Mass Consolidation Sweeps Through Medtech Industry: What Startups Can Do About It

By Jim Kasic, Boulder BioMed

Imagine a fire sweeping through a forest. It moves quickly, burns through almost everything in its path, produces immense destruction, and changes entire landscapes. It also clears out dead debris and overcrowded areas, releases critical nutrients into the soil, and creates an open environment where new seeds can germinate. Grasses, ferns, and shrubs sprout. Many trees die, but some resilient ones with thick bark survive.

Through this process of ecological succession, the ecosystem transforms from a charred landscape to a regenerating environment. What is happening today with mass consolidation in the medical device industry is analogous, particularly for startup and early-stage companies.

Consider that the industry was, for decades, relatively fragmented and characterized by high growth. Things began to change significantly 10 to 15 years ago, and that change has accelerated rapidly in the past few years. There is no question that mass consolidation is a huge driver in the industry, making it harder for smaller early-stage companies to survive. Like wiping out all the undergrowth in a forest fire, mass consolidation is sweeping up these small organizations.

Ecological Succession In The Industry

Yet there is a silver lining: the med device industry’s ecological succession. We are seeing smart, agile, small companies identifying opportunities precisely because the consolidators are ignoring parts of the market. They may be small parts, but they are large enough to be successful. A rebirth is taking place.

Med device startups and early-stage companies that want to be part of this rebirth must have a clear understanding of just how mass consolidation is playing out. Then they can develop strategies for taking advantage of the new ecosystem, whether by developing niche, innovative devices or positioning themselves as acquisition targets.

Financial Arbitrage

Looking at the big picture, we start with the fact that there is too much money out there chasing too few goods. For startup and early-stage medical device developers, the issue shows up in the actions of private equity firms.

While many factors come into play, the growth of U.S. retirement funds is playing a large role in private equity interest and investment in medical device development. As individual investors with sizable retirement funds seek places to invest their money, private equity funds are frequent targets.

In turn, those private equity funds need to deploy their money. They aren’t, after all, like banks. To make money, they need to invest the funds people have entrusted to them. To make more money — and provide a good return for their investors as well as themselves — they need to find ways to further increase the returns.

Generating Higher Multiples

That’s where financial arbitrage comes in. Simply put, in this context, it occurs when a larger company acquires several smaller companies and integrates them. The smaller companies will generally have relatively low valuation multiples, which are financial ratios used to compare one company’s value to another's. In the medical device industry, EBITDA (earnings before interest, taxes, depreciation, and amortization) is a commonly used ratio that evaluates a company's core operating profitability.

After acquisition and consolidation of several smaller companies, a private equity firm can generally value and sell the resulting larger entity at a higher market multiple. For them — and their investors — this creates value through the difference. The investors want to go after the bigger fish, not the littler ones.

Financially, this may make sense. But in the medical device industry, the smaller companies — particularly supplier companies manufacturing specialty items — have typically been built from the ground up. The people involved are generally concerned with customer relationships and care deeply about device quality.

Operational Efficiencies

When a company like this is acquired, along with others like it, operational efficiencies will come into play. Departments may be combined. Administrative functions may be consolidated. The manufacture of items that are critical but not deemed profitable enough may stop. Layoffs may happen. When expenses decrease (all other things being equal), metrics like EBIDTA go up. That’s good for the investors, but maybe not so good for the customers, employees, and even the technology itself.

Problems proliferate when it comes to influencing how these consolidated companies do business. In addition to operational economies of scale, investors prefer to work with a few large customers rather than several smaller ones. From an efficiency standpoint, it may be reasonable. But the result is that smaller customers often are cut out. When they can’t obtain services or items they need, their business suffers. It becomes an issue for the entire food chain.

Changes In Company Culture

Another downside of consolidation is that company culture changes as businesses move from small to large. Management generally starts to turn over. The quality of customer relationships declines. Then, employees who may have honed specialized skills leave. When the one technician who knew how to make one particular component leaves, the company loses more than an employee. It loses that bit of the technology that made it what it was in the first place.

What To Do

A stellar device is no longer enough. To survive — or to be acquired — startup and early-stage company success increasingly depends on the ability to strategically execute quickly and agilely.

1. Conduct market research — early on.

Most developers have heard, time and time again, that market research is critical. Yet many are still developing devices that need a market, rather than identifying a market need and then developing a device that meets it.

The problem is understandable, as it’s realistic to expect medical device ideas to spring from technology and engineering experts. But today, developers need to get it right the first time. “Speed to market” is an essential adage, but it does little good if a device isn’t speeding to solve a known need with quantifiable prospects for financial success.

Market research is not just going through some steps, calculating total addressable market, and hoping for the best. It is a science in and of itself. Ideally, it is a continual process to identify unmet clinical needs. For any potential device, companies must confirm true market need, specify user types and decision makers, and identify risks before investing in development. Those risks include regulatory hurdles, possible device failure, cost and pricing, the competitive landscape, and, of course, user preferences and acceptance.

Many developers work with market research specialists to conduct research, home in on true needs, and help define a device’s unique selling points for potential buyers. Others work with specialized medical device development companies that maintain expertise and experience in every aspect of market research and risk management.

2. Establish a backup for anything on the critical supply list.

Second sourcing takes valuable time and effort. And having two vendors in place that can do the same thing often means you’re paying twice for a given service. For these reasons, developers working on shoestring budgets and tight timelines often skip the step. But for critical items, a second qualified source can mean savings of tens or hundreds of thousands of dollars when the need arises — and the need often does. The number can be exponentially higher if it means a device will get to market faster (or at all).

In this vein, don’t rely solely on singular relationships. There was a time when you could call a familiar supplier, ask for an R&D production run, and have it in six weeks. But mass consolidation is hitting the supplier world, too. That six weeks might easily become 26 weeks, a year, or never, even for an FDA-cleared device. The company could have shifted its operations to more profitable ones, or its own investors could have made decisions to pursue other priorities.

Sterilization is almost always on the critical supply list. Supply chain issues in recent years have caused developers to lose money on a monthly basis because they are unable to get their devices sterilized. Those that don’t have another sterilization contractor on board can suffer serious go-to-market consequences.

3. Be smart and stay flexible in manufacturing.

Speeding manufacturing while reducing costs is usually at the top of a startup company’s list (especially for any plastic parts). But the fastest, cheapest methods can often make disassembly or replacement a real challenge if the design needs refinement down the road. Instead, think ahead and incorporate alternative features into your device design that will allow for low-volume production or troubleshooting flexibility. When the design is set and ready for market launch, it won’t be difficult to replace those features with more automated or advanced options.

4. Hustle.

Getting a medical device to market has never been easy, fast, or direct. Today’s environment calls for different tactics and an all-in commitment. In the development process, CEOs and other executives looking for big salaries (or, often, any salary) should look elsewhere. They need to move quickly but strategically, think beyond short-term dollars, and be ready to adapt goals and visions.

Moreover, don’t try to do it all on your own. With so much on the line, accept that no one person can’t know it all or do it all. Utilize experts who know how to market test a device, how to design and manufacture it for efficiency and efficacy, and how to navigate the complex regulatory process.

Conclusion

Mass consolidation in the medical device industry presents pros and cons for the startup and early-stage developer. On the plus side, there are more exit paths and more acquisition opportunities. On the negative side, it creates significant barriers to entry, increases market concentration, and changes how innovative devices reach the market.

Yet even as consolidation seemingly wipes out the undergrowth of smaller developers, there are voids and holes to fill. Large companies will ignore or overlook some crucial market needs. Startup and early-stage developers can work to identify and seize these opportunities. While they may represent small portions of the market, they can still be big enough to be very successful.

About The Author

Jim Kasic is the founder and chairman of Boulder BioMed. With more than 30 years of experience in the Class I, II, and III medical device industry, he holds more than 40 U.S. and international patents. His career includes experience with companies ranging from large multinational corporations to startups with a national and international scope. Kasic has served as president and CEO of Sophono, Inc., a multinational manufacturer and distributor of implantable hearing devices, which was acquired by Medtronic. He also was the president of OrthoWin, acquired by Zimmer-BioMed. He received a B.S. in physics and an M.S. in chemical/biological engineering from the University of Colorado and an MBA from the University of Phoenix. He can be reached at jim.kasic@boulderiq.com or on LinkedIn.