An MD&DI February 1997 Feature
With improvements in FDA product review performance--and despite an ever more challenging domestic market--device company executives are more optimistic than ever.
In late 1994, executives of medical device manufacturing companies expressed the most negative opinion of the business climate yet recorded in MD&DI's annual surveys. FDA was cited by many as a leading source of their pessimism, while nearly as many blamed the disconcerting restructuring of the health-care provider marketplace. Two years later, device company executives report a substantial improvement in FDA's performance, particularly in 510(k) product approval times. The marketplace, however, still poses a daunting challenge, with many executives pointing warily to growing price pressures.
Given this somewhat mixed report, one might reasonably expect a moderate but not unprecedented improvement in ratings of the business climate this year. But in fact, this year's survey, conducted last October and November, marks the highest business-climate ratings ever in the five-year history of the survey.
Two reasons for this optimism are suggested by the survey results and follow-up interviews with device company executives. First, the impact of FDA's internal reforms and review-time improvements is more significant than might appear at first glance. The agency has not only reduced the product approval delays that slowed new product introductions, but perhaps more importantly, has also greatly reduced both executives' and investors' uncertainty about the timeliness of future product introductions. Secondly, while the heath-care marketplace is probably more challenging than ever, many companies have not only come to terms with the new realities, but have found new business opportunities in them.
The survey from which these findings are drawn was mailed in late October, 1996, to executives of U.S. companies that make medical devices. Conducted by the independent research firm Readex, Inc., the survey tallied a total of 156 responses. (See box, below, for survey methodology.)
While the overall results of the survey indicate widespread satisfaction with the medical device business climate, the optimism is not necessarily uniform. Some market segments may indeed have lower expectations than the general tone of this article will suggest. Attitudes will differ, notes Richard Martin, president and CEO of Physio-Control Corp. (Redmond, WA), "based on what part of the device industry you happen to be in. For people in the implantable business, for instance, the dynamics of their markets are dramatically different from those of the high-ticket capital equipment manufacturers." Nonetheless, it seems clear that for a majority of companies in the industry, business prospects are looking up.
As shown in Figure 1, a substantial majority of respondents--nearly 6 in 10--characterized the business conditions for the U.S. medical device industry as good or excellent. Just 11% called them poor.
Figure 1. Respondents' rating of the current business climate for the medical device and diagnostic industry as a whole.
Figure 2 shows that these numbers constitute a record level of optimism for the past five years. Given the diversity of the medical device market, it's difficult to imagine that the rating could get much better than this year's.
Figure 2. Executive ratings of device industry business climate, 1993-1997.
In fact, a third of respondents predicted that the business climate will improve, well below the peak of 48% in 1993 (Figure 3). By contrast, only 10% felt things would get worse--a record low for pessimism and a 19-point improvement on the most pessimistic year of 1994.
Figure 3. Expectations of respondents for business conditions in the medical device and diagnostic industry, 1993-1997.
When asked how 1996 sales performed, 63% indicated that sales increased, with just 6% reporting declines. More than 7 in 10 predicted increased sales in 1996. Half of those responding said that sales were up by 10% or more in 1996 and predicted 20% or better increases in 1997 (Figure 4).
Figure 4. Median sales volume change experienced by respondents' companies in 1996 (actual), and change expected for 1997.
A FRIENDLIER FDA
One important cause of this year's improved outlook is clearly the perceived improvements in relations with FDA. As shown in Figure 5, the decline in complaints about the agency mirrors the increase in positive business outlooks. The 20% of respondents reporting harmful effects from FDA policies is indeed the lowest ever, down more than 10% from last year's record of 31%. Much of this improvement is no doubt due to the dramatic decrease in the last two years of 510(k) product approval times, which FDA has made a leading focus of its internal reform efforts.
Figure 5. Percentage of MD&DI survey respondents reporting that FDA policies were having harmful effects on their business, 1993-1997.
Bearing out FDA's positive statistics, just 28% of respondents reported 510(k) delays in 1996 (Figure 6; see also Table I). While still a substantial fraction, it is dramatically smaller than in previous years.
Figure 6. Percentage of survey respondents reporting delays in FDA's clearance of 510(k) products, 1993-1997.
What seems most hopeful to medical device executives is not simply the improved performance by FDA's reviewers, however, but the clear sea change in FDA's approach to industry. "There has been an improvement in attitude," says John Navis, president of Medigroup, Inc. (Aurora, IL). "There's no question about that. I still remember pointedly talking with a FDA official as little as three years ago who insisted, 'That can't happen,' when in fact I had a letter from FDA contradicting him. If something like that came up today, the response probably would be different."
Similarly, Ray Larkin, president and CEO of Nellcor Puritan Bennett (Pleasanton, CA), underlines the extent of the improvements at FDA. "As critical as I may have been a year ago, I think there have been significant improvements on both the product approval and the compliance sides. The whole regulatory environment is improving."
To be sure, not everyone shares this positive view of FDA's efforts at reform. "I've seen no improvement," says John Borgos, president and CEO of Vasamedics, Inc. (St. Paul, MN). "I still can't get the people at FDA to return phone calls, even when we get 510(k) comments back and the reviewer's name and phone number are there. We have to keep calling until we find him in. That is really frustrating--that agency is far from user-friendly."
And Tom Loarie, head of Keravision, Inc. (Fremont, CA), argues that 510(k) review times don't tell the whole story. "The review times for 510(k)s have indeed continued to come down, and that's helping manufacturers in that area to prosper," he says. "But the overall development time for PMAs [premarket approval applications] has increased, so manufacturers with those products are still facing some strong regulatory challenges. The difficulty is that it takes so long to get through the process of approving a truly innovative device that companies can't find adequate funding."
An improved regulatory situation benefits medical device companies not just in lowering a significant barrier to putting a product onto the market quickly and keeping it there, but also in raising funds for new products and new ventures. As Casey McGlynn, chairman of the Life Sciences Group of Wilson Sonsini Goodrich & Rosati (Palo Alto, CA), points out, venture capitalists have in the past hesitated to fund promising new ideas for medical devices due to uncertainty about whether and when FDA would approve them. Now, he says, "the venture community feels that FDA is more predictable today than it was three years ago. They have an understanding of how long it will take for a 510(k) and how long for a PMA." McGlynn quickly adds, however, "that's not to say we don't still have to reform FDA. If we don't, there's a risk that FDA will move backwards and become more difficult to work with again." This, in fact, is a common sentiment among the executives interviewed by MD&DI.
Just as outlooks on business prospects are influenced by market segment, so too are they affected by geographical markets. The key difference, of course, is that in theory, at least, international markets are open equally to all companies. In fact, large companies have a clear advantage over small ones in entering foreign markets. Of the companies surveyed this year, while 91% were selling to the U.S. market, just over half were doing business in Europe and Canada, while 36 to 40% were in Latin America and Asia. Of the largest companies surveyed--those with over $50 million in annual revenues--90% or more were involved in all markets listed in the survey except for Latin America other than Mexico, which was cited by 80% of the large-company respondents.
The potential benefits of international markets are underlined by Neville Jeharajah, vice president of investor relations and corporate planning for Baxter International, Inc., who notes that Baxter "could be in a different position from most companies." According to Jeharajah, his company is one of "the few" U.S. firms that have more than 60% of their sales outside of the United States and more than two-thirds of their earnings. "Those markets are growing extremely fast--more than twice the rate of the U.S. market--and we are doing very well in them."
When asked what markets offer them the best growth prospects in 1997, more respondents (80%) named the United States than any other market (see Figure 7). This response is clearly swayed by the dominant number of small companies in the survey. When limited to companies with more than $50 million in annual revenues, the numbers are quite different: Europe comes first, at 86%, followed by the Pacific Rim, at 61%, and then the United States, at just 49%.
Figure 7. Expected key markets of the medical device industry for 1997, as indicated by survey respondents (multiple answers permitted).
Small companies may well assume that although foreign markets may offer better prospects than the U.S. market, it simply isn't practical to focus on them with limited resources. Dave Gryska, CFO of Cardiac Pathways Corp. (Sunnyvale, CA), argues that this doesn't have to be the case. Cardiac Pathway's sales this year and next will be primarily international, he notes, adding that business climate for his company is "very good" this year. Gryska acknowledges that trying to sell direct in foreign countries would be "exceedingly tough" for a small company. He recommends a different approach. "What's important in international markets for a small company like ours," he advises, "would be to have a good distributor who understands the market, who will work with you in registrations of the product, who wants to spend the time training people to understand and use the product, and who is willing to make a substantial investment in partnering with you to launch and support the product."
As Figure 8 indicates, device companies are not limiting their international activities to sales of their products. A range of 10 to 15% of respondents indicated that some portion of their product design, clinical trials, first regulatory approval, packaging, R&D, and assembly is being conducted outside the United States. The largest number, 21%, reported themselves to be manufacturing some of their products abroad. Predictably, large companies are much more active in these areas internationally. Except for the strategy of seeking marketing approval first abroad, which 37% report doing, all these international activities are engaged in by upwards of half the large companies, with the largest number, 75%, engaging in manufacturing abroad.
Figure 8. Activities currently conducted outside the United States (52% of the respondents reported one or more).
When asked whether they are considering moving all of their manufacturing abroad, the numbers answering affirmatively are lower. This year, 16% of all respondents, and nearly a third of large companies, said they were considering this drastic move. While this is a significant number, it is lower in than all previous years except for 1993. This question is not so much an indication of international strategies as it is a barometer of frustration with regulatory or business conditions in the United States. As such, this year's answers suggest that a greater number of U.S. companies are finding the domestic market more attractive than before. This is borne out by the percentage of respondents rating the U.S. market a top one for growth in 1997. While the 80% response is much lower than the 95% of 1993, it is 12 points higher than the low point in 1995.
Even a company like Cardiac Pathways, which currently sells only outside the United States, has chosen to manufacture domestically. "We explored manufacturing overseas in 1993," Gryska says, "and based on the analysis we put together then, it didn't make sense from our perspective, for a company our size, with our technology, and it still doesn't."
THE U.S. MARKET
One reason that the U.S. market has become more attractive is clearly the lightening of the regulatory burden that has taken place in the last two years. But just as clearly, the difficulties of selling into the U.S. market have increased. The ongoing growth of managed care, along with the continuing consolidation of hospitals and the rise of chains like Columbia/HCA, are creating increased demands for price concessions, high-volume contracts, extensive pre- and postsales services, and a variety of inventory management capabilities, such as just-in-time (JIT) delivery, bar coding, and electronic data interchange.
The open-ended questions on this year's survey asked, "What customer expectations impose the greatest difficulties for your company's product sales?" and "What do you feel will be the greatest challenge facing your company in the next 12 months?" A large majority of the answers cited either price pressures, delivery requirements (such as JIT), or the challenges posed by the high-volume needs of large buying groups.
STRATEGIES FOR SMALL COMPANIES
In such an environment, it would seem obvious that large companies have a substantial advantage over small ones, given their greater ability, through their economies of scale, to meet these kinds of requirements. Yet the small companies surveyed this year expressed a surprising degree of optimism about their business prospects. Why? The answer seems to be that as small companies come to understand the changes in the marketplace, they are taking advantage of the nimbleness and adaptability that comes with small size to find and exploit new opportunities.
The competitive hurdles facing small companies are indeed significant. As Physio-Control's Martin says, "It's clear that large companies have an advantage in this marketplace. The larger companies that, in effect, leverage their deep pockets, if they do it well, can bring a level of service to the customer that a small company just can't." Vasamedics's Borgos, whose company is currently pursuing a distribution agreement with a larger manufacturer, agrees: "A small company just can't provide the support services and training that may be necessary on a complex product."
|FDA-Related Problem||Total (%)||1996 Sales Volume in $Millions (%)||Geographic Distribution (%)|
|<$1||$1-$4||$5-$49||>$49||New England||Middle Atlantic||Midwest||South||West|
|510 (k) clearance delays||28||18||40||29||61||18||24||32||31||30|
|GMP inspection problems||9||7||17||7||14||0||14||18||6||6|
|PMA/PMA supplement clearance celays||8||3||3||18||35||7||4||8||5||12|
|Enforcement actions (injunctions, seizures, etc.)||3||2||3||4||2||0||0||4||4||6|
|MDR/user reporting problems||2||0||3||0||0||0||4||0||5||0|
|Encountered one or more problems||42||25||57||57||71||30||28||47||40||53|
Table I. FDA-related problems encountered by respondents during the past 12 months.As Table II suggests, small companies to date have had less success than large ones in selling to high-volume customers like group purchasing organizations (GPOs).
|Purchasers||Total (%)||1996 Sales Volume in $Millions (%)|
|Group purchasing organizations||21||15||27||26||55|
|Other health-care professionals||18||17||17||25||4|
|Integrated health-care networks||17||10||20||25||25|
|Freestanding outpatient centers||16||13||17||22||14|
|Home health-care agencies||10||10||13||7||6|
Table II. Direct purchasers of medical products manufactured by respondents (multiple answers permitted).The "critical mass" for device companies, says Martin, "has grown significantly. I don't know what it is, but I know it isn't $50 million or $100 million. You've got to be substantially larger than that in order to compete effectively going forward." John Cumming, of WDI Capital Markets, a health-care advisory and investment banking firm in Hilton Head, SC, offers recent study results that seem to reinforce Martin's analysis, if not the exact numbers. According to Cumming, "Of medical device companies under $10 million in annual revenues, something like 88% were unprofitable. To get to the point where 50% of the companies in a group were profitable, it took about $25 million in sales."
Small companies are adopting a number of strategies to succeed in this environment. One approach is simply to sell out to a larger company. Richard Martin argues that the realities of the evolving marketplace won't doom small companies, but "will simply change the expectations of what one does when one engages in invention. We're seeing small start-up companies that are starting with a new technology or clinical idea that they don't ever intend to market themselves, because it's too complex and too big a job. Instead, they're going to bring the technology to the point where it's salable. So as long as there's a feeder mentality and the larger companies are willing to pay premiums for good technology, I don't think there will be a problem."
John Cumming cautions, however, that because smaller companies tend to be unprofitable, they need "a very novel product with good patents" to be attractive prospects. He also suggests that small companies should look to merge with other small companies instead of being acquired by a large one, because "that's where the bigger gain is." If he were running a small company, he says, "I would look to merge with two or three or four other companies. Even though I'm going to be diluted, in the end I'll have a larger company that will sell for a higher multiple of sales, and I'll make more money than by selling out early."
Another approach is partnering. Cumming says that his firm encourages small companies "not to try to build their own distribution infrastructure, but to form a strategic alliance with another company that already has it in place. Partnering is critical for a small company. Not having the scale, a small company will have credibility problems with hospitals, however unfairly."
Partnerships can be just as important for large companies. Ohmeda, for instance, has an agreement with Hewlett-Packard covering specified areas of distribution and product development. According to Joe Pepper, Ohmeda Medical Devices Div. president, the agreement with HP is a model more companies will likely follow in the future. "Alliances, or partnerships with a small p, will have to be undertaken to fill gaps in your line, or to be able to bundle either a therapy-specific or a specialty-specific package together. I think you're going to have to do partnerships to get access to technology or R&D or to technologically trained people that you either don't have or would need too long to develop." He adds that partnerships will have to be expanded to both customers and suppliers as well. "The idea has to be expanded across the whole value chain."
Even in today's marketplace, small companies can parlay a cost-effective and innovative product into a success. "If your company has a technology that is unique in its ability to provide better monitoring, diagnosis, or therapy, and it cuts costs--and you don't have competition from a larger company with very similar products--you're going to be just fine," says Ray Larkin. "Go sell the hell out of it!"
Anil Rastogi, president and COO of Sabratek (Niles, IL), attributes his small company's success in part to the fact that "we have high-quality products with an attractive pricing structure for our customers. They feel that with our products they can reduce their operating costs and at the same time provide better quality service to their patients." One way his products help cut costs, he says, is by incorporating telemedicine into them, so that patients can be remotely monitored at their homes, thus reducing the need for nurse visits.
Protocol Systems (Beaverton, OR) has had a similar success, says director of corporate communications Grant Gibson, by developing what he calls "enabling technologies." According to Gibson, Protocol's highly portable monitors that communicate directly with central displays allow hospitals to cut costs "by moving higher-acuity patients to lower-cost areas." This example, he says, "is what we believe is going to make a difference in the future in the domestic market in terms of growth. If you're just selling the same product and selling it the same way you were five years ago, it's not going to be enough."
But technology alone is not enough either, says Robin Young, a device industry analyst with Stephens, Inc., a Little Rock, AR, investment bank. Many small device companies today are strictly technology driven, he says, "and the reality of the marketplace today is that you have to be marketing and production driven. It's almost as if they have to become like a Japanese automobile manufacturer--you have to learn just-in-time, you have to effectively set up and operate a sales force, and so on." According to Young, "the companies that seem to be prospering right now are those that have their own R&D, manufacturing, and direct sales force. And companies that have sought designations such as ISO 9001 certifications are finding easier acceptance among GPOs and consolidated hospital organizations. It's a marketing tool, but it's also creating a more efficient manufacturing process."
As daunting as the new requirements for marketplace success seem to be, the majority of small and large companies alike seem to share an optimism that they will find strategies to prosper. Few executives underestimate the challenges. Ray Larkin's comment is typical: "It takes much more work today, much more planning, much more information about where you actually are, and much more of a focus on the cost side, than even five years ago." With regulatory problems much diminished, the ability of device companies to master the new marketplace is much improved, however--as is the business outlook. As Richard Martin puts it, "in general, I don't know anyone who isn't encouraged right now, and that feels good."
MD&DI's Business Outlook Survey was conducted by the nationally recognized independent research firm Readex, Inc. (St. Paul, MN), from October 23 to December 16, 1996. Questionnaires were sent to 450 executives whose names had been randomly selected from domestic recipients of the magazine and who serve as general managers, presidents, CEOs, COOs, chairmen, owners, principals, CFOs, or vice presidents.
The survey was closed when 223 reports were received--a 50% response rate. The number of responses tabulated was narrowed to 156 to ensure that respondents were with companies that manufacture FDA-regulated medical devices. The margin of error for percentages based on 156 responses is ±7.6% at the 95% confidence level.
1997 BUSINESS OUTLOOK REPRINTS
The complete results of MD&DI's exclusive 1997 "Business Outlook Survey" are now available in reprint format. The bound volume includes the complete text and graphs from this month's summary, along with previously unpublished tabular breakdowns for each question posed in the survey, both by geographic region and by company sales volume. Individual copies are priced at $35 prepaid (California residents, add 8.25% sales tax).
To order copies, send payment to "Business Outlook Survey," Canon Communications llc, 3340 Ocean Park Blvd., Ste. 1000, Santa Monica, CA 90405. For further information, call 310/392-5509, or visit the Canon Communications Bookstore on the World Wide Web, at http://www.devicelink.com/bookstore.