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The Dynamics of Medical Device Innovation: An Innovator's Perspective

ALAN KAHN

Innovation in the medical device industry is very different from that in the pharmaceutical industry. There are major differences in who does the research and development (R&D), the nature of that R&D, and the public policies that affect it. For example, if we compare the device industry to the drug industry, we see smaller companies taking the lead, a more fluid innovation process, and looser regulations on medical devices. This chapter addresses the major differences between device and drug innovation and their implications for public policy.

PATENTS

The significance of patents as incentives to innovation is influenced by the different natures of drug and device R&D. Drug patents tend to be more useful, for it is very difficult to design a drug that simulates all the efficacies and side effects of another drug. A further difference between patents in the two industries lies in which aspects of the innovation lead to patentable claims. An example in the drug industry is the use of antihistamines to treat allergies. The basic principle of using antihistamines is not patentable, but the specific drugs are. In the device industry it is often just the opposite. The basic principle can be patentable, but specific devices usually are not. Generally speaking, it is possible to design a medical device for a specific application in a number of different ways. The innovation often lies in the underlying principle being used in the particular application. For example, the concept of pulse oximetry was patentable, although specific implementations of the idea were simply design exercises and did



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The Changing Economics of Medical Technology 6 The Dynamics of Medical Device Innovation: An Innovator's Perspective ALAN KAHN Innovation in the medical device industry is very different from that in the pharmaceutical industry. There are major differences in who does the research and development (R&D), the nature of that R&D, and the public policies that affect it. For example, if we compare the device industry to the drug industry, we see smaller companies taking the lead, a more fluid innovation process, and looser regulations on medical devices. This chapter addresses the major differences between device and drug innovation and their implications for public policy. PATENTS The significance of patents as incentives to innovation is influenced by the different natures of drug and device R&D. Drug patents tend to be more useful, for it is very difficult to design a drug that simulates all the efficacies and side effects of another drug. A further difference between patents in the two industries lies in which aspects of the innovation lead to patentable claims. An example in the drug industry is the use of antihistamines to treat allergies. The basic principle of using antihistamines is not patentable, but the specific drugs are. In the device industry it is often just the opposite. The basic principle can be patentable, but specific devices usually are not. Generally speaking, it is possible to design a medical device for a specific application in a number of different ways. The innovation often lies in the underlying principle being used in the particular application. For example, the concept of pulse oximetry was patentable, although specific implementations of the idea were simply design exercises and did

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The Changing Economics of Medical Technology not provide patentable material. In instrumentation products, patenting the design of the instrument itself is a futile exercise because it is not difficult to design another instrument in a different way that performs in exactly the same manner. An instance illustrating this difference took place when we started a medical device division in Hoffmann-LaRoche, a drug company. The Roche attorneys insisted on patenting the circuit diagrams of the equipment because of their similarity to the structural formulas for drugs. This, however, was a false analogy. Patents appear to be of relatively less importance in many segments of the device industry. Once a product is introduced, competition usually follows quickly. However, patents play other roles in the process of innovation. Until the recent changes in the income tax laws, the patent application played a significant role in determining whether royalties paid to the inventor would be treated as ordinary income or capital gains. The simple fact that a patent had been applied for signaled the Internal Revenue Service (IRS) to treat the subsequent royalties as capital gains. Another situation in which the patent plays a role surfaces when a small company needs investment capital. Potential investors usually are concerned with whether the new development is covered by one or more patents. The patents can be trivial, but the investors feel reassured. WHO DOES R&D? The development of new medical devices generally takes place in small, entrepreneurial companies. Once an introduction is made, larger corporations tend to buy up the smaller innovative companies and their products, or the corporations may introduce their own version. There are several reasons why small companies take the lead in innovation in the medical device industry while large companies are dominant in the drug industry. The drug industry is relatively more restrained by its risks and regulations. That restraint is not nearly as important in the device industry, on the part of either the regulators or the technology. A small company can bring a new product to market in a fraction of the time required by a large company. In the small company the innovator usually is also a key decision maker and can take risks based upon his first-hand knowledge of the technology and its applications. In a larger organization the decision makers often are several management layers removed from the innovators and cannot feel the reassurance provided by direct involvement in the process. Without this involvement these decision makers do not have the tools to assess the risks and tend to avoid the risks altogether. On the other hand, in the past, large corporations have tended to set up expensive research divisions in order to generate innovation. Researchers within these divisions find an environment permitting creativity but without any of the urgency of the entrepreneur to develop applications in a timely manner. Many of the large corporations

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The Changing Economics of Medical Technology have become disenchanted with this kind of R&D and have found it much more profitable to purchase innovations developed by the small companies. Another difference between the two industries that helps explain why small device companies lead in innovation is that the market for new devices is not always well defined. This is illustrated by the history of the cardiac pacemaker. When this device was first introduced, a market survey revealed a total of about 1,000 patients around the world who needed the device, about 500 of them in the United States. This tiny market was of no interest to major corporations. A small company—Medtronic, Incorporated—with only $2 million in annual sales, agreed with the inventors to develop and market this product for this orphan device market. As we now know, the market turns out to be in the order of 200,000 units a year in the United States alone. Arnold Beckman tells a similar story of his experiences in introducing the pH meter. The estimated market size was so small that is was only of interest to the tiny company that Beckman organized. The market turned out to be many orders of magnitude greater than that estimate and was the stimulus for the establishment of Beckman Instruments, Incorporated. The point of these examples is that an evaluation of the market before a device is diffused into clinical practice can grossly undervalue the technology to a degree that only very small companies would find the prospects interesting. These differences help explain why, in certain segments of the market, large medical device companies generally are not innovators in the early development of medical devices. Innovations such as pacemakers customarily are developed and introduced by small companies. Such innovative devices are invented or optimized by individuals and are not the result of the really intensive team efforts that take place in the large drug companies. The exceptions to this small-company rule lie in a few selected areas, such as medical imaging, where devices are complex and costly. The cost of developing these large, expensive systems is outside the level investors and innovators are comfortable with. These kinds of systems tend to be developed and introduced by the larger companies. FINANCING OF INNOVATION Lest one get overenthusiastic about the opportunities of entrepreneuring, it should be pointed out that a majority of the small entrepreneuring companies end up as business failures. The reasons can too costly a technology, a lack of marketing ability, too small a market, or undercapitalization. Entrepreneuring in this area is becoming more difficult as the regulatory environment becomes more demanding and venture capital becomes more limited. The investment community is not as enchanted with the medical device industry as it once was. New technology is no longer welcomed in the hospitals unless cost effectiveness can be demonstrated early in the product cycle.

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The Changing Economics of Medical Technology In many areas of the device industry, public sector financing has played a relatively small role in supporting the R&D process leading to device innovation. A major portion of these new developments is pursued in the small business environment where public sector support usually is not readily available. Although public support does finance basic research in universities and clinics, these are not where the invention and reductions to practice generally take place. Financing of these companies is accomplished through investment capital from individuals and venture capital firms. In a few instances the federal government has been instrumental in providing support to small businesses for such technologies as the artificial heart, but these are exceptions to the rule. One source of public funds available to small companies is the Small Business Innovation Research (SBIR) program. This program was instituted as a result of a public law requiring that branches of the federal government providing research grants and contracts must allocate a certain proportion of this budget to small business. As a result, SBIR grants are available from the National Institutes of Health (NIH), Department of Defense, and other agencies. A typical SBIR grant is allocated in several phases. The Phase I award, typically around $50,000, supports an exploratory phase of about 6 months' duration in which feasibility of a technology is assessed and established. Upon successful completion of that phase, an application is made for a Phase II grant, which is typically in the order of several hundred thousand dollars. It is the purpose of this phase to develop the application to a point where a product or service will result. The timing on these phases is such that a rather long period of 6 months to a year or more separates the completion of Phase I and the initiation of Phase II support. While the SBIR program has been responsible for stimulating some new developments, it is generally unsatisfactory for several reasons. First, some granting agencies require so much administrative and reporting procedures that the cost to a small company does not justify the $50,000 awarded in Phase I. In addition, the time period between the funding of Phase I and the funding of Phase II is often so long that a small company could not possibly wait that period to continue with its product development efforts lest it run out of funds in the interim. As a result, other moneys are used to continue the development begun in Phase I. No company can consider waiting for a year to continue its development projects, especially a small company operating on limited capital. REGULATORY DIFFERENCES Drugs and devices are regulated differently because the two fields are so disparate. Traditionally, the technologies associated with drug products have been based on chemistry and biochemistry, and the Food and Drug

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The Changing Economics of Medical Technology Administration (FDA) has been able to develop a significant expertise in these technologies. In contrast, devices are based on a wide variety of technologies, such as biomaterials, electronics, optics, mechanics, fluidics, and so on. Even our largest corporations embrace only a portion of these technologies, and it is not feasible for the FDA to become expert in all of them. This factor makes it far more difficult to assess and regulate medical devices. This concern is balanced by the fact that most medical devices do not have the potential for profoundly influencing body processes and generating potentially damaging short-term and long-term effects. As a result of these two factors, many medical device technologies are subject to less restrictive regulations than are drug products. In fact, the FDA has made use of the 510(k) provision, originally intended for allowing continued marketing grandfather devices at the time the current law was passed, to maintain surveillance of the introduction and market penetration of medical device products that did not perform functions that could be potentially dangerous. Recently, the use of the 510(k) provision for regulation of medical devices has been curtailed significantly. An important difference between drugs and devices lies in the ability and propensity to make changes in the device product during clinical evaluation and after it has been marketed. A drug product is usually in its completed form prior to marketing and is described by its chemical formula, and the dosage form remains stable for most of the life of the product. In contrast, devices constantly are being modified to remove defects, improve performance, and add features throughout the product life. These changes occur frequently and are driven by competition among the manufacturers in order to offer the best product performance and features. Prior to the advent of the microprocessor, these changes were implemented through hardware redesign. These types of changes are expensive and were done relatively infrequently. Many of today's device products are operated by microprocessors, and most of their functions are dictated through the internal software. Software changes are very easy to make and to test. As a consequence, product changes are now very frequent and almost impossible to track by a regulatory agency. These changes are especially frequent during the first 6 months after the introduction of a product, during which time the broader clinical exposure exposes minor defects and limitations. The FDA has initiated a program to gain better regulatory control of device software. Another important difference between medical devices and drugs lies in the product life. Once introduced into the market, a drug will enjoy a product life of at least 5 years; indeed, some drugs have been around for 50 years or longer. The continuous product changes that devices undergo eventually render the product obsolete, often within 2 years or less. Device manufacturers must bring products to market more rapidly than drug manufacturers in order to keep up with this high rate of product obsolescence.

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The Changing Economics of Medical Technology THE ROLE OF LIABILITY All of the players in the delivery of health care are subject to significant financial liability. Device manufacturers are at somewhat less risk than drug manufacturers, since many of the products are less apt to affect the body functions of patients. The concern about liability on the part of the physicians and hospitals has had a significant effect on the medical device industry. Many medical devices provide the physician and the hospital with the means for testing and monitoring patients in order to decrease the likelihood of morbidity and mortality. As the concern about liability and malpractice has increased, new laboratory tests and monitoring procedures have been welcomed as a safety net by physicians and hospitals. The risk of litigation has played a significant role in the direction of the development of new technologies in medical devices in recent years. Monitoring patients provides the clinical staff with documentation that provides evidence for the quality of care provided. Since the burden of proof of adequate care falls on the health providers in malpractice cases, this documentation is helpful. A specific example of this trend can be seen in the increasing use of various monitoring technologies by the anesthesiologist. It is, of course, most important to have a record of the patient's status during periods when critical changes are taking place and emergency situations arise. However, it is just during these periods when the anesthesiologist is busy with the patient and has no time to generate records of the patient's status. Automated systems for performing measurements and collecting information fill this gap and provide substantiation of the management of the patient. This is of particular importance to the anesthesiologist, because in the absence of proof of competent administration of care, awards are usually given to the plaintiff. REIMBURSEMENT Another factor that influences the direction and energy applied to innovation in a particular technology is the likelihood that the providers of care can get reimbursed for the application of the technology. This is a particularly difficult area for device manufacturers because the third-party payers will not directly reimburse the new technology until it has proven itself in the marketplace. Since new technologies often take several years to prove themselves and, in addition, may prove themselves in an area of care not originally intended, theoretically new innovative technologies will not be reimbursed. However, it is common practice to code these new technologies within the framework of existing codes in order to generate reimbursement during the early periods of introduction. Eventually, the payers will establish a new code for a new, successful technology. An innovation novel enough to be difficult to fit within the existing codes has an especially

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The Changing Economics of Medical Technology difficult acceptance by the health care system. An ideal new device product will be reimbursable within existing codes, decrease the likelihood of malpractice suits against the health care provider, decrease the cost of managing the patient, and, perhaps, improve the quality of care. CONCLUSIONS Although most of the attention of this publication is directed toward the pharmaceutical industry, these discussions seem incomplete without considering the medical device industry as well. The concerns of the device industry are different from those of the pharmaceutical industry in the areas of R&D, patents, regulation, liability, and reimbursement. In particular, policy makers will need to take into account differences between drug and device innovation, as well as the importance of the small business community in generating devices. SELECTIVE BIBLIOGRAPHY 1. Ekelman K (ed). New Medical Devices: Innovation, Development, and Use . Washington, D.C. : National Academy Press , 1988 . 2. Kessler DA , Pape SM , Sundwall DN. The Federal Regulation of Medical Devices . New England Journal of Medicine 1987 ; 317 : 357-365. 3. Roberts EB. Technological Innovation and Medical Device Innovation . In Ekelman K (ed). New Medical Devices: Innovation, Development, and Use . Washington, D.C. : National Academy Press , 1988 .