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LEGAL ISSUES

When Big Changes Happen to Small Companies

Imagine your entire company being put into an upheaval by a change in your industry's regulatory environment.
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Imagine your product-development, manufacturing, distribution, marketing, and financial strategies being put into an upheaval by a change in your industry's regulatory environment

One of the biggest challenges for small-business executives is reacting to external changes, particularly changes that threaten a company's original business model. Historically, highly regulated businesses like mine have provided executives with a relative amount of stability and predictability. Knowing the rules allows a boss room to focus on critical internal company issues while developing realistic plans. I learned the hard way, however, that with one swift stroke of the pen or one key personnel change, market conditions can literally change overnight. Therefore, no company can afford to think its environment will be stable forever. Regardless of regulation, companies must develop the ability to turn problems into opportunities. Integrated Surgical Systems Inc. is a case in point.

ISS, which employs 33 people, is a four-year-old privately held company in the medical-device business. We manufacture the Robodoc surgical-assistant system, which uses 3-D computer imaging and a robotic tool to aid surgeons who plan and perform total-hip-replacement procedures. ISS is based on technology developed at IBM; I left IBM's Thomas J. Watson Research Center, in fact, to lead engineering and serve as president of ISS. We all believed that a small entrepreneurial start-up could commercialize this technology better than Big Blue could.

When we started ISS, in 1990, it typically took from two to four years for a medical-device company to develop and bring a product to market, owing in part to the time required to obtain authorization from the U.S. Food and Drug Administration to market the product. Although that process may seem both long and costly for start-ups, many technologically innovative U.S. device companies thrived at that time, earning handsome profit margins. Because of the potential return and the predictable environment, capital markets were willing to underwrite companies.

As a matter of course, virtually all U.S. medical-device companies have built their business and marketing plans with a focus on the United States as their first, most critical, and principal marketplace, owing to both the sheer size of the U.S. market and its receptivity to new and potentially promising medical technologies. At ISS we took that traditional route. Our product-development, manufacturing, and distribution strategies were all focused on the U.S. market. We planned to introduce our product here first, and after a successful introduction, to then distribute it in Europe and then in the Far East. With that plan we were able to raise $7 million -- enough, we believed, to enable us to develop our product and bring it to market in three years. Then we hoped to conduct an initial public offering of $10 million to $15 million to finance future growth.

However, over the next two years several unforeseen events drastically altered ISS's plans. A new FDA commissioner was appointed, and several well-publicized problems with medical devices, such as heart valves and breast implants, led to a far more judicious approach by the FDA. Almost immediately, the rate at which the FDA reviewed and approved new-product applications for the U.S. market slowed considerably. We had initially planned on a three-year process. We were now looking at a six-year one -- optimistically.

I have tremendous respect for the FDA and the role it must play in judging the safety and efficacy of products before they reach the public. It performs that public duty extremely well. But while I respect the FDA's essential role as an overseer, I also see that the lengthier approval process has radically changed the medical-device industry to which we belong.

The delay in getting approval to market our technology in the United States has forced our company to radically reevaluate and change our rollout strategy. While the U.S. regulatory process unfolds, we, like virtually all the medical-device companies I know of, now plan to introduce our product initially overseas -- in our case, first in Europe, then in the Far East, and ultimately in the United States. That has made us an international company far sooner than we had originally planned.

Ironically, the changed regulatory climate has resulted in a stronger ISS. Previously, we considered ourselves a northern California company selling to the United States; now we're truly an international operation. In Europe we have set up a company in the Netherlands to manufacture and distribute our products. We also have established European sales and distribution channels. The margins are smaller, but the trade-off in increased sales capacity makes it worthwhile.

Though we have adjusted to the new demands, I often wonder about the cumulative economic effect of many companies like ours seeking opportunities and creating jobs outside the United States. Many of us find it ironic that patients overseas will receive the benefit of technologies developed in the United States long before the folks back home will.

The new regulatory environment affects one other crucial area: the capital markets. When companies like ISS have to recalibrate their plans so radically, investors back off. Since most investors equate the unknown with higher risk, the capital markets have been less willing to invest in manufacturers like ISS until the climate is better defined by Washington. Initial and additional investment in medical-device businesses has all but shut down. The United States, currently the world's most fertile breeding ground for technological innovation, will lose its global leadership position if that continues. Moreover, the massive initial capital outlay required to develop a new drug in this country has limited that kind of development to large pharmaceutical companies. I fear that one day such onerous demands will drive out small entrepreneurial medical-device companies as well.

Obviously, we've had to make adjustments to our financial model. Initially, we planned on spending $7 million. We have now raised $15 million through private placements and anticipate seeking another $10 million to $15 million. Because we have had to focus our financial resources on getting Robodoc to market, we have essentially slowed the concurrent development of new, additional applications for the system that we had originally planned. And our investors, whose funds were committed under a different set of conditions, have had to adjust their expectations. For our employees, many of whom hope to benefit from an IPO, the fast-changing environment and requisite changes in company strategy and direction have been unsettling.

ISS is not out of the woods yet. But I believe our experience shows how, for any start-up, the environment can -- and will -- change quickly and in unexpected ways. In our case, one regulatory agency with the power to slow the growth of an entire industry has greatly raised the bar for introducing a successful product. Large businesses often have the resources to weather such changes. In small companies, the ability to rapidly react to those changes is the key not only to success but often to survival. It is our challenge to build organizations that can adapt to changes and seize the new opportunities they always bring.

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Bela L. Musits is president and chief operating officer of Integrated Surgical Systems Inc., based in Sacramento, Calif.




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