Posted on Thu, Sep. 22, 2011
last updated: September 22, 2011 05:00:51 PM
WASHINGTON — When Cook Medical Inc. decided to spend $35 million to build two manufacturing plants in Canton, Ill., it wasn't just business. It was personal.
The company's founder, the late William Cook, grew up in Canton. He knew firsthand the town's devastation when International Harvester closed its 33-acre manufacturing plant in 1983, leaving 3,000 workers jobless in a city of 15,000. The area never fully recovered.
"So our intent was to try to help a Midwestern town that had fallen on some difficult times through no fault of their own," said Kem Hawkins, the president of Cook's parent company, Cook Group Inc.
William Cook's vision was to build a plant every year or two in struggling communities throughout the Midwest to create jobs and "begin that process of restoring hope," Hawkins said.
Cook's death in April hasn't deterred the company from that goal, but an unforeseen obstacle has jeopardized the effort.
In 2013, the Affordable Care Act will begin to levy a 2.3 percent excise tax on U.S. sales of certain medical devices, ranging from stents and defibrillators to artificial hips and bedpans. The tax is supposed to raise $20 billion over 10 years to help fund universal health care.
It will cost Cook, the world's largest privately owned medical-device company, about $17 million of its $1 billion in annual U.S. sales. Hawkins has done the math.
"That's a plant a year that we're not able to reinvest in. Or it's a large clinical study that we can't invest in. Or it's maybe 10 or 12 or 15 new product innovations that we can't reinvest in," Hawkins said. "If we can't build the plants, then we can't hire the people."
The medical device industry shares his concerns. It's lobbying Congress to repeal the tax or at least postpone it.
The United States is the world's leading exporter of medical devices, and each new industry job adds more than four to the overall U.S. economy. An industry report claims that 43,000 U.S. jobs will be lost because of the tax, many of them to foreign countries such as India and China, where labor, taxes and raw materials are cheaper. That's more than 10 percent of the nation's 422,000 medical-device workers.
Industry analyst Jeff Jonas, of Gabelli & Co. of Rye, N.Y., said the tax could cut a company's U.S. profits by about 3 or 4 percent, but he disagreed with the report's "aggressive assumptions" about job losses.
"There will be job losses because of it, but I think a more realistic number would be somewhat lower than 43,000," he said.
Small development-stage companies, particularly those that are just beginning to book revenue on newly approved products, will take the biggest hit, said Brad Perriello, co-founder and editor of MassDevice.com, an online journal that covers the device industry.
"Those companies are generally revenue-negative or not yet profitable, and taking a slice of their top line right off the bat could be very difficult for them to cope with," he said.
In a forum on Capitol Hill this week, device company executives met with Republican lawmakers to discuss the tax and growing regulatory head winds that could curb growth in one of the nation's strongest and most promising sectors.
Several Republicans are sponsoring legislation to kill the tax, including Rep. Erik Paulsen of Minnesota and Sens. Dan Coats of Indiana and Scott Brown of Massachusetts.
Democratic Sen. John Kerry of Massachusetts, who helped cut the tax from 4.6 percent to 2.3 percent during last year's health care debate, also would consider repealing it as part of a comprehensive restructuring of corporate taxes.
Not everyone is having second thoughts about the tax, however.
John Boyd, the president of the Boyd Co., a site-selection consulting firm in Princeton, NJ., said that rather than sending U.S. jobs overseas, the tax probably would cause manufacturing jobs to move from more expensive areas to smaller, lower-cost cities such as Rochester, Minn., Sioux Falls, S.D., and Madison, Wis.
"We're not one of these companies running around projecting this incredible exodus" of jobs, Boyd said. "In fact, I've been saying just the opposite. There are lot of macro and micro trends that actually speak well for the U.S. in the next several years for the industry."
Boyd said the device industry was less vulnerable to offshore job losses because of the weakened U.S. dollar, as well as intellectual property and piracy concerns in countries such as China. He thinks those problems will lead some device companies to move their foreign production back to the U.S. over the next few years, while device makers in Canada and Europe could bring operations to the U.S.
And because the excise tax can be deducted from a company's income taxes, the true impact will be more like 1.4 percent instead of 2.3 percent, said Jonas, the industry analyst. A research and development tax credit of nearly 2 percent further eases companies' tax burden, Jonas said.
Jonas said larger device makers such as Boston Scientific, Covidien, Medtronic and Cook could raise prices while reducing costs and discretionary spending to offset the tax.
In addition, low tax rates on their European, Asian and South American operations allow large device makers to better absorb the tax hike.
"If you're a big medical device company, you might be getting 30 percent of your sales in Europe and that means 30 percent of your business has a 15 percent tax rate," Jonas said. "That's how their (overall corporate tax rate) creeps lower."
Cook manufactures in Australia, Denmark and Ireland. But Hawkins argued that competition is too keen to assume that they can just hike prices without hurting sales.
"This notion that we can 'just pass it on' is simply untrue," Hawkins said. "Because we're a private company, we can take a little less profit and do the right thing. But you have to ask yourself, at what point do we start to lose business because we can no longer compete on price because of the advantages of companies manufacturing in low-cost" foreign countries?
At Zoll Medical Corp. in Chelmsford, Mass., company CEO Rick Packer said the tax would cut the company's investment in research and development. "That means fewer jobs for engineers," Packer said.
About 1,800 of its 2,000 employees are based in the U.S., but Zoll, which makes resuscitation devices, has no foreign manufacturing operations. That could change, however, Packer said.
"I'm an old manufacturing guy that just believes I ought to try and do it in the United States if I can. But if I have to go and squeeze every last nickel out of my cost structure, then I need to move my manufacturing to offshore places and lower my costs and try to fill in the hole that the tax is going to cost," Packer said.
That's not an option for smaller firms with low profit margins or those that are struggling to become profitable. Because these companies often need venture capital to expand their operations, even a small hit on profits can make outside funding more difficult to secure, particularly in these economic times.
"They just don't have as many levers to pull as the big guys" when it comes to trying to offset the tax, Jonas said.
That doesn't bother John Reid, a co-founder of AbbeyMoor Medical, in Parkers Prairie, Minn. In a state with more than 400 medical-device companies that employ more than 50,000 people, Reid's company has fewer than 10 employees, who make devices to treat male urinary problems.
He hasn't thought too much about the tax, and he isn't worried about its impact.
"I just look at it and say, 'if it comes, I have to contend with it, because everyone else will have to contend with it,' " Reid said. "I just can't see it having a material impact on us in the short run. I can't."
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