M e d t r o n i c M i n i M e d i n t h e

I n s u l i n P u m p I n d u s t r y :

T h e P o w e r o f C o m p l e m e n t a r y A s s e t s

a n d R e i n f o r c i n g L o o p s

1 5 . 9 1 2 T e c h n o l o g y S t r a t e g y

Johanne Auerböck

Maria Grunwald

Ethan Russell

May 11, 2005

Table of Contents

1 Background, ...................................................................................................................... 1

2 The Insulin Pump Industry .............................................................................................. 1

3 Technological Development in the Industry – S-curves............................................. 2

4 Value Chain and Value Capture .................................................................................... 4

5 Five Forces Analysis........................................................................................................ 6

6 Complementary Assets and Uniqueness ..................................................................... 7

7 System Dynamics of the Industry – Reinforcing Loops ............................................. 9

8 System Dynamics Simulations..................................................................................... 12

9 Conclusion....................................................................................................................... 14

10 System Dynamics Simulation Exhibits........................................................................ 16

In this paper we present a thorough analysis of the US insulin pump industry and explore how

one firm, Medtronic MiniMed, has been able to achieve and retain dominance.

1 Background1, 2

About 1.1 million people in the US suffer from Type I, or insulin-dependent diabetes, a chronic

disease requiring regular insulin replacement in order to ensure survival.3 An additional 10 million people

suffer from Type II, or non-insulin dependent, diabetes. Recent research suggests that about 48% of

patients with Type II could benefit from supplementary insulin, and 25% of the 48% actually inject

insulin. The total market of insulin users is therefore about 2.3 million people. The total insulin-injecting

population is growing 1-2% a year.

Insulin delivery is currently achieved using three distinct technologies. First and second are

syringes and insulin pens, which require a patient to self-dose and self-inject boluses of insulin several

times a day. The third technology is insulin pumps, computerized devices that can help the patient

calculate insulin doses4 and which provide continuous release of insulin through a catheter placed under

the patient’s skin. Soon, patients will have access to non-invasive technologies such as oral, inhaled or

transdermal formulations of insulin, and research efforts are ongoing to find a vaccine or cure for diabetes.

2 The Insulin Pump Industry The insulin pump market includes both a durable good and a consumables component. The pump

itself sells for about $5,000 and lasts for 5 years; consumables cost the user about $6 per day. Currently,

the vast majority of the insulin-injecting market still uses substitute products with a longer history in the

market (syringes or insulin pens). Only about 10% of Type I diabetics (~100,000 people) use infusion

pumps, and almost no Type II diabetics use them.5 This is changing as people start to better understand

the benefits of tight insulin control, and gain comfort and familiarity with being connected to an insulin

pump 24 hours per day (Figure 1, below). Growth rate in the insulin pump industry is about 9% per year,

compared to about 2% in the overall diabetic population.6

1 General industry information was gathered from: Hamilton, Gayle, “The Diabetes Market Outlook,” 2004.2 Frost & Sullivan, “The U.S. and European Diabetes Delivery Systems Market, B034-54,” 2002.3 National Diabetes Fact Sheet, United States CDC, 2003. http://www.cdc.gov/diabetes/pubs/pdf/ndfs_2003.pdf.4 Calculations are based on based on inputs about blood sugar levels and carbohydrate intake.5 Frost & Sullivan, 2002.6 Ibid.

1

FIGURE 1: FEATURE TRADE-OFFS

Comfort/Familiarity

lin

i /

InsuPumps

Syr ngesPens

As pump manufacturers educate patients and physicians & overcome lack of familiarity/comfort with the new technology, the pump market will take over much more of the delivery market.

Disease control

3 Technological Development in the Industry – S-curves As hinted at in the industry background, the insulin delivery industry has been subject to

significant technological change over its history, resulting in significant improvements in performance as

measured by the control of blood sugar levels. When insulin was first brought to market as a therapy, it

was injected using standard syringes, with patients calculating their dose and administering it via bolus

injection. Incremental innovations to suit the needs of diabetics injecting insulin resulted in the insulin

pen, a simple device that looks and functions like a syringe containing its own vial of insulin and which

simplifies dose measuring and injection. The potential for performance improvement on this model is

limited, however, by diabetics’ need for a basal dose, a small amount of insulin to be delivered constantly

throughout the day and night in addition to boluses at mealtimes. Although research has produced

varieties of long-acting insulin to be injected once daily in addition to meal boluses in order to provide a

basal dose, the uptake of long-acting insulin cannot be tailored to the needs of individual patients.

Insulin pumps, though the initial models were large and obtrusive, offered immediate

improvements in terms of blood sugar control (see Figure 2). Pumps consist of an insulin reservoir

controlled by a small computer, connected to the patient through a catheter inserted under the skin. Pumps

are designed to deliver insulin continuously after being programmed with the patient’s varying insulin

needs throughout the day7, and deliver boluses on demand based on inputs about the amount of

carbohydrate intake and current blood sugar levels. Incremental innovations have reduced the size of the

7 For example, many patients require more insulin in the early morning when blood sugar levels naturally tend to rise (the “dawn phenomenon”), and less during the day when the patient is active and moving around.

2

Oral,Patches,Inhalation

The

Pre

sent

Tightregulation

Inadequateregulation

Coupled toglucometer

unit, increased the convenience and control of dosing, and promise to eventually have the pump self-

regulate, essentially working like an artificial pancreas.

FIGURE 2: INSULIN DELIVERY MARKET S-CURVES

Syringes

Pumps requiring

manual input, large &

inconvenient

Islet cell transplants

Flex pen

Vaccine

Genetic engineering

Per

form

ance

(c

ontr

ol o

f blo

od s

ugar

leve

ls)

Time

Fully self-regulating,

unobtrusive

Oral, Patches, Inhalation

Syringes

Pumpsrequiring

manual input,large &

inconvenient

Islet celltransplants

Flex pen

Vaccine

Geneticengineering

Per

form

ance

(con

trol

ofbl

ood

suga

rle

vels

)

Time

The

Pre

sent

Fully self-regulating,

unobtrusive

Tight regulation

Inadequate regulation

Coupled to glucometer

Self-regulatingSelf-regulating Non-Non-Manual insulin pumps; “Cure” PreventionManual insulin pumps; “Cure” Preventioninvasiveinvasiveinsulin “artificial insulininsulin “artificial insulin

injection pancreas” delivery injection pancreas” deliveryBeyond deliveryBeyond delivery

Supported by innovations in theSupported by innovations in theinsulin being delivered (e.g. fast-insulin being delivered (e.g. fast-

acting, recombinant, “smart cells”)acting, recombinant, “smart cells”)

Up to this point, the only way to deliver insulin has been by subcutaneous injection, but new

delivery mechanisms – possible discontinuous innovations – are planned for launch in the near future that

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will allow for oral, inhaled, and transdermal delivery of insulin. Based on completely different

technologies, these routes of administration could eventually allow for blood sugar control superior to that

of syringes, in a manner that is less invasive and therefore likely more attractive to many patients.

Because pills, inhalants and patches are pharmaceutical products rather than medical devices, their value

chains are very different from those of pumps, pens or syringes, requiring very different skills and

competencies, which would make it very hard for current delivery companies to bridge the discontinuity

if these technologies ended up gaining wide acceptance. Broadly applicable transdermal technologies,

however, could be incorporated into future generations of pumps to provide through-the-skin instead of

under-the-skin delivery. Pump manufacturers could be well situated to take advantage of transdermal

delivery by making less invasive pumps, or from another perspective, programmable patches.

Finally, it is obvious that the natural technological limit of all these delivery methods is that they

only manage the disease; no amount of injected insulin can cure diabetes. The need for any sort of insulin

delivery would be obviated by the development of a vaccine or a cure for diabetes – both subjects of

significant research efforts. Unfortunately for diabetics, but fortunately for the delivery companies, all

current efforts still face major hurdles and years of development before they will be commercialized.

As alluded to above, it should be noted that innovations in the insulin industry have important

effects on the insulin pump industry. Current R&D efforts are developing self-regulating insulin that is

absorbed into the blood stream in proportion to the amount of blood glucose that is present.8 A self-

regulating insulin could require a single daily injection to cover both basal and bolus needs. This would

overcome many of the drawbacks of multiple daily injections and make syringe or pen delivery more

attractive than pumps.

4 Value Chain and Value Capture Diabetes pump companies create significant value for patients, physicians, insulin manufacturers,

and insurance payers. They free patients from multiple daily insulin injections, and create value for

patients and physicians by providing better controlled delivery of insulin (and therefore regulating the

disease better) than is possible through bolus injections via pen or syringe. They create value for insulin

manufacturers by providing a better mode of delivery than pens or syringes – one that helps make sure

patients take their medicine regularly and on time – thereby helping to deal with compliance issues that

can reduce insulin use. Finally, by providing better regulation of the disease, they create value for

insurance payers by reducing the costs associated with the complications of diabetes.

The typical pump manufacturer’s business model for capturing the value they create is to fully

integrate into the value chain by designing, manufacturing, marketing and distributing both durable

8 See, for example, the website for SmartCells: http://www.smartinsulin.com/tech/tech_howitworks.html, 2005.

4

pumps and consumable supplies directly to patients. Accordingly, business models are not focused on a

single element of the value chain (Figure 3).

FIGURE 3: VALUE CHAIN DIAGRAM

Support Activities

FIRM INFRASTRUCTURE

HR MANAGEMENT

PROCUREMENT

in

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TECHNOLOGY DEVELOPMENT

INBOUND LOGISTICS

OPERATIONS OUTBOUND LOGISTICS

MARKETING AND SALES

SERVICES

Marg

Pr mary Act es

Marg

Supp ers -components

-Raw mater-P ast-Meta

Manufacturing and Assembly Outsource In-house Skilled labor

-In-house -Brand bu ng -Co-brand ng -Reputat on -Sa es reps -Se ect ve advert ng -Phys an re at onsh ps

str but on: -Customer buy d rect

-Own str but on

network

R&D n-house

Pr or emp oyee tra ng necessary

Centra zed

Sma to med um-s zed d vers ed compan es

- Pat ents nvo ved - Phys an re at onsh ps

Innovat on Operat onaEff enc es

Customer Target ng

Back end Front end

Application knowledge

High quality human capital

Brand

Reputation for quality and reliability Close customer relationships

The key elements in terms of interfacing with customers and making an impression on them are

sales and marketing, and distribution. Pumps are distributed directly to patients, mediated by a pump

company sales rep who provides information and intensive support.9 This allows the company to carefully

control the customer’s experience with the product, and prevents the companies from having to share

profits with a middleman such as a pharmacy or other distributor. In addition, a sales and distribution

network able to provide this incredibly high-touch service reliably and efficiently for a relatively small,

widely dispersed pool of patients (only about 30,000 pumps get sold annually over a widespread

geography) is difficult to set up and sustain, and therefore represents an important, difficult-to-replicate

resource for the firms that have it, with MiniMed being the best-equipped.

9 Support includes helping connect the patient with a doctor who can prescribe the pump, filling out insurance forms and negotiating with insurance companies, helping patients who self-pay devise strategies to cover the pump cost, training the patient in the use of the pump, and providing an on-going contact person after purchase.

5

5 Five Forces Analysis The insulin pump industry is an attractive industry with high margins. The five-forces analysis in

Figure 4 helps demonstrate why: high barriers to entry, low supplier power and very low rivalry.

FIGURE 4: FIVE FORCES ANALYSIS

BTE: High • FDA approval • Brand/trust • Relationships w/ prescribers &

HMOs for reimbursement & dist. • Sales/service infrastructure

Supplier Power: Low Rivalry: V. Low Buyer Power: High • Commodity components • Compete on service & • The market grows and shrinks according to • Low risk of forward relationships Medicare and insurance reimbursement

integration • Low product policies, but policies to date have been differentiation favorable

• Individuals have little power, though • High switching costs; viable alternatives

Substitutes: High • Most people use syringes or pens • Alternatives are cheaper & more

established

The two dark spots in the five forces analysis are high buyer power and high threat of substitutes.

Insulin pump buyers are typically Medicare and private insurers; because of the expense, pumps are less

frequently purchased out of pocket. Fortunately for pump manufacturers, buyers have generally not

exercised their power, and most policy changes regarding reimbursement have been favorable to the

pump industry. For instance, Medicare recently began reimbursements for pumps at a rate of $5,000

(down from the nominal list price of $6000). In addition, although most insulin-injectors currently use

syringes or pens, widespread reimbursement represents an important source of change and growth in the

industry as pump manufacturers work to convert non-pump users.

Medtronic MiniMed remains the dominant player in the market, with 80% market share and the

strongest brand and reputation.10 As of 2001, MiniMed enjoyed gross margins of 67%.11 Its position and

profits are protected by the industry’s high barriers to entry, but are threatened by a variety of large

potential entrants with resources that might enable them to successfully overcome these barriers. Three

firms have entered in the past 5 years (bringing the total number of firms in the market to five), and more

may be expected to enter in the next few years.

10 Frost & Sullivan, 2002.11 U.S. Bancorp Piper Jaffray Inc. Research note on MiniMed Inc. Apr 19, 2001.

6

6 Complementary Assets and Uniqueness Figure 5 shows the relative positions of the five insulin pump manufacturers in terms of

complementary assets and uniqueness.

FIGURE 5: COMPLEMENTARY ASSETS AND UNIQUENESS

Complementary Assets

Freely available Tightly held

Easy to maintain

Uniqueness Hard to

maintain l

Di ic iic

De tec setron

Dana An mas

Medtron

Compared to other medical devices, insulin pumps are a relatively simple technology that is

difficult to protect with IP, and have significant product spillovers that make it difficult for pump

manufacturers to maintain uniqueness for any length of time. Therefore, uniqueness is much less

important to competitiveness than complementary assets; uniqueness is conferred mainly by speed to

market and less so by protected technology. The leading manufacturers do put significant energy into

R&D to deliver a technologically superior product and add substance to marketing claims. This helps

drive adoption as product functionality improves, but as we will discuss in the next section, spillovers

create a balancing loop limiting the reinforcing effects of R&D (Figure 9). Thus, while uniqueness can be

used as a niche strategy to the extent that there is some heterogeneity of demand – for example, Animas

targets diabetic children with its pump’s waterproof design and ability to deliver very small and precise

doses of insulin – it is not a strategy well suited to helping gain wide adoption in the general market.

Competitiveness in this industry is mainly determined by complementary assets such as customer

service, branding, reputation, distribution channels, and relationships with physicians and insurers. As

noted above, firms have forward-integrated into the value chain by selling pumps and consumables

directly to patients. Knowing that the administrative details of managing prescriptions and insurance

reimbursements can be as stressful for patients as managing the disease itself, firms stress customer

service and total quality of life more than they do innovative features. Here, the pump company’s

knowledge of state-specific insurance regulations constitutes a complementary asset. Once a firm acquires

a customer, lock-in is facilitated by automatically shipping refills of consumables and handling insurance

reimbursement issues seamlessly for the patient. Manufacturers provide generous warranties in order to

keep customers happy for repeat business and word-of-mouth referrals to other interested diabetics. Other

features of enhanced customer service are 24x7 availability of pump representatives, education/training

7

programs for current customers as well as the general diabetic population, provision of loaner pumps for

when traveling, and upgrade programs. Branding is another complementary asset, achieved largely

through advertisements in Diabetes magazines, websites and publications of the American Diabetes

Association, as well as through relationships with physicians and education and training sessions. These

complementary assets all enable customer lock-in despite common product technology. Again, the next

section will show how these complementary assets create a reinforcing loop, building word of mouth and

market share that help expand the revenues and therefore the amount of money that the company can

plow back into marketing to strengthen the brand (Figure 8). Changes in the industry and its environment

will affect the way these complementary assets play in the future. For instance, a key service that reps

currently provide is helping patients who lack insurance figure out how to finance their pumps. As

insurance, Medicare and Medicaid coverage become more available, this will be less important.

It is not surprising that the most successful companies have the most tightly bound

complementary assets, while those companies that cannot rely on brand and reputation invest more

heavily in unique features. Medtronic MiniMed is the 800 pound gorilla in this industry with top market

share, garnered through the most highly developed sales and service force, and a strong and trusted brand.

However, MiniMed does not necessarily have the most technologically developed products. Disetronic, a

company with less tightly held complementary assets, is ambitiously pursuing uniqueness by developing

DiaPort, a percutaneous insulin delivery system that will more closely simulate first pass insulin delivery

and could result in quicker, more efficient insulin absorption. (DiaPort is already available in Europe,

though not in the US.)

It is unlikely that the overall dynamics of how uniqueness and complementary assets contribute to

companies’ success will change dramatically in the medium-term. Innovations may give certain firms a

slight advantage in uniqueness despite relatively weak complementary assets, but as competitors develop

similar features, complementary assets will continue to be the key to success. As the market grows and

small players gain traction, it becomes more likely that a competitor will eventually be able to establish a

solid brand and a sales and service infrastructure to compete with that of MiniMed. This would enable the

competitor to erode some of MiniMed’s market share. Below, in section 8, we use a system dynamics

model to explore how these scenarios could play out.

8

7 System Dynamics of the Industry – Reinforcing Loops The forces at work on this industry mean change is likely in store, but this will probably not be

catastrophic for the incumbent, MiniMed. When this market was less mature, with no reimbursement and

little patient acceptance, it was very small. The reinforcing loops in the industry mean that the market is

expanding very quickly, making the industry bigger and more attractive. Fortunately for MiniMed, there

are prominent firm-level loops that give it an advantage that will be hard for competitors to replicate.

There are two key reinforcing loops in the industry which serve to expand the size of the market.

Figure 6 shows how increased sales allows companies to spend more on educating payers in the economic

and medical benefits of the pump, increasing reimbursement and therefore affordability, overcoming

financial barriers to adoption. This loop has played an important role historically, with the 1999 Medicare

decision to cover the pump being an enormous boost to the industry. Going forward, we expect the

second loop (Figure 7) to be especially important, as increased revenues allow companies to spend more

on marketing to overcome patients’ psychological barriers to pump use, currently the primary hurdle for

adoption. In this loop, clinical data documenting the importance of tight control contributes to payers’ and

patients’ understanding of the medical and economic benefits of the pump as well.

FIGURE 6: DRIVER OF MARKET SIZE: AVAILABILITY OF REIMBURSEMENT. Before reimbursement from Medicare and private insurance became widespread and generous, affordability of pumps and supplies significantly limited the size of the market. Therefore, one of the primary historical drivers of market expansion was increasing availability of reimbursement. By lobbying payers and politicians, pump manufacturers grew the market without having to lower price.

+

+

+

+

+

+ R

Availability of reimbursement

Affordability

Sales & Revenue

Lobbying spend

Payors understand economic & medical

benefits

Clinical research

9

FIGURE 7: DRIVER OF MARKET SIZE: PSYCHOLOGICAL ACCEPTANCE. Currently, potential users’ psychological acceptance of being tethered to a pump is the most significant barrier to expanding the pump market. Therefore, a critical driver to expanding the market is disseminating information about both medical benefits and improved convenience compared to substitutes (multiple daily injections).

+

+

+

+

+

+

R R+

Psychological acceptance

Sales

Marketing spend

Patients understand medical benefits

Patients understand lifestyle with pump

"Better disease management"

"More convenient"

Clinical research ­

These two loops combine to increase the size of the market significantly, with the current annual

growth rate of the patient base of 9% expected to increase.12 This growth rate and the substantial margins

being earned by the firms within the industry (on the order of 60-70%)13 is likely to attract entrants over

the next years, despite high barriers to entry. However, both the chance of new entry and its impact on

rivalry is mitigated by the fact that this is a durable goods industry with a lot of room to grow, and with

generous reimbursement.

The fact that this is a durable goods industry creates an interesting competitive dynamic.

Reimbursement covers a pump roughly every 5 years. Therefore, once a pump has been purchased,

switching is unlikely for a 5-year period (though switching costs are relatively low when the 5-year period

is up). This means that, for a new firm trying to enter the market, only about 20% of current pump users

are potential buyers in any given year. Incumbent firms enjoy the advantage of drawing subscription

revenue from their installed base in the form of consumables, providing cash to feed into their reinforcing

loops. Although the number of patients is growing by a healthy 9% per year, this translates to only 10,000

new patients per year off a population base of 100,000. Therefore, this industry, which already contains 5

firms, is currently selling to about 30,000 possible annual purchasers. Firms already in the industry have,

as we will soon see, competitive advantages resulting from reinforcing loops, and while this industry

doesn’t have huge economies of scale/scope or learning curves (mostly, these would be in terms of

service provision), a new entrant must consider how to achieve minimum efficient scale and traverse

learning curves off what is bound to be a very low volume of sales.

12 Frost & Sullivan, 2002. 13 U.S. Bancorp Piper Jaffray Inc., 2001.

10

Also, despite significant recent entry, competition in the insulin pump industry remains

characterized by very soft rivalry. This is not likely to change in the near future for two key reasons. First,

the fact that pumps currently only have about 5% of the potential market and have a strong value

proposition for much of the remaining 95% means that it is much more productive to expend resources

towards moving people currently using substitute products to the pump (increase the size of the pie), than

to fight over those patients already on the pump (increase your share of the existing pie). Second, high

technological spillovers, lack of defensible IP, and temptation to sell the pump cheaply to collect revenue

from consumables might at first suggest that price competition will become more prevalent when the

market becomes saturated. However, the fact that reimbursement levels are set at $5,000, and many

patients don’t experience the cost of the pump, means that there is little reason to lower cost. (Figure 8

shows the effects of insurance reimbursement on the market to be equivalent to a subsidy.) Thus, even

when the market becomes more saturated, it is likely that rivalry will remain soft and firms will continue

to compete more on complementary assets than price.

Insu

ranc

e R

eim

burs

emen

t

FIGURE 8: EFFECTS OFINSURANCE REIMBURSEMENTON THE MARKET. Insurancereimbursement acts as a subsidy for thepumps and supplies. As expected, asreimbursement becomes morewidespread and generous, the marketequilibrium quantity increasessignificantly. Because pumpmanufacturers lobby payers andpoliticians to make reimbursementavailable with generous terms, they haveincreased demand without cutting price

S

D

Q

P S’

Increase in demand

In addition to the two industry loops, there are also two key firm-level loops that affect the market

share of individual firms. These loops help explain why incumbents, especially MiniMed, have such a

strong position in this very attractive industry. The first loop (Figure 8) is marketing spend, which

contributes to brand awareness, which is a key factor in patients’ choice of which company’s product to

buy – greater market share also means greater word of mouth, which further increases brand awareness.

R&D spend (Figure 9) is also important, but spillovers create the balancing loop that causes uniqueness to

be less important than complementary assets in this industry.

11

FIGURE 8: DRIVER OF COMPETITIVE DYNAMICS: BRAND BUILDING. Given the literal “life and death” nature of insulin pumps, patients’ and doctors’ trust in the brand is vital for a firm’s success. Word of mouth is powerful in the small community of diabetics who require insulin.

+

+

+

+

+

+ R

+

R Revenues

Market share vs. competitors

Marketing Budget

Marketing

Brand Awareness

Word of mouth

FIGURE 9: DRIVER OF COMPETITIVE DYNAMICS: SPILLOVER. Firms create value through R&D and product innovation, but uniqueness is hard to maintain because of product spillovers. Therefore, firms invest in R&D mostly to boost the complementary asset of brand equity; those who do not invest will be recognized as perpetual followers and will lose brand equity.

+

+

-

+

R B +

+

+

+ Uniqueness

R&D spend

Product functionality

Spillover

Competitors' functionality

Product innovation

Sales.

8 System Dynamics Simulations Given the reinforcing loops surrounding marketing and brand acceptance that are at work in this

industry, it would appear difficult for an entrant to gain substantial ground against MiniMed, the well-

entrenched incumbent. Nevertheless, three entrants have appeared over the last several years, and even

more are expected due to the above-average profits and potential to expand the pie in this nascent market.

Our goal in this section of the paper is to evaluate the strategies of an entrant intent on toppling the market

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leader. We evaluated the influence of market share strategy, pricing and marketing expenses through a

system dynamics analysis using the Industry Evolution Simulator to how David can slay Goliath.

In our model, MiniMed pursues an aggressive market share strategy, targeting 80% of the market,

with a neutral pricing strategy. R&D expenses are high at 9% of revenues, and marketing expenses are

15% with a minimum annual spend of $500,000. The competitor had the same parameters, except as

varied in the scenarios. We sampled market share, price per unit and cumulative profit at 5, 10 and 15

years. (The full set of industry inputs used for this model are shown in Exhibit A.)

Parameters MiniMed Competitor Pricing neutral vary Market share strategy aggressive vary Target market share 0.8 0.8 R&D 9% 9% Process development 2% 2% Marketing 15% vary Minimum marketing spend 500k vary

Considerations For a number of reasons, the Industry Evolution Simulator is an imperfect model of the insulin

pump industry. First, due to reimbursement from Medicare and private insurers, pump prices are not

expected to fall drastically; in the simulation, prices plummet to near $1000 per unit within the first year.

Second, the model does not account for the subscription revenue that pump manufacturers reap from sales

of consumables, amounting to about $6 per user per day. Third, we were not able to account for

significant hurdles to penetration such as users'psychological acceptance, so growth rates are faster in the

model than what we would expect in reality. Despite these considerations, we believe that the model

provides some valuable insight into the dynamics of competition in the industry.

Results

1. Varying Market Share Strategy (Exhibit B1) If the competitor pursues an aggressive or fixed strategy, both companies compete away profits. If the

competitor's market share strategy is opportunistic or conservative, MiniMed expends its profits and the

competitor can benefit. This makes sense, since the competitor adjusts its strategy better to the market

demand. Note that the high year 5 profit and loss in scenario B are due to pump sales at high initial prices

($5000) before dropping due to competition.

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Takeaway: With minimal network effects, companies should not sacrifice profits for share.

Recognizing this, we had the competitor use an opportunistic market share strategy for all subsequent

simulations. In a fixed-price world, this also suggests that a low-share, niche approach can be profitable.

2. Varying Marketing Expenses (Exhibit B2) An increase of marketing expenses yields an advantage for the competitor at 20% and 35% of revenue.

(At 25% of revenue MiniMed has a short-term advantage, which is inconsistent with the 20% and 35%

investments; this is likely a coincidental effect of precipitous price drops combined with pumps’ five year

durability.) All increases are short-term, and the increase at 35% is most significant for the competitor,

resulting in almost $1B in profits for the competitor at year 5. If the competitor reduces its marketing

spend, both companies end up with low profits, but the competitor is able to reap the benefits of

marketing spillovers from MiniMed’s investments without making its own investments.

Takeaway: Although there are spillovers from marketing, the effect of growing the pie makes it

worth it for both companies to invest generously.

3. Varying Pricing and Marketing (Exhibit B3) While a high-price strategy pays off for the competitor in the long-term and hurts MiniMed, low prices

lead to losses for both companies, especially the competitor. MiniMed gets hurt in both cases because of

its aggressive market share strategy (although in reality, unlike in the model, MiniMed’s aggressiveness

would likely result in increased marketing expenditure, not decreased prices). High or very high prices

coupled with increased marketing spend lead to the highest payoffs for both players.

Takeaway: As expected in a brand-reliant industry with few network effects, a high-price

competitor is more formidable than a low-price competitor.

Overall Simulation Conclusions From our analysis, it is clear that marketing is crucial. The optimal strategies for both MiniMed

and the entrant are to invest heavily in marketing and keep prices high. Although MiniMed may be an

aggressive incumbent, it should not cut price to maintain share.

9 Conclusion In this paper we have explored the insulin pump industry in depth. We compared insulin pumps

to substitutes (syringes and pens) in terms of comfort/familiarity and disease control, and charted the

technology evolution and S-curves in the management of insulin-dependent diabetes. Then we examined

the insulin pump value chain and noted that companies are fully integrated from manufacturing to direct-

to-consumer sales in order to capture all the value created. A five forces analysis shows this to be an

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attractive industry with high barriers to entry, low supplier power and soft rivalry, in which buyers are not

exercising their power, and consumption of substitutes marks the greatest possibility for expansion.

In gauging the importance of complementary assets and uniqueness, we discovered that spillovers

make uniqueness hard to maintain, and that brand equity and high-touch service are the complementary

assets that largely form the basis of competition. The system dynamics analysis revealed reinforcing loops

around education and marketing that grow the industry as a whole, and a substantial marketing loop that

reinforces the brand equity asset. Finally, our system dynamics simulations confirmed the value of

marketing and of maintaining high prices, and showed that MiniMed will not be immune to attack if

competitors undermine the company’s complementary assets.

In summary, there are changes taking place in the insulin delivery market that will vastly increase

the size of the industry and attract entry over the next years. There is good reason to expect that MiniMed

will remain dominant, but also that entrants might profit at small volumes and in certain niches. Indeed,

the biggest threats to incumbents are likely from outside the pump industry, where discontinuous

innovations in non-invasive insulin delivery, self-regulating insulin, or a cure will make pumps less

attractive or even unnecessary. Due to soft rivalry resulting from generous reimbursement and the

significant potential to increase the size of the pie, it appears that cooperation among all players to grow

the market may be the most profitable approach. If pumps can be established as the dominant design for

intensive insulin therapy, pump manufacturers may be able to extend the life of their industry in the face

of these discontinuous innovations.

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10 System Dynamics Simulation Exhibits

EXHIBIT A: INPUTS TO INDUSTRY EVOLUTION SIMULATOR:

INDUSTRY SETTINGS & MARKET DEMAND PRODUCT Initial Size of relevant population 2.2M or 200k Max level product functionality 100 Population Growth Rate 2% or 15% Productivity of innovative effort Medium Initial industry maturity intermediate Functional spillovers yes Word of mouth high Spillover time 1 year Impact of marketing on adoption Medium PROCESS Sensitivity of demand to price Low Lifetime of capital plant 10 years Product durability 6 years Learning curve strength Low CUSTOMER PREFERENCES (sensitivity to:) Experience spillovers no Product functionality 0.3 Spillover time -Marketing 0.8 COMPLEMENTARY GOODS Available complementary goods 0 Price ($/complement) N/A Compatibility with others 0 Normal margin on complements N/A Product availability 1 How many required/unit N/A

Price -0.8 Time for complementors to enter/expand capacity N/A

COMPETITOR (MEDTRONIC) STRATEGY Initial price ($/unit) N/A Competitor price level relative to yours Neutral Average useful life N/A

Competitor target market share 50% Sensitivity of complement producers to expected profits N/A

Competitor share strategy aggressive TECHNOLOGY Does competitor embrace your std No Initial Price $5,000 % costs (unit direct costs/price?) 20% Unit direct costs, fraction of price 20%

Product development 0.09 (9% on R&D) Fraction of direct costs that are variable 50%

Process development 0.02

Marketing 0.15 30% on SG&A

Complementors N/A

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EXHIBIT B1: VARY MARKET SHARE STRATEGY

Strategy 1: vary market share strategy a. Pursue same strategy as Minimed

neutral pricing, aggressive mkt share, target m s: 0.8 Conclusions:

"Comp" Minimed year 5

"Comp" Minimed year 10

"Comp" Minimed year 15

market share price per unit profit

50% 1.2

-3.9

50% 1.2

-3.7

50% 1.1 -8

50% 1.1 -8

50% 1.1 -14

50% 1.1 thousand -14 million

both companies lose

b. Follow opportunistic strategy neutral pricing, opport mkt share, target m s: 0.8

"Comp" Minimed year 5

"Comp" Minimed year 10

"Comp" Minimed year 15

market share price per unit profit

50% 1.4 174

50% 1.1

-203

50% 1 3

50% 1.1 2.5

50% 1

9.4

50% 1.1 thousand 7.5 million

short term advantage for competitor

c. Follow conservative strategy neutral pricing, conserv mkt share, target m s: 0.8

"Comp" Minimed year 5

"Comp" Minimed year 10

"Comp" Minimed year 15

market share price per unit profit

50% 1.4 177

50% 1.1

-203

50% 1 3

50% 1.1 2.5

50% 1

9.4

50% 1.1 thousand 7.5 million

short term advantage for competitor

d. Follow fixed strategy neutral pricing, fixed mkt share, target m s: 0.8

"Comp" Minimed year 5

"Comp" Minimed year 10

"Comp" Minimed year 15

market share price per unit profit

50% 1.2

-3.9

50% 1.2

-3.7

50% 1

-8

50% 1.1 -8

50% 1.1 -14

50% 1.1 thousand -14 million

identical to aggressive strategy both companies lose

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EXHIBIT B2: VARY MARKETING EXPENSE

Strategy 2: vary marketing strategy a. Increase marketing expense to 20% Conclusions:

neutral pricing, opport mkt share, target m s: 0.8

"Comp" Minimed "Comp" Minimed "Comp" Minimed year 5 year 10 year 15

market share 50% 50% 50% 50% 50% 50% ST payoff for higher marketing price per unit 1.4 1.1 1 1.1 1.1 1.1 thousand expenses reduce profits profit 321 246 3.1 3.9 9.7 10.1 million cross-benefit for Minimed?

b. Increase marketing expense to 25% neutral pricing, opport mkt share, target m s: 0.8

"Comp" Minimed "Comp" Minimed "Comp" Minimed year 5 year 10 year 15

market share 50% 50% 50% 50% 50% 50% (short term) advantage for Minimed price per unit 1.5 1.1 1.1 1.1 1.1 1.1 thousand comp overspends on makertg in long-run profit 459 744 3.4 5.4 10.6 13.2 million quality of marketing

c. Increase marketing expense to 35% neutral pricing, opport mkt share, target m s: 0.8

"Comp" Minimed "Comp" Minimed "Comp" Minimed year 5 year 10 year 15

market share 50% 50% 50% 50% 50% 50% short term advantage for competitor price per unit 1.8 1.2 1.2 1.2 1.3 1.1 thousand profit 947 1.9 4.6 9.2 14 21 million

d. Decrease marketing expense to 5% neutral pricing, opport mkt share, target m s: 0.8

"Comp" Minimed "Comp" Minimed "Comp" Minimed year 5 year 10 year 15

market share 50% 50% 50% 50% 50% 50% do not underspend on marktg price per unit 1.2 1.1 0.9 1.1 0.9 1 thousand both companies lose profit -1 -1 1.6 0.125 8 2.9 million

e. Decrease marketing expense to 0% neutral pricing, opport mkt share, target m s: 0.8

"Comp" Minimed "Comp" Minimed "Comp" Minimed year 5 year 10 year 15

market share 50% 50% 50% 50% 50% 50% do not underspend on marktg price per unit 1.2 1 0.9 1.1 0.9 1 thousand both companies lose profit -2 -1.4 -1.3 -0.9 3.2 0.7 million

f. Eliminate marketing (i.e. skip minimum marktg spending) neutral pricing, opport mkt share, target m s: 0.8

"Comp" Minimed "Comp" Minimed "Comp" Minimed year 5 year 10 year 15

market share 50% 50% 50% 50% 50% 50% do not underspend on marktg price per unit 1.2 1 0.9 1.1 0.9 1 thousand both companies lose profit 0.3 -1.3 3.3 -0.8 9.9 1.1 million but competitor saves some money!

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EXHIBIT B3: VARY PRICING AND/OR MARKETING

Strategy 3: vary pricing strategy or pricing+marketing strategy a. Increase prices to very high Conclusions:

marketing 15%, opport mkt share, target m s: 0.8

"Comp" Minimed "Comp" Minimed "Comp" Minimed year 5 year 10 year 15

market share 50% 50% 50% 50% 50% 50% LT payoff for higher prices price per unit 2 1.2 1.4 1.2 1.4 1.2 thousand however moderate profit 8.5 2.5 27 10.6 59 25 million

b. Decrease prices to very low marketing 15%, opport mkt share, target m s: 0.8

"Comp" Minimed "Comp" Minimed "Comp" Minimed year 5 year 10 year 15

market share 50% 50% 50% 50% 50% 50% both lose price per unit 0.9 1 0.6 0.95 0.65 0.92 thousand profit -8.7 -4 -23 -8.3 -46 -15 million

c. Decrease prices to very low AND increase marketing to 35% marketing 35%, opport mkt share, target m s: 0.8

"Comp" Minimed "Comp" Minimed "Comp" Minimed year 5 year 10 year 15

market share 50% 50% 50% 50% 50% 50% both lose price per unit 1.1 1 0.8 1 0.8 1 thousand marketing does not help competitor profit -8 -2.1 -22 -3 -44 -4 million

d. Increase prices to very high AND increase marketing to 35% marketing 35%, opport mkt share, target m s: 0.8

"Comp" Minimed "Comp" Minimed "Comp" Minimed year 5 year 10 year 15

market share 50% 50% 50% 50% 50% 50% competitor has higher profits price per unit 2.6 1.4 1.8 1.3 1.7 1.3 thousand profit 9.7 5 29.8 18 71.3 40.5 million

e. Increase prices to very high AND decrease marketing to 5% marketing 5%, opport mkt share, target m s: 0.8

"Comp" Minimed "Comp" Minimed "Comp" Minimed year 5 year 10 year 15

market share 50% 50% 50% 50% 50% 50% competitor has higher profits price per unit 1.8 1.2 1.3 1.2 1.3 1.1 thousand although marktg is much lower profit 7.5 1.6 26 7.8 57 19 million

f. Increase prices to very high AND eliminate marketing completely marketing 0%, opport mkt share, target m s: 0.8

"Comp" Minimed "Comp" Minimed "Comp" Minimed year 5 year 10 year 15

market share 50% 50% 50% 50% 50% 50% competitor has higher profits price per unit 1.7 1.2 1.2 1.1 1.2 1.1 thousand although marktg is much lower profit 8.5 1.2 27 7 57 17 million

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