The medical device industry is engaged in a feeding frenzy, gobbling up competitors in an effort to shore up market share, reinvigorate sales forces and resupply product pipelines.
Though it's likely a cyclical, evolutionary moment, similar to what happened in the pharmaceutical industry several years ago, consolidation creates an opportunity for large, diversified healthcare companies to offer hospitals a Chinese-menu style of choices in supplies -- all bundled into one supposedly discounted price.
But will they be such great deals? Mergers and acquisitions in the medical device industry may not be bad for hospitals, some industry insiders say, but that doesn't mean they will be good either.
Among high-profile public companies such as Johnson & Johnson and Guidant Corp., consolidation predictably sparks fevered speculation on Wall Street and scrutiny from federal regulators. When successful, such deals also frequently beget more deals among rivals. Yet while mergers and acquisitions in the healthcare industry are often seen as an opportunity for shareholders, it can be unsettling for hospital customers, who are suddenly negotiating with a bulked-up sales force and product line.
Newly consolidated companies offer a wider range of products and greater opportunities for vendors to market their disparate lines in one big package. The practice, known as bundling, has a spotty reputation. Big vendors love to bundle because it gives them one convenient platform on which to market their varied product lines. Small vendors loathe it for shutting their products out of the marketplace. Providers frequently sign on to it without really understanding all the consequences.
"Bundling is a strategy that multidivisional suppliers (use to) entice hospitals. But when you examine it closely, it actually results in hospitals paying much higher costs, although it leads the unsophisticated buyer to think they have a good deal," said David Ricker, chief operating officer of Broadlane, a group purchasing organization. "Suppliers do not employ programs that result in margin erosion; they only employ programs that result in more sales and higher margins. That's what they are directed to do."
By far the most prominent deal unveiled in recent months was J&J's $25.4 billion proposal late last year to acquire Guidant Corp., a marriage that will bring Guidant's highly lucrative and fast-growing electrophysiology business under J&J's massive umbrella. Guidant shareholders approved the proposal on April 27. Regardless of the Federal Trade Commission antitrust investigation it spurred in February, and the decision by the European Commission last month to open a second phase review, officials at both companies said they are confident the deal will close as expected in the third quarter. Guidant and J&J officials declined to comment for this story.
J&J's buying spree
Still, that huge deal did not seem to diminish J&J's usual appetite for acquiring smaller companies. Last month, the healthcare conglomerate acquired TransForm Pharmaceuticals, Lexington, Mass., a privately held drug discovery and development company, for approximately $230 million. J&J first announced plans to buy it in March, just one week after announcing a deal to acquire Closure Medical Corp., Raleigh, N.C., for about $370 million. Closure Medical, which makes biomaterial-based adhesives, has worked closely with J&J's Ethicon unit since 1996 on the development of topical adhesives. Closure Medical's board approved the sale on April 25, and the FTC terminated its review earlier this month. The deal is expected to be completed soon after Closure Medical's stockholders meet on June 2.
Also in April, J&J announced an agreement to acquire Peninsula Pharmaceuticals, Alameda, Calif., a privately held biopharmaceutical company focused on developing antibiotics to treat infections, including hospital-acquired infections, for approximately $245 million. The deal is expected to close this quarter.
More recently, German conglomerate Siemens purchased CTI Molecular Imaging, Knoxville, Tenn., in a deal valued at approximately $1 billion. Siemens officials said the acquisition was the natural progression in the companies' long association, which in 1987 spawned CTI PET Systems -- a joint venture combining CTI's expertise in PET with Siemens' global distribution network. Siemens' May 5 acquisition of CTI's portion of the joint venture as well as all of its other businesses will accelerate and strengthen its position in the fast-growing area of molecular imaging, said Michael Reitermann, president of the nuclear medicine group at Siemens Medical Solutions.
The rash of activity in the medical device industry is not really "any more rampant now than at other times in the recent past," said Kem Hawkins, president of Cook Group, the world's largest privately held medical device manufacturer, in an e-mailed response to questions. "Most of it seems to follow the pattern of small, emerging technology companies being acquired by bigger public corporations that need fresh technology to fill their product pipelines and have the capital and equities to pay for it and the marketing or sales power to drive those technologies to the marketplace."
Meanwhile, GPOs, many of which are transforming their business practices under pressure from the Senate Judiciary Committee's antitrust subcommittee, are watching the activity with caution.
Concerns about bundling
"I think the latest spate of merger activity is certainly an opportunity for great bundling, but it's too early to tell what the impact will be," said John Strong, president and CEO of Consorta, a GPO that primarily services Roman Catholic hospitals. "I know that providers are concerned about the ability of manufacturers to bundle bigger and bigger product" categories.
Large deals like the J&J and Guidant proposal, frequently unleash speculation that similar deals will follow, said Jason Wittes, senior medical device analyst for Leerink Swann & Co., a healthcare equity research and investment banking firm. Wall Street is now rife with predictions that Boston Scientific Corp., J&J's only competitor in the surging drug-eluting stent market, will now have to make a move. One candidate for acquisition by Boston Scientific or another company would be St. Jude Medical in
St. Paul, Minn., a prominent player in the electrophysiology space, Wittes said.
In reality, the medical device industry has been on a consolidation roll for at least the past five years, part of the natural cycle of smaller fish getting swallowed by larger competitors.
"Any small company, when it reaches a certain level of sales, usually gets acquired," he said. "I would say it is just a constant drumbeat."
The J&J agreement with Guidant stands out among the normal ebb and flow of deals in that Guidant already commands considerable size and market share in its own right. But with its single-minded focus on cardiology, Guidant's business has matured after 10 years of "tremendous growth," Wittes said. "Once a market reaches maturity, management has to figure out a way to reinvent themselves or sell themselves."
That's good for shareholders but not necessarily for hospitals, Wittes said. Consolidation "means more power to suppliers, and they try to leverage their strength," Wittes said. "At the same time this does open the door to more bundling. So J&J can now bundle stents with orthopedics and everything else. ... I think bundling is a fact of life. It's not always effective, but it's always attempted."
Three seems to be the magic number for consolidating healthcare sectors, said Mike Hildebrandt, director of materials management for 338-bed High Point (N.C.) Regional Health System. Several years ago, Hildebrandt said he had as many as nine different players to choose from when buying orthopedic implants for the hospital. That has been whittled down to three. If J&J acquires Guidant, he will be left with only three major players in the cardiovascular arena, including Boston Scientific and Medtronic, he said. Even medical device distribution has consolidated to just three: McKesson Corp., Cardinal Health, and Owens & Minor, he said. Likewise, GE Healthcare, Philips Medical Systems and Siemens dominate diagnostic imaging.
"It certainly has limited the choices we have in purchasing," Hildebrandt said. "But as long as there are three out there, I don't think it is going to be a particularly bad thing or punitive thing. We're not seeing a huge effect on pricing as long as there are three."
Searching for the sunny side
James Thrall, chairman of the radiology department at Massachusetts General Hospital, Boston, sees a sunny side to consolidation in the big-ticket diagnostic imaging sector of the healthcare supply industry. All three of the major imaging companies have jump-started many product lines through acquisition, Thrall said.
The Siemens acquisition of CTI fills in "an important component of its product line," he said. "Frankly, it's always been somewhat confusing to have two organizations bidding against each other who are selling the same devices, so I particularly welcome this consolidation and think it is a very wise move on the part of Siemens because of the growing importance of the PET scan." With at least two other strong competitors in the marketplace, "that will keep pricing honest," Thrall said.
Consolidation in the industry is "a natural phenomenon and in the long run, healthy for us as long as there are three or four major global competitors," he said. Without the consolidated global players, companies with interesting technologies but no capital would "languish in a sort of perpetual undercapitalized state," Thrall said. "So there's a natural phenomenon of a new company getting started, demonstrating it has a viable and novel technology and growing to a certain point and then getting purchased by a larger company that's in a position to leverage global marketing and economies of scale."
Bundling does not pose a problem for large academic medical centers such as Massachusetts General because no one vendor offers the best product in every product line, he said.
Like Hildebrandt, Thrall noted that various sectors of the diagnostic imaging business have consolidated in recent years: film companies, equipment manufacturers and pharmaceuticals. But one category is still ripe for consolidation, he said -- information technology.
"That's the newest category, and interestingly, it's the one with the most companies active and successful right now, so it speaks to the concept of a natural process of consolidation," Thrall said. "I think it's quite possible that all the major imaging companies will try to have enterprise information solutions."
Erich Reinhardt, president and chief executive officer of Siemens Medical Solutions, said Siemens was the first of its competitors to move into IT with its acquisition of Shared Medical Systems. "We assume we will see more global players in IT," he said. Siemens' overall strategy is to integrate its vast array of services and equipment "to improve the efficiency of healthcare in a patient-centered system" that will ultimately improve quality and reduce costs, he said.
As a global company, Siemens is able to summon the resources needed for research and development. The large conglomerate can take bundling even beyond the reaches of its medical company, offering hospitals other Siemens products such as telephones, electrical power and security, he said. "One of the advantages of a large company is there are more company solutions that you can offer to a customer," Reinhardt said.
But J&J's acquisition of Guidant poses a more troubling scenario for hospitals. FTC investigators have solicited comment from Consorta, said Nancy Walsh, the GPO's senior director of medical supplies. "Irrespective of who the players are, our concerns come into play when there are fewer players in the market," Walsh said. "We think the most competitive opportunities exist when you can go to multiple sources for products and negotiate. When you eliminate a player from the market, you are obviously removing competition."
Walsh said she doesn't believe there is ever a situation in which there are too many companies in a marketplace. The more competitors there are, the more prices are driven down, she said. But "anytime you have these monopolies continuing to grow, it becomes more difficult for smaller manufacturers to do business with GPOs or hospitals because of all the bundling that occurs."
The Senate Judiciary Committee's antitrust subcommittee, which has been scrutinizing GPOs for three years, has been sharply critical of bundling, and nearly every GPO has forsaken the practice in individual codes of conduct. But manufacturers still bundle, going around the GPOs to negotiate directly with hospitals, she said. "That's the only way you can get more aggressive pricing. If you want a price concession, you really have to commit much more to the manufacturer than a single product category," Walsh said. Since Consorta doesn't bundle, "that eliminates our ability to negotiate," she said, leaving hospitals on their own to haggle with vendors. Making it worse, some companies will bundle completely disparate products, cutting across physician practices, she said.
As a result of the Guidant acquisition, J&J potentially could begin bundling drug-eluting stents and implantable cardioverter defibrillators -- products that cut across different physician practices, making hospital purchasing decisions even more complex. "I don't see why they wouldn't" bundle the two vastly different product lines, Broadlane's Ricker said. "I would expect them to. Both Cordis (the J&J company that makes drug-eluting stents) and Guidant do so. It's a course of practice that has served J&J very well."
Since most GPOs no longer engage in the practice, vendors are offering bundled discount packages to hospitals individually. Though the bundled price tag might seem attractive to an unsuspecting hospital, it can be deceiving, Ricker said. For example, it might seem like a sizable discount if hospitals used to paying $2,500 for drug-eluting stents and $5,000 for pacemakers are offered $250 discounts on the stents in a bundled deal. But hospitals would be locked into both prices, and thus lose the discount if pacemaker prices were to sharply decline, which is very possible in today's market, he said. Bundling "locks (hospitals) up on so many product categories, it keeps (hospitals from benefiting) from normal price degradation," Ricker said.
Jeff Rooney, vice president and chief financial officer at 177-bed Rush North Shore Medical Center in Skokie, Ill., said consolidations always raise concerns about cost, but the situation in the device industry does not seem to have gotten "to the point where we feel vendors have extraordinary pricing power. I still think there is sufficient competition that prices are remaining reasonable." The hospital's supply costs of approximately $28 million increased about 8% from 2003 to 2004 and went up about 7% this past year, but that was driven by increases in certain drugs, which vary by patient mix, he said. "Consolidation seems to be much more about companies' internal needs than about any way it affects their customers," Rooney said.
On the positive side for hospitals, vendors bulked up by acquisitions are able to bring new technologies to the market more quickly, said Hawkins of the Cook Group. "Dealing with larger companies also usually offers providers better access to product information and training, and one-stop shopping across product lines, which can help contain costs."
But Patrick Flaherty, service line coordinator in corporate purchasing for the University of Pittsburgh Medical Center, said he has concerns with any consolidation that removes a competitor from the field, even Siemens' seemingly logical acquisition of CTI. "It is disproportionately stratifying for people like me to successfully negotiate on PET/CT when I only have four (vendors) to begin with and then it is diminishing to three," Flaherty said. J&J's acquisition of Guidant is of even more concern as J&J's "business model and approach tend to be that of a drug company, and drug companies are notorious for having high margins," he said.
"It's a bellwether change for us. We do a lot of business with Guidant," Flaherty said. "J&J is saying it is a great opportunity for taking the best and moving forward to a more beneficial future. I sincerely hope that's true. I'll reserve judgment on that. I have no reason to doubt their sincerity, but I work on one side of the equation."
Published in Modern Healthcare, May 16, 2005