New challenges and opportunities for medtech industry

Ernst & YoungOct 19 2010

The US and European medical technology industry struggled to sustain historic rates of revenue growth in 2009 but managed to improve overall net income by nearly 11% as companies realigned to achieve improved financial discipline. While medtech has fared better than many industries in the current economic downturn, new challenges will put increasing strain on the industry's long-standing business model. These and other findings are highlighted in Pulse of the industry: medical technology report 2010, Ernst & Young's annual report on the industry's performance, released today at AdvaMed 2010.

The report details a confluence of factors that are creating unprecedented financial pressures on many medtech companies. These include the continued tightening of capital markets, the implementation of comparative effectiveness research (CER), increasing regulatory approval costs and hurdles in many markets, and the impending "device tax" passed under US health care reform, which is anticipated by many to disproportionally impact smaller, pre-profitable companies.

"The medtech industry showed impressive discipline last year by improving bottom-line performance even as revenues remained flat, but even bigger challenges lie ahead," said John Babitt, Ernst & Young's Medtech Leader for the Americas. "With the financing model under enormous strain, the industry will need new ways to fund innovation. As hospitals consolidate purchasing decisions and payors look to CER, companies will need to demonstrate value as never before, and with revenues plateauing — particularly in mature markets — they will have to find new sources of growth."  

Key industry findings described in Pulse of the industry include:

• Efficiency boosts bottom line. Revenues for publicly traded medtech companies in the US and Europe grew by only 0.3% in 2009 to US$294.1b, well below the 11% growth seen in 2008, as companies confronted a challenging global economic climate. Net income increased by 10.8% in 2009 to US$13.2b, driven by a 29% increase in Europe coupled with a 4.3% increase in the US.  
• Debt fuels financing. Capital raised by US and European companies in 2009 totaled US$13.1b, a 45% increase from the previous year. This increase was driven by an 88% increase in the US, fueled by a handful of large debt transactions that took advantage of historically low interest rates. This trend has continued into the first half of 2010, with total financing up 104% compared to the same period in 2009.  
• Venture capital (VC) stays strong.  VC continued to flow to the sector at a relatively strong pace in 2009. In the US, total VC funding reached US$2.7b in 2010, down from the heights of 2006-8 but surpassing the amounts invested annual between 2000 and 2005. European medtechs received US$701m in VC financing in 2009, which was essentially flat compared to 2008. For the first six months of 2010, VC investment in the sector for both the US and Europe totaled US$2.4b -- a pace that, if continued, would enable both regions to surpass the totals raised in 2009. Distribution of VC has become more skewed than at any time in the last decade however, as investors are increasingly targeting later stage funding opportunities at the expense of emerging medtechs that have historically driven innovation in the industry.                                
• IPOs. The US and European medtech industry saw one IPO each in 2009 and one each so far in 2010. For the US, these were the first IPOs since the first quarter of 2008.  Historically, the US market averaged 14 IPOs per year between 2004 and 2007.
• M&As decline. The total value of mergers and acquisitions (M&As) in the US and Europe in 2009 was US$15.7b, a 62% decline compared to 2008 and the lowest total since 2002. Deal activity has rebounded through the first half of 2010, with 89 deals totaling US$16.9 billion announced (excluding Novartis' acquisition of a majority interest in Alcon for US$28.3b which would have brought the six month M&A total to US$45.2b).

Fundamental challenges emerging

The report finds that many of the basic elements of the medtech industry's long standing business model are being challenged in ways not seen in the past, raising concerns as to whether important elements of this model will need to be revisited. Key challenges highlighted in the report include:

Sustaining innovation: The traditional innovative model in medtech has been represented by rapid product development cycles, iterative product improvements driven by physician collaboration and interaction, and a funding model seen as shorter and less risky when compared to drug development. Each step along this cycle is now being challenged as new restrictions on products eligible for 510(k) marketing clearance may result in a lengthier approval process and new concerns emerge on the impact that proposed measures to increase transparency in physician interactions will have on the ability of medtech to use their insights to achieve post-approval product improvements. In addition, emerging companies are expected to not only face a continued constrained funding environment but those that would have traditionally sought an exit through acquisition are finding that potential buyers are increasingly seeking mature and commercialized assets requiring substantial capital investment.

Delivering value and outcomes:  Companies are finding the value proposition of their products under increasing scrutiny by payors, regulators and customers. Trends expected to exacerbate this challenge include the adoption of CER and the acceleration of hospital purchasing consolidation which is reducing the number of options available in a particular product class.

Fueling growth: While the medtech industry is weathering the challenges brought about by current economic conditions, identifying a path for long-term growth will be an ongoing test for the industry. The report finds that companies will need to emphasize diversification in all aspects of their business, from diversification into new product lines better aligned with delivering improved health outcomes, expansion into non-product offerings such as consulting services and solutions and geographic expansion into emerging markets.  

"The road ahead includes significant new challenges for the industry, but also tremendous opportunities," said Heinrich Christen, Ernst & Young's Medtech Leader for Europe, Middle East, India and Africa. "Seizing the opportunity will require fundamental changes to business models, partnering with nontraditional players, creative pricing and product development approaches to capture growth opportunities in emerging markets — and, above all, demonstrating the value of their products before someone else establishes their value for them."