On this a16z podcast, Sonal Chokshi discusses “disruption theory” with Michael Raynor. They explore the origins of the theory and Raynor provides clarity on the definition and commentary on its common misuse:
Disruption theory is a pathway, a particular way in which a small under-resourced entrant can succeed against well managed, dominant incumbents. It is not a description of your impact on the established market.
The Disruption Pathway*
Disruptors start in segments of the market that incumbents aren’t motivated to fight for or fundamentally don’t see. This is referred to as the “low end” or an entirely new market competing with non consumption.
It requires a fundamentally different business model that allows you to serve profitability the niche that the incumbents don’t want to serve. The reason the incumbents don’t want to serve those niche markets is because they can’t do it profitability.
The last piece is an enabling technology — something that allows you to take that same business model and begin to serve the mainstream markets that the incumbents do care about. But now it’s too late because the incumbents can’t respond because you have broken the trade-offs on which they were depending.
*As described by Michael Raynor in the a16Z podcast: https://soundcloud.com/a16z/what-disruption-is-and-is-not
With this framework established, it’s interesting to explore how disruption theory might be applied to the medical device market. Today, dominant incumbents sell high margin physician preference devices to hospitals and surgery centers. Physicians use medical devices to treat insured patients at these facilities. Insurance companies pay physicians for their professional services. They also pay hospitals and surgery centers for providing the site of service.
Physician and facility payments are determined by established diagnosis and procedural codes. Medicare (CMS) is the nation’s largest payor (2015 NHE projected to be $3.8 trillion). CMS committees develop these codes and meet regularly to determine appropriate payment levels. With more than 7,800 unique codes, they are often in place for many years before they are reevaluated.
Medical device manufacturers develop products to address large patient populations in therapeutic areas with established reimbursement. This approach ensures that facilities can purchase their devices and physicians are paid to use them. Patients with clinical conditions for which there are no established reimbursement pathways have fewer options when seeking care.
Medical device incumbents market their products by hiring sales people to call on physician users. These distribution channels are expensive and take years to hire, train, and develop. The model favors well resourced incumbents and is a barrier to entry for new market entrants. Most commercial stage medical device startups raise venture capital to commercialize their new products by developing similar distribution models. This approach plays to the strengths of incumbents and is both capital and time intensive.
Low End Market Segment
To embark on a disruptive pathway, a new medical device market entrant would target the low end of the market. This niche market must be impossible for incumbents to serve profitably. The disruptor would have to employ a fundamentally new business model that breaks these tradeoffs. It would use an enabling technology as an accelerator to expand its addressable market until it was effectively competing with incumbents for their profitable mainstream market.
Since disruption is a theory of customer dependence, let’s first define a potential “low end” market segment:
Uninsured Americans in need of procedural interventions requiring medical devices are not currently served by incumbents. A segment of these patients could be considered underserved with consumption limited to over-the-counter (OTC), non-operative treatments. The vast majority, however, are non-consumers of treatments enabled by medical devices. By definition, a market entrant focused initially on this niche of the market would be following a disruptive pathway.
Different Business Model
To follow a disruptive pathway, a new market entrant would need a fundamentally different business model that would allow them to serve uninsured Americans profitably. This new model would have to break the trade-offs facing incumbents.
Hospitals and surgery centers operate on narrow profit margins due to the significant overhead required to maintain facilities, purchase and service capital equipment, and employ a skilled, unionized workforce.
Medical device manufacturers have high gross margins but invest heavily in R&D, clinical trials, patent portfolios, and regulatory approvals. Additionally, investments in sales & marketing activities can account for as much as 50% of revenue.
Selling generic medical devices directly to uninsured patients through the prescription of a physician who can perform a medical procedure at his own facility could enable a market entrant to serve this low end of the market profitably.
Enabling Technology
The disruption pathway requires the use of an enabling technology that accelerates the viability of a market entrants new business model until it can eventually compete with incumbents for the mainstream market.
Many medical devices are manufactured using titanium, steel, and other metallic alloys. Instruments and application devices often require plastic parts produced through injection molding processes.
Using rapidly evolving 3D printers to produce “on-demand” implants and instruments could enable the reduced manufacturing costs required to sell highly discounted medical devices to uninsured patients.
Other enabling technologies that could be considered include:
On-demand workforce to reduce logistics & shipping costs
On-line marketplace models that sell surplus facility supply (hospitals & surgery centers) to physicians treating uninsured patients
Robotics that could replace cost of the treating physician
Reduced cost and high growth of connected mobile devices in low income populations