Kevin Nickels' company has developed a new way to treat hard-to-heal wounds and, like many medical entrepreneurs, he believes the discovery can reduce suffering and save lives.

Influential people agree. The company, Celleration Inc., of Eden Prairie, has raised millions of dollars from top venture capital firms. His technology, a combination of ultrasound and saline mist, has been approved by regulators in the United States and Europe and is backed by a dozen scientific studies.

What's missing? Paying customers. Celleration has been turned down for coverage by Medica, HealthPartners, Blue Cross and Blue Shield of Minnesota and the giant federal Medicare program. "There is not enough money to go around,'' Nickels said. "Payers are saying 'Stop: We just can't afford what you're selling.'"

Nickels' story is being repeated at one med-tech company after another as a new austerity settles over the nation's health care economy. The drive to rein in health care costs has made insurance companies and government agencies more stingy about paying for new technology. Meanwhile, venture capitalists, battered by stock market losses, are less willing to invest in promising startups if they can't foresee healthy profits and a big payout.

The result is that medical technology, long an engine of Minnesota's economy, is slowing to a crawl. The industry has shed more than 1,000 people in the past year and the chill is threatening what analysts call Minnesota's "innovation ecosystem.''

That's the community of inventors and investors that produced signature companies such as Medtronic Inc. and St. Jude Medical and could nurture the next generation of med-tech companies.

"This could have a long-term negative impact on the Twin Cities," said Mike Berman, a prominent medical device entrepreneur and investor.

Medical devices certainly remain a lucrative industry. With the nation's population aging and millions of baby boomers set to retire, demand for treatments of chronic diseases such as diabetes, heart failure and memory loss remains robust.

But whether it's reluctant insurers or tapped-out investors, med-tech startups are finding it increasingly difficult to get their treatments to patients. The extra cost and time required to launch a new device unnerve venture capitalists, who wonder if they'll ever recoup their money, much less turn a profit.

"The timelines [to market] are getting longer, which makes it financially challenging," said Peter McNerney, a partner and co-founder of Thomas, McNerney & Partners, a prominent Minneapolis-based venture capital firm that invests in med-tech companies.

Squeezing innovation

Ever since Earl Bakken invented the first battery-powered pacemaker 50 years ago, Minnesota has prided itself as an incubator of medical technology.

His company, Medtronic Inc., became the world's largest medical device maker and spun off scores of engineers, entrepreneurs and other companies, including St. Jude Medical and what is now the cardiac rhythm division of Boston Scientific.

Today, the state has more than 500 med-tech companies, with 40,000 employees and tens of billions of dollars in annual revenue.

Startups, in turn, became a crucial source of innovation for the industry giants, which increasingly rely on small companies to develop new technologies that they later acquire.

To stay profitable, the industry needs to innovate constantly; two thirds of med-tech revenue last year came from products introduced over the previous two years, according to a report by Ernst & Young, the accounting and consulting firm.

But as the stock market tumbled in the past year, wealthy investors lost both capital and enthusiasm for risky new ventures.

"They just don't have the money to invest," said Thomas Gunderson, a longtime med-tech analyst with Piper Jaffray. Because the market for public offerings has essentially dried up, so has the expected windfall that makes investors rich.

If a device doesn't treat a chronic disease affecting a large population, their interest wanes further.

Nationally, venture capital investment in medical devices, an industry long thought to be recession-proof, declined 27 percent, to $412 million in the first quarter, according to the MoneyTree report by PricewaterhouseCoopers and the National Venture Capital Association.

In Minnesota, venture capital investments in medical device startups fell sharply between mid-2008 and early 2009, and most of this year's money went to just one company, Atritech Inc. of Plymouth, which makes a device to prevent strokes.

"Something is fundamentally changing," said Berman, the entrepreneur. "We won't get back to the go-go years anytime soon."

Compounding the anxiety of investors, the drive for health care reform has made government agencies and private insurers less willing to pay for every new device and treatment that comes down the pike.

In the past, insurers would almost always award coverage if the Food and Drug Administration (FDA) approved a device.

Not anymore, says Dr. Brent O'Connell, chief medical officer for Argenta Advisors, a reimbursement consulting firm in Woodbury. Now, he said, FDA approval is "just the entry fee."

Does new mean better?

Insurers used to evaluate devices solely on benefits and performance; now payers want companies to demonstrate "comparative effectiveness," O'Connell said. That's a much higher standard that requires a device maker to prove that the technology is significantly better than devices already on the market.

One reason is cost. Americans spent $2.3 trillion on health care last year, or more than 16 percent of the nation's total economic output, up from $243 billion, or 9 percent of GDP, in 1980.

Even though medical devices account for only about 1 percent of total health care spending, the government attributes a large chunk of the rise in costs to use of new technology and lack of reliable information on medical outcomes, quality of care and cost.

Speaking last year to the annual conference of the industry group Life Science Alley, Dr. Reed Tuckson, chief of medical affairs for UnitedHealth Group Inc., said the medical device industry tends to favor innovation over usefulness.

"No one can sustain the escalation of health care costs,'' Tuckson said. "There are lots of smart people here who take innovation and market it to people, so they want everything. But the innovations are more expensive than what they are replacing."

With Medicare forecast to run out of money in 2017, President Obama wants health care reform to include evidence-based medicine -- treatments with proven effectiveness.

Last month, for example, Medicare declined to cover virtual colonoscopies, ruling that "there is insufficient evidence ... to conclude that screening CT colonography improves health benefits for ... average-risk Medicare beneficiaries.''

Decisions by Medicare, which covers 44 million elderly Americans, often influence other payers.

In addition, the federal stimulus bill provides $400 million to the National Institutes of Health to test whether new medical technologies really represent an improvement on existing therapies.

That might not spell good news to Kevin Nickels at Celleration, the ultrasound wound-care company.

From the beginning, Nickels knew that gaining reimbursement would be tough. Now, he could be asked to fund additional large and costly clinical trials before insurance companies will pay for his therapy.

"I asked someone at [Medicare] what else do I need to do," Nickels said. "He said: 'Just a little bit more.'"

Nickels says he's had to conserve cash by "slowing the business down.'' He pared back his sales force this year, even though he needs more boots on the ground to convert doctors and insurers. The 50-employee company decided to staff only markets where Nickels feels the company has a reasonable chance to get reimbursement.

His experience has been repeated at dozens of other companies.

Employment in the state's medical device industry, which was growing at a brisk 4 percent to 5 percent annually for much of the last decade, has contracted sharply in the past 12 months.

Stalled marketplace

The last Minnesota device company to go public with a stock offering -- EnteroMedics Inc. of Roseville -- hit the market in November 2007.

Some observers say tougher scrutiny of new devices is not all bad if it means that only the best and safest technologies get to market. Economists have estimated that as much as 30 percent of American health care spending, including some for new technology, has no demonstrated effect on patient health.

"I'm amazed at the high prices of health care services," said Darrell DeMello, president of ScyFIX, a Chanhassen-based start-up that is developing a device that uses electricity to treat blindness. "If you give someone so-so treatment but expect to charge a premium price for it, then I have a problem with it."

Adapting to the tougher new environment, however, is taking a toll on his colleagues across Minnesota.

Investing in med-tech "used to be worth it," said Mark DuVal, managing partner of DuVal & Associates, a Minneapolis law firm that advises drug, food and device companies. "Should we still be in medical devices?'' he asked. "It's just not what it used to be." • 612-673-7744 • 612-673-7752