What Medical Device Embedded Developers and Vendors Need to Know About Obamacare

Medical device companies and embedded vendors that sell to this market segment are facing, depending on the outcome of the 2012 presidential election, a huge downturn in this market segment. Unless Romney is elected president and the Republicans get control of the senate, the provision of the Obamacare (Affordable Care Act) tax on medical device manufactures will have significant repercussions. It is ulikely that this tax will be overturned if the current makeup of congress and the white house remains in 2013.

Especially hard hit could be the hundreds of small companies developing medical software applications. Many of these apps can significantly impact and enhance the practice of medicine. The IRS is deciding now whether to treat apps as medical devices subject to the tax – somehow I don’t find comfort in the potential outcome.

As a result of the looming device tax, many medical manufacturer companies are moving production overseas, good jobs are going to Europe and Asia, and many cutting-edge medical devices will now be produced elsewhere for import into the U.S. It would be irresponsible for CEOs to wait until after the election and the seating of the new congress to not take appropriate actions to protect their company.

Therefore the impact of the Obamacare tax may cause irreparable disruptions. Embedded vendors will need to re-strategize their sales efforts and offerings to the medical device segment. Vendors will need to show:

  • That the use of their tools, operating systems, processors, etc. will result in a lower development cost (data based)
  • That these will result in products being shipped earlier meeting targeted windows of opportunity (again supported by data)
  • That such tools, OSes, etc., will be reusable for future designs and developments

 A 2.3% tax will be charged to medical device manufacturers on each sale (not on profits) and will take effect in January 2013. Given that many medical device manufacturers operate on an average 4.5% profit margin, this tax will force manufacturers to reduce employment and cut R&D and many development programs. For a typical company, a 2.3% tax on sales revenue equals a 15% tax on profits. When combined with a 35% corporate tax and state corporate taxes, the tax rate for the medical-device industry may exceed 50% in most jurisdictions. Many marginally profitable businesses will find themselves in a financially difficult position, since they’ll have to pay the Obamacare excise tax whether they are making money or not. This will certainly curtail employment as well as the purchase of needed embedded products and technologies – one can’t afford much when they are being driven out of business. Estimates are that $30 billion in annual costs must be cut by manufacturersto meet the expected tax increase as a result of the Obamacare tax on medical devices.

The 2.3% tax on medical-device sales, not profits, was imposed by the Democratic controlled congress and the Obama administration under the theory that sales by medical-device companies would surge after patients newly insured by the Affordable Care Act poured into the system. What the industry lost in margins, it was supposed to make up in greater volume.

That calculation ignored the fact that the vast majority of medical-device consumers already are covered by Medicare, Medicaid or private insurance. So there will be little or no increase in sales volume to offset the added cost of $30 billion—according to the Congressional Budget Office—to the industry. This tax comes straight out of a company’s bottom line. Because many devices are sold to hospitals, physicians and other providers through multiyear contracts, the prices are already locked in, so the tax cannot be passed on to the buyer. This was borne out by the Massachusetts healthcare initiative (currently called Romneycare) wherein there was no increase in medical device sales in Massachusetts notwithstanding that having 100% of the population covered.

Many U.S. device companies, in response, have already announced layoffs, canceled plans for domestic expansion and slashed research-and-development budgets. There will certainly be more.

The medical-device industry has been a great American success story. America is the global leader in medical-device production and sales. Last year the U.S. device industry enjoyed a net $5 billion more in exports than was spent on medical device imports.  This tax threatens to cripple this US dominated marketplace. In Massachusetts alone, the medical device industry employs, directly or indirectly, more than 400,000 people. Nationwide the numbers are in the millions. And according to a Pew Foundation report, compensation is 25% higher for medical device workers than for the national average.

The challenges to the embedded marketplace will require new and strategic innovations. As an entrepreneur who built and took two medical device companies public, I’m shocked by the lack of attention by embedded vendors to this crisis situation and to what they need to do to address these issues and to become more competitive.

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