The Limits of the Traditional Models of Innovation

The medical device industry is subject to many of the same economic forces that affect all highly innovative industries. Device producers must make reasonable profits, ever vigilant of the commercial strategies and technological advances of competitors. A rich scholarly literature on innovation has developed models of the innovative process. Scholars have identified essential stages of innovation, which appear in Figure 5.1 (1).

FIGURE 5.1

The stages of innovation.

The process begins with pure science—the systematic study of phenomena to add to the total of human knowledge. The technology stage is directed toward use and includes the process of invention and development. Invention is the first confidence that something should work and the first tests to demonstrate that it does. Development involves a wide range of activities that measure the chances of success of the product. Finally, the market stage includes adoption of the innovation and its diffusion into the stream of commerce. The steps can be distilled into two categories: the early stages affect the research and development (R&D) of innovative products; the later stages seek to influence adoption and diffusion of such products.

Much of the medical device industry can be understood by referring to the traditional innovation literature, which describes the links between these stages of innovation; how technology is transferred from one stage to another; how firms are organized to facilitate the transfer of technology; and other issues of competitiveness, strategy, and profitability. However, this literature takes a limited view of the environment in which innovation occurs. In particular, it often ignores the role of government in the process. Traditional theorists often assume that innovation is driven primarily by the play of free-market forces in the private sector. And, by traditional measurements, the medical device industry is highly innovative. First, the industry reinvests a high percent of sales in R&D (7.5 percent). The total number of patents issued to innovators has increased, and shipments of medical devices are growing, with sales growth projected into the 1990s (2). But medical device innovation does not take place in a vacuum. Public policies impact the process at every stage. Conventional measures of innovation—industry R&D spending, number of patents issued, annual sales and shipments—may not tell us much about the role and impact of government intervention.

The Pivotal Role of Public Policy

Public policies such as federal regulation, product liability statutes, reimbursement rules, and government funding for basic research have had a significant impact on the production and diffusion of new medical devices.

Figure 5.2 notes some of the many federal and state institutions and activities that can affect innovation in the medical device industry.

FIGURE 5.2

The stages of innovation: impact of institutions.

This chapter emphasizes federal regulation and reimbursement, two of the most important policies that affect medical device producers. As Figure 5.2 illustrates, there are other important policies as well, and reference is made to them throughout. For example, the National Institutes of Health (NIH) funds intramural and extramural projects that deeply affect the quality and quantity of biomedical scientific research. Product development and marketing strategies inevitably weigh the legal product liability environment, and government's actual or proposed interest in technology assessment may affect adoption and diffusion in the marketplace.

Such a diversity of government influences almost guarantees polyintervention, but before turning to an evaluation of this condition, the unique characteristics of the patient—that is, the medical device industry—must be explored.

Case Study: Lithotripsy

The introduction of extracorporeal shock wave lithotripsy (ESWL) in 1984 illustrates dynamic innovation in the private sector and its relationship to public policies (25-28). Kidney stones in the urinary tract (urolithiasis) develop when minerals, primarily calcium and oxalate, form crystals rather than being diluted and passed out of the body. More than 300,000 patients a year, 70 percent of them young to middle-aged males, develop kidney stones. For many, treatment with fluids and painkillers is sufficient; in 20 to 40 percent of cases, however, the stones cause secondary infections, impaired kidney function, or severe pain, warranting more aggressive intervention, but until the past decade, surgery was the only form of medical help in most cases.

The first major advance included percutaneous endoscopic techniques developed in the early 1980s that permitted stone extraction or disintegration and reduced the morbidity associated with conventional surgery. The second major advance was ESWL. Its most exciting feature was that it offered a noninvasive way to treat kidney stones. The first ESWL devices required the patient to be placed in a water bath. After X-ray monitors positioned the patient, intense sound waves were generated by a high-voltage underwater spark. The resultant sound waves disintegrated the stone into fine bits of sand that could easily pass out of the body. Subsequent technological modifications eliminated the need for the water bath, and mobile units were developed. Currently, devices that use optical fibers as conduits for pulses of laser light that fragment stones are in experimental stages of development.

Although ESWL is an exciting innovation, several factors might have led to skepticism about its likely commercial success. The equipment was very expensive (early models cost at least $1.5 million), there was a viable surgical alternative, and the patient base was small and likely to remain so. When the constraints of public policy—regulation and cost containment—are added, the successful adoption of the technology becomes even more doubtful. The device was subject to the highest form of FDA regulation—Class III— requiring pre-marketing approval by the FDA. In addition, payment incentives seemed to be against its rapid adoption by hospitals. Only a small percentage of kidney stone patients are covered by Medicare, and current Medicare payment levels for outpatient ESWL do not adequately cover the costs of the treatment for those patients who receive it.

Despite these barriers, the product took only 13 months to receive FDA approval and then diffused rapidly. There were 200 lithotripters in operation within 2 years of introduction. The market now includes 220 devices and is basically saturated. There are 10 firms in the market. Only four have received FDA approval, and the others have devices in investigational stages. The market leader is Dornier Medical Systems, the first to receive a pre-marketing application (PMA), along with Medstone, Diasonics, Technomed, and Northgate Research.

The next generation of machines is already in development. In a relatively short period there have been major improvements in the original device; other designs, such as the use of laser technology, are on the horizon. There have been a number of creative marketing solutions to the problems of high cost and low patient volume. Entrepreneurs have put together joint ventures with physicians and hospitals that ensure a broad patient base, lower the unit cost of treatment, and amortize the cost of the device. Some freestanding centers have developed symbiotic relationships with providers of other forms of kidney stone treatment so that comprehensive services and alternative treatments to lithotripsy are all available in one center.

What lessons about innovation in the device industry can be learned from this case? How can we explain the success of this expensive, highly regulated technology? One explanation is that truly useful technologies usually succeed despite the barriers placed in their paths. There is, no doubt, truth to this conclusion. However, it may be that the dynamism and creativity of the industry are based on the expectation of enormous market expansion through the application of this technology to patients with gallstones, a much more prevalent clinical condition.

There are 20 million gallstone patients in the United States, with 487,000 gallbladder removals in hospitals every year. The treatment of gallbladder disease is a $5 billion market (28). If lithotripsy could be applied to many of these patients, hospitals could avoid much of the costs associated with surgery, and the firms could compete for this greatly expanded market.

Whether that expansion will occur is now in doubt. Here is where the policy process reenters. In October of 1989, an FDA advisory panel recommended that the agency disapprove the PMAs filed by Dornier Medical Systems and Medstone International for biliary (gallstone) lithotripters. The panel members expressed concern about the safety data in the PMAs. Questions also were raised about the effectiveness of lithotripsy for destroying all gallstones. Preliminary evaluations reveal that only a small percentage of patients with gallstones may benefit from EWSL (29). The delay in marketing approval will allow competitors to catch up with the two leaders, although the ultimate clinical usefulness of biliary lithotripsy remains uncertain. Manufacturers have been slow to gather data because the lack of any third-party reimbursement for this new procedure has limited the number of patients who have received it. In addition, because the drugs used in conjunction with the treatment work slowly, studies often take a long time to complete.

The failure to receive FDA approval may be only a temporary and minor delay. It may also mean that the technology is inappropriate for the proposed use and that the FDA sagely is placing safety concerns ahead of the desires of the innovative firms to rush to market. Or we may be seeing a regulatory failure in that the FDA is inappropriately obstructing the entry of a valuable innovation into the marketplace. FDA's decision delays reimbursement from third-party payers, including Medicare, which will rarely pay for unapproved technologies, further burdening the innovators. Nor does FDA approval necessarily guarantee Medicare coverage of the procedure. The Health Care Financing Administration (HCFA), Medicare's payment authority, makes its own assessments of new technologies for coverage and payment decisions, often independent of FDA findings.

At this point, the lithotripsy industry remains dynamic, highly innovative, and very competitive. However, the market for kidney stone treatment is not expanding. No improved technology to date has left the others outmoded. Whether the expansion for use in gallstone treatment will occur depends upon the public sector—the FDA and third-party payers (primarily Medicare). The marketplace must wait for the policy process to resolve the debate.

Case Study: Intraocular Lenses

Millions of Americans, particularly the elderly, suffer from eye diseases causing impaired vision. Cataracts, opacities of the lens of the eye, are often a result of degenerative changes in old age or of such diseases as diabetes. The symptoms include gradual loss of vision. The usual treatment is removal of the diseased lens and implantation of an intraocular lens (IOL) (30-34).

Ophthalmology in general, and IOLs in particular, represent one of the largest and most dynamic health care markets. IOLs are regulated by the FDA. Because most of the implant candidates are elderly, the market is strongly tied to Medicare policy as well. The interaction of regulation and reimbursement has the potential for significant impact on the industry.

IOLs are one of the few ophthalmic products that the FDA has placed in Class III. Regulated since 1979, IOLs are subject to special requirements imposed by Congress and enforced by the FDA. FDA reviews data on safety and efficacy for all Class III devices in the PMA stage. During the experimental stage, Class III products may receive an investigational device exemption (IDE) that allows them to be used in controlled studies while the manufacturer gathers and evaluates data about safety and efficacy. The collection of data supporting a PMA is expensive and time consuming and may represent a significant barrier to entry for innovative firms. For IOLs, however, a special exception was made. Producers could charge for the costs of the implanted lenses in the IDE stage. This exemption facilitated the development of IOLs during the 2 or more years of device testing required in clinical practice.

The vast majority of IOL implants are done on elderly patients with cataracts or other degenerative eye problems. Indeed, the availability of Medicare payment guaranteed a large, stable market for lens removal and IOL implantation. The average cataract patient is 68 years old, so Medicare is virtually the only payer for cataract surgery. The numbers of implants grew rapidly in the 1980s. There were 177,000 implants in 1979 and 888,000 in 1986. In 1987 there were 1.1 million implants in the United States and another 1 million internationally. IOL sales have been estimated at $400 million annually.

Cataract surgery costs the federal government close to $1.5 billion a year. It is the largest item in the Medicare program. During the 1980s, much of the treatment shifted from hospital to outpatient surgery centers or physicians' offices, which are covered under Part B of Medicare. Medicare provides the funding; growth can be attributed to advances in technology, including cataract management, anesthesia, surgical technique, and postoperative care. New IOL technology includes soft lenses that can be implanted with smaller incisions (the one-stitch lens is popular), bifocal implants, and other specialty lenses.

There are a number of companies in the IOL market, ranging from large firms such as Johnson & Johnson (IOLAB), Coopervision (acquired by Alcon/ Nestle), and Allergan (purchased by Smith Kline in 1989), to such smaller firms as IOPTEX Research, a small, privately held industry leader, and Chiron Ophthalmics, a subsidiary of Chiron Corporation, a biotechnology firm. There are foreign IOL makers from West Germany, France, Belgium, Israel, and Japan as well.

Changes in Medicare policy as well as FDA regulations present some threats to the market for IOLs. Congress has reduced federal Medicare payments for cataract surgery twice since 1986. HCFA has lowered the amount of payment to physicians for the procedure, which had increased 61 percent in a 3-year period. HCFA also plans to establish a new payment rate for an IOL implanted during the cataract extraction. This proposed rate of $200 would mean an average decrease of at least $100 on the former IOL rate. Some have advocated a tiered rate to accommodate the higher costs of newer specialty lenses. To date, the proposed flat rate of $200 stands.

The FDA has also imposed new requirements for data collection. For new bifocal and multifocal products, 50 implants have to be studied for a year, and then the studies can be expanded to 500 implants. Overall, it is likely to take nearly 4 years before a new lens will receive its pre-market approval. The guidelines have made it difficult for new companies to introduce competitive products.

This longer period for approval is less onerous if the innovator receives at least partial payment for experimental lens implants. Rumors have been circulating that the exemption allowing payment for IOLs under IDEs soon will be rescinded. The HCFA officials say that this will encourage producers to move from the IDE to PMA stage. They assert that companies have been allowing products to languish under IDEs because the exception reduces the economic incentive to go to market. The device is paid for in either case. However, the longer testing requirements and threatened withdrawal of payment during the investigational period probably will have an inordinate impact on newer, less well-capitalized entrants.

The changes in Medicare payment rates and FDA regulations could each have an adverse effect on innovation. The collective impact, however, is likely to be even more significant, particularly on smaller or newer firms. Clearly, cost containment and safety are important considerations. There have been serious concerns about overcharging for the implant procedures and the products as well as suspicions about unnecessary implants and concerns about the safety of some designs. However, it remains to be seen how the pursuit of safety, efficacy, and cost containment will affect innovation in this dynamic segment of the device industry.

Fine-tuning Individual Policies

As policy makers implement their goals, they should be sensitive to the potential impact on innovation. A brief look at regulation and reimbursement illustrates this point. If proposed reforms make regulation more stringent, as pending bills appear to do, certain precautions are essential. The well-documented drug lag occurs when regulation delays entry of innovative pharmaceuticals onto the market (35). Recent efforts by the FDA to speed up the regulatory process, particularly for drugs for life-threatening conditions such as AIDs and cancer, should be applauded. Similarly, tightening controls on medical devices must never be allowed to create a “device lag.” Congress should consider this possibility and make appropriate legislative accommodations, including adequate resources for timely device evaluation. Congress should also consider better use of post-marketing controls to monitor devices in use. These regulations do not delay entry into the market and are less burdensome on innovation than pre-marketing regulation. However, given the intense criticism of FDA's post-marketing surveillance system, Congress is skeptical of FDA's commitment to this form of regulation. The general point to be made is that the FDA should balance the desire for innovation with its goal of promoting safety and efficacy in medical devices. Lessons learned from the pharmaceutical experience should help develop an appropriate balance between safety and innovation.

Policy makers in the business of containing costs should also be sensitive to the value of innovation. Many have expressed concerns about stifling innovation, but because it is an elusive concept to measure and costs are spiraling ever higher, it is easy to overlook this value in pursuit of another. Proposals that support innovation include allowances for scientific advances or pass-throughs for certain new technologies during some designated trial period; automatic temporary approval for coverage by third-party payers of all FDA-approved technology for designated periods of time; and allowances for experimental treatments and technologies in designated centers of excellence to gather information on costs and benefits of innovations. Innovation need not increase costs, although many innovations do, particularly when first introduced. Premature decisions about the value of innovations may inhibit more thoughtful and accurate evaluations that can come only with experience. The system must permit more flexibility in order to protect innovations, particularly when public payment policies to do otherwise influence such a sizeable share of the potential market.

Understanding Polyintervention

It is also possible to conceptualize reform among the various policies, particularly to control duplication and overlap in the polyinterventionist environment. To illustrate, Figure 5.4 takes another view of the policy matrix.

FIGURE 5.4

Interaction of public policies that affect innovation.

Three types of interactions are denoted by lowercase letters: “a” represents the interactions within boxes, “b” represents interactions between boxes on the vertical axis, and “c” represents interactions across boxes on the horizontal axis. Again, a cautionary note is appropriate. The discussion that follows is meant to highlight how the analysis might proceed; it is not intended to propose comprehensive policy reform.

Policies within one box on the matrix, “a,” presumably intend to accomplish similar goals (to inhibit supply or promote demand, for example). In some cases there is policy duplication and overlap, often imposing unnecessary costs and constraints on innovators. I have written a detailed discussion of the interaction between regulation and product liability with suggested proposals for reform (21). The general point of that article can be summarized succinctly. Both regulation and liability are systems designed to promote safety. Although their goals overlap, the institutions that carry out these policies employ vastly different methods and evaluate safety in different ways. The value of device safety can be protected without two elaborate institutions. Reform of the system depends on a wide range of factors. The ultimate goal would be to preserve or improve the pursuit of safe medical devices while eliminating overlapping, inconsistent, and irrational attributes of both systems. Similarly, one can evaluate more rational coordination of policies in box 4—for example, linking technology assessment mechanisms to HCFA's cost controls.

It is also possible to coordinate policies between boxes on the vertical axis, represented by “b.” These policies share common goals—to inhibit or to promote innovation—albeit at different stages of the innovative process. Coordination might make the policy environment more coherent for manufacturers and might reduce costs of federal intervention in the process.

An illustration of such cooperative efforts by the FDA and HCFA is the Cardiac Pacemaker Registry. Following controversies about unnecessary implantation of pacemakers and serious safety violations by some pacemaker companies, the FDA and HCFA proposed a joint rule to establish a registry. Physicians and providers requesting or receiving Medicare payment for implantation or removal of a pacemaker must provide product safety and performance information to the pacemaker registry database. The final rule permits HCFA to deny Medicare payment to providers who fail to submit required information to the registry (36). The FDA's independent jurisdiction extends only to manufacturers, not providers. By developing a cooperative scheme, the FDA can acquire information about pacemaker performance to which providers, not manufacturers, have direct access. The link to payment is a strong incentive for compliance.

It is also important that the two agencies do not duplicate evaluations. There is a current controversy about whether the HCFA should engage in safety evaluations of products that have received FDA approval. Some believe that these efforts are redundant and that safety determinations need to be made only once by one federal agency; FDA approval should be sufficient for other agencies. Others accuse the HCFA of using safety inappropriately as a pretense to deny coverage and reimbursement for medical technologies that it does not want to pay for. Regardless of the merits of these accusations, it is legitimate to question federal duplication of safety evaluations.

It is also possible to coordinate policies even when the goals are very different—that is, promotion of R&D and inhibition of diffusion and adoption. This is represented by “c” on the matrix. For example, NIH, or other sources of federal research money, could be used to promote products that would specifically reduce health care costs. It is legitimate to ask, for example, why NIH promotes artificial heart research when it is unlikely that Medicare would ever be able to pay for the procedure for all the elderly that might want or need it. It is interesting to note that some NIH officials tried to curtail the program in 1988, but Congress prevented that action. The fight to save the program was led by Senator Orrin Hatch (R-Utah), in whose state much of the funded research takes place.