RoboTech Case Study

Description

You are asked to serve as consultants/advisors of the case, use the following as the template/headings for your answers:

1. Brief introduction about the case [2 points]

2. Key Issues (planning) [6 points]

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b.

c

d

3. Suggestions/action plans (control) [6 points]

a

b

c

d

4. Recommendations (decision-making) [6 points]

a

b

c

Use bullet points to illustrate briefly on each of the above.

For the exclusive use of R. Daniels, 2021. 9 – 9 1 8 – 50 1 SEPTEMBER 12, 2017 CHRISTOPHER A. BARTLETT RACHEL GORDON JOHN J. LAFKAS RoboTech: Storming into the U.S. Market In early 2017, Pat Chen was in her office in the heart of Singapore’s Science Park, working past midnight again. Her company, RoboTech, had just closed the books on its third successful year in the United States, selling an innovative robotic device for spinal surgery. As the dominant player in its segment, RoboTech had again exceeded its sales and profit budget. Despite the positive financial results, Chen was concerned. Her management team had told her that to protect RoboTech’s strong position, the company needed to make major investments that could again plunge it into a loss situation.

Reflecting on her 18 years as RoboTech’s CEO, Chen knew she had met many big challenges—engineering a turnaround, tackling a slumping business segment, and implementing a major diversification. However, deciding what to do right now felt like the most important strategic decision of her career. Company and Product Background In 1999, financed by her family and a bank, Chen took over a small, struggling industrial robotics company. It was a big risk for a 29-year-old mechanical engineer who had only seven years’ work experience in the semiconductor industry and an MBA she had earned at night. But as a hardworking, competitive risk taker, Chen believed she could turn RoboTech around.

The Company: From Operational Turnaround to Strategic Transformation Chen’s first move was to focus on developing specialty robotic devices. Linking RoboTech’s expertise in motors, motion control, and sensors with recent advances in miniaturization, she led the company to develop an expertise in miniature robotic devices that were small, precise, and extremely strong. Over several years, its capabilities in fine welding applications requiring accuracy to 10 microns helped RoboTech become the leading supplier of aircraft-welding robots. Eventually, competitors caught up with its technology, and particularly during the financial crisis in 2008 and 2009, once-lucrative contracts became unprofitable. Chen’s experience of price wars in the semiconductor market led her to consider diverting funds from current operations to new applications. ________________________________________________________________________________________________________________ HBS Professor Emeritus Christopher A. Bartlett, writer Rachel Gordon, and HBSP Senior Editor John J. Lafkas prepared this case solely as a basis for class discussion and not as an endorsement, a source of primary data, or an illustration of effective or ineffective management. Although based on real events and despite occasional references to actual companies, this case is fictitious and any resemblance to actual persons or entities is coincidental. Copyright © 2017 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. This document is authorized for use only by Ramona Daniels in Accounting for Executives (Summer 2021) taught by Dr. Hock Gin Chong, Prairie View A&M University from Jun 2021 to Nov 2021. For the exclusive use of R. Daniels, 2021. 918-501 | RoboTech: Storming into the U.S.

Market After much research, she focused on robot-assisted surgery. Noting that orthopedic surgery demanded extreme accuracy, Chen decided to focus on spinal surgery, a field in which robotic surgical devices had not yet been developed. Due to the complex nature of spinal anatomy, surgical precision for it was even more essential than it was for knee replacements, where surgical robots were already effective. Unlike surgeons performing knee replacements, spinal surgeons often could not see the body parts on which they operated. Chen saw parallels with RoboTech’s aircraft-welding robots’ ability to make accurate placements in sites not visible to the operator. The Innovation: Leveraging Capabilities, Developing Partnerships While Chen felt RoboTech had the technological capability to develop the surgical arm that guided the tools and implants, she knew it would need help with the software controlling the device’s delicate movements.

After months of searching, she connected with an old mentor from Singapore University, who introduced her to a team working on 3-D imaging software for advanced medical robotics. Chen described the groundbreaking nature of the innovation they called the Kinetics System: Before spinal orthopedic surgery, orthopedic surgeons use pre-operative imaging to familiarize themselves with the patient’s anatomy. During surgery, visibility is often poor, so they constantly update the imaging. But the Kinetics System’s preoperative software allows the surgeon to create an exact map, eliminating the need to adjust or update it during surgery. Its mechanical guidance system enables him to direct drills and implants to their exact planned location within 1.5 mm of accuracy. It’s a huge breakthrough! In exchange for developing the Kinetics software and for providing ongoing updates and support, the Singapore University team received a fee of $5 million, plus 10% of the sales price for each machine sold. RoboTech capitalized the acquisition fee and planned to expense it over five years. But to achieve the desired performance, the Kinetics System also required a range of analytical tools, data sources, guidance systems, tracking tools, and verification technologies that were well beyond RoboTech’s capabilities. For example, one piece of software displayed a catalog of surgical instruments and implants, presented virtual views of the chosen implant from various positions, and through computer-generated simulation, allowed the surgeon to design and practice the surgical technique before performing the actual procedure.

This was just one of the specialized components supplied by RoboTech’s partners, whose products represented almost half of the prototype’s cost of goods sold. As Chen signed contracts with each of these partners, she recognized that while outsourcing reduced the company’s investment needs, it left it vulnerable to its suppliers, particularly on price. Meanwhile, RoboTech’s development of the core surgical machine turned out to be a $45 million “bet your company” R&D investment that required it to tap its entire cash flow and appreciably increase its debt. Even though the company planned to write off that investment over five years, the elevated R&D expenses led to reported losses, something that Chen’s conservative family investors particularly disliked. But by early 2011, RoboTech had a working spinal surgery robot. The Industry and Competition Due to growth in the elderly population, there was a rapid increase in demand for orthopedic surgery, including osteoporosis, arthritis, and degenerative disc disease. Within that market, spinal surgery seemed a promising niche. 2 BRIEFCASES | HARVARD BUSINESS SCHOOL This document is authorized for use only by Ramona Daniels in Accounting for Executives (Summer 2021) taught by Dr. Hock Gin Chong, Prairie View A&M University from Jun 2021 to Nov 2021.

For the exclusive use of R. Daniels, 2021. RoboTech: Storming into the U.S. Market | 918-501 The Orthopedic Spinal Device Business Spinal surgeries sought to decompress a pinched nerve root or stabilize a joint by implanting screws, rods, or wires or by inserting bone grafts, spacers, or bone cement to provide relief from pain. Because accurate and safe placement of the implants in hard-to-reach target areas was so challenging, traditional spinal surgery had a high failure rate. Although surgeons defined success as whether the spine fused or the disc was removed, and so reported success rates as high as 98%, studies tracking reduction in patients’ pain reported far less positive outcomes. One widely cited study suggested that two years after spinal surgery, about a quarter of patients were dissatisfied with the results.1 Worldwide, of the 78 million people who suffered from untreated back pain—11 million in the United States alone—many were candidates for back surgery.

In 2012, the global market for orthopedic medical devices was $34.5 billion, with spine devices accounting for about 20% of the total.2 In the United States, 451,000 spinal fusions were performed in 2012, making it the fifth most commonly performed procedure.3 Competitors in the Orthopedic Device Space A few large players dominated the spinal device business, offering surgical tools and implants used in traditional surgery. Medtronic led the segment with a 41.7% share, followed by DePuy Synthes ( Johnson & Johnson’s orthopedics organization) with 24.3%, and Stryker with 10.1%.4 Several factors had kept these companies from developing orthopedic robots: the robots’ high cost, the lack of clinical evidence proving their superiority, and the long learning curves needed for surgeons to master the new techniques. But many industry experts believed as the technology improved and surgeons became more comfortable using it, hospitals would invest in it.

Two small companies had already launched robotic orthopedic devices. Mako Surgical, founded in 2004, had launched a knee replacement system in 2006. It cost $750,000, not including implants or service.5 After going public in 2008, Mako immediately launched a successful hip replacement robot. In 2012, NavioPFS received FDA approval for its knee implant device, which was priced at $450,000.6 Unlike Mako, this system let surgeons use implants of their own choosing. RoboTech’s Decision: Assessing Potential, Developing Strategy In 2012, after two years of clinical trials, RoboTech’s device was approved in Singapore. Chen now wanted to quickly leverage RoboTech’s first-mover advantage in robotics for spinal surgery, and this meant entering the U.S. market, which accounted for more than a third of the global potential. The U.S. Market Chen created a team to evaluate the U.S. opportunity. It found that about 360,000 thoracic or lumbar procedures—the Kinetic System’s focus areas—were completed annually in the United States. Surgeons performed these operations in facilities ranging from small surgery centers to giant teaching hospitals.

The team estimated 1,000 to 1,500 of these institutions could afford the proposed system price of $869,000, an annual four-year service contract at $55,000 after year one, and disposables at $1,800 per procedure. It also estimated that each hospital would perform between 75 and 85 procedures annually. While the initial projected gross margin for machine sales was only 45%, primarily due to RoboTech’s heavy reliance on outsourced components, service contracts and disposables would be more lucrative. With estimated gross profit margins of 70% and 60%, respectively, overall profitability HARVARD BUSINESS SCHOOL | BRIEFCASES 3 This document is authorized for use only by Ramona Daniels in Accounting for Executives (Summer 2021) taught by Dr. Hock Gin Chong, Prairie View A&M University from Jun 2021 to Nov 2021. For the exclusive use of R. Daniels, 2021. 918-501 | RoboTech: Storming into the U.S. Market was expected to rise as the installed base grew. This assessment was speculative, however, especially because of the major systemwide changes unleashed by recent U.S. health-care legislation.

The U.S. Regulatory Environment In 2010, the U.S. Congress had passed the Patient Protection and Affordable Care Act (soon dubbed “Obamacare”) to offer health-care access to all citizens. Leveraging the private insurance market, the act required everyone to purchase coverage on health insurance exchanges, guaranteeing no one could be turned down for coverage. Subsidies were offered to low-income individuals and families. The U.S. government estimated that by 2019, over 30 million previously uninsured people would be covered.7 The RoboTech team focused on how the legislation would affect reimbursement processes. The existing fee-for-service model, which offered reimbursement to hospitals, physicians, and other care providers for each intervention, had often resulted in fragmented care, with little incentive for cost savings or cross-provider coordination. This model was being replaced by reimbursement based on quality of care as measured by patient outcomes, improvements on specific metrics (e.g., reduced hospital admissions), provision of preventive care, and use of health-care IT systems. The government’s goal was to convert 30% of fee-for-service Medicare payments to value-based payments by the end of 2016.8 Because 40% of patients undergoing spinal surgery were over 65 and covered by the government’s universal aged care program, Medicare, RoboTech decided to work within that payment paradigm. Furthermore, Medicare reimbursement coverage and levels were likely to become the standard followed by most private insurance providers. The current system assigned codes and set reimbursements for each medical condition. Doctors and hospitals received payments based on the set rate, regardless of actual treatment costs.

Reimbursement for spinal surgery ranged from $40,000 to $60,000, depending on the procedure. But because there was no reimbursement for capital costs such as the Kinetic System, RoboTech would have to prove its device could improve operating time, patient recovery, or other quantifiable benefits that would repay the initial equipment cost. Launch Decision and Entry Strategy Stalled industrial sales, falling prices, and R&D investment write-off had all taken a toll on RoboTech’s earnings. With creditors becoming nervous and some family members inquiring if their investments were secure, Chen was anxious to exploit the new opportunity. When the market-entry team estimated that RoboTech U.S. could sell 25 units at $869,000 in its first year, Chen decided to pursue FDA regulatory approval. Her U.S. regulatory consultant sought fasttrack consent for a device “substantially equivalent” to an existing approved device.

Leveraging the proven effectiveness of existing robotic surgery devices, as well as its own successful clinical trials, RoboTech obtained marketing approval in eight months. In September 2013, Chen established a subsidiary, RoboTech U.S. She set up a sales office in Chicago, where she interviewed candidates for the U.S. Sales Director position. From a dozen finalists, she chose Brian O’Hanlon, a regional sales manager with 20 years’ experience at orthopedic device heavyweight Zimmer. Together, they developed a three-year U.S. sales strategy and budget. The 2014 plan targeted the entry team’s forecast of 25 units. In January 2014, after hiring his team of six sales representatives, a service tech, and four staff in office, training, and support roles, O’Hanlon began implementing a three-pronged strategy focused on targeting key facilities, training orthopedic surgeons, and educating patients.

He first planned to 4 BRIEFCASES | HARVARD BUSINESS SCHOOL This document is authorized for use only by Ramona Daniels in Accounting for Executives (Summer 2021) taught by Dr. Hock Gin Chong, Prairie View A&M University from Jun 2021 to Nov 2021. For the exclusive use of R. Daniels, 2021. RoboTech: Storming into the U.S. Market | 918-501 contact top academic hospitals, not only because of their influence, but also because they were highly competitive. O’Hanlon believed if he could get one or two to commit to the device, a domino effect would bring the others along. Meanwhile, the training manager opened a center to offer hands-on experience to leading surgeons, who would in turn advocate for the system at their hospitals. In parallel, O’Hanlon contacted a public relations company to present spinal surgery candidates with information about the new technology. Lacking the funds to support a major marketing program, he also asked the PR firm to obtain press coverage emphasizing this breakthrough innovation and patient success stories.

Implementing the Strategy: Early Wins, Emerging Worries In early 2017, three years after its U.S. launch, Chen was pleased with RoboTech’s progress. (See Exhibits 1a and 1b for RoboTech’s U.S. subsidiary and parent income statements and Exhibit 2 for Robotech’s balance sheet.) But a few clouds were gathering on the horizon. The First Year: Sales Success and Systems Stress Following a strong launch, RoboTech shipped 24 systems in 2014. At the end of 2014, it had six more on back order. Industry analysts were bullish about robotics implant surgery. One predicted it would become the de facto standard in knee and hip surgery within five years and in spinal surgery a few years later. Another suggested that once penetration reached 35%, hospitals without these systems would risk losing their best doctors. But market success came with costs. The Chicago office was overwhelmed by sales requests and technical inquiries, resulting in long delays and embarrassing communications breakdowns. The rush of orders exceeded Singapore’s production capacity, and fulfillment ran months behind promised delivery dates. Furthermore, the training center was at capacity, with a months-long waiting list.

Yet orders continued to roll in. When Chen committed to expanding manufacturing capacity to 80 units during 2015, O’Hanlon felt confident in budgeting sales of 60 units. If the continuing changes in healthcare reimbursement did not disrupt demand, the goal seemed achievable. Reimbursement Reverberations and Cost Concerns As reimbursement practices moved toward a “bundling” model, health-care providers adapted to receiving a single procedure payment covering facility fee, physician’s fee, anesthesiology, implants, pain management, and postoperative and rehabilitation care for 60 to 90 days. One study found a 30day bundle for a spinal surgery averaged $33,522, while a 90-day bundle was $35,165.9 This was far less than the $40,000 to $60,000 reimbursement RoboTech had assumed in its forecasts and budgets.

Value-based reimbursement also led to buying decisions shifting from physicians to administrators. As purchasing processes became more complex and time-consuming, RoboTech’s sales staff found they had to spend more time managing the sales process than originally estimated. Beyond emphasizing improvements in spinal procedures, they now had to document cost savings associated with lower rates of repeated surgeries and faster recoveries. O’Hanlon conceded he had been unable to scale up his sales force quickly enough to provide the support necessary to address new market needs. The Second Year: Customer Conversions, Cash Constraints Notwithstanding these challenges, sales boomed through 2015, creating new strains on the company.

In response to financial pressures caused by production expansion, R&D investment, and debt repayment programs, Chen asked whether O’Hanlon could capitalize on market interest by HARVARD BUSINESS SCHOOL | BRIEFCASES 5 This document is authorized for use only by Ramona Daniels in Accounting for Executives (Summer 2021) taught by Dr. Hock Gin Chong, Prairie View A&M University from Jun 2021 to Nov 2021. For the exclusive use of R. Daniels, 2021. 918-501 | RoboTech: Storming into the U.S. Market asking customers to pay a 30% deposit with their order to guarantee their place in the production schedule. While such a request was unheard of in the industry, O’Hanlon understood RoboTech’s financial constraints and said he would try. This unusual request simply added to customers’ discontent.

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