Hospitals are swallowing bitter pills for distributors of medical-surgical supplies, but at least the ailing industry might recover.
That's the most common take on the breakup of Baxter International, the overhaul of Owens & Minor and other recent news in medical-surgical distribution. Struggling for economic viability, distributors have increased prices and reduced products carried in the past year.
A gloomier view is that more painful medicine lies ahead. One top purchasing executive, who requested anonymity, said he sometimes doubts the three largest med-surge distributors will survive as pre-eminent firms, if at all.
Good distribution is critical to hospitals' operations. Many keep only a few days' stock of med-surge supplies and less of pharmaceuticals.
The term "med-surge" describes hundreds of thousands of products, from basic examination gloves to custom sterile packs of as many as 60 items. Firms usually specialize in either med-surge or pharmaceutical distribution.
Sensing vulnerability, at least one drug wholesaler is expanding its presence in med-surge distribution.
Competition already has bloodied every med-surge distributor (May 27, p. 38). To win business, firms undertook top-drawer service for bargain-basement prices. "They nearly priced themselves out of business," said Larry Dooley, vice president of distribution services at VHA, an Irving, Texas-based alliance of 1,100 hospitals. After taxes, acute-care distributors earned an average of 1 cent for every $1 worth of distributed good in 1995, Dooley said.
The carnage was worsened by inefficient systems. VHA plans on easing distribution by giving manufacturers incentives to use electronic commerce and fill orders promptly, among other changes. Beginning in July 1997, its hospital members will pay higher distribution fees for the products of "inefficient" manufacturers.
Pharmaceutical wholesaling-where a uniform drug code and electronic commerce prevail-is in better health. Nevertheless, wholesaler FoxMeyer Drug Co. filed for bankruptcy recently (Oct. 7, p. 6; Sept. 2, p. 26). Its woes prove how severely distribution in general has been undervalued, Dooley said.
For the moment, med-surge distribution seems to be rallying.
The September spinoff of Baxter med-surge distribution, for example, could ensure the unit a critical dose of capital. The new Allegiance Corp. plans significant investments in information systems to build itself as a cost-management company. Helping hospitals cut costs-by using products better, for example-is a more promising business than pure distribution, Allegiance President Lester Knight said. Allegiance, based in McGaw Park, Ill., also includes some manufactured products and custom procedure kits.
The spinoff should mean executives will pay more attention to the needs of distribution, said Ed Kuklenski, senior vice president of shareholder services at Child Health Corporation of America. Allegiance is the prime distributor for 30 of the 35 pediatric hospitals in Child Health, based in Shawnee Mission, Kan.
There are other benefits. For example, some manufacturers might use Allegiance as a distributor more readily than they used the Baxter unit, Kuklenski said. That's because they perceive competition with Allegiance as less fierce.
A five-year agreement allowing General Medical Corp. to distribute Allegiance products is good news, too (Sept. 30, p. 4). Previously Baxter was the main distributor of its products, but it never succeeded in the alternate-site market as did General Medical. The new partnership is expected to result in $100 million in sales for both companies.
Allegiance, particularly, must improve its profitability. In the first half of 1996, it earned $27 million on sales of $2.2 billion for a 1.2% profit margin (July 29, p. 19).
"The spinoff really helped us clarify our objectives," Allegiance spokesman Geoffrey Fenton said of the turnaround in policy. Expanding alternate-site sales is one key goal. Allegiance still is evaluating policies for distributing its products through competitors, he said.
Other likely steps toward better margins, however, are causing concern among some hospitals. For example, Allegiance plans to reduce its 60-plus distribution centers to about 40 eventually. Fenton declined to discuss when or where it will close centers.
Allegiance also has pulled rarely ordered items into a central facility and started a "best value" program for suppliers. The first move is an annoyance for some hospitals because of new freight charges; the second move potentially could transfigure distribution.
"Best value" suppliers manufacture quality products and save Allegiance money with such systems as electronic data interchange, said Barrie Kaiser, an Allegiance corporate vice president. Some Allegiance contracts actually set expected "best value" purchases for integrated networks, Kaiser said. Other distributors are implementing similar ideas.
All say they won't step on the toes of purchasing groups, which are busy naming their own preferred suppliers. Regardless, hospitals and groups fear conflicts will arise if distributors push their own favorites or stop carrying low-volume suppliers. "We need to pay attention to where these distributors are heading because it's going to impact our contracting abilities," warned Gary Condry, vice president of materials management at Holy Cross Health System Corp., a 12-hospital system based in South Bend, Ind.
Kuklenski, however, worries more about the alternatives: "If (distributors) don't do things that are economically necessary, they won't survive."
Cutthroat competition wounded Owens & Minor most visibly. The Richmond, Va.-based distributor managed to earn $4.5 million on sales of $1.5 billion in the first half of 1996, after an $11 million loss in 1995. But first it hiked distribution fees a full percentage point and cut the number of stocked products roughly 15%.
Rumors are that Owens & Minor, and every other distributor, could be up for sale. Tom Sherry, a senior vice president at Owens & Minor, declined to confirm or deny the rumor. But he said, "We are looking for good business partners to be part of our value network." One example is an alliance with an alternate-site distributor. Sherry was promoted from vice president of sales and marketing in an August management shuffling. Also at the time, Glenn Dozier, Owens & Minor chief financial officer, resigned to pursue other interests.
Allegiance, Owens & Minor and Richmond-based General Medical are the largest med-surge distributors to hospitals, holding roughly 61% of the market. Regional firms, however, are winning more contracts lately. Distributors to physician offices also are gaining ground as integrated systems proliferate.
At least one drug wholesaler is launching an aggressive challenge. Bergen Brunswig Corp., Orange, Calif., will expand on the West Coast this year, either by acquisition or building its own centers, said Don Roden, company president. It recently hired Bill Elliott, a top supply executive at VHA, to head its med-surge subsidiary. The subsidiary-now called Bergen Brunswig Medical Corp.-more than tripled its market share to 3.8% this year from 1.2% in 1994.
Creating one ordering point for med-surge and drug distribution would streamline ordering and billing for hospitals, Roden said. The tools Bergen uses in drug distribution, such as electronic commerce, could make med-surge distribution less costly, too, he said.
At six to eight hospital systems, Bergen is running both types of distribution. Meanwhile, Columbia/HCA Healthcare Corp., a Nashville, Tenn.-based for-profit chain, is considering consolidating its distribution under Bergen, Roden said.
The possibilities intrigue many hospitals. Consequently, there is much speculation that other drug wholesalers also may expand in med-surge. Integrating distribution "makes a ton of sense," said Larry Dickson, materials management director at Sisters of Providence Health System, Seattle, which operates 16 hospitals.
The largest wholesaler, San Francisco-based McKesson Corp., declined to talk about strategy. It might have its hands full, however, because it just agreed to buy FoxMeyer, upping its market share to 25%. Analysts said McKesson will get roughly $750 million in assets for $680 million in cash and obligations.
Cardinal Health, a drug wholesaler with a $100 million business in med-surge distribution, said expansion doesn't make sense. The return on capital in med-surge distribution is "ugly" at 10%, said Jim Millar, president of Cardinal Distribution. Although all three top med-surge distributors could be available for purchase, "I don't see anyone in the drug industry going over there to grab them," Millar said. "It's not a good spice to stir in our soup."
