Medical Device Link.

Healthcare E-Business: Dot-Com or Dot-Gone?

There's no question that the Internet-fueled New Economy has entered a phase of slow growth. The same holds true for healthcare dot-coms—or does it?

Cliff Henke

With all the news of dot-coms crashing daily, some observers may wonder what these companies and their investors were thinking. Among the 30-plus Internet firms in the healthcare sector, none has yet turned a profit. In one indicator of the dot-com economy, several reports have noted that Internet advertising fell precipitously in the first half of 2000 when compared with the same period in 1999. And even the most profitable segment of Internet companies, pornography Web sites, is beginning to show signs of market saturation.

Do these statistics mean that all the hype was phony? Not a chance, say analysts—especially when it comes to the healthcare sector. The savings potential for medical technology companies with the right e-business strategies is enormous, and market reports continue to forecast a very large prize indeed for the right solutions.

The Mighty Have Fallen

The medical technology companies that have waited to see how e-commerce would develop in their industry might well consider themselves lucky. One of the earliest fields to be targeted by the dot-com cavalry, on-line distribution of medical equipment and supplies has turned upside down in the past year, leaving many medical device executives second-guessing their Internet sales strategies.

Take just one example of the mighty's plight. Ventro (Mountain View, CA), one of the oldest and most visible high-tech dot-coms, having acquired one of the older healthcare Web sites, Promedix (Salt Lake City), reported third-quarter results in 2000 that missed even the most pessimistic analyst's expectations for revenues and gross profits. The company then hired a strategic advisor to sell its two wholly owned marketplaces, Chemdex and Promedix, but that didn't prevent Robertson Stephens (San Francisco) from downgrading the stock from long-term attractive to market performer. "The company has an unclear strategy and business model moving forward, where a major reorganization of the company is in process with no clear execution plan," said Eric Upin, a business-to-business e-commerce analyst with Robertson Stephens.

The healthcare dot-coms have responded to the year's tough financial news in the usual ways—through consolidation and fine-tuning of their business models. Take, for example, Healtheon/WebMD Corp. (Atlanta), a healthcare portal that in January 2000 entered into an agreement with Medibuy.com Inc. (San Diego), an e-commerce service provider for healthcare supply procurement, to design and operate a new integrated e-commerce marketplace for physician procurement of medical and nonmedical supplies. The contract between Healtheon/WebMD and Medibuy.com provides for the development of cobranded informational and educational pages for healthcare professionals. The content appears on the Healtheon/WebMD professional portal, WebMD Practice, as well as on Medibuy's site.

The three-year agreement calls for Healtheon/WebMD to promote and market the Medibuy. com service to its members. Physicians accessing the WebMD site will be able to purchase healthcare supplies and equipment via integrated services programmed and delivered by Medibuy. Presently, the situation for healthcare dot-com companies is so fluid that sometimes strategies change even while being implemented. For example, Medinex Systems Inc. (Post Falls, ID), a small healthcare dot-com, first announced and then curiously aborted a corporate restructuring designed to streamline operations, reduce costs, and strengthen the company's financial position. The plan originally called for the transfer of the company's political and public-policy assets to Politics.com (Washington, DC), which would have become an 80% subsidiary of Medinex. In addition, members of the Medinex executive team voluntarily reduced their compensation by 25–50%, a move billed as a vote of confidence in the long-term success of the company.

"As we phased out of the product-development stage and began focusing on the sales and deployment of our software, we found areas within the company that needed reorganizing to improve our operating efficiencies," said Tony Paquin, chairman, president, and CEO of Medinex, at the time of the initial announcement. Later, however, the companies inexplicably voided the deal. Company officials agreed it would be "mutually beneficial to unwind the acquisition transaction," but would not elaborate.

For healthcare dot-coms, financial hardship has become widespread (see insert below). Of the 36 on-line medical supply-chain service companies mentioned in an article 6 months ago, at least four have either merged with others or have folded outright.¹ The fate of healthcare e-commerce companies in the past year suggests a fundamental trend that goes beyond the travails of a few underperforming medical supply-chain management sites.

A Crowded Field

What fueled the crash, then, and why did it happen in the lucrative healthcare sector, where there are plenty of supply-chain savings to be had? Part of the reason why stock prices and revenues have failed to meet analyst expectations is the sheer number of sites devoted to medical technology e-commerce. Even with the heavy consolidation that occurred in the last two quarters of 2000 among healthcare dot-coms, the sector remains overcrowded. The field still consists of more than 30 players, which, according to some industry watchers, may be twice what the field will support. For healthcare e-business to show any signs of financial success, much more consolidation is in order. In its current state, the market is saturated due to the existence of too many competing companies.

Veranto: New and Improved? The arena became even more crowded in July 2000, however, when Veranto Inc. (Redwood City, CA), launched its new marketplace. Open to all segments of the medical industry, the site links manufacturers, distributors, providers, and group purchasing organizations (GPOs), and integrates their business processes to streamline commerce throughout the broader industry supply chain. The company claims to have more than 700 medtech manufacturers, 50,000 providers, and 120 distributors among its community.

"Veranto is using the Internet to create efficiencies within the current structure and relationships of the medical industry," says Michael Bittner, research director at AMR Research (Boston). "Their focus on cost saving is correct, and I think their open marketplace will prove to be a successful business-to-business strategy."

Although a latecomer, Veranto is the first enterprise to be launched out of Model N, a highly publicized Silicon Valley incubator that plans to roll out a series of Internet-based procurement marketplaces. Veranto believes it will succeed where others have failed because, unlike its predecessors, the company will take advantage of trends in the medical device marketplace instead of merely jumping on the dot-com bandwagon.

"Between 1995 and 1997, most of the Internet software was designed to connect intranet systems to the Web," said Nimrod Goor, interim CEO of Veranto, in an interview with eHealthcareBusiness.com (San Francisco). Goor noted that second-generation sites, the dot-com exchanges, have not reduced prices for buyers because 90% of healthcare procurement is based on prenegotiated contracts.

Veranto's "third-generation" software takes into account the contractual requirements of manufacturers, distributors, and buyers. It also works with clients' legacy systems, enabling hospitals and suppliers to retain current technologies. By using both the technologies and market constraints of the stakeholders, Goor says, Veranto focuses on cost savings, not just price reductions. "Everyone else is solving [only] part of the problem," he adds. "Our business model creates an industrywide solution."

Table I. Public healthcare dot-com companies listed in order of market capitalization. Source: Morningstar.com (Chicago).

The New Health Exchange: On-Line Healthcare Comes Home. Frustration with the high transaction fees charged by e-commerce service providers, as well as with their lack of understanding of the medical technology industry, has led medtech associations to introduce their own e-commerce services. Take, for example, The New Health Exchange (Minneapolis), created last spring by major medical technology distributors to enhance healthcare supply-chain efficiency. The company is on track to launch its first service offering in spring 2001. The New Health Exchange management team will work closely with healthcare distributors, wholesalers, manufacturers, hospitals, physicians, extended-care providers, GPOs, laboratories, and retail pharmacies to streamline healthcare procurement and decrease costs across the healthcare supply chain.

"Our founding companies—among them McKesson HBOC (San Francisco), Owens & Minor (Glen Allen, VA), and Fischer Scientific International (Hampton, NH)—alone will drive more than $65 billion of annual transaction revenues and millions of daily orders to our Web site," says David M. Hurley, CEO of The New Health Exchange. "As a unique healthcare exchange backed by the industry's leading physical distribution infrastructure, we have the management personnel, the industry resources, and the strategic alliances necessary to be successful. Our priority is to streamline the movement of information along the supply chain." The New Health Exchange insists that it is a commercially neutral entity that serves as a point of convergence for healthcare product and contract information.

The Global Healthcare Exchange: On-Line in Real Time. Meanwhile, The Global Healthcare Exchange (GHX; Chicago), formed in spring 2000 by five of the largest global healthcare companies—Johnson & Johnson (New Brunswick, NJ), GE Medical Systems (San Ramon, CA), Baxter International Inc. (Deerfield, IL), Abbott Laboratories (Abbott Park, IL), and Medtronic Inc. (Minneapolis)—continues to grow. In October 2000, the company signed up Coloplast (Humlebaek, Denmark), a global leader in the therapeutic areas of ostomy, continence, and wound and skin care. To date, 36 companies have joined the exchange, with the ongoing addition of other healthcare organizations, including manufacturers, GPOs, distributors, and hospital systems. When launched, GHX will offer ordering with customer-directed distribution, inquiry of order status, order confirmation, product catalogues, and access to correct contract terms—all on-line.

In addition, GHX recently announced the acquisition of CentriMed (Westminster, CO), a privately held e-procurement software company devoted to healthcare providers. Terms of the agreement were not disclosed. A provider of Web-based, business-to-business solutions, CentriMed aims to improve communications between customers and suppliers, and to connect members of the healthcare industry in real time over the Internet. "The acquisition will help GHX streamline the healthcare e-procurement process by improving supply-chain efficiency and reducing costs for customers throughout the healthcare industry," says Mike Mahoney, general manager of GHX.

Too Many Cooks? There is some concern that the large consortia and association-led exchanges might distort marketplace competition and thus violate antitrust laws. However, the recent Federal Trade Commission ruling in favor of Covisint (Detroit), the auto-parts exchange created by the major automobile manufacturers, is widely viewed as paving the way for similar sites in the medical technology industry—as long as they continue to be available to anyone who wishes to join.

Some analysts don't believe such exchanges will exert undue influence in the market or crowd out commercial sites. "Companies have to control their distribution channels and customer relationships," says Bill Osgood, president and CEO of the consulting firm The Provence Group (Newport Beach, CA). "Why would any company willingly give that up? Competitors will never cooperate when revenues and profits are involved. Public companies are required to act in the best interests of their shareholders, not in the best interests of a cooperative exchange."

Osgood thinks the trend may soon go in another direction. "Isn't the promise of e-business to get closer to your customers, to communicate and interact more effectively with them, to be more responsive?" he asks. "I think companies will try to connect more tightly with their customers directly through the use of extranets. They should be looking to enhance customer relationships with on-line tools, not replace customer relationships with on-line tools."

Why Not All News Is Bad

Not all for-profit exchanges are doing poorly. The few that are succeeding can provide insight into how medical technology companies should develop their Internet strategies. Indeed, analysts can give solid reasons for the differences between the good and the bad performers. Basically, these reasons boil down to achieving two important results on-line: effective strategic partnerships and strong synergies with other nonhealthcare aspects of their business.

One example is Neoforma.com Inc. (San Jose), a provider of business-to-business e-commerce solutions for the global medical marketplace. In the third quarter of 2000, the company posted net revenues of $2.3 million. That amount consists primarily of transaction fees paid in connection with use of the company's shop exchange and on-line auction services, professional fees from its services delivery organization, and subscription and license fees for its services and software. The gross value of transactions on which the company earned revenues for the third quarter was approximately $22.7 million, a record high for the company, while operating expenses were lower than expected.

Neoforma also benefits from its joint venture with Novation (Irving, TX), supplier to VHA Inc. (Irving, TX) and the University HealthSystem Consortium (UHC; Oakbrook, IL), the largest GPO in healthcare, based on 1999 purchasing volume. The joint venture, called Marketplace@Novation, has garnered a significant number of new hospital and supplier sign-ups.

"The combination of increased revenue and reduced expenses, as well as the progress in attracting buyers and suppliers to our marketplace, demonstrates the company's focus and solid execution," explains Zollars. For 2001, he and other Novation executives are projecting double-digit growth in purchasing, which they expect will be fueled by efforts to increase member commitment, programs designed to serve large-member systems in a more-tailored fashion, and further implementation of Marketplace@Novation.

"As long as we continue to deliver value for both members and supply partners, we'll grow at a healthy pace," adds Mark McKenna, president of Novation. The partnership with Neoforma helps Novation members reduce costs associated with supply procurement, and gives members access to data that will help them improve both clinical and operational processes within their organizations. "Through Marketplace@Novation," says McKenna, "members will be able to purchase both contracted and noncontracted items, enabling them to use the marketplace for the majority of their purchasing needs."

Size in this game of partnering and synergies also seems to matter. Novation serves the purchasing needs of 2100 healthcare organizations—the members and affiliates of VHA and UHC. The largest supplier cost-management company in the healthcare sector, Novation manages more than $14 billion in annual purchases.

"It's back to Business 101," summarizes Osgood of The Provence Group. "If there's a revenue stream and a viable business model, healthcare dot-com companies will survive. If not, they won't." Osgood believes that traditional companies are the only business-to-business applications that will survive. "And they will take the lessons learned from the dot-coms and apply them judiciously to their business," he adds. With the current dot-com meltdown, traditional companies will be even more cautious. "For sure they will need a Web site. But how much further they go depends on the expected return on investment."

Healthcare Is Still the Brass Ring

With all the turmoil surrounding dot-com companies, should medical device companies put their on-line strategies on hold? Absolutely not, say most observers. In fact, analysts still believe the time is right for investing in e-business strategy. The real issue is choosing which dot-coms to partner with.

"There has never been a better environment in which to make bold moves toward the networked economy," says Kenneth McGee, a research fellow with Gartner Group Inc. (Stamford, CT). "The present condition is ripe for technological breakthroughs, the only variables being the boldness and conviction of business leaders in the wake of the dot-com hysteria."

Osgood cites the example of a large medical device company where sales representatives spend a great deal of time taking phone calls from nurses who need a heart valve of a certain size in a surgical suite. "Nurses frantically call their sales reps, who may be tied up with other customers. And once they make contact, the sales reps frantically call other hospitals or reps to see if they will swap out a valve," he says. "This frequent occurrence could be better handled on-line."

In another example, too many mistakes in the supply chain occur from customer service representatives taking telephone and fax orders from hospitals and sales representatives and manually entering them into a database or filling out other paperwork by hand. Turnover can also compound the mistakes, as can products with many variations and accessories. In addition, multiple products are ordered at the same time, further complicating the order-entry process. And of course, when stock-outs occur, items are typically placed on back order, which makes matters even worse.

The savings potential here is huge. The U.S. medical equipment market may total more than $87 billion by 2004, with on-line procurement making up $27.3 billion, or 31% of the value of transactions in the healthcare sector.²

Despite all the recent consolidation occurring in the healthcare supply chain, it is still extremely decentralized. According to SMG Marketing (Chicago), there are more than 700 organizations in the United States that act as group purchasing agents. This figure includes integrated delivery systems within metropolitan areas that aggregate their healthcare systems' purchasing volume, as well as regional and national companies that are organized exclusively for the purpose of group contracting. According to the Health Industry Group Purchasing Association (Washington, DC), hospitals in the United States purchased more than $135 billion in supplies in 1999, and at least 70% of those purchases went through GPOs.

The payoff could be even larger. Of the 535,000 physicians in the United States, fewer than 190,000 used the Internet in 1997, but about 277,000 were using it by 1998, reports Abaton, a medical e-marketplace owned by distributor giant McKesson HBOC. Physicians direct about 85% of the $1 trillion spent on healthcare each year.

But is healthcare too complicated for an Internet-based supply chain solution? "Think about Cisco Systems," Osgood answers. "No medical product order is more complex than ordering a custom-configured router. It's easy to picture a medical device company with front-end configuration software similar to what Cisco uses, allowing the customer or sales representative to order the correct configuration and accessories on-line. This would provide immediate suggestions for substitutions on out-of-stock items and offer cross-selling suggestions at the same time. Customers will be happier because they will receive what they ordered. Sales reps can spend more time supporting customers. Fewer mistakes will reduce costs, and more order-entry self-service will reduce staffing and training expenses."

Conclusion

Although many healthcare dot-coms are finding on-line medical device marketplaces to be challenging territory, some are beginning to see daylight ahead. Medical device executives in charge of planning their companies' on-line sales strategies need to know that, just as in the real world, business in cyberspace depends on developing sound relationships with customers. In fact, in the complicated and huge business of medical technology, strategic relationships and an understanding of the marketplace are even more critical.

"We advise the companies we work with to assess carefully the business opportunities at all their interfaces with constituents—customers, suppliers, employees, regulatory agencies, and business partners," says Osgood. "We look for important and unmet needs in the way the company communicates, interacts, and transacts. This is accomplished by using proven market research techniques.

"The technique we prefer is 'voice of customer research,' developed by John Hauser at the Massachusetts Institute of Technology (Cambridge, MA) several years ago. Needs are translated into potential e-business initiatives. And then we dig in and understand the costs and benefits before making a decision to move forward with an e-business solution. We are going back to the basics with e-business. Instead of blind decision making, medtech executives will now make informed decisions regarding e-business."

Concludes Osgood, "The driver of successful e-business solutions in medical technology is sound decision making."

References

1. C Henke, "Electronic Business: Has Its Time Come for Healthcare?" Medical Device Executive Portfolio, June/July 2000, 137–143.

2. D Anast, Biomedical Market Newsletter [on-line] (Costa Mesa, CA: Biomedical Market Newsletter Inc., 2000 [cited 31 July 2000]).

Cliff Henke is a freelance writer based in Southern California.

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