I recently read a book called "The Truth About the Drug Companies," by Marcia Angell, M.D. As editor of the New England Journal of Medicine for two decades, Dr. Angell had first-hand exposure to the pharmaceutical industry’s role in American healthcare.

Dr. Angell’s book goes on to discuss this and other topics. It’s an interesting look at Big Pharma and its impacts on the healthcare industry.

But I couldn’t stop thinking about the parallels to the medical device industry. So I did a bit of research on the "Rhetoric vs. Reality" of the costs of medical devices.

The sales agenda
Sales representatives from medical device manufacturers meet with materials managers and physicians weekly (if not daily), looking for the sale. A sale that commands the highest price maximizes the rep’s personal income as well as his or her company’s profit.

What the hospital can afford may be a secondary consideration.

An inquiry into why the price is what it is may be met by the sales representative with an observation that the state-of-the-art technical features and benefits of his company’s product command a high price. Their technical sophistication makes devices and implants costly to manufacture.

He may also state that devices and implants are costly because the manufacturer must recover high costs for research and development, and be rewarded for taking risk.

You may even hear an implied (or overt) threat by the manufacturer’s rep that, without being able to pass on the high costs of R&D, technological innovation will be slowed, or cease altogether. Lower prices will dry up the product pipeline, and patients will suffer for it.

So what are the costs of medical devices?
Knowing the cost structure of any product is a useful input to purchasing negotiations. Unfortunately this information is difficult to obtain from physician preference item (PPI) companies.

For this report, CMS teamed up with the money men – healthcare device company analysts from major Wall Street firms such as Morgan Stanley, JP Morgan, Merrill Lynch and UBS. Their concise report can be downloaded to share with physicians and administrators.

Well, we knew that. So how do we go about helping our physicians become more price-sensitive and less prone to believing that lower PPI prices will hurt R&D?

First, share this cost breakdown from the CMS analysis for products from medical device companies, including Biomet, Boston Scientific, Edwards Lifesciences, Guidant, Medtronic, St. Jude Medical, Stryker and Zimmer.

Simply put, less than half the cost of a representative cardiovascular or orthopedic implant or device is fixed:

28% - cost of goods sold
10% - research and development
10% - taxes, etc.
48% of medical device product cost

The other 52% of device costs are where ample latitude exists in price negotiations with hospitals.

A whopping 33% – one-third of the product price and three times the allocation to R&D! – is consumed by Sales, General and Administrative Costs (SG&A). One might wonder whether these are technology companies or marketing companies.

What’s in SG&A? That’s difficult to know. The rep’s compensation might be allocated here…or it could be in the cost of goods sold. SG&A may include the costs of marketing to physicians to develop that "strong relationship" referenced by the Wall Street analysts. SG&A may include the costs of industry lobbyists, "education" and executive salaries.

Then there is the 18% net income margin – most hospital CFOs would love to have a margin even half that.

Physicians generally respond well to fact-based, objective analyses – they’re scientists after all. It is up to the hospital to find and share balanced information with physicians.

Here are three more steps you can take:
1.Revisit the paragraph at the start of this article taken from Dr. Angell’s book. Substitute "medical device companies" for "drug companies." Do not be taken in by the argument that lower prices compromise technological innovation.

2.Enlarge a copy of the graph provided here. Make it really large and in color. Post it in the physicians’ lounges near your operating room and cardiac cath lab. Put it into the medical staff newsletter. Share it with the Board. Point out that lower prices need not hurt R&D – there are other areas where manufacturers can cut their costs and still preserve an 18% net operating margin for their shareholders.

3.Download and read the CMS report. Give a copy to your CFO and any physician or clinical specialist that touches PPI. Highlight the paragraphs of greatest interest to them.

Medical devices are 40% of your supply spend. You need to have the facts about cost if you are to get your hands around this critical area of your supply chain. HPN