Report: Medtech Firms Must Evolve Their Business Model to Survive

Battered by a “perfect storm” of tougher regulations, funding constraints and a shift to value-based healthcare, the industry is finding solace—and some success—in business models that differentiate their offerings through expanded healthcare services, delivery options and funding channels. New innovative strategies are essential if medtech companies are to survive and grow, according to a state-of-the-industry report released by global advisory services firm Ernst & Young at the recent AdvaMed 2013: The Medtech Conference.

“…with the old model, you developed a new product and showed it to physicians. They liked it, and it went from there,” Invendo Medical Inc. CEO Berthold Hackl told the report’s authors. “Those days are over. With new devices and technologies, you have to look at the environment in which they will be used. [At Invendo], we talk with insurers, hospital boards, physicians, nurses, even patients.”

Medtech’s traditional product- and treatment-focused growth model has lost its potency in recent years as venture capital dwindled, pricing pressures increased and government bureaucracy multiplied, the report notes. To recapture pre-recession growth, device companies must develop products that focus more on prevention and maintenance than acute care or long-term disease treatment.

Building New Business Models
The shift to value-based healthcare is making patients and payers more influential, prompting medtech firms to experiment with business models that reflect the needs of new customers in three ways:

• Beyond the product: Services and solutions to improve outcomes or lower costs. These services could be add-ons to enhance the value proposition of existing products for patients and for payers/providers. But services also could be stand-alone offerings that help payers and providers improve outcomes and/or lower costs in product-agnostic ways (e.g., Philips’ a 15-year agreement to provide Georgia Regents Medical Center with consulting services and technology). For medtech companies accustomed to creating value through technological advances, the expansion into services and solutions represents a significant shift in thinking. The biggest opportunities to create value may come from remarkably low-tech solutions. “They may not seem as ‘innovative’ as new products and technologies, but initiatives such as preventive medicine and disease management are very important,” said Philipp Schulte Noelle, senior vice president, corporate business development/M&A for Fresenius SE & Co. KGaA. “They can help providers and payers better understand disease progression and decrease costs by identifying the right intervention and reducing the length of hospital stays.”
• Beyond treatment: Prevention and remote monitoring, to more efficiently improve outcomes (e.g., Medtronic Inc.’s $200 million purchase of developer, manufacturer and clinical telehealth solutions provider Cardiocom LLC). Remote monitoring and earlier identification of at-risk patients increasingly are valued by payers as cost-effective interventions. To refine their value propositions for payers, medical device companies are starting to offer services and solutions that span the cycle of care.
• Beyond the hospital: Enabling patients to manage their conditions at home, without frequent and costly clinical interventions. Medtech companies can achieve a better balance between home and hospital care by developing mobile products that allow patients to manage their conditions without frequent clinical intervention, as has been the case for some time in diabetes treatment. They also can provide services designed to keep patients out of the hospital such as care delivery, mhealth and training both patients and outreach care providers (e.g., Covidien plc’s Sandman program, which treats sleep disorders through training, education and patient encouragement).

To succeed at business model innovation, device firms must develop new capabilities that change stale mindsets and fill gaps in their current lineup of skills. Companies can accomplish such a task by focusing on capital efficiency to use scarce 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 data and develop insights; adopting disease/value pathways to identify and fix “value leakages”; and using scalable processes with appropriate metrics for robust business model innovation.

“The medtech industry faces significant challenges, but for companies that can deliver differentiated health outcomes in cost-efficient ways, there are strong opportunities for growth,” Ernst & Young Global Pharmaceutical Sector Leader Patrick Flochel said. “Clearly, firms need new capabilities, but they can also redeploy existing strengths which will be very useful in the new healthcare environment: customer-centric design, the ability to identify and fill gaps for customers, and medtech’s core strength in engineering new solutions for complex challenges. In doing so, they will do much to restore the trust of customers and investors, which will make business model innovation easier in the future.”

Restoring investor trust is essential for fostering the kind of innovation that engages patients, payers and physicians alike. Ernst & Young’s “Pulse of the Industry” report found that venture capital investments fell 21 percent to $3.5 billion in the 12-month period ending June 30, 2013, the lowest level in more than a decade. Innovation capital—funds available for the vast majority of pre-commercial companies—declined by 11 percent to the lowest level in at least seven years.

U.S. public medtech company earnings were skewed by exchange rates and several large deals in the last year. Revenue rose 2 percent to $210.1 billion June 2012 and June 2013, but a strong U.S. dollar as well as Johnson & Johnson’s acquisition of Synthes and Asahi Kasei Corporation’s purchase of Zoll Medical Corporate prevented the further escalation of proceeds, by 6 percent.
Net income similarly was impacted by a series of major, multi-year merger-, impairment- and litigation-related charges by companies such as Alere Inc., Boston Scientific Corp. and Hologic Inc. After adjusting for the charges as well as for the Synthes and Zoll acquisitions, net income would have risen slightly, by 0.5 percent, rather than falling 37 percent to $8.7 billion, the report notes. Research and development expenses climbed 2 percent to $10.2 billion as roughly two-thirds of all U.S. companies increased their investments.

The combined revenue of therapeutic device companies, which accounts for 55 percent of all pure-play revenue, essentially was unchanged in 2012, slipping 0.1 percent compared with a 5 percent increase the previous year, according to Ernst & Young’s report. Unlike 2011, when each of the six largest disease categories experienced top-line growth, only four categories increased revenue in 2012. Oncology (up 14 percent, led by Accuray Inc.), dental (up 13 percent, led by Dentsply International) and women’s health (up 12 percent, thanks to Hologic) all grew double digits while cardiovascular and orthopedic proceeds were adversely affected by the acquisitions of Zoll Medical and Synthes.

Four of the six largest disease categories racked up net losses in 2012, just a year after each of them produced positive bottom-line results. The report’s data show that CR Bard Inc., Intuitive Surgical Inc. and Medtronic Inc. drove the “multiple” segment’s 12 percent increase, while $5.1 billion in accounting charges from Boston Scientific Corp. contributed to a 314 percent decline by cardiovascular/vascular.

Research and other equipment led all segments with a 10 percent annual growth rate, followed by other (up 2 percent) and imaging, which boosted revenue 0.2 percent, Ernst & Young’s report indicates. In addition to therapeutic devices, non-imaging diagnostics was the only other segment to experience a decline in profits (1 percent). 

Other key findings described in the report include:

• Slow revenue growth: Revenue for public medical technology companies in both the United States and Europe totaled $339.6 billion in 2012, a 2 percent increase compared with the previous year and well below pre-crisis growth rates. After adjusting for the Johnson & Johnson-Synthes megadeal and exchange rate fluctuations, revenue would have risen 8 percent, or double the growth rate of 2011. Similarly, the normalized net income growth rate would have been 3.5 percent—significantly better than both the reported 2012 decline of 22 percent and the 2011 normalized rate of 0.5 percent.
• Steady capital: While it remained relatively stable at $29.5 billion, most of the capital funding raised in 2012 went to a few large companies. Debt represented the vast majority of total funding, with debt offerings by a handful of commercial leaders contributing 82 percent of the industry’s total financing. The majority of new debt issuances were used to refinance existing debt.
• Solid deal-making: The value of mergers and acquisitions involving U.S. and European medtech companies increased 23 percent to $47 billion last year. But after adjusting for a $15.8 billion mega-deal, the value of M&A fell 19 percent to $31.2 billion.

“While the industry’s 2012 financial results were better than 2011 on a normalized basis, looking at the longer term reveals a more troubling picture. The industry’s financial growth is significantly below levels before the financial crisis, when medtech routinely delivered double-digit increases in revenue and robust net margins,” the report concluded. “As companies grapple with increasing pressure from market forces, payers and regulators, they will need to take action not to merely sustain their recent performance but rather to return to the top-line growth and bottom-line profitability they enjoyed before the financial crisis. And meeting that challenge will require revisiting how they innovate both their medtech products and their business models for medtech’s new normal.”