Medical Device Link.

Originally Published June 2000

ADVERTISING, DISTRIBUTION, & SALES

Global Distribution Issues and Strategic Options

Developing the right distribution strategy can be a make-or-break proposition.

Undoubtedly you've heard the saying: it's a small world. The increasingly global marketplace and the Internet have dramatically changed the way both small and large medical device manufacturers sell and distribute their products. In addition to navigating the regulatory and sales and marketing mazes in the United States, today's successful manufacturers also must focus on which international markets to include in their marketing efforts, determine if they should build their own distribution system or outsource the function, and figure out how Web-based solutions fit the business.

More than Shipping

Manufacturers may define "distribution" in several ways. Typically, distribution includes the supply-chain services of warehousing, inventory control, shipping, and tracking. But distribution also can entail customer service, billing and collections, and sales team functions. For the purpose of this article, all of these functions are considered part of "distribution"—whether they are performed directly by the medical device company or by one or more outside firms.

Medical device companies face increasing pressure to select the right distribution options since many manufacturers have been locked out of the acute-care market by exclusive group purchasing organization (GPO)–manufacturer distribution agreements. In addition, the fragmented nature of the alternative-site distribution market requires that device companies distribute products properly to gain a reasonable return on their investment.

Distribution Options

In the U.S. market today, manufacturers that decide to outsource distribution have several options. Manufacturers may choose outside firms that provide only customer service, warehousing and shipping, or billing/collections functions; those that offer customer service, billing/collections, warehousing, and shipping; and those that bundle all of these services as well as provide a sales team. In general, there are seven major types of distributors:

• Direct distributors represent the build-it-yourself model. Manufacturers that choose direct distribution establish their own warehousing, shipping, customer service, billing/collections, and selling functions.
• General distributors provide all of the distribution functions except for sales. In the United States, these distributors are known as "trucking" companies.
• Specialty distributors are generally focused on the acute-care market in a specialty area such as cardiology or respiratory therapy. Companies with limited budgets often turn to these distributors to launch new technologies.
• Logistics management companies provide one or more services, excluding sales. Most logistics management companies handle warehousing, customer service, shipping, and billing/collections.
• Manufacturers' representatives sell products targeting one or more markets. Most of these reps carry multiple lines.
• Contract selling organizations (CSOs) are sales forces for hire. CSOs will sell in a particular geographic or specialty market and may become part of the manufacturer's organization if desired by both parties.
• Strategic alliances come in multiple forms. Many smaller medical device companies partner with larger companies to increase their reach in the marketplace—especially when trying to sell products in international markets where the larger company already has established distribution channels.

Table I summarizes the advantages and disadvantages of these options.

Choosing an Option

When selecting a distribution option, manufacturers should be certain to address a number of key strategic issues. After a manufacturer has decided which product lines will be sold overseas, it must determine the following.

Which Countries Will Be Targets. One of the most important factors in determining which distribution option to use is deciding in which country or countries products will be marketed. While the United States remains the largest medical device market in the world, some manufacturers have carved out significant market shares in international markets. Countries that represent significant opportunities for medical device manufacturers include Australia, Brazil, Canada, China, the member states of the European Union, Japan, Mexico, Singapore, South Africa, and Taiwan. These countries represent the largest opportunities for medical devices because they have organized regulatory bodies, fairly favorable tariff policies, and sophisticated distribution channels.

International targets should be prioritized by their predicted adoption rates of the medical technology, regulatory hurdles, and availability of appropriate distribution partners. While the adoption rates of technology and regulatory issues differ depending on the type of medical device, the selected distributor needs to be capable of building market share for the new line and have a history of success in the same medical specialty (e.g., cardiology, oncology).

A lot of market research is necessary to determine how to prioritize international targets, and this task should not be taken lightly. Manufacturers will need to interview international distributors, contact industry experts in each country, review public information on regulatory requirements, and leverage relationships with other experienced medical device manufacturers to determine the reasons for their successes and failures in each market. Unfortunately, there is no single source for all the varied types of information that a manufacturer might need to know about doing business overseas. Manufacturers should be prepared to explore as many sources as necessary. The research process generally takes about four to eight weeks per country studied.

Size of the Potential Market. How large a team will need to cover the projected markets in each targeted country to meet budgeted revenue? Can an in-house team handle the work, or do on-site teams make more sense? To learn the answers to these questions, a consultant or the medical device company will need to conduct detailed market research. Information that should be gathered before proceeding with a distribution strategy includes: the number and types of customers to be targeted, utilization information, reimbursement coverage, and market trends.

Capital Available for Launch. Available capital will often drive the in-house–versus–outsource decision for sales and logistics solutions. More capital often results in direct distribution; companies with less capital tend to outsource more distribution functions.

Stage of the Product Life Cycle. The stage of the product life cycle is a critical strategic component when determining distribution method. The four stages of the product life cycle are introduction, growth, maturity, and decline. Managers should consider different distribution options for different product lines, depending on their stage in the product life cycle. Traditionally, manufacturers have followed one of the following two models.

• Specialty distribution for introduction and growth, followed by direct sales teams and general distributors or logistics companies for maturity and decline.
• Direct sales throughout the product life cycle, with smaller firms outsourcing logistics management and larger firms handling logistics directly.

Acute versus Alternative-Site Targets. The market for alternative-site care (outside-of-hospital market) is growing rapidly. In this market, deciding what entity should sell the product can be difficult. A company's strategic direction will depend on the number of target audiences and the method of promotion. For example, telesales may be a viable alternative in combination with a small direct sales team for many medical device manufacturers. The decision to include telesales is a complex one that involves research on the types of calls acceptable to customers, then an assessment of the return on investment for telesales calls.

Here or There?

Once a company has chosen which markets it will be targeting and determined its budget, the decision about whether to tackle distribution in-house or outsource part or all of the distribution function needs to be made. Manufacturers may take several steps in evaluating the "make-versus-buy" decision.

First, managers should determine which strengths and weaknesses their company and outside firms would bring to the distribution process. Ideally, the manufacturer's marketing, sales, and logistics executives—perhaps with the aid of an independent consultant—will conduct an unbiased, thorough analysis. For example, a medical device manufacturer likely has excellent relationships with its customers and great familiarity with the product's features. An independent firm, though, may be better able to devote a large number of people to sales, offer a wider range of know-how and expertise in high-tech areas, and free up the manufacturer's time so that it can concentrate on its core business.

Second, financial experts who are familiar with activity-based costing (ABC) should analyze the true costs of each function being considered. Unfortunately, manufacturers' accounting models do not apply to distributors that are service companies. Activity-based costing means accounting for all of the costs from the time a product is entered into distribution until it is delivered to a customer, and it includes both direct (e.g., materials and labor) and indirect (e.g., corporate overhead) costs.

Once all of the costs are identified, the next step is to decide whether the funds that would be spent internally could be better used to focus on other core functions. This essentially means looking at the opportunity costs of the monies spent.

Outsourcing is not a magic bullet. Managers will need to set performance criteria and evaluate costs and performance throughout the contract period. In the medical device industry, the results of outsourcing distribution have been mixed. Considering the many approaches to outsourcing, the medical device industry may simply be on a learning curve that may produce better results over time. In addition, logistics managers are becoming more sophisticated in their analyses of options and management solutions, and the development of more-integrated IT solutions will improve the process.

The key challenges in managing outsourcers are maintaining control, continuing customer relationships, integrating systems, continually retraining personnel, and integrating forecasting and planning functions. If the outside firm can essentially become a department or extension of the medical device company, then the relationship can succeed. But if the companies are at odds with one another's objectives, then outsourcing will inevitably fail. Table II outlines the advantages and disadvantages of outsourcing.

It's important to remember that one size doesn't fit all, and the make-versus-buy decision has to be carefully evaluated within each company, target country, and product line. One of the biggest mistakes made by medical device manufacturers is trying to fit one sales and logistics solution to all situations. For example, a direct sales team may fit a higher technology acute-care line in the United States, but managing a direct sales team in Japan may prove nearly impossible. Using a third-party logistics company may fit a manufacturer needing only outsourced customer service, billing and collections, warehousing, and shipping, but this strategy may not work for a manufacturer whose major GPOs require that products be delivered by a general or specialty distributor.

On-Line Distribution

In addition to the more traditional routes of product distribution, the World Wide Web now offers several medical distribution models.

Asset Management. Asset management models manage the inventory of medical devices such as infusion pumps, inhalation therapy, and diagnostic imaging equipment. In these models, the Web company works on behalf of a healthcare provider to manage the purchase, inventory, refurbishment, and placement of medical equipment among facilities. Two firms of this type are Medasset.com and Empact.com (a Columbia investment).

Physician Office Sales. Physician office–based models have been developed by companies such as PSS and Neoforma.com. These models seek to get physicians to purchase equipment and supplies on-line by providing order entry, inventory management, and competitive pricing. A study conducted by Cherney & Associates (Brentwood, TN) found that physician office staff members were more likely to use this method if they thought they would be able to order products more quickly than via the telephone.

Hospital Sales. Hospital-based product acquisition models are a hot target of Medibuy.com, Empact.com, Neoforma.com, and the new manufacturing consortium formed by Baxter, GE Medical, Abbott, Johnson & Johnson, and Medtronic. With the exception of the manufacturing consortium, these companies earn their revenue through facility participation fees charged to the hospitals that buy products on-line, and they may also charge manufacturers a percentage of the revenue generated by the sale. Because margins are already squeezed, manufacturers are concerned about fees as high as 4% being added to their supply-chain costs, which is why manufacturer consortia are forming. More medical device manufacturers and their distributors will likely be creating their own Web-based strategies soon to counter this fee.

Used-Product Sales. Used-product and used-equipment sales models also are proliferating on the Web. These models create a channel for manufacturers and providers to redeploy underused assets profitably—a significant offering for large healthcare systems that are seeking a new use for old equipment.

If a medical device manufacturer hasn't yet developed a Web-based strategy, it may be at risk of losing margin to another Web-based company. Columbia/HCA CEO Thomas Frist invested $45 million in Empact. com to reduce $25 million annually from Columbia's materials management function. Manufacturers and distributors were put on notice that they had to comply. It's important to understand where customers are heading with their on-line systems so that manufacturers can ensure they will continue to fit into their business.

Conclusion

Distribution of medical products today is more challenging and complicated than it has ever been in the past. Determining which products to sell in which markets is just the first step in choosing which channels of distribution will be most successful. But whether your company outsources distribution, handles it in-house, or builds a Web-based system—or some combination of the three—one thing is certain: the world is now your market.

Alison Cherney is president of Cherney & Associates Inc. (Brentwood, TN), a company that provides healthcare marketing and sales consulting services.

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