Wednesday, April 5, 2017

Porter's Five Forces in the context of Applied Medical

I was a full-time Process Engineer at Applied Medical in 2015. The company aims to make healthcare safer and more accessible through innovations and breakthroughs in manufacturing technology and instrument design.

From 2010 to 2015, Applied Medical increased its revenue from $387MM to $907MM, while more than doubling its full-time employee strength from 1351 to 2741 [1]. In 2015, Applied reported gross profits of $402.5MM or 44%, which was higher than those of similar-sized medical device companies (Covidien Ltd. had a profit margin below 25%) [2]. Applied is now the second largest provider of trocars in the US, and is responsible for 85% of the market share (by units) of hand access laparoscopic devices [3]. Using the "The Five Competitive Forces That Shape Strategy" described by Porter, we can see how Applied utilized the existing configuration of the medical device industry to carve out its niche [4].

Threat of new entrants: The medical device industry was an oligarchy between a few key players when Applied was founded back in 1987, partially due to lack of government involvement. New entrants faced a formidable cost to entry: relationships between medical device companies and insurance companies and hospitals were well established, complying with existing standards was challenging, and manufacturing equipment was expensive to setup and run.

Bargaining power of suppliers: Suppliers of manufacturing tools and materials were few in number and had contracts with incumbents that prevented newcomers from using the same production processes and materials. Additionally, users were pigeon-holed users to choose only between a few companies for certain types of devices.

Bargaining power of buyers: Insurance companies, hospitals, and large private practices had incentives to renew contracts and stick with their existing medical device provider. Moreover, buyers in this field did not want to risk using unproven suppliers and products.

Rivalry among competitors: Rivalry between existing competitors was not strong enough to drive prices down; instead, there more or less existed an oligarchy in which the few companies each produced specialized devices that for which they charged exorbitantly.

Threat of substitutes: Due to the large capital investment required for research and manufacturing, and the advantage of scale economy, the threat of substitute devices and suppliers was low.

So how did Applied Medical "stake out a position that was less vulnerable to attack and erosion" [5] ?Applied Medical first litigated for the federal government to limit the oligarchy in the industry. Even in 2015, they sued the fed for government-sanctioned overpricing of keyhole surgery clip guns [6]. Applied Medical vertically integrated the production process, bringing everything from raw material processing to injection molding to assembly and quality control in-house. To reduce R&D costs, Applied carefully imitated and modified existing designs without stealing intellectual property. Using efficient in-house production methods such as stamping, the company was then able to deliver comparable quality and specification at significantly lower costs. Lastly, by utilizing in-house training and focused engineering teams, Applied lowered labor costs and decreased the cycle time for their devices.

References:

[1] Applied Medical Resources: Inc Fact statistics. https://incfact.com/Premium/CompanyReport-5b6c55fa60ec82ebd83bfcd8c3aabc30.htm

[2] Google Finance: Covidien Ltd. https://www.google.com/finance?q=NYSE:COV&fstype=ii&ei=XKHkWLCEI8O2mQHLwLHoCg

[3] Facility Expansion: Applied Medical Adds Technology and Development Facility. http://www.appliedmedical.com/NewsEvents/News.aspx?pid=0

[4] Porter, M., The Five Competitive Forces That Shape Strategy. Harvard Business Review, January 2008

[5] Competitor Analysis: Understand Your Opponents. Harvard Business School Press, ISBN-10: 1-4221-0257-2

[6] Applied Medical sues federal government over price of keyhole surgery clip guns. Financial Review. http://www.afr.com/business/legal/applied-medical-sues-federal-government-over-price-of-keyhole-surgery-clip-guns-20150427-1mu56k

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