Medical Device Link.

Originally Published MX March/April 2005

BUSINESS PLANNING & TECHNOLOGY DEVELOPMENT

Systematically pursuing product-development milestones can help medtech companies meet investor expectations.

Craig Scherer

Small, early-stage medical technology companies often are better equipped to bring inventive new products to market than large, established ones. Specifically, early-stage companies can take advantage of their flexibility, agility, lean organizational structure, and innovative thinking to develop the type of products that larger companies might avoid because of the risks and costs involved.

Illustration by ROB COLVIN

Venture capitalists (VCs) often provide the financial foundation upon which medtech start-ups can base their drive to innovate. VC investment in the medical products sector more than doubled from 1995 to 2003, growing 119% over that period. From the first quarter of 2003 to the first quarter of 2004 alone, first-round venture investments in medical device companies rose 17.4%, an increase that outpaced other industry sectors.¹

With such strong investor involvement, early-stage medical product companies need to understand investor expectations and be able to manage their responses to them in order to be successful. Each relationship between an investor and that investor's chosen company is unique. However, certain VC expectations are common to most companies' experience. This article is intended to help companies understand them. It explores ways that start-up firms can optimize the early product-development process so as to be more likely to meet those expectations.

Integrating Agendas

Michael Crarusi

Investors are interested primarily in valuation. Medtech companies, on the other hand, are interested primarily in the success of their scientific innovation, which may or may not translate into improved valuation. Michael Carusi, a general partner at the investment firm Advanced Technology Ventures (ATV; Palo Alto, CA), states it plainly: "We take a market-driven approach rather than an engineering-driven approach." But most medical device companies take an engineering-driven approach. These different mindsets have to come together on a middle ground.

A key to understanding investor expectations is awareness of the investor's decision points prior to funding. VCs commit to an early-stage medtech company because:

1. The company possesses a compelling technology or product innovation that can fulfill a defined market need and for which the market is willing to pay.
2. They believe the company is capable of meeting its product-development milestones.
3. They believe that, once the company has met its development milestones, the general investment community will respond with a higher valuation.

Investors incline to support a company because it clearly fulfills the first condition. The company's challenge, then, is to deliver on the second so that the investment community will respond as anticipated in the third decision point. It sounds as simple as one, two, three, but that second step—meeting product-development milestones—is fraught with difficulties, the first of which is defining the milestones to the mutual satisfaction of investors and company managers.

Together, VCs and company executives generally define development milestones up front. However, the differences in their key concerns are reflected in their roles through the product-development cycle. For company managers, particularly those heading the product-development effort, product development means the stages of the project running from product conceptualization through manufacturing handoff. Investors tend to refer to that spectrum of activity as engineering, however. For them, product development is something broader, encompassing clinical trials and regulatory approval as well as engineering. Use of the term early product development may be helpful in distinguishing the phase from conceptualization to manufacturing handoff from the larger idea of product development as the full process culminating in market introduction.

So, company management focuses on the details of early product development, while investors tend to focus on the mile-high goals. Among the latter may be counted moving the product into animal or human trials by a specific date, achieving specified results in clinical trials, partnering with an established company or making a distribution deal with a corporate partner, obtaining patents on the intellectual property, and, ultimately, gaining regulatory approval.

With respect to day-to-day product-development details, the investors' approach is to let management handle it (see sidebar). Handling it involves meeting or exceeding investors' performance expectations. Therefore, that is management's primary objective with respect to company investors.

Tom Dickerson

Failure to manage the details well can derail the project. "Investors are not operators," says Tom Dickerson, chairman of Tullis Dickerson & Co. (Greenwich, CT). "We rely heavily on management." Investors expect management to resolve day-to-day issues and provide realistic assessments of progress. They don't want to "own" the company in that respect any more than a mortgage lender wants to own the home buyer's house, in Dickerson's analogy.

Start-up medtech company managers must handle myriad issues, in fact, but those can be boiled down to a set of basic goals that correspond to investors' chief considerations for the company (see Table I). This article examines each of those management goals and suggests approaches based on product-development best practices to help executives reach them. With each topic, a sampling of investors have their say.

Setting the Schedule

Investors want to move the product as rapidly as possible to the stage at which its clinical effectiveness is tested and proven. Depending on the type of device it is developing, a company may focus more intensely on the engineering phase of development or, alternatively, try to move as quickly as possible to trials. Mike Carusi tends to separate companies into two different buckets, as he calls them. "If you are improving upon an existing device—developing an evolutionary product—there's a known clinical need, and you are focusing on optimizing ease of use. You can get greater value in the design stages because you can get clinician feedback.

"The other bucket holds companies focusing on the revolutionary breakthroughs—new implants, a new procedure, new approaches to treating a disease." In these cases, says Carusi, the company needs to gain physiological knowledge through animal and human testing. "You want to get into those models as quickly as possible because, with breakthrough innovations, there's greater risk that the product may not succeed clinically."

Gary Shaffer

If a company's product falls into Carusi's first bucket, speed to market is critical from a competitive standpoint. If it belongs in the bucket for brand-new devices and procedures, speed to clinical trial is important for obtaining early data on clinical effectiveness. Either way, with the nature of today's marketplace, one of management's top goals is speed. Investors and development experts caution, however, that the drive for speed must be tempered by thorough, careful product development. "Companies often try to go faster than they should, and they sometimes take shortcuts that actually end up slowing them down," says Gary Shaffer, a general partner at Morgenthaler Ventures (Menlo Park, CA). In particular, in trying to meet investors' scheduling milestones, companies sometimes sacrifice development steps they would otherwise undertake. Minimizing or eliminating activities such as project screening, user research, and solicitation of marketing and manufacturing department input may enable the company to achieve early milestones more quickly, but such project streamlining can seriously jeopardize future profitability. These activities are discretionary, true; however, they are often success drivers that make the difference between winning and losing.²

A wise approach is to get investors, up front, to buy into a schedule that incorporates these discretionary but important development steps. If the company negotiates the scheduling of discretionary steps with investors on the front end, the stage will be set for a neat balancing act matching the attainment of investors' scheduling milestones with a thorough product-development process.

Deliberate speed is the best course. The Romans advised making haste slowly. And an old Spanish proverb, cast as the words of an aristocrat intending to avoid precipitate action, had it: "Dress me slowly, I'm in a rush."

Delivering Performance Requirements

Surprisingly, many medtech firms undertake product development with feature sets only loosely defined. As a result, the project suffers from feature creep. The best-case scenario when this happens is that loose or ineffective product definition impairs the company's ability to stay on schedule and within budget. In the worst-case scenario, the outcome is product failure.

The critical features of the product—those, at the very least—must be clearly defined at the front end of the development cycle. Critical product features are those that enable the product to meet its minimum performance requirements. They directly affect the product's ability to compete in the marketplace. To a large extent, investors measure management's success in early product development by its ability to deliver the minimum performance requirements. Therefore, pinpointing the critical features before engineering and design get under way is of prime importance.

"There are some features that are essential and others that are desirable," notes Morganthaler's Shaffer. "The essential features must be implemented in order for the product to be successful." Shaffer provides the example of a catheter that promises important new advantages as long as it is smaller than a market-defined maximum size. If that catheter fails to meet the size requirements of the marketplace, however innovative its other attributes, it may be relegated to a niche and be less successful than otherwise-inferior competing products. When a company launches a new product that cannot satisfy the critical requirements of its market, that is unable to compete in the mainstream, investors may feel compelled to seek an early exit from the project.

Minimum performance requirements for a new product might be, for example, that it simplify a procedure or raise the success rate for that procedure to some defined point. Or the product might be required to diagnose a condition with greater sensitivity, more rapidly, or in a less invasive manner. Investors and the market, between them, may demand a certain level of device performance; it is the job of the medtech company managers to define the critical product features that will deliver that performance.

Elizabeth Lewis

"Defining the critical features requires an understanding of unmet user needs and the competitive environment," says Elizabeth Lewis, director of research for Insight Product Development LLC (Chicago). Researching competitive products helps a product-development professional set the bar for minimum performance requirements. Study of user needs and task flows enables the developer to define opportunity areas based on unmet user needs. Executives of the early-stage medtech company then consider these opportunity areas in conjunction with other considerations underlying product requirements, for example, marketing goals such as volume estimates, cost targets, and distribution channels; manufacturing process limitations; regulatory requirements; and so on.

"It's easy to lose sight of the desired end point with so many factors influencing feature definition," says Lewis. Echoing the first investment motivation of the VC, she adds, "The overriding goal is to define features that will enable the product to meet an important, unfulfilled user need for which the market is willing to pay."

Defining Features Effectively

While development teams often have to stretch to achieve all of the product's target specifications, the critical features typically are quite reachable. Gary Shaffer points out that investors frequently find themselves in a gray area, judging whether the improvement over the competitive baseline the product offers is large enough not just to compete successfully but to make a big difference and result in market leadership. Investors don't typically deal with go/no-go circumstances; rather, it tends to be that gray area.

Management needs to clarify that gray area in the early project stages. That is, it has to show investors the competitive value of the product. Two approaches are effective. One is to define a product feature set that directly addresses unmet user needs as those have been defined through user research. Another is to supplement the features that fulfill the critical requirements with an additional set of desirable features that will strengthen the product's usability and attractiveness to users.

Allan Ferguson

Allan Ferguson, managing director of East Coast operations for 3i Corp. (Palo Alto, CA), observes that "getting a product in front of a physician or surgeon is one of the most difficult sales. Clinicians tend to be conservative. Many of them tend to stick with what they've learned in medical school." Market adoption depends not only on the product's meeting minimum performance requirements, but also on its being usable and being perceived as highly desirable.

User research in front-end discovery is the medtech manufacturing company's chief tool for identifying desirable product features and implementing them in the design (see Table II). The complexity of medical products requires that product developers understand the needs of a variety of stakeholders, from patients to clinicians, and from original equipment manufacturers to biotechnologists. Likewise, product developers must take into account complex environments of use and a broad range of clinical scenarios. Interviewing users and observing product use (that is, the use of similar products and procedures) can bring to light unmet user needs, human factors issues, areas for process improvements, and the capabilities of competitors' products. Analysis of the data gathered and translation of key findings into product features can mean the difference between a groundbreaking product and one that, in spite of embodying great technological innovation, fails to penetrate the market.

Company managers can present the fruits of user research to investors as objective, scientific backup supporting their product definition decisions and pursuit of a particular R&D path. Choice of the right R&D route has a direct positive effect on both schedule and budget; consequently, investors, though they generally have limited involvement in the details of product definition, expect management to select an efficient R&D path. User research directs and supports such a choice.

Surprisingly, many medical device companies still underinvest in the front end of development. One of the most pervasive mistakes Gary Shaffer has observed is a tendency to truncate front-end efforts to evaluate and optimize a product, and to leave a lot of that discovery for the pivotal human trial. "By that time," he argues, "you should already know how well your product performs. If you're doing a lot of discovery in the late-stage clinical trial, you have to ask whether you did enough at the front end to characterize the product." If significant unmet user needs are discovered only during the clinical-trial stage, the best-case scenario from that point is a delay in product release. The worst-case scenario is early investor exit as a result of the product failing to meet critical product requirements.

Adele Oliva

According to partner Adele Oliva, her investment firm, Apax Partners (New York City), looks to the ability of start-up company executives to manage schedules and come up with the right product. At the same time, Apax believes that it's very important to have empathy for managers coping with the ups and downs that occur along the development process. "We never want management to meet a scheduling milestone at the expense of developing the right product," says Oliva. Yet, when timelines slip, additional capital is being expended while other companies going after the same therapeutic areas are gaining ground. "It's a balancing act between getting the right product to market and doing it efficiently in a specific time frame," says Oliva.

Ensuring Usability

Investors commit to a project in the first place because it involves a core technology or innovation that promises an improvement in clinical effectiveness. Ultimate market adoption of the new product will depend on how well the product's implementation of the innovation makes end-users' jobs easier or enables them to perform more effectively. Therefore, while usability is not in the center of the investors' radar screen, it is nevertheless a critical management deliverable.

"The key at the end of the day is that these devices need to be easy to use," observes Mike Carusi. Because the medical applications medtech manufacturers are trying to support are difficult in terms of the physiology involved, the devices they design can become difficult, complicated contraptions. If product developers take their eyes off the ease-of-use ball, someone in the company has to watch for that and restore the focus on the device's marketability. "If an elegant initial idea becomes a complex solution," warns Carusi, "it's not a solution at all."

Project managers can promote usability in product design and keep the focus on user acceptance by incorporating frequent user validations and iterative design into the development process. Giving users multiple opportunities to interact with the product throughout early product development—the stages of concept development and implementation—makes problem solving user driven. An iterative cycle of design, prototype, validate, and redesign enables developers to reduce user hesitation, confusion, and errors in operating the device. It is incumbent upon management to build iterative testing into the development timeline at the beginning. By doing so, company executives will be aligning their own scheduling expectations with those of the investors.

Testing for usability often and early minimizes the impact of problem solving on the schedule and budget. Good usability in a product design acts as a long-term cost-reduction lever by making later demands on customer support, training, and technical support lighter. So, even though investors may not take a detailed interest in user validation and iterative design processes, they will be pleased to know that these approaches to usability have a direct positive impact on the product's return on investment (ROI).

Watching the Development Budget

The bubble of a few years ago is gone. Now, investors have to focus intensely on keeping cash flow low. According to Tom Dickerson, people five years ago behaved as though the supply of money was endless. "Companies that were going public at $500 million in that era would now be taken public at $150 million and, despite the lower valuation, at a point much later in their development cycle. Today's reality is that, whether through sale or IPO, exit values are lower, and you have to spend more money to get there. In short, you need to do a lot more with less."

Recognizing today's more difficult market conditions, investors expect companies to streamline their expenses while nevertheless delivering the promised results. Successful product development thus might now be characterized as moving through a series of progressively higher gates while practicing expense avoidance. Investor Allan Ferguson looks for ways to reduce the cost of development. "With early-stage medical companies," he notes importantly, "there's no family of products across which to spread the cost of development."

Investors commonly see company managers take steps that hurt the ROI. Perhaps they'll raise $6 million to $10 million to reach their clinical milestone, says Mike Carusi, but, failing to execute the engineering stage well, they'll burn through that money without achieving their goals. "They'll go to their investors for more money and may be in trouble," Carusi continues. "The VCs aren't in too deeply at that point. They may choose not to move forward with the investment, or they may decide to upgrade the management team." That is, if the funders believe in the idea of the company, rather than bail out they will look to bring in new executives who they feel know how to execute.

In a gated development process, expenses rise an order of magnitude as each gate is passed. When the company's success is a make-or-break proposition depending on only one product, management cannot afford to send R&D down the wrong development path. Front-end discovery research is an important tool for directing developers along the most effective path. Early and frequent user validations enable R&D to make minor course corrections earlier rather than later, thus minimizing deviations from budget and schedule. And finally, a gated development process provides natural checkpoints at which management can report to investors on development progress before incurring the next stage of expense.

Communicating

While the CEO is the point person for investor relations, investors are virtually unanimous in wanting to establish lines of communication with other top company executives. Those other managers are sources of information to corroborate or elaborate on what the CEO has been reporting to investors. However, while VCs approach other management figures for information, they generally send suggestions or instructions to the CEO in order to maintain the flow of management directives from that office to the company staff.

Investor confidence is based largely on the quality of communications from upper management. Investors want a realistic assessment of product-development progress, even if company executives must deliver bad news. Mike Carusi speaks for them: "We want to understand the nature of the challenges we're facing. We want to see that there's a process in place to come up with solutions. We want a realistic assessment of the risks." VCs often bring to the table expertise or support to resolve roadblocks, and they expect company leaders in turn to approach the management of risk actively.

Avoiding Investor Disappointment

Not surprisingly, when investors in start-up medtech enterprises discuss the pitfalls they encounter in early product development, they talk mostly about the management team. Management depth is nearly nonexistent in early-stage companies, according to Allan Ferguson. But "it's all right for the management team to be very thin, as long as the problem they're solving and the technology they're offering are compelling," he says.

Nelson Stacks

Nelson Stacks, director of communications for healthcare information technology at 3i Corp., argues that management must be willing to outsource functions for which it lacks expertise. "It's smart management to say, 'We're very knowledgeable in these areas, but we lack expertise in those other areas.' It's good to know what you don't know." Stacks is very comfortable working with the companies his firm funds to bring in outside experts who can add value.

Gary Shaffer urges a company's managers to use "all reasonable steps"—testing, modeling, world-class expertise, and so on—to uncover problems with their product. He wants them to anticipate problems rather than react to them afterwards. "I have never seen even an experienced management team overestimate the effort required to get clinical sites fully comfortable with a new technology," he says. "There's a strong bias toward underestimating that requirement." User research and user feedback can help management to address issues surrounding the clinicians' comfort level.

The exit is probably the largest point of contention in the investor-management relationship. Tom Dickerson notes that rapid changes in technology and the volatility of medical markets mean that companies that have investors should be aware of, and open to, the possibility of exit from the time the investment funds are received. The reason is that difference in mindset. "The company looks at the success of the scientific invention; the investor looks at the success of the commercial product."

According to Dickerson, the bottom line is that "investors get excited only when they hear a presentation that causes them to say to themselves, 'Wow, I'm going to make an enormous amount of money if I invest in this.'"

Conclusion

By starting with a core technology or innovation, by incorporating elements of user input into the product design to make the core technology usable and desirable, and by taking an energetic approach to scheduling and risk management, the medtech company management team minimizes the likelihood of delivering a product that will make the market—and prospective new investors—yawn. They should be in a strong position, as the time for the second round of money approaches, to allay investors' worst fear: that they are giving a party to which nobody will come.

References

1. PricewaterhouseCoopers, Thomson Venture Economics, and National Venture Capital Association, "MoneyTree Survey: Total U.S. Investments by Year, Q1 1995–Q3 2004," [on-line spreadsheets] (New York: PricewaterhouseCoopers, 2004); available from Internet: www.pwcmoneytree.com/exhibits/NationalAggregateData95Q1-04Q1.xls.
2. R Cooper and S Edgett, "NPD Practices: The Dark Side of Time and Time Metrics in Product Innovation," Visions (April/May 2002): 14–16.

Craig Scherer is cofounder and senior partner of Insight Product Development LLC (Chicago), a product development firm with primary expertise in the development of medical devices and commercial and consumer products.

Copyright ©2005 MX