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T he Dilemma of Device Medical Device Pricing in the USA: Using Value-Based Pricing to Suppor t Support Product Positioning Pr oduct Positioning

By Nancy L Reaven

November 2006

Reproduced from the Journal of Medical Device Regulation, 2006, 3(4), pages 26-34 with the kind permission of Global Regulatory Press, London, UK (Tel: +44 (0)1305 783020, Email: [email protected], Web: www.globalregulatorypress.com).

THE DILEMMA OF MEDICAL DEVICE PRICING IN THE USA: USING VALUE-BASED PRICING TO VALUE-B UE-BASED SUPPORT PRODUCT POSITIONING

By Nancy L Reaven Nancy Rea eav

Developing the `right' price for a medical device is one of the most difficult decisions in the product development process. The price of a technology, particularly a new technology, is essentially a message to all the current and future stakeholders of the technology about the technology's value. These stakeholders include investors, potential partners or distributors, company employees (internal stakeholders), public health agencies making coverage and reimbursement decisions, private insurers, customers (often hospitals or other healthcare facilities), users (typically physicians) and patients (external stakeholders). The dilemma is, each of these stakeholders has a different perspective of price-as-value and these perspectives frequently conflict. Company investors view the price of a technology as a key component of a company's potential revenue and profits. Investors need to anticipate whether the price will be high enough to support research and development, device production, clinical trials, and the costs of roll-out and still make an attractive return within the time frame of the anticipated exit strategy. So, company valuation is highly dependent on technology price and anticipated market share. Marketing partners and distributors view price as a potential opportunity. A price that is too high can create barriers to product placement and sales, undermining the business relationship. A price that is too low can threaten the distributor's margin by limiting their return in relation to their costs of marketing, sales and distribution. Employees, especially executive staff, view price as a different kind of opportunity. If the technology price is competitive enough to generate sales and profits, then employees may receive bonuses and returns from stock options. On the other hand, company valuation, which is based in part on the impact of pricing on anticipated sales and market capture, can have significant financial benefits for employees as well. There are also indirect benefits from being associated with a company that is known for its market success (e.g. better job prospects and possibilities for career enhancement). The three stakeholder groups outlined above want the price of the technology to be as high as possible without creating obstacles to sales. On the other hand, reimbursement decision-makers, customers and technology users typically want the exact opposite. Adding to this complexity is the fact that medical devices are rarely directly reimbursed in the USA. The price (or cost) of medical devices

Journal of Medical Device Regulation

Stakeholders' differing perspectives of priceas-value often conflict

Company investors, distributors and employees want the highest price possible without creating a barrier to sales

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is typically embedded in reimbursement for the procedures or services that use the technology. Thus, the impact of price is an indirect one for the second group of stakeholders. Public health agencies want technology prices to be low because they want to avoid having to increase procedure reimbursement to accommodate the cost of expensive technology. Government-financed healthcare in the USA (primarily through the Medicare and Medicaid programmes) is mandated by law to be budget neutral, so significant procedure cost increases in one procedure initiate a series of tough decisions about mandating reimbursement decreases for other procedures. Private insurance in the USA is provided through a competitive bidding process to employers or individuals. Insurers want to keep procedure costs (which include device costs) in check in order to keep their premiums to employers and individuals competitive. Device company customers, typically hospitals and physicians, want technology costs to be low so that their procedure-based reimbursement will generate profit or surpluses net of the other costs of the procedure. An expensive new technology can effectively eliminate any profit for the provider-customer for a period of time until (and if) procedure-based reimbursement is raised to cover the cost of the technology. This dilemma is particularly acute for hospitals where reimbursement is fixed, based either on the discharge diagnosis of the patient (DRG) or based on the number of days the patient stays in the hospital. The issue of device pricing and consumers is just emerging as a significant issue. As more of the costs of treatments are shifted to consumers through new health insurance products in the USA, like Health Savings Accounts (HSAs), patients are becoming aware of the cost of the devices and diagnostics used in their care. Over time, this is expected to result in lower medical device costs as patients (and their doctors) actively shop for competitive prices and quality. Along with consumers, other influencers include employers, who purchase the insurance programmes accessed by consumers, as well as the media and other advocacy groups. With so many stakeholders, it is no wonder that medical device pricing has become a topic of heightened public debate in the USA. Until very recently, the costs of medical devices were barely considered ­ effectively hidden under the rising tide of negative attention focused on pharmaceutical pricing. However, as more costly medical devices are commercialised and pricing is increasingly showcased in newspaper articles and other public forums, public awareness is rising.

A major procedure cost increase would be likely to cause reimbursement decreases for other procedures

Patients are becoming increasingly aware of the cost of devices used in their treatment

Historical Approaches to Pricing

Historically, medical device pricing has been geared to the goals of internal stakeholders. As the cost of medical devices is largely buried in procedure costs which are paid by third parties, the need to justify price to technology buyers or users was minimal. Thus the financial goals of investors, distributors and employees were the

Journal of Medical Device Regulation

Historically there was little need to justify prices to technology purchasers or users

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Pricing strategies have had to adapt to changes over the past few decades

primary drivers of price. Sales and marketing efforts were focused on extolling the features and benefits of the technology, not on its proven cost efficacy, largely because cost efficacy was not an issue. If a customer asked about price, the typical response of the sales representative would be to cover the important clinical features of the technology, get an influential physician to push for its purchase and to offer a myriad of financing options to close the deal. The price itself was almost irrelevant. Pricing based on company-desired return-on-investment (ROI) was the primary strategy for new technologies and shadow-pricing was the primary pricing strategy for technologies that were second or third to market. The last few decades of rising costs and decreasing reimbursement have fundamentally changed the landscape for technology companies and altered their pricing strategies. Hospital financial decision-makers have pushed back ­ hard ­ at large capital equipment purchases and expensive implantables without some justification of price. Also, hospital materials managers who are in charge of purchasing less expensive devices and supplies have become extremely price sensitive, sometimes switching products for a few pennies of savings.

Value-Based Pricing

Value-based pricing caters for internal and external stakeholders Value-based pricing is a strategy that explicitly takes into account the perspectives of both internal and external stakeholders in developing a pricing strategy that will promote product adoption. Business model specifications for cash-flow and ROI provide the basis of the estimated pricing, just as it always has. The difference is that this base price is adjusted, both up and down, to take into account the perspectives of external stakeholders as well. If done thoughtfully, the resulting price point is both justifiable to outsiders and viable internally. The following characteristics of new technologies are known factors that have a significant impact on product adoption. In valuebased pricing, the point is to quantify these factors in ways that are uniquely relevant to external stakeholders in order to develop a meaningful product price. True Innovation Technologies that are true innovations can typically charge a higher price than those that represent incremental improvement to an existing technology or procedure. This is especially true if the innovation takes place within a clinical area that is un-served or under-served by alternative procedures or technologies. Innovative technology can provide additional benefits to hospital and physician customers by drawing in new patients for new services or for additional services that provide revenue to hospitals and physicians. Market Timing Technologies that are first-to-market can typically add a premium, at least initially, due to the absence of competitors. The business

Truly innovative technologies can command a higher price

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model should reflect the high probability that pricing will be reduced once competitors enter the market. Unmet Clinical Need Technologies that address areas of unmet clinical need can generally add a significant premium to base pricing. This is particularly true if this is a clinical problem affecting a large number of patients in an insured situation. For example, a technology that provides a clinical benefit to stroke patients in the hospital can generate a higher price than a technology that benefits stroke patients in their home, where insurance coverage is more limited. Strong Patient Demand Technologies that can generate strong patient demand can typically add a premium, at least for a time. This is especially true of technologies that address an unmet clinical need among a large number of patients and where patient advocacy groups are organised. High Economic Value Technologies that can substitute for expensive procedures or long expensive treatments can also add a premium, depending on where the service-substitution occurs. If it occurs at the same setting of care that is purchasing the technology, then the Economic Value premium can be somewhat higher than if the technology adds cost to one setting of care but saves costs somewhere else. For example, a technology that can avoid days in the hospital and reduce the intensity of services provided to inpatients will be more attractive to hospital purchasers at a higher price than a technology that is provided in the hospital but saves on pharmaceutical costs later on. Improved Quality of Life Technologies that improve quality of life can add a premium, particularly if there is strong patient demand for the technology or if there is significant unmet need. The most beneficial combination for a technology with respect to pricing is the following: True Innovation + Unmet Need + High Economic Value + Strong Patient Demand + First to Market. The pricing advantage conveyed by the above characteristics can become a disadvantage when technologies fail to meet these standards. Technologies that represent incremental improvements to existing technologies (as opposed to true innovations) are unlikely to be successful if tagged with a much higher price than the current market price. However, if the technology provides significant improvements in efficiency that can translate into high economic value it can hold the market price or even a bit more. Being first to market is only an advantage if the technology has something distinctive to offer, either clinically or economically. Otherwise being first to market means that there is no benchmark for pricing, and can mean a more expensive ramp-up period as sales

Journal of Medical Device Regulation

Premiums can be higher if unmet clinical need affects many patients in an insured situation

Strong patient demand can boost premiums

Being first to market is not necessarily an advantage

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Placing a device on the market in an already saturated clinical area will decrease prices

personnel spend valuable time educating customers about the advantages of the product. This is especially true if the price is judged high compared to current technologies. Products that are second or third to market can sometimes grab significant market share by capitalising on the work done by first to market companies and by slightly lowering price. Introducing a technology into a clinical area that is already saturated with devices will tend to depress prices unless the new technology is truly an innovation or offers significant economic benefits through improved efficiency. Device companies want to avoid situations where their technologies quickly become `commodities' (i.e. where product differentiation is achieved primarily through price). Technologies that have low economic value have to achieve high value on one or more of the other criteria to avoid serious price compression. It is extremely difficult to attach a high price tag to `me too' technologies that do not dramatically improve the economics of a procedure or service. In this situation, shadowpricing existing technologies and focusing on other benefits of the technology, like ease-of-use, is the most effective approach.

Turning Market Challenges into Opportunities for Value-Based Pricing

Market challenges can be used to develop the optimal product price To develop the optimal product price, it is constructive to use market challenges to develop a justifiable rationale for the price. Take the following example of a hypothetical technology for heart failure patients with the following characteristics:

· first-in-class product ­ no benchmark products for pricing

comparisons;

· dearth of medical devices treating this condition, mostly drug · · · · ·

therapy; elderly patient population; few physician or patient advocacy groups active; specialty society in infancy; clinical trials did not collect economic data; clinical trials prove the device improves patient outcomes.

These challenges have different implications for the various external stakeholders. The ultimate price point should address these implications. Let us assume that the ideal price range for this technology would be US$12,000 to $15,000, based on internal company calculations specific to the desired ROI. The following discussion suggests how Value Analyses can be used to modify this base pricing. The price premiums suggested below are not necessarily cumulative. The information should be analysed collectively to develop a price that is defensible to all stakeholders. Public health agencies and private insurance companies will make coverage and reimbursement decisions about this product that will determine, in part, how attractive the product is to

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customers and users. The fact that this product is first-in-class raises special challenges and opportunities because there is no existing product for reimbursement decision-makers to use as a benchmark. Consequently, the pricing strategy should explicitly take into account the price point at which the technology can, in effect, pay for itself. In the case of heart failure, the primary drivers of rising costs are the increasing size of the heart failure population, the high rate of inpatient admissions and intensive medical resource use by these patients and their high mortality rate, which translates into significant end-of-life hospital care. One variable in the pricing strategy is the price point at which the new technology creates a break-even situation when compared with the potential savings in one- to three-year medical costs for this patient population. This may require some data analysis to quantify the economic impact of this technology in relation to the current costs of heart failure patients if economic data were not collected in the clinical trial. By establishing a price point for which the technology essentially pays for itself within a reasonable time period, technology companies specifically address the fears of insurers about spiralling technology costs. On the other hand, the fact that there are few other medical devices used for the heart failure raises some challenges for insurers. The drugs that are commonly used for heart failure control are typically covered under a separate pharmaceutical plan of benefits whereas the medical device would be covered under the overall medical benefits plan. Private insurers collect an additional premium for pharmaceutical benefit plans, and government payers maintain a separate budget for it. Our hypothetical device will likely raise costs for the medical benefits plan and potentially lower costs in the pharmaceutical plan (if the device will reduce the use of pharmaceuticals.) The `break-even analysis' provided to reimbursement decision-makers should incorporate the potential savings in pharmaceutical costs, to the extent it occurs, to provide support for a higher break-even price. Moreover, this process will have contributed overall to more favourable procedure reimbursement decision-making. Despite public pronouncements by insurers (especially Medicare) that the costs of technology are not explicitly taken into account with respect to insurance coverage decisions, the reality is quite different. Insurers are likely to engage in several tactics to mitigate the impact of high-priced technologies, including:

It is beneficial to calculate the price at which the technology pays for itself within a reasonable timeframe

Examples of tactics used · stalling on reimbursement decisions; · requesting additional clinical information that can require new by insurers to reduce the trials;

· assigning the technology to low-paying reimbursement categories; · establishing non-coverage or narrowly defined coverage

categories. Any one of these outcomes could wreak havoc on this technology's carefully designed business model.

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impact of high cost technologies...

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Reimbursement adjustments actually occur months or years after a new technology has been introduced

Potential reduction in losses from a new technology should be quantified...

...by analysing procedure scheduling patterns, length of patient stay and bed turnover patterns

Physicians and hospitals have a somewhat different perspective on pricing. Hospitals will want to know how the new technology affects the financial margins for procedures and admissions using the technology. [In an ideal world, reimbursement for admissions using new technologies is already adjusted to take into account the cost of the new technology. In reality this rarely happens. In most situations, and especially under Medicare, reimbursement adjustments occur months or years after a new technology has been introduced. So the financial impact of new technologies can be severe unless the technology reduces procedure costs.] In the example of heart failure, the value message for hospitals could focus on reduction of current losses. Heart failure patients typically experience multiple inpatient admissions annually (the average is two admissions per year for all heart failure patients and higher for patients with advanced heart failure). These hospitalisations are usually unprofitable for hospitals; they cost the hospital more than they get reimbursed. The pricing strategy should explicitly address this issue by quantifying the potential reduction in losses made possible by this new technology (if valid) to calculate a price for the technology that enables the hospital to cover its technology acquisition costs through reduction in current losses over a defined number of expected downstream hospitalisations. Some technologies can also generate revenue for the hospital because they reduce the time required to perform certain procedures or they reduce recovery time associated with current procedures. In these cases, quantifying these benefits from the hospital's perspective can help to position a higher price. An analysis of procedure scheduling patterns, length of patient stay and bed turnover patterns can quantify the extent to which the technology might generate new revenue for the hospital. The ability to schedule more cases or free beds for more admissions can have a favourable financial impact on hospitals and can create a more flexible pricing environment. (Note that some hospitals are already operating at capacity and would not reap these benefits.) Physicians become very interested in technologies that contribute to their practices, either by saving them time or money or attracting new patients or improving the clinical outcomes of their patients. The price of technologies can explicitly account for the value associated with each of these potential benefits. For technologies that are actually purchased by physicians, time and technology cost savings can be calculated and used to modify the base cost of new devices. For technologies that are used by physicians but purchased by hospitals or other facilities, these same calculations can be used to develop physician advocates who will push hospitals to purchase the device. In this simplified example, the base price range of US$12,000 to $15,000 could clearly support value-based premiums and still represent a value purchase by a hospital.

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Planning for Value-Based Pricing

Technology companies that strive to develop value-based pricing should plan for it early. The steps described in Table 1 are helpful in ensuring that the information and data needed to develop a realistic value-based product price is available when needed. This process should be initiated early in product development and used to develop data endpoints for clinical trials, tactics and strategies for early stage marketing activities as well as supporting the business model.

Table 1. Useful steps to ensuring that the information needed to develop a realistic value-based product price is available

1. Identify the internal stakeholders: · investors; · distributors/marketing partners; · employees. 2. Identify the external stakeholders: · payer mix (Medicare, Medicaid, private pay); · customers (hospital, physician, other); · patient population (e.g. elderly, organised). 3. Identify the challenges and opportunities for the technology with respect to each group of stakeholders: · cost saving; · revenue generating; · increased efficiency; · better outcomes. 4. Consider the value characteristics of the technology: · innovation? · market timing? · unmet need? · patient demand? · economic value? · quality of life value? 5. Develop approaches for data acquisition to quantify each value characteristic specific to each stakeholder: · economic data collection as part of a clinical trial; · data collection at hospital sites and/or physician practices to quantify the potential impact of the new technology; · retrospective analysis of insurer data to quantify conventional care and anticipate the impact of the new technology. 6. Develop ROI information for each external stakeholder group. 7. Use stakeholder-specific ROI data to calculate and modify the value-based price point.

The ultimate goal of this strategy is to develop a product price that is defensible to all the stakeholders. However, this information has a myriad of other uses as well, including:

· information for potential investors; · information to support favourable coverage and reimbursement

decisions;

· data for publication and presentation;

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Information collated during this process has several other uses...

· data to share with medical specialty societies, regulators and

patient advocacy groups;

· data on product staging decisions, and marketing and sales

strategies and tactics. Information about the value of the technology from the perspective of each stakeholder can help the company build a solid product positioning strategy and a meaningful price that will lead to high levels of product adoption - the ultimate goal of all medical technology companies.

Nancy L Reaven is President and Founder of Strategic Health Resources, a healthcare consulting and datamining company based in Los Angeles, California, USA. She can be reached at [email protected]

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