Which model will work going forward?

Which model will work going forward?

There is a debate going on in the glucose monitoring market over which business model makes the most sense. One school of thought believes that the market cannot be saved, prices will continue to fall and scale is the key is to success. Others believe that while the market for Type 2 or non-insulin using patients is beyond repair, new technology can drive insulin using patients to test more frequently but remain brand loyal. There is yet another group, albeit a small one, who believes the entire market, can be reinvigorated and growth can return to double digit rates, these folks also believe advanced technology will make the difference the main difference here is they see a broader application of the technology beyond insulin using patients.

Besides having different beliefs about what the future will look like, each group also has a distinctly different business models. Looking at the current crop of the major branded players – LifeScan- Bayer- Roche and Abbott (NYSE:ABT) – they all fall into the first group. Call it the benefit of experience or lack of vision; these companies have cut costs to the bone in a desperate attempt to maintain margins. This is one reason there is so much speculation that Bayer will soon buy Abbott, members of this group understand that glucose monitoring is just as much about scale as it is about technology, actually more so.  As the market stands today under the current reimbursement system it’s hard to argue with this belief, the only way to increase revenues and/or margins is to sell more strips. Given that market growth has fallen to low single digits about the only way to increase share in a significant way is to buy share. Given the way the market is structured where these four players control nearly 90% of all test strips sold, the only way they can bigger is to buy a rival. Considering that LifeScan is the current market leader it would be difficult for the company to buy any of their rivals, while such a move is financially possible Diabetic Investor doubts such a move would make it past antitrust concerns.

In the second group is a host of BGM newcomers, Sanofi (NYSE:SNY). General Electric (NYSE:GE) and Telcare. These companies see the reimbursement environment changing where strip sales are only part of the revenue stream. They believe that one day physicians and/or managed care plans will be compensated for producing better patient outcomes. This is why each in their own way is driving towards becoming a leader in the trend towards interconnected diabetes management; as they believe that once physicians are compensated for producing better patient outcomes they will embrace these systems as it will ultimately help them better manage their patients with diabetes. The same theory applies to insurers, managed care providers and pharmacy benefit managers as they too in theory would embrace and actively promote interconnected systems.

In one respect Sanofi is unique as they also see BGM as another avenue to sell more Lantus and/or Apidra. Of all the companies in the race to provide an interconnected diabetes system, Sanofi at this point is the only player who has all the components so that a physician would no longer prescribe each individual component rather a complete diabetes management system that contains the patient’s drugs, devices and disease management. Their first device the iBGStar ™ is just the beginning, as they will soon have an insulin pen and pump that also communicate with their iPhone app, which ultimately will expand beyond the just iPhone users but include the Android operating system too.

Considering the current reimbursement environment Diabetic Investor believes for members of this group scale is needed to help bridge the gap between where things stand today and where things will be 5 or 10 years from today. The fact is while the future of diabetes management may be with interconnected systems, that is the future and no one is quite sure just when the future will arrive. Without scale it’s doubtful that any of these BGM newcomers, no matter how much capital they have or how advanced their technology may be, could survive or even compete without scale. What many forget is that BGM is mature, well established market with deeply entrenched players who will  do whatever it takes to protect their turf, or put another way BGM can be and quite frankly is; a dirty and often times cutthroat business not for the faint of heart.

The harsh reality is that Sanofi and GE must buy scale if their dreams are ever to become reality, a quite different scenario than Telcare who is more likely to be acquired by a major player as they would see the Telcare platform as a way to compete against Sanofi and GE. This is one reason Diabetic Investor remains skeptical that Bayer will actually buy Abbott, that’s not to say that buying Abbott would not help Bayer rather that Abbott could likely command a higher multiple selling to either Sanofi or GE. Even though Abbott has done their best to run this division into the ground and has made more than their fair share of mistakes, the fact remains that it’s still a valuable property given that the FreeStyle line is very popular with insulin using patients, the exact patient population everyone wants.

The real loser here is Roche the number one player on a global basis. Like LifeScan, they are too big themselves to acquire a rival, yet unlike LifeScan their patient base does not fit well within the future of BGM. While there may be some who believe that the entire BGM market both Type 1 and Type 2 can be reinvigorated and once again see double digit growth, Diabetic Investor believes this is pure fantasy. The simple fact is the Big Four did a pretty good job of screwing things up and there really is no way this damage can be repaired. When the future comes and people look back they will likely say the BGM became doomed once the players allowed it to become a commodity market where price not performance or value mattered.

Truth be told, the beginning of end began way back when Bayer decided to give away meters for free. While everyone in the BGM market knew the real technology was in the test strip and not the meter, the consumer believed the exact opposite. With meters given away freely it created the impression in the patient’s mind that there was little value in testing. Combine this with fact that patients were never educated as to what these test results mean or how they could use them to better manage their diabetes; the market was doomed to fail.

Diabetic Investor continues to believe that while the players in BGM will change, the market itself won’t. To Diabetic Investor the BGM market is like a baseball team who brings in a new manager, builds a fancy new stadium and comes up with slick new uniforms but fails to add the most important element for a winning team, players who can play baseball. The look and feel of the team may be different but unfortunately for the fans the results will be the same, another season of wait until next year.