Time To Innovate: Ensuring A Future Without The Medical Device Tax

By Eileen Sullivan-Scully, LZ Lifescience

Medical Device companies in the U.S. celebrated a victory when the medical device tax was suspended in December 2015. The 2.3 percent tax on sales, which went into effect in January 2013, raised $913 million in the first half of that year to help fund the Patient Protection and Affordable Care Act (PPACA), colloquially known as ObamaCare.

Some believe the burden imposed on medtech by the tax placed innovation in the industry in decline, with a particular impact on smaller and mid-sized medical device companies. As the industry continues its two-year journey free from the tax, we’ll review the appetite for technology in a reinvigorated industry, as well as examine the tax’s future.

Suspension of the medical device tax was not a long-term remedy, rather a temporary reprieve and a step in the right direction for medical device manufacturers. Full repeal of the tax remains a top policy priority for the Pennsylvania Biotechnology Association (PBA) and the organization will continue to work toward this goal, according to Christopher P. Molineaux, president and CEO of PA Biotechnology.

In addition to extending the medical device tax suspension, the PBA proposes three additional ‘business-friendly’ tax provisions in its “extenders package.” The first aims to make the R&D tax credit permanent, another would enable start-ups to access the R&D tax credit, and a third would allow the R&D credit to again be claimed against the alternative minimum tax (AMT).

The Industry Impact

One of the biggest impacts of the medical device tax on the industry has been its evisceration of the funding necessary to drive innovation and fuel growth in the sector. For many medical device manufacturers, the tax’s added burden took away any incentive to install new technologies, such as automation software, artificial intelligence (AI), or robotics. Perhaps ironically, such technologies have the potential to bring great time and cost savings to the industry.

In addition, many companies viewed the tax as a severe financial drain and delayed hiring additional employees to keep costs manageable. In some cases, the tax was blamed for substantial job losses. For example, a survey by the Medical Device Manufacturers Association (MDMA) found that three-quarters of companies slowed or halted hiring to pay the new tax. Another industry group, the Advanced Medical Technology Association (AdvaMed) warned that the tax has cost the US as many as 39,000 jobs.

Within markets that service the medical device sector, a ripple effect was experienced after the tax’s implementation. For example, many service and product vendor markets slowed down, because potential clients could not justify updating their manufacturing processes and systems at a time when they were being subjected to higher taxes. The negative effects of the tax reached global markets, too, affecting international service vendors and product providers.

Now, as we pass six months since the tax suspension, there already are signs that medical device manufacturers are rebounding and taking advantage of the opportunities afforded by the two-year tax break:

1. Adoption Of New Technologies

Small and mid-sized companies now are able to invest in infrastructure and R&D to fuel innovation. Not only are they generating efficiencies and improving manufacturing processes, they are demonstrating to the government that the tax break has enabled them to invest in and improve their operations.

It’s important to remember that medical device manufacturers must deliver their products to precise parameters in an increasingly competitive market. The adoption of technology is helping to improve efficiencies, reduce errors, and support compliance in a highly regulated environment. For example, manufacturing execution system (MES) software can help manufacturers to manage and monitor their operations in real-time. As a result, MES solutions are being adopted by the life science industry at a faster rate than any other vertical market (Strategic Analysis of the Global MES Market, Frost & Sullivan). With the greater financial freedom owed to the tax break, this is expected to continue.

2. Continued Shift In The Medical Device Landscape

As medical device firms start to free up funds, we expect to see more M&A activity. Larger firms are likely to invest in smaller companies in order to expand their own offerings and provide specialist services. A recent report, entitled Profiling the Top Mergers and Acquisition Within Medical Devices Space, states that a considerable number of deals in 2014-15 involved larger companies acquiring smaller companies that had created novel technologies proven to be superior to existing solutions.

We expect the industry to move further and faster in this direction as manufacturers recognise the value in providing a “one-stop shop” service model. Companies that expand their capabilities in this manner can achieve a competitive advantage and greater bargaining power.

In addition, as the healthcare landscape continues to evolve toward more patient care being delivered outside of hospitals, medical device manufacturers are increasingly looking to for opportunities to provide products that enable home and long-term care by “layman” caregivers. This can be achieved by acquiring the necessary capabilities through M&A, or by forming partnerships with complementary organisations.

3. Global Collaboration

The tax break also presents the opportunity for more global collaboration. U.S.-based medical device companies can again reach out globally to take advantage of the many innovations the industry offers. Countless global markets who do business in the U.S. will witness more products and services moving, thus creating more opportunities for growth.

4. Greater Focus On Outsourcing

The fact that uncertainty remains over whether the two-year suspension will be extended (or abolished altogether) creates a barrier to employing full-time staff. As a result, we expect to see increases in outsourcing and the use of consultants as companies use extra funds to fuel innovation, access specialist expertise, and improve manufacturing processes. The resulting cost savings, along with any R&D tax credit, may create opportunities to grow in-house teams in the longer term.

Winning The Tax War

The big question now is, “how can medical device companies ensure the tax suspension continues?” The industry must be able to demonstrate that it has been able to use the tax suspension to innovate and grow in order to avoid the tax’s reinstatement. The ability to show results will be paramount, creating a need for more efficient online reporting.

About The Author

Eileen Sullivan-Scully is a manufacturing execution software sales executive at LZ Lifescience.