Could Implant Makers Lose Their Crutch?

There are very few markets in which multiple competitors selling similar goods can enjoy high margins and good pricing power while maintaining the ability to introduce slightly improved but relatively untested products at still higher price premiums. Now, imagine this happening without corporate collusion.

Orthopedic implant manufacturers have coexisted in such a dreamlike market, but I believe the dream is going to end.

My thesis is based on the argument that all their products are basically the same: It's all just metal. It comes in different shapes and sizes, different metals, and it may have different coatings, but in general, if I lined up all the products in front of an objective eye, there is a paucity of differentiation across the product lines.

While competition is certainly intense, it's not based on price. There are three interesting aspects of this market that have insulated it from normal price competition.

Whether replacing a hip or a knee, an orthopedic surgeon generally uses manufacturer-specific instruments to perform the procedure. This surgeon has been trained on a particular manufacturer's instruments by his mentor during residency, naturally establishing a high switching cost that is very difficult to overcome. Surgeons are loath to go through a retraining process, which means essentially that implant manufacturers win clients for life. The surgeon is the central element of the pricing paradox.

Hospitals have tried for years to force their surgeons to consolidate purchasing to a few select manufacturers to get an edge on pricing. This has repeatedly failed, as most recently demonstrated by HCA's mea culpa in February. There is a feedback mechanism in place to short-circuit the process.

The root of that mechanism is surgeons' feet and hospitals' goal to tie up market share. If a hospital demands that an orthopedic surgeon use a different manufacturer's implants and he refuses because he is unwilling to learn to use new instruments, the surgeon can leave that hospital and join another, taking his patients with him. The hospital would lose much more in profit than it would gain had it been successful in consolidating purchasing. Status quo maintained.

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