Research Spending Impact On Medical Tech Profits.

Introduction

The medical devices’ industry (MedTech) plays a crucial role in life of people and provides them with services which improve customer safety and health constantly. The industry is strongly regulated by the government, especially by the Food and Drugs Administration (FDA), which checks the effectiveness, the adequacy of quality and safety of devices in order to give permission to be placed on the MedTech market. (MedPAC 2017, pp. 207-208) Medical devices help people to monitor diseases, detect and treat them on the earlier stage. The global healthcare industry during the last years strongly changes the focus from high sales, treatment of patients’ health to improvement of physical health of nations and to successful outcomes of a treatment process.

The MedTech market is strongly diversified regarding products, a portfolio of a company can be broad and includes the number of products, from latex gloves to hi-tech machines, for example, a magnetic resonance imaging (MRI) or computer tomography (CT). (MedPAC 2017, p.208) However, there are few global companies with diversified portfolios, and a lot of small and medium sized companies with the focus on particular products and equipment. These companies usually spend a high amount of money on their research and development activities. (MedPAC 2017, pp. 210-211) As noted earlier, nowadays, the healthcare industry is heavily oriented on the outstanding results of patients’ treatment without targeting the volume of sales. Nonetheless, the MedTech industry overview by Statista (2018, pp. 7-8) indicates the increasing revenues of total global medical technology during the last ten years. In 2018 global net sales made up 433 billion U.S. dollars with the decreasing annual growth rate. The analysts expect it to reach the level of 5 percent in 2022 with the constant rate of decrease.

Germany is on the 1st place concerning the expenditures on the healthcare and in 2015, the country spent more than 344 billion euros to improve the overall population’s health. (GTAI 2018, p. 4) The German market has a tenacious potential to boost the world market position by increasing the efficiency of this spending. According to GTAI (2018, p. 2), ‘In 2016, almost 70 percent of medical technology products made in Germany were exported to international markets. Domestically, more than 99 percent of the country’s 82 million residents are covered by health insurance. German health insurers cover … 11.3 percent of GDP’ (GTAI 2018, p. 2). There is still a potential to increase the market by 1,5 billion euros because of a good location of the country to other countries in Europe. More than 55 percent of the market in 2017 is concentrated on the production of high- tech equipment. Thus, in vitro diagnostics accounted for 13 percent of the market, equipment for the analysis of cardiology diseases took 12 percent of the market share, diagnostic imaging also ranks among the top three and accounts for 10 percent of the total market, orthopedic machines accounted for 9 percent of the market, solutions for examining patient ophthalmological problems accounted for about 7 percent of the medical equipment market. (Statista 2018, p. 26) Germany has more than 30 clusters of companies, which produce innovative devices and focus on improvements of innovations and effectiveness of R&D activities. The country provides the ability of open communication and collaboration between research institutes and market developers. Germany has the strongest regulation of standards, for instance, ISO 13485 (regulation of quality management systems) and ISO 14155 (clinical evolution of clinical technology). (GTAI 2018, p. 3)

This research is going to focus on diagnostic imaging systems. These devices make non- invasive series of scans to diagnose a patient. Machines usually generate some dose of radiation and provide the qualified and detailed images of particular parts of a body. There are three global leaders in MedTech: Siemens (23.2 percent), GE Healthcare (22.2 percent) and Philips (19.7 percent). The next two companies are also well-known for their medical innovations, they are Canon (9.8 percent) and Fujifilm Holdings (5.5 percent). (Statista 2018, p. 28)

Background

The topic is interesting and actual to research as the global leading companies are continuing to increase their spending on research and development activities to improve their technologies. It has to be mentioned that innovative medical devices are important not only to create better treatment of diseases, but rather to indicate potential diseases on early stages. Most companies care about the cost-effectiveness only on the last stage of production. However, insufficient efficiency management of expenses can lead to losses. Therefore, it is crucial to pay attention to it on each step of the developing process. In their research, Vallejo-Torres, Steuten, Buxton, Girling, Lilford and Young (2008, p.459), stated that the cost-effectiveness determination is not a key activity for the medical devices’ companies.

However, the deep analysis of all stages of development can help companies to make superior decisions on early stages and have more benefits at the end of production. In the study of medical innovations (Lehoux, Roncarolo, Oliveira & Silva, 2016, p. 120), the authors believed that investors spend a huge amount of money on R&D to create new medical devices and replace current versions of these products. Lehoux et al. believed that these expenses determine the innovation today. Stone and Lane (2012, p.2) reported that the government also spends money on R&D in medical sector to improve the Government Performance indicators. According to Statista (2008, pp. 9-11), complete worldwide research and development spending in medical technology is expected to increase and to reach the level of 39 billion US dollars in 2024 comparing to the level of 30 billion US dollars today. However, the growth of R&D expenditures per year will decrease. Therefore, the companies should spend money more effectively. This academic paper will focus on research and development expenditures, since the authors assume that R&D strongly supports the advancement of innovative products. It is important to understand which parameters define innovative products nowadays. Many authors believe that innovative devices are those which are technologically advanced. Nevertheless, implants’ companies call their solutions innovative even though they produced them in the last century.

Research Questions

As it was mentioned already above the HealthCare sector contributes a lot of financial resources to provide people with better solutions and services which constantly improve customer safety and health. High volumes of investment in R&D do not guarantee the high performance on the market. Therefore, this paper will attempt to answer the following research questions:

1. How does research and development spending impact profitability indexes of medical technology companies? Should medical industry companies control the cost-effectiveness indexes at the early stages?
2. Why do research and development activities play a crucial role in the advancement of innovative medical devices?

Research Objectives

The main long-term goal of this scientific study is to analyze the influence of research and development activities on medical technology companies’ profits. It is also important to develop the understanding of how the company should inspect cost-effectiveness approach to be successful in their financial performance. To achieve these two main results the following secondary tasks have to be completed:

1. To provide a deep analysis of the business and academic literature related to a topic of Medical Technology Industry
2. To determine technical and economic factors of the development of innovative diagnostic imaging devices
3. To collect available data on profits of main leading medical devices’ companies and research and development expenditures
4. To define the potential impact of research and development expenditures on the profitability of medical devices’ companies based on gathered profits from diagnostic imaging devices
5. To revise all available cost-effectiveness approaches which create superior profits at the final stage for the companies
6. To implement the results of case study of diagnostic imaging systems in other categories of medical solutions
7. To construct the set of charts, diagrams and tables that will illustrate the findings and patterns of the research

Research Design and Methodology

In this research, the authors will analyse the primary data which will be gathered through in-depth interviews with the top-management of MedTech companies from Marketing and Sales Departments. Additionally, secondary data will be gathered from statistical services, available researches and companies’ annual reports. In order to collect reliable and valid primary data the in-depth interview will be properly structured and planned. To get the unbiased data the homogeneous group of interviewed managers will be selected in advance. Tuttlingen, Baden-Wurttemberg is one of the biggest medical manufacturing clusters in Germany (the number of medical companies is bigger than 40). This area was chosen for the interviewing process. The structure of interviews will be also determined in advance, all questions will be open-ended in order to gather more reliable and interesting insights. The responses are going to be collected via face to face interviews.

The invitation to participate in a survey will be sent by e-mail to Marketing and Sales departments of the companies. The main advantage of depth-interviews is that they help to collect more detailed information concerning the topic. The main disadvantages are that they are time-consuming, and the results cannot be generalized, however, the insights could be used for secondary data collection. The purpose of in-depth interviews is to determine in detail the technological and economic factors which define innovative medical systems. After the interview process the comprehensive analysis of answers will be made to determine the current situation on the market and further steps for gathering secondary data.

Primary Data

Gathering the primary data is crucial for the start of the paper to obtain new insights for research and to answer the questions which were mentioned above:

1. How does research and development spending impact profitability indexes of medical technology companies?
2. Which technical and economic factors define innovative diagnostic imaging devices?
3. Do companies control their expenses on all stages of the development of new technologies or do they only think about successful strategies for sales of current project?

The primary research will be using in-depth interviews with the representatives of the medical devices’ companies. To obtain sustainable results from the interviews it is important to plan it in advance. In such way, at the first step of collecting primary data it is critical to define the homogeneous group with sufficient number of respondents from the companies, in this research, the authors define this number as N≥10. At the second stage, the comprehensive analysis of the answers is needed to identify the additional data which should be collected from the secondary resources. In-depth-interviews with MedTech companies’ representatives The main goal of in-depth interviews is to collect qualitative data with insights from the industry. Therefore, this study will be based on expert interviews which are required to be properly planned in three basic steps: planning the interview, execution and comprehensive analysis of experts’ responses.

The planning of the interviews usually includes identification of a group of respondents, definition of the information which is required to be gathered to construct the set of open- questions, pre-test interviews to check the quality of questions. In this study the experts would be managers from the Marketing and Sales department of MedTech industry, these people are responsible for the creation of strategies to entry the market, they know all technical and economic factors which make goods innovative and responsible for the profitability of companies. It is crucial to understand from the interviews which factors at the moment define innovative devices in medical industry and which factors are important in order to develop a successful device in terms of profitability. In this way, the interviews should consist of open-questions and interviewee have to be as close as possible to the final product. Respondents should not feel uncomfortable, so all conditions of the interview should be carefully considered and tested on a test group. The interview should be structured from open to closed questions that can be scaled from 1 to 5. If all stages above are completed, the interviews can be conducted. It is better to make interviews not alone, but in a group of two or three people because the interviewer should concentrate on the questions and do not have a possibility to make notes. The notes from the interview should be analyzed on the last stage. At the last step, the comprehensive analysis of all collected responses should be made. It is better to structure all responses in the same way to make them comparable. Following that, it is important to interpret the findings using charts and tables. It is expected that research results may not be comparable, therefore it is very important to observe the rule of homogeneous sampling, in order to avoid this problem. It is also very important to notify correspondents that the interview should be based on the experience of companies, and not on their personal experience or opinion.

Secondary Data

The main sources of secondary data will be statistical reports, annual reports by companies and existing literature. In order to make the industry review the Statista will be used. The source has the data on “Medical Technology Industry - Statistics & Facts” 2018 which consists of information on the overview of medical technology industry, the companies’ financial and economic performance, the costs and revenues by the product segmentation, last IPOs, M&A and funding activities. The companies’ annual reports will help to find information about profitability, the overall expenses and research and development expenditures in detail based on their portfolios of products. The reports are also useful to define their main activities during the last years. In addition, the authors of this research will use literature resources. The main study “Medical devices: managing the mismatch: an outcome of the priority medical devices project” was made by World Health Organization in 2010. In this research, the authors developed the opinion that the medical devices’ industry strongly keeps attention on constant spending on research and development activities and innovation. The main reason behind this is the constant improvement of technology to meet the needs of users. (World Health Organization 2010, p.18) In their article, Schmutz and Santerre (2012, p.165), concluded that spending on research and development activities significantly depends on the value of the companies.

Another research (Lee 2018, p. 14) summarized the idea that companies’ performance indexes (Sales, ROE, ROI, earnings and gross margins) and research and development are negatively affected by the level of taxes. The developers of innovative medical devices always keep in mind the idea that innovations improve health and quality of life at the same time help to reduce costs of treatment and diagnostics. (World Health Organization 2010, p.63) However, as it was stated above that the annual growth of spending on research and development will decrease to 2024, which means that all expenditures should follow the cost-effectiveness approach. Technologies are changing constantly, so the life cycle of each innovation is approximately 2 years. In order to produce them according to cost-effectiveness approach Vallejo-Torres et al. (2008, p.461) described the Bayesian approach which includes three main theories.

Firstly, the estimation of potential cost-effectiveness on early stage to avoid bad investments on ineffective devices. Secondly, the support companies in prioritization of competitiveness of devices. Thirdly, the identification of parameters which have a greater effect on efficient production of devices. In their research, Mistry and Mason (2018, pp. 222-242), tried to understand whether the cost-effectiveness analysis is necessary or not by examining 27 Diagnostic Assessment Reviews (DARs). They found that the DARs are different in methodology of economic models, and there is some uncertainty of understanding the cost-effectiveness approach for technologies, so, they stated that research has to be continued to identify better criteria of analysis.

The business literature consists of two basic reports on the medical industry. The first report by MedPAC (2017) provides information that the medical devices’ industry is a strong dynamic market. However, the elasticity of the market depends on the products that the company produces. For example, surgical gloves have more elastic demand, so companies compete on price. While high-tech products can set high prices and the profit margin of such devices is usually 20-30 percent. Therefore, to produce high-tech devices companies should invest more money in innovations. Another report by GTAI (2018) describes the current situation on the German market of medical systems. The report consists of information on the demand for innovative products is constantly increasing and that Germany has a good location to improve the world position in the Healthcare sector. There are more than 500 small and medium-sized companies which produce innovative solutions specializing in very specific things. Therefore, innovative companies should enter global markets as soon as possible in order to strengthen Germany’s position in the MedTech market. Also, the report has a brief of European and German medical device regulation.

Results

Every day millions of people use innovative medical technologies which help nations to improve their standards of life and health, provide advanced decisions and facilities to succeed in treatment. Technical advances were enormous in recent decades. However, it is only the starting point of medical revolution, the greatest impact on medical technology will make digitalization. In order to come up with innovative solutions and systems companies spend a huge part of their financial resources on research and development. However, according to Statista (2018 pp. 22-23), the high expenses on R&D do not mean competitively good performance in a future.

The companies need to understand more properly which factors define the innovative medical devices and how their expenditures on development influence the profitability of these devices on all stages of production. The observed data will be analyzed according to qualitative and quantitative approaches. The results of this research will show the factors which determine innovative medical devices. This paper will also demonstrate the pattern between research and development expenses and profitability of medical devices. At the last, the recommendation on controlling cost-effectiveness indexes will be provided based on literature and modelling the new approach according the current market situation. The main reason of these findings will be a provision of MedTech industry’s insights for medical companies and the complete understanding how to develop innovative medical products and solutions effectively.

Timescale

During this research project, the authors will carry about three main steps: the collection of all available secondary data, in-depth interviews with experts from the industry and the interpretation of all findings. To get the sustainable and feasible outcomes, the design of in-depth interviews and gathering of secondary information should be completed during the first month. During the second month of research the invitation to interviews should be sent to the respondents and the final list of interviewees have to be conducted as well as the pre-test of the interview should to be completed. The third month will be spent on the analysis of responses and summarization of it. To create comprehensive results and to draw final sustainable conclusions two more months are required. Overall, the research project will make up 5 months.