distribution in Asia and in the Balkans.
  • Getinge. Acquisitions in Brazil, and sales force expansions in China and Singapore from 2005.
  • At the level of governance, several firms still have their original founders on the board or in leading executive roles. The founder of Synthes served as chairman on the board until their recent acquisition by Johnson & Johnson. A cofounder of Boston Scientific remains on their board, despite five years of money-losing performance following the firm’s acquisition of Guidant.
Manufacturing Devices for Regional Consumption. Another characteristic of the sector is a general practice to manufacturer products in the area of the globe where they are used and consumed. Thus many firms have plants in Europe for the European Union (EU) markets, plants in the United States or Canada for North America, and in Japan or China to serve the major Asian markets. For instance, Terumo, based in Japan, does manufacturing for the home and near Asian markets in Japanese plants, but builds products for the North American market at plants located in the United States. There is a sense—not often explicit—of wanting to make products or consumables for patients at close proximity in geography to where they live. For some firms, especially the joint replacement businesses such as  Wright Medical Group and Zimmer, there is the demand for speedy, semicustomized manufacturing so that products can be adapted to unique patient needs.
 
For example, here’s a closer look at Wright Medical, which makes bone and joint replacement products for the knees and hips, and small joints (ankles). These products are manufactured largely from titanium and other high-tech materials that are expensive, difficult to machine, and require cutting-edge machine tools and computer aided design (CAD) systems. Wright and its competitors, such as Stryker and Zimmer, constantly innovate to adapt designs to varying patient bodies. They do this by constant and close consultation with doctors and surgeons—to the extent that their sales force working with the doctors is part of the R&D loop. As they receive feedback on the fit and use experience, the designs are adapted for future patients. The development process of a new device or material is iterative in nature and can take multiple iterations to perfect. To build the products, the adapted products are then fed in to a highly customized manufacturing operation that makes very few, highly adapted products to extremely demanding specifications and standards.
 
Wright recently closed its European manufacturing operation in France to concentrate manufacturing for its high-value, low-volume, and high-customization joint replacement products at a single plant in the United States. In general, this industry is not characterized by the highly integrated, single-source supply chains that have come to characterize the high-tech device industries such as computers, cell phones, or LCD displays and TVs.
 
Low Debt. On the financial front, most businesses have relatively low or no levels of debt financing. These businesses are generally not capital intensive because the high value-add in the manufacturing process and the relatively high margins that are paid for the expectation of quality control means that heavy borrowing is not required to fund infrastructure. The prime source of expense is usually marketing and sales, which is funded from and for ongoing operations.
 
One exception to the low debt rule is Biomet, which was taken private in 2007 in a classic equity investor privatization that added high levels of debt. Although privately held, the firm issues 10-K reports for the many continuing bondholders, which reveal it has lost money consistently since the privatization. This leverage-based technique may work for mature, low technology businesses like automotive parts, and even in rapidly consolidating businesses, such as software. It has been less successful in a business that requires continual investment in product technology improvements and high levels of spend on marketing, the characteristics of this medical device sector. However, Biomet has been losing less each year since 2008, with losses down to mere $47 million in 2011, and it will likely be positioned for an IPO once the economy is on a more solid footing, so the equity investors can cash out.

Next: Key Challenges to Continued Success

Yair Holtzman is director and global life sciences leader at WTP Advisors (White Plains, NY). Tom Figgatt, Sr., is an associate at the firm.

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