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Medical devices have traditionally been characterised as a high growth market with low price pressure. However, several trends are creating a new competitive dynamic characterised by slower growth, increasing price pressure and new purchasing dynamics.

For example, a recent Frost and Sullivan report characterised the European medical devices market as follows:
“Regional hospitals in most European countries are collaborating to gain better bargaining power and benefit from the economies of scale derived from bulk purchasing…device manufacturers are left with no option but to review prices and make do with reduced profits in order to win purchasing contracts.”

The same report also said that: “As part of the prevailing cost-containment strategies, European hospitals are creating diagnostic-related groups (DRGs) that classify the patients’ hospital stay according to their medical conditions. Each DRG has a reimbursement ceiling, compelling hospitals to rationalise patient treatment and ensure that all related costs are confined within this limit. While this system aims to contain costs, it also reduces the availability of extra funds that could have been used to procure new and innovative technology.”

It concludes that:
“Medical device manufacturers operate in a highly competitive environment. Innovations in medical devices are constantly being introduced and rapidly adopted…to sustain market leadership or dominate the industry, manufacturers need to differentiate their product offerings through ongoing and exciting innovations…and maintain a large product portfolio to ensure that business levels remain robust.”

How can all of these statements be true? While certainly margins for device manufacturers are high as a starting point, how can companies have no choice but to accept reduced margins to win contracts, while at the same time be expected to continuously invest to win an R&D “arms race?” It seems like other approaches must be out there.

Indeed, we don’t believe that “doubling down” on R&D (to win the “arms race”) or slashing SG&A (to counteract increasing price pressure) are the highest value responses. The former creates the potential for even lower returns if R&D doesn’t meet new customer needs and the latter could lead to a vicious cycle of lower sales and marketing spend, resulting in even lower growth.

Instead, companies must build a clearer understanding of the specific needs of different customers (both hospitals and physicians) and design targeted offers. This requires segmenting based on variables and dimensions that truly drive different customer behaviours, in terms of willingness-to-pay and switching, as well as prioritising growth strategies and investments in-line with this segmentation. This will require companies selling medical devices to make different and clearer choices in how they focus on customers. For example, some companies probably need to begin experimenting with new distribution models designed with significantly less “touch” by a sales force or clinical support staff.

Changing customer behaviour
Hospitals and physicians are beginning to behave in ways that are shifting previously well-established competitive dynamics. The customer, previously a physician, is now frequently some combination of hospital and physician working together to make purchase decisions. In some hospitals, teams of physicians and administrators comprise new product committees that only grant approval to products that make clinical and economic sense for the hospital.

Physicians primarily care about product effectiveness and the support they get in caring for patients. Administrators are equally concerned with reducing cost and increasing overall hospital efficiency. Perhaps R&D should be focused on cost reduction and quality, and marketing strategies should be developed to show hospital administrators why products are both economical and effective. More importantly, perhaps companies should target some hospitals via the old go-to-market model and others with this fundamentally different approach of choosing not to allocate sales resources towards certain types of accounts.

Ideas for winning: evolving the offer
In our experience, there are three steps to moving from the one-size-fits-all approach to customised offers that better meet customer needs profitably:

1.  Understand customer behaviour and profitable headroom for growth
2.  Segment customers and design new offers
3. Re-align resources to drive value creation

Figure 1: Measuring accessible profitable headroom

1. Measure profitable headroom for growth and understand customer behaviour
What is “profitable headroom?” Headroom equals total market size (in pounds/euros/US dollars) less your current market share less inaccessible competitor market share. For example, if a customer spends €100K and you currently capture €25K,

in theory there is €75K available. But, if €25K of that is held by a competitor to which a particular physician is loyal, it isn’t accessible in reality. The notion of profitable headroom simply layers on what you can pursue and still earn positive economic returns (see Figure 2). So, if another €25K of the original €100K customer spend is available, but only by reducing prices by 75% (or investing in significantly more sales and support resources), then it won’t qualify as profitable headroom. Two hospitals that each spend €100K and offer you 10% share today might represent extremely different sources of profitable headroom.

2. Segment customers and design new offers
Ideally, segmentation helps generate ideas for how to tailor an overall offer (product features, service levels, etc.) based on willingness to pay. Furthermore, it provides ideas for what type of marketing messages will resonate with customers to actually drive different behaviour within a segment. For the client described in our case study, we uncovered three core segments and then articulated several changes to our client’s overall offer that would drive share gains with each segment.
Our analysis suggested that there were three key needs of hospitals—some were interested in efficiency, others wanted to be shown how the company’s product would help them make money and a third was focused on technology (“make me cutting-edge”). Perhaps most importantly, it was clear that the “make me money” segment’s needs could only be met with significant offer and positioning changes, leaving the client with a clear decision to either invest in those changes or reduce focus on those customers.

Figure 2: Need-based segmentation example. For a larger version of this figure, click here.

Ultimately, what was developed was a simple yet very different way of going to market that created a new focus on meeting different needs with different customers instead of focusing on product features alone.

3. Re-align resources to drive value creation

The key to achieving a step change in profit growth is to combine the design of new offers with clear alignment of costs that deliver customer benefit. Some R&D costs currently focused on increasing the performance of existing product lines or introducing new products might be better spent on designing effective products at lower prices. Alternatively, sales costs currently focused on serving price-sensitive accounts or those loyal to a competitor might be either reduced significantly or re-aligned against high headroom accounts that are more likely to switch.

Case illustration: building profitable share in the US diagnostics market
The challenge: The US diagnostics market has historically been big, profitable, and fast-growing. But recently, the stagnant overall healthcare market and budget squeezes for diagnostics testing have created strong headwinds to both growth and profitability. In addition, new nontraditional competitors (large-scale test labs and specialised niche players) have picked off historically profitable customers.

Table 1: The three customer segments in the case study

The result was a fierce battle for market share. Our client, a global diagnostics company operating in Europe and the United States, was at risk of becoming stuck in the middle, competing against old and new competitors. Their historical sources of advantage were not strong enough to build or retain share profitably.
The question: How should our client refocus its strategy to target customer segments with the most headroom for profitable growth?

Our client’s response: Our client responded with a new approach to targeting and tailoring to customer segments.

1. Segmented the market based on three key measures:

• Customer profitability—economic profit contribution by customer
• Willingness-to-pay (WTP) and key features that drive WTP
• Accessible headroom as determined by customer switching behavior

2. Resulted in three customer segments (see table)

3. Tailored strategies to each segment:

• Increased focus and resources on “make my life easier” and “make me cutting-edge” customers and away from “make me money” customers
• Reduced the overall market share target but increased it for the two focus segments
• Invested in two key features of the offer for each segment:
  -“Make my life easier:” complete test menu, technician suppor
  -“Make me cutting-edge:” advanced test menu, point-of-care support

Impact
Maintained overall share in the US diagnostics business, resulting from increasing share in “make me cutting-edge” segment, holding share in the “make my life easier” segment, and giving up share in the “make me money” segment. Solidified position as “go-to” supplier for test and point-of-care innovation. Increased overall profitability despite declines in profitability of average competitor.

Conclusion
Growth is slowing, prices are declining and hospital behaviour is changing with new non-physician customers increasingly emerging. In this environment, many companies have chosen to “double down” on R&D or slash SG&A. We believe that a better response is one that focuses on understanding customers’ new behaviour (i.e., with the customer defined as hospital, laboratory, physician or some combination of these). This can be followed by customising the offer to better meet new needs and developing plans to re-align resources. To make this happen, companies will require different information about and lenses on their customers, revised go-to-market strategies and updated offers.

Brian Burwell and
Dave Bard
co-lead Marakon’s Healthcare Practice.
Mark Skoskiewicz has experience working with device manufacturers helping them uncover value creation opportunities through better customer insight.