International Intrigue
Trepidation over healthcare reform and sluggish sales are prompting medical device firms to look overseas for long-term growth.
At some point during his hiatus from the academic world, Bruce C. Arntzen turned into a celebrity of sorts. Not the sunglass-wearing, paparazzi-hounded, scandal-tainted luminary typically found in Hollywood, but the peer-respected, well-educated, genius type prevalent at top-tier universities.
Arntzen isn’t sure when he became a pseudo-celebrity. Quite frankly, he wasn’t even aware he was a celebrity until he returned to his alma mater, the Massachusetts Institute of Technology (MIT), two years ago to run the master’s degree program in supply chain management. Only then did he learn that a paper he co-authored more than a dozen years before had become famous, almost legendary, in academic circles. Much to his surprise, Arntzen discovered that the paper, “Global Supply Chain Management at Digital Equipment Corporation,” was the most quoted article in its field in 1995.
It would seem only logical then, that MIT officials would want to showcase their “star” upon his return to the school in 2009. They asked Arntzen to re-present the paper.
Arntzen agreed, but wanted to review the material first. He retrieved the slides that accompanied the paper and began a sojourn down memory lane. Each page of the slide presentation seemed like its own time capsule, chock full of compelling information on import duty rates, international labor cost trends, currency exchange rates and the global supply chain, all of it painting an accurate (albeit irrelevant) portrait of the world the way it existed in 1995. Perhaps the most telling sign of the data’s obsolescence, though, was not the exchange rates Arntzen included in the slides or the duty charges listed. Rather, it was the omission of one word: China.
“We talked tremendously about international trade and flows, market areas, major regions of the world for manufacturing, regions of the world to sell product and so forth. I had lots of examples about what things were like in different countries but never once in about 50 slides did we talk about China,” recalled Arntzen, Ph.D., executive director of the Supply Chain Management Program at MIT’s Center for Transportation & Logistics in Cambridge, Mass. “That is just mind-boggling because if you’re going to have any kind of discussion about international manufacturing, distribution, marketing or whatever, China is in the first sentence you’re going to talk about. And yet we didn’t say anything about it. It’s as though we were not thinking at all about China in 1995.”
Indeed, few companies were thinking about China back then. Those that did braved the industrially immature nation mostly to take advantage of low labor costs and mass-produce clothing, toys or shoes for consumers. Medical device manufacturing practically was non-existent in 1995. But in less than a generation, China has morphed from a scrappy developing nation into a global manufacturing hub, producing everything from wheelchairs and infrared thermometers to medical tables and anesthesia machines. Establishing a manufacturing base in China—once reserved only for multinational corporations—now is necessary for long-term growth.
“China has risen very quickly. The sheer number of people in the country means that they’re going to have a huge economy,” Arntzen noted. “Even if China still has a billion people with very low wages, they now have a middle class population as big as the whole U.S. population (300 million). As this middle class grows rapidly in both numbers and spending power, its purchasing power will dramatically change the flows of products globally.”
The precise magnitude of this sector’s purchasing power is still undetermined, but preliminary estimates are promising: Middle-class spending in China is expected to top such expenditures in the United States by 2020, according to the Paris, France-based Organisation for Economic Cooperation and Development. The group also is predicting that China and India will comprise 41 percent of the world’s middle-class consumer spending in 20 years (up from just 5 percent of global middle-class consumer spending in 2009).
Such drastic improvements in middle-class spending over the next two decades is expected to have a significant impact on China’s healthcare system. With more discretionary money at their disposal, experts claim, the middle class will pay more attention to their health, leading to a domino effect on providers, hospitals and medical supply companies. Indeed, the 12th Five-Year Plan the Chinese government released in early March is based on jump-starting private consumption in the Middle Kingdom. The plan focuses on three major pro-consumption initiatives: developing “large-scale transactions-intensive industries” such as healthcare; boosting wages; and building a social safety net through the funding of programs such as Social Security, private pensions and both medical and unemployment insurance. Morgan Stanley economist Stephen Roach believes the plan will “change the character of China’s economic model—moving from the export- and investment-led structure of the past 30 years toward a pattern of growth that is driven increasingly by the Chinese consumers…[This plan] is likely to spark the greatest consumption story in modern history. Today’s post-crisis world could hardly ask for more.”
Neither can the medical device industry. Lured by consumer healthcare spending forecasts of 11.6 percent annually through 2025, an increasing number of medtech firms in the United States and Europe are expanding their existing operations in China or setting up shop there. The robust economic growth in Asia and parts of South America is acting as a beacon of hope for device companies battered in recent years by a perfect storm of increased regulatory scrutiny, more stringent reimbursement requirements, aggressive new procurement procedures and a badly bruised economy.
Markets long ignored by the industry’s largest companies now are being treated like belles of the (medtech) ball as device firms enlist their help to secure long-term growth.
The Building BRICs of Medtech Growth
Olivier Bohuon is not a big fan of change. After he assumed the helm of Smith & Nephew plc in April from retiring CEO David Illingworth, there were little, if any, immediate differences in staff or daily operations. There were no major personnel moves, no complex restructuring of departments. Nothing.
“Whenever a company gets a new CEO there is a lot of speculation about what he’s going to change, what he wants to do, and what will change in the strategy. I do not believe in change for change’s sake,” he told investors during an Aug. 5 conference call to discuss second-quarter earnings. “When I make changes it is because I see anticipated changes in our environment, customers, markets, and competitions, and we need to address this to be successful.”
Bohuon’s colleagues in management learned a very important lesson about their new boss during his first few months on the job—he is a man of his word. Less than two weeks before he publicly shared his tenet about change, Bohuon handed down his first major directive as CEO: an ambitious realignment of Smith & Nephew, streamlining operations in developed countries and targeting growth in the emerging markets of Brazil, Russia, India and China (known collectively as the “BRIC” countries), a quartet of nations with a combined population of 2.7 billion people, a gross domestic product that ballooned 92.7 percent over the last decade (2000-2010), market capitalization valued at $6.4 trillion last year, and—perhaps most importantly—an incredible need for healthcare products and services.
This certainly was no change for change’s sake.
The realignment divides Smith and Nephew into four operating units, with two focusing on established markets and two concentrating on international opportunities. Responsibility for the established markets—Australia, Canada, Europe, Japan, New Zealand and the United States—will fall to the new
Advanced SurgicalDevices Division (a combination of the company’s Memphis, Tenn.-based orthopedic reconstruction business and its Andover, Mass.-based endoscopy unit) and Advanced Wound Management.
A new division, meanwhile, will focus on the BRIC markets, selling endoscopy, orthopedic and wound management products as well as driving research and development (R&D) initiatives. And a fourth division will hone in on international markets such as Central and Latin America, Eastern Europe, South Africa, South Korea and Southeast Asia. While this division mainly will be served by distributors, Bohuon said Smith & Nephew management will work to modify the number of distributors it uses and find new investment opportunities.
Clearly, the realignment is designed to help the company grow sales in the BRIC bloc—executives are aiming for a four-fold increase within the next five years, from $120 million to $500 million. Given the demographics and unprecedented economic growth in the BRIC market (its import and service demands are estimated to be more than $2 trillion, or 13.5 percent of global imports), Smith and Nephew’s 2016 revenue goal may not be such a difficult one to attain.
“In the last few years we have seen the markets around us change, some significantly,” said Joseph Metzger, senior vice president of corporate communications for Smith & Nephew. “Our established markets, especially in North America and Europe, are under pressure. At the same time emerging markets have huge potential.”
Colossal potential, actually, according to industry data. China’s medical device sector, valued at $8.6 billion, is expected to grow 131 percent this year, making it one of the world’s fastest-growing markets, figures from United Kingdom-based Espicom Business Intelligence indicate. The business intelligence services firm estimates Brazil’s medical market to be worth 6.7 billion real, or $3.6 billion, with most imports coming from Europe and the United States. The Russian market is estimated at nearly $6 billion, though per capita spending there is low compared with the rest of the world, at around $42.
About 73 percent of the market in Russia is supported by imports, with most medical equipment coming from Germany, Japan and the United States, Espicom data indicate. India’s medical equipment market is worth about $2.7 billion, though the overall healthcare sector is worth significantly more—$50.2 billion this year and $78.6 billion by 2016, according to India Law Offices in New Delhi.
Estimates for the orthopedic sector are equally as staggering. Toronto, Ontario-based Millennium Research Group Inc. expects the reconstructive joint implant market in Brazil, China and India to expand 19 percent annually through 2015 due to significant increases in procedures. Growth drivers in the three countries are nearly identical to those shaping the U.S. market—increasing numbers of elderly and the obese, a rise in osteoarthritis cases, physician training in joint reconstruction, and medical tourism. India’s reconstructive joint implant market is projected to sustain the most significant growth, expanding 20 percent annually over the next four years, while Brazil’s market is expected to approach $290 million by 2015.
Demand for bone graft substitute products (synthetics, demineralized bone matrices, bone morphogenetic proteins, xenografts and non-proprietary allografts) and hyaluronic acid (HA) viscosupplementation treatments are expected to grow as well during the first half of this decade, with the bone graft substitute market expanding more than 25 percent annually through 2015 and the HA viscosupplementation sector rising to $190 million in all three countries.
But these statistics, in all their glory, are only partially responsible for the massive investments of late in the BRIC bloc. Certainly, companies such as Boston Scientific Corp., Covidien plc, DePuy Orthopaedics Inc., GE Healthcare and Medtronic Inc.—all of which announced new investment plans this past summer in China and India—have their respective bottom lines at heart. Growth is growth, regardless of its origin.Yet money is not the sole motivation for turning to the BRIC brothers.
Some companies are investing in those markets to fulfill a need for patient-specific device designs.
Taking its cue from the likes of Adidas, Mercedes-Benz and Nike, among others, healthcare conglomerate Johnson & Johnson opened an innovation center in China earlier this year to develop and market devices and diagnostic products specifically for Asia’s emerging markets. The Johnson & Johnson Medical Companies Asia Pacific Innovation Center in Suzhou, China, is part of an overall company strategy to better serve its Asian customers. Covidien has similar plans for its new 100,000-square-foot R&D center in Shanghai, China, when it opens next summer. J&J and Covidien, however, face some serious competition in the Asian market from GE Healthcare, which recently moved its 115-year-old X-ray business to Beijing from Waukesha, Wis. The move is part of a broader company plan to invest $2 billion in China—including $500 million for six new Customer Innovation Centers—and break into the country’s growing market for primary healthcare, a key goal of the Chinese government’s healthcare reform plans. To penetrate that market, GE Healthcare executives plan to boost China-based research that will enable it to introduce at least 20 products for the local market over the next three years. Of those products, 70 percent will be used in primary care by a general practitioner or family doctor.
Indeed, the potential benefits from BRIC bloc investments are enormous. But so too, are the challenges and risks that must be overcome to support durable and balanced long-term growth. One of the most daunting challenges (besides adequate intellectual property protection) is the complex, often confusing regulatory landscape found in each of the countries. Medical devices in Brazil, for instance, undergo a lengthy and highly variable registration and licensing process that is subject to sudden changes from ANVISA, the nation’s health surveillance agency. India’s regulatory system, on the other hand, is in shambles; experts claim most medical products hit the market with little or no oversight.
Some of the risks that companies face in the BRIC nations are the same ones they face at home, namely lead times (generally longer compared with domestic markets), quality (complicated by counterfeit products and poor supply chain management) and cost. In China, appreciation of the yuan inevitably will increase labor costs, and a growing emphasis on transparent, low-impact supply chains could prompt some companies to move manufacturing closer to headquarters in order to reduce their carbon footprint.
And, there’s always the risk of economic stagnation. Even in the Promised Land. “The policy-driven boom of the past couple of years will not be repeated anytime soon,” HSBC Holdings chief economist Stephen King told Bloomberg. “It’s difficult to see how emerging [BRIC] nations can ride to the rescue once more.”
Beyond the BRICs:Betting on Europe and Central America
If King is correct—and that’s a big if—there are plenty of countries on the planet that are ready (and willing) to assume the role of hero from the BRIC brethren. Medtech clusters are thriving on all seven continents, some as old as the industry itself, others as fresh as the innovation that defines the sector.
Many of these clusters are located in Europe, where medtech sales reached 95 billion euros ($136 billion) in 2009. Despite its recent troubles with debt, the industry there is growing at more than 5 percent annually and reinvests about 8 percent of its total sales in R&D, according to data from Eucomed, the Brussels, Belgium-based trade group representing Europe’s medical technology industry. The industry employs about half a million people in nearly 22,500 companies; almost half of those companies (49 percent) are based in Germany, while 12 percent are headquartered in the United Kingdom and 6 percent are in Switzerland.
The Swiss have long been associated with neutrality (the country has not been in a state of war in nearly 200 years) and watch-making (Breitling, Victorinox, Omega, Tag Heuer and Tissot rank among the world’s top brands) but over the last several decades or so, the nation quietly has been growing its medtech industry. Total gross revenue in the sector amounted to 22.9 billion Swiss francs in 2008, or about 2 percent of the country’s gross domestic product, the highest percentage of any country, according to industrial consulting firm Roland Berger and Deloitte. The industry comprises about 1,300 companies that employ 49,000 people in the production of such products as dental and orthopedic implants, surgical tools, urinary infection diagnostic products, electrocardiographs, sterilization devices and ophthalmology measuring tools.
A combination of government technology development programs, a talented and well-educated labor pool and favorable tax rates have helped turn the Swiss medical technology industry into one of the country’s fastest-growing sectors, with an average annual growth rate of 6 percent to 8 percent for each of the last 15 years. From 2006 to 2008, the sector grew between 25 percent and 30 percent; this year, growth is expected to hover around 12 percent.
With a solid base of organizations that support medtech innovation and competitive tax rates (a 7.6 percent value-added levy, one of the lowest in Europe), Switzerland has some pretty powerful tools to compete in the global medical device market. Its most compelling, though, may be the nation’s closely guarded reputation for top-notch quality.
“I believe Switzerland has the competitive advantage of having this ‘Swiss mindset’ which is very closely associated with quality all over the world,” said Patrick Dümmler, managing director for Medtech Switzerland, a Bern-based association representing the country’s medical technology industry. “I just read a study regarding the perception people have about quality and Switzerland ranks number one. Having that Swiss brand or Swiss name on a medical device can really differentiate it from a competitive product. It helps differentiate us from other countries.”
Countries such as Ireland, which has developed quite an imposing medtech industry of its own over the last two decades. The sector employs 25,000 people, more than any other country in Europe on a per capita basis. The 32,595-square-mile island lays claim to 200 medical technology companies that export 7.2 billion euros worth of devices and diagnostic products annually, or 8 percent of the country’s total merchandise exports, according to the Dublin-based Irish Medical Devices Association. Such a healthy trade system has turned Ireland into the second-largest exporter of medical products in Europe, trailing only Germany, with exports climbing more than 14 percent between 2008 and 2010.
Like most countries vying for a chunk of the global medtech pie, Ireland offers financial incentives to companies that relocate, including R&D tax credits, patent royalty tax exemptions and employment grants. The latter helped convince executives with Waters Corporation, a Milford, Mass.-based designer and manufacturer of analytical technologies, to establish a subsidiary in the country 14 years ago.
“We received grant assistance from the [Irish] government,” said Terry Shortt, vice president of Worldwide Manufacturing and Quality/Compliance Global Operations and Services for Waters Technologies. “There were two elements of grants available to us—a capital grant and an employment grant, where for every permanent employee you took on there was a grant that lasted a certain number of years to cover the costs of training and development. This grant may not be widely available at this time in Ireland. We elected to go with the employment grant and that has been very successful for us.”
Other companies have been drawn to the Emerald Isle for its relatively quick and hassle-free regulatory system (a product approval in Ireland guarantees an endorsement from the European Union), ready access to the wider EU market, and a workforce that is more productive than the career-obsessed United States, United Kingdom, France, Germany, Japan and the Netherlands, according to the World Bank. The workforce also tends to be better educated, too: The World Economic Forum ranks Ireland eighth out of 133 countries in the quality of its education system, and a 2010 European Commission study concluded that the country produces the world’s most highly employable graduates.
Ireland’s English-speaking workforce and a corporate culture similar to the kind that exists in U.S. firms also are a draw, having attracted the likes of such large device OEMs as Abbott Laboratories, B. Braun, Boston Scientific Corp., Cook Ireland Ltd., Covidien, DePuy Orthopaedics, Medtronic Inc., Stryker Corp. and Symmetry Medical Inc., among others.
“I think the English language is a very important factor when you’re talking about U.S. multinationals. Once U.S. companies come here and the interaction starts between the subsidiary and corporate headquarters, the communication is very clear because thecultures are very similar, so therefore there tends to be less misunderstanding,” explained Bill Doherty, executive vice president of Cook Group Europe. “Also, the track record here is very strong. There’s been an increasing investment in Ireland over the last 30 years and companies have migrated from a simple manufacturing operation to what they have today, which is typically complex manufacturing with a significant portion of core R&D activity and service functions. The industry has evolved over the last 30 years and evolved very successfully.”
The reasons for relocation (or expansion) are a bit different in Central America, where the medical device market largely is still developing. Nicaragua’s device industry, for example, grew 47 percent in 2009 compared with the previous year, but the 50,567-square-mile country (comparable to the state of Alabama) still is primarily agricultural. While it lacks an imposing list of OEMs and home-grown device firms, the country has attracted the attention of Command Medical Products Inc., which operates two manufacturing facilities in Managua. James Carnall, vice president of operations for the Ormond Beach, Fla.-based contract manufacturer said the company chose to locate in Nicaragua for its cost-effective labor, solid utilities base, its proximity to headquarters (a 2.5-hour flight from Miami, Fla.) and relatively quick shipping times (six to 10 days as opposed to eight to 10 weeks for China-bound containers).
Many of those same reasons have convinced device firms to set up shop in Costa Rica in recent years. The country virtually was unknown to medtech companies when Baxter International opened a manufacturing plant in Cartago 23 years ago. Since then, the industry has grown to encompass more than 10,000 employees from such companies as Boston Scientific, Hospira Inc., St. Jude Medical Inc., Hologic Inc., Koros USA Inc., Arthrocare Corporation, Allergan Inc. and SMC Ltd. Medical device exports have grown four times faster than other exports, at an average rate of 31 percent annually from 2002 to 2010.
“The labor [pool] is part of it, the government incentives are part of it, the distribution points are part of it, but you also have to look at where your customers are going,” noted Bob Stoesser, vice president of international business for SMC, a Somerset, Wis.-based contract manufacturer that opened a 20,000-square-foot facility in San Jose earlier this year. “If you don’t grow with your customers and expand to the areas where they need you, then you won’t be fulfilling their expectations.”
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There was a time not too long ago when medical devices were considered the less risky alternative to biotechnology in the race to discover and apply new innovative technologies in healthcare. Devices typically had fewer regulatory hurdles, quicker times to market and only the occasional high-profile failure. And, acquisitions were a successful exit strategy for founders and early stage investors. But times have changed. Thanks to a number of controversial recalls and questions over the efficacy of the product approval process, device makers in the United States are facing an enormous amount of pressure at home.
This pressure has forced them to look overseas for respite and many have found salvation in the Chinese, Indian and Brazilian markets. While companies that have invested big bucks in these areas are beginning to reap the rewards of their efforts, experts say the fix may only be temporary: “Many companies are sourcing from China now. But conditions in China are changing,” Arntzen notes. “Wages in coastal China are rising and ... affluence usually means buying imported products. Who is going to manufacture all the imported goods that this massive Chinese middle class will want to buy?”
Truly a question for the ages.