Christopher Delporte10.21.06
Outsourcing 2007: The Right Place at the Right Time
As Industry Experts Examine the Road Ahead, Market Growth in 2006 Should be Mirrored by Further Expansion in 2007
Christopher Delporte
Group Editor
It shouldn’t come as a big surprise to anyone in the medical device industry that 2006 was another growth year for the sector. While industry segments and product categories may have fluctuated individually, the overall strength of the market was strong this year—and looks as if it will continue to be in 2007. Here’s a quick snapshot of where the industry’s been and what may lie ahead.
According to figures from AdvaMed, the medical device market in the United States should be approximately $86 billion by the end of 2006 (close to $220 billion worldwide), with a 10% annual growth rate expected for the coming year. The outsourcing market was equally robust. Within the cardiovascular, orthopedic and endoscopic market segments, outsourcing and contract manufacturing were roughly a $3.5 billion business. If you include all other market specialties, outsourcing in the United States could be valued at closer to $8 billion, according to Andrew Kinross, managing consultant for Navigant Consulting in Burlington, MA.
Despite recent concerns regarding the safety of drug-coated stents and flattening sales, the cardiovascular market continues to be one of the industry’s largest and strongest sectors. While sales of stents slowed in 2006, the cardiac rhythm management (CRM) market, for example, continued its growth.
A report from consulting firm Booz Allen Hamilton predicted a growth rate of 18% or more for CRM by 2010. The report also noted that much of the gains in the cardiovascular sector came not from price increases, but from increased volume and the introduction of new technology with higher pricing.
Though pricing also has flattened in the past year in the orthopedic sector, the market is showing positive signs for cervical discs and spine devices, according to a report by Merrill Lynch Research analysts. The spine and orthobiologics markets are expected to collectively reach $5.6 billion in 2006, up 12%. According to the firm, bone grafts and orthobiologics—proteins that prompt bone growth, which are used primarily used in spinal procedures—should reach $1.3 billion by year’s end, a 17% increase.
“These two segments represent approximately 24% of the estimated $25 billion worldwide orthopedic industry, a market we estimate will deliver 9% growth in 2006 with a projected 10% annual compound growth rate through 2009,” Merrill Lynch analysts said. The report cited Medtronic as the spinal market leader with a share of more than 40%. Rounding out the top three are Johnson & Johnson with 15% and Synthes with 12%.
There clearly has been a “significant increase” in new product development activities and new products coming to market in 2006, said William Morton, president of Medical Device Consulting Inc. (MDCI). The North Attleboro, MA-based firm provides regulatory, clinical, and quality assurance consulting to medical device companies. “The number of 510(k) submissions MDCI handles has increased,” Morton said, reflecting overall market expansion.
Another growth area in the device market for 2006 and in the foreseeable future is minimally invasive surgery (MIS), which impacts multiple device sectors, particularly cardiovascular and orthopedics. Minimally invasive surgery is performed without making a major incision or opening, resulting in reduced trauma for the patient and reduced healthcare costs, in large part through shortened hospital stays, fewer complications and comorbidities, as well as shorter recovery time. MIS procedures have created a multibillion-dollar market for the specialized devices and instruments used for these procedures, which is of particular interest to contract manufacturers and suppliers.
According to a new technical market research report from BCC Research in Wellesley, MA, the global market for MIS devices and instruments will reach $12.9 billion by the end of this year. By 2011 it will reach $18.5 billion, an average annual growth rate of 7.5%. These figures include catheters, balloons, stents and other devices and specialized instruments.
The United States accounted for about 60% of the world market in 2005, with an annual growth rate of 7.2%. By 2011, the US market will reach $11 billion, the report concluded. Surgical devices are the largest product segment of the MIS market, with a 69% US market share. Monitoring and visualization systems were the second largest segment, with an 11% market share, followed by endosurgical instruments, electrosurgical equipment and robotics. Surgical robots are the fastest-growing equipment/device segment, with an average annual growth rate of 12% through 2011, followed by surgical devices at 8%.
The impressive gains in the medical device market are the result of a number of factors. An aging population is one of the most obvious drivers. As the average age of the population increases, the consumption of medical device also goes up. For example, by 2030, it is estimated that 20% of the US population will be of Medicare age, the primary demographic for joint replacement procedures and cardiovascular devices. The number of older Americans may be increasing, but lifestyles also are more active across most age groups, which also leads to greater medical device consumption.
Other market growth factors to consider include rapid improvements in technology and the expansion of international markets. Middle-class populations are growing throughout Asia (China, in particular) and Latin America. Nancy Travis, AdvaMed’s associate vice president of global strategy for Asia, recently told MPO that middle- and upper-class Chinese citizens are “increasingly savvy and well-informed” medical technology consumers.
Full-Service Growth
The firm footing of the medical technology sector entering 2007 obviously bodes well for the outsourcing industry that serves it. OEMs increasingly are turning to partners to help them with full-service outsourcing, allowing them to focus on core competencies such as research and development, new product design, and marketing.
“This was probably the year when more OEMs realized the benefit of outsourcing some their operations,” said George Blank, president of the MedTech Group of South Plainfield, NJ. “Outsourcing has certainly been growing over the last five years, but more companies are interested and enthusiastic over the last year. We have really felt it.”
He also said that 2006 was the year in which full-product outsourcing really began to take off. Blank explained that outsourcing partners can provide capabilities at a lower cost than an OEM could invest using its own equipment, people and facilities. This translates into products that get to market more quickly, greater efficiencies, more revenue and higher profits for the OEM.
“What has happened over the last few years is that companies are more willing to find the right partners. A growth market and a strong economy have allowed [OEMs] to open space in their facilities for new things,” Blank explained. “There is an ongoing drumbeat to become more efficient, and outsourcing is part of that model. It appears as if 2007 will continue to be positive. Companies are developing new products and need more help.”
The numbers seem to support Blank’s optimism. According to business research and consulting firm Frost & Sullivan, outsourced component manufacturing has been roughly 86% of the contract manufacturing market during the past few years, while finished goods only have made up roughly 14%. By 2010, the finished goods market is expected to nearly double to 27%.
“We have been preaching the virtues of the one-stop-shop model since 1987, from ship testing, to bio-burden testing and everything in between, right through product delivery,” said David Slick Sr., president and founder of Command Medical Products in Ormond Beach, FL.
Slick said OEMs are getting away from traditional “brick and mortar” manufacturing models and the trend became much more evident in 2006.
“We’re in the right place at the right time,” he said, noting that his business has expanded significantly over the last five years, with the strongest growth in the last two years. “We’ve seen customers buy out others with larger market share, so that’s good for us. I don’t see any kind of letup in 2007.
“It’s more about partnering than purchasing,” Slick continued. “Companies are much more integrated. The regulatory environment is such that people are looking to cut risk and regulatory burden. It’s more difficult when you have tubing, assembly and packing, for example, in different places. It’s too many different paper trails and different regulatory challenges.” The risks in outsourcing are more execution-based than development based, perhaps making the industry more secure, he noted.
Morton said he also has seen a marked increase in the outsourcing of regulatory activities, “with no sign of a decrease for 2007 at this point.” OEMs increasingly are turning to firms with more experienced personnel to help them navigate the regulatory waters of the FDA and international regulatory bodies. “It’s saving them significant time and money,” he said.
Show Me the Money
The market’s solid performance in 2006 also has lead to a swell of consolidation and investment. Blank predicted even more moving forward. “We’ll see a lot more venture capital interest in healthcare and new technology, especially in cardiology and orthopedics,” Blank said.
Ron Sparks, CEO of Wilmington, MA-based Accellent said during a presentation early in 2006 that the medical device outsourcing market also is “ripe for consolidation.”
Sparks called outsourcing “extremely fragmented,” with many companies specializing in a single technology with redundancy in specialties. Merged companies are able to consolidate marketing and administrative costs and sales forces, he said.
Accellent, which is one of the device industry’s largest outsourcing service providers, also is one of the most notable examples of the financial community’s increased interest in the market. The company was purchased late in 2005 by New York City-based private equity firm Kohlberg Kravis Roberts & Co. for $1.27 billion.
Ben Dunn, managing director and David Anderson, vice president of Covington Associates, a Boston, MA-based investment firm focused on the healthcare and technology arenas, agreed that the role of private equity in will increase.
“There’s a lot of money sloshing around out there and more private equity players are looking at outsourcing,” Dunn said. He credits the profitability and stability of outsourcing as part of its attractiveness to potential investors. Private equity investment, however, is more attracted to larger companies with well-established intellectual property than it is to smaller companies or startups, he said. The enthusiasm of private equity firms also may depend on interest rates and whether rates rise.
In the overall device market, Anderson said startups are really giving the larger manufacturers “a run for their money.”
“We might see companies such as Boston Scientific and Johnson & Johnson looking at early stage companies and going for an acquisition, because they’re getting hurt as they lose market share,” he said. “Last year was robust from an M&A [mergers and acquisitions] standpoint. We see this trend continuing.”
Aside from the sector’s biggest deal—Boston Scientific’s $27 billion purchase of Guidant Corp.—other notable transactions in the past year include the $10 billion merger of Thermo Electron Corp and Fisher Scientific International Inc.; Danaher Corp.’s acquisition of Sybron Dental Specialties for $2 billion; Siemens Medical Solutions’ $1.86 billion purchase of Diagnostic Products Corp.; and St. Jude’s purchase of Advanced Neuromodulation Systems in late 2005 for $1.3 billion.
As far as growth areas over the next year, Anderson pointed to imaging and diagnostics as the sector to watch for “heightened activity” in the next 12 to 24 months. He also predicted an uptake in the surgical equipment market.
“Consumer-driven healthcare is another growth area,” he added. “As consumers have a greater say in what devices are being implanted, that will affect the sector. More early stage companies are exploring technology that minimizes the length of stay and improves outcomes.”
The Regulatory Road
In 2007, reauthorization talks for the second iteration of the Medical Device User Fee and Modernization Act of 2002 (MDUFMA) will be “front and center,” according to Mark Leahey, executive director of the Medical Device Manufacturers Association (MDMA). This year, Leahey said the association, along with other industry stakeholders, has been “setting the table” for negotiations next year. Industry and FDA must agree on MDUFMA II prior to Oct. 1, 2007, or the user-fee system as structured now would sunset.
The key players in the negotiations—the FDA, AdvaMed and the MDMA—have remained mum thus far as to what the discussions have entailed. Leahey said the MDMA’s expectations for the user-fee program in general have been and will continue to be “enhanced performance from the FDA and reasonable user fees.”
A stakeholder meeting held by the FDA, which has taken place annually since the implementation of MDUFMA, is expected by the end of the year to get industry feedback. According to a report released in February 2006, commissioned by the FDA and conducted by the Lewin Group, the industry’s temperature is lukewarm when it comes to the perceived value of the MDUFMA.
“Industry perceives little or no evidence to date of attaining the main intent of the program or in realizing a favorable return on investment,” the report said. “Almost 70% of responding device manufacturers perceived that MDUFMA goals have not resulted in meaningful improvements in either predictability or timeliness of device reviews.”
This year, the FDA announced the last round of user-fee rates under the current program. As part of the correction mandated by the Medical Device User Fee Stabilization Act of 2005 (MDUFSA), premarket approval applications (PMAs) and 510(k) user-fee rates for fiscal year 2007 increased 8.5% over last year, compared to double-digit increases prior to 2006.
The MDUFSA was implemented after user-fee increases under MDUFMA skyrocketed and Congress failed to appropriate promised budget increases for the FDA’s Center for Devices and Radiological Health (CDRH).
In 2007, PMA fees will increase from $259,600 to $281,600. For small businesses (less than $100 million in annual revenues), the fee goes from $98,648 to $107,008. Fees for 510(k)s move from $3,833 to $4,158, and the hit for small businesses goes from $3,066 to $3,326.
Another area to which the device industry will want to pay close attention in the coming year is postmarket device evaluation. Early in 2006, the CDRH announced a plan to improve the agency’s ability to identify, analyze and act on postmarket safety data. With its “Postmarket Transformation Initiative,” the agency said it would develop an electronic reporting system for adverse reactions, standardize the identification process, obtain the medical records of patients who use the devices and increase communication with professional organizations and the device industry.
When FDA announced the initiative, Daniel Schultz, MD, director of the CDRH, said the FDA’s priority for the next year would be to “make sure that we have a postmarket safety net that is equal to our premarket review process.”
Morton predicts there’s more to come. “The FDA will be more aggressive with its postmarket risk assessment,” he said. “And we’re apt to see an increase in postmarket requirements for devices.”
The CDRH is expected to release additional information its postmarket program later this fall. As of press time, no report had yet been issued. Industry associations remain cautious given the current funding environment and demands on the agency’s resources. The CDRH has faced early difficulty due to patient privacy concerns and preserving trade secrets. v