Raising Robotics: An Interview With Intuitive's Lonnie Smith
Executive Summary
The tremendous success of Intuitive Surgical over the past two decades seems clearly to argue that robotics is more than a techy's pipedream. Intuitive has already revolutionized at least one procedure - laparoscopic prostatectomy - and it figures to make significant progress in a range of others, in men's health, women's health, and cardiovascular surgery, to name just a few relevant clinical spaces. Even more impressive has been its success as a publicly traded company; for much of the middle years of this decade, Intuitive's stock was the strongest performer among all medical device public offerings. And perhaps most interesting: until recently, Intuitive was virtually the only robotics company to achieve any kind of success at all. In Vivo interviews Lonnie Smith, the CEO of the company for much of the 1990s and 2000s, to whom much of the credit should go.
by David Cassak
The test of any medical technology, particularly highly engineered medical devices, comes when concept meets reality. A physician or engineer has a fascinating idea for a new approach to a procedure or technique that looks great when drawn on a piece of paper – but will it work? And will other physicians adopt the new procedure/technique in their everyday practices? Nowhere is this truer than in surgical robotics, an area in which there is a huge potential to transform the practice of surgery, and an equal measure of skepticism about its applicability. To its advocates and supporters, robotics are the future of medicine – not just surgery, but interventional procedures as well; to its detractors and skeptics, it's folly, part Rube Goldberg, part flying machine.
Even for its skeptics, however, the tremendous success of Intuitive Surgical Inc. over the past two decades seems clearly to argue that robotics is more than a techy's pipedream. Certainly, adoption challenges remain, and some surgeons may never fully accept the notion that robotics provide manipulation and tactile sense every bit as good as, if not better than, those of conventional surgical techniques. But Intuitive has already revolutionized at least one procedure – laparoscopic prostatectomy – and it figures to make significant progress in a range of others, in men's health, women's health, and cardiovascular surgery, to name just a few relevant clinical spaces. Even more impressive has been its success as a publicly traded company; for much of the middle years of this decade, Intuitive's stock was the strongest performer among all medical device public offerings. And perhaps most interesting: until recently, Intuitive was virtually the only robotics company to achieve any kind of success at all. To be sure, Intuitive's success is the result of the contributions of many, but a large share of the credit has to go to the person who was CEO of the company for much of the 1990s and 2000s, Lonnie Smith.
A bit of background: Smith grew up in Idaho, where his father had a small construction company. Smith himself thought he'd be a civil engineer, but when his father died in a car accident when Smith was a sophomore in college, he came home to briefly take over the family business. When he eventually returned to school, Smith no longer wanted to be a civil engineer and changed his field to electrical engineering, which led to his first job, working for IBM Corp. At IBM, Smith joined a program, new at the time, to train promising young managers. Soon after, Smith decided to go to business school – but not before being drafted into the army during the Vietnam War. Celebrated as a manager, Smith says his experience in the army was formative. "I discovered that you can learn from what people do wrong as well as what they do right; you learn from everybody," he says. "It was also a good experience in that in the army, you're stripped down to nothing and have to again reassert and build your relationships with other people in terms of the value you bring, and you only bring value in terms of leadership." When his military career was over, Smith turned down a regular army commission and returned briefly to IBM before going on to business school, this time choosing Harvard University over Stanford University.
From business school, Smith went to work for the Boston Consulting Group, where he soon became involved in a consulting project for a Midwestern health care company, Hillenbrand Industries Inc., makers of Hill-Rom hospital beds and Batesville caskets, among other products. He joined Hillenbrand at 32 as a senior vice president and eventually rose to the office of the president, sharing the role with Dan and Gus Hillenbrand, before being recruited for a small West Coast start-up pioneering robotic technology for surgery, Intuitive Surgical, where he joined founders Fred Moll, MD, and Rob Younge in the development of robotic technology that was born out of Palo Alto's SRI International.
Smith would run Intuitive for the next 13 years, until his recent retirement as CEO. (He remains chairman.) Over that time, Intuitive not only helped establish the use of robotics in medicine, but it also transformed at least one clinical space: laparoscopic prostatectomy. Even more impressive, Intuitive went public in 2000 and over the past several years it has become one of the best performers among publicly traded med tech stocks. Indeed, though Smith says he's a believer in the "pinball theory of life," – you start out in one direction, but things change and you find yourself going in another – he earned a reputation as a superb manager with strong operational skills, one who kept Intuitive on a steady course, even as it was building a business in a technology that attracted fascination and skepticism in equal measure.
In the following interview, adapted from the Stanford BioDesign's Innovator's Workbench series this spring, Lonnie Smith talks about Intuitive's early days and the role and impact of robotic technology on medicine.
Q: You came to Intuitive from a company, Hillenbrand, that makes arguably the least futuristic technology imaginable: hospital beds. What was your first reaction when you were approached about the Intuitive job? What was your reaction to robotic technology itself, which in those days was in its infancy? Was that part of the appeal? Or did your days at Hillenbrand make you skeptical about something as far away in the future as robotics?
Actually, Hillenbrand was much more creative than you'd think. In our core hospital bed business, we had a product that essentially disrupted the market and took us to market leadership: the electric hospital bed, which was invented by Hill-Rom. By the time I got there [from Boston Consulting Group], however, the market for electric beds had slowed, and what we found was that electric hospital beds have a great adoption curve for the first generation, but the product life was too long, so Hill-Rom had to innovate to shorten the product life. Even the Batesville casket had disrupted the market; it invented the sealer casket, which was air- and water-tight. It displaced everyone else and they were able to consolidate the market through distribution. As a consultant for Hillenbrand, I had done adoption curves for both of those products – they were the clear market leaders – and also looked at the threats to adoption, such as cremation [for the casket]. At Hillenbrand, I had worked with disruptive technologies, but they were disruptive in a different sense of the word. In fact, that convinced me it was time to move on. It just started to feel like Groundhog Day to me, going from division to division, doing the same thing over and over. Gus Hillenbrand and I were running the company as office of the president, and I went to Gus and said, "I'm looking at other opportunities." He thought I was nuts, but I had three opportunities and two of them were big companies, over $1 billion in revenues. The third was this little company out here in the Bay Area. I came out and met with Fred Moll, Grant Heidrick, Russell Hirsch, and several other VCs. When I met with Joe Mandato [now a partner at DeNovo Ventures], he told me that one of the key differences he found working for a start-up was that all the arrows come from the front. I spoke with several doctors in an attempt to assess the viabily of the technology. Intuitive's initial business plan was focused on minimally invasive cardiac surgery. With robotics, we wouldn't have to split the sternum and we could operate on a beating heart. And I guess being naïve helped a lot because I just couldn't see all of the risks. So I decided that going to a start-up sounded a lot more interesting than working for another large corporation.
Q: When you talk about the risks Intuitive faced, were they market risks or technology risks? Was there an issue of perception? It seems to me that in the realm of innovative medical technology, robotics operates in an interesting space. For a lot of people, it captures the imagination and seems to embody the best that medical technology can do. But it also generates a fair amount of skepticism, especially among those who think it's just never going to be real. How much was that an issue for Intuitive in its early days? And does it remain much of an issue today?
It was a big issue in the beginning, but I think it's less of an issue today. I also don't think it's unique to robotics – the adoption of any new technology goes through stages. As I said, we started out to do cardiac surgery. And once we built the first systems, we got a lot of the early adopters to show interest. We sold 10 systems in the first year. But early adopters, by their nature, are drawn to anything new but have short attention spans, so they're not likely to help you build a sustainable business. They'll buy something, play with it, and then they're on to the next new thing. But we were extremely lucky. We has an extraordinary team of engineers, who designed and built a very complex product consisting of 10,000 discreet components, 3,500 subcomponents, and a million lines of software code, going from the early prototype that SRI had developed to a shippable product in three years.
Q: How many iterations were there?
There were three. The first one was called Lenny, after Leonardo DaVinci; the second was Mona, after the Mona Lisa, and then the third was the da Vinci. The engineering team named them all. Our two-person marketing team tried to come up with a better name, but they couldn't, so we stayed with da Vinci. We had a wonderful team of people, most of whom are still with the company. It was a real blessing to have such a gifted team when I came into the organization. But here's where the good fortune comes in. One of the first sales we made was to the University of Frankfurt, which was going to use the system to perform cardiac surgery, coronary artery bypasses. But there was a young urologist named Jochen Binder, who decided he could do a laparoscopic prostatectomy with it. He had never done a laparoscopic prostatectomy in his life. Because of his lack of laparoscopic experience and out of concern for the safety of the patient, he actually made incisions, put in the cannulas, and sutured them back up – and it took him 13 hours. Now, most people would dismiss that. And at that time, whenever I'd run into a cardiologist or cardiac surgeon, the first thing he'd ask is "How long does the procedure take?" Because at the time, Heartport [since acquired by Johnson & Johnson] was the high flyer and everyone was talking about the Heartport procedure, which took a long time, resulted in several aortic dissections, and ultimately failed.
That first prostate procedure was pretty ugly, but it was the beginning. In fact, most true opportunities aren't very pretty at first. I have a sign in my office that says, "Most people miss opportunity because it comes dressed in overalls and it looks like work." I mean it's ugly and it looks hard. But Dr. Binder's was the first step. But once he did it, other doctors decided they'd give it a try. One of those doctors was Mani Menon, at Henry Ford Hospital in Detroit. He had just come from Boston to be chief of urology and was very interested in laparoscopic procedures. In fact, he went to France to learn the procedure, training at the Hospital Montsouris with Drs. Vallacien and Guillonneau. Dr. Menon's interest in laparoscopic prostatectomy ultimately led him to the laparoscopic capabilities of the da Vinci system, and he convinced his friend Raj Vattikuti to create the Vattikuti Urology Institute at Henry Ford and to buy a da Vinci system. Dr. Menon is a very thoughtful man and did something that I think is unique for a surgeon. He asked his patients preoperatively to rank their desired clinical outcomes. He then measured those outcomes, comparing his first 100 da Vinci prostatectomies with his last 200 open prostatectomies. The patients' first priority was to have all of the cancer removed, and his positive margins went from 24% in his last 200 open procedures to 6% with his first 100 procedures using the da Vinci system. The patients' second and third priorities were continence and potency. Here, too, the results were great. Continence improved from 60 to 96% six months after surgery if I remember correctly, and potency doubled: from 33% to 66% six months post-surgery. In addition, complications dropped from 15% to 2%, transfusions went from 11% to zero, and length of stay in the hospital fell from about three and a half days to one day. However, the initial reaction of the medical community was disbelief. But others started doing it and they also found significant surgical outcome benefits for their patients. All of a sudden, the procedure was proving to be a compelling value to the patient, the surgeon, and the hospital.
Q: I think that raises an important issue for technologies like robotics. But before we pursue that, talk about the transition from a company focused on cardiac surgery to one revolutionizing prostate surgery. How difficult was that? Were the people at Intuitive supportive? Or did everyone say, "Wait a second. We're a cardiac surgery company. Who cares about urology?"
Well, I think the reaction was mixed. I remember one of the founders saying, "You can't get a decent multiple in urology." So there was certainly resistance. Some of those who were concerned about pursuing urology prepared a business plan, called ISI2. The plan was essentially a re-start and laid out a new strategy for pursuing the cardiac opportunity. Ultimately, we didn't pursue that plan because my attitude was, "Listen, we have to go where we bring value." I wasn't so committed to the cardiac piece that I'd stick with it at all costs. And ISI2 was the beginning of the plan for Hansen Medical [Hansen Medical Inc.], which is another robotics company in the Valley. It's never an easy call. It's easy to look at success in the rear view mirror; but it's very hard to see it going forward. Otherwise, all VCs would have a 100% hit rate. As I said, a lot of companies are born ugly and even some great ideas don't succeed.
Q: What was the process by which the da Vinci made its way out of cardiac surgery and into prostate surgery? How quickly did that happen? And again, were you actively promoting that? Or did you sit back and let the clinical community drive it? Did you have to go back to the FDA and get a new round of approvals?
The whole FDA process was interesting because we had approval for laparoscopic surgery, and during one of our quarterly investor conference calls, someone asked if we had approval for prostatectomy, and we said we thought it fell under our laparoscopic approval. It seemed like a reasonable assumption, but the next thing we knew, we got a letter from the FDA saying, "You don't have approval for prostatectomy." Now, that whole process was initiated by a competitor, but it meant we had to file a 510(k) and meet with the FDA. We were very fortunate at the time in that there was a new head of medical devices at the FDA, a doctor from New York, and he had not become enmeshed in the bureaucratic processes of the agency. When we met with him, I explained that the AUA (American Urological Association) meeting was coming up, and people are going to present papers on prostatectomy with our system. Now, we can either tell everyone that we don't have FDA approval for this, but if you want to learn more about it, talk to one of the doctors doing it. Or we can push forward to get FDA approval quickly so we can actually train surgeons who want to do this. And our question to you is, "Which is best for the patient?" And the head of the device group at FDA, Dr. Statland [Bernard Statland, MD, PhD], said something amazing. He said, "You'll have approval before the AUA." Now he didn't remain at the agency for very long, but he followed through and we received 510(k) approval before the AUA meeting.
In terms of adoption by surgeons, one of the things we did that was really smart at the beginning – and also very lucky – was that we tracked every procedure. We knew every time a prostatectomy was done using a da Vinci, where it was done, and by whom. And we could tell you every month how adoption was progressing. And pretty soon it became clear that the cardiac surgery business wasn't growing, but prostatectomy was really taking off. Remember, I had come from BCG where I had done lots of adoption curves, and we started to plot an adoption curve to see how strong the fit was, and it turned out the fit was great. If you then projected an adoption curve, we figured we'd get to full adoption in about six years. And that was a great grounding. We continue to track every procedure and draw adoption curves for those that show consistent growth. Now, how much did we promote it? Manufacturers are the least credible people to promote a procedure or product because we have a vested interest in its success. Hospitals have the next greatest vested interest, followed by doctors. The most credible group to promote a procedure is patients. And we were fortunate in that prostatectomy is a disease of men of a common age group and quite prevalent. It's very likely that if you're my age, you know men who've had prostate cancer. That's a different kind of adoption dynamic than, say, mitral valve repair, which affects both men and women and represents a much smaller patient population. We were fortunate that we found a disease state to which we brought great patient benefits, that hits a large common demographic, and in a demographic that communicates about these kinds of things with one another. An adoption curve is a diffusion curve – it's like when you drop some ink into a vessel and the ink spreads as the molecules interact or come in contact with one another and diffuse throughout the vessel of water. That's exactly the way adoption works. The next significant clinical space in which we brought significant clinical benefits was gynecology, which is growing quickly. Guess what? Women are even better communicators than men, and it's a disease state that affects specific age groups, especially for hysterectomies, myomectomies, and sacrocolpopexy.
Q: But it seems to me that, before you get to that diffusion curve, before you get to the point when patients can ask for a robotic procedure, you've got to hit a certain critical mass of procedures. It doesn't have to be a huge critical mass, but you've got to get to a point where they're hearing about these cases. In the early days, what was the reaction of surgeons to robotic technology per se? You once said to me that da Vinci takes surgery beyond the limits of the human hand, which is an interesting statement in a clinical specialty where physicians particularly prize tactile sensation. What was it like trying to convince surgeons to adopt this technology early on, because surgeons are not the most eager adopters of new technology.
Actually, it differs by surgical specialty. Cardiac surgeons are the most conservative, and convincing them was hard. The other group that was difficult at the time was general surgeons, not because they're so conservative, but because the laparoscopic general surgeon wasn't interested in making it easier for other surgeons to do what he had spent years acquiring the skills to do. That plus the fact that we added things like wrist articulation and 3-D vision. Our relationships with general surgeons weren't warm. They weren't excited about our system, and when we were together, there was a visceral sense of tension in the room. But once the urology community started to see the benefits, it really took off. You're right; it starts with one surgeon doing this, who then tells another surgeon, and then they each tell another surgeon, and pretty soon we began to see clusters where our systems were being adopted. Hospitals, too, once they had the data began to promote it – or at least to create awareness. But certainly, once we began to have success in urology, it got a lot easier to move into other areas. Actually, our initial assessment was that gynecology wouldn't be a great opportunity. But our first procedures were for endometrial cancer, and there the clinical benefits are compelling, just as with prostatectomy, and once we were established there, it became easier to move to other procedures, particularly things like vaginal prolapse where the surgeon has to do a lot of reconstruction. We bring the most value to complex procedures that often require a significant amount of reconstruction.
Q: You mentioned briefly that general surgeons didn't like having less skilled surgeons suddenly having a tool that helped them do sophisticated procedures. One of the other early catch phrases of robotics was that it makes good surgeons great and great surgeons better. The classic adoption model in medical devices is to get some key opinion leaders. But I know that there were some great surgeons who really didn't like the notion of making mediocre surgeons better. Was adoption quickest among the non-thought leaders in this space? What was the reaction of thought leaders to robotic surgery?
I would say initially we tried to follow that model. But it became very clear early on that the early adopters would be not the number-one surgeons in the market, but rather those who had something to gain, not those who had something to lose. Even with hospitals, we were more likely to go not with the biggest hospital in the market, but with the number-two hospital, that wanted to gain share from number-one. To this day, Dr. Pat Walsh, who was the head of urology at Johns Hopkins University, talks about how he's got to have tactile feel. He was on the Charlie Rose Show and said, "I've got the touch." Well, good for him. The fact is that the system so dramatically improves articulation, precise motion control and visualization that it offsets the loss of tactile feel.. The surgeons who use the system do so because the visualization and visual cues are so good that tactile feel becomes less important.
Q: Of course, there's also the reaction of surgeons who do adopt the system. You were telling me before about running into a surgeon while on ski vacation who told you that using da Vinci has changed his practice. When you find surgeons who use it, how does it change their practice?
I was in Park City and riding up the ski lift, when a couple got on with a child. I don't know how it came up, but we started talking and it turned out both of them were doctors. So I asked if either of them was a surgeon, and it turned out the husband was a gynecological surgeon. And so I said, "Have you ever heard of the da Vinci system?" And he said, "I use it all the time." And then he said, "It's totally changed my practice." I hear that all the time, even the head of gynecology at Sloan-Kettering [Memorial Sloan Kettering Cancer Center] told me that his patients do so much better if he does the procedure with a da Vinci. Now, this isn't randomized data, but he said that most of his patients would normally leave the hospital after three days, usually four. But with da Vinci, everyone leaves after one day, and he said, "That's a big difference." And then, as we were saying before, women have the procedure done and then they go home and talk about the experience with their friends, and that drives volume to those centers. And that's critical if you understand the economics of a hospital. Most costs at a hospital are fixed costs. That means the value of a marginal patient to them is huge, because 80% of the marginal patient revenue either helps cover those fixed costs or drops to the bottom line. Incremental revenue is important to any organization. But if you have high fixed costs, it can mean the difference between profit and loss.
Q: You said before that hospitals were the second least likely to push and promote. But a lot of people say that the success of robotics has come precisely because hospitals are looking for a kind of marketing edge -- something innovative or cool to attract physicians and patients. And a lot of people hear about da Vinci not so much from other patients, but from things like radio ads that hospitals run. How much has the hospital been a factor in aggressively promoting da Vinci precisely because it sees it as a benefit to bring in new patients into its facilities?
It varies. Certainly if a hospital is making a large capital equipment purchase, it does want to see it utilized. On the other hand, I would argue that anything a hospital does in the media is more about awareness and that the real compelling credibility comes from another patient. When people have a good experience, they talk about it, just as if they have a bad experience, they talk about it. I hear that a lot – that da Vinci is just a marketing gimmick. But I hear it mostly from people who failed to adopt early and are late into the market and have lost patients as a result. But today the real awareness doesn't come from hospitals. Patients get on the Internet – or a family member will get on on their behalf. In gynecology, there's an Internet group called the Hyster Sisters. It provides a forum for women to ask questions and to share their experience. That's what drives this. That, and physicians who see the benefit for their patients. If a technology doesn't deliver real clinical value, you can't build a sustainable business. You may get some sales for a while, but if it doesn't work, you're not going to create a billion-dollar business. I'm sorry, that's just the way it is.
Q: We've talked about surgeon adoption and the role of the hospital, and you mentioned the consumer. Let me ask one follow-up question about consumers. I don't know if it's still there, but the last time I was at Intuitive's offices, there was a photo montage on the wall in the entrance that featured all the consumer magazine covers that da Vinci has graced over the years, such as Paris Match and Life magazine.
Those were from the very early days. We got a lot of media coverage, especially in Europe.
Q: What was the impact of that? Was that media coverage in the general press all to the good? Was there any downside? I know some physicians and surgeons who don't like it when companies appeal directly to consumers because they don't like having patients walk in and ask about the latest drug or device that they heard about on TV or read about in a magazine, saying, "Can you do this for me?"
Or just asking questions about it. You're right. I don't know what the impact was. I tend to think those things have a short half-life. When you start out, you love being on the cover of Scientific American and Life magazine and stuff like that. But it doesn't sustain anything. The only thing that sustains you is creating patient value, which in turn drives demand. Early on, we hired a publicity firm. It lasted about a year and then we fired them, because the fact is the technology was interesting enough that it could get media coverage without our pushing it. I do believe there's a role in creating awareness and we try to help hospitals that want to buy a system, if they want to showcase it at a civic event. In those cases, we're happy to help. We have some systems that we use for demos.
Q: You've made the point to me many times over the years that da Vinci's success hasn't come because it's a robot, but people adopt robots because they deliver great outcomes and great clinical care. When you're covered in the press, whose interest seems to be prompted by the razzle dazzle of the technology, do you feel that you're covered appropriately, the way you'd like to be?
It depends. I think there are those [media outlets] that are fairly objective, and some that are just – I mean, they're very thin. Ultimately, what we have is a tool, and if that tool enables surgeons to get better outcomes, that's a good thing. Early on, trying to create awareness was important. But it creates its own dynamic. People will see both good and bad in the technology, depending on where they're coming from. Hospitals are competitive with one another, so you hear charges of people starting an arms race and things like that. My own belief is that I would rather not have a system in every hospital; hospitals that don't do a significant volume in a certain procedure shouldn't have a robot. That's true of all surgeries – open, laparoscopic, robotic: you want to be under the care of a surgeon who does a lot of them. They'll simply do a better job. I'm not eager to have systems in hospitals where surgeons are doing a case a month. It's bad for the patient, bad for the health care system, and bad for us. Now, what the system can do is to consolidate markets – hospitals that do a lot of procedures can do even more by attracting patients from those hospitals that don't do a lot. You'd much rather have your procedure done in a hospital that's doing three or four cases a day, and if you go to a major center, that's what you see. There, the team develops a rhythm and works together well. For them, the da Vinci is a tool to help them do that. But it's a tool that helps to consolidate the market by delivering superior outcomes for the patient, the surgeon and the hospital.
Q: I keep talking about the razzle-dazzle factor of the technology. But Intuitive as a company has been no less impressive. You've been successful far beyond all measure. You went public in 2000, at a time when very few device companies were going public. I don't have to ask if it was the right move; for much of this past decade, Intuitive was the Google of medical technology stocks. But why did you go public? What did it do for you? [See Deal]
We went public because we needed the money, and our VCs wanted an exit. I'd much rather have stayed private. And our stock did not perform like Google's initially. We came out at something like $9 a share, before we had FDA approval. And we kept telling people the approval was in the mail. We had been through randomized clinical trials, and the FDA had us on a PMA track. We'd been through our panel meeting, we'd done all the randomized clinical trials they asked for, we'd done everything, and we still didn't have approval. We were on our road show, and I get a call from Phil Phillips, who was then a deputy director at the agency, and he says, "Why is this a PMA?" I said, "I don't think that was our call." And he says, "Well, I don't think it should be. It's going to be too onerous, both for you and for us." So we wound up being a 510(k). At the time, I didn't realize – none of us realized – what a fortuitous decision that was. Originally, we thought the PMA was the right way to go because it would erect a bigger barrier to anyone else coming in behind us. But we would have had to do a clinical trial every time we changed the software. We have a million and a half lines of software code, and being a PMA device would have dramatically stalled future development.
Q: What was the predicate device used for the 510(k)?
The first predicate was actually AESOP [ Automated Endoscopic System for Optimal Positioning; a competitive robotic system launched by Computer Motion Inc.].
But we went public without the approval and the stock immediately sunk. At its lowest it was around $4 or $6. We acquired Computer Motion as a means of settling the patent lawsuits between the companies. [See Deal]
Q: That was in 2003.
Yes. And at the time, we were really good at losing $20 million a year. We'd become professionals at it. In 2002, we got all the employees together. Our revenue growth had grown from $10 million to $26 million to $56 million – and we were on target to hit $72 million in 2002. It was a pretty nice trend, right? But we had fixed costs that were running parallel to that revenue trend, and in fact just above it. I had a hard time getting people, even our finance team, to focus on fixed costs. So we brought everyone together and I said, "Let me explain something to you. We will never break even. Even if our costs of goods were to drop to zero, we will never break even." So in 2002, I announced that from that point forward, we were not going to add another dollar of fixed costs for one year. We just froze our fixed costs, and after that we would grow our fixed costs at no more than half of whatever our revenue projection was. From that point, we achieved profitability in two quarters.
Q: Two quarters in 2003 or 2002?
In the second quarter of 2003. Then we bought Computer Motion, which had lost $30 million the prior year, and we still broke even in 2003. And then 2004 was the first year we became profitable for a full year. The value of managing on a fixed and variable cost basis is that you know what is a marginal value of a dollar of sales. We've evolved since then, but we still grow our fixed costs at a slower rate than we grow our revenues.
Q: I would imagine at the same time you were trying to ramp up sales and continue to develop the system. How did you manage not to spend another dollar of fixed costs for a whole year?
We told people they could re-allocate costs, but there's no room for additional spending. If you spend money here, you're not going to spend it there. It's a matter of priority. Were people happy about it? No. We'd all gotten into an attitude – and it's so easy to do – that we're successful and so we can spend money on whatever we want. And it's even worse for us now because we're quite profitable and we've got a lot of cash – over $1 billion in cash. Naturally, that leads people to think, "We've got the cash. Let's spend it." But I'm a true believer that creativity comes from limited resources and that unlimited resources never, never drive creativity. The Japanese have a term for it: creativity before capital. We do two things that I think work really well. From the beginning, our projects started with small teams of really smart people, starting with five and maybe getting to six to eight. One advantage we've had is that a lot of our best people have been with the company a long time. Even during the dot-com boom, people stayed with us. And the advantage of having a consistent team is you don't make the same mistakes over and over again. The second thing we do is to break everything down into what we call "core versus context" or "core versus support." That's a Geoffrey Moore concept. Core are those things that create value for the customer. Moore says that start-ups are 80% core and 20% context, and Fortune 500 companies are the inverse, 20% core and 80% context. Context are essentially support activities that do not directly create value. Moore says that context activities are like hygiene. Taking a daily shower is a good thing, but taking 10 showers a day is not. We try to allocate 80% of our budget costs to core functions first: engineering, sales, etc. And the rest we allocate to support functions – those things that don't touch the customer. And that approach makes a big difference because people know that we're investing our resources – our dollars and our people and everything else – into those things that improve our technology and touch our customers. That's where we create value.
Q: Let's go back to the story of Intuitive as a publicly traded company. When you say the company's stock was not a particularly stellar performer, was that for the first three years until the Computer Motion acquisition?
I think it became a performer when we turned profitable.
Q: Because from that point on, it became a hugely successful stock.
The other thing is that our cash flow has always been strong. And for that I give credit to the original business model. We may have been wrong about cardiac surgery and about micro-code versus software, but our original business model has been a good one. I've seen few businesses that can grow at compound rates of 60% and still throw off cash – that's pretty incredible. I think we're valued more on a cash flow basis than on a reported earnings basis.
Q: Starting around 2003 or 2004, Intuitive began a run of several years of simply extraordinary share price growth, growth that was simply unheard of in the medical device space. What was it like managing a company that was doing so well? We hear all the time that the job of CEOs of publicly traded companies is to increase shareholder value. At the same time, you were trying to introduce into the market an amazingly complex new technology.
Well, let me challenge you on that. We did not believe that increasing share price per se was what we were trying to do. We have a hierarchy of value, and the first group we want to create value for is our patients. We define patient value as efficacy divided by invasiveness. The second is for the surgeons and the hospitals. We want to help them build their practices by providing superior outcomes for their patients. And third, we want to create value for our employees, the people who touch and support our products and our customers. The fourth and last group are our shareholders. But if you turn those around and focus on your shareholders first, you don't create value. It's a hollow effort. There's no substance there. If we create value for our patients, our customers, and our employees, we will create value for our shareholders. When our stock took a huge jump, I sent an e-mail to our employees saying, "Don't focus on this because it's probably going to go down." I was wrong at the time, but the message was right: "Don't get distracted by this because quite frankly, the market does these things." And of course, our stock did eventually go down in 2008. We went from around $340 a share to $90 or something like that. But I don't think people got rattled about it. They understood, and now we're back. We believe that if we create value in that order, we'll create value for our shareholders.
Q: That's such a contrarian view. But when the stock was high, say $240 going to $340, did that enable you to do things you couldn't if the stock had not performed as well?
I don't know. We don't use the stock to do anything. We're not using it to make acquisitions. That's not to say there weren't benefits. A lot of our employees and shareholders have done well. As you know, stock options are an important part of the compensation package and are key to attracting top technical talent in Silicon Valley. Every employee in our company is a shareholder. The way we look at it, a stock option is essentially a 10-year, interest-free loan on a certain value, which is the number of shares times whatever the stock price is. You can then create a chart that shows what the value is if the stock goes up 10% compounded over a 10-year period. You want employees to see [stock options] as a way to put their kids through college or to buy a home. I think our people feel good about the way the stock has performed, but I don't think it's the reason they come to work.
Q: As I say, the stock has done phenomenally well, but was there any downside to being public? You said you needed the cash, but, once public, was there anything you didn't dare do because you were a publicly traded stock and were afraid of the impact on the share price?
We don't really manage the business that way. I don't think there's anything that we do with the thought of how it's going to affect the stock price. Everything we do, we do with the thoughts, "How does it affect our patients, our customers? How will this affect the business? Are we being fair?" But if you manage by considering how a certain move will affect the stock price, you're taking a pretty short-term view. And if you don't manage in the right way, the stock price isn't going to do well over a long time anyway. And then you might as well sell your stock right now.
Q: A decade ago, there were two major robotics companies in this space: you and Computer Motion, and then, as you pointed out, in 2003, you acquired Computer Motion. Talk about why you did that deal, and what impact it had on the evolution of robotics as a technology and as a commercial product.
I'm not sure it had much of an impact on the evolution of robotics. Computer Motion made a product named AESOP, which allowed surgeons to control the scope in laparoscopic surgery through voice commands. The surgeon would say, "AESOP, right" or "AESOP, left" and the scope would move in that direction. That gave the surgeon direct control over the scope and removed one FTE from the OR. The only problem was that it was a little bit slow, and so often you'd see the surgeon grab it and move it around manually, which meant that instead of a robot, it became, essentially, a scope holder. Well, who's going to pay a lot of money for a scope holder? Highly skilled laparoscopic surgeons, the people who do laparoscopy all the time.
That was how they started. Later, when Computer Motion decided that they were going to get into surgical robots, they went to those same customers, highly skilled laparoscopic surgeons, and asked, "What should this look like?" And the customers told them exactly what you'd expect. They said, "Make it do just what I do. Straight sticks are fine, and you don't need wrists or 3-D vision." What they did was essentially put a computer between the surgeon and the patient, which brought little additional value. At the same time, they also created a lot of early intellectual property around robotics. So they had a bunch of intellectual property, we had a bunch of intellectual property, and when they started to fall behind Intuitive in the marketplace, they did what a lot of companies that are losing do. They sued us. In fact, they tried to stop us from going public. So we went to visit them, and I said, "Listen, we can start negotiating a deal around a cross-license, but we are about to go public. I look forward to working this out." And Computer Motion's CEO at the time said, "In the best of all worlds." So they sued us and we went public; it didn't stop us. They sued us on 10 patents in California. We counter-sued them on some patents, and we won in Delaware. But all along we knew that going before a jury on patent issues, with people who don't understand the technology, is a very tricky thing. We tried to settle a couple of times, but got nowhere until they became desperate. They were losing money, and it wasn't clear whether they could raise additional capital. I really didn't want to do the deal [to acquire Computer Motion]. But finally it just became obvious that we had to get the litigation behind us. They had by that time a robotic system called Zeus MicroWrist, and we tried to see if we could combine Zeus and da Vinci, but there really wasn't anything there. In the end, we wound up taking some of their people and consolidating all of the operations because they were losing so much money, and shutting down the Santa Barbara operations.
Q: They had three models: the AESOP, Hermes and Zeus. Can you buy any of those today?
You can buy a used AESOP. But Hermes was never FDA-approved, and Zeus was less capable than da Vinci and therefore was never really a viable product and not a platform we could build on.
Q: So initially it was just you two in the robotics space. More recently we've seen a bunch of new companies that are all in and around the space of robotics: Stereotaxis [Stereotaxis Inc.], Hansen, Corindus [Corindus Vascular Robotics Inc.], companies like that. Do you consider those companies competitors to da Vinci? And I realize that you bought Computer Motion because of the IP issues. But why has M&A not factored more into your strategy – particularly when you had such a robust share price that you could have used as a currency to make those acquisitions?
First, most acquisitions don't yield very good returns. Second, we truly are a surgical company. We have bought some IP from companies. We acquired NeoGuide Systems, which had some interesting technology in flexible robotics. We got several of their engineers and some IP. And we've done that multiple times: we have been an acquirer of intellectual property that we believe will enable us to practice the art. Hansen Medical is focused on vascular medicine. We have a cross-license with them. It's very different from what we do and not something we're going to get into in the foreseeable future. Now, we realize we have to be careful when we say things like that. When you have a disruptive technology, you live by it or you die by it. We've seen a lot of that in this Valley. Drive down any highway and you'll see former headquarters of companies like Silicon Graphics that were leaders one day and also-rans or out of business the next. Things happen very fast in technology-driven markets. So you don't want to close off opportunities. On the other hand, I don't think it's appropriate for us to get into new areas willy-nilly. When you're already growing at 60%, and just trying to hold everything together, acquiring another entity can be a challenge. I've been there, done that, and the distraction to management is huge. [See Deal]
Q: Following on that, I know that cardiac surgery remains a kind of presence in the background at Intuitive. Where do you see the cardiac surgery applications of da Vinci going down the road? And each of the three companies I mentioned, Stereotaxis, Corindus, and Hansen, are all in the cardiac space. Wouldn't it be a great way to get into that space by acquiring another technology rather than trying to migrate da Vinci into cardiac surgery on your own 10 years down the road?
But they're also on the interventional side, not the surgery side. That might be a path to take later on. Right now, I think we do bring a lot of value in cardiac surgery to mitral valve repair because we can enable a closed-chest mitral valve repair, and surgeons using the da Vinci system have been getting a 95 to 98% repair rate, compared with the repair rate for open surgery of slightly above 50%. And if the patient gets a valve repair instead of a valve replacement, he is not on Coumadin [warfarin] for the rest of his life. But it's pretty difficult and there aren't a lot of centers doing this right now. I think the Cleveland Clinic is doing a significant percentage of their valves with da Vinci today, and it appears to be growing.
I'm still a believer in the cardiac opportunity. It may be hard to get it through my head, but I still believe we bring such value to the patient in cardiac surgery that we'll be able to build a substantial business there. One of the centers that has moved aggressively in coronary artery bypass is the University of Maryland. When Rob Poston left and they brought in Johannes Bonatti from Austria to replace him. Poston's paper in the Annals of Surgery compared doing what he calls a mini-CABG on a beating heart with open surgery, and it's in applications like that that I think hold tremendous promise. In his paper, he found 99% patency one year post-op compared with 80% open, as well as an 85% reduction in major adverse cardiac and cerebral vascular events, an 83% reduction in intubation time, and a three- to seven-day reduction in the length of stay. Not a bad story. So I think the cardiac applications will come. Cardiac surgeons are so conservative, but the interventionalists are just kicking their rear ends. We always say, "Patient value equals efficacy divided by invasiveness, perhaps squared." And the reason surgeons are losing patients to interventionalists right now is that a stent isn't very invasive. Patients will pick it every time over splitting open their chest, if they can.
Q: A long time ago you told me that you thought robotic adoption was going to take decades, not years. It's been several years since you said that to me. Where do you think we now stand in terms of adoption of robotics? Are we still at the early stages? Or is it possible to talk about mature robotics?
Boy, I hope not. I remember saying that and I still believe it. People sometimes get impatient. They looked at laparoscopy, where the lap choly reached full penetration after five years. And even prostatectomy was taken up very quickly. But all of these adoption curves are different, with different slopes. Mitral valve will be pretty long. Prostatectomy was, because of the demographics, about a seven-year curve. With robotics, there isn't going to be one large curve, but a lot of smaller curves, procedure by procedure. And the technology isn't static. We're constantly improving it. I started my career at IBM; soon after leaving the army I remember going down to LA to a lunch presentation by Frank Cary who was chairman of the board at that time. He held up a glass jar and said, "There's more memory in this glass jar than we have installed throughout the world." Today, I can put in my pocket a flash drive with more memory than they had installed throughout the whole world at that time. That's how technology advances. I'm not smart enough to know where it will all go, but if we can't constantly evolve, we're going to be out of business. I know the technology will get smaller and more specialized. And if we don't take it there, somebody else will. And by the time we do that, I think we'll see the lines of separation of some specialties, like interventional cardiology and cardiac surgery, become very blurred.
Q: One of the most interesting things to me about robotics is that you'd think in a complex, sophisticated technology space, you'd see small companies constantly innovating and leap-frogging each other for leadership. But Intuitive's been the clear leader for 15 years. To what do you attribute Intuitive's success to stay ahead – well ahead – of the rest of the market all of these years? There really hasn't been anyone to come along and seriously challenge you.
First of all, we have a lot of intellectual property. That's a barrier. But it's not obvious how to succeed in this business. You mentioned we got profitable on about $120 million [in invested capital], but if you looked at our retained earnings, we crossed over before we lost $120 million. Hansen's lost $220 million, and Stereotaxis has lost more than that – probably around $300 million. That's a huge disincentive to others. Maybe someday, someone will come along and change that paradigm. Look at what happened in PCs – you know, the world can change pretty quickly. The thing I worry about is that we'll look at it and dismiss it, saying it's somehow inferior and then wake up to a formidable competitor. But success in this business isn't obvious. J&J came in and looked at what we were doing and walked away saying, "We don't get it." And most of the VCs dismissed us saying, "That's just a technology looking for an application." And they were exactly right. Thank God we found that application.
Q: You mentioned at the very beginning the great results you've gotten early on in the clinical cases that have been done with da Vinci. We're entering an era of health care reform, and I have to say, every time I have a discussion with someone about the implications of reform and the advent of comparative effectiveness, the technology cited most often, if not exclusively, as the kind of technology we can no longer afford is robotics. Their point: it costs too much and delivers too little – it's innovation for innovation's sake. How do you respond to that? Have you heard the same thing? Do you think robotics will be in the cross hairs as we go deeper into discussions about things like comparative effectiveness?
The people who say that have no idea what they're talking about. On one of my slides, I note all the technology laggards, like the head of the US Patent and Trademark Office who said in 1902 that everything that could have been invented already has. Or Harry Warner of Warner Brothers who said about talking movies, "Who in hell wants to hear actors talk?" Advances in our society are always about capital replacing labor, and that's what robotics does.
I welcome comparative effectiveness studies because I think once those studies are done, we'll win. The only thing I worry about is if people start to do those studies with pre-conceived notions about what they want to prove. And there's a lot of that right now – people doing these studies with clear agendas. But on a level playing field, we will win. I've crunched the data, looking at hospital beds and average length of stay and the cost per patient day is around $3,000. Now, that's all fixed cost. If we can save $1,000 per patient day, which we've shown we can in doing prostatectomies, and do it in hysterectomy and cardiac surgery, using some very conservative assumptions, by reducing the number of patient days, robotics absolutely becomes cost-effective. I've seen figures that 70% of surgical cases today could be converted to minimally invasive surgery; if we can do that, we can save 17 million patient days a year. In fact, I think the story behind robotics will only get better. But you're right, the noise [against robotics] will be loud, particularly among people who don't understand the technology. Do you know what the first application of the steam engine was? To pump water out of mines because you couldn't get a mule down the mine shaft. The engine wasn't as efficient as a mule, but it didn't matter because the mule wouldn't go down the mine. But pretty soon we were using it to drive locomotives and steam ships. You know what the response of the sailing ship industry was? Well, they created the Thomas L. Lawson, which had seven sails, on the theory that if some is good, a lot is better. But on the Lawson's first trip across the Atlantic, it didn't steer very well, and when it hit rough water, it sunk. So people fight change. Einstein said his penalty for being a heretic in his youth was that he became an expert in his old age. We have to be careful we don't cling to old paradigms. That is a very dangerous place.
Q: Every couple of years, you see an article in the news about someone working on telemedicine and telerobotics but nothing comes of it. Do you see a viable place for telerobotics moving forward?
The military is working on several programs. But personally, I'd medvac the injured soldiers out to a place that can provide complete and sterile care. As the technology evolves, I wouldn't be surprised if we were able to do telerobotics. But we can't today. Now, I do believe that telemetry and teleproctoring are real, and we have that capability in our system today. You can be in one place and see what's going on in an OR somewhere else – see exactly what the surgeon sees and communicate with him by both voice and writing on a screen. I think we'll see a lot of things like that. But at this point, I don't see the value of having a surgeon working remotely. If you can afford a million-dollar piece of equipment, you probably can afford to have a surgeon there. I just don't think we're there. But I'd never say never.
Q: Couldn't someone do a da Vinci procedure right now in South Dakota from a Chicago hospital?
You're correct. "Can't" is the wrong word. We could, especially as the Internet's gotten better and the speed of connections is faster. All of that makes it possible. And if you think about something like a phone that you could see yourself on – when I was a kid, that was the kind of thing you only saw in Popular Mechanics. But it's a reality today. So I'm the last one to say that won't happen. But today, surgery is a kind of choreography. You want to have a surgery in a setting where the whole team is orchestrated well, and everyone knows his or her role and does it well. These things are important. For me personally, I'd rather have the surgeon there.
Q: I'm curious about your board of directors. What kind of role did they play in the early years and how did that evolve over time? What do you look for in a director and how do they help you do your job?
We look for people who can bring different viewpoints to the board. I am very opinionated about the role of corporate boards. I think there are two primary roles in a company: those who run the company and those who own the company. This isn't something you're taught at Stanford Graduate School of Business or Chicago or Harvard, but I don't believe the board can run the company. When I hear someone say that the board is going to set the strategy of a company, I just don't believe it. A board member who maybe comes in six times a year, more often four, is going to set the strategy for the corporation? I don't think so. They certainly ought to question it, and bring viewpoints and ask questions. But I sit on some boards and I can't set strategy. The board's first responsibility is to make sure it has the right person running the company. Its second responsibility is to determine whether it's worth more in someone else's hands than it is in those of the current ownership, and if it is, then it ought to sell it. We have some physicians on our board, some tech people, and some people like Alan Levy, who's done multiple start-ups and was an R&D officer at J&J. In the end, what I look for in a board member is what I look for in my employees: very smart people who are highly dedicated and committed to supporting the mission and the team in fulfilling that mission.
Q: The corporate board aside, how did you put together your scientific or medical advisory board, and what did you see as its role, particularly in the early days when robotics was not a widely adopted technology?
Well, I won't use any profanity here, but for us, the scientific advisory board was a joke. What's a typical SAB? A bunch of big name surgeons whom you can point to when you're doing your IPO. That was our SAB. But they're so busy, they never showed up at any meetings, and they didn't really understand what we were trying to do. I don't even remember who was on our SAB and I certainly don't remember any value they brought. The real value came from people you'd least expect it from – some young surgeon who didn't know what he was or wasn't supposed to do, and started doing, things you didn't know the system could do. It wasn't the big-name surgeons, it was somebody who was really smart, really aggressive, and was driven to make a contribution.
Q: :You're stepping down as the CEO. Are you going to stay on the board?
I'm chairman of the board, and I'll remain the chairman for a while.
Q: Will your role change?
It already has changed. I've moved from decision maker to an advisor, and I try not to cross that line. Gary [Guthart; Intuitive Surgical's current CEO] and I talk a lot, but it's his call.