No space in the middle

No space in the middle

It’s no secret that the conventional blood glucose monitoring (BGM) market has undergone dramatic change these past few years. As this market has fully transformed itself into a true commodity market companies in the market have struggled to maintain reasonable margins. The initial reaction by most of the major players has been to cut costs sometimes with reckless abandon. Gone are huge expensive sales teams, no more free meters, miniscule marketing budgets and deep cuts to R&D.

Today there are basically two ways for a major player to grow, either steal patients from the competition, i.e. covert them from a competing product to their own, or get their installed user base to test more frequently. These are efforts are complicated by the fact that the majority of patients use a system endorsed by their health insurance plan. It’s not an overstatement to say that formulary placement is the most critical factor when it comes to determining market share. Universally all the major players have tried to offset less than favorable formulary placement through the use of co-pay equalization programs, programs which add to costs and crimps margins.

To date most of the major players have also been unsuccessful at what Diabetic Investor considers the low hanging fruit for growth, namely getting their existing patients to test more frequently. Think of it this way, say a company has an installed user base of 1 million patients and just 30% of that base tests their glucose just one more time per day. That’s an immediate 30% increase in strip usage. The issue has always been how a company can cost effectively convince their existing patients to test more.

It should surprise no one that Diabetic Investor has always maintained that patient education is the answer. That there are hundreds of studies which prove that educated patients test their glucose levels more frequently and it doesn’t matter whether they are Type 1 or Type 2. Even with this well documented evidence that education is not just good for patients but also good for business, until recently companies have been resistant to spend capital on patient education.

While these efforts in patient education are just getting off the ground Diabetic Investor is aware of at least two major players in the BGM space who are considering another alternative for increasing margins. At the moment the vast majority of patients refill their prescriptions at their local pharmacy, either physically picking up their refills or having them sent through the mail.  However some of the major players are seriously considering eliminating the middle man and selling strips directly to patients. This tactic is currently employed by TelCare and iHealth; ironically both companies are employing cloud based technology to make this process very easy for the patient.

Basically TelCare, iHealth have taken a page from the insulin pump playbook. As we have noted the goose that lays the golden eggs for Medtronic (NYSE:MDT) is not the sale of new systems rather the continual sales of pump supplies; supplies which for Medtronic are automatically shipped to over 70% of their patients and paid for by the patients insurance. Well with either the TelCare or iHealth system the reorder process could be further simplified and actually require no patient interaction at all. These systems know how many strips a patient uses and could be programed to automatically send more strips after a pre-determined number of tests. Just as Medtronic bills the insurance company for pump supplies, TelCare and iHealth can do the same for test strips.

Think what a system like this would mean for a company like Johnson and Johnson (NYSE:JNJ), Roche, Abbott (NYSE:ABT) and yes even Bayer. Companies who have scale and broad formulary coverage, companies who have are moving their patients to systems which communicate with the cloud.

Considering that none of the majors have been able to unload their glucose monitoring units and have run out of areas where they can cut costs, this move towards eliminating the middle man is a logical next step.  Heck this just might the only way these companies can survive for as sure as football begins tonight so it’s true that market conditions will not improve. Diabetic Investor would actually argue market conditions will get even worse especially as the FDA moves towards new rules asking for even greater meter accuracy; a move which once again increases cost at time when price continue to come under pressure.

The fact is the major players are being squeezed from all sides. Even though the BGM market seems headed for the toilet, new players continue to enter the market. Although these newbies have yet to steal major share from the majors they are chipping away and in today’s market every share point counts. As noted above the FDA will soon seek greater accuracy for the systems these companies make. Competitive bidding isn’t going away and private payors will remain relentless in their pursuit to drive costs even lower. Payors who are already passing a greater share of this cost to patients through higher co-payments which limits growth even more. Diabetic Investor believes it’s just a matter of time payors stop reimbursing for test strips for non-insulin using patients; already we have seen payors place greater restrictions on how many strips they will reimburse for. And did we mention that …wait for it… generic test strips are on the way.

The final act of capitulation will come not with the traditional consolidation of players, as this isn’t possible for several reasons the biggest being there really isn’t much cost savings should JNJ say buy Abbott’s BGM unit. There would be some limited back office savings but that’s about it. No Diabetic Investor sees the final act beginning with Roche spinning off their diabetes devices unit and the remaining players plodding along until one or more them say enough is enough shutting the units down completely. Our current betting line places Bayer as the most likely to be the first to surrender.

For anyone who doubts this scenario we suggest taking a look at the personal computer market, a market once filled with profitable companies, which then consolidated and now consists primarily of a handful of players. Well the BGM market is headed that way as the Big Four will soon be the Big One, the minor two and everyone else. With Bayer likely to sink into the abyss that leaves it to Roche and Abbott to battle for the number two position behind JNJ.

There was time when BGM was a great business, filled with great ideas, great products and great people …thanks for the memories.