As we turn our attention from what happened at the conference to who can actually execute on what they said. The capital markets are speaking loud and clear that Dexcom was the big winner coming out of the show. Not really a surprise to us as we have said consistently that Dexcom besides having the best product on the market also has the best management team. Yet this talented team is in for a challenge as their main rival Abbott is racing to the bottom.
Now when we say a race to the bottom we are talking about price. Abbott’s strategy with Libre is very clear sell it for as cheap as possible. Hence the reason the company is investing heavily in new capacity. The truth is the CGM business isn’t that much different than the BGM business in that the more of these suckers you make the cheaper you make them for. Scale drives efficiencies, which in turn increases margins. Given that Libre is just a small part of Abbott overall the company can invest heavily in capacity expansion while at the same driving volume growth. Simply put Abbott will suffer short term pain on pricing to build share but will benefit over the long term as COGS come down.
The problem for Dexcom is not a strategy problem as Dexcom as well will likely increase capacity. The question for the company isn’t whether or not to do this but how much capacity do they add and where do they do it. Before we go any further let’s state emphatically this is the right to problem to have as it means demand is growing. Yet on the flip side unlike Abbott which does more than just CGM, that’s all the Dexcom does. Simply put they cannot spread the cost of this additional capacity over multiple product lines, the cost of this capacity expansion will directly impact their financial results.
We’re confident they can manage this additional cost and that the payoff will be there but the Street will pay attention.
This extra capacity also points to a much bigger problem for the competition. Medtronic, Senseonics and all the Dexcom wannabes are caught in a dangerous vortex. How do they cost effectively drive volume growth so they can compete on price. Medtronic is in the best position here for two reasons. First they have a built in large installed user base and like Abbott CGM is not the only product they make. Should they choose to do so Medtronic could follow Abbott to the bottom, suffer in the short-term while they build enough volume so the can eventually turn a profit.
As much as we believe that even the new Medtronic sensor is inferior to the Libre or Dexcom sensor payors don’t care about things like whether the system needs to be calibrated or not. Payors care about one thing and one thing only, money. Given Medtronic’s history in the pump business they could lose money on the sensor to protect the goose that lays the golden eggs. They could if they chose to do so go after Libre using price as weapon, build share thus forcing Dexcom to lower their price.
Senseonics has the biggest problem as the cost of the sensor is just one factor as the product must also be implanted in the patient which adds to the cost. Yes the company could eat this cost but that would crimp margins. What Senseonics must do is convince payors there system has a place in the CGM mix and while more expansive is worthy of reimbursement. Senseonics could pivot and follow what Medtronic did with pumps using value based contracting but this strategy has pitfalls not just because it requires lots of capital but also because like Dexcom all they do is sensors they cannot offset this cost anywhere else.
Now comes all the Dexcom wannabes who are faced with multiple problems as the established players continue to gobble up patients making gaining any traction in the market very difficult. Stop and think for a moment what these wannabes must do;
1. Get the damn thing to work.
2. Get the damn thing covered by payors.
3. Get the damn thing into the hands of as many patients as possible.
4. Have the ability to make the damn thing on a massive scale producing accurate and reliable sensors.
5. Turn a profit on the damn thing.
Way back in the day when BGM ruled the glucose monitoring world it was the same story. Back in the day LifeScan and Roche effectively controlled 80% of the BGM market forcing everyone else to fight for the 20%. Just as we have a plethora of Dexcom wannabes today back then we had an equal number of LifeScan wannabes. Just as today everyone says they are as good as Dexcom back then everyone said they were as good as LifeScan. And just as today none of the Dexcom wannabes have a clue as to how they make, market and support their toy should it get through the FDA, the LifeScan wannabes had the same problem.
During the conference we commented many times how astonished we were that the CGM market is commoditizing so much faster than the BGM market did. A main reason for this is that back in the day payors didn’t hold the keys to the kingdom in terms of patient access but once they figured that out it was only a matter of time before it became a race to the bottom for BGM. Many see competitive bidding as the reason the BGM market collapsed, while it certainly didn’t help matters any it was not the sole reason. The reality was the market was headed in this direction anyway and competitive bidding was just the final nail in the BGM coffin.
This is one reason we suspect that Dexcom, Abbott, Medtronic, Senseonics and everyone else will be forced to find new sources of revenue. That sensors once fully commoditized will not generate enough profit to support these franchises. Hence the reason for all the partnerships with insulin pump and/or connected pen companies. Just as Apple cannot depend on the sale of $1,000 iPhones, their main source of revenue today, neither can the sensor companies count of sensor revenue alone to keep them profitable. Just as Apple is looking to increase non-hardware related revenue, the sensor companies will do the same thing.
Here as well massive scale will separate the winners from the losers. Therefore it stands to reason that Dexcom, Abbott and perhaps Medtronic will be the only sensors companies still standing when this happens. Once scale is achieved they can offer ancillary services which will offered on monthly subscription basis i.e. Shave Club for Men.
Right now it’s one huge patient grab with Dexcom and Abbott doing the majority of the grabbing. But it would be foolish to ignore the longer term direction of this market. As Momma Kliff used to say it’s a trap to get caught up in what’s happening today for no mater who well you handle it the future will soon be here and if ill-prepared for that future you won’t have one. Abbott and Dexcom are not just playing for today but planning for the future which is just one more reason we see these two fighting it out for many years to come and that is not a bad thing for either company.