New paths to profit

As publicly traded firms ready their year-end financial statements this month it’s clear that the med-tech industry’s high-flying days aren’t coming back any time soon.

Wall Street analysts expect companies in the sector to release cautious forecasts for sales and earnings in 2012, reflecting a series of factors conspiring to put pressure on their top and bottom lines. Lower procedure volumes, pricing pressure and the unstable European economy all play a part, according to Barclay’s Capital analyst Adam Feinstein.

"We continue to believe that a big turnaround remains out of reach near term, as device makers will likely continue to face lower utilization, pricing pressure, payer pushback, and challenges in Europe," Feinstein wrote in a note investors. "In our view, there is not a ‘quick fix’ to the macro drivers that impact med-tech market growth, including unemployment, insurance coverage, benefit design, elective procedure delays, and government and hospital budget constraints."

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"In 2012 we see the macro headwinds that have pressured the med-tech space for the last few years continuing to restrain sales and earnings growth," added Leerink Swann analyst Rick Wise in a research note.

According to the Boston Consulting Group,
gross margins will drop 2% across the med-tech sector (defined as medical device, supplies, equipment and diagnostics) over the next decade, with meager revenue growth averaging just 4% to 5% annually. From 2006 to 2010 the average total return to shareholders across all industries was 6%, according to a BCG report, "Strength in the Storm." For the med-tech space, however, TSR was just 3% over that time. And for the medical device sector, that number is 0.

"The heyday of the sector is waning, and 10 years from now the income statement of the typical successful med-tech company will resemble that of a high-tech or even an industrial goods company: Lower gross margins and, by necessity, a more modest cost structure relative to the traditional med-tech profile," according to the report.

So what’s a device company to do? Colm Foley, partner and a managing director at BCG, told MassDevice that there are 3 things med-tech firms should focus on to weather the rough seas ahead: Expand into emerging markets, embrace "value-based health care" and expand into new business areas that might pose more risk – and therefore more reward.

Foley

"It’s a completely different mentality and the industry doesn’t have enough of that," Foley told us. "It’s interesting to tell an industry to take on riskier projects – you’ll have a higher rate of failure. But we believe that’s the right direction for the industry, because clearly their current path isn’t going to be rewarded."

That means well-planned forays into fast-growing emerging markets.

"The trick is to ensure that the growth in target markets is matched with sensible margins and to customize approaches to address different demographics, commercial and regulatory environments and distribution networks," according to the BCG report. "A wave of product approvals from low-cost countries is on the horizon. From 2000 to 2010, emerging markets’ share of device registrations doubled for Class II devices and almost tripled for Class III devices."

In terms of value-based health care, the BCG prescription calls for a strategy aimed at taking costs out of the health care system.

"The global med-tech industry is $350 billion – it’s a small portion of the total health care picture," Foley told us last week at the JP Morgan health care conference in San Francisco. "If you can eliminate clinical issues, if you can save hospitals time, if you can improve workflow, the value for this industry to grow into is enormous."

Citing Edwards Lifesciences (NYSE:EW) and its success with the Sapien replacement heart valve, the BCG report notes that Edwards took a flyer on creating a game-changing device. The risk the company took panned out; it’s now got a clear and convincing lead in the heart valve market.

"When Edwards introduced its Sapien transcatheter aortic valve in Europe, in 2007, the company gained first-to-market advantage in an area of unmet need and created a paradigm shift," the report noted. "Companies should assess both their need and their ability to diversify, in order to determine whether doing so is valuable for long-term value creation."

For device makers, that means re-tailoring their business models to become more appealing to what BCG calls "purchase influencers" at hospitals, rather than concentrating on their traditional end-user base – doctors.

"And in some cases, device companies must devote substantially more attention to reaching payers," according to the report. That also means adjusting the value proposition to address the needs of providers and payers, the report notes, adding that device companies must also adjust their sales channels to reflect the new purchasing/paying paradigm.

"The challenge in the short to medium term is for companies to add new call points within some hospitals to reflect the changing purchasing process while maintaining their high-touch physician model," according to the report.