October 12, 2016
Medtech in the Fast Lane: Embracing Services, Solutions and Consumerism
by Rafe Hanahan and David W. Johnson
Manufacturing built America. The iconic automotive industry epitomizes this organic relationship between industrial strength and economic growth. Since the early days of Ford and General Motors, car-makers have followed a clear playbook: design an appealing product, manufacture efficiently, market aggressively, and sell units at high volume.
Occasional crises (high gas prices in the 1970s, Japanese automakers in the 1980s) catalyzed incremental innovations and performance improvements. Yet, the industry’s fundamental business model and value proposition have remained the same for over a century.
Today, the auto industry is at the brink of transformation. Vehicles are becoming more computerized and integrated. Serial disruptor and Tesla CEO, Elon Musk, has helped power this shift.
Musk’s early innovations (electric-powered engines, cutting out dealerships) seemed revolutionary, but pale in comparison to Musk’s “Master Plan, Part Deux.” With the advent of auto-pilot technology, Musk envisions Tesla vehicles will become intelligent nodes operating within learning networks.
This is not the fevered dream of a lone madman. Google is leveraging its mapping and street view data to develop its own auto-pilot software. Uber is currently testing a fleet of self-driving vehicles manufactured by Volvo.
To remain viable, traditional car manufacturers must master software development, data analytics, transportation solutions and consumer services. Winners in tomorrow’s auto industry will not succeed with “your father’s” business model.
What does transformation in the automobile sector have to do with medtech? Just about everything. Advances in information technology and machine learning combined with consumer-driven demands for value-based healthcare products and services create daunting new market dynamics.
Enlightened medtech companies are responding by exploring new business models that emphasize data analytics, consulting services and consumer products. Their collective efforts are fundamentally reinventing the sector’s approach to developing, marketing and using medical devices and technology.
Market repositioning embodies real risk. As in the automobile industry, however, the greater danger is not adapting quickly enough to disruptive market realities. Buckle up. It’s going to be a fast and bumpy ride into medtech’s future.
Medtech’s Disruptive Moment
Historically, medtech companies have concentrated on medical device design, manufacturing and regulatory approval. With FDA approval, companies apply their marketing muscle to sell clinicians on their products.
Armed with clinician support and a CMS reimbursement code, medtech companies negotiate with payers on a state-by-state basis to cover the (often high) costs of their products. Lather, rinse and repeat.
New FDA guidelines have reduced the time and costs required for regulatory approval; however, it remains difficult for medtech companies to secure CMS payment codes for new devices.
Moreover, commercial payers are less inclined to accept new CMS coverage decisions without corroborating medical evidence of treatment effectiveness. Likewise, providers now assess the comparative effectiveness and relative benefits of new devices with more scrutiny.
This shift to value and consumerism places greater emphasis on price, quality, and patient experience. In particular, purchasing managers within hospitals and specialty physician groups are targeting high-cost devices and implants.
The introduction of mandatory CMS bundled payment programs for joint replacements, cardiac rhythm management, spinal implants and endoscopic/energy devices accelerates this trend.
Consumers are also reshaping product and service demands. Increasingly at-risk for managing their own healthcare expenditures, consumers want mobile, cloud-based products and services that make their lives better, healthier and easier.
Medtech’s focus on outcomes and costs is new. In heavily-regulated, volume-based, fee-for-service payment environments, medtech companies won by selling high-margin products to clinicians. There was little incentive to lower costs and/or improve provider efficiency.
Going forward, medtech companies will win by developing cost-effective medical devices and working in concert with provider partners to deliver more consistent, higher-quality outcomes.
Medtech suppliers are generally ahead of their provider customers in appreciating the urgency of re-engineering surgical processes to gain competitive advantage. For medtech companies to win, their provider customers also must win. Consequently, many now consult with clinicians and hospitals to improve surgical operations and care outcomes.
Medtronic CEO, Omar Ishrak, says that the biggest challenge facing the sector is the need to embrace the imperative that “patient outcomes are the most important criteria” for measuring value.
While Ishrak acknowledges that medtech companies are prone to building “walls around devices” without considering the outcomes those devices generate, he believes the healthcare industry as a whole has overlooked the significant impact that technology can have in improving outcomes in the shift toward value.
This is medtech’s disruptive moment. It’s time to rethink everything.
Active repositioning is underway. Large-cap medtech companies are funding acquisitions and investments in new business models. Unencumbered venture-backed startups have more freedom to explore innovative, even disruptive, approaches to the design, development and marketing of medtech products and services.
Whether top-down or bottom-up, medtech companies are striving to do the following:
- Reduce the costs of medical device technologies
- Improve performance and efficiency during and after treatment
- Enhance connectivity between patient, provider and device
- Generate meaningful clinical, economic and satisfaction data
- Extend time horizons for monitoring outcomes
Some companies are applying LEAN manufacturing principles to aid providers to reduce costs and improve surgical efficiency and post-surgical care. Intralign, for example, is a specialty healthcare services company that reduces implant costs by leveraging a “rep-less” model. Intralign’s “Surgical First assistants” are less expensive but expert in surgical process improvement.
Medtronic, the industry’s largest stand-alone device manufacturer, has invested in hospital-managed services to optimize performance in cath-labs, operating rooms, intensive care units and cardiovascular units. It’s expanding its consulting services through acquisitions, such as its purchase of NGC Medical, and internal investment in its Integrated Health Solutions business.
Medtronic also is investing in effective, lower-cost devices and diagnostics. In rural India, for example, Medtronic identifies patients with heart disease through low-cost electrocardiogram machines which transmit data wirelessly to doctors. Medtronic works with local suppliers and financiers to make its pacemakers and other devices more affordable.
Philips has developed a new equipment purchasing program where providers pay for equipment as they use it. Philips discovered that customers were spending much-needed capital on devices they did not always use. Purchase and payment flexibility encourages clinicians to try new devices and ties value to their use rather than their cost. The result is more sales for Philips and less risk for its customers.
Many medtech companies, particularly startups, are developing cost-effective, direct-to-consumer health and wellness products accessed through mobile and social media platforms. Here are several examples:
Blue Spark Technologies has developed a wearable patch called TempTraq that transmits real time body temperate data and alerts to parents monitoring a sick child.
iRhythm Technologies has developed its own patch, called the ZIO, to monitor and record heart data and detect arrhythmias in vulnerable patients.
Kindara has developed a fertility tracking app and blue-tooth-enabled basal thermometer that monitors temperature, hormone, nutrition and exercise data to help women manage and predict their fertility cycle.
Moving Beyond Funding Roadblocks
Industry disruption isn’t easy for medtech investors either. The IPO “window” for medtech private equity investors is more closed than open. The sector’s mediocre returns have discouraged expansive venture investing.
M&A transactions, while up, are occurring later in companies’ growth cylce. Overall, timelines for investor “exits” have lengthened considerably. Restrained by high company valuations, acquirers have become more cautious. There is a shortage of high-quality deals for growth-equity investors.
The comfortable position for many medtech investors is to remain on the sidelines and wait for the sector to stabilize. Waiting also carries risk. Breakthrough medtech products and services need funding now.
Investors savvy enough to recognize and invest in winning technologies will reap whirlwind returns. That will take courage and the understanding that traditional business models and funding approaches are ill-suited for medtech’s post-reform marketplace.
Recognizing the need for new thinking, some provider-based funders are aligning their investments and acquisitions with their own product and service needs. KP Ventures, Kaiser Permanente’s venture capital arm, is at the top of this class.
Describing their due diligence process, KP Ventures’ senior managing director Sam Brasch says, “We rely on Kaiser leaders in evaluating our investment opportunities because we want to invest in things that are aligned with the way we deliver healthcare.”
Brasch acknowledges that’s a balancing act. While Kaiser Permanente is oriented toward value-based care, the products and startups that KP Ventures supports must also succeed in a traditional fee-for-service environment. iRhythm Technologies, mentioned above, straddle both “value” and “fee-for-service” payment models.
Kaiser Permanente’s initial diligence was “very supportive,” Brasch notes, because the company’s Zio Patch offered a more efficient diagnostic process for clinicians and patients compared to traditional halter monitors. Still, KP Ventures withheld investment until it determined that the product could prosper within the existing reimbursement landscape.
Seattle-based Providence Health & Services is another health system active in new company development. Providence has partnered with MultiScale Health Networks to develop real-time clinical decision-making tools. MultiScale develops and tests product applications within the Providence delivery network.
Like Kaiser, Providence also runs its own venture fund. Its fund focuses its investments in consumer products and disruptive technologies. Smart money finds its way to value, but there are no guarantees. This is white-knuckle time for medtech companies, funders and customers alike.
Racing Toward Success: Medtech’s Brave New World
The process of competitive differentiation intensifies during periods of industry disruption and transition. New market dynamics force themselves on incumbents. Companies adapt to survive.
In the computer sector, for example, IBM survived the transition from mainframe to desktop computing by reinventing itself as a services company. Digital Equipment Corporation’s (DEC’s) inability to manage the transition to desktop computers led to its bankruptcy.
Winning medtech companies will innovate faster and more expansively than their peers. They will discover new sources of value for their existing customers. They will find new customers, many in the consumer marketplace. They will collaborate with like-minded partners to create better products and services. Their focus on outcomes and value will lead them to adopt service-oriented business models and develop consumer-focused cultures.
This repositioning is fraught with risk. It takes adroit leadership and an agile culture to manage the financial, operational and strategic challenges imbedded within new market dynamics. Sometimes companies can be too late. Sometimes they can be too early. There are no guarantees.
Despite its bold vision, Tesla may not sell enough new-age vehicles to remain viable. Having just survived a near-death experience, traditional car companies like GM may not have the vision, resources and cultural flexibility to reinvent themselves again.
The challenge for established medtech companies is to sustain existing product lines while developing new, potentially disruptive business models. During transition periods, changing cultures and mindsets are even more important than perfecting products, services and business models. Real leaders emerge and redefine their companies.
The medtech industry is familiar with technology’s disruptive power. Historical lines between device manufacturers and service providers are blurring. Clinging to old business models and playing defense are losing propositions.
The best health companies create value for customers through better outcomes, lower prices and superior customer experience. It is time for medtech companies to jump into the fast lane and race toward a future defined by value-based care delivery where winning translates into better healthcare delivery, healthier patients and healthier communities.
Rafe Hanahan leads Cain Brothers’ Medical Technology and Devices Advisory practice. Mr. Hanahan joined Cain Brothers in 2015 with over 14 years’ experience advising both public and private companies in a variety of merger and acquisition, capital raising, and strategic advisory transactions.
Cain Brothers is a pre-eminent investment bank focused exclusively on healthcare. Our deep knowledge of the industry enables us to provide unique perspectives to our clients and is matched with the knowhow needed to efficiently execute the most complex transactions of all sizes.www.cainbrothers.com