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To thrive in the healthcare environment of tomorrow, orthopaedic device companies will need to operate within a greater portion of the supply chain, assisting upstream and downstream customers in finding operational value. This will require companies to forge stronger relationships, focus on internal efficiencies and launch services, not just devices. Ultimately, the business models of orthopaedic device companies must radically change if they want to maintain profitability, margins and independence in coming years. This was the message from OMTEC® 2016 keynote speaker Bill Tribe, Ph.D., Partner at A.T. Kearney’s Health Practice.
The message is bold, yet not surprising. One needs to look no further than the product—not device, but product—launches of the largest industry players in recent years. Observe a number of examples: DePuy Synthes’ focus on bundled payment services, Stryker’s purchase and subsequent launch of the Mako robot, Smith & Nephew’s development of Syncera. Additional players and offerings, like Cardinal Health’s expansion into the commercialization of orthopaedic implants and Millstone Medical Outsourcing’s direct-to-patient and hospital distribution model, are reaching new portions of the supply chain.
Tribe referred to these as pilot programs. While it can be assumed that a large amount of research and resources, both personnel and capital, went into the creation of these technologies and services to gain meaningful return on their investments, most on this list are too early in their lifecycles to deem successful long-term.
What these companies attempt to do with these models, though, is to solve a different problem for their customers while generating a new revenue stream for themselves. They move beyond legacy devices and distribution to target new price points and customers, and even create new audiences. Tribe argued that all orthopaedic companies, regardless of size or position in the supply chain, should introduce alternative business models that match the shifts in healthcare and their own company needs
Bill Tribe, Ph.D.
A.T. Kearney
Here is why.
The Economic Case
Margins across the medical device sector have been falling for more than a decade, and will continue to erode by about 5% if unaddressed, according to Tribe’s research. Compounding that is the continued negative impact of price pressure, at nearly 3% per year. An average orthopaedic company would need to reduce its cost of goods by 12% or its Selling, General and Administrative expenses by 8%, or some combination of the two, to offset that 3% in price pressure, he says. That pressure is consistent; therefore, companies must get leaner each year.
On a positive note, orthopaedics is a $46 billion industry growing in the low-single-digits year over year, according to ORTHOWORLD’s THE ORTHOPAEDIC INDUSTRY ANNUAL REPORT®. Healthy procedural volumes due to a growing and aging population, and untapped and underserved markets, mean that the industry remains attractive.
By A.T. Kearney’s estimates, $4 billion to $5 billion in combined operating profit and working capital opportunity is up for grabs from now until 2020 for orthopaedic companies that are able to respond to the industry’s disrupting factors (more on these below) by restructuring business models, products or both.
In attempting to capture that opportunity, Tribe referenced two important points. Number 1, the implant is a small percent of the overall procedure and post-operation cost. For example, an implant accounts for about 3% of a total hip replacement procedure and post-operation cost.
Number 2, Tribe’s analysis of each group within the value chain found that orthopaedic device companies large and small experienced the greatest margins. (See Exhibit 1.) As the customers on either side of the OEM—from the contract manufacturers to the hospital—face increasing pressures in the healthcare environment, they will continue to reference that unevenness and push back against their device company partners.
Notes on Exhibit 1: Distributors based on Cardinal Health, McKesson & ABC; OEM majors based on Zimmer Biomet, Stryker, Smith & Nephew, challengers based on NuVasive, Amplitude and Exactech; hospitals based on American Hospital Association and Kaiser Permanente; CMOs based on Greatbatch, Symmetry and estimates for private players.
Therefore, companies need to adapt their business models to preserve margins and preserve relevance. Assisting in cutting waste pre-, during and post-surgery is just one possible solution.
“If you are one of the companies in the 20% to 25% margin, one of the things you want to be careful about is shrinking to become a provider of increasingly commoditized products,” Tribe said. “That situation doesn’t sit easily with 20% to 25% margins. The only way it does sit easily with 20% to 25% margins is if you become a true cost leader in the industry. Frankly, at the moment, no one has that level of cost advantage to justify that level of margin. It may come, but it doesn’t exist right now.
“The alternative, and one that we think makes sense, is that you use the scale that you have and you use the influence that you have. The 3% of the hip procedure influences the rest of the value chain. You use that to bundle with products and services; you unlock different sources of value across the value chain to build stickiness into the buying relationship, so that you preserve your margins and your access to markets.”
The Disruptors
In strategizing ways to obtain a portion of that $4 billion to $5 billion that Tribe asserts is ready for the taking, it is imperative to understand the present prevailing headwinds.
Tribe outlines these disruptors as:
- Power shift to payors and providers
- Heightened regulatory scrutiny
- Unclear sources of innovation
- New healthcare delivery models
- The need to serve lower socio-economic classes
These disruptors are not new, and because they have presented themselves in various forms in recent years, they are casually mentioned in today’s conversations. Still, these disruptors are acute, they need to be addressed and, importantly, they hold strategies for ways to move forward.
Tribe offered useful context in understanding the scale of these disruptors.
Power Shift to Payors and Providers
Hospital administrators and committees have largely taken over implant decisions once made by surgeons. These decisions consider several factors, including reimbursement from private and public insurers.
Tribe cited that today, 70% of orthopaedic surgeons are hospital employees; 73% of all hospital purchases are now covered by group purchasing organization (GPO) contracts and 14 states in the U.S. have one insurer with at least 50% market share (data released before the Aetna/Humana and Cigna/Anthem mergers were announced).
Heightened Regulatory Scrutiny
A multitude of new U.S. and ex-U.S. regulations have forced companies to shift resources to support regulatory and quality compliance. One example is the overhaul of the EU Medical Device Regulations, which are covered in this article.
Tribe cited changes in the 510(k) process, UDI implementation, the now-suspended medical device tax and increased scrutiny of orthobiologics, instruments and sterilization.
Unclear Sources of Innovation
Conversation after conversation at industry meetings turn to lack of innovation in orthopaedics and the continual commoditization of products. Orthopaedic companies still focus on product line extensions and incremental updates instead of novel technologies that must undergo stricter and longer regulatory timelines.
Tribe cited that between 2004 and 2014, orthopaedic Premarket Approvals (PMAs) dropped by 8%, while FDA 510(k) clearances increased 11%. At the same time, venture capital has dried up, leaving a hole for companies seeking to develop innovative technology and thus limiting the once tried-and-true model of big companies buying technologies from a large pool of smaller companies.
New Healthcare Delivery Models
The push from volume to value, and specifically the advent of bundled payments, is a prime example of the way that orthopaedic companies can impact the focus on reducing procedure costs.
As mentioned earlier, Tribe cited that the implant represents 3% of the cost of a total hip replacement. This leaves 22% of the cost associated with the operation, 29% of the cost associated with hospital-based post-operative care and 46% of the cost tied to post-discharge care.
Need to Serve Lower Socio-Economic Classes
In the past, orthopaedics primarily served the population that could afford treatment. Today, though, that’s not the sector of the population that holds growth potential. Opportunity can be found in underserved portions of the market, from developing countries to even Americans now covered by the Affordable Care Act. Tribe said that he expects orthopaedic companies to consider a tiered model of products, ranging from personalized to premium to low-cost products, in the future.
Tribe cited a $6 billion growth potential in the medical device market, driven by access to different underserved population groups.
Conclusion
As noted by Tribe in his February 2016 ORTHOKNOW article, companies will see the greatest success if they take the aforementioned economic and disruptive drivers and tailor their business model to their needs and the needs of their customers.
He recommends starting with a clear picture of what is driving margin performance across product ranges, down to who is the customer and what combination of products they purchase within individual regions.
“You need to know what’s driving margins and overall performance, whether that be service or cost, and you need a clear notion of where you can compete,” Tribe said. “Our experience is that companies have general understanding of that, but lack the understanding on a detailed level.
“Once that detailed understanding is in hand, it’s easier to overlay that with industry trends and specific disruptive forces that will influence the sector. Once you have that mapping done, you can ask, ‘Where can I compete more effectively? What can I augment and enhance, while taking out anything that is unnecessary?’ Mapping the detailed performance advantages of specific companies is the basis to figure out where you want to compete.”
During his OMTEC presentation, Tribe recommended a list of specific questions management teams should review.
That list of questions includes:
- How do our portfolio choices help manage supplier relationships?
- What upstream relationships can create the most value for us?
- How can you define differentiated supply chains to serve different markets and segments effectively?
- How can we enhance end-to-end cost efficiencies?
- What drives a more scalable & efficient supply base?
- How can bundling be managed?
- What services truly enhance our current products
- and the ability provide value?
Orthopaedic device companies that ask these questions are adapting their traditional business models to offer bundled payment services, personalized devices, robotic assisted systems, simplified surgical processes and streamlined distribution models. Tribe expects that more orthopaedic companies will commit to these “experiments,” as he called them, and begin to scale.
Observations from company announcements and conversations with peers do suggest that the major orthopaedic players are leading these changes. However, it’s vital for the health of all companies to consider asking these questions.
The imbalance of power among parties in the value chain will continue to place economic, regulatory and relationship pressures upon orthopaedic device companies. As Tribe noted, there are many attractive and profitable opportunities waiting for those that are able to adapt.
“It’s very clear that these alternative pathways really represent a huge opportunity for those that embrace them,” he said. “The companies that sit still in the traditional model and simply provide products are going to fall behind those companies that find alternative ways to operate across the value chain and make their products important to their customers.”
Carolyn LaWell is ORTHOWORLD’s Chief Content Officer. She can be reached by email.
To thrive in the healthcare environment of tomorrow, orthopaedic device companies will need to operate within a greater portion of the supply chain, assisting upstream and downstream customers in finding operational value. This will require companies to forge stronger relationships, focus on internal efficiencies and launch services, not...
To thrive in the healthcare environment of tomorrow, orthopaedic device companies will need to operate within a greater portion of the supply chain, assisting upstream and downstream customers in finding operational value. This will require companies to forge stronger relationships, focus on internal efficiencies and launch services, not just devices. Ultimately, the business models of orthopaedic device companies must radically change if they want to maintain profitability, margins and independence in coming years. This was the message from OMTEC® 2016 keynote speaker Bill Tribe, Ph.D., Partner at A.T. Kearney’s Health Practice.
The message is bold, yet not surprising. One needs to look no further than the product—not device, but product—launches of the largest industry players in recent years. Observe a number of examples: DePuy Synthes’ focus on bundled payment services, Stryker’s purchase and subsequent launch of the Mako robot, Smith & Nephew’s development of Syncera. Additional players and offerings, like Cardinal Health’s expansion into the commercialization of orthopaedic implants and Millstone Medical Outsourcing’s direct-to-patient and hospital distribution model, are reaching new portions of the supply chain.
Tribe referred to these as pilot programs. While it can be assumed that a large amount of research and resources, both personnel and capital, went into the creation of these technologies and services to gain meaningful return on their investments, most on this list are too early in their lifecycles to deem successful long-term.
What these companies attempt to do with these models, though, is to solve a different problem for their customers while generating a new revenue stream for themselves. They move beyond legacy devices and distribution to target new price points and customers, and even create new audiences. Tribe argued that all orthopaedic companies, regardless of size or position in the supply chain, should introduce alternative business models that match the shifts in healthcare and their own company needs
Bill Tribe, Ph.D.
A.T. Kearney
Here is why.
The Economic Case
Margins across the medical device sector have been falling for more than a decade, and will continue to erode by about 5% if unaddressed, according to Tribe’s research. Compounding that is the continued negative impact of price pressure, at nearly 3% per year. An average orthopaedic company would need to reduce its cost of goods by 12% or its Selling, General and Administrative expenses by 8%, or some combination of the two, to offset that 3% in price pressure, he says. That pressure is consistent; therefore, companies must get leaner each year.
On a positive note, orthopaedics is a $46 billion industry growing in the low-single-digits year over year, according to ORTHOWORLD’s THE ORTHOPAEDIC INDUSTRY ANNUAL REPORT®. Healthy procedural volumes due to a growing and aging population, and untapped and underserved markets, mean that the industry remains attractive.
By A.T. Kearney’s estimates, $4 billion to $5 billion in combined operating profit and working capital opportunity is up for grabs from now until 2020 for orthopaedic companies that are able to respond to the industry’s disrupting factors (more on these below) by restructuring business models, products or both.
In attempting to capture that opportunity, Tribe referenced two important points. Number 1, the implant is a small percent of the overall procedure and post-operation cost. For example, an implant accounts for about 3% of a total hip replacement procedure and post-operation cost.
Number 2, Tribe’s analysis of each group within the value chain found that orthopaedic device companies large and small experienced the greatest margins. (See Exhibit 1.) As the customers on either side of the OEM—from the contract manufacturers to the hospital—face increasing pressures in the healthcare environment, they will continue to reference that unevenness and push back against their device company partners.
Notes on Exhibit 1: Distributors based on Cardinal Health, McKesson & ABC; OEM majors based on Zimmer Biomet, Stryker, Smith & Nephew, challengers based on NuVasive, Amplitude and Exactech; hospitals based on American Hospital Association and Kaiser Permanente; CMOs based on Greatbatch, Symmetry and estimates for private players.
Therefore, companies need to adapt their business models to preserve margins and preserve relevance. Assisting in cutting waste pre-, during and post-surgery is just one possible solution.
“If you are one of the companies in the 20% to 25% margin, one of the things you want to be careful about is shrinking to become a provider of increasingly commoditized products,” Tribe said. “That situation doesn’t sit easily with 20% to 25% margins. The only way it does sit easily with 20% to 25% margins is if you become a true cost leader in the industry. Frankly, at the moment, no one has that level of cost advantage to justify that level of margin. It may come, but it doesn’t exist right now.
“The alternative, and one that we think makes sense, is that you use the scale that you have and you use the influence that you have. The 3% of the hip procedure influences the rest of the value chain. You use that to bundle with products and services; you unlock different sources of value across the value chain to build stickiness into the buying relationship, so that you preserve your margins and your access to markets.”
The Disruptors
In strategizing ways to obtain a portion of that $4 billion to $5 billion that Tribe asserts is ready for the taking, it is imperative to understand the present prevailing headwinds.
Tribe outlines these disruptors as:
- Power shift to payors and providers
- Heightened regulatory scrutiny
- Unclear sources of innovation
- New healthcare delivery models
- The need to serve lower socio-economic classes
These disruptors are not new, and because they have presented themselves in various forms in recent years, they are casually mentioned in today’s conversations. Still, these disruptors are acute, they need to be addressed and, importantly, they hold strategies for ways to move forward.
Tribe offered useful context in understanding the scale of these disruptors.
Power Shift to Payors and Providers
Hospital administrators and committees have largely taken over implant decisions once made by surgeons. These decisions consider several factors, including reimbursement from private and public insurers.
Tribe cited that today, 70% of orthopaedic surgeons are hospital employees; 73% of all hospital purchases are now covered by group purchasing organization (GPO) contracts and 14 states in the U.S. have one insurer with at least 50% market share (data released before the Aetna/Humana and Cigna/Anthem mergers were announced).
Heightened Regulatory Scrutiny
A multitude of new U.S. and ex-U.S. regulations have forced companies to shift resources to support regulatory and quality compliance. One example is the overhaul of the EU Medical Device Regulations, which are covered in this article.
Tribe cited changes in the 510(k) process, UDI implementation, the now-suspended medical device tax and increased scrutiny of orthobiologics, instruments and sterilization.
Unclear Sources of Innovation
Conversation after conversation at industry meetings turn to lack of innovation in orthopaedics and the continual commoditization of products. Orthopaedic companies still focus on product line extensions and incremental updates instead of novel technologies that must undergo stricter and longer regulatory timelines.
Tribe cited that between 2004 and 2014, orthopaedic Premarket Approvals (PMAs) dropped by 8%, while FDA 510(k) clearances increased 11%. At the same time, venture capital has dried up, leaving a hole for companies seeking to develop innovative technology and thus limiting the once tried-and-true model of big companies buying technologies from a large pool of smaller companies.
New Healthcare Delivery Models
The push from volume to value, and specifically the advent of bundled payments, is a prime example of the way that orthopaedic companies can impact the focus on reducing procedure costs.
As mentioned earlier, Tribe cited that the implant represents 3% of the cost of a total hip replacement. This leaves 22% of the cost associated with the operation, 29% of the cost associated with hospital-based post-operative care and 46% of the cost tied to post-discharge care.
Need to Serve Lower Socio-Economic Classes
In the past, orthopaedics primarily served the population that could afford treatment. Today, though, that’s not the sector of the population that holds growth potential. Opportunity can be found in underserved portions of the market, from developing countries to even Americans now covered by the Affordable Care Act. Tribe said that he expects orthopaedic companies to consider a tiered model of products, ranging from personalized to premium to low-cost products, in the future.
Tribe cited a $6 billion growth potential in the medical device market, driven by access to different underserved population groups.
Conclusion
As noted by Tribe in his February 2016 ORTHOKNOW article, companies will see the greatest success if they take the aforementioned economic and disruptive drivers and tailor their business model to their needs and the needs of their customers.
He recommends starting with a clear picture of what is driving margin performance across product ranges, down to who is the customer and what combination of products they purchase within individual regions.
“You need to know what’s driving margins and overall performance, whether that be service or cost, and you need a clear notion of where you can compete,” Tribe said. “Our experience is that companies have general understanding of that, but lack the understanding on a detailed level.
“Once that detailed understanding is in hand, it’s easier to overlay that with industry trends and specific disruptive forces that will influence the sector. Once you have that mapping done, you can ask, ‘Where can I compete more effectively? What can I augment and enhance, while taking out anything that is unnecessary?’ Mapping the detailed performance advantages of specific companies is the basis to figure out where you want to compete.”
During his OMTEC presentation, Tribe recommended a list of specific questions management teams should review.
That list of questions includes:
- How do our portfolio choices help manage supplier relationships?
- What upstream relationships can create the most value for us?
- How can you define differentiated supply chains to serve different markets and segments effectively?
- How can we enhance end-to-end cost efficiencies?
- What drives a more scalable & efficient supply base?
- How can bundling be managed?
- What services truly enhance our current products
- and the ability provide value?
Orthopaedic device companies that ask these questions are adapting their traditional business models to offer bundled payment services, personalized devices, robotic assisted systems, simplified surgical processes and streamlined distribution models. Tribe expects that more orthopaedic companies will commit to these “experiments,” as he called them, and begin to scale.
Observations from company announcements and conversations with peers do suggest that the major orthopaedic players are leading these changes. However, it’s vital for the health of all companies to consider asking these questions.
The imbalance of power among parties in the value chain will continue to place economic, regulatory and relationship pressures upon orthopaedic device companies. As Tribe noted, there are many attractive and profitable opportunities waiting for those that are able to adapt.
“It’s very clear that these alternative pathways really represent a huge opportunity for those that embrace them,” he said. “The companies that sit still in the traditional model and simply provide products are going to fall behind those companies that find alternative ways to operate across the value chain and make their products important to their customers.”
Carolyn LaWell is ORTHOWORLD’s Chief Content Officer. She can be reached by email.
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Carolyn LaWell is ORTHOWORLD's Chief Content Officer. She joined ORTHOWORLD in 2012 to oversee its editorial and industry education. She previously served in editor roles at B2B magazines and newspapers.
