Zimmer Biomet Pricing Spineometer: 4 of 5 Vertebrae

Zimmer Biomet, a medical technology company specializing in knees and hips, had a positive Q3 2023. Revenue rose 5% to $1.8 billion and earnings before interest and taxes rose 9% to $267 million over the same period last year.

A review of Zimmer Biomet’s November 7 earnings call and financial report provided insight regarding the importance of pricing on performance.

Ivan Tornos, on his first earnings call as the newly promoted CEO, laid out his three-pronged strategy for his future at the helm of Zimmer Biomet:  purpose and people, operational excellence, and portfolio diversification.  While each of these initiatives is laudable, market dynamics will challenge him and his team greatly in the coming years.

Though a global company, Zimmer Biomet’s largest market is the United States.  Medical procedures in the U.S. requiring Zimmer Biomet’s products and services are shifting away from a hospital-centric modality toward the ambulatory surgical center (ASC) setting.  Typically, surgeons themselves are owners in part or in full of the ASCs, unlike their relationships with hospitals.  This changes pricing, offering choice paradigms, and decision-making dramatically.

In the hospital setting, surgeons typically search for their perceived best solution to a medical challenge, and, to a large extent, their demands are met by the hospital administrators and operating room managers.  Surgeons often know neither the cost of their chosen medical devices nor the cost of their procedures.  Price is a secondary issue in the hospital doctor-administrator decision-making process. As long as the price is reasonable and justifiable, the medical devices and solutions will be purchased.

In an ASC setting, the surgeon is also the budgetary decision-maker. This tends to lead toward a much higher price sensitivity and a higher willingness to choose a solution that is “good enough and low-priced” rather than the one that is “the best but at a higher price”.

These shifts indicate that Zimmer Biomet’s market will be more price-sensitive in the future than it has been in the past.  How will Zimmer Biomet compete in this environment?

Suky Udaphyay, CFO of Zimmer Biomet, expressed awareness of this challenge. He said, “We’re seeing a more moderated pricing environment, still erosion.”  Single-digit price erosion is great for patients, but bad for businesses.

And, Zimmer Biomet’s value proposition has expanded greatly from implants to include robotics, software, data analytics, and even the application of artificial intelligence in medical procedures.  Many medical technology companies have been tripped up in the process of pricing and marketing their software and data capabilities.  To my knowledge, no firm has defined the template for marketing artificial intelligence to surgeons to date.

Nonetheless, Ivan Tornos focused on the more positive possibilities from the expected changes.  In speaking about the market, he said, “In plain English, healthy market, great patient dynamics, new technology, disruptive innovation, a lot has changed. And I don’t see us going back to four or five years ago.”  In speaking about performance, he said, “We also know that innovation, customer-centric innovation and commercial execution are the two key drivers of sustainable revenue growth.” In speaking about innovation, he said, “We do need to diversify our portfolio, and we’ll do that. We’re going to do it through organic and inorganic means, we’re going to do it through innovation and M&A.” he plans to monitor it with a “vitality index” and “innovation profitability index or IPI”.

Being a newly promoted CEO, it is natural to take a positive stance.

Given Zimmer Biomet’s operations, we would expect between 15 and 70 people to be dedicated to pricing.  Given the challenges and dynamics of their market, we would expect Zimmer Biomet to be in the middle of this spectrum.

1. A significant portion of the pricing team would be focused on transactional pricing or commercial execution with ASCs, hospitals, and government purchasing bodies both in the states and across the globe to ensure revenue growth goals were met.
2. Another significant portion of the pricing team would be focused on new-product pricing and pricing of portfolios within M&A target companies. If Ivan Tornos plans to diversify its offering portfolio, the new offerings will need to be properly priced.
3. Given the opportunities for rebate management to drive revenue performance with ASCs, we would expect a small team to focus on commercial policy design, implementation, execution, and performance in coordination with the commercial team.
4. Ivan Tornos spoke briefly about incentives and their impact in his opening remarks. Deal Quality Scoring is a proven incentive structure for driving sales performance in the market that leads to higher revenue growth and better price capture.  Sales compensation is a proven area where pricing expertise can contribute to company performance.
5. And, then we get to the strategic issue of pricing AI and other related software and data offerings. These offerings hold great promise but need to be properly monetized.

Research into the investment by Zimmer Biomet in pricing yielded both encouraging and underwhelming results.

1. The pricing team size is well within industry benchmark expectations.
2. The pricing team’s responsibilities unfortunately were overwhelmingly focused on commercial execution (contract pricing and pricing analytics specifically). Price setting, commercial policy, incentive alignment, and the strategic pricing of digital offerings appeared to be managed outside of pricing, perhaps by consultants or product managers themselves.
3. Team roles varied from analyst and manager to director and even senior director and principal. The absence of an identifiable vice president of pricing is aligned with the operational, not the strategic, focus of pricing at Zimmer Biomet.
4. Geographically, pricing was dispersed across the globe to include people in the United States, United Kingdom, Germany, and Singapore to name but a few sample countries.
5. And, I believe Zimmer Biomet is a Vendavo customer, reinforcing the suspicion that pricing at Zimmer Biomet is focused mostly on commercial execution rather than being expanded to include broader strategic issues identified.

Given the importance and capability of pricing at Zimmer Biomet as indicated in financial reports, management statements, and our pricing team research, and given their performance, we have come to the following conclusion as of December 2023.

Zimmer Biomet Pricing Spineometer: 4 out of 5 Vertebrae.

ZBH (Zimmer Biomet Holdings Inc.) was relatively unchanged at 109 the day prior to their earnings call and 108 one week later. FY 2022 revenue of $6.9 billion with 10% operating margin and P/E ratio near 16.

For FY 2022, a 1% improvement in price would yield a 10% improvement in operating profits holding all else constant at Zimmer Biomet.