Squeezing out Waste in the US Medical Devices Industry

February 26, 2015

Medical devices companies are in for a gut-wrenching transition over the next five years.  While many companies have enjoyed gross margins in excess of 70% and a relatively static and complacent competitive environment over the past two decades, it seems that the industry is in for a pronounced shift.

Average selling prices (ASP) are being compressed due to hospital procurement initiatives.  FDA and other industry-specific regulatory requirements have steadily increased.  The market is litigious and fraught with every type of business risk imaginable.

Necessity is the mother of invention.  It’s also the prime driver of step-change improvement in any business.  Many devices companies are examining their position in the marketplace and realizing that the ‘true’ cost of their products as viewed from their customers’ eyes is grossly inflated by parties and process steps that add little to no value.  These inefficiencies will in all likelihood be squeezed out of existence.

Remarkably the implants, instrumentation, devices, surgical expertise, and the hospital footprint required are only a fraction of the total cost of any procedure.  From my own experiences in the industry over the last twelve years, there are a long list of inefficiencies that drive up the cost of a medical procedure in the US health care system.  Here are five of the most pervasive wastes:

  1. Forecasting Waste – Many devices companies have inaccurate demand planning habits and forecasts.  They manufacture more implants, components and instruments than they need to.  Often under the guise of ambitious product development and marketing initiatives, sometimes new products and revisions are a bust before they even hit the market.  Many firms build the cost of failures into the successful products in their portfolios.  The new reality will be for devices companies to achieve an average forecast accuracy that is 98% or above.
  1. Supply Chain Waste – Often the device or some of the ancillary surgical components will expire or become obsolete in the supply chain.  In some cases, shipments to end-user locations may be 10-12% higher than sales due to shrink.  In practical terms, there are relatively few ways to drive financial accountability for losses to the surgeon or hospital system, because surgeons will dump the manufacturer in favor of another with looser terms and conditions.  Companies that manage shrink, inaccurate inventory, obsolescence and expiry-based wastes down to near-zero will compete well in the new health care environment.
  1. Moral Hazard Waste – Hospitals and distributors like to hold massive levels of inventory on consignment basis, because they do not bear the cost of the inventory.  This means that valuable devices sit idle on the shelves and result in poor overall inventory availability, and asset utilization.  The manufacturer bears the cost of the device and the kitting required to perform the surgery, while there are relatively little repercussions for poor inventory utilization on the part of the consignee.  Companies that seek and eliminate moral hazard will have an advantage against their peers.
  1. Distribution Waste – Up to 20% of the cost of a surgery is paid in the form of a commission to a sales rep or distributor who holds a close relationship with the surgeon.  The market has already begun to eliminate these ‘middleman’ relationships through more stringent purchasing practices.  Companies that explore direct selling relationships with lower cost of sales will be more efficient players than those that are shackled to antiquated go-to-market strategies.
  1. Transportation Waste – It is customary for the manufacturer to bear the cost of shipping or freight to the point of surgery.  However, last-minute ordering and reactive planning on the part of the surgeon’s administrative team will often express itself in terms of overnight, next-day air freight charges which can be 10-15 times the cost of a proactive shipment made through a less expensive mode of transportation.  Disciplined freight and transportation cost management will give forward-thinking manufacturers a leg-up on the competition.

Medical devices companies should take stock of the changes that are likely to occur in the industry.  In much the same circumstance that Blockbuster perished when Netflix turned the home movie industry on its head, medical devices companies need to reassess their processes, systems and behaviors for the potentially devastating shift that is already underway.

By: Adrian Travis