The drumbeat continues

The drumbeat continues

Diabetic Investor has learned that Abbott (NYSE:ABT) has once again swung the layoff ax eliminating 100 or so positions in their troubled glucose monitoring unit. Speculation within the company is that this is just the first round of cuts and more are coming. Whether this speculation turns into fact really doesn’t matter as one thing is crystal clear, the end of BGM as we know it is quickly approaching.  The harsh reality is the current crop of BGM companies just cannot come up with any new ideas or strategies to deal with the impact of competitive bidding and its corresponding fallout.  With nothing new in their bags they resort to the tried and true tactic of when all else fails cut costs.

Now Diabetic Investor isn’t saying that BGM shouldn’t align their costs with the existing environment, what we are saying is no company can cut their way to growth.  Abbott in some respects is a poster child for what’s wrong with BGM. Here we are just days after they launched their latest whiz bang way cool meter and the layoffs begin.  Like so many in this space Abbott is missing the point, new technology no matter how cool is the answer to their problems.  Basically Abbott is throwing in the towel and will milk their existing patient base for all it’s worth until they find another company to take this unit off their hands.

As we have pointed out on numerous occasions while the margins in BGM are no longer obscene, the margins aren’t razor thin by any stretch. Medicare is reimbursing $10.41 for a box of 50 test strips which comes to 21 cents per test strip. Based on knowledge of the industry Diabetic Investor would peg the cost to make each strip at less than 10 cents, add in another 3 cents for sales, marketing and distribution costs which makes the all in cost 13 cents per strip. Using some very simple math that means even at the new lower Medicare reimbursement rate a company can still make 8 cents per strip, or about $4 for a box of 50 strips. Granted this is not  what the BGM companies are used to but it’s still a respectable margin IF and this is a huge IF the company has a strategy that goes beyond cutting costs.

To prove this point consider the following scenario; let’s assume for the moment that Abbott has an installed user base of 2 million patients. Let’s further assume that they increased testing frequency by just one strip per day for 20% of their installed base, or 400,000 patients. That translates into an additional 146 million test strip sold each year or nearly 3 million boxes of 50 test strips (2,920,000 to be exact). Assuming our math is correct and they make $4 per box that translates into $11,680,000 of additional profit and that’s without adding one more user to their existing patient base. Even if Diabetic Investor is off on our math and they are only making $2 per box that translates into nearly $5 million of profit.

The fact is BGM companies had it easy back when reimbursement was over $32 per box and all they had to do to increase usage was to launch a new whiz bang meter. Actually they weren’t increasing test strip usage as average testing frequency hasn’t changed in the last 15 years. Back in the day the market was expanding not contracting like it is today, so launching a new system was an easy way to capture a share of what was a growing market.  Some companies like LifeScan, realized that the final step to having the ultimate cash cow was to obtain prime formulary position.  Needless to say back in the day BGM was like owning a cash station.

Given the amount of time we have devoted to this subject it is not necessary to once again review just how much the market has changed. The fact is while it was obvious to everyone else that this cash cow would eventually run dry, all the major BGM companies couldn’t or wouldn’t acknowledge the market was transforming.  This is not unlike Microsoft failing to understand the transformation for PC to mobile computing or the major television networks failing to see the threat from cable TV.  However unlike Microsoft or the major TV networks, who have transformed themselves to deal with these changes, the BGM companies are stuck on one path and one path only, cut costs.  This is not the path to redemption as it only deals with one side of the equation.

The questions all the BGM companies are ignoring are what will happen when there are no more costs to be cut. Or put another way what can they do to increase strip usage within their existing base or take share away from a competitor. Based on what we have seen to date the only bullets they have in their guns have been fired and they are now out of ammo.

So look for this drumbeat of layoffs and cost cuts to continue.  A sad tune indeed.