It’s not exactly news that the med-tech industry is under pressure from a variety of fronts – an uncertain regulatory environment, a looming tax burden and, not least, downward pricing pressure from its health care provider customers.
That last issue is particularly acute for medical device makers because their business model has long been anchored by developing high-ticket products and raising prices even further for each new iteration. Health care reform, if it survives in its present form, will change all that. It’s no longer sufficient to develop an innovative device to treat an unmet need; new products today must also demonstrate their ability to take costs out of the healthcare system.
That presents an inherent conflict between the need to control costs (and thereby keep costs down) and the need to spend on innovation. For Philips Healthcare (NYSE:PHG) CEO Steve Rusckowski, however, that’s a false choice.
"I see innovation as the solution to the problem of cost, not a problem of cost," Rusckowski told MassDevice.com during a lengthy interview on the sprawling Philips Healthcare campus in Andover, Mass.
"Many industries have applied innovation to improve quality and lower cost," he said, citing the automotive industry’s drive to automate plants. "What you can buy a car for, the quality of that car versus what we had 15 years ago, it’s remarkable. And it’s only because of the investments the automotive industry has made in the automation of facilities, robotics, information systems.
"In health care, I always have been a believer in technology and innovation as part of the solution to the problem of cost and quality. When it comes to the question to the question of cost, what we find throughout the world is there’s value to be brought to health care. My argument is always around value. We bring value and we get value back on price. And if we bring value, health care system people are willing to give you back the value of price. We also believe that we can value-engineer some of our products to bring new price points to products that we’ve never seen before," Rusckowski said.
Philips Healthcare, ranked 7th on the MassDevice Big 100 list of the world’s largest med-tech players, employs about 35,500 people worldwide. A division of Koninklijke Philips Electronics NV, the Dutch electronics conglomerate, it’s been a leader in medical imaging
since 1918, when Royal Philips Electronics developed the first medical X-ray tube. Philips Healthcare enjoys large shares in markets including patient monitoring, resuscitation and HIT and accounted for nearly 40 percent of total revenues for its corporate parent in 2011.
The healthcare business weathered a tough 4th quarter and 2011, reporting operating profits of
€359.0 million (~$465.2 million) on sales of €2.72 billion (~$3.53 billion), for a top-line gain of 3.1 percent but a bottom-line slide of 21.8% compared with Q4 2010. Full-year profits for the division were €93.0 million (~$121 million) on sales of €8.85 billion (~$11.47 billion) – representing a 2.9% sales increase but a whopping 89.9% decrease in profits.
Being a global operation puts Philips Healthcare at the mercy of global events. When we spoke last month, Rusckowski – who was recovering from a nasty bout of pneumonia – explained why the Japanese earthquake, the ongoing debt crisis in Europe and even the revolutions in Egypt and Libya combined for some considerable headwinds last year.
MassDevice.com: The 4th quarter was a tough one for Philips Healthcare, with operating profits down substantially for both the quarter and full year. I’m hoping you can give me a little color on that.
SR: We always report comparable sales growth. Our comparable sales growth for health care last year was about 5.3%. We had some headwinds last year – 1 was Japan. Japan is the 2nd largest market in the world this year; it affected our commercial delivery, and I don’t know if you hear about this that much, but we had significant supplier issues related to Japan. Primary, secondary, tertiary suppliers.
We worked our way through it last year, it was March of last year, but as a year, it took away from other things, like cost improvement goals and improvements in our value-engineering. Wars in North Africa – we’re a global company, and in Libya and Egypt we have a sizable business – we couldn’t deliver products that we wanted to deliver. We had floods in Thailand, we have business there, but also there’s distribution issues and then finally in the 2nd half of the year, we saw a significant slowdown in Europe, in the European crisis. So we start to see this in Q3, where orders start to soften. So if you look through Q3 actually this business was growing 7% comparable. So it’s a very strong growth rate if you stack it up against other companies.
And then in the 4th quarter, given the softening conditions in Europe, coupled with people not even wanting what they had planned to have delivered in the 4th quarter, what we had was a 3rd quarter that grew about 3%. We continued to invest in a number of products – in the last 18-24 months, we introduced 80 products in the last 18 months. Our product portfolio has never been stronger.
So when we hit the 4th quarter and saw what was going on, softening in the market, but continuing to invest in R&D and also sales force – we invested considerably in new sales forces in some of the developed areas, but also in emerging markets. So expense is growing fast and the top line, we didn’t have a lot of time to react in the 4th quarter, although that will be adjusted going forward. That was the primary issue.
Emerging markets continue to be a great growth opportunity for us. We grew double digits in the past, we will continue to look at high-single-digit and double-digit growths in those markets. Last year, we did 22% of our top line in emerging markets. We are about roughly a €9 billion business, or $13 billion, so if you go through the math, it’s close to $3 billion from emerging markets.
China, by itself, for us is about a $1 billion business. We’re exporting out of this site, and all our sites around the U.S., everything we make. So the folklore that emerging markets are only about value-engineered products is not true. It’s an enormous opportunity for everything we make, both in the mid- to higher-end products and also mid-low.
I’ll give you another fact: China is the largest CT market in the world now, for all suppliers. We have more high-end CT scanners – we sell a product called ICT, which is a 256-slice scanner – we have more of those installed in China than we do anyplace else in the world. So emerging markets continue to be a great growth opportunity. And that’s China, but then you go right down the line: India, Brazil, Russia, Middle East, Africa, southeast of the Great Wall.
In the U.S., the sluggish recovery is continuing, health care continues to chug along, if you will, the Affordable Care Act is going to put more money into the system, that’s what it was all about. So that’s going to continue to grow. The U.S. market is okay, it’s okay, that’s the way to describe it.
Then if you look at Japan, we hit a bump last year, they’re coming out of it. They’re going to have to make an investment, so some pent-up demand there. Then if you go into Europe, you have to be careful, because there are portions of Europe that are doing all right. Germany as a market, which has the largest market for us in Europe, is actually okay. U.K., as you read, is going through a whole re-engineering of their NHS system, which is currently in Parliament. The biggest issue in Europe, as we all know, is southern Europe – Italy, Greece, Spain – where we have substantial businesses that have slowed.
So you put it all together and you say you still have a marketplace that’s growing, the prognosis going forward is reasonable, you know, given what the world is at right now, where the U.S. is, the emerging market promise is still there, that’s not changing. And the question mark that remains is Europe. And you saw that in the 4th quarter, so prospectively, you adjust accordingly and you go forward. The strategy is working and the delivery of the products that we introduced across our complete product line has been impressive. Our product offering has never been stronger.
MassDevice.com: It’s an uncertain era on the regulatory front in the U.S. What’s your take on the push to reform the 510(k) process here? Are there technologies or investments you’d pass up because the risk of not winning clearance or approval here is too great?
SR: I think there are 2 sides of regulatory. One is product approval, 2nd is regulatory compliance. On the product approval side, it’s a moving target. In the U.S., we’ve been working our way through things. In our side of the business, maybe because very few of our products are PMA, it’s been predictable within reason. I’ll add to that that now we need to worry about regulatory not just in the US. All our products have to go through the SFDA in China. This is our 2nd largest country in the world. So we need to apply for regulatory approval with the FDA, we then need to apply for regulatory approval with China. For example, we just introduced a brand-new MRI product called the Ingenia and we’re waiting for regulatory approval in China, even though we’ve been delivering product here in the U.S. and in Europe for over 12-18 months. We hope to get it in the first half [of 2012]. So the non-U.S. portion of regulatory is a challenge, because every market in the world is thinking through that.
As for quality compliance, I don’t think there’s a medical device company in the world that hasn’t had its struggles with different quality compliance areas and I would say that the vigilance of the FDA has increased. I’m always a believer that I can never argue with what the FDA regulations say we should do. The onus is on us as medical device companies to deliver against it. I would say that we have as an industry gotten better, and we continue to get better going forward. So some of the issues that have surfaced over the last 2 or 3 years throughout the industry, I think it’s a good, healthy practice to keep us on task, to deliver what we said we should do. Nobody can argue the basic premise of what’s in the right. So that’s my color on it.
Are there some things we would not do because of the environment? We do think about it. When you look at the time it’s going to take for getting the clinical evidence for a PMA, you start to realize that it’s easier for us to get that done outside of the United States. As a matter of fact, we are introducing some products, such as the high-field focused ultrasound product, we’re actually starting with that as a commercial product in India. Because 1 of its best applications is uterine fibroids, we’re actually using it clinically and selling it commercially in India. And the advantage of some of these countries like India and China is the ability to do some of the clinical evidence-gathering there because of the sheer numbers. It’s just a huge opportunity to accelerate things.
The good side of this is emerging markets in this industry are a great opportunity. How many industries in the world are actually designing, manufacturing and exporting good products to China? To India? To Southeast Asia? It’s opening us up to thinking about ways of doing things differently for different business models and getting products on the ground more quickly because of less barriers on the regulatory side.