The U.S. spends roughly $3 billion more than it should on orthopedic implants. Orthopedics represents 3% of U.S. overspend on drugs and devices and 0.45% of total overspend.
Introduction
The past twenty years have seen an explosion of innovation by orthopedic companies. The new generation of metal-on-metal and ceramic-on-ceramic hip and knee implants are in many ways better than what nature gave us to start with. These new implants not only give mobility back to elderly women with osteoporosis, they let 50-year old distance runners keep running into their 80’s and 90’s. Coupled with new advances in orthobiologics – putties, pastes, and glues that promote bone healing – innovation in orthopedics has inarguably improved the lives of millions of Americans.
The promise of implants in erasing some of the thorniest issues of old and middle age has led to an outpouring of demand for these new procedures. From 2000 to 2009, the number of yearly joint replacement surgeries in the U.S. almost doubled, from 575,000 in 2000 to 1.1 million (est.) in 2009. Look around. One in 30 Americans are now walking around with at least one new joint. Ten years ago that number was 1-in-60.
This kind of medical success story doesn’t come without a price. Ten years ago, Americans spent 54 cents for hip and knee implant surgeries out of every $100 they spent on any kind of healthcare. Today they spend 78 cents. Total costs for hip and knee replacement surgery have grown at 10.2% annually since 2000, with about 70% of the growth driven by the amount of procedures, and 30% of the growth driven by the cost of each procedure.
Like most other costs in American healthcare, this rate of growth is unsustainable over the long term. But hips and knees are hardly an especially notable culprit. While at the outset it may seem like spending on hips and knees is growing out of control, the truth is more benign. At 10.2% annually, total growth in spending on hips and knees does outpace overall U.S. healthcare expenditure growth of 8%. Most of this difference comes from the fact that the number of hip/knee replacements are growing at 7% every year, while the U.S. population is growing at a comparatively anemic 1% and only growing their per capita usage at another 1% a year. Putting this growth in the amount of procedures aside, then, you’ll see that pricing for hip and knee procedures has grown at 3% annually. That’s not so bad, all things considered. Pricing growth (or as healthcare economists would term it, ‘inflation’) is running far below the U.S. average of 5.8%.
Doubtless, our country’s expenditures on hip and knee procedures has been growing unsustainably at 10.2% annually. But most of this growth is coming from increasing procedure volumes, not out-of-control costs. Expensive though it is, increasing the number of procedures performed is easier to swallow when you realize these operations are demonstrably helping people live more mobile, active lives free from pain. It seems wrong to ‘ration’ access to hip and knee implants in any way when it’s clear they do so much good.
All this background is part context and part qualifier. Neither the orthopedic industry, orthopedic surgeons, nor the patients who get hip and knee implants is really any more to blame for healthcare spending growth than the next group of companies, doctors, or patients you might take a look at. But things could still be a lot better.
In the next two parts of this article, I will explore where we are missing opportunities to save money, and why.
We’ll start with a look at the orthopedic implant industry, which has managed to keep implant prices sky high despite competitive and commoditization pressures that would have destroyed margins in other, less ‘unique,’ industries.
Next, we’ll explore how hospitals and insurers/payors have failed to push back against high implant prices and unnecessary surgeries. We’ll also examine surgeons and the role they play. They are the main source of friction. Whatever changes need to be made need to be made through them. And they haven’t been very receptive thus far.
Part 1 of Ortho: orthopedic companies and the role of sales reps
Let’s start the fun with a look at how the cost of hip and knee implants has influenced the overall costs of hip and knee replacement surgery. Hip and knee implants make up about 41% of the U.S.’s total annual expense on hip and knee surgeries. That’s $7.1 billion out of a total, projected spend of $17.2 billion in 2009.
This $7.1 billion chunk spent on implants deserves a lot of attention. It’s the fastest growing of the three major cost buckets. Implant costs rose at 4% annually from 2005 to 2009, versus annual growth of 3% in hospital costs and annual declines of 2% in payments to orthopedic surgeons. The 4% annual cost growth is actually a significant moderation from past rates of growth. Over the wider, 8 year period from 2000 to 2009, implant costs grew 6% annually, 1 point above medical cost inflation.
This $7.1 billion chunk is also the expense that we should theoretically be most able to control. After all, hip and knee implants are just hunks of metal, plastic, and ceramic. Competition in the industry, productivity improvements, and manufacturing efficiencies should help lower implant costs over time. Outwardly, the orthopedic industry seems to be structured in a way that would promote competition. But under the surface there is a lot going on that keeps prices artificially high.
The first sign that the orthopedic industry is special comes straight off the income statements of the companies that design and manufacture the implants. Their gross margin on implants sold in the United States hovers around 80%. In other words, these companies charge U.S. hospitals $5000 for an implant that costs only $1000 to manufacture. All the other costs that orthopedic implant manufacturers incur to design, market, sell, and service their products shave off another 45% of revenue, leaving before-tax cash profit margins at an extremely attractive 35%.
These margins are the third highest in healthcare – behind only large pharma and biotech companies. The orthopedic industry’s perch atop these margin rankings has been durable. Overall industry margins actually increased 3 to 4 percentage points over the last 8 years, cementing their spot near the top of the pack. Driving this margin increase has been a steady rise in implant prices. Prices per implant rose by 60% over the last 8 years, even as volumes grew by 65% over the same period.
As consumers we’re used to flat screen TV’s that drop in price as competition and volume increases. At the very least, if we’re paying the same for a laptop today as we did in 2000, today’s laptop is now 100X more powerful. These rules don’t hold in ortho. The five main companies that make up about 90% of the hip and knee market no longer have significantly differentiated products. They are commodities. Innovation has stalled. The same premium metal-on-metal and ceramic-on-ceramic implants have been around for years.
Differences between the implants of today and the implants of 5 years ago are minor. There are new coatings, new orthobiologics, some new materials – but all in all they are almost indistinguishable. Yet prices have continued to rise. Despite competition between five companies, despite a commoditization of the core hip and knee implant product line, and despite an ear-popping near-doubling of procedure volumes, prices are 60% higher today than they were in 2000.
There are a couple reasons why industry observers might argue prices deserve to rise so much. The first is that hip and knee companies have to pay for R&D and regulatory approvals for their products, and so higher prices are necessary to support these ever-increasing expenses. They might point out that pharmaceutical industry gross margins are even higher, around 90%. The seeming logic to this argument is belied by the numbers. Pharma companies spend about 20% of revenues on R&D. Hip and knee companies spend 6%. Every drug that pharma companies develop goes through lengthy development processes and regulatory approvals that cost tens or hundreds of millions of dollars. Orthopedic companies get virtually all of their products approved through the 510(k) process, a regulatory pathway that takes 6 months and costs an order of magnitude less than drug approvals. Pharma companies are no saints when it comes to drug prices. But at least their compounds eventually lose patent protection and go generic, reducing prices to the consumer by 90% or more. The same paradigm doesn’t exist for orthopedic companies. They spend much less on R&D and regulatory processes, and they don’t face significant patent cliffs like pharma. Rising prices in ortho go straight to the industry’s bottom line, in near perpetuity.
The second reason why prices might deserve to rise is that ortho companies must service their products. During many implant surgeries – routine and otherwise – a sales rep from the ortho company is in the operating room with the surgeon to assist with product selection and usage. Usually this help takes the form of simply giving the surgeon the right sized screw when asked. In rare cases the rep might virtually perform the surgery, using a laser pointer over an inexperienced surgeon’s shoulder to position incisions and implant placement. In the former case, there’s little value; while in the latter case salespeople can make a difference in patient health. In both cases, these services come with major pricetags. Keeping sales reps on call to do surgeries in the hospital is expensive. The average orthopedic company spends about $37 for every $100 they make on sales and marketing – by far their single biggest expense. They spend it for a reason. Sales reps are the most important differentiator amongst companies with commoditized products. The right sales rep is always 30 minutes early to pre-surgery planning sessions, has products available at a moment’s notice, and sends copious amounts of holiday cards. In the past, sales reps also funneled financial incentives to surgeons in exchange for the surgeons using their company’s product. While direct financial incentives are now a thing of the past thanks to a Department of Justice investigation, the relationships that sales reps nurture between themselves and orthopedic surgeons are nonetheless strong and long-lasting.
Reliant on sales reps to maintain and grow market share, the orthopedic industry as it is structured currently is not a very leverageable business model. In plain terms, to sell more implants, you need to hire more sales reps. And to incent sales reps properly, you need to pay them a lot, sometimes even more than the orthopedic surgeons are paid themselves. So implant prices need to rise each year to support this chunk of sales rep salary and benefits expense that also needs to rise annually.
Spending on sales reps creates a virtuous cycle for the orthopedic implant companies. The relationships that sales reps form with orthopedic surgeons tend to make market share sticky, preventing hospitals from negotiating implant pricing effectively to save costs. More sales reps support higher prices. And higher prices support more sales reps.
Reps keep pricing high by monopolizing the loyalties of the surgeons they cover. The rule in the past has been that hospitals tiptoe very carefully around negotiating prices for ‘physician-preference items’ like orthopedic implants. When hospitals try to negotiate implant prices by threatening to switch to another implant manufacturer, surgeons tend to revolt. For hospitals, it’s a cost savings. For surgeons, switching manufacturers means switching reps and having to train on new implants, equipment, and procedures. Hospitals generally can’t afford to lose top orthopedic surgeons. At 5-15% overall margins, depending on payor mix, ortho departments can be one of the more profitable areas of a hospital. Profit here helps pay for other services and charity care that hospitals don’t make any margin on. This delicate balance between over-compensated sales reps, status quo-favoring surgeons, and hospitals reluctant to negotiate works to dampen competition. With little threat of other companies stealing their business, incumbent orthopedic implant manufacturers in each hospital are free to raise prices every year.
What have consumers of healthcare gotten in exchange for these increasing costs? A higher annual pricetag for the same hunk of metal.
Part 2 of Ortho: hospitals, payors, surgeons
To defeat this cycle of ever-rising implant prices, there are short- and long-term changes that need to happen. We’ll never be able to get U.S. implant pricing down to European levels (about 60% what we pay), because our payor and hospital systems are too fragmented. But with a series of steps, the U.S. healthcare system can stoke competition in the industry to keep costs where they should be.
In the short-term, hospitals need to use new tools to push back against rising implant prices and invite competitive bidding. We’re already seeing the first stages of a revolt. Some hospitals are now using implant pricing consultants and in-house financial analysts to set a fair maximum price per implant. They invite implant companies to ‘pay to play,’ without trying to consolidate manufacturers and limit surgeon choice. ‘Capitated’ pricing agreements can lower hospital costs for implants by up to 15%, and they can prevent yearly price increases by holding the capitated price flat for long periods.
Hospitals that have succeeded in imposing capitated pricing have only succeeded because their surgeons were on board with the price control efforts. Sometimes it’s surgeon outrage that does the trick. Telling your surgeons that the sales reps looking over their shoulders make 2X a surgeon’s take-home can be potent, but it’s an awkward conversation. Some other hospitals have attempted gains-sharing plans. And still others have purposely recruited surgeons who are more team players than lone rangers.
The pivotal role that surgeons play in the orthopedic implant cost equation means that they must be the ultimate target of cost-control efforts. Getting surgeons to leave sales reps at the operating room door would be a good first step. By taking the sales rep out of the equation, implant companies would have more leverage-able businesses models and could absorb pricing competition. Sales reps would also have less sway over surgeons, improving the ability of hospitals to negotiate on price with implant companies. But kicking reps out of the OR is easier said than done. Some surgeons rely on them for help with procedures. And sales reps often make the life of a surgeon much easier by helping to manage hospital inventory and keeping the surgeon trained on and informed of the latest advances in the field.
The mechanics of breaking the surgeon-sales rep relationship are complex. The 2007 Department of Justice settlement took away the hard financial ties of surgeons to their reps. But the soft ties between surgeon and rep still remain, because the reps do provide real value to surgeons. It’s just that the value provided does not match the value that the reps are able to extract from our healthcare system. The majority are glorified vending machines. Yet they persist. Currently, most implant manufacturers are investing even more in their salesforces.
In an ideal world, surgeons would take care of their own training and be familiar enough with their equipment to operate without help from sales reps. Hospitals would diligently manage inventory to make sure that the right implant is available when needed. And both would work together to provide the best patient care possible while not letting implant companies walk all over them on pricing.
In the real world, surgeons are busy. They don’t want to burn billable hours planning negotiations and retraining on new kit. Many hospitals don’t have enough expertise to manage complex sets of instruments and supplies. And the two camps can be mortal enemies when it comes to medical costs.
Change in surgeon behavior, then, probably has to start with payors. At the end of the day, someone has to decide that ‘enough is enough’ – we won’t continue to pay more every year for orthopedic procedures unless we get vast improvements in patient care in return. Both Medicare and private payors appear like they might finally smell the proverbial blood in the water. Recent proposed payment increases for orthopedic procedure codes are one-half to one-fifth of past increases. Lack of product innovation by the orthopedic implant companies and unsustainable growth in costs appear to have convinced payors that they no longer can afford to support this area of medicine to the same degree as in the past. One area that payors have quixotically not yet explored is the separation of the Ortho surgery payment into an implant piece and a service piece. Isolating the cost of the implant would allow payors to focus on it specifically. Logically, it makes sense. But feedback from payors generally boils down to: “it’s not worth the trouble.”
However it’s done, this reining in of payment growth can undercut the profitability of orthopedic procedures, also undercutting the clout that orthopedic surgeons carry. Slower payment growth for orthopedic procedures should help control costs by changing the balance of power within the hospital. But it won’t be without pain for hospitals, doctors, and patients. While the payors’ ultimate goal is to win back the 50% we over-spend on orthopedic implants from the manufacturers themselves, they have to work through the hospitals to do so. Hospitals are the ‘human shields’ between the orthopedic industry’s guerilla pricing tactics and the payors’ offensive countermeasures. Unfortunately for hospitals, payors can’t help causing collateral damage.
To maximize the pain that the implant manufacturers feel and minimize the pain in the rest of the system, we need changed attitudes from our doctors. Orthopedic surgeons need to partner with hospitals to drive down implant prices. A stark choice faces surgeons. They can partner with hospitals now. Or they can keep humoring their sales reps and leave payors no choice but to bring the hammer down. Radiologists had a similar choice between unsustainable cost growth and changing their habits in the late 90’s and early 2000’s. They chose the status quo, and payors ripped them to shreds a few short years later.
Endgame
The orthopedic industry shows that it is theoretically possible to provide the same level of patient care with much lower costs just through changes in doctor behavior. If surgeons can be convinced to ditch their reps and to act slightly more cost-consciously, then the entire bloated structure of the orthopedic industry would collapse overnight. Prices would fall as volumes rise, just like in all other industries. Companies would spend more on real innovations in care instead of seeking competitive advantage through their salesforces. Applied to other areas of healthcare, and changes in doctor behavior like these might enable us to defeat the relentless 9% annual rise in medical costs per capita that has plagued the U.S. since the 1970’s.
The difficulty with this accounting of what has happened in the orthopedic industry is just how much blame gets placed at the feet of orthopedic surgeons. They are the patsies in this story, played by orthopedic companies who unsympathetically but unsurprisingly are looking to maximize their profits. Yet the blame is justified because these surgeons are the stewards of our medical care. The buck stops with them. Maximizing the quality of care provided to the U.S. population means ensuring that its cost is sustainable, else its cost will increasingly ration care away from people who need it. Asking surgeons to take this broader view of their mission, kick out their sales reps, and cooperate with their hospitals hardly seems unreasonable. It’s neither decorum nor a smart career decision to bankrupt the people paying the bills.
Sources are here
