Schafer: Maturing medical device industry must change

For Norm Dann, it's pretty simple.

"If the medical device industry is going to survive," he said, "the business model has got to change."

It's now a mature, slow-growth industry, he said. It has to make simpler and less costly products. And companies have to significantly shrink their hugely expensive sales and marketing organizations.

These are not the observations, by the way, of some industry critic from the realm of media or politics. Dann is about as device industry establishment as they come.

In fact, he's one of the reasons Minnesota even has a disproportionately large base of medical device companies.

A former venture capitalist, sales representative and Medtronic executive, Dann turned 86 in April and is continuing his work as a consultant and board member for a number of medical device companies.

And with all that experience has come clarity on how the business has to change. "The market," he said, "it's absolutely the best teacher."

When Dann started working with medical devices more than 50 years ago, it was one of those emerging markets that only start-ups like Medtronic seemed to want to enter. As the device business started to take off, a key player in driving the growth was the individual sales rep working directly with physicians.

The physicians didn't know what a pacemaker was, and the thought of implanting one in someone's chest sounded crazy. They hadn't been trained in any of these new gadgets, and they depended on the sales rep to understand how a product worked and how patients could be safely treated.

Dann observed that teaching a physician about a new pacemaker happened to be an excellent way to spend enough time to build a deep personal relationship. And because the doctor controlled the purchase and wasn't overly concerned about price, it was an excellent way to sell, too.

For a while Dann operated a sales and service company that worked for manufacturers. One time the firm lost one of its product lines, and so his reps had to go to docs and explain that they would no longer be handling a main product line. According to Dann, their response? "We don't care, you're still going to be taking care of us, right?"

That model, taking care of the docs, worked well for decades.

"We built this huge, extravagant business," Dann said. "The sales and marketing costs are now twice what they are in other mature industries. We have this huge distribution capability, and it just isn't needed for a 20-year-old product."

Senior research analyst Thom Gunderson of Piper Jaffray & Co. said larger medical device companies have an average sales, general and administrative expense of about 33 percent of sales, and he generally thinks the administrative piece is about 4 to 6 percent of sales.

St. Jude Medical had sales, general and administrative expense of about 35 percent of net sales in its most recent quarter. If Dann is right and it should be closer to companies in other mature industries, look at the 3M Co.

This is something other than apples-to-apples, of course. But 3M also employs salespeople, marketing staff and product managers, and had expenses on this line of about 21 percent of sales.

St. Jude is thought of as a well-managed company in its industry, but getting those expenses to 21 percent of net sales would mean taking out about three-quarters of a billion dollars in annual expense.

Gunderson said the most vulnerable part of the device company sales model may be the actual sales rep, who has historically been both a highly skilled and a highly paid part of the team.

These reps had to be skilled enough technically to teach physicians and solve problems with new technology, skilled enough socially to build deep relationships with doctors, and skilled enough in business to negotiate purchase orders and supply contracts.

But the nature of the device customer is changing rapidly. Physicians are more comfortable with devices of all kinds and need far less hand-holding.

They are also losing their ability to influence purchasing decisions. Executives at hospitals and other health care systems are increasingly decisionmakers, and they continue to narrow their list of vendors and seek more attractive business terms from the vendors they keep.

Once the purchasing decision for the year is made at a big health care provider, say, 80 percent of the annual buy will go to Medtronic and 20 percent to St. Jude Medical, what is left for the high-cost sales rep to do?

"Do I still need to have a specialized physician sales rep?" Gunderson said. "Maybe I need a specialized physician educator. But that person doesn't make $350,000 a year."

You can understand management's reluctance to embrace a lower-cost model for selling, since getting rid of your experienced salespeople is not exactly a proven formula for making sure this year's sales goals are met.

"Imagine yourself in the position of [managing] the medical device company," said Peter Lawyer, senior partner and managing director in Minneapolis for the Boston Consulting Group. "You really don't have tremendous insight into individual accounts. That relationship has always been held by the individual rep. So changing that is an incredibly scary proposition."

Lawyer hesitates to call the traditional model dead, but he said he has advised medical device clients that "it's much better to get ahead of the curve on this one."

That's advice that Dann has also offered, speaking in a couple of different forums over the last year.

"It's not that this is some magic and I spewed out something no one knows," he said. "The difficulty is in doing it."

lee.schafer@startribune.com • 612-673-4302