Medical Device Daily Executive Editor

SAN FRANCISCO — When Omar Ishrak took over 18 months ago as CEO of Medtronic (Minneapolis), one of the largest med-tech companies in the world, he identified some major changes he wanted to make both in strategy and internal structure. During a wide-ranging interview with Medical Device Daily at the J.P. Morgan Healthcare Conference, Ishrak noted that much has been accomplished, but he stressed that the company still has more to do in order for it to be at the level that he has envisioned for Medtronic's future.

Upon taking over at the company, Ishrak identified some transformational changes to the very culture of the company that he wanted to make both in the short-, mid- and long-term. One critical change that needed to be made, he noted, was to turn around perceptions that the company's execution was poor. The company had gotten the reputation of not being able to make its plan and was regularly missing on its quarterly guidance. "There was a high degree of frustration both externally and internally that we weren't able to execute."

A second issue that Ishrak identified upon taking the helm was the need to more aggressively pursue emerging international markets, in particular developing countries like China and India with very large populations. "We were punching below our weight in terms of our presence in emerging markets," he said.

A third item that Ishrak identified was the company's inability to gain any growth from its investments. "Productivity or our investments, not only in engineering, but in general, was not gaining any traction."

Ishrak noted that the company's basic fundamentals were sound and the things he had identified were not jeopardizing the company at that point, but he said that over time "they could sink the company if we didn't do something about it."

To address the issue of executing on financial numbers, Ishrak said the company needed to be aligned structurally "in a little more rigorous fashion." He said the alignment of goals between businesses, regions and functions just needed that extra degree of clarity so that everyone was moving in the same direction." He noted that same clarity also "enabled people to focus on releasing new products as their priority, and what I've seen is that not only have we released those products in time, but that has translated into commercial success as promised and that's helped our performance."

Ishrak also said that he is insisting on a higher level of accountability for the markets for the company. He noted in healthcare, there are fundamental opportunities that need to be realized. Since the company has market leading positions in virtually every market, "we should consider it our responsibility to grow the market and we cannot use the excuse of markets dropping as an excuse for lack of performance. We've got to build a business model that is resilient to that."

Ishrak said the company was spending enough money on R&D, somewhere in the neighborhood of 9% to 10% of its revenues, "but we were obviously not getting the return" on that money that the company had expected. The company was not having the commercial success for new products that Ishrak thought it should and, he noted that products were not being launched on time either. He said these issues has been fixed and stressed that the company is now also doing a better job of articulating the economic value of its products. "In this industry and the state of the market, that's very important. Otherwise, healthcare is just viewed as a cost, and it isn't just a cost, there is value in healthcare." He said that healthcare needs to be articulated not just in clinical terms but also in financial terms. If it's not articulated in financial terms, it's highly subjective and therefore, the cost of healthcare is not neccesarily assessed fairly, you don't know what to compare it to."

The urgency to show the benefit of a product from both a clinical and financial perspective was fueled in part by the looming shift in the U.S. from a fee-for-service to a pay-for-performance model, and Ishrak said Medtronic "felt it should be leading the charge for pay-for-performance." He noted that if innovation isn't viewed as anything more than a cost then a true value cannot be assigned to it, and "if we did that, we would not be innovating anymore."

Medtronic wants to take a leadership position in this journey by working in what Ishrak termed "a very granular fashion," identifying where the financial benefits are for its technologies and conveying that to its customers.

"We're working with major hospital systems to run pilots to show benefits to their financial systems. Once those pilots are successful, we intend to scale them across those systems and eventually do even broader market expansion. In addition to that, for future products and across our entire business, we're asking the questions about economic value before we spend any money on products. This whole approach is changing, to a large degree, the mind set and the thinking and the culture in the company."

While it is important to harmonize the cost and improve efficiencies within hospitals, Ishrak believes it is critical that disease management is ultimately paid for in the U.S. "We have to work with the payers to get some of these costs reimbursed."

Medtronic sees emerging markets as being a critical cog in its future, and Ishrak is looking to double Medtronic's exposure to emerging market business within the next several years. It was 10% in FY 2011; and the company expects to take that to 20% over the next couple of years.

Of critical importance on the emerging market side is China, the largest country in the world. "The opportunity [in China] is not only enormous, but it's one that any company of our size which has any aspirations of staying around has to be there and has to win there. Otherwise we will not be a leader in healthcare." He said that if the company doesn't win there, "in ten years, we will be a non-player in the world's largest market."

The first important evidence of Ishrak's focus on China came in last year's acquisition of Kanghui (Changzhou, China), a provider of orthopedic devices, for $816 million in cash (Medical Device Daily, Oct. 1, 2012). That deal was followed closely by a strategic alliance with LifeTech Scientific (Shenzhen, China) (MDD, Oct. 18, 2012). The companies said the alliance will serve cardiovascular patients and clinicians who have been previously unreachable by either company alone and to develop a more robust cardiovascular platform. Medtronic has agreed to purchase a 19% equity interest in LifeTech, and will receive the right to distribute current and future LifeTech products as well as the opportunity to acquire additional ownership upon the achievement of certain financial or development milestones.

Medtronic said it will purchase its initial equity investment for roughly HK$3.80 a share ($46.6 million). Medtronic will also purchase a $19.6 million convertible note representing an additional 7.4% equity on a fully-diluted post-conversion basis. The company will also have the opportunity to acquire additional convertible notes upon the achievement of certain revenue or development milestones.

An interesting point that Ishrak made is that while healthcare is controlled by the government in China, "almost 60% of Chinese healthcare is patient paid." The amount that the government pays is very basic. Additionally, the amount that the government will reimburse for healthcare varies from region to region. So some regions like in Eastern China, where richer cities like Beijing are located, set a higher rate. Conversely, the more rural parts of China "where they need healthcare even more" reimburse at substantially lower rates. In the next five years, the country has identified several disease states that it wants to treat fully, including diabetes and cardiovascular disease. "They've got a set of rules, and we're going to follow the rules."

Ishrak outlined a three-prong strategy for China, that includes selling existing technologies to people that can afford them; moving towards creating more of a presence in so-called tier 2 cities (often provincial capitals); and to start investing in value products.

The move towards investment in value products is particularly important because the Chinese government determines what a premium product is for reimbursement purposes. Thus, the heightened recent investment in Chinese companies. "What's important about the [Kanghui and LifeTech] investments is that this has given us a critical mass of skilled engineers who understand the Chinese patients. That expertise in a market that has a much larger population than in the West creates a platform for us that we think will be a long-term growth vehicle."

Contrast India with China. In India, as in China, about 60% of patients self-pay. Another 5% of patients have private insurance. Another 30% of patients are government-employed and reimbursed by the government for their healthcare expenses, with the remaining 5% being government funded patients below the poverty line.

The true muscle in India is the large private healthcare systems that have scale and are expanding rapidly into tier 2 cities in that country. "They are highly patient focused, highly competitive and cost conscious. This is driving a level of quality and cost in India which I think is in many ways ground-breaking."

Medtronic is working with hospitals throughout the country in partnerships "to create methods for patient identification and funneling them into the hospital."

Holland Johnson; 404-262-5540

holland.johnson@ahcmedia.com

No Comments