Bridging the Innovation Gap

June 1, 2015 - Rich Nazarian President and CEO Minnetronix, Inc.

Changing med device landscape signals new role for contract manufacturers

The medical device business landscape is changing rapidly in response to a wide range of socioeconomic and government pressures. By 2030, 20 percent of U.S. residents will be over 65, compared with 13 percent in 2010 and 9.8 percent in 1970i, and that changing demographic is making the demand for better and more cost-effective medical care more acute. This challenge is amplified by the fact that per person personal health care spending for the 65 and older population was $18,424 in 2010, five times higher than spending per child ($3,628) and three times spending per working-age person ($6,125)ii.

At the same time these forces are driving the need for greater innovation to address escalating costs, there is a continuing trend toward longer timelines and rising costs associated with device approvals (another article and blog on that later). Adding to those barriers are reimbursement challenges for new technology posed by the Centers for Medicare and Medicaid Services as they try to manage their spending. When looked at together, these elements present a significant deterrent to early-stage investing. Although total venture dollars invested in medical devices have rebounded over the past year, it remains difficult to attract capital to early-stage device opportunities. The exits for investors are likely far away and development and regulatory risks are significant for companies still seeking FDA approvals. This is borne out by the fact that
Series A medical device investing in 2013 was less than 25 percent of 2008 levels. As a result, there is a widening “innovation gap,” between capital deployed from funds dating from 2010 and later, and equity invested in the form of follow-on investments from older funds.

The shifts in the medical device ecosystem create both challenges and opportunities for firms like Minnetronix that rely on and support the success of the sector. This is not the first time in
the device market’s history that roles and responsibilities of partner firms have changed significantly. Over the past 20 years, outsourcing in medical devices has evolved from the contract manufacture (CM) of components and sub-assemblies to turnkey assembly of finished devices (first generation or 1G), design and development (2G) and ultimately into the support of semi-virtual original equipment manufacturing (OEM) medical device companies (3G). Looking into the future, there are opportunities for companies like Minnetronix to step into the “innovation gap” and play an important role in shaping how life-impacting technology reaches patients. This role will go beyond providing skills or capabilities that OEMs might not have internally, to actually deploying technology (4G) that is created independently and can complement or differentiate the OEM’s products.

Although now widely accepted, even the first generation of medical product outsourcing followed a less-aggressive trajectory than in other industries. The reasons for this slower uptake are important and industry-specific. Concerns over regulatory compliance, risk (both business and product liability), quality, and a tendency toward total ownership and vertical integration contributed to a general reticence to outsource medical product manufacturing. As thoughtful and effective solutions have developed to address these concerns, the advantages provided by outsourcing in terms of speed, efficient use of capital and flexibility have driven the increasing use of medical manufacturing partners. The acceptance of contract manufacturing has grown not only in scale but in breadth of services as well. Ultimately, the CM’s value is realized by bringing to the relationship manufacturing technology and capabilities that their customers do not possess. This partnership allows OEMs to do more with their fixed resources and to focus on the core elements that increase their enterprise value.

As medical electronics technology has progressed, the need for specialization in a wide range of areas has increasingly driven the integration of outside turnkey engineering into OEM’s thought processes. Medical device firms have long made effective use of consultants and contract engineers in key areas. Many of the same concerns that inhibited the use of turnkey contract manufacturing kept medical product companies from turning over the reins of product development to outside firms. The fundamental concerns of contract manufacturing are compounded in engineering because of the non-linear and unpredictable nature of product development, particularly as it relates to new technology or innovative products. Through consistent communication and developed trust, partnership approaches have evolved to become an effective and efficient mechanism for product introduction. In these development relationships, the partner firm’s greatest value is realized by providing capabilities, expertise or technology that the OEM does not possess internally in ways that provide the OEM increased flexibility and reduced time to market.

In recent years, the desire to reduce corporate infrastructure has created a demand for partner firms to provide more and more of the operational enterprise for OEMs. From 2007 to 2013, the median time from company inception to first 510(k) approval increased from 3.5 years to 5.6 years (60 percent), and the average cumulative cash burned over those years was $40 million. The ability for the contract firm to act increasingly like a medical device OEM in terms of design controls, quality systems, product management and regulatory compliance, allows the OEM to preserve capital and frees it to focus on its true value drivers: intellectual property (IP) development and sales and marketing footprint. This is a critical value proposition in a world of increasingly cautious, if not shrinking, investment capital. This places a burden on the partner firm’s IT and regulatory organizations that is far beyond what would be routinely contemplated by a contract services company: they need to provide quality systems operations as a service. The firm’s value in this relationship derives from its ability to eliminate significant amounts of infrastructure from the OEM’s operation.

Until recently, the conventional approach to product outsourcing was based on a unidirectional flow of differentiating IP from the OEM through the partner firm into the product. Influenced by a range of factors, this approach is changing. The future of medical device innovation will increasingly rely on new business models that can deliver innovative technology while mitigating the challenges posed by scarce capital and protracted timelines. Proprietary technology from partner firms is now going beyond the general-purpose expertise that traditional outsourcing has provided and is moving in the direction of clinically relevant technology and even products. True leverage and acceleration are being realized as partner firms bring domain and market driven IP to the relationship. The ability of the outsourcing firm to not have to build and maintain a “standing army” for an individual product while at the same time being able to hunt for and nurture differentiating technology is a game-changing proposition. By stepping into the void between the laboratory and the clinic, partner firms are realizing greater value as they bring their own product features and identities to the market in ways that are meaningful for treating patients and improving outcomes.