Medical Devices: A Tale of Two Countries

For the medical device industry, business as usual ended in 2013. A convergence of factors created a perfect storm of disruption for the sector, particularly in two of its major markets—the United States and Mexico.

The first factor is the phased implementation of President Obama’s healthcare plan, which will eventually extend health insurance coverage to an estimated 32 million Americans who do not have any form of health insurance.

Second, Mexico passed a major initiative to provide basic healthcare coverage to the country’s entire population by 2020, causing an expected annual average spending increase of 10.2 percent between 2013 and 2017.

Third, a new 2.3-percent U.S. excise tax on medical devices took effect in January 2013.

Fourth, intense price pressure from payers—insurance companies, corporations, and government—is shrinking margins.

Fifth is a payer-driven shift in performance requirements—from selling devices and treating episodes to delivering positive patient outcomes.

Finally, there’s a transition to a more geographically dispersed distribution channel.

Medical device manufacturers are struggling to adapt to this flood of fast-paced change—particularly to the pressure of reducing costs. In the past, the sector enjoyed robust profit margins—some as high as 40 percent for high-end devices. Those days are gone.

Unquestionably, the industry succeeds in meeting some tough service challenges—delivering products that heal, maintain, or save lives in a manner that meets exacting service demands. At the same time, though, the medical device supply chain is costly. Manufacturers load the supply chain with buffer inventory—everywhere—to avoid stockouts. Effective inventory visibility and control is limited or non-existent. Emergency orders drive the design of the entire system—even the non-emergency devices supply chain. Track-and-trace requirements keep growing, and a difficult reverse product flow further complicates the picture.

The result: While the medical device supply chain delivers extraordinary service, it does so at a high cost structure that is unsustainable going forward, given the new market realities in the United States and Mexico.

Medical device manufacturers recognize change is imperative, and are looking at all aspects of their business for solutions. The supply chain has risen to the top of the agenda as a prime instrument with which to address these convergent pressures.

The End of Business as Usual

The medical device industry is large and global. The U.S. medical device sector, which is valued at more than $60 billion, is the world’s largest, and accounts for nearly 20 percent of the $350-billion global industry, by production, according to the U.S. International Trade Commission. Moreover, seven of the world’s 10 largest medical device original equipment manufacturers (OEMs), by revenue, are headquartered in the United States.

Although far smaller, the Mexican medical device market—valued at $2.8 billion in 2008—is projected to grow at a CAGR of 5.7 percent to an estimated $5.4 billion in 2020.

Intensifying Cost Pressure

The pressure to reduce cost across the medical device supply chain has never been greater. "Our nation’s fiscal challenges and our industry’s bulk are on a collision course," writes Paul Keckley, executive director of Deloitte Center for Health Solutions, in a recent report about the U.S. market. National health spending is projected to grow at an average rate of 5.7 percent annually between 2014 and 2021, which would be 0.9 percent faster than the expected annual increase in gross domestic product during this period, according to the U.S. Congressional Budget Office.

Concern over this health spending increase is prompting hospitals and other medical providers to focus on cost cutting. Medical device manufacturers are caught in the crossfire, according to the Deloitte Center for Health Solutions. Hospitals and other medical providers are requiring better prices, and health plans want steeper discounts.

Because of intensifying price pressures from insurers and governments, the traditional sales model for medical devices is beginning to change. Doctor preference typically drove hospital purchasing decisions, particularly for high-value devices such as hip or knee implants.

"While that’s still the case, hospitals are doing what they can to reduce the number of suppliers, and better control their SKU portfolios for lower value or less ‘preference-sensitive’ medical device products," says Wayne Wooddell, vice president, business development-life sciences and healthcare at Exel Inc., a third-party logistics provider with U.S. headquarters in Westerville, Ohio.

At the same time, insurance companies and regulators are shifting toward performance-based healthcare management, focusing on patient outcomes rather than procedures. This puts pressure on medical device manufacturers to compete either on cost, or by differentiating their products based on superior patient results.

The Aging Boom

The populations of the United States and Mexico are growing older—fast. The growth in the number and proportion of older adults is unprecedented in U.S. history. Two factors—longer life spans and aging baby boomers—will combine to double the population of Americans aged 65 years or older during the next 25 years to about 72 million. By 2030, older adults will account for roughly 20 percent of the U.S. population, up from 14 percent today, according to the Centers for Disease Control. In Mexico, an estimated 12 percent of the population will be 65 or older by 2030.

Simultaneously, there has been a major shift in the leading causes of death for all age groups, from infectious diseases and acute illnesses to chronic diseases and degenerative illnesses, including diabetes, cancer, and heart disease. Treatment for conditions such as these consumes more healthcare resources over a longer period—pushing government healthcare budgets skyward at a rapidly accelerating rate.

New Track-and-Trace Regulations

New safety regulations introduced in the United States and elsewhere require device makers to implement robust product tracking and data collection systems in the supply chain, at a substantial cost.

Specifically, in 2013, the Food and Drug Administration (FDA) released a final rule establishing a unique device identification system designed to identify devices through distribution and use.

Thefinal rule, which began taking effect in 2013, requiresdevice labelers to include a unique device identifier (UDI) on most device labels and packages readable by automatic scanners.

Device labelers must also submit certain information about each device to FDA’s Global Unique Device Identification Database (GUDID). The public will be able to search and download information from this database.

The FDA issued the rules in an effort to improve patient safety and modernize post-market surveillance of device performance. Manufacturers have up to seven years (2020) to fully comply for all devices ultimately requiring a UDI.

The European Union is in the process of revising its medical device safety regulations along similar lines, again to enhance patient safety. Other countries are likely to follow suit.

Supply Chain Challenges

Beyond these market forces, the traditional medical device supply chain carries significant challenges of its own. While these issues vary somewhat in nature and degree between the United States and Mexico, essentially they boil down to four key concerns:

1. Inventory everywhere. For both the United States and Mexico, managing inventory is a critical challenge. "There is inventory everywhere—in the regional distribution center, forward stocking locations, the logistics service provider’s warehouse, the sales reps’ car trunks, on consignment in the hospital, and at the sterilization point," says Scott Cubbler, president, life sciences and healthcare-Americas for Exel/DHL Supply Chain.

   With regard to the forward stocking points, "It is not uncommon for a medical device company to operate a network of small distribution points sprinkled across their markets—anywhere from 40 to 100 such locations," explains Phil Siewert, senior director business development, Exel/DHL Supply Chain. "These facilities are small—about 2,000 square feet—and are used to feed product to end customers in final-mile delivery."

   This inventory-everywhere system is not only expensive, but the complexity of trying to track product throughout the chain is enormous. It is easy to lose visibility of product in the channel.

2. The unknown in the operating room. Another factor that adds complexity and cost to the devices supply chain—particularly implants—is the need to hedge against the unknown in the operating room (OR). In planning an implant procedure, the surgeon requests a tremendous volume of parts. For a left knee replacement, the doctor may order a surgical kit with knee sizes two through 10, and only use size four. Each implant comes with essentially a closet-sized tote bin of product going into a surgery.

   Unused equipment, which is still owned by the device-maker (consignment inventory), is out of circulation and unavailable for sale. "With devices such as pacemakers, three or four sizes might be sent to surgery, which is not a big deal from a cost-of-inventory perspective," explains the supply chain director at one device manufacturer. "Orthopedics, however, requires sending a tool truck-sized kit into surgery. The doctor uses just a fraction of that inventory, and the rest comes back to be sterilized, inspected, re-kitted, repackaged, re-inventoried, and stored—until it moves out to the field again to start the cycle all over."

   This means turn rates for very expensive consignment inventory are extremely low.

3. The high cost of service. In the United States, intense competition among medical device manufacturers has prompted many to use delivery as a competitive lever. Manufacturers try to outdo each other on service, so they further complicate the supply chain by guaranteeing hospitals that orders placed by 7 p.m. can be delivered the next morning.

   As a result, hospitals often wait until the last minute to place orders, which forces manufacturers to rely on a costly premium delivery system to fulfill next-day deliveries. This means manufacturers must have distribution centers (DCs) located next to air express hubs to get product to the hospitals next day. They also load the system with inventory in order to fulfill their high level of order promising.

   "For supply chain operations, this last-minute ordering profile drives tremendous variation in workflow through the distribution channel," Siewert notes. "It also means the supply chain must operate in ’emergency mode’, with a huge spike in workload occurring at the end of the day. And shipments must move via expensive next-day delivery service."

4. Expanded demand footprint. In Mexico, the expansion in healthcare coverage means medical device manufacturers face a rapidly growing geographic distribution footprint, as healthcare delivery services reach beyond the major metropolitan areas. They must now ship products to more remote areas far from DCs, which are usually located in large cities, adding cost to the supply chain.

Solutions for the Future

Leading medical device manufacturers are turning to innovative supply chain solutions to tackle these challenges—and working closely with third-party logistics service providers and customers to execute these new ideas. Among the new supply chain strategies:

• Leveraging shared capacity. In both the United States and Mexico, medical device manufacturers typically have customer overlap, meaning multiple companies are shipping to the same group of customers, creating considerable duplication of supply chain assets, resources, and costs—all geared toward serving the same customer cluster.

It would make sense, therefore, for manufacturers to reduce this redundancy by using a single logistics service provider to create a shared, multi-customer supply chain solution. This solution would manage the flow of medical device goods and services to and from the hospital. The idea would be to cluster manufacturers in a single warehouse near the hospital they are servicing, and consolidate deliveries and services to the hospital.

"Having six different deliveries to a hospital, and going to six different wards with four different highly trained drivers doesn’t make sense," explains Wooddell. Instead, the 3PL could create a metro hub, consolidate deliveries, eliminate overlapping deliveries, and provide full service with just two drivers.

"This shared capabilities model would enable manufacturers to compete on the basis of their product, rather than on the final-mile delivery," Cubbler adds.

"In the United States, we have the challenge of a complicated supply chain for medical devices," says Wooddell. "The challenge in Mexico is simply to get the product to the point of use. But because Mexico doesn’t have the demand yet, its medical device sector is in a position to learn from the United States, build the right supply chain, and set the right behaviors to help them avoid the costly infrastructure required to meet customer expectations in the United States."

Direct to Market Delivery

To this end, some manufacturers operating in Mexico are considering using a qualified 3PL to provide direct-to-market delivery. In this scenario, a single 3PL would replace the numerous small distributors that currently serve as the go-between in the manufacturer-customer relationship.

Some manufacturers are also working with 3PLs to set up forward stocking facilities in major metropolitan areas to service hospitals and stand-alone surgical centers. Under this arrangement, "we position consignment inventory in the forward stocking location instead of spreading it across many hospitals," says Daniel Pardo, president, Mexico and life sciences LATAM, for DHL Supply Chain. "This way, we can deliver product quickly, while reducing the amount of inventory in the supply chain."

• Collaborating toward Lean. One practice that would complement this shared services supply chain is greater collaboration among all trading partners—manufacturers, their customers, and 3PLs—in the devices supply chain.

"We’re working with customers to improve our scheduling," reports the supply chain director for one device manufacturer. "The more time we have to react to something, the better we can plan.

"From a reconstructive perspective, if we know the schedule of surgeries in advance, we can plan and sequence our implants to the hospital on a just-in-time basis," the director adds. "Every knee set costs $55,000, so the better we plan, the less inventory we have sitting idle in the field, and the more we reduce our costs."

• Streamlining inbound to manufacturing. Better forecasted demand visibility enables device companies to pool inventory farther upstream in the channel, in fewer, more centralized locations. "The challenge is to streamline inventories in the field, maximize velocity, and, at the same time, not miss surgeries," notes the supply chain director.

Exacting Information

More advanced planning and forecasting also would include additional details about exact order requirements. This is particularly important for implants because it would reduce the volume of product being exchanged with the hospital in operating room surgical kits.

"If we had more exact, accurate information about what’s needed for a procedure, we could deliver a tackle box-sized kit to a spinal procedure instead of a tool truck-sized kit," comments a logistics director for a major U.S. device manufacturer.

Longer lead times and better forecast information would enable manufacturers and their logistics service providers to manage the flow of product in a more controlled manner across the distribution network.

"It would reduce reliance on high-cost express delivery systems," Wooddell says. "It also would reduce the need for buffer inventory at hundreds of stocking points, while still delivering high levels of availability and customer service."

The path forward is not an easy one for the medical device sector, as it reengineers its business model and the supporting supply chain. "Fortunately, healthcare institutions in particular, and the industry as a whole, are beginning to realize that the level of cost savings needed won’t come just from squeezing suppliers for price concessions," observes one manufacturer. "One multi-billion-dollar hospital system told us, ‘we could beat you up on price, but we know to reach our cost objectives, that won’t be enough. We need to take a more systemic, strategic approach to reducing costs.’"

Changing the Status Quo

"Supply chain innovation offers a powerful opportunity to change the status quo and drive cost out of the system," suggests Siewert. "If the industry can improve the quality and flow of information, reduce uncertainty, and develop solutions such as shared supply chains, it can create a more efficient path to market. This will help the industry meet the challenges of controlling and reducing costs, while delivering on its service promise."

"This is not something we can accomplish alone," notes one device manufacturer. "We need to bring all of our supply chain partners to the table, and all work together to streamline how we get product to the customer."