Medical Device Link.

Originally Published MX May/June 2002

BUSINESS PLANNING & TECHNOLOGY DEVELOPMENT

Moderated by Steve Halasey

Company leaders work hard to create award-winning products such as those described in the previous pages, but keeping the pipeline filled with products to be launched in the future can be even more daunting. To find out how companies manage this task, MX interviewed six industry executives with experience in developing complex product lines. Excerpts from the interviews appear here; the complete text is also available.

MX: What conditions in the general economy are helping or hindering companies that are developing new medical products right now?

Stephen N. Oesterle, MD: Companies like Medtronic are buffered from economic turns in the wrong direction because people are going to be sick, no matter what the value of the dollar or the valuation of the stock market. So in times of economic downturn, medical product companies look like relatively safe havens.

John P. Wareham: A large piece of the healthcare industry moves with government support. Generally speaking, in the in vito diagnostics sector of the healthcare market, where Beckman Coulter competes, that support is now relatively stable.

In the late 1990s and into the early 2000s, our industry went through some difficult changes around the world, especially in the United States, Germany, and Italy. Today the reimbursement side of the IVD business is fairly stable, and part of that is due to the fact that hospitals are also in a better financial position. All in all, the environment is pretty favorable.

Kshitij Mohan, PhD: For established medium and large companies, while there is some belt-tightening, a declining economy also presents an opportunity. That is manifested in a stronger flow of talent from the unstable part of the industry to the more stable part; in large companies being able to buy up small companies for considerably less than what has already been invested; and in terms of lower prices to license the results of others' R&D.

Oesterle: I'm not sure I agree with that. The bargain companies are generally at a very early stage of product development. If we were to purchase such a company, when it has timelines that are three or four years out from product launch, it would actually represent a drag on our earnings. And in this economy, large companies are reluctant to take on such dilutional acquisitions.

Ajit S. Gill: The larger companies have ongoing development programs. And development cycles being what they are, it's not like you can start a development this year and expect to see the fruits of your labor real soon. So, the larger companies have their long-term development programs under way already, but because of earnings pressures some of them are probably cutting back.

In many cases, the earnings pressures are probably driven less by the economy than by pending patent expiration, causing revenues to tail off more steeply than had been expected. Those companies are dealing with that in sort of a typical way: programs on the margin get eliminated or trimmed in some fashion.

At the other end, smaller companies are feeling the pinch. They don't have cash. There's also a different type of squeeze on certain mid-cap companies that have become profitable. If their initial products weren't blockbusters, they're wondering how they can stay profitable and keep investing enough in product development. They're finding a completely different type of challenge that is squeezing their ability to do product development.


Investor Pressures

There is significant investor pressure to be profitable and pay dividends. On the other hand, the product pipeline has to stay full or the company will wither and die. How does an executive deal with that dilemma?

Gill: If I were in a company that was being squeezed, I'd be looking to transfer some of my current costs into future costs by licensing in technologies. The company would pay for that strategy in the form of royalties, but royalties are a future cost that comes out of earnings.

In the device industry, it's often said that small companies provide a lot of innovation that large companies depend on. Does a soft economy such as we have right now harm that product development pipeline?

Wareham: The model for this is dynamic, and it goes through phases. The companies at the small end of the scale were very well funded in 1999 and 2000, so those that were unable to turn innovation into marketplace technology or a new project are just now starting to run out of cash. The greater challenge is with companies that can't get the venture capital to move forward with their innovations.

Mohan: I'm not too alarmed that this might turn investors away from biotech. Ever since the dot-com bubble burst, our industry has presented an even better-looking opportunity for investors. In the short term there may be some tightening up that would represent a good time for large companies to acquire small companies. But in the intermediate or long term, money's going to return to the device and biotech areas.

What about the funding of projects in the device industry? Are those decisions made on a long-term basis, or are they reviewed annually? How do you decide how much funding to put into a project and when to put it in?

Oesterle: For the most part, our projects are funded against the completion of development milestones. So naturally, we are bound by fiscal concerns, but we are generally able to fund projects to the next development milestone and redefine in advance the performance criteria we expect. If a project we're developing does not appear to meet our performance expectations at a particular milestone, that would be a reason to terminate the project.

One of the most difficult decisions in medical technology is the decision of what not to do, or when to stop a particular project. We review our minority investment portfolio every month, and we always question whether it makes sense for Medtronic to be involved. And if we determine that a company's direction is not consistent with our stated mission, we'll trade out of it if we can.

Pipeline Strategies

For the companies that are feeling the pinch of current conditions, what are their options to fill their pipelines? In the current economy, should they emphasize in-house development, licensing, purchasing individual technologies or product lines—or a combination?

Gill: In some ways, their choices are limited. If a $500 million company were to spend 30% of revenues on R&D, that would be a little more than $150 million. But I recently saw a report that calculated all the R&D costs and divided them by the number of approved products, and estimated that it now costs an average of $800 million to develop a product. So even if a company were able to put $150 million each year behind one product, it would still take a number of years' worth of R&D to develop just that one product.

Wareham: It's hard to generalize because every company's pipeline development process is a bit different. At Beckman Coulter, we've been very successful in using distribution alliances, where, for example, another company optimizes its chemistry for use on our automated drug discovery systems, and then we market the whole package through our own distribution channels. So we're leveraging our capabilities with those of a smaller company for an overall better outcome.

We've also used sort of a reverse on that, licensing an immune system testing technology to large vaccine producers for their use in comparative animal studies. That strategy has enabled us to enter the drug-discovery market.

One thing we've tried to do is to leverage products internally, through what we call the biomedical testing continuum, where we move technologies from one market segment to another. So there's another model that companies can use to create yet another major opportunity.

Mohan: These are all good options, and most successful companies employ all of them. Technology-intensive companies need to have in-house development capabilities, not only to develop things themselves but so that they have the wisdom to acquire correctly.

Companies also need to examine their portfolio of products and fill in the gaps. And, considering the long development time for products in this regulated industry, acquisition can be the way to go. That's especially true right now, when companies have an opportunity to acquire certain things at bargain prices.

Keep in mind though, that it is easy to buy companies. It's much harder to integrate an acquisition and maximize its value. It takes a special kind of leadership to develop good in-house capabilities, the wisdom to acquire correctly, and the ability to assimilate another corporate entity into your company's culture.

Some large companies put a fair amount of money into venture capital funds and are actually funding early-stage research. Others put their R&D money into fairly late-stage products that are ready for manufacturing. Is there a reason for adopting one strategy over the other?

Riedel: The way that we access early-stage innovation is made up of several pieces.

First, we do have in-house discovery research, and it is a pretty significant part of Baxter. Second, we have alliances in place with biotech and technology companies to commercialize their discovery research and with academic centers of excellence to access their innovation. And third, we also work with a fund that places our investments into early-stage companies.

So our efforts are spread across the various ways in which one can access innovation, including academic centers, biotech companies, a venture fund, and cutting-edge in-house R&D.

Big Companies, Small Companies

In certain economic conditions, like we have now, small companies can become very attractive acquisition targets. In these conditions, do licensing arrangements, partnerships, and alliances also fall in favor of large companies?

Wareham: That might be more true today than it was a couple of years ago, when small companies had relatively open access to capital. Today it's a little more difficult for them to access capital, whether it's venture capital or IPO capital.

Mohan: Strictly in terms of technology, it is a pet peeve of mine that many large companies focus on in-licensing but rarely out-license their intellectual properties.

Steve, when you have intellectual properties that you feel Medtronic can't get to, do you consider spinning them out, or licensing them to other firms?

Oesterle: Yes, but I wouldn't say there's an enormous history of that at Medtronic. But as this company gets larger and larger, it's obvious we can't do everything. We have a lot of in-house technology, and there is a significant opportunity to consider spinning out some of it. I suspect you'll see some of that in the coming years.

Wareham: We currently have some initiatives in that area, but in the world today you also need some trading cards. Companies need to have properties that they can trade with others to get what they want—particularly when dealing big company to big company.

In the current economic conditions, can small entrepreneurial companies make a go of it in the public market, or is their only available exit strategy to be acquired?

Gill: I'm not sure that one answer fits all. There clearly are companies that have a decent cash position and will be able to take their own products sufficiently far toward launch so that, if they have good data, investors will be willing to put some money into the company. Those companies will have an opportunity to do it themselves. In these cases, the higher the risk, the greater the reward.

There are other companies that find it harder to gain access to cash. Those companies may have an opportunity to address the needs of large companies and mid-sized companies with limited R&D budgets, by working with them.

The arrangements can also be mixed. For instance, a company might license its first one or two products to somebody else. Royalties from that agreement would then put the company on sounder financial footing, so that it might be able to take its third product to market by itself.

Some small companies that are just entering the market might be surprised at how much they need to do. Is that another reason why they open themselves to alliances and partnerships—because there are so many capabilities that they just don't have?

Riedel: I mean this in a very respectful way, but a lot of early-stage biotech companies have to climb up the learning curve of what it takes to bring a product to market. Some of them have had to learn the hard way about elements such as regulatory requirements to prove safety and efficacy, or the resources necessary to be a sustainable commercial manufacturer and sales organization.

Funding Product R&D

If all of the big money is in large companies, does that put an extraordinary burden on those large companies to fund all of industry's R&D, one way or another?

Gill: Small companies will end up getting their early risk capital on their own. I don't think the large companies are going to provide seed financing. I think they will provide development financing for companies that have reasonable data to demonstrate that their product will work.

Large companies will get the benefit by investing later in the process, when a start-up company is a less risky investment. But they'll also have to accept a correspondingly lower rate of return, because if they insist on getting their historically high returns, they won't be paying the small companies enough to survive. And if that happens, then in the long run the product development pipeline will run dry. If investors in small companies cannot get decent returns, they're going to put their money elsewhere.

Wareham: I don't think it's ever going to be that extreme. Everything cycles, and there are all kinds of different arrangements a company can make. Even a small company with a new technology can get access to venture money today.

Right now, the pendulum has swung in the direction of favoring companies that have development capabilities within their capital structure. But I don't think we can conclude that this is a permanent situation.

Oesterle: I'm not sure I view it as a burden; I sort of view it as an opportunity. In the past, start-ups would go much further along before looking for a partnership with a company like Medtronic. But today, we see more and more companies coming in at an earlier stage, when we could develop a strategic alliance, often with a minority investment. That enables us to promote the start-up's R&D while also ensuring that the arrangement is not dilutional. We would also then seek options on the finished project or on the start-up company itself.

Scott R. Ward: I certainly agree that we don't really perceive this as a burden at all. The current economic environment creates some opportunities for us to make investments in companies that are in new technological fields that we may be interested in, longer term.

How early in the process will big companies be looking? Are they looking at products that are commercializable in two years, one year, or what?

Gill: The later the product, the more attractive it is. But if you look at recent transactions as indicative of a trend, the cost of those products has skyrocketed. Some argue that those costs are not sustainable, but time will tell.

On the other hand, if you want to pay a lot less, you've got to move earlier in the development process. If a company has at least Phase II data, that's a time when it can start to partner.

When you are deciding whether or not to move ahead with a particular product, does your strategy vary according to the type of the product, its complexity, or the sector that it's intended for? How do you sort out the factors that would drive your decision making in that area?

Wareham: There's no simple answer to this. Companies have to take a lot of factors into account. Probably the most important pieces of the matrix are the company's current business, current strength, and market position; the competitive framework of the market, including growth rates or potential growth rates; and the maturity of the current technologies. At some point, of course, all of this has to be assessed against whether the proposed product will fulfill customers' needs so that somebody is willing to pay for the product. And so those are the kinds of things that we weigh when we try to decide which projects to fund.


The Product Development Team

Do you have market research and marketing people involved very early in the decisions to develop a product line or to invest in a particular kind of research?

Wareham: Absolutely, and that's an art in and of itself. There are only a few people that are really good at it, that can actually see the steps in the market development process and how difficult it will be. So that's part of the art of product development, for sure.

Riedel: Yes. We do not engage in a full-blown product development project unless we have input from R&D, clinical, marketing, and regulatory affairs. And we must also have a really good understanding of the unmet medical needs—the opportunity—and how we as an organization can provide a product that differentiates itself enough to make a difference relative to existing therapies.

Do you have a fixed team of people that evaluates these needs?

Riedel: No. Like most organizations, we have marketing, development, and regulatory affairs departments. Typically, the teams that perform such due diligence are made up of members of those departments. But the membership varies and changes, depending on the product opportunity.

Mohan: Most successful and enlightened companies have some model for product development that is based on this kind of multifunctional approach. It defines the development and use cycle of a product fairly well, all the way from identifying customers' needs, through product concept, rational funding decisions, and so on.

Such a model becomes a real competitive advantage, because other requirements—such as those from FDA, Wall Street, or whatever—all get fitted into the overall product development decision-making structure.

Norbert, how do you see your role as chief scientific officer in facilitating the work of your product development teams—including decisions to invest in partnerships or alliances?

Riedel: I look at Baxter as an organization whose skills are in two areas. First we have great capabilities in development and commercialization. So, my investment dollars are more likely to be targeted toward late-stage development and commercialization, including manufacturing, than toward early-stage discovery. That emphasis, of course, immediately triggers our strategy to seek alliances and strategic partnerships to complete and complement our pipeline.

The second area where we have enormous strength is in our core technical competencies, which enable us to conduct effective product development in pharmaceuticals, biopharmaceuticals, and devices.

So we combine a focus on investing in alliances for late-stage development and employing our core technical competencies to create unique opportunities.

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Copyright ©2002 MX