The “X” Factor
TaXed in 2013 and veXed about regulatory and market issues, industry experts share their thoughts about the year coming and going.
As 2012 marches toward its close, the imposition of the medical device tax looms as an important issue for the medtech industry in 2013.
But for most of the industry professionals with whom Orthopedic Design & Technology chatted to get their views on the year-end outlook for the industry in general and the orthopedic sector in particular, the 2.3 percent excise tax that will, barring a legislative miracle, take effect as the calendar flips over to the new year isn’t even the biggest issue of concern going forward.
As Tobias “Toby” Buck, CEO of Pierceton, Ind.-based contract manufacturer and designer Paragon Medical Inc., puts it emphatically, the biggest single issue facing the medtech sector is “regulation, hands down.”
Buck said there’s an “unbridled regulatory doctrine” being imposed on the industry.
“We’re actually trying to regulate instruments and cases and trays in the same fashion as we regulate implants, and it’s just amplifying costs and simply going in the wrong direction,” he said. “It’s economic lunacy to do what the FDA (U.S. Food and Drug Administration) is doing to this industry. The pendulum has swung so far to the right in terms of regulatory constraint; we are not paralyzed, but we certainly are exceedingly constrained.”
Mark DuVal, whose Minneapolis, Minn.-based firm DuVal & Associates PA practice focuses on drug, device and food law, says the biggest issue is the “sorry state” of the industry’s relationship with the FDA. The bottom line, he said, “is that what we’re seeing before our very eyes is the slow destruction of the 510(k) program. A lot of incremental innovation that would have been accepted as part of the 510(k) path in previous FDA administrations is no longer being accepted today.”
DuVal said the agency uses its newly constructed interpretations of the 510(k) program definitions to “kick devices off” the 510(k) path.
“They do this without ever looking at the clinical and performance data being submitted by an applicant. We’re losing the very heart and soul of the 510(k) program,” he said. “Not everything can be handled as a de novo or a PMA (premarket approval application). FDA approves 22 to 35 PMAs per year and clears 3,000 to 4,300 510(k)s. We cannot make the 510(k) program PMA-like or we’re going to be shutting down this industry.”
For her part, Joanne Wuensch, medical device industry analyst for BMO Capital Markets in New York, N.Y., said the industry is looking ahead—but it isn’t all positive.
“It’s looking toward the device tax in 2013,” she said. “It’s looking toward managing in a more mature market environment. The markets have become more stable—stable ortho markets, stable cardio markets. The word ‘stable’ keeps coming up as we think about and write about these companies.”
The medical device tax might be the singular, discrete issue facing the industry in the near term, she said, but she considers other matters such as FDA warning letters, product launches, healthcare utilization, pricing, and austerity measures in Europe as “the main issues that we worry about.”
John Babitt, medtech leader for the Americas at global consulting giant Ernst &Young, leans toward neither the device tax nor regulatory issues as leading the list of key issues facing the industry in 2013. He suggested that the bigger issue really is how medtech companies get a “larger slice of the healthcare economics.” He characterized the medical device tax and dealing with FDA as “here and now” issues.
“What we’ve done is taken a bigger-picture view,” Babitt explained. “If you look at the challenge for 2013 and 2014 as getting a bigger slice of the economics, in order to really accomplish that—and this is really the bigger challenge over the next several years—medtech needs to rethink its business model.”
He said the question for medical device companies—that he characterized as an “issue and opportunity”—for 2013 and 2014 is: “Can they move closer to the provider and participate in some of the dislocation of healthcare delivery to really get a bigger slice of the economics for treating those patients?
Babitt added that the value proposition for medtech traditionally has been delivered by manufacturing new products for physicians and maintaining highly specialized, well-trained sales forces that focused on selling to physicians.
“But if you look at the value proposition going forward, it’s really going to have to be more focused on payers and demonstrating value,” he explained. “That’s how they’re going to get paid, that’s how they’re going to get bigger economics.”
He said that another trend going into 2013 is a continuation of a healthy appetite for mergers and acquisitions (M&A).
“We still see a pretty robust M&A environment,” he said. “We’ll see smaller deals, but there’s a pretty active environment amongst the corporate, the conglomerates, the private equity firms. There’s pretty good activity, and we expect that to continue in 2013 as well.”
One orthopedic sector deal that captured considerable attention was Medtronic Inc.’s late-September agreement to buy Chinese orthopedic implant maker China Kanghui Holdings in a deal valued at $816 million. The planned acquisition was seen as giving the Minneapolis, Minn.-based firm a broader foothold in the global medical device market with what would be its biggest overseas acquisition.
The deal will bring Medtronic closer to its goal of getting 20 percent of sales from emerging markets by 2016, up from less than 10 percent in 2011.
“Kanghui brings Medtronic a broad product portfolio, a strong local R&D and manufacturing operation,” said Chris O’Connell, president of Medtronic’s Restorative Therapies Group. He added that the deal provides “advantages in the fast-growing Chinese orthopedic segment, as well as a foothold in the emerging global value segment in orthopedics.”
Speaking on the opening day of the Cleveland Clinic’s 10th annual Innovation Summit in late October, Richard Parker, M.D., chair of orthopedic surgery at the clinic, spoke about the challenges inherent in the changing healthcare landscape.
“Over the next 20 years we’re going to have to do more with less,” he said. “We’re going to need to demonstrate and prove value. We’re going to be expected to be paid for performance. We’re going to need to share risk and we’re going to need to demonstrate comparative effectiveness.”
Raj Denhoy, managing director at Jefferies & Co. in New York, N.Y., picked on some of the same themes, telling The Wall Street Transcript in a recent conversation: “The broad theme that we continue to focus on is that there is a fundamental shift taking place right now in the way medical devices are being sold and brought to market. The way that this industry has done business over the last 25 or so years is fundamentally changing. The model for a long time has been that the surgeon or the clinician who uses the technology was the ultimate customer. That is now changing.”
He said the customer is being more broadly defined.
“The customer is still the clinician, but it now includes the hospital, the insurance company and the governments who are paying for the technology, and their focus tends to be a little bit different,” he said. “And the industry is still trying to adapt to this change.”
Denhoy added that some of the larger device categories such as hips, knees and spine are starting to show the effect of this changing dynamic.
“A lot of what's sold in those markets could be considered commodities,” he said. “There is very little clinical differentiation among the various products and the various companies. And as the purchasers tend to focus on this more, it's starting to drag down pricing. I think this trend is going to continue for a long time as a major secular headwind for this industry.”
Venkat Rajan, advanced medical technologies industry manager in the San Antonio, Texas, offices of global consulting firm Frost & Sullivan, described the industry as being “in a state of flux.” He cited a combination of factors: “The healthcare reform issues, all the changes that are happening there; a great deal of transition in a lot of the big medtech companies, with new CEOs coming into place, business units being merged or contracted, new strategies being looked at in terms of emerging markets; the scheduled enactment of the medical device tax next year.”
Rajan added: “I think you’re seeing a lot of companies in a state of transition where they were geared to a certain market and business model over the past decade or more, and now they’re readjusting in terms of how they look at certain disease states and their technologies, how they look at the importance of emerging markets, things like that.”
One of the big orthopedic companies that very much fits Rajan’s description of being in transition is Kalamazoo, Mich.-headquartered Stryker Corp., which in late September named Kevin Lobo, the head of its orthopedics unit, as its president and CEO. Lobo, a former Johnson & Johnson executive, joined Stryker in April 2011 to head its neurotechnology and spine division, then was promoted two months later to head the company’s flagship orthopedics division.
While Lobo had never previously been a CEO, analysts said his experience in international markets would benefit Stryker as it seeks to build sales in those markets.
Asked to describe the state of the orthopedic sector as 2012 draws to a close, Paragon Medical’s Buck cited the combined impact of amplified regulation, the imposition of the Affordable Care Act, and the medical device tax.
“We still have a tremendous amount of anxiety in anticipation of full deployment of the Affordable Care Act,” Buck said. “I think we as an industry are trying to understand or introduce clarity in what the DRG (diagnosis-related group, used for hospital payment) configuration is going to be in terms of reimbursement doctrine. The industry is searching for answers as to how it is going to cover the 2.3 percent medical device manufacturers’ fee, which is on gross revenue, right off the top line. A lot of people don’t understand the sensitivity to the fee and the magnitude of its impact on a given organization’s income statement.”
He said the large multinational firms Paragon does business with are going to have to “pass it on or push it down, and what they’re trying to do is manage their inventory thresholds in the field and are compressing their safety stock levels across the board.”
Buck, who spoke with ODT while in the midst of an extended business trip to Europe, touched on reports that Europe is eyeingrevisions to its regulatory structure that may leave it looking a bit more like the FDA.
“If the European Union actually leans toward the adoption of FDA-like rules, they’re moving in the wrong direction,” he said. “That would change the landscape and further constrict the introduction of new products.”
Officials of the two Washington, D.C.-based national trade associations serving the medtech industry leaned toward both the medical device tax and the regulatory environment as key issues facing the sector.
While saying he believes that “many pieces are in place for the industry to turn the corner of what have certainly been some challenging years,” Mark Leahey, president and CEO of the Medical Device Manufacturers Association (MDMA), aimed the association’s and industry’s guns at the device tax.
“I don’t think it can be overstated just how onerous the impact of the medical device tax will be if this policy is not repealed,” he said. “The past several years have been challenging with the regulatory environment, pricing pressures and uncertainties in the marketplace. Just as we are starting to see some improvements in the economy, this vibrant sector will be severely impacted by an excise tax that will thwart innovation and patient care. Whether a startup or an established company, the device tax will have a devastating impact on this industry.”
On the regulatory side, Leahey hailed what he termed “the successful completion and negotiations” of the medical device user fee reauthorization (the Medical Device User Fee Amendments of 2012, or MDUFA III) and the beginning of its implementation, which he said consumed much of MDMA’s and industry’s focus this past year.
David Nexon, senior executive vice president at the Advanced Medical Technology Association, or AdvaMed, also pointed to the pending medical device tax as the biggest single issue facing the industry as it marches toward 2013, “because that’s set to go into effect Jan. 1 and will have a very negative effect on the industry. We’re working our tails off to try to prevent it from happening.”
He said the FDA’s performance “is terribly important” to the industry, “and in the vast scheme of things FDA is probably more important to the industry than anything, but we’re hopeful that’s on a better course. It’s not like there’s a single decision that is going to change things—they’re more accretive changes that will work themselves over time.”
Nexon noted that there’s a broader issue that has not been addressed as much: the overall U.S. tax system apart from the medical device tax.
“This a very competitive industry, in general, and there certainly are many other countries that would like to take over leadership from the United States,” Nexon said. “There have been studies that show that although we’re still the world leader in this sector, our relative strength is declining a bit, and in part that’s because we have a very uncompetitive tax system. So, we think the fact that both [political] parties [in the United States] are committed to tax reform and see competitiveness as an important issue offers an opportunity to improve the prospects for our industry in the U.S. and may also play a role in freeing up an improvement in venture capital and other investment in the industry.”
Interestingly, in late October, a leading orthopedic manufacturing firm, Warsaw, Ind.-based Zimmer Holdings Inc., announced that it appeared to have overstated the expected impact of the medical device tax. James Crines, executive vice president of finance and chief financial officer, said, “We now understand that the expense is not going to be quite as significant as the $40 million to $50 million that I referenced [earlier].” It is expected to be half that instead,” Crines stated. “So that perhaps is going to provide us with some opportunity to invest in 2013 a bit more aggressively, whether it’s in the sales channel or product development.”
Noted medtech entrepreneur and investor Josh Makower, M.D., long has been critical of the FDA’s performance. But with the adoption of MDUFA III and some of the milestones that were agreed to, Makower is hopeful that improvements will be made to the medtech ecosystem.
“I am hopeful that we will see improvements to the medtech ecosystem that will benefit patients and innovators alike,” he said. “The health of American innovation is too important for us not to achieve the improvements we all seek.”
Makower, the CEO of Mountain View, Calif.-based ExploraMed Development, a venture partner at New Enterprise Associates, and consulting professor of medicine at Stanford University, said the biggest question will be whether key ideas supporting better risk-benefit balance, predictability, transparency or “least-burdensome” approach that have been reinforced within MDUFA III will be implemented in a manner that will drive the “visible, meaningful and swift improvements needed to bring investors back into the space.”
Ann Quinlan Smith, president of the Minneapolis, Minn.-based Clinical & Consulting Division of NAMSA, a regulatory consulting firm headquartered in Northwood, Ohio, also cited FDA performance as a key issue facing the medtech sector.
“FDA appears to be trying to respond to concerns from industry that timelines for new approvals are just too long,” she said. “However, we may need to be careful what we wish for as the new post-market requirements are defined.”
She added that the advent of the medical device tax is placing incredible pressure on the industry, and, combined with the challenges of getting FDA approval, many companies are considering commercialization outside the United States in more lucrative and easily accessible markets such as China, India and Brazil.
DuVal said his biggest concern is the way the FDA is “unilaterally” changing the 510(k) program.
“They [the FDA] have a real disdain for the 510(k) program,” he said. “If you take the totality of the small, incremental definitional and procedural changes that CDRH (the FDA’s Center for Devices and Radiological Health) has made in the aggregate—and there’s a ton of them—they are essentially rewriting the 510(k) program almost out of existence through administrative fiat. The FDA is not a legislative body; it is an administrative organization meant to implement laws, not create them, yet the sum total of their administrative reinterpretation is rewriting the 510(k) program.”
He added: “This administration is pushing everything toward a de novo or a Class III medical device classification. FDA likes being in the never-never land of the PMA world, where they can pretty much ask for whatever amount of data they want. When FDA uses its stage-gated review process to kick devices off the 510(k) path and on to the de novo path, it results in an unannounced de facto trend of quietly up-classifying devices to de novo or Class III status.”
Buck said key orthopedic segments are “reasonably stable” at present, but without any “significant areas of growth.” He said hips and knees are still showing 2 to 3 percent growth, spine is “flat” and trauma and sports medicine are up because they most often are sudden, non-elective events that generally happen because of sports injury or accident.
“The industry essentially is in abeyance, but our backlog is strong for new product introduction, which has been slow over the past several years,” Buck said. “But we have passed the point where new product introduction has to occur because we have sat on our hands so long.”
For growth segments in 2013, he cited trauma and the extremities markets as “still experiencing a significant amount of growth.” Hips and knees—traditionally the industry’s mainstays—have been a different story.
“[They have] been flat across the board globally while at the same time the number of baby boomers has continued to grow, which means the demand is unavoidable,” Buck explained. “Between now and 2020, the number of hip and knee surgeries must double in the U.S. just to meet demand. How long can we kick that can down the alley? We’re all an orthopedic event that has already happened or is waiting to occur.”
BMO’s Wuensch agreed with Buck’s assessment, noting the hip and knee market has stabilized with a 2 to 3 percent growth rate.
“Similarly the spine market is in the low single digits, from a 1 to 2 percent growth rate,” she said. “I won’t call the spine market stable; I think it’s still a little more under siege than the hip and knee markets,” adding that in the spinal space, “an improvement in volumes would be a plus, and less-invasive would be a plus. There are some interesting products in terms of artificial discs that either are just about to make it or are beginning to make it through the FDA pathway.”
Wuensch said the extremities market still seems to be growing high single digits, with the foot and ankle market growing faster than the shoulder market.
“In general that market seems to be a little more robust and a little more concentrated in terms of market participants,” she said.
Ernst & Young’s Babitt said, “Ortho is a tough space right now. If you look on the contract manufacturing side, it is a real battle. Most technologies are viewed as relatively monetized.”
He noted that hospital procurement is playing a larger role.
“Physicians are becoming hospital employees, so while they have a seat at the procurement table, they aren’t as influenced by manufacturers as they used to be,” he explained. “Instead of a ‘Zimmer doc’ you now have a ‘Zimmer hospital.’ So I think we’ll continue to see further evaluations of just how orthopedics are delivered in the acute setting. It’s a very expensive delivery model right now with all the consignment inventory and all the service obligations that the device companies sign up for.”
Babitt added that this is one area where “size does matter,” and the large players are in a position to bring “thoughtful business model innovation” to the provider world.
“Hopefully that’ll be an area for advancement, and an area where they can get more of a holistic role for treating these types of patients and bringing efficiencies to the operating room,” Babitt said. “Several of the orthopedic companies have actually bought consulting businesses so they can be more consultative in bringing their expertise into the orthopedic surgical suite.”
The “big challenge” in the orthopedic sector, particularly in the spine, is reimbursement.
“A lot of these technologies are relatively new and there are bona fide questions about the outcomes and the benefits and the cost savings compared to other procedures, so it’s going to have a lot more clinical rigor applied to it and the companies are going to have to be more forthright in collecting data and partnering with payers to analyze the data,” Babitt said. “Hopefully a revenue-sharing model will evolve, but it’s a space where there are quite a few headwinds right now. You need consultants who can articulate the cost savings.”
Frost & Sullivan’s Rajan added that as far as growth sectors are concerned, most of the established orthopedic products have hit maturity, so they have single-digit growth rates, even single-digit declines in some cases.
“Essentially if you looking for growing markets you have to look at the underserved need,” he noted.
Buck expressed strong views on the outcome of the November elections, saying, “I think Gov. [Mitt] Romney must prevail. If [President Barack] Obama is reelected, I think you’re going to see an acceleration of job loss in the medical device sector. This administration simply does not understand the medical device industry, nor does it understand business in the broader sense. You’re not going to see things turn in the direction it needs to turn, where we actually get a tailwind instead of a headwind, if Obama is reelected.”
He said he believes that if the Romney ticket prevails, “you’re going to see some seminal moments in terms of a market adjustment and an uptick in demand as inventories are replenished.”
AdvaMed’s Nexon said he doesn’t expect dramatic changes, regardless of the election outcome.
“Obviously if Gov. Romney were to be elected, you’d have a whole different set of people to deal with, but, in general, we feel the fundamentals are going to be pretty similar no matter who gets elected,” Nexon said. “In terms of what affects us in healthcare, leaving aside the device tax for a moment, the biggest thing is the changes in the payment system, reorienting the system toward rewarding people for efficiency and quality and away from fee for service. That’s a good thing, but it can have the unintended consequences that if you’re not careful about where those changes are headed, they can also incentivize people to skimp on care and deny people access to the technologies they need and have a chilling effect on medical innovation.”
Leahey echoed Nexon’s sentiments.
“Regardless of which party is in control of Congress or the White House, our hope is that we can continue to move toward a more predictable and transparent regulatory framework, and that innovation and improvements to patient care will be valued and encouraged,” Leahey said. “The crucial element that medical technology innovators are looking for is to know the rules of the road, and that they won’t change once they’ve started their respective journeys.”
Makower took a more philosophical approach, avoiding a path that’s too political.
“It has long been my hope that elections never have any impact on the regulatory environment,” he said. “Science and data should always be the guiding lights of regulation and innovation, whether or not the Republicans or Democrats control Congress or the White House.”
Wuensch said she didn’t expect the outcome of the November elections to have any immediate impact on the industry in 2013. “It’s what you see is what you’ll get,” she said.
Jim Stommen, retired editor of industry publication Medical Device Daily, is a freelance writer focusing on the medical product sector.