Stryker is a company is a medical technology company based in Kalamazoo, Michigan*. The headquarters is described in earnings calls as ‘’a little tiny corporate office at the end of the airport runway in Kalamazoo. Some accountants sitting there and a couple of attorneys.’’ In an era where corporate headquarters are getting flashier and more expensive for shareholders, it is refreshing to see Stryker settle for a humble HQ.
Stryker offers products and services in three segments: Orthopaedics, Medical and Surgical, and Neurotechnology and Spine. Stryker was founded by Dr. Homer Stryker in 1946. He was a practicing surgeon in Kalamazoo. That was just his day job though. At night, he was an inventor. The very first product he came up with in the research lab in his basement was a special gurney that allowed caregivers to turn patients with serious back injuries. 74 years later, innovation is rooted more deeply than ever in Stryker’s DNA, and as I will explain, is one of the company's most important competitive advantages.
Each of Stryker’s segments contains several sub-segments. For example, Orthopaedics is divided into knees, trauma & extremities, hips and other. Segments are further subdivided by region, and there are a total of 20 businesses. Each of these businesses are run separately, in a decentralized manner. That means that each business has responsibility for its own P&L, sales, marketing, product development and improvements, allowing each business to be laser focused on customers’ needs. Consequently, group heads are compensated according to their group’s financial results. Further, R&D personnel at various manufacturing locations maintain relationships with staff and distribution locations and customers, to understand changes in market and product needs.
Stryker offers more than 57 000 products in 100 different countries. The company operates in an area with few competitors, particularly in their biggest segment, Orthopaedics, due to breadth of competitors, scale, local and global expertise and complementary product offerings. Below I go deeper into Stryker's competitive advantages.
Stryker has a hi-touch salesforce that specializes by segment and accompanies physicians from the pre-sales process to long after the sale is made. I believe this sales model is a source of competitive advantage, since they teach surgeons how to use the instruments, which creates huge switching costs. What further compounds the high switching costs is that surgeons’ preferences for their vendors can stretch back to their days in residency training. Stryker capitalizes on the importance of switching costs through their Stryker Academy. The Academy is a platform designed to support medical residents and fellows through their training years and early careers. Switching to another med-tech provider’s system would require time for re-training, developing a relationship with a new sales rep and working less efficiently at first.
This proximity is a competitive advantage. While scrolling through online surgeon forums, I found a few comments like this one from beneficiaries of Stryker products: ‘’ I love our Stryker rep, he has basically taught me how to do certain surgeries.’’ Quite telling.
Since most of Stryker’s products are marketed directly to doctors, hospitals and other healthcare facilities, specialized sales forces for each principal product allows Stryker to have focus and expertise for each medical specialty served.
A key metric that shows the value Stryker adds to its customers are the growth of its sustainability solutions throughout the years. Stryker was the very first company in the medical devices space to provide reprocessing and remanufacturing services for medical devices, comprehensive recycling and redistribution initiatives. Basically, hospitals can reuse several products which were thrown away previously. The company measured the value add of these solutions through pounds of waste diverted from landfills for their customers and money saved in supply costs.
In 2013, Stryker helped its customers save more than 255 M$ in supply expenses and divert close to 8.9 million pounds of waste from landfills. In 2018, these number reached 339.5 M$ and 13.2 M, respectively. While the sustainability solutions segment is a negligible one as a percentage of revenues to Stryker, I will be closely tracking these two metrics in the next few years. They are one of the valuable proxies to track the value-add to customers from Stryker and further deepen Stryker’s moat in an overall inefficient healthcare landscape. Since there is starting to be a shift of the purchasing decision towards larger provider networks, administrators and executives who prioritize cost improvement and patient outcomes, money saved is another important differentiating factor for Stryker.
Stryker has also consistently been in the top 5 of Fortune World’s Most Admired Companies in Medical Equipment for the past few years, demonstrating the great reputation the company has with physicians, healthcare providers and patients.
Another competitive advantage for Stryker is its relentless focus on innovation. The founder Dr. Stryker’s legacy is certainly being sustained today since physicians and medical personnel assist in Research & Development efforts. For example, their partnership with customers includes one with doctor Lawrence Morava, an orthopedic surgeon, which led to the introduction of System 7 – Stryker’s most dependable and highest performing reconstructive power tool system to date. Physicians inventing Stryker products allows them to feel closer to the product and more confident during operations, which further adds to Stryker’s list of competitive advantages. Stryker’s Mission Statement best captures their focus – ‘’together with customers, we make healthcare better’’. This innovation is empowered by the firm’s decentralized operating model.
Stryker’s focus on Research and Development is probably best shown through the R&D metric directly. R&D went from being an investment of 393.9 M$ in 2010 (5.4% of sales) and has trended up every single year since to reach 862 M$ in 2018 (6.3% of sales). This is a CAGR of 10.3%.
Another important metric are the number of US and international patents Stryker has earned. These show, at least partly, the effectiveness of Stryker’s research and development efforts. Stryker owned 1 125 patents in the US and 1 945 internally in 2010, and in 2018, they owned 3 068 US patents and 4 716 international patents. These are increases of 2.7x and 2.4x, respectively. Obviously some of these patents are more valuable than others but it’s good to see a healthy increase in patent numbers.
Another example showing Stryker’s willingness to be an avant-gardiste and an innovator was its Mako acquisition in 2015, for 1.6B$. Mako is a Robotic-Arm Assisted Total Knee replacement tool. The acquisition showed Stryker was willing to disrupt the knee surgery space. Stryker was the first of its competitors to bring in a robotic arm to the growing knee surgery space. The demand for primary knee replacement procedures alone in the U.S. is expected to increase 673% by 2030. Clinical outcomes data from 2017 from the Journal of Knee Surgery also showed that Mako robots led to less bone and soft tissue damage, less need for opiate analgenics, less total knee mean pain, less time for hospital discharge and less need for in-patient therapy sessions, meaning greater overall customer satisfaction.
Another of Stryker’s key competitive advantage are its stellar capital allocation abilities.
Their capital allocation priorities are in this order: 1) acquisitions, 2) dividends, 3) share repurchases. Free cash flow, while lumpy, is quite high, so they need to redeploy somehow, and these are their three strategies. Stryker is opportunistic both with acquisitions and share buybacks. For example, their last significant buyback was in December 2018 (307M$), during the market pull-back. All acquisitions are done in markets adjacent to the ones they operate in, to give a broader offering.
Each year, the company does a white paper process to determine whether they should expand into other segments through acquisitions and different acquisition options are assessed. Potential acquisitions are also screened for culture, customer focus and innovation. CEO Kevin Lobo has stated on several earnings calls that many acquisitions have been abandoned in the past because culture was lacking at target companies. Thanks to the company’s decentralized operating model, CEO Kevin Lobo dedicates a lot of time to thinking about capital allocation. Their acquisitions are made over 90% in cash. Debt is used sparingly, and shareholders never get diluted.
Below are the number and size of Stryker’s acquisitions the past 9 years:
2010: 5 acquisitions (2.06 B$), 2011: 3 acquisitions (265 M$),
2012: 1 acquisition (154 M$), 2013: 1 acquisition, 2014: 5 acquisitions (916 M$), 2015: 0 acquisitions
2016: 2 acquisitions (4.3 B$), 2017: 2 acquisitions (831 M$)
2018: 6 acquisitions (2.4 B$)
And 2019: 1 big acquisition announced, Wright Medical, for 4.1 B$
In sum, I decided to invest in Stryker because its focus on the customer radiates through its hi-touch customer sales model, its focus on innovation and solid capital allocation. All these competitive advantages deepen the moat around Stryker’s castle. With the decentralized operating model and a solid capital allocator at the helm, I remain confident about the future prospects of this business.
Stryker currently has a market capitalization of around 80 B$.
*Kalamazoo, Michigan is also the hometown of newly inducted Hall of Fame baseball player, Derek Jeter. I wonder what other gems Kalamazoo has produced.
Disclosure: I own shares of Stryker.
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