What are your top three takeaways from this article? Trouble Ahead: Ethics and M

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What are your top three takeaways from this article?

Trouble Ahead: Ethics and Medical Devices

The medical device arena—so green in venture capital money, yet so gray in areas of conduct—may prove tempting to Elliot Spitzer if companies don't reexamine their own selling models, and soon.

That was the message of Glenn Reicin, a managing director of Morgan Stanley, who addressed the 5th Annual Alumni Healthcare Conference on November 5, 2004. Reicin (HBS MBA '90), who analyzes medical supplies and technology, presented an overview of the medical device industry and described typical practices that may be ripe for censure.

"I think most companies, as they think through their codes of conduct, have to make sure that marketing and R&D are not providing direct sales inducements," warned Reicin.

Test yourself. Do the following (true) cases that Reicin outlined sound to you like examples of medical research—or kickbacks?

In case one, a doctor performs an orthopedic implant. The implant manufacturer asks the doctor to fill out a questionnaire six months later in order to monitor how the patient is doing. The manufacturer says it wants to learn about implant performance and patient mobility. In return, the doctor will get a check in the mail for $1,000. Amount of time necessary to fill out the questionnaire: fifteen minutes.

In case two, a doctor gets paid more than $1 million annually to proctor (supervise) other physicians on how to perform minimally invasive hip surgery. The surgery he proctors happens to only use one company's implants.

In case three, an orthopedics medical practice wants to expand in order to conduct research. It wants to hire a fellow. So it establishes a not-for-profit foundation to fund a fellowship. One of the medical device companies sponsors the fellowship, and the fellow carries the company's title.

"Are these appropriate or not?" Reicin asked the audience. For the case of the physician filling out a 15-minute questionnaire, one member of the audience questioned why a physician would accept $1,000 for the cursory assessment of a product that was presumably already FDA-approved. Said another, "We need to define the doctor as an intermediary, not a customer. The patient expects the doctor to be his or her fiduciary representative."

Very green
Since 1999, according to Reicin, medical device stocks have been the best or second-best performers within healthcare behind the specialty pharmaceuticals group.

"We see a shifting of funds from the pharma sector to devices," he explained. "A couple years ago, there was a trillion dollars in market capitalization in the domestic pharma sector and only $300 million or so in the medical device sector." More recently, however, investors have been concluding that the drug business is riskier than the franchise model of medical devices, because drug patents eventually expire. It is true that medical devices have very quick product cycles but, Reicin said, device companies also develop lasting relationships with their customers and create sustainable franchises.

"The Medtronic name, for example, will mean more to customers than [the name] Viagra or something. So I think investors have come to appreciate that," he said.

The relative returns of medical devices still show room for margin improvement, he said. And there have also been great advances in medical technology, another reason for cheer. The most promising advances include drug-eluting stents, cardiac resynchronization therapy (a specialized pacemaker for the treatment of congestive heart failure), and the use of biologics combined with devices to treat certain ailments.

For investors, he said, the most important message is that medical devices are expected to continue to show improving returns going forward, while the pharmaceutical sector may have more difficulty.

Who is my customer?
In the medical device industry, the customer is usually not the patient. (In fact, the patient often has no idea what anything costs.) Instead, the customers may include the hospital administrator, doctor, and/or nurse.

A look at just two kinds of medical devices from the low end to the high end shows the growth prospects in the industry as well as the different relationships that abound.

"Sharps": At the low end, there are needles and syringes, known in the business as sharps. Reicin said this is a $2.25 billion market with extremely low share volatility. Growth is around 5 percent per year. Research and development costs as a share of sales are very low, only 3 or 4 percent, "if that much," he said. The average selling price of a device is twenty to forty cents. The customer is the hospital administrator. The secondary customer is the nurse, in the event that some training is necessary to learn how to use the product, especially safety products. The products are stocked in hospital inventory, Reicin said, so there is no need for the sales representative to be present when the product is used, in contrast to orthopedic implants.

Orthopedic implants. This is an $11 billion market, said Reicin. There is low share volatility and mid-teens growth. A low amount of sales income is being spent on R&D, less than 6 percent. Five companies are contenders. "If you look at a lot of these products, you probably couldn't tell the difference between them," he said. Prices rise about 4 percent every year. The customer is the orthopedic surgeon; the secondary customer is the surgical team. Hospitals do not keep inventory of orthopedic implants, since there is a left and a right of every product. The instruments used to put in an implant are usually owned by the sales rep who essentially "lends" them to the hospital. A company's sales support is involved in every implantation. "The relationships between the doctor and the rep are very cozy," Reicin added.

Further fuel for controversy in the medical device arena is that group purchasing organizations (GPOs) and volume discounts are starting to attract litigation.

"There are organizations that are trying to police the medical device industry. The best one is AdvaMed," he said. "They created a code of conduct which I think is very constructive and a good step," though he also complained it is broad and too open to individual interpretation.

"All this reminds me of another case: that of an equity analyst who was involved with investment banking," said Reicin. "He pitched an equity offer for a company but he also participated in the selling of that deal. Several years ago, that was all commonly accepted practice. We all know how that turned out.

"A guy named Elliot Spitzer came in one day and said, in effect, 'This is ludicrous, it makes so sense whatsoever, it's a clear conflict of interest.'"

It is time for the medical device industry to wake up, he continued. "I think it's extremely important for companies to monitor their practices or at least better police their practices," he said. "All the VC money pouring in to get involved in the orthopedic or cardiovascular markets could be jeopardized if someone [else] must redefine the relationship between the company and the physician."

Explanation / Answer

The first takeaway from this article is that in the medical device industry, companies should make sure that marketing and research & development do not give direct inducements for sales. One example provided is that of an orthopedic implant done by a doctor. After six months on the pretext of research, the manufacturer sends a questionnaire to the doctor to get information about patient mobility and implant performance. For filling this questionnaire that takes fifteen minutes time, the doctor gets a check of $1,000. This according to the article is a kickback. The key takeaway is that kickbacks of such nature are unethical and should be avoided by medical devices companies through their code of conduct.

The second takeaway is that stocks of medical devices companies are attracting more investor funds than pharmaceuticals. The rationale is that the relationships formed by medical devices companies with their customers (mainly doctors and hospital administration) are stronger and create sustainable franchises. Moreover, medical devices have more scope for improving their margin. This means that medical devices companies will continue to show improving returns in the future.

The third take away from the article is that the customer in the medical devices industry is the doctor, hospital administration, and nurses. The article points out that in the case of sharp devices such as needles, the primary customer is the hospital administrator and the second customer is the nurse. In case of surgical implants, the customer is the orthopedic surgeon and the secondary customers are the surgical team. In the medical devices industry, the group purchasing organizations and volume discounts are so controversial that they attract litigation. There is a conflict of interest as far as the physician, and the hospital administrator is concerned. Companies must monitor the practices to get business in the medical devices industry. Their code of conduct must have stipulations that prevent unethical practices.

References:

Trouble Ahead, Ethics and Medical-Devices

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