Medical device manufacturers face unprecedented pricing and profit pressure in today’s market. Several factors shift power toward the buyer. These include changes in the relationship between physicians, vendors, and economic buyers, along with the emergence of third-party purchasing consultants. On top of all of these factors, regulatory changes point to the distinct possibility of reduced profit margins.
Government Health Care Reform
The federal government pays nearly 50 percent of all medical outlays in the U.S. With dark cost clouds and record budget deficits approaching, the government is desperate to find ways to cut medical costs. The most visible attempt is the passage of the U.S. Patient Protection and Affordable Care Act (PPACA) in 2010. Beginning in 2013, medical device companies will have to pay a 2.3 percent excise tax on gross revenues. In return, the government is trying to reassure manufacturers that the increase in insured patients will more than offset the new cost. For most device makers, however, it will require volume growth in excess of 20 percent to fully offset the tax and remain profit neutral.
Moving Beyond the Physician
For medical device manufacturers that sell physician-preferred items (e.g., spine, stents, pacemakers, orthopedics), the physician/hospital/sales representative relationship is constantly morphing. Physicians are increasingly unwilling to fight to use a certain manufacturer’s products because they are either now employed by a hospital or the hospital has told the doctors to stay out of the negotiations. Hospitals are also employing more sophisticated buyers who are more effectively bidding suppliers against one another to lower costs.
Third-Party Consulting Organizations
The third source of pressure is coming from consultants—third-party traditional consultant companies, internal consulting groups, or group purchasing organizations (GPOs). Due to the mass membership of vendors (medical device manufacturers), GPOs can secure competitive pricing for hospitals, eliminating the need for hospitals to secure pricing with each vendor on their own. GPOs are looking to add additional value for their members by offering software tools to manage their contracts, supplier negotiations, and spend analysis.
While the challenges facing medical device manufacturers are intense, there are select market opportunities that innovative companies can leverage. These include the growth in the number of covered patients, an aging population, and growth in developing markets. Vendors will need to position themselves to take advantage of this growth and secure their fair share in the marketplace.
So what can medical device manufacturers do to survive and grow in light of this very dynamic environment?
Pricing Strategies to Maximize Profit Capture
It begins with building a set of pricing and profit management strategies to gain control over pricing processes, value stories, and profit visibility. Armed with four strategies, the astute manufacturer will be in a position to defend price levels, manage inevitable pricing variations and improve the quality of pricing decision making.
1. Optimize New Product Pricing
Innovation has been the lifeblood of many medical device manufacturers. In the past, a more favorable pricing environment provided a greater margin of error in capturing value from new products. Today, getting it right at launch has never been more critical.
Optimizing new product pricing begins with a direct focus on provider return on investment (ROI). How will this new offering improve the ability of the doctor and hospital to earn a higher profit—either through increased procedure volume, reduced length of stay, or greater unit margins? It is essential for manufacturers to translate product features into economic benefits, focus on the enhanced performance of the new product, and build a health economic “value bridge” from the old solution to the new solution.
2. Manage Price Variability
With ever-escalating pressures from buyers, price variability is inevitable as medical device companies seek to optimize individual deals and agreements. The keys are to strategically manage this price variability and to avoid prolific, one-off exceptions that can ultimately drive down average prices, and destroy company value.
A well-designed customer segmentation framework is the first step toward establishing structure and logic to manage price variability in the market. Customer segmentation simply recognizes differences in value perceptions, motivations, and willingness-to-pay among groups of similar buyers, forming the basis for tiered offerings at various price points.
3. Improve Deal Structuring
Even with a solid segmentation framework in place, purchasing decision makers will inevitably challenge pricing strategies. When negotiations, price exceptions, and concessions are called for, the negotiation should be made with a thorough review of the relevant facts. With a rigorous, fact-based negotiation process in place, providers and field representatives are less likely to make emotional or outlandish requests, and the device manufacturer is more likely to extract fair value. These facts should serve as the basis for the deal structure—taking into consideration products, service levels, commercial terms, and performance commitments.
At the heart of any deal is the set of products and services being purchased. While this fact seems rather apparent, many manufacturers overlook establishing a logical progression of offerings from an opening price point to a mid-level performance option and up through a premium-positioned solution. Having a consistent series in place helps decision makers understand the price and value continuum, forcing them to make their own tradeoffs.
4. Upgrade Profit Visibility
Many medical device manufacturers fly blind when it comes to understanding the complete profit picture by customer or by segment. In a recent survey of device companies, only 38 percent could “strongly agree” that they have a clear and consistent view of net price by customer (after discounts, promotions, rebates, etc.).
A popular practice is to develop a price waterfall that depicts profit performance in a meaningful and actionable manner. In doing so, manufacturers harvest and aggregatr the various on-invoice and off-invoice discount items, along with the essential cost-to-serve buckets, to arrive at a bottom-line pocket margin (amount of profit left in pocket after all adjustments). Begin with the largest, most available, and controllable discount and cost buckets, and invest the most time there. Go deep on the critical few buckets rather than try to account for every last item. It is important to remain practical and resist the urge to go for unattainable precision with a 10-step waterfall when most of the leverage exists in a handful of variable price and cost buckets.
Enable & Sustain
From a tactical standpoint, there are two essential requirements for operationalizing and perpetuating well-developed pricing and value management strategies: (1) organizational alignment and (2) technology. Without investments in these areas, a strategic pricing initiative can end up as a one-off project with no ability to sustain positive performance. Done correctly, these key enablers will produce a lasting competitive advantage to generate profit growth amidst a sea of challenges and uncertainty in the medical device industry.
Perhaps most essential to enabling a high-functioning pricing capability is a well-aligned company. Internally, there must be a clear mandate from the CEO on the priority of improving profit performance through strategic price management. Given that pricing directly or indirectly affects all business functions, executive commitment and active leadership team support is a must.
Organizational alignment goes well beyond lip service, and includes a number of characteristics:
- Profit-focused incentive compensation systems that reward price quality
- Well-developed and executed change management plans
- Widely communicated (and rewarded) early wins to build organizational confidence
- Pricing decisions moved as close to the customer as possible, but not beyond roles with pricing accountability
- Defined pricing organization and value stewardship roles
Tools & Technology
Achieving pricing excellence requires an investment in systems and technology to collect accurate pricing and profitability data, to identify profit-improvement opportunities, to optimize price levels, and to facilitate the end-to-end price management process.
Companies increasingly employ supply chain management tools, benchmarking services, and negotiation training, all aimed at commoditizing supplier’s products.
Leading pricing systems offer:
- Scientific segmentation algorithms to ensure customers are properly segmented
- Pricing analytics to improve full profit visibility and reduce price leakage
- Price optimization capabilities to generate prescriptive pricing guidance
- Deal management software to ensure consistent pricing rules are efficiently applied
By employing tools that use science to minimize emotional decisions, suppliers have a better probability of offering a price point that is relevant to the market with less risk of “following the competition,” or emotional pleas to make pricing decisions.
In a period of extraordinary industry change and uncertainty, medical device manufacturers have little choice but to embrace strategic price management as a key element of their business plans. A one percent change in price equates to an 11 percent change in profit for typical companies, and there is no greater leverage point to drive performance.
Tom Monheim is a manager at Kalypso with 20 years of experience across pricing, marketing, product development, information technology, and strategic planning. Phil Holladay from PROS Pricing contributed to this article. Tom can be reached at firstname.lastname@example.org.