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Morningstar | Smith & Nephew Ventures into Regenerative Medicine with Latest Acquisition

Smith & Nephew's impressive innovation has allowed the company to carve out a slice of the orthopedic and wound-care markets. Though Smith & Nephew is smaller than the dominant orthopedic competitors, it has been a strong contributor in terms of introducing meaningful innovation with its pioneering hip resurfacing implant and knee replacements with Verilast technology, which the firm contends can last for 30 years. These are significant improvements that exceed the evolutionary innovation typically seen in orthopedics. Nevertheless, over the long term, we think the company's relatively small size leaves it vulnerable as the hospital customer base seeks to consolidate vendors to save costs. The firm's market share--about 10% of hips and knees--translates into a tenuous position. Share shifts in this market are glacial, at best, thanks to significant switching costs, and new technology does not necessarily trump those switching costs. Smith & Nephew's strong show of meaningful innovation translated into a mere 200-basis-point gain in share over the past eight years. This showdown between technical innovation and the stickiness of surgeon preference only underscores how difficult it is to induce practitioners to switch. This dynamic and S&N's smaller user base mean the firm could find itself locked out of more hospitals and healthcare systems in the future. The firm has been aggressively pivoting to reduce its reliance on large-joint replacement with the acquisition of ArthroCare for its sports medicine presence, its new Syncera low-touch sales model of joint implants, concerted efforts to penetrate emerging markets, and the impending purchase of Osiris Therapeutics for its regenerative products. The jury is still out on whether this is enough to allow Smith & Nephew to compete effectively against competitors that continue to grow larger and remain independent. As the market moves gradually toward more vendor consolidation, we would not be surprised to see Smith & Nephew eventually pair up with a larger competitor, such as Stryker or Johnson & Johnson, in order to better compete.