Med-surg distributors quietly do their part in supply chain - News

Hunkering down and making it through a distracting, if not tumultuous decade in the 1990s, the three remaining national medical-surgical supply distributors appear to have shaken off the turmoil and settled down to doing what they do best, namely making sure that the nation's 5,600 hospitals are supplied with the life-saving products they need in time to save those lives, and doing it for a reasonable price.

After a period when the urge to merge swept through, transformed and consolidated the industry, the past few years have brought no new major mergers. Nor have distributors been forced to revisit the embarrassment of the days when a combination of overzealous bidding on group purchasing contracts and a tough economy led to a humiliating plea to those same GPOs to lift margin points on contracts distributors had willfully signed just months earlier.

According to the current numbers at least, each distributor has been quietly and efficiently going about its business. Like good umpires, a good med-surg distributor is rarely noticed (other than perhaps by its shareholders). For the most part, no news is good news for distributors and hospitals alike. "This segment has experienced a very glacial rate of change," says Chris McFadden, a senior analyst who has long been covering the distribution sector for Goldman Sachs in New York.

During this current lengthy downturn in the general economy, distributors have faced the same economic pressures as hospitals, obliging them to do more with less mad find innovative solutions to perplexing problems. Most notably, hospitals are asking their med-surg supply distribution partners for help in tightening the supply chain, an area seen as the key to cutting second-dollar supply costs.

Perhaps as a testament to the soundness of the consolidation strategy that left the industry with only those three true national distribution choices (in addition to a number of worthy regional and local distribution outfits scattered across the country), and partially because of determined negotiations by GPOs, no single distributor has stood out as a low-cost or low-margin supplier. This development is in sharp contrast to the situation of less than a decade ago when distributors competed overtly on prices devised through complex account grids. Today, those grids musty remain, but the real advantages mad selling points are found in areas such as technological superiority and quality service. Hospitals are more willing to pay for these services. "No one distributor has taken a price leadership position," says McFadden. "And distributors are doing a great job of integrating themselves into their hospital customers' operations."

McFadden points out that becoming technologically and logistically entwined with their customers makes it mere difficult for a hospital to change distributors and more prone to try and work out issues and team up to solve problems as or even before they occur. "Exit costs are significant," he says. That development makes it each distributor's business to lose, so to speak, which in turn stabilizes market share. According to McFadden, the current market share lines up with Owens & Minor Inc., Richmond, VA, and Cardinal Health, McGaw Park, IL (the former Allegiance entry), "very close" in the mid-30 percent range of share, followed by Richmond-based McKesson Medical-Surgical in the low double-digits, leaving about 15 percent up for grabs. McFadden gives Owens & Minor, the duly "pure play" national med-surg distributor in existence, particularly high marks for its strong performance, both in financial numbers and in terms of efficient work.

He says that Owens has gained a reputation for loyalty to its customers and has managed to boost its sales above expectations on the strength of contracts like the five-year deal signed in June with Nashville-based HealthTrust Purchasing Group, a 900 member GPO, while maintaining a healthy 10.5 percent gross margin. "Owens has also continued to add new non-distribution services that are getting traction in the market," says McFadden. One of those is an Owens' consulting arm known as OMSolutions, a supply chain management consulting and implementation service launched last November.

After a period of cynicism and low-grade conflict, this is a time of detente between hospitals and their distributors on the med-surg side. After years of trying, distributors seem to have finally convinced hospitals that fire job they do is by and large an effective one that doesn't cost ton much money after all. Staying unconvinced are the few hospitals and integrated delivery networks that operate self-distribution systems within their networks. Florida's LeeSar Cooperative Services, which supplies Sarasota Memorial and Lee Memorial Hospital in nearby Fort Myers, FL, is one such exception, although LeeSar is also a GPO of sorts and earns revenue from a contracting service aside from functioning in a self distribution mode.

Noise has been made about self-distribution in the past, and observers like McFadden generally discount the commotion. "It's not clear to me that the mood for sell-distribution has changed dramatically," he told HPN.

But there are others who say that the scent of self-distribution is still in the air and remains an option under the right circumstances. Ted Almon, CEO of The Claflin Company, a regional distributor based in East Providence, RI, says that certain hospitals and integrated delivery networks cad self-distribute. While not advocating the strategy, be waves off the notion that most hospitals use distributors mainly because they are too lazy or uninterested in trying alternative strategies that might work. "I don't buy people's low opinions of hospitals," he says. "There are IDNs that are run aggressively by aggressive business people. Some IDNs are able to leverage their size and achieve economies of scale. But what a hospital does is not necessarily what a business would do. Labor unions and job preservation are reasons why a hospital or an IDN might keep working with a distributor. Maybe hospitals aren't truly businesses after all. Hospitals are required to provide services regardless of patients' ability to pay, which makes them different from other businesses."

Cardinal maintains consistency

In a service segment where dependability and steadiness is a virtue, Cardinal Health is virtuous indeed. Despite tough economic times, Cardinal's med-surg operation, which is part of its Medical Products and Services (MP&S) unit, has performed well (MP&S includes self-manufactured Cardinal products, not solely distribution, and accounts for 26.5 percent of overall Cardinal earnings). That's in contrast to the parent company's stock volatility this summer, mostly due to even tougher times in its pharmaceutical wholesaling business. Although Cardinal does not break out its med-surg distribution numbers from its overall reports, McFadden describes its med-surg results as "relatively consistent." According to Cardinal's 4Q03 and fiscal 2003 report (ended June 30), MP&S "had a strong quarter, posting record revenues, operating earnings and return on sales. Revenues reached more them $1.7 billion, up 7 percent on the strength of acute care distribution sales. New distribution contracts contributed to the volume gains during the quarter and represent strong volume momentum moving into fiscal 2004. For the fiscal year, MP&S generated a record $6.6 billion in revenue, an increase of 6 percent. Strong productivity improvements coupled with gains in gross margins in manufacturing and distribution operations drove an operating earnings increase of 12 percent to $605 million, also a record."

Numbers aside, within Cardinal, the word is focus. "Everyone here is focused on driving efficiency and cost reduction into the supply chain," says Tom Slagle, president of the company's Medical Products and Services distribution unit. "We are in a good, growing market and we feel good about our share position, and we also feel good about having the opportunity to integrate efficiency into every step in the supply chain."

One of the ways that Cardinal has helped achieve supply chain success is through its venerable ValueLink, a distribution program best known for its stockless and just-in time services to hospitals. Slagle says that of late there has been "renewed interest" in ValueLink, and reports that there are currently 293 ValueLink customers (more in actual numbers due to IDN contracts that cover multiple hospital venues).

Slagle says that Cardinal has worked hard to back up its guarantee of 100 percent pricing accuracy, with much of that hard work displayed in a Continuous Pricing Accuracy program that he calls "a huge win for customers." Through CPA, which he says has more than 500 users, no invoice is sent until pricing accuracy is assured. Slagle also says that with an eye toward fine-tuning customer service Cardinal has invested in customer relations management software that smoothes the information flow and works to solve problems in real time. Plus, the company has upgraded its suture management and O.R. management offerings, and has long helped hospitals with product standardization efforts.

These services, he says, have enabled Cardinal to grow its annual med-surg distribution business "by 3 percent to 4 percent."

McKesson Med-Surg trails the pack

The company that analyst McFadden calls "the clear number three" has been "continuing on an upward trend on a weak base" this year. He says that while the second half of the fiscal year "war disappointing," margins are improving. New management may signal that the century old drug wholesaler turned med-surg distributor (via the 1997 acquisition of General Medical Corp.) is moving in the right direction in terms of both service and stability. Even so, there is work to be done. Reports are that McKesson Med-Surg has been slow to grow revenue in the acute care market.

Indeed, there has been discontinuity in upper level management. Division presidents have come and gone and a new chief, Gary Muensterman is the latest successor to the mp job. Muensterman took over from Fran Dirksmeier (left the company) in September 2002, who took over in April 2001 from Kevin Swan who took over in March 2000 from Paul Julian (now in McKesson corporate).

Management churn notwithstanding, among the improvements have been an expansion of McKesson's Interest presence with the launch of what the company calls "a newly enhanced and unified Web based resource" known as Supply Management Online. The site offers distribution customers real-time ordering, tracking and managing of pharmaceutical and med-surg products.

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