Soapbox

Crucial Metrics for Medical Device Manufacturers: Contract Profitability (Part 1)

By Shawn LaRocco
March 16, 2021


• Categories: 02-MedTech Economics, 03-Manufacturing Execution, 04-Product Design & Development, Soapbox

I have been in the medical device service business for more than 20 years, and most of those years have been spent in leadership roles for companies that generate multi-billions of dollars in service revenue. Over the course of those years the conversation has evolved from following quality-related metrics like parts per million (PPM) and defect rates to understanding the cost to service a product and contract profitability down to a customer and asset level. No matter the company size or the metric in question, analyzing the data for your chosen metric in real time often does not come easy. It’s difficult to measure profitability with poor data.

This two-part series takes a look at why real-time, accurate data is crucial, and the two metrics—contract profitability and cost-to-serve—that are crucial for medical device companies to prioritize.

Why Is Real-Time Data So Crucial?

As a service leader, I’ve seen it take more than two months to analyze data for one metric. It doesn’t take long to pull mountains of data—most companies are already sitting on all the data they need to perform value added analysis. Analyses become inefficient once you factor in the time it takes to comb through the data, clean it, scrub it and format it. Even then, you often don’t have a complete picture, and by the time you do get what you need, many executives find themselves asking if the data is even relevant anymore. Is it going to provide you the insights you need to make meaningful decisions, or has it taken so long that you can no longer be proactive, but find yourself now in a reactive state?

For example, let’s say a medical device company released a new surgical product two years ago. The installed base (IB) is growing and there is a healthy amount of product IB on warranty being converted to a service contract post warranty. The company’s ability to run a real-time analysis on two key metrics related to the product—contract profitability and cost to serve—will be crucial to understanding and maintaining customer satisfaction and driving business decisions. These two metrics will answer questions about the product’s performance and how much is being spent to support the asset and allow the manufacturer to catch a failure trend in a certain facet of the product or determine if the cost of quality is impeding on the revenue and growth projections of the business.

The ability to answer these questions in real time allows the business to react proactively and course correct before a situation ends up costing the business and impacting the customer, resulting in lost sales, trust and confidence. I’ve seen scenarios like this too many times to count, which is why I advocate that the medical device customers I work with prioritize and understand contract profitability and cost-to-serve.

What is Contract Profitability?

Contract margin analysis is especially important for the service business. Contract margin and profitability analysis have a direct link to cost to serve analysis. They complement each other and together tell a powerful story. Service organizations rely on contract sales to lock in revenue and drive healthy margins, and in most cases contract sales are the largest contributor to the top line (parts and time and materials are the other two, often smaller, revenue streams). Each contract must be managed from a cost perspective, and the total pool of contracts must maintain a target margin for the overall service business. There will always be outliers that will be less than desirable from a margin perspective and the rest of the pool will pull those losses up, however they should be just that…outliers. The service business needs visibility into all contracts down to the customer level to truly manage the health of the contract.

Understanding the health of the contract allows a medical device manufacturer to achieve the following:

• Identify pricing gaps. As you slice the data you will uncover at least two areas where you can determine if your price points are hitting the mark. The first area is on the contract pricing itself. If the failure trends are not out of the norm and cost to serve is accurate, but you are losing margin on the contracts as a whole then you may want to look at your contract pricing. Your pricing may not be set up to support the product and the obligations in the contract appropriately. Second is spare part pricing. You will be able to slice the data and get down to component level performance and spare part usage. Here you can determine if it’s the parts and possibly the quality of your parts that are pulling your contract margins down. This can trigger a quality investigation or even a supply chain and vendor investigation.
• Flag quality trends. Here you can flag quality declines or spikes in failure on both the parent asset as well as child asset. You can also drill down to identify component failure trends to see if a particular part or consumable is causing the spike in failures.
• Trigger End of Life (EOL) and End of Service Life (EOSL). Watch your assets over their life and proactively identify based on failure trending a more accurate time to call EOL on the product. Visual management and having real time data will give you a much more accurate way to proactively establish EOL and EOSL.
• Escalate product issues that are uneconomical to repair and pull sales in to offer an upgrade/replacement plan. Control service costs, customer experience, and drive growth by having the data at your fingertips to have a conversation with your customer about when it is time to upgrade to a new asset. Not doing this proactively and with the facts at hand will cause decline in margin, decline in customer satisfaction and decline in market share if the experience pushes them to a competitor.
• Trigger customer escalations. Get proactive by having the data real time and at your fingertips. Identify failures down to the account and asset level to head off any unplanned outages that will impede on a customer and patient experience. Set proactive flags to know when an asset at an account is not performing and rally the team to get in there and correct the situation. It is always easier to fix a machine that is not performing then a customer who has lost confidence in both your product and your ability to support it.

What Are the Benefits of Knowing Contract Margin?

A medical device manufacturer that knows its contract margins can control pricing, leakages and concessions. Service businesses have a target margin they want to achieve, and if contract revenue is the biggest part of the pie, then that means it makes up the largest contribution to the margin. Hence, a manufacturer that is able to manage the margin of their contracts down to the product and customer level will be more proactive and make more informed decisions to manage their business.

Like cost-to-serve, which I will detail in the next article, contract profitability requires real-time visibility into assets so medical device manufacturers can understand how their customer contracts are performing and make decisions proactively rather than reactively. If a manufacturer’s contract margin is causing the business pain, then the product under contract is more than likely causing the end customer pain. If a manufacturer relies on their capital assets to generate pull through revenue from consumables, the pain is felt by the OEM from a revenue/margin perspective and productivity/financial hindrance from the customer side. As services become more outcome based and shared risk, the overall performance has a ripple effect for both the OEM and customer. Having this data at the manufacturers’ fingertips in real time allows the organization to take the actions needed to ensure their customer is taken care of and customer excellence is maintained before issues escalate and become costly for both manufacturer and customer.