Merger-mania carries huge sales and marketing implications for large and small firms

While 1995 merger and acquisition activity in the medical device industry may not equal last year's remarkable $5 billion in transactions, it is clear that 1994 was certainly no aberration. The last six months have been witness to a hefty number of deals, including the $865 million purchase by Boston Scientific Corp., Watertown, Mass., of SciMed Life Systems Inc., Maple Grove, Minn., and the $168 million acquisition by Johnson & Johnson, New Brunswick, N.J., of Mitek Surgical Products, Norwood, Mass.

Just as important, however, are pairings involving smaller or midsized firms, such as C.R. Bard, Mentor, Ohio, and MedChem Products, Inc., Woburn, Mass. ($100 million) and Arrow International, Inc., Reading, Pa., and Therex Corp., Walpole, Mass. ($16 million). Indeed, as consolidation moves forward, the niche players will have just as significant a role as the industry behemoths. It takes two to tango, after all. To see how the M&A dance is likely to progress - and the implications for sales and marketing - one needs to begin with the three major forces driving consolidation: cost-consciousness, the FDA approval bottleneck and liability costs.

The rise of managed care has, of course, completely altered the economics of the medical marketplace. In a world of continually scrutinized budgets, technological innovation - which has given birth to many a one-product company - has been devalued. HMOs and insurers are no longer wowed by high-tech advances that require large expenditures, even in exchange for long-term savings over more conventional therapies. Unfortunately, this situation will only become more severe as managed care providers find themselves mired in their own fight for survival. The end of the first quarter of this year saw a number of leading HMOs announce dissappointing earning reports. As markets - as well as the patients themselves - mature, profit margins are likely to shrink further, with the resultant pressures on purchasing departments. The above is hardly a convivial environment for a $10 million company trying to peddle its new pacemaker.

FDA hurdles loom

But before a company can even get to market, there are two large hurdles to clear. The first and most notorious is the FDA approval bottleneck. The horror stories abound. Although required by law to rule on an application within 180 days, waits of several years are the norm. And for truly new devices that require a pre-market approval (PMA), the process is practically a lottery, with less than a dozen approvals granted out of literally hundreds of applications. Not surprisingly, more and more companies are aiming their efforts at the European market as a way of staving off the brutal capital strangulation caused by such delays.

Product liability difficulties are no less troubling. The indemnity costs to a small firm are staggering, and becoming more so as purchasers require larger amounts of coverage in an era when a firm the size of Dow Coming can be forced into Chapter 11. And a device company that is able to provide the needed protection may still find itself shunned if potential purchasers harbor even the slightest doubts regarding the device company's future.

Pharma-biotech...with a twist

To be sure, some of these pressures may be alleviated by legislative reform, particularly if a third-party review process is established. But with Capitol Hill wading though its own backlog, it's realism rather than pessimism to expect that the situation will remain unchanged in the foreseeable future. As a result, the momentum behind the M&A wave will continue, pushing smaller and larger firms together.

The situation is similar to the ongoing pharma-biotech mergers, with a twist: Unlike biotech companies, almost all of whom are still looking for their first big hit, most device start-ups already have a viable product. But like their gene-splicing brethren, it is much easier to operate under the umbrella of a larger entity that has distribution and marketing clout. Indeed, it is in the latter phases of sales and marketing, rather than on the bench, where a new medical device faces its trial by fire.

Seismic sales implications

From a sales and marketing point of view, the implications are seismic. FDA approval delays mean that your hands are tied in marketing the product at all, while the threat of litigation makes the marketplace less receptive to new ideas. Furthermore, the cost-consciousness motivating providers means more and more purchases will be made with buying groups or consortia looking to work with a smaller number of vendors. Here, volume becomes both the carrot and the stick, with the promise of high volume used to drive serious price concessions.

This is fast becoming the dominant model for transactions throughout the health care industry; witness, for example, the coalition recently formed by ten large corporations, including American Express and Merrill Lynch, to purchase standardized health coverage for 240,000 of their employees. That coalition - representing a combined $1 billion in buying power - is in turn patterned after regional buying groups that have been successful in driving HMOs to lower prices. Or, as one medical device executive was quoted as saying recently, "Anytime you start standardizing things, you reduce costs on the customer's side and the supplier's side."

For a large device firm, the move to a coalition format means you no longer have a large detail force to call on 5,000 physicians, but rather a core team of strategists and analysts to support 20 or 30 national accounts managers, each building one-to-one relationships with the same number of key accounts. And it is no longer unusual for a company CEO and other executive officers to be a part of that team, given the importance of each one of these deals to the life and the future of a firm.

For the single-product, technologically driven company that has been the traditional backbone of the device industry, the implications are equally significant. Many niche players, particularly those whose offerings were without easy substitution, have been able to use a small sales force to target the 100 or 200 physicians who would use their specialized product. In competition against the majors, the playing field was made a bit more level by the mere fact of being so broad. The exponential contraction in the number of potential customers itself makes for a more difficult selling environment. This is compounded by the fact that those customers are now hindered by broader exclusivity agreements with their large vendors.

Risk sharing as "Sales Strategy 2000"

In looking to develop a marketing strategy for the closing years of the century, it would be understandable for a small or midsized device firm to concentrate on figuring out how to get the attention of those consortia. There is another development that is just under way, however, that needs to be taken into consideration: the advent of capitation purchasing. Increasingly, device companies are being asked to become partners in risk sharing. Rather than contract for a given number of pacemakers at a set price per item, hospitals will ask for bids to provide them with all of their cardiovascular device needs - from cardiac assist to implantables - for three years at a capitated rate.

Obviously, the economies of scale implied in risk sharing appear to work against smaller firms. But if risk sharing closes one window of opportunity for them, it opens another. Risk sharing is a package deal, which puts a premium on a vendor's ability to offer the most comprehensive package possible. That means disease management - offering a complete array of products for a given indication. Indeed, in a capitation arrangement, compiling a sufficiently broad array of diagnostic and therapeutic tools becomes as much a responsibility of the vendor as the provider.

Both small and large companies feel effect

As I mentioned above, the travails caused by FDA approval gridlock and burdensome liability costs will continue to push small firms into the arms of their larger suitors, or smaller firms together in the hopes of building the necessary clout. But risk sharing will be a much stronger, and more positive force, allowing technologically driven firms to trade on their strengths. While it initially appears as an obstacle, it is likely to increase the value placed upon innovation. A particular product may first appear to the materials manager as an expensive niche item that impinges upon an exclusivity agreement with a major vendor. But teamwork between small and large firms transforms the product into a valued part of that vendor's more complete array of tools for managing a given indication.

Of course, an all-out acquisition (with the subsequent integration of sales staff) is only the most dramatic approach to combining products and forces. Many small firms have been entering into alliances of various forms with larger companies as a way of tapping into the latter's access to key buyers and distribution infrastructure, while maintaining their independence. Some companies are skipping sales to end users entirely, preferring instead to establish licensing agreements with global concerns from the start.

It would be a mistake, however, to think that a future dominated by mergers, acquisitions and alliances somehow diminishes the sales and marketing function of all but the largest firms. Indeed, building relationships, reading therapeutic trends, and marshaling outcomes evidence is as crucial as ever for everyone. But for many device firms, changing economics is broadening the definition of who the key customer is. Once only the physician, it has recently expanded to include the materials manager. But more than ever that group now also includes large device firms looking to fill gaps in their product offerings. It is a situation that spells equal opportunity for both the innovative small firm and the giant.

Michael T. Kelly, a former vice president at St. Paul, Minn-based St. Jude Medical, is a managing director of Russell Reynolds Associates, a global executive recruiting firm. Kelly leads the firm's medical device practice from the company's Minneapolis and Menlo Park, Calif. offices.

COPYRIGHT 1995 J.B. Lippincott Company
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