Distributors wrestle with serving new integrated systems

Health Industry Today, August, 1995 by Curt Werner

The opportunities are certainly there for a well-organized, motivated med-surg distributor to succeed in an industry that seems to be bursting with demand, despite the fact that there are fewer hospitals operating in the U.S. than ever before. According to research provided by Smith Barney Inc., New York, the U.S. market includes $16 billion in med-surg sales by distributors, representing 49% of the total U.S. med-surg supply market. And that total market is growing at an annual rate, Smith Barney says, of 3% to 5% through 1998. By that time, distributors will represent 59% of the total U.S. supply sales and be growing their sales by almost 10% annually.

The wild card is the nation's 300,000 alternate care facilities, an increasing number of which are becoming aligned with either investor-owned chains or accepting buy-outs from hospital systems. By 1998, the analysts says, once-sleepy physician's offices and other alternate care facilities will represent 30% of total distributor sales, up from 25% in 1994, a development that gives distributors fortunate enough to gain some contract awards an opportunity to expand their margins after years of seeing their margins on the acute acre side whittled away by group purchasing organization contracts.

Distributor sales to the alternate care market are estimated to be as much as two to three times that of sales to hospitals, Smith Barney says. Despite the fact that distributors' operating expenses to the alternate care market exceed expenses involved in hospital sales, the analysts believe that distributor sales to the alternate care market offer operating margins that are at least 50% in excess of distributor sales to hospitals.

In one way, however, the emergence of integrated delivery systems may throw something of a damper on that optimistic outlook. An alternate care site that joins a system gains access to that system's GPO contracts, including distribution agreements - contracts and pricing it never had before. The end of the era of widely disparate margins to alternate sites may be approaching.

Midland Medical succeeds with one IDS

Distributors are convinced they can service these large new accounts and make money at it. One of these is Al Borchardt, who is president of Midland Medical Supply Co., Lincoln, Neb., and among the last of a vanishing breed of independent entrepreneurs in the industry.

"If you do what's asked of you and aren't afraid to take risks, you can increase your level of business," he said. "We're doing well because we can make decisions quickly and give customers what they want."

Midland has one local integrated system account and the situation has worked out well. "Our service levels to physicians offices has always been high. We sit down with them and work up an inventory program that covers product and inventory reductions and satisfies their requirement of having a knowledgeable rep call on them."

Hospitals, he said, don't understand a clinic's distribution problems, most notably space limitations and product preference among physicians who have affiliated with a group, but also want to remain independent.

"We explain to the docs the differences in product, especially private label products, and what the cost savings are. We also back up what the (parent) hospital says regarding use of private label supplies, when needed. Ultimately, we let the docs make their own decisions, but we try to guide their choices."

Borchardt says he can't do much about the frequently wide divergence in acute and alternate care margins. "It's been a low margin for hospitals traditionally and we can't give those hospital prices to clinics, but we can work with a system on price."

To serve this system, which he requested not be named, Midland delivers to about 20 sites, but he says access is easy. At first, the system attempted to handle deliveries itself with vans and other vehicles, but found it couldn't perform efficiently.

Borchardt says that the most difficult part of servicing an integrated system is driving product standardization. "Physicians are jealous and often hate each other, and none of them like product standardization," he says. That being said, he believes that in the next two to three years, as hospitals buy up physicians and clinics, many physicians will regain their lost autonomy and product decision-making power. To accomplish this, these physicians will have to leave the IDS. Most have one- to three-year non-compete agreements, though, so this change likely won't be taking place right away, but Borchardt is sure it will.

But already, a group of 27 to 30 primary care physicians in Lincoln is organizing its own network that seems to be getting business and support from some major local employers like Mutual of Omaha and Blue Cross/Blue Shield. The plan is to allow the doctors to keep their autonomy and treat patients in the way they want. Midland already has relationships with these physicians.

Borchardt has been selling more to CFOs than materials managers. "It's easier to sell to administration because they're more attuned to finances. But you don't talk product to CFOs. Materials managers who understand cost are great, but you really gotta go upstairs."