Thoughts on Regulatory Constraints of Business Models

by Sheppard Mullin Richter & Hampton LLP
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I am often called upon to address the nature of how regulatory controls may apply to the organization of healthcare companies in their ability to create, deliver, and capture value (their ‘business models’). While no summation could adequately capture all of the complexity inherent in this question, it would seem appropriate to briefly comment on some of the general recent trends I have seen, and how they may be shaped by various regulatory authorities.

Healthcare is on the leading edge of science, applying new technology to the cure and treatment of diseases. Gene therapy, nanotechnology, and personalized medicine are all actively exploited to bring new and exciting advances in healthcare. While healthcare is technologically advanced, in many ways the business models of healthcare companies have been slower to evolve. For example, the distribution of medical services is still largely mired in the traditional models that have existed for decades. The distribution of medical services is still, for the most part, a local affair, and largely dependent upon the regional availability of such services. By contrast, consumers of household goods are capable of shopping on a global scale, taking advantage of companies such as Amazon.com to obtain economies of scale and access to goods produced in every part of the world. Entertainment is now streamed digitally, allowing for instantaneous delivery of music, software and movies.

Government and industry have come to realize the benefits that could be obtained through such business models, and healthcare is poised to enter a period of evolutionary change. The Center for Medicare and Medicaid Innovation is currently evaluating a number of new payment and service delivery models in accordance with the requirements of section 1115A of the Social Security Act, as well as other Congressional legislation, including the Affordable Care Act. These innovation models address a number of different needs, such as transforming primary care to strengthen and increasing access for patients, speed the adoption of best practices, and accelerate the development and testing of new payment and service delivery models.

Products Versus Services

The U.S. Food and Drug Administration (“FDA”) regulates the marketing of medical products (drugs and medical devices), but refrains from the regulation of what it refers to as “the practice of medicine,” or medical services. Regulation of medical services is largely left to the various state agencies and professional boards.[1]

Many healthcare companies, however, are now blurring the line between medical products and medical services by manufacturing products that are primarily designed to offer a service. Pill reminders can be integrated with communication devices to allow users instantaneous access with pharmacists or nurses if they have a question about their medication. Commonly used diagnostic devices such as blood pressure cuffs and blood glucose meters can instantaneously transmit measurements to physicians for remote monitoring. This integration of medicine and technology opens the possibility for companies to profit not just from the sale of the device, but from the associated services. In some cases, an ongoing subscription to a service may be more profitable to a company than the sale of the device.

One of the difficulties faced by companies that move from offering a product to a service is the fractured and inconsistent state regulation of medical services generally. Ideally, the economies of scale are benefitted by providing services from a central location. State licensure and other regulatory requirements may dictate a more diffuse network of service centers.

Related issues arise in the context of cloud computing, which involves the delivery of computing as a service rather than a product. FDA-regulated product manufacturers are required to establish their requirements for cloud computing services, including those related to quality, and ensure that those requirements are being met by the service. If patient records are involved, regulatory compliance with both the Health Insurance Portability and Accountability Act (HIPAA) and Health Information Technology for Economic and Clinical Health (HITECH) Act must be addressed. Further, with shared cloud based systems, controls (including contractual controls) must be established to protect intellectual property.

Contractual Risk Sharing

When a medical product also offers a service, there are questions as to supervision of those services. Of course, if the manufacturer maintains a direct relationship with the patient, such as with services offered through nonprescription devices, the responsibility is clearly on the manufacturer. For devices bundled with a service that are specifically prescribed by a physician or other medical professional, the responsibility over those services may become clouded. For example, a physician that contracts with a device-bundled service on the behalf of a patient may potentially hold some risk of liability when the patient calls the device manufacturer’s service center after hours to report a medical emergency. Contractual relationships must address these risks, and the service provider may need to retain appropriate professional coverage to mitigate the liability for their contracting physicians. In other situations, these contractual relationships may be explicitly mandated by regulatory authorities, such as with electronic health records under HIPAA and HITECH.

Modern Distribution Chains

Drugs and medical devices, particularly those restricted by prescription, are distributed through a heavily regulated network. Software marketed for a specific medical purpose, for example the display of medical images, is regulated by FDA as a medical device, and would traditionally be distributed through the same network used by other medical products.

Software, by its nature, does not need to be shackled to this traditional distribution system. It may be downloaded directly from the manufacturer, or it may be provided through an “application store” such as those servicing the various smartphone platforms. This raises a number of interesting issues that have not fully been resolved.

An example of one of these unresolved issues involves user manuals and other required labeling. FDA has a longstanding policy of requiring manufacturers of medical devices to provide user manuals and other labeling in a hardcopy format. While digital copies of such manuals may supplement the hardcopy version, they may not be provided in place of such manuals. Virtual distribution platforms cannot, by their nature, provide a hardcopy manual at the same time the software is distributed to the user.

Another example of an unresolved issue involves the loss of control that manufacturers face with conducting recalls and collecting information on product complaints. Distribution over an application store may present the most direct route to users by avoiding the need for users to have an “unlocked” smartphone. This access, however, comes at a loss of control. Applications offered through application stores generally must be reviewed and approved by the owner of the platform. This could result in delays when manufacturers need to implement critical device upgrades, as review of updates may extend to over a week or more. Further, complaints with the application may be first reported to the owner of the platform, impairing the ability of the manufacturer to report critical adverse events to FDA in the necessary timeframe.

Until FDA addresses these issues, companies must build in safeguards to ensure that regulatory risks are contained. This involves both developing and implementing internal policies, and using contractual risk sharing. Notwithstanding these hurdles, the medical field is poised to see an evolutionary change in business models over the next few years. While there may be growing pains with adapting to the various regulatory requirements, these should not be barriers to innovation.

If you are interested in learning more about how these regulatory requirements impact and influence business models, I invite you to attend Duke University’s Fourth Annual Informatics Conference. I will be speaking on the topic “Vision for the Future – Business Models,” along with moderator Derek Perkinson, Director, Strategic Planning at Comcast Corporation, and panelists Sam Bastia, General Manager, Global Strategy & Innovation at Verizon, Jimmy Childre, CEO of Washington County Regional Medical Center, and Dr. John Murphy, Head of Clinical Informatics at Quintiles.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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