Same Old Story?

Time loops are an incredibly frustrating phenomenon. Complex and incomprehensible, they are frighteningly random and strike without warning, snaring their victims in a perpetual cycle of repeat events. The experience can be a disconcerting—if not maddening—one, depending on the recurring reality’s overall vapidity.

Though the mechanics of time loops are quite simple (play, rewind, repeat, ad infinitum), their objective often can be difficult to determine. Some loops, for instance, exist to prevent certain actions (like the bombing of a Chicago, Ill., commuter train in the 2011 film “Source Code”) while others are merely self-improvement/spiritual transcendence vehicles (the 1993 classic “Groundhog Day”). A disturbing number, however, are illogical, subsisting solely to torture their victims—common souls like the convicted murderer at the heart of the 1961 “Twilight Zone” episode “Shadow Play.” In the episode, the criminal professes his innocence, claiming to be caught in a dream, but fails to convince his accusers before being executed. Alas, the convict does not die, but awakens from his electrocution in the courtroom, where he relives his nightmare with the same cast of characters in different roles (e.g., a fellow inmate is now the judge).

Fortunately, such ghastly loops are purely fictional; their reign of terror is limited to the imaginary worlds of parallel universes, extra-terrestrial encounters and time-traveling humans. But life has a funny habit of imitating art (far less creatively, of course), regardless of the consequences. Thus explains the “pseudo-loops” that can hinder our ability to resolve problems and learn from past mistakes.

For the last several years, the medical device industry seems to have penned its own version of “Groundhog Day”—battling the same foes, encountering the same hardships, hitting the same roadblocks. “Same-old, same-old,” as Bill Murray groused in the film.

“We’re still facing the same challenges, but now that it’s been a few years, those challenges seem more intense,” said Vicki Anastasi, senior vice president of medical devices for Aptiv Solutions, a Reston, Va.-based contract research organization serving the medical device, pharmaceutical and biotechnology industries. “Reduced availability of VC [venture capital] funding for devices, the increasing regulatory burden, the need to have innovative products moved into the market, and the overall concern about reimbursement and pricing—those are the challenges we face. They may have been more evident this year than in the past but these challenges have been fairly consistent for the last 20 years or so in some way, shape or form.”

That’s quite a powerful time loop.

Indeed, pricing pressures and regulatory rigmarole weighed heavily on the industry in 2013. Lingering fallout from the planet’s economic implosion, increased competition and hospital spending cutbacks have eroded product prices in recent years and capped their increases at less than 50 percent of the pace of U.S. inflation. A study released by the Advanced Medical Technology Association (AdvaMed) in September found the average inflation-adjusted prices for seven of the largest medical device categories fell between 2007 and 2011, with some plummeting as much as one-third. Drug-eluting stents sold by Abbott Laboratories, Boston Scientific Corp. and Medtronic Inc. experienced the largest devaluation, plunging 34 percent, while artificial knees from Johnson & Johnson, Stryker Corp. and Zimmer Holdings Inc. held their value best, slipping only 17 percent, AdvaMed’s data show. Other products averaged a 25 percent price differentiation, with implantable defibrillator fees falling 24 percent, cardiac resynchronization therapy defibrillator charges dropping 26 percent, pacemaker prices slipping 26 percent, artificial hip premiums sliding 23 percent and bare metal stent fares tumbling 27 percent.

Cost-conscious hospitals and bureaucrats weren’t the only price-busting spoilsports to thwart product value this year, though. The Centers for Medicare & Medicaid Services (CMS) contributed to the decline as well through the expansion of its national competitive bidding program. On July 1, the agency began requiring diabetic seniors to order testing supplies through a national mail-order program or a Medicare-approved pharmacy. The change affected 2.3 million Medicare beneficiaries who receive traditional fee-for-service Medicare assistance.

The program is part of a competitive bidding process created by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003. The process applies not only to diabetic testing supplies but also to products like wheelchairs, walkers, hospital beds and oxygen equipment. Authorities contend the competitive bidding process will save taxpayers $26 billion and Medicare beneficiaries $17.2 billion through 2022.

“In my mind, the single biggest issue that affected the [medtech] industry this year was pricing pressure,” said Dave DeMarco, Northeast Life Sciences leader at global services firm EY (formerly known as Ernst & Young). “This affects the entire industry—from the large manufacturers to the small startups. Two examples come to mind—the first is CMS [the Center for Medicaid and Medicare Services] opening up diabetes-related devices to competitive bidding. That will arguably push these devices toward commoditization, and that is going to exert tremendous price pressure on the manufacturers. Another example is Medicare’s payment for dialysis. That’s yet to be finalized but in talking with some of our clients in this space, the proposed 9.4 percent rate reduction would be extremely burdensome for their business. They are hoping to get that reduced through discussions.”

Pricing pressures clearly loomed large this year, but the issue nearly was overshadowed by an equally powerful blast from the not-too-distant past: the redefinition of medtech innovation.

In their 2011 state-of-the-industry report, Ernst & Young’s medical device gurus warned of the need for medtech firms to change their innovation models. A plethora of familiar risks—from regulatory constraints to healthcare policy uncertainty, shrinking reimbursement rates and pricing pressures—is creating a consumer- and payer-centric future where proven clinical outcomes will be paramount, they said. This “new normal” would require companies to revamp their business models and re-evaluate their product development, manufacturing and marketing practices.

Experts have rehashed their caveat annually since 2011 (often using the same terminology, but in each successive report, they’ve detailed the steps companies must take to compete in an outcomes-focused healthcare system. Last year, EY analysts advised device makers to embrace revolutionary new patient-empowering and information-leveraging technologies—advancements like smartphone apps, social media platforms and sensor-enabled smart devices. This year they recommended manufacturers incorporate those “disruptive” technologies into new business models that better reflect customer needs. These models, consequently, must move beyond the product (focusing on services and solutions that improve outcomes or lower costs), beyond treatment (prevention and remote monitoring) and beyond the hospital (enabling patients to manage their conditions at home).

Companies can achieve such business model innovation by focusing on capital efficiency to use scare resources wisely; initiating ecosystem-wide scanning to better understand the evolving healthcare environment; fostering collaborative cultures to tap the strengths of diverse players; becoming open data enterprises to pool information and develop resulting insights; adopting disease/value pathways to identify and fix “value leakages;” and using scalable processes with appropriate metrics to revamp business strategies.

“I think the biggest issue facing medtech companies [this year] was the scramble to redefine innovation in the face of increased pricing pressures and the greater levels of evidence required to demonstrate both clinical and commercial value. With this higher scrutiny on the end effects of a device or diagnostic, it has become apparent that new products that do not move the needle on outcomes, costs or underserved patient populations will not have the attractive ROI (return on investment) for OEMs that they may have had in years past,” noted Benjamin Dunn, a managing director with Boston, Mass.-based Covington Associates, a specialty investment banking firm serving the healthcare and technology sectors. “Customer and patient value will have to come in the way of services rather than products, and this is an enormous shift for many device makers.

“How companies define innovation will dictate who survives long-term,” he continued. “Companies that can’t figure out how to redefine innovation in this new world are the ones that face the real danger. Innovation must demonstrate both clinical and commercial value in the ROI. The stakeholders and buying decisions for medical devices are changing. It’s not just wowing a surgeon or clinician with some new improved device anymore, you now have to convince the hospital boards and payers that your device is better and has an economic ROI. That’s a different way of thinking about how you innovate for the products you’re developing. In my mind, it’s a longer-term issue towards which devices and companies will survive and be able to innovate in this changing world.”

VC Funding Down for the Count
Surviving the new world order in medtech innovation will require a mindset shift in both business model innovation and financing. Familiar forces like pricing pressures, comparative effectiveness research and dwindling product reimbursement have chased venture capitalists away from the device sector in droves and turned other benefactors into money-grubbing misers. Domestic and international regulatory scrutiny has been particularly worrisome for investors, curbing their appetite for risky medical technology.

The Physician Payment Sunshine Act and changes to the U.S. Food and Drug Administration’s (FDA) 510(k) process have soured capitalists on the homefront while the possibility of a centralized FDA-style system in Europe is spooking overseas lenders.

The proposed medical device directive currently before the European Commission proposes a pre-market approval procedure for high-risk Class III (implantable) devices, to be administered by a new committee within the European Medicines Agency.

Critics of the idea fear the directive will make the European medtech approval system as difficult as the FDA’s process. The directive could have repercussions in the United States as well. Companies frustrated with the FDA’s convoluted device approval process increasingly have released products in Europe first to obtain the market experience and patient data required for U.S. consent.

Such regulatory uncertainty and lower growth prospects on both sides of the Atlantic have decimated medtech funding. In the 2012-2013 fiscal year, innovation capital—the funds available for pre-commercial companies—fell 9 percent to pre-recession levels, according to Ernst & Young data. The firm’s statistics also show that innovation capital, which once accounted for nearly two-thirds of all medtech investment, provided less than 20 percent of the sector’s financing in 2012-2013. And most of the capital was awarded to established companies, leaving early-stage firms struggling for survival. Early rounds captured just 16 percent of the total funding in FY 2012-2013, down from 33 percent five years earlier.

“Think of it from the perspective of a venture capitalist,” DeMarco noted. “Your job is to find opportunities to invest that can give you a significant return on your money. In the past, developing devices have been good investments compared to pharma or biotech—devices have a relatively short regulatory path and only need a relatively modest amount of venture capital and yet can generate significant revenue. However, from a venture capitalist standpoint, pricing uncertainty and regulatory uncertainty are the things they tend to shy away from or think twice about and that’s becoming more of an issue now with devices. It’s not surprising that we don’t see as much venture capital as we have in the past.”

The industry’s unchanging choice of funding vehicles isn’t all that surprising either. Time loops, after all, don’t offer its victims much variety.

Debt has continued to constitute the vast majority of the sector’s total funding, driven largely by a handful of commercial leaders that have taken advantage of historically low interest rates. As in the prior year, there were eight individual debt offerings of at least $1 billion in 2012-2013. These leaders were responsible for an astonishing 82 percent of the industry’s total funding. In addition, more than 70 percent of the proceeds from debt financing have gone toward refinancing existing debt or restructuring balance sheets rather than for growth purposes.

Overall funding seemed stuck in rewind as well. Funding for medical device companies fell steadily in the first half of 2013 (as it did in 2012), plummeting 26 percent in the first quarter and 22.4 percent in Q2, according to Thomson Reuters data contained in MoneyTree Reports from PricewaterhouseCoopers and the National Venture Capital Association. Investments jumped 12 percent to $566 million during the third quarter (ended Sept. 30) but deal volume shrank 8 percent.
“What’s most significant to me is that these problems have been out there but they still haven’t been resolved,” Dunn said. “There still hasn’t been reform at the FDA and there still hasn’t been relief in the lack of funding for device companies, so the fact that some of these issues keep cropping up is itself an issue. We know what the problems are, but we haven’t been able to make progress on them. There’s been some change at the FDA, but I’m still hearing some very scary stories from people on how long the approval process is taking and how difficult the regulatory pathway is. And the FDA slowdown directly impacts venture capital funding. There is no clear timeline to when products will be approved, so venture capitalists are very slow to invest money when they don’t have a clear sense when their exit might be. These issues still remain front and center, and a big part of the paralysis is coming from Washington.”

Tax Battle Lines Redrawn
Stephen J. Ubl is quite familiar with that paralysis. For the last several years, it has thwarted his organization’s repeated efforts to block or repeal a 2.3 percent excise tax on medical devices—a levy the industry fears will cost the nation valuable jobs and its leading edge in medtech innovation.
In some respects, the sector’s attempts to kill the tax has unfolded in true “Source Code” fashion, with the same characters, setting and strategies recurring in a constant loop. But unlike Jake Gyllenhaal’s movie character (a U.S. Army helicopter pilot), the industry’s civil and commercial soldiers have not yet determined a way to avert disaster.

Medtech militia members have relived the “Tax Code” loop twice so far, each time mustering enough reinforcements from the same mercenaries in both political parties to prompt encouraging abolition votes in Congress. Last year, tax repeal legislation passed the U.S. House of Representatives but stalled in the U.S. Senate; this year’s skirmish followed roughly the same trajectory but died in action during the contentious 16-day government shutdown. While disappointed, Ubl and other industry leaders refuse to surrender, vowing to continue the fight (and repeating the time loop) until the tax is rescinded.

“The medical device tax was a priority area of focus, especially late in the year,” said Ubl, AdvaMed’s president and CEO. “We have been using every advocacy tool at our disposal to call attention to the need to repeal the tax, and the results show. For the first time, a strong bipartisan majority of Senators voted to repeal the tax this [past] spring. Repeal bills in both the House and Senate have solid bipartisan support with co-sponsors being added throughout the year. Addressing the tax was a key provision in proposed bipartisan budget compromises in both chambers. We are heartened by the strong and growing bipartisan support for repeal that we saw in both the House and Senate, and many members of Congress have committed to keep repeal of the tax front and center as debate on fiscal issues moves forward. AdvaMed and the industry are committed to full repeal of the tax, and we are going to continue to work to achieve that goal.”

It won’t be easy, though. Industry analysts believe opponents would have a greater chance of success by proposing an alternative funding source for the industry’s $30 billion subsidization of the Affordable Care Act (ACA). Neither legislators nor lobbyists have come up with a viable substitute.

More clarity about the tax’s financial repercussions also would help. Repeal advocates, for instance, have long warned about the tidal wave of job cuts that would be triggered by the levy (a projected 43,000 nationally, according to senior fellows at the conservative Manhattan Institute and Hudson Institute) as well as its chilling effect on innovation. And while some companies have instituted layoffs since tax repeal efforts intensified last year, Factcheck.org, a project of the Annenberg Public Policy Center at the University of Pennsylvania, concluded the cuts are nowhere near as large as lobbyists claim.

Layoff announcements cited by both the industry and Republican National Committee’s research team show that 8,725 positions have been or will be eliminated—20.2 percent of the estimated 43,000—but most companies did not blame their workforce reductions entirely on the tax, Factcheck.org noted. In a few cases, the tax wasn’t even mentioned.

Some of the cutbacks may have been premature, or in some cases, unnecessary, since many OEMs miscalculated the levy’s overall impact on their profits. Medtronic Inc. was off by $25 million and Warsaw, Ind.-based Zimmer Holdings Inc. erred by $10 million. AdvaMed’s appraisal was the most accurate: Through the first six months of the levy’s Jan. 1 implementation, the industry paid more than $1 billion in taxes on gross sales of medical devices.

The overestimated tax bills most likely were an honest mistake, the result of a confusing and ambiguous Internal Revenue Service (IRS) code, experts claim. The IRS, for example, allows businesses to deduct “all excise taxes that are ordinary and necessary expenses of a business;” hence, Moody’s investors services believes the net tax effect for companies is actually 1.5 percent.

“There’s been a lot of confusion as to which number to calculate the [device] tax on,” Dunn told Orthopedic Design & Technology. “If you use outsourced suppliers, it’s not clear who is responsible for which portion of the tax. It’s created a major accounting problem for companies. The IRS has been trying to provide guidance but they are still learning as well. There’s been a great deal of confusion, which has only added to the hassles of complying with the tax.”

Game. Set. Rematch?
Regardless of its complexity, the device tax is law (for now) and unlikely to be repealed in the near future. But the controversy it has generated most certainly will continue as abolitionists prepare for another bout with ACA defenders.

Another chance to alter reality.

Another trip through the time loop. Rewind and repeat.

“It goes without saying that if the device tax is still in effect, repeal will again be our number one priority,” Ubl said.

The device tax won’t be the only issue to resurface next year, though. Analysts also expect encore showings of pricing pressures, regulatory scrutiny (in America and Europe), shrinking reimbursement rates, a capital funding drought and emerging market strategies.

“The rollout will be in full swing as we embark on healthcare reform in whatever stage it is. Even if Obamacare was to be repealed, something is going to come in its place. There has to be some kind of U.S. healthcare reform and right now it’s Obamacare,” said Mark Bonifacio, president of Bonifacio Consulting Services LLC, a medical device manufacturing consultancy in Natick, Mass. “It’s the law. You can either comply with the law or break the law but the fact of the matter is it’s law. That’s going to be forefront and will shape the industry as we begin to see more clarity. There’s still a little bit of uncertainty connected with the law—are we going to see 30 million new patients? Is that going to drive the demand that people were talking about? Will the adoption be slow? That’s going to be huge domestically. On a global basis, I think seeing how China begins to come into the marketplace and what their spend is like and the kind of products taking off in the BRIC nations will shape how the industry operates in 2014.”

Trade groups such as the Washington, D.C.-based Medical Device Manufacturers Association expect the Physician Payments Sunshine Act and accountable care organizations to have a bigger impact on the sector next year, while Covington Associates’ Dunn predicts a strong showing in the robotic surgery space.

“Robotic surgery will be very interesting to watch in 2014,” he said. “The increased scrutiny on safety and efficacy that has introduced some doubt about traditional platforms hasn’t waned interest in this area in light of the $1.65 billion Stryker acquisition of Mako and the continued level of venture capital going into companies such as Medrobotics and Mazor Robotics’ recent decision to raise up to $46 million on the NASDAQ stock exchange.”

Other analysts forecast robust growth next year in neuromodulation devices and orthobiologic products. To ensure success in these respective product sectors, however, companies must accept the industry’s “new normal” and find ways to link clinical results to health economics, experts noted.

“The regulatory challenges in the U.S. and Europe, the reimbursement challenges, the lack of venture capital—all that was the same this year. And I think that we should not continue with the same negative views but look to the solutions,” Aptiv Solutions’ Anastasi said. “What we need to do is get beyond that and realize that this may be where we are. We are going to have regulatory hurdles, we are going to have to worry about safety, we are always going to have to look for funding and look for ways of using our funding to the best of our abilities to move products forward. It’s time for the industry and the investors to look for ways to accept this new reality and do what we need to do. Next year, we need to focus on efficiencies, addressing trial design and linking our results to health economics to address the challenges of regulatory, reimbursement and funding.

“It will be a little bit boring if we have this conversation the same time next year and we’re still talking about the same challenges because the challenges will still be there.”
Waiting inside the loop.