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The Medical Device Industry’s Biggest Challenge: Innovation or Taxes?

Thu, 07/15/2010 - 9:57am
Paul Steiner

In the last few months, the medical device community has found itself amidst a political fallout that threatens any forthcoming economic improvements. To fund the healthcare reforms set forth by Congress, medical device manufacturers will soon be charged a 2.3 percent excise tax on the sale of most medical devices.

The manufacturers that have survived the recession have done so because they have been able to balance the economic pressures and corporate mandates with the need to push innovation. They’ve understood that removing innovation from the equation is not a survival strategy – it’s a death sentence.

Just as many sectors of industry are improving, like the automotive sector, many medical device companies are facing a targeted threat on their survival. With narrow profit margins, many of these manufacturers and their suppliers will be forced to decrease innovation and/or staff to accommodate the medical device tax increase.

If the medical device excise tax were applied to the 2009 U.S. revenues of the largest 10 medical device manufacturers, it would have cost them $1.87 billion had the law gone into effect in last year. While the largest manufacturers will bear the lion’s share of the tax, the cost impact on mid-sized and small manufacturers is not to be ignored. This impact will be heavy against their small profit margins.

The voice of discontent is loud. Executives in the industry have shared their concerns not only with industry influences but also with the general public through interviews and op-ed pieces with major broadcast and print media. Unfortunately, how manufacturers can offset this tax increase has not been in the discussion. A pushback on the healthcare reforms that have taken years to pass won’t provide a speedy solution. If manufacturers in the medical device industry want to neutralize the effects of a tax increase, they must act today.

The first thing that companies must do is identify areas of wasteful spending in their operations. Many will claim they’ve already done this – numerous times – and there’s nothing left to cut. However, they may be surprised to learn that even the leanest manufacturers overpay their key vendors billions of dollars every year. This is especially true in the categories of transportation/logistics, technology, telecommunications and energy. On average, manufacturers overpay 10-20 percent of their overall spend with these vendors.

The problem is that even the most sophisticated procurement teams don’t have access to real-time vendor pricing data. Most IT, logistics and procurement teams go through a major software or shipping contract negotiation once every year or two. They have no idea how much their competitors are paying for the same product or service with the same vendor. For that reason, vendor pricing can vary as much as 30 percent translating into mass overspending. Removing the 30 percent worth of overspending can help fully or partially offset the negative impact of the medical device tax increase.

Benchmark

Companies should benchmark their annual spend in complex spend categories like transportation, technology, telecommunications and energy. It’s impossible to manage spending if you don’t fully understand where your dollars are going. To ensure you are getting fair market pricing from your vendors, you must acquire the necessary industry specific data and cost-to-serve insight to gauge fair market value.

Justify

Vendors widen their profit margins through subtle tactics like annual price increases which are built into your contract. These include fuel surcharges, accessorial charges and maintenance rates. Over time, these year over year increases can become the most significant part of your spend. If your small parcel carrier implemented a 4.9 percent net rate increase, will you have to absorb these costs or pass them onto your customer? Is a five percent increase in maintenance fees from SAP justifiable if your level of service and solution remains the same? These are just two examples of why vendors must justify any price increase.

Renegotiate

If you think you have to wait until the terms of your contract expire, think again. Contracts can be renegotiated any time. In the spirit of partnership, let your vendor know that you want to keep a positive relationship but need to come back to the table to negotiate fairer pricing and terms.

Bid

If you feel you’re not receiving the fairest terms and pricing from your vendor, it’s time to invite other vendors to the table and start over with the RFP process. Not only will it put your current vendors on high alert, you will have access to current and competitive pricing, rate structures and terms. Furthermore, this forces you to re-evaluate the services and products you actually need. For example, do you really need premium software support? You may be surprised at the savings to be had since your last RFP process. What about your incumbent transportation carriers? If you’ve used an incumbent carrier(s) for a significant period of time, chances are your relationship and contract are fraught with complacency. It may be time to bring in a competitor to take a fresh look at your operation and contract pricing.

The threats to and opportunities for the medical device industry over the next several years will be equally substantial. Reducing rampant vendor overspending is one way to tip the scales in favor of manufacturers. By offsetting the recent tax increase, medical device companies can commit more spend to R&D, protect jobs and innovate. And it’s faster than waiting for a political solution.

Paul Steiner is director of logistics for NPI’s transportation division. NPI is a spend management consultancy serving supply chain organizations across the globe, including many in the medical device industry.

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