Death of the Device Salesman

“The Death of the Salesman? Change Coming to Ortho Sales Model, ” was the provocative headline of Bank of America analyst Bob Hopkins’ investor note on May 1, 2013.

Hopkins was referring to the April 30 announcement by Wright Medical Technologies, Inc.’s CEO Robert Palmisano that Wright is beginning to sell their orthopedic devices directly to hospitals without using sales reps.

Disintermediation

The news continues a story of changing dynamics in the sales and marketing of orthopedic devices. We like the term “disintermediation.” It was only a couple of years ago since the then-CEO of Medtronic, Inc., Bill Hawkins, declared the end of the surgeon champion era as the company shifted its sales focus from surgeons to hospital paymasters.

Device reps caught in that changing dynamic have also had to deal with the rise of physician-owned distributorships which further impacted their value in the distribution chain.

Palmisano’s announcement added another chapter (or nail in the coffin) to the disintermediation story.

Wright Direct

During a call with analysts, Palmisano announced the early stages of a new program called Wright Direct. In short, the program sells certain orthopedic devices directly to hospitals and requires them to own and manage the inventory. He said the program is taking advantage of changing dynamics in U.S. healthcare and the resulting cost pressures being faced by many hospitals.

“Hip and knee replacement procedures are one area where a growing segment of hospitals are looking for a comprehensive solution to help solve this problem. This creates a compelling opportunity for a device company such as Wright that can offer a total solution, including high-quality, clinically-proven products at low prices, training and logistic support.”

Wright had a similar program a couple of years ago. Palmisano told analysts that program “didn’t work all that well, ” because it wasn’t complete enough.

Institutional-Driven Purchasing

This time the company studied the market and saw a movement to institutionally driven purchasing decisions as opposed to physician-drive decisions. Wright hired Mitt Romney’s old company, Bain & Company, to help figure out how to segment the 6, 000 hospital market in the U.S.

The report came to the conclusion that about 10% of the U.S. hip and knee procedure market is institutionally driven. That, according to Palmisano, is up from about 5% only two or three years ago. And it’s looking to be 15% to 20% in the next couple of years. “So there’s a clear drift towards institutions gaining more control over the purchasing decisions.”

He noted that institutions are controlling more of the physicians by buying physician practices and gaining alignment in the institution to make sure that they operate more profitably.

Price Reduction

The Wright Direct program is a turnkey operation where an institution takes over the responsibilities that are currently borne by the company.

For example, currently there’s a rep in every case. Under the Wright program, that won’t be the case. Also, currently inventory is held by the distributor or the company. In the Wright program, the inventory will be held by the institution. In return there would be a price negotiated meant to compensate the institution for taking on their additional costs.

Palmisano said he thinks Wright is particularly well situated to do this because this would not conflict with the company’s other business (such as extremities and biologics). “We do not have a lot of business today in these institutions that will be cannibalized as other companies might. So I think that this is Wright healthcare going lower-cost. We will be able to provide very clinically proven, very effective products, and the institution would take over some of the logistics and some of the in-case support. And it will turn out to be a win-win between us and the institution.”

The company is just launching the program as it builds an organization that is used to calling on hospital CEOs and CFOs instead on physicians. “We’re building an organization that knows the ins and outs of the C-Suite in hospitals.”

Wright has most of the people hired and expects to start seeing the effects of this later in the year. The company also has a couple of pilot programs up and running. Palmisano said they’ve gotten a “very good” reception to the concept and it’s a matter of having the people on the ground. “We don’t want to go too fast and just try to get some quick sales. The object is to be a long-lasting business solution to institutions.”

Dividing Up Savings

How will the commission structures change for distributors?

During a question and answer session with analysts, Palmisano acknowledged that 10-15% on the dollar for these implants is paid out on the commission for sales and distribution. He was asked if that’s the 10-15% that the company will be sharing with the hospitals.

Palmisano said that there will still be a distributor area that will get a portion of what they used to get. “Not the whole thing, but they’ll get a portion of it because they will still be needed, in some ways, to help the account in certain situations. But the majority of the distributors today do not get commissions. So it’s nothing but a positive to them to some extent, that they would get some commission to help us out when needed. But the discount rate (to the hospital), I’m sure, will be more than the 10-15% that we save in commissions.”

The program is not an order online program added Palmisano. “It is a program for which we have a different organization than our current organization, calling on these accounts and interacting with them at just a higher or different level than the current distributor organization interacts with physicians.”

He added, “We don’t do a lot of bundling and those kinds of things. So I think that offering a solution to these institutions [where they] can get products at a very different cost structure than they currently have…doing some of the work themselves and carrying the inventory and those kinds of things, we think that will provide us with an entry into those institutions that we don’t currently have.”

Impact on Ortho Market

Bob Hopkins said the program will have no impact on Zimmer Holdings, Inc. or Stryker Corp. as the roll out will take time. “Wright is a small hip/knee player (less than 5% share) and the target list will be focused given that a minority of hospitals will initially want to take on the costs and infrastructure demands that will go along with this type of model. But longer term this type of model would likely put more pressure on orthopedic pricing and we do think it will gain traction over time.”

Hip/knee market growth has fallen from the high teens to the low single-digits over the last several years, said Hopkins, “Yet the ortho companies are spending more today on SG&A as a percentage of sales than they did when growth was robust.”

“From a total spending perspective there has been no real change to the high-touch, relationship driven orthopedic sales model despite an enormous change in the growth dynamics of the industry.”

Where’s the Surgeon?

One person no stranger to the disruption of the distribution chain in orthopedics is John Steinmann, M.D., a founder of the physician-owned distributor concept.

Steinmann told us that the Wright model, while an attempted response to a demand for lower costs, “has some serious flaws that will considerably dilute its effectiveness.”

He says the model is directed toward those institutions that are in a position to drive 10% of decisions in implant choice. “The obvious problem is that it does not address the other 90%.”

In addition, Steinmann says this model makes an incorrect assumption that the hospital has the expertise to identify quality and to appropriately value newer technologies. “Surgeons are the only individuals that can identify appropriate quality and the only individuals that can appropriately value newer technologies. Every model that I have seen that takes surgeons out of the equation fails. This is inappropriate.”

The answer, he says, is to align the surgeon, hospital and device company in a manner whereby each demonstrates a meaningful interest in the well-being of the others. “The surgeons need to hold device companies accountable to fair pricing, through value based competition, while helping to reduce the need for device companies to expend inordinate amounts of money on sales, promotion and inventory. Device companies, relieved of considerable inventory, sales and promotional costs, need to adhere to fair pricing while enjoying a reasonable profit for further research and development efforts. Hospitals need to respect and pay fair pricing while focusing on providing efficient assistance to the surgeons.”

“The Wright model falls far short in achieving meaningful alignment and meaningful healthcare savings primarily because they have shut the surgeon out of the equation and failed to gain sustainable alignment.”

Wright: Surgeon Already Involved

Ted Davis, president of Wright OrthoRecon, told us the institutionally driven hospitals in the Wright model include those where the surgeon is already an advocate of a differentiated business model.

He added that an important component of the Wright Direct model is that it will be targeted at, “institutions where meaningful alignment already exists between the hospital and the surgeon, who remains an important and integral part of the decision-making process. Based on the data, approximately 10% of the hip and knee procedures in the U.S. are being done in hospitals that are institutionally driven, which includes the core tenet of physician/hospital alignment. This is up from about 5% only two or three years ago and could double in the next couple of years. As this transition occurs, surgeons will continue to play an important role in product selection at these hospitals.”

Davis continued that the Wright program provides ‘clinically proven products at low prices and the training and logistics support for successful hospital implementation and surgeon collaboration.”

While Hopkins’ provocative title of the death of the device salesman may be dramatic, the sales model for orthopedic sales continues to change as payers and hospital paymasters take over purchasing decisions.