MedTech companies, feeling the squeeze from bigger insurers, hospital systems and drug companies, are looking to control their own distribution channels via forward-integration strategies that bring them closer to their customers.
Morgan Stanley Blue Papers, a product of our Research Division, involve collaboration from analysts, economists and strategists across the globe and address long-term, structural business changes that are reshaping the fundamentals of entire economies and industries around the globe.
It's no secret that a wave of consolidation among insurers, hospitals and nursing homes has swept the health-care industry in recent years. Less reported are the implications for medical technology companies, which are arguably feeling the biggest squeeze from customers' growing purchasing power.
The reason: While other health-care segments are combating pricing pressure through consolidation, medical device companies have less leeway to acquire competitors or complementary businesses. Chalk it up to the specialized nature of MedTech, which includes everything from dental implants to diagnostic imaging.
The next logical solution for these makers is forward integration—taking control of their distribution chains by acquiring or opening retail outlets or medical facilities. “We expect forward integration to become an increasingly important investment debate over the medium-term," says Michael Jungling, Head of European MedTech and Services research at Morgan Stanley and lead author of a recent Blue Paper, “MedTech: Forward Integration."
For investors, the challenge is identifying which companies are most likely to take this path. The space isn't only heterogeneous, it is global, with every region subject to its own timelines and market nuances.
To identify the most promising segments, the Morgan Stanley Research team looked at two primary factors—industry pressure and ability to forward integrate. “The sweet spot for forward integration is where industry pressure is high and where concentrated forward-consolidated assets exist," says Jungling.
Their analysis points to three areas of MedTech most likely to integrate: hearing aids, corrective lenses and in-vitro diagnostics. In all examples, companies not only can take control of their supply chains and sell directly to customers, but industry pressure is already pushing them that way.
Consider corrective lenses. The largest optical manufacturers have forward-integrated into prescription laboratories, but they have yet to move directly to retail. “We see it as likely that a large lens manufacturer would start to pursue owning its own retail shares in the next three to five years," Jungling says. “This could drastically change market shares and technology adoption."
Over the past 20 years, the number of hearing-aid manufacturers has shrunk from 20 to 6; many have moved into diagnostics and testing. Over the next three to five years, larger hearing-aid manufacturers may close the circle by acquiring retail chains, the revenues from which comprise nearly all of their core business.
In-vitro diagnostic manufacturers and reference labs—which analyze blood, urine and saliva samples collected by hospitals, clinics and lab facilities—face mounting pricing pressure as their customers consolidate. While many of the largest in-vitro manufacturers have consolidated, acquiring clinical labs could save on marketing and sales costs, boost pricing power and drive best practices. “With many large and small labs chains globally, a change in market structure is possible over the coming years," says Jungling.
Forward integration isn't on the table for some key markets. Makers of stents, pacemakers and orthopedic equipment, for example, face some of the most intense pricing pressure, but taking control of the supply chain—in most cases, hospitals—simply isn't an option.
Investors should look for other pockets of the industry to eventually move closer to their customers. Forward integration between home sleep-aid manufacturers and distributors, though not likely in the immediate future, “would eliminate the rebates paid away in the system and improve working capital management," says Jungling.
Radiation oncology is another area where forward integration is possible. However, the industry pressure is such that management teams likely won't go this route in the immediate future. In the near term, however, “it may well be a consideration, especially if the radiation equipment market does not show a recovery in expected growth," says Jungling.
Dialysis is also an attractive area for forward integration. While the US leader in dialysis has already integrated, opportunities still exist elsewhere globally.