PHARMA AND MEDICAL DEVICES: KISSING COUSINS

Many of the skills and techniques that you may hone to choose winning pharmaceutical investments will also serve you well for the medical device industry. The two areas of endeavor could be called “cousins” as they are closely related. In fact, many of today’s device companies were once divisions of various pharma conglomerates, or vice versa. (One of the last true medical conglomerates, or “one stop shop” for every kind of medical innovation, is Johnson&Johnson. Almost every other corporation has chosen to focus either on devices or on drugs…).

That being said, there are a few critical differences that one should keep in mind when choosing between pharma and device investments.

First, most device companies and pharma companies reward their investors in different ways. Because pharma companies have robust, annuity like streams of predictable income, they often pay dividends between 3% and 6%. Most large device companies, such as Stryker or Medtronic, pay minimal dividends (between 1 and 3%) and choose to create value for investors by pursuing the maximum escalation of the stock price. The results have been explosive; $10,000 invested in Stryker stock twenty years ago (1997) would today be worth $146,565, after twenty consecutive years of averaging a 14.84% return per year. This means that Big Pharma stocks may be better for retirees living off a fixed income, while med device could be more appropriate for younger investors trying to build up their networth.

Another noteworthy distinction is how medical device concerns obtain revenue. For many Big Pharma corporations, the end user is really the insurer who pays the bill (or doesn’t) for the drug. While some patients receive drugs in the hospital, the bulk of pharma transactions happen in an outpatient setting through some kind of pharmacy. For medical device companies, the ratio is exactly reversed. While some devices are used in an outpatient setting, more often than not, the “end client” is the hospital and committee of surgeons who will be using the devices at the hospital.

This means that physician buy in is even more important for devices than pharma, as there is very little direct to consumer advertising for devices, and insurers play only an indirect role. The nature of this transaction also puts even more pressure on device companies to be relentless corporate consolidators, constantly sucking up smaller companies into just a few ever growing industry leaders. As hospital chains and hospital buying organizations consolidate into fewer and fewer large purchasers, the med device world often feels that “big must face big” otherwise there would be too few buyers, and too many sellers, hurting profit margins for the sellers of medical devices. More on this trend later.

Decision makers have a different way of thinking about problems in the device industry. This is because end clients are often surgeons, instead of physicians. Just for clarity, all surgeons are physicians, but not all physicians are surgeons. While the two categories of healers must work closely together to achieve good patient outcomes, the two groups often have distinctly different perspectives on the patient.

An example of a physician would be a rheumatologist. This is a doctor who manages a patient’s arthritis using a wide range of medical interventions, some of which attack the problem directly, and some of which merely help to alleviate the painful symptoms of arthritis. However, the key word is “manage.” Most rheumatologists are trying to stop a bad situation from going to worse; or trying to gracefully slow the inevitable deterioration that most arthritis patients face as they age.

When a patient is finally at his wit’s end, and suffering excruciating daily pain in his knees, he may finally be referred to an orthopedic surgeon for a knee replacement. The surgeon often faces a distinct problem with a beginning, a middle, and an end. In other words, if you suffer from arthritis, you will probably form a lifelong relationship with your rheumatologist. But you would hope to see your orthopedic surgeon for a short period of time. Once the surgery is complete and complications have been avoided, your problem has been solved. A lot of doctors who choose to become surgeons have an emotional preference for solving problems, instead of just managing them.

In addition to a passion for solving problems, many surgeons really love to do surgery. When I say that surgeons love to do surgery, I mean that they are often attracted to the physical act of working with their hands, working with tools (called instruments in medical jargon) and applying the latest technology to their work. Surgery is literally a “hands on” job. It’s not uncommon at all to find retired surgeons who are master woodworkers or other kinds of artisans.

Lastly, surgeons are notorious for personalities than can range from confident to megalomaniacal. Surgeons tend to hold strong beliefs and do not hesitate to take action on their beliefs. They are not afraid to take control of a stressful situation. Think about the confidence and emotional resilience that would be necessary to spend every day cutting open human bodies and molding human tissues as if you were taking apart a car. To say the least, confidence and assertiveness would be necessary personality traits.

This combination of love for solving problems, passion for physical craftsmanship, and assertiveness means that many of the best medical innovations come from surgeons themselves. If they don’t feel that they currently have the tools for the job, it’s not uncommon for them to invent something new for themselves. In fact, practicing surgeons hold more than ⅓ of all medical device patents in the United States (3)

Dreaming up a medical patent is a big enough achievement, but obtaining the patent is just the beginning of the marathon, not the end. In fact, only about 5% of all patents will result in an approved, marketed medical device, and of those, only a small percentage will become “blockbusters.” (4)