J&J raises ire of med-surg distributors by cutting prompt payment discount

Health Industry Today, August, 1995 by Curt Werner

In the mind of most distributors, J&J's decision will have serious consequences and could threaten business partnerships and transform Johnson & Johnson, the world's largest manufacturer of med-surg supplies and the largest customer of practically every company in the distribution industry, from distributors' ally into an adversary.

On May 18, New Brunswick, N.J.based Johnson & Johnson advised distributors of its decision to cut its prompt payment discount to 1.5% 10 days EOM from the previous 2%. Notification was made in a registered letter typed on Johnson & Johnson Health Care Systems Inc. letterhead and signed simply by "Johnson & Johnson."

J&J explained its position in the letter, which began: "Over the past decade, Johnson & Johnson has aggressively worked to improve efficiency and reduce costs throughout the supply chain. Improvements in the areas of electronic data interchange, logistics and contract management provide you with error-free delivery, pricing accuracy, invoice accuracy and timely price notification from the J&J Professional Companies. These result in reducing your costs and increasing the value provided by Johnson & Johnson products.

"To continue investing in advancements in supply chain efficiency and to remain competitive in this changing marketplace, we have reassessed our prompt payment terms."

Over 70% of J&J sales through distributors

According to Johnson & Johnson, more than 70% of its sales are through distributors, up from 40% 10 years ago. The company expects that its volume through distributors will continue to increase, citing among other factors increased Ethicon Endo-Surgery market share in the minimally invasive surgery segment (estimated by the company at more than $500 million) and J&J Medical's "continued effort to transition existing direct business through the distributor network."

Health Industry Today was unable to solicit comment from Johnson & Johnson officials on the situation, though subsequent letters to distributors outlining and reiterating J&J's position have been obtained.

Distributors reject J&J's position

The developments could prove devastating for many distributors, particularly since estimates are that the half-percent for the average HIDA-member firm could translate to a 31% reduction in net profit before taxes. Margins are already razor-thin. According to HIDA figures, distributors' pre-tax profit in 1993 stood at only 1.6%. That year, 17% of HIDA companies reported losses, up from 9% in 1992, but down from 33% in 1989.

One distributor executive, Ben Welch, president and CEO of Colonial Health Care Supply Co., Lake Zurich, Ill. (whose company was recently acquired by Bergen Brunswig Corp., Orange, Calif.), rejected J&J's position, in particular its citing of EDI improvements as a distributor benefit.

"J&J is a fine company, but I don't like this at all," he told Health Industry Today. "The cost of bringing EDI to the industry has been high. But the vast amount of the benefits will go to the receiving party and that is J&J."

Welch also disclosed that J&J had provided Colonial with 20% fill rates, an unusually low mark for any manufacturer. That 20% fill rate means that his costs are often five times higher than he believes they should be, especially in the areas of invoicing, multiple picking tasks and multiple shipments to customers.

Former HIDA president Ted Almon, president of The Claflin Co., East Providence, R.I., estimates that about $3.5 billion is spent with J&J annually. In a letter to Dennis Longstreet, chairman of Johnson & Johnson Health Care Systems, Inc., Piscataway, N.J., Almon railed at J&J's decision. "The medical distribution industry simply cannot afford this change at a time when it is expected to be investing in the technology of supply chain management intended to eventually reduce mutual costs."

R.I. distributor says it cannot agree to new terms

Almon said his company "cannot agree to the policy change and is unable to comply" with the new terms. He pointed to the fact that Ethicon's rival, United States Surgical Corp., Norwalk, Conn., has offered distributors a higher margin opportunity, even before the discount reduction. Almon called J&J's action "the unkindest cut" to distributors who have resisted representing U.S. Surgical out of what he called "unrequited loyalty to Ethicon."

Almon insisted that direct distribution costs J&J more than private distribution. On another point, Almon added that "a true act of loyalty" by J&J to established distributors would have been resisting the authorization of McGaw Park, Ill.-based Baxter ValueLink as a distributor.

Almon also argued that any J&J decision to increase business through distribution has been based upon economics or customer demand: "Are there customers demanding that you reduce the prompt payment discount?" That final comment could presage eventual price hikes to providers as distributors like Claflin wrestle with their only apparent options: Absorb the loss or pass it on in the form of higher prices that no one wants.