Will a new tax drive medical device firms away from the U.S.?
ccording to Michael E. Porter's Cluster Mapping Project at the Institute for Strategy and Competitiveness at Harvard Business School, medical devices were one of only nine industry clusters to create a net positive total of jobs between 2005 and 2010, creating 11,011 jobs in the U.S. even as the overall net change in jobs during that span was down by more than 1.9 million positions.
In other words, the perfect time to impose a new tax on the industry.
Specifically, it's on the industry's products: a 2.3- percent excise tax went into effect Jan. 1, 2013, as part of the Affordable Care Act. Various branches of the industry have complained of the burden, though Obama administration officials deflect the criticism by calling attention to the 30 million new customers the ACA is bringing them.
The just-released Jones Lang LaSalle 2012 Global Life Sciences Cluster report notes that medical devices are prominent in some of the top-ranked clusters, including No. 1 Greater Boston, No. 7 New York/New Jersey, No. 8 Los Angeles/Orange County (which recently has welcomed leases or coming expansions from such firms as Alcon and Masimo Medical), No. 12 Chicago, No. 17 Southern Wisconsin and No. 18 Florida, where a medical device cluster is just emerging in the Jacksonville region, says JLL.
No. 9 Minneapolis is known for the prominence of HQs or major operations from major medical device manufacturers such as Medtronic, St. Jude Medical, Smiths Medical and Boston Scientific. Even before the new tax became reality, it was on those companies' radar, says the JLL report:
"Consolidation of space has been common among some of the larger medical device firms in the last year," said the report. "Medtronic vacated 100,000 square feet of office and lab space in the Northeast submarket in late 2011 and Boston Scientific is consolidating its space in the Twin Cities after its acquisition of Atritech in early 2011. Currently Boston Scientific has a combined 125,000 square feet of space for lease in two buildings: 25,000 square feet in the Northwest submarket and 100,000 square feet in the Northeast submarket. Cheaper manufacturing options overseas, uncertainty in the current U.S. Food and Drug Administration (FDA) approval process and the potential for a new medical device tax are significant factors contributing to the current landscape."
A last-ditch effort in December by elected officials in Washington to delay the tax's implementation was unsuccessful. It applies to all medical devices regulated by the FDA that are not retail, and the first installment is due late this month. A typical criticism was aired in early January by Rep. Bob Latta (R-Ohio) in a column in The Hill:
"A 2.3 percent excise tax will be devastating to the medical device industry, threatening to stifle innovation and the creation of American jobs," he wrote. "Combined with a 35-percent corporate tax rate, state and local taxes, and the 2.3-percent tax on its sales, not profits, many medical device manufacturers are faced with a severe tax hike. As a result, companies are looking at a host of options to offset this tax in order to remain competitive and profitable, including increased consumer prices, relocating business to overseas where tax rates are much lower, and layoffs."
Critical Mass Softens Blow
Latta went on to cite a Reuters report that publicly traded medical technology companies cut approximately 7,000 American jobs in 2012, and an AdvaMed survey conducted in late December that reported 62 percent of companies surveyed said they are planning layoffs or reduced hiring to help offset the tax.
Just how influential will the new tax be when it comes to location investment decision-making? One expert says it will influence small firms the most.
"They don't' have the portfolio of production to spread the costs around," says Matt Szuhaj, director, strategy & operations, for Deloitte Consulting, and a life sciences specialist. "The conventional wisdom is, where these companies can, they'll pass along the price of this tax. More product in more markets means more potential to spread the cost around."
But if you're a smaller company, in Florida, with one or two commercial products, it's a much narrower channel, and there's less opportunity to mitigate the cost.
"If you go offshore to Costa Rica to manufacture, but still sell into the U.S., you'll still be levied the tax," he reiterates. "If you can go to Costa Rica and realize a huge cost savings, so you're managing margin by removing costs, it may drive some offshore investment, but then you have extended supply chain, quality issues … all the things that come from taking things offshore."
So, yes, says Szuhaj, there is potential for companies to move because they need to offset the cost, but the effort is substantial, "and the cost savings involved may not be large enough to make you do it." That's especially true of small companies with limited technology transfer resources.
As for the large firms, "it's not as big a concern for big companies," he says. "Will it drive people offshore en masse? I'm doubtful. Some larger companies may shift production around. The easiest lever to pull is recovering some of the cost through pricing."
The Shift Is On
Szuhaj acknowledges the fundamental shift all companies will have to deal with as a result of the ACA, as margins come down and, according to the plan, volume rises when those 30 million people come on board in 2014. He also says history shows that legislated regulatory change for a sector usually leads to consolidation.
But there's a bigger context beyond the ACA, as state formularies determine new reimbursement formulas, and another fundamental shift occurs in healthcare in the move from emergent care to a more vertically integrated model focused on preventative care and wellness. Ultimately manufacturers will re-evaluate how they distribute product, as aggregated payer-providers emerge, the direct-to-consumer option begs for consideration, and practitioners align themselves with hospital systems.
Because of the cadence of the ACA's implementation, says Szuhaj, "it will really have an impact first on the payers. Then that has a trickle-down effect to the providers. Then eventually it will have an impact on how the manufacturers are structured," with a turn toward more of a generics market.
As for direct impacts of the ACA on business, "people were always looking at growth outside the U.S.," says Szuhaj, but the new law "definitely has reinvigorated the emphasis on emerging markets." But margins are reduced in places like Brazil and India too, "because it's by and large socialize medicine," he points out. "It's power buying. But if the country where I made the biggest margin — the United States — is going to reduce my margin, I have to replace that revenue."
But one little-discussed potential bright spot is on the horizon, he says.
"Right now it takes quite a bit of time to get an approval from the FDA — 180 days if everything goes perfect," he says. Again, delays like that can hurt smaller companies much more than large firms. But the new medical device excise tax is in part supposed to subsidize additional resources for the FDA. And more resources are intended to lead to faster approvals.
"So there may be a long term benefit," he says. "It depends on how they use the money, and if they do what they're saying they're going to do."