New Market Forces Reshape Medical Device Sector

There aren’t too many people that wouldn’t benefit from the proverbial crystal ball—particularly when it comes to predicting the fortunes of the medical technology market. And there are plenty of unknowns clouding the picture of future market performance.

Though he may not be clairvoyant, but Bryan Hughes, director of P&M Corporate Finance, LLC, was able to provide attendees at the recent Orthopedic Design & Technology Conference and Exhibition with some statistics and insights into what the next few years of medical device manufacturing could look like. Issues such as U.S. Food and Drug Administration (FDA) device clearance performance, healthcare reform and a looming $2 billion a year tax on the medical device industry are among the many issues that even the most astute industry observer is attempting to sort out.

“As healthcare reform becomes a reality, and pricing pressures have compounded the impact of lower procedure volumes, medical technology companies will have to focus on all aspects of their business, particularly cost,” Hughes said.

He cited figures showing that the global medical device market is larger than $250 billion in annual sales, made up of more than 20,000 firms (compared with the pharmaceutical industry’s more than $850 billion and 7,000 companies). While orthopedics (approximately $17.3 billion in 2009) and cardiovascular ($27 billion last year) remain the largest industry sectors, they aren’t the fastest growing. According to figures from Frost & Sullivan, the neurology ($3.7 billion) and cosmetic and aesthetics ($1.8 billion) markets are growing at a livelier pace—approximately 17 percent and 14 percent, respectively.

According to Hughes, healthcare reform will be a mixed bag for the device industry. While the reform is expected to bring 32 million new patients into the healthcare system, the industry tax that was part of the legislation pulls in a different direction.

“To be clear, health care reform is a good thing for Americans and over a long-term horizon we believe the medical technology industry will experience a modest push from the legislation,” he told attendees at the annual conference based in Fort Wayne, Ind.

With more Americans receiving coverage for the first time, the influx of new patients into the healthcare system will have a “profound, yet selective impact” on the industry as a whole. “Many industry analysts have stated that this rapid influx of patients will increase spending on medical devices by 10 to 20 percent,” Hughes said.

He explained, however that the 32 million uninsured patients would be a bigger boon for technology companies targeting younger patients than firms promoting preventative and diagnostic therapies. People older than age 65 already are covered by Medicare. For example, 82 percent of knee replacement patients and 75 percent of hip replacement patients are older than 55.

“While only select companies will benefit from increased coverage, all medical technology companies will pay for the privilege. Most industry analysts predict that the medical devices tax will reduce profits on average 4-5 percent,” Hughes explained. “Because the tax is based on revenue generated inside the United States and not profits, smaller companies lacking international footprints and high margins will likely experience a much higher reduction in profits, up to 15 percent by some accounts.”
This reduction in profits isn’t likely to be fully absorbed by shareholders, he told the orthopedic audience. More than likely, it will result in companies laying off employees and cutting research and development budgets.

The “silver lining,” Hughes noted is that companies will now focus on the actual cost to manufacture products. As a result, firms will be forced to focus on operational efficiency and will need to look to manufacturing partners to make this happen. He cautioned that device suppliers must have comprehensive quality systems in place and make them the highest day-to-day priority. He added that suppliers might spend more time directly interacting with the FDA.

“The FDA has full regulatory authority over medical devices and this authority extends all the way through the supply chain,” Hughes explained. “Under CFR 21.820, device OEMs are responsible for the quality systems under their own roofs, but also those of their suppliers. The supply side of this equation has created significant issues for several OEMs. Every company is acutely aware of the potential regulatory issues and should be laser focused on the quality systems of its suppliers.”

Increasingly, as companies look to more of a partnering model, engineering and design capabilities also are becoming a “driver of success.”

Medical device companies “want a little bit of everything” when evaluating suppliers to outsource manufacturing. As the supply based continues to evolve, Hughes explained, OEMs will ask their manufacturing “partners” to take more responsibility in the completed process. Thus, contract manufacturers and outsourcers will need to have a diverse manufacturing capabilities and capacity.

“You don’t need to be everything to everyone, but if you are able to bring experience with multiple types of equipment and processing methods, you are much more likely to become a preferred supplier,” he added. “Preferred suppliers are important to device companies, as the cost of a stock-out or launch delay are devastating. Not only is revenue lost for that particular instance—which, with gross margins around 95 percent in some cases, means huge dollars on the bottom line—in many situations, not delivering for a surgeon or other physician can irreparably harm that relationship.”