By developing insights from pharmaceuticals, tomorrow's winners in medical technology will adopt six strategic building blocks
The pillars that supported the historic pharmaceutical industry business model of “global/fully integrated/blockbuster/primary care-focused/small molecule products” have been disrupted in the last decade. The result is that the new leading companies are those that have adopted a variety of alternative business models, by which they have been the beneficiaries of differentiated shareholder value expansion. For example, leaders in specialty drug franchises, generic commercialization, large-molecule (biotech) discovery and development, functional process outsourcing, and PBMs all have outperformed the traditional Big Pharma business model.
During the next decade, the traditional medical technology business model—characterized by customer value proposition, key business processes and capability, and profit model—is likely to experience the same type of adjustment as has occurred in pharmaceuticals. This change could lead to current market leaders (absent leading the next-generation of winning business models) getting displaced by companies that lead the creation of new business models that are consistent with future market requirements for differentiated customer value provision.
There will likely be six key strategic process and capability building blocks, with alternative approaches in each, that future winning customer value propositions and profit realization models will build around. (See Exhibit 1.) I describe each one below.
Innovation Model. For existing, clinically proven franchises, the focus of R&D will need to shift to a focus on creating good enough global value product platforms versus iterative premium product cadence. Instead of the historic focus of adding potential clinical benefit irrespective of the cost, good enough products are designed to meet the core clinical needs of the majority of the target users as economically as possible, factoring in all the health care system costs of providing the procedure. A number of companies, such as GE Healthcare (part of General Electric Co.) in ultrasound and x-ray, have started to leverage R&D programs focused on China, India, and other emerging markets as a basis for creating first local, and then global, good enough products. Also, investments in comparative effectiveness studies may be needed in certain franchises to support penetration, and offer the potential for differentiated claims to support share gain in others.
For the therapy and diagnostic areas where medical technology holds significant new potential, R&D and business development investments to lead the creation of major new medical technology therapies with the potential to demonstrate cost-effectiveness at high price points to important patient groups will cost more, take longer, and be higher risk. This will put pressure on ROI expectations and make leveraging existing global commercial, development, and operating capabilities more critical. Success will require a commitment to exploring a range of technology options working both internally and with VC-funded startups, investing in the comparative effectiveness data and in developing the space, all of which will require multiple years of patience. Although Edwards Lifesciences Corp.’s stock price is currently getting rewarded for its position in percutaneous heart valves, this is hardly an overnight success; one cannot overlook the years of investment in building this innovative evolution of the valve market that has taken the company to this point, or the large uncertainty as to how the development of the U.S. market might yet play out.
Commercial Model. As the role of the physician changes in the product development and adoption process, the commercial model will likely need to change to scale the intensity of the physician contact to what is permitted and appropriate, based on where the product is in its physician adoption life cycle. Analogous to the transition that is being experienced by the pharmaceutical industry, there will be pressure and ROI justification to expand sales forces to the point at which it becomes clear to everyone that the current model is broken.
Globally, payers and providers will become increasingly important in the product utilization decision-making processes. This will require the creation of value propositions as well as selling capability to cost-effectively address the needs of both of these groups. The traditional medical technology pricing model that has taken advantage of physician price insensitivity and that has been based on pricing for each customer and in each market based on what is the maximum price that can be realized, will be replaced by a structure with increased payer and provider decision-making roles and global price transparency, requiring the development and disciplined implementation of worldwide price strategies and account level pricing decision rules.
With the U.S. becoming increasingly less central to the profit economics of medical technology companies due to profit margin and growth constraints in the U.S. and the increased growth of markets in China, India, and other developing countries, commercial resource investment will need to be optimized globally with the model and investment level tailored to each market’s decision processes and profit potential. To support changing decision-maker roles and criteria, globalization and margin pressures, alternative channels versus direct sales representative contact will become increasingly important, including e-channels, along with vendor neutral comparative effectiveness and physician education organizations. While many companies are experimenting and piloting a number of these new business model approaches, so far the experiments and pilots are additive to historic commercial approaches, as opposed to being used to displace current commercial infrastructure.
Building New Capabilities. The changing regulatory mandates and associated required changes to companies’ business models will necessitate they build a broad range of new capabilities, including alternative commercial channels, comparative effectiveness data, and provider sunshine compliance. To avoid having a company’s profits eaten up by the building of these new capabilities, it will be critical to group the new capabilities into those that are price-of-admission capabilities, where low-cost capability adoption is critical, versus those that will be the basis for building competitive advantage, where investing to create the appropriately differentiated capability will be high payoff. Building these required new capabilities will require conscious investment, optimization of make-versus-buy decisions, and the development and evolution of the internal team, as well as recruitment of new skills from outside to manage these efforts.
As the global health care systems shift from payment for procedures and interventions to payment for managing patients’ conditions or disease states, there will be increased opportunities shift from product selling and servicing for a procedure to getting paid for providing the products and services that facilitate more cost-effective total patient management. Historically, the services provided by medical technology companies have largely been included in the product price paid by the hospital at implant, even when (as is the case in the cardiac rhythm management business), the service is provided for the patient product utilization life for free to physicians, despite distinct reimbursement to the physicians for monitoring the patients. Delivering and making money off of playing an expanded role in patient care management will require a number of new capabilities to support this very different business model, but might become critical to profitability as the procedure product model gets increasingly commoditized.
Significant Reduction in the Cost Structure. It is likely that only a few companies in this changing environment can maintain high growth rates and margins based upon an innovation-focused strategy that delivers differentiated products that require high levels of physician engagement and field support. For the majority of the companies and product franchises, globally rationalized pricing, along with the cost pressures from building the required new regulatory and strategic capabilities, will necessitate 30%+ cost reductions (about 10% of sales) in the majority of traditional functional activity areas to offset the likely 5% or more of sales gross profit compression and around 5% of sales of added investment in capability.
While cost has become an increased area of focus (especially during the global financial crisis), to date it has targeted 10% to 15% improvements versus the likely required 30%+ targets. Despite being painful and requiring superb execution, there are a broad range of demonstrated tools and actions that can be used to realize 30%+ cost reductions, including low value added activity elimination, process redesign and IT/e-enablement, and outsourcing/offshoring/shared service center creation. To achieve the sort of cost reduction that will be required, the corporate center needs to rethink its model and structure to be consistent with the strategy and business model approach taken. As an analog, in pharmaceuticals, the corporate offices and practices of a generic company are very different from those of a similarly sized innovation-focused company.
Global with Emerging Market (versus U.S.) Focus. The majority of global medical technology companies are based in the U.S. with U.S. citizens making up the large majority of the senior management teams, driven by the U.S. historically accounting for more than 50% of their global sales and profitability, despite comprising only around 5% of the world’s population and health care needs. With non-U.S. markets, especially emerging markets such as China and India, increasingly responsible for the majority of future market growth, shifting the whole organization from a U.S.-centric to a global mindset will become foundational. This will require distributing globally at least some key business and functional activity, along with having the development path for key future leaders include significant non-U.S.-based assignments.
Historically, the requirements of the U.S. market have set the standard for the design and development of products, functions, and processes. Although the U.S. will continue to be the most important market for the next decade plus, increasingly, emerging and other non-U.S. markets should both set the base level requirements and become a base for operational activities, such as manufacturing, shared services, and R&D.
Business Consolidation and Leadership. The historic profitability of medical technology has allowed the number four, five, and six players in markets to earn sufficient returns to stay in and reinvest in the business. This has been particularly true in orthopedics, vascular, and a range of other markets. The majority of businesses in the world at large tend to have at most three competitors that earn sufficient returns to create shareholder returns for required reinvestment levels. As the future of medical technology plays out, picking a basis of focus for competition and leadership will become more important. Each medical technology company should evaluate its business/regional/functional portfolio and decide which areas it wants to focus on to sustain and become a leader versus which areas it should evaluate selling or harvesting to free up capital to invest in the selected areas of focus.
Getting Started by Selecting a Strategy
Many medical technology companies may be tempted to believe that they can build on their historic success by experimenting with and adopting only incrementally many of the elements of the building blocks discussed here. Such an approach could open the market to disruptive entry from nonconventional, likely non-U.S.-based competitors. Traditionally, the physician-driven premium price adoption of the U.S. market created sufficient scale and profitability to allow competitors to manage the rest of the world, based upon marginal economics.
Sale of global premium products at the price levels they have been sold at in Germany and other low-priced markets historically has been supported by the price level and scale of the U.S. covering all the fixed investment costs and a lack of global price transparency and migration. To the degree that the growth of emerging markets, constraints in the U.S., and the migration of low price points such as those that typically exist in reimbursement-constrained countries such as Germany create low-cost good enough global competitors (analogous to generic competitors in pharmaceuticals), a strategy of incremental business model changes will unlikely be sufficient for a device company to remain profitably competitive in many product areas. Like many industries before it, the medical technology industry will likely move from one primary winning business model with multiple companies all being successful, to multiple winning models where picking one and being a top player is critical to creating shareholder value. Historic success and strength of current strategic assets will not be a guarantee of future success.
To get out front and build profitable market leadership in this changing medical technology world, companies should:
Develop an objective, fact-based view of their business situation today and how it might evolve, given a forecast of future market dynamics (not the reality they wish, but the one that is and likely will be).
Focus on creating a long-term strategic view and plan on how to win given future market requirements of winning versus just optimizing for the next few quarters. The updated strategy and associated business model should include an aligned view of the target customer and value proposition, supporting key business processes and capabilities, and profit realization model
Take an agile and flexible approach that leverages pilot programs and experimentation to support continuous transformation consistent with the strategic vision and plan. Pilots and experiments may need to be separated from existing businesses to support the level of change required.
The medical technology arena is one of the few industries where U.S. dominance has increased during the last few decades, but given the current and future dynamics and the need to shift business models, U.S. dominance will be challenged. Since the U.S. and other developed countries will maintain their interest in being the global hub of a healthy medical technology industry, in addition to each company working to create its own winning approach, the industry as a whole—and on a global scale—should be working with industry associations to create a common voice to advocate for more supportive government-driven regulation and industrial policies (or at least to head off misconceived new regulations and policies). By adapting business models to a changing environment, device companies and the industry itself will increase the likelihood of successfully evolving to meet these new challenges and maintain their competitive profile.
The author is an adjunct lecturer in the Management Division at Babson College and was an executive vice president at Boston Scientific Corp.
This article is adapted from Gilbert, J. "Creating a Winning Medtech Business Model for a Post-Reform World." In Vivo, 28 (7) (2010): 46-51.