6 Potential Effects of the Medical Device Tax on Orthopedics Companies Featured

Written by  Heather Linder | Friday, 18 January 2013 18:17
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As of Jan. 1, all sales on medical devices will be taxed an additional 2.3 percent, as the federal government looks to make $20 billion in 10 years to pay for programs within the Patient Protection and Affordable Care Act. Exactly which programs has not yet been defined.
"There has been a lot of thinking that they should go after [the medical device] industry, which has been strong in the past and has a high cost of devices overall," says John McLean, vice president and co-leader of the Life Sciences Practice at the executive search firm Witt/Kieffer. "I think it's incredibly unfair."

Manufacturers, surgeons and patients are demanding a certain level of care, and the device tax is spawning concerns for the future of medical devices in the U.S., he says.

Eric Olson, president and CEO of Salt Lake City-based device company Amedica, says he is also highly disappointed that the tax was not repealed, as many industry officials anticipated. Amedica will continue to be a vocal opponent of the tax, he says.

Meanwhile, device developers and surgeons are trying to cope with the excise tax. Here are Mr. McLean and Mr. Olson's six predictions for how the tax will affect the medical device industry.

1. Innovation may take a hit. The process for securing FDA clearance is already a long and costly one. With increased costs, developers will have harder choices to make before seeking new device or incremental improvement clearance.

For instance, Amedica has developed a new interbody fusion device for the spine market that is made of silicon nitride which is an alternative to PEEK, a plastic material. Several PEEK devices were recently recalled, and few viable alternatives are available. However, Amedica's device has been proven to provide strong, anti-infective and osteopromotive properties, Mr. Olson says.

The tax could reduce the company's resources to promote and distribute its innovative technology, which would impact overall care to U.S. patients.

"It could have a negative impact on spine surgeons who are seeking alternatives to a less-than-optimal interbody device," he says. "If we were an earlier stage company, this tax would significantly impact sustainability and impede the development of innovative technology. Ultimately, that results in a lower standard of care for patients.”

2. Broad languages means an unclear impact. The language of the legislation is meant to be broad, and industry experts are still not clear on exactly what devices are included, Mr. McLean says.

The unclear language could mean that not only are medical implants and devices taxed, but also supplies, such as wheel chairs. Unintended consequences may follow, he says.

"It will impact a wide range of industries and populations," he says. "It's still not clear what exactly is included, and as it states now, the legislation is meant to be broad."

3. It will force budget cuts and possible closures. The language of the legislation implies that companies are not to pass off the expense of the tax to consumers through increased device price tags, Mr. Olson says. Companies will be forced to cut budgets and streamline efforts to cope.

Research and development, marketing, sales and human resources are the typical targets for internal budget cuts. Budget cuts in these areas often translate to future projects being canceled or delayed.

Cutting costs can be particularly worrisome for start-up device companies, which do not make a profit for several years, Mr. McLean says. "If you tax every sale on the revenue side, it hits profitability that is already slim or none," he says. "We say we want this industry to be innovative, but the 2.3 percent federal excise tax is coming off of revenue. The vast majority of new ideas are from up-and-coming, struggling firms. [This tax] hits profitability so it's not good to invest in innovative ideas."

Even large spine and orthopedic device developers, such as Medtronic and Stryker, have announced they will reduce employees or close facilities to streamline business. As more companies experience the impact, closures and layoffs may follow.

"In terms of how many people are directly affected, it's close to 400,000," Mr. McLean says of the number of employees in medical device companies nationwide. "If those companies cut costs, the natural reaction will create a ripple across a wide range."

4. Patients and surgeons will suffer. Orthopedic and spine devices particularly thrive on continual upgrades and improvements, and the device tax may alleviate incentives to produce better devices that can handle an increasing spectrum of ailments, Mr. McLean says.

"My guess would be that surgeons want to have the best and the greatest technology to treat their patients. This will impact their access [to that technology]," he says.

Fewer device clearances and releases will impact patients, who expect to have choices in how their diagnosis is treated. Less innovation brings less choice in treatments.

5. Overseas innovation will grow. The United States has always been a leader in medical device innovation, Mr. Olson says, but increased regulations and taxes have shifted much of that innovation to countries in the European Union.

"A lot of companies are inclined to take innovation overseas to Europe [rather] than to the U.S.," he says. "It's not a positive direction for the domestic market."

Given that the European market is more attractive for revenue-generation, companies may focus efforts on revenue-generation in Europe rather than fueling ongoing development, Mr. Olson says.

"There is no potential upside [to this tax] domestically," he says.

6. The effects won't be known for years. Device companies have already altered their budgets for 2013 in anticipation of the tax, but until it has been in effect for a longer period of time, companies cannot fully anticipate the effects.

While this tax may be limiting or stifling, industry members will have to adjust to survive in the future.

"I have great faith in the industry itself," Mr. McLean says. "I think long term they will figure out ways to work with it."

However, he says, in the next three or so years all companies will take a hit. To stay viable, manufacturers will need to make sure their device is the absolute best in the marketplace or risk losing too much revenue.

"It's hard to say how this will play out long term, but from a hypothetical sense we are forced to make some very difficult decisions," Mr. Olson says. "Across the board this will have an impact on all aspects of our organization and the spine industry."

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