A monster merger and a splashy corporate breakup are provoking questions in the agitated hospital-supply field:
Is bigger really better?
Is there hope for small firms?
Does vertical integration lie ahead?
Two particularly thought-provoking events occurred in the hospital-supply industry in the last quarter of 1995.
First, three hospital alliances, American Healthcare Systems, Premier Health Alliance and SunHealth Alliance, agreed to create a single company with about $10 billion in annual contract purchases. That is nearly 20% of all hospital spending on drugs and supplies, according to SMG Marketing Group of Chicago.
Few industries equal healthcare in the concentration of supply purchases. The contracts of the second-largest alliance, Irving, Texas-based VHA, make up more than 12% of hospital spending, according to SMG. Several other groups each control more than 4%, and all are wrestling to increase their share by limiting members' noncontract spending.
Second, Baxter International announced plans to split into two companies, dissolving much of its controversial 1985 merger with American Hospital Supply.
Before Baxter stepped in, the for-profit chain Hospital Corporation of America-which merged with Columbia in 1994-nearly created the first vertically integrated healthcare company with American. Now some observers wonder if another provider will try.
Management experts warn against drawing too many lessons from the rash of industry deals. "Companies are doing this all the time," said Joel Shalowitz, M.D., director of the health services management program at Northwestern University's J.L. Kellogg Graduate School of Management in Evanston, Ill. There is, in all industries, a "perpetual cycle of buy and divest."
Perhaps the most debated question among purchasing heads is the value of buying-group size. The new alliance claims size not only will bring price discounts but, more importantly, will ease access to capital and enhance potential managed-care ventures (Nov. 27, 1995, p. 2).
On the other hand, competing regional alliances and some companies argue fiercely that, in price negotiations, size can be outweighed by product standardization and geographic concentration of facilities.
Indeed, integrated networks might do better negotiating contracts than their large buying groups, some industry observers contend. One reason: a buying group of 1,000 hospitals using intravenous solutions exclusively from one firm can't easily switch to a competitor; networks can, earning bargaining clout.
Meanwhile, the policies of these large groups, combined with their size, frighten smaller firms. In varying degrees, groups are stressing long-term, sole-source contracts and high contract compliance, figuring that great service and lower prices will justify lost flexibility.
Suppliers often score sales to hospitals even if they've lost the group-contract bid, but groups' drive for compliance could make that much harder. Smaller firms aren't sure they can thrive. For one reason, if they lose contracts, they might be unable to support the manufacturing capacity to bid next time around.
"What is going to happen to the little manufacturer if these big guys get this kind of compliance?" asked Gary Appel of SMG, which tracks purchasing groups. "There is a great deal of concern among small to mid-sized companies."
Many products, of course, never will be subject to long-term, sole-source contracts because of rapid innovation and strong physician preferences. Where such agreements are widespread, small suppliers can ally with larger ones, as is common in the biotechnology industry, purchasing executives said.
Groups also said they try to fuel competition. For example, AmHS started an investment fund in 1995 to support emerging firms. It hopes to spur competition as well as make money, said Jack Bernard, AmHS vice president of corporate planning and marketing. Last year, the fund held $36 million.
The most speculative talk concerns vertical integration. In 1985, HCA and American dreamed of creating Kuron Corp. to package healthcare and the products that aid it under one company. Competing providers hated the idea, and AmHS threatened to pull millions of dollars in contracts.
Such a pairing isn't likely today, observers said. Some hospital groups are big enough to support an in-house manufacturer on their own, so competitive conflicts wouldn't matter. But usually, companies with in-house manufacturers like them to sell outside to keep sharp, said Edward Zajac, another Kellogg professor.
A top VHA executive said paying for manufacturing assets probably doesn't make sense, although he jokingly asked to be informed if any company wished to be acquired. "Very fundamentally, the competencies required to be successful in the two businesses are quite dissimilar," said Bill Elliott, VHA senior vice president of supply chain management. "It is hard for me to imagine a company pulling it all together. The other challenge would be how the balance of the market would relate to the new entity."
AmHS also isn't interested in buying suppliers, preferring strategic partnerships, Bernard said.
Several large publicly traded suppliers and providers declined to comment or didn't return telephone calls, probably because they can't discuss theory without strategy being inferred.
Strategic partnerships, sometimes called "virtual" integration, bypass some of the disadvantages of vertical integration, Zajac said. They dissolve more easily if desired and don't consume providers' assets.
Virtual integration, however, might not be immune to competitive concerns. "The jury is still out," said Wick Goodspeed, president of McGaw, an Irvine, Calif.-based intravenous-products manufacturer. "The battle lines get increasingly drawn between for-profit and not-for-profit. I think it could be very hard to be associated with two major players on either side."