HDI and Bayer Report
Listening to the fourth quarter and 2008 full year results for both Home Diagnostics (NSADAQ:HDIX) and Bayer, both of whom who reported this morning, it’s becoming clear that the blood glucose monitoring market is in the midst of a cataclysmic change, but not for the reasons Diabetic Investor had previously anticipated. Like the other players in the market both HDI and Bayer are experiencing tough market conditions. Pricing pressure continues while demand slows.
Looking towards the future Diabetic Investor had previously believed that the industry’s reliance on new technology to drive growth was a major mistake as there were already too many monitors on the market that basically did the same thing. We reasoned that with pricing pressure intensifying that these companies could no longer afford to ignore the fact that the majority of patients don’t value the information provided by their monitors. With demand slowing Diabetic Investor thought BGM companies would finally wake up and begin educating patients as to why they should be regularly monitoring their glucose levels.
Yet after looking over the results for 2008 and listening to the various companies conference calls it’s quite clear the majority of BGM companies just don’t get it. Instead of adapting to changing market conditions they are following old strategies that will merely delay their day of reckoning.
Years ago Diabetic Investor believed that with the BGM transitioning to a commodity market where price is the primary driver companies like HDI would gain share. We reasoned that since the majority of monitors did exactly the same thing that retailers, insurers and mail order companies would transition their patients into cheaper co-branded monitors. Monitors that carried a higher profit margin and more closely tied the patient to the seller rather than the particular monitor brand.
Liberty Medical was the first company to successfully implement a successful co-branding strategy. Liberty correctly understood that the majority of patients really didn’t care which monitor they used as long as the product was approved by the FDA. They understood that their customers valued the Liberty brand name more than the many branded monitors available. Finally they knew with their huge patient base even if their co-branded was unsuccessful the mere presence of such a product would allow them to squeeze better pricing from the name brands who desperately needed Liberty’s market share.
Diabetic Investor believed it was only a matter of time before retailers such as Walgreens (NYSE:WAG) and CVS (NYSE:CVS) followed Liberty’s example and began pushing their co-branded monitors.
As it turns out Diabetic Investor was once again well ahead of everyone predicting the future. However, the reason for this change has little to do with this over-reliance on technology and more to do with the dismal economy. With branded test strips costing nearly twice as much as co-branded products retailers, insurers and mail order companies are gaining the upper hand basically forcing companies to lower their prices to remain competitive. With companies like HDI and AgaMatrix around they know they can offer their customers a high quality state of the art monitor that carries a higher profit margin under their own name.
As it turns out the sellers of monitors have awakened to the changing market conditions and are now controlling the market. Just as Liberty did years ago, they know that the Big Four desperately need them to sell their products and cannot afford to lose valuable market share in this intensely competitive environment. In effect they can force the Big Four to lower their prices. Wal Mart (NYSE:WMT) the world’s largest retailer is already moving to a one price fits all strategy. Walgreens, CVS and Rite-Aid (NYSE:RAD) are also aggressively pushing their co-branded monitors to boost margins.
This puts the major brands into an almost unwinnable situation. Either they capitulate to the demands for lower prices or risk being shut out of major distribution channels. As Diabetic Investor has been reporting this is the reason every member of the Big Four has restructured their business cutting costs anywhere they can. With their huge SG&A costs they cannot maintain margins and have no choice but to cut costs.
Given that most experts believe it will be some time before the economy recovers it’s difficult to imagine a scenario where the Big Four will regain control of the market. It’s already clear that the government will be seeking greater price concessions which will only make the problem worse. Just as the economy is stuck in a cycle of what seems like continual bad news the Big Four are facing an equally daunting series of bad news. They cannot simply launch a new monitor to make up for lost market share.
Nor can they ignore the demands made by insurers who can effectively control market share numbers with formulary placement and co-payment decisions.
As Diabetic Investor mentioned earlier this is the reason the Big Four will soon become the little three or the minor two. Consolidation is critical for survival. This is particularly true for Bayer who lacks the product depth to compete going forward. While Bayer has done an outstanding job of reinvigorating their BGM unit they are basically dependent in the success of their Contour monitor. Unlike LifeScan, a unit of Johnson and Johnson (NYSE:JNJ), who can spread their costs among a line of monitors who all use basically the same test strip, Bayer only carries two systems which use different test strip platforms.
LifeScan has the additional benefit of being a major player with insulin using patients, patients who on average monitoring their glucose levels more frequently. Looking back LifeScan’s decision to gain an exclusive agreement with Medtronic (NYSE:MDT) to supply monitors that communicate with Medtronic’s insulin pumps was brilliant. This is also the reason JNJ bought the Animas. Basically LifeScan monitors now communicate with 90% of the insulin pumps on the market. And when it comes to test strip usage insulin pump patients are the crème de la crème using on average eight test strips each day.
While Bayer also has an agreement with Medtronic it’s for the much smaller international pump market.
With Abbott (NYSE:ABT) and Roche floundering in the BGM market, the time is right for Bayer to strike a deal. As Diabetic Investor has said before Bayer buying Abbott’s diabetes device unit makes so much sense that it probably won’t happen.
Deal or no deal, it’s becoming clearer by the day that the light at the end of tunnel is a freight train and it’s headed straight for everyone with the possible exception of LifeScan. Given the comments made by Roche and Abbott both remain absolutely committed to turning a once large fortune into a small fortune. Bayer for their part has shown they have what it takes to succeed; the question now is will they take the necessary next step and remain a player in the market. The clock is ticking and time is running out, that light at the end of the tunnel is getting brighter.
