The Journal of Healthcare Contracting

Bob Walter
Bringing Cardinal from food wholesaler to healthcare giant

In 1971, with an MBA from Harvard Business School in his pocket, 26-year-old Bob Walter started Cardinal Foods, a food wholesaler serving central Ohio and the Midwest. By the end of the decade, he had expanded the company's mission to drug wholesaling with the purchase of Bailey Drug Co. in Zanesville, Ohio. To reflect the change, he renamed his company Cardinal Distribution Inc. In 1983, he brought Cardinal public with common stock trading on the NASDAQ at $1.03 per share.

The 1980s saw Cardinal continue to expand through acquisition, with the purchases of wholesalers Ellicott Drug Co. (Buffalo, N.Y.), James W. Daly Inc. (Peabody, Mass.) and John L. Thompson Sons and Co. (Troy, N.Y.).

In 1988, Cardinal sold its food operations to Roundy's Inc. Free to focus on drug wholesaling, the company was, by 1994, the third-largest pharmaceutical wholesaler in the United States, with a presence throughout the country.

In 1995, Cardinal made its first non-distribution acquisition by buying Medicine Shoppe International in St. Louis, the country's largest franchise of retail pharmacies. One year later, the company acquired Pyxis Corp. in San Diego, a manufacturer of automated supply and pharmaceutical dispensing systems. It also formed CORD Logistics to offer drug manufacturers warehousing, information systems, customer service and financial support systems.

In 1997, Cardinal acquired Owen Healthcare in Houston, a provider of outsourced management services for hospital pharmacies and materials management departments. The next year, Cardinal expanded its offerings for drug manufacturers by acquiring R.P. Scherer Corp. in Troy, Mich., a developer of drug delivery systems, and by forming Cardinal MarketFORCE to recruit sales and marketing teams for manufacturers. One year later, Cardinal became a major player in the medical-surgical and laboratory market by acquiring Allegiance Healthcare Corp. in McGaw Park, Ill.

Since then, Cardinal has continued to grow in size and mission. For example, in 2003, the company opened a 265,000-square-foot complex to offer a variety of advanced pharmaceutical services, including drug development, formulation of delivery technologies and clinical manufacturing. In that same year, it acquired Gala Biotech in Middleton, Wis., which owned a proprietary gene insertion technology used in manufacturing biopharmaceuticals.

Today, Cardinal Health employs more than 55,000 people on six continents and produces annual revenues exceeding $65 billion.

Recently, The Journal of Healthcare Contracting spoke with Cardinal's founder, chairman and CEO, Bob Walter, about his business.

The Journal of Healthcare Contracting: Cardinal has grown into much more than a national drug wholesaler, including a retail pharmacy and manufacturer. What's the vision behind all these moves? Is Cardinal a manufacturer, distributor and buyer of medical products and services simultaneously?

Bob Walter: The short answer is that we are all of these things, and in this diversity there is tremendous strength. Our vision, however, is to define ourselves in terms of the capabilities and solutions our customers need, not the individual businesses we're in. Whether a customer needs greater financial health, improved clinical performance, quality manufacturing, medication safety or supply chain efficiency, our approach is to be a strategic partner and to define our success in terms of helping our customers succeed. This approach is what sets us apart in our industry.

JHC: Do you see synergies between your drug distribution and medical-surgical distribution businesses? To what extent have hospitals and integrated delivery networks (IDNs) bought into the one-stop-shop concept?

Walter: A growing number of customers are turning over their entire pharmaceutical and medical-supply procurement to us, so they can focus on clinical issues that are more central to their missions. Customers see the value in partnering with us across traditionally separate business platforms, such as medical and pharmaceutical distribution, and we're taking bold steps internally to make it easy for us to work with hospitals and others in this way.

Our LogisticSource service, for example, brings together pharmaceutical and medical-surgical supply distribution with our Pyxis brand automation systems, consulting services and information management to automate replenishment throughout medical institutions, all the way to the point of care.

JHC: Has your one-stop-shop approach motivated group purchasing organizations (GPOs) and IDNs to seek company-wide contracts with Cardinal Health? Is it difficult to bundle the products and services of a $65 billion company in one contract?

Walter: National accounts represent one of our fastest-growing segments of business today, and we are focusing our resources on these customers, because, by working together, we can help make really dramatic improvements in an IDN's economic and clinical performance. In total, we've signed about 200 strategic corporate agreements with health systems, which include products and services from multiple Cardinal Health businesses. For GPOs, we offer a coordinated account approach that makes it easy for these groups to access Cardinal Health resources. Contracting is still done primarily on a product-by-product basis, but we make sure there is always clear accountability for service. Many of our GPO relationships go back decades, which we feel is a great privilege and responsibility.

JHC: It appears that the drug supply chain is undergoing a revolution. Why is it necessary for Cardinal Health to shift from the traditional buy-and-hold model to a fee-for-service model, which calls for the manufacturer to pay distribution fees?

Walter: A major shift occurred in the market during 2003. Pharmaceutical manufacturers made changes to sales and inventory practices for branded pharmaceuticals, which had the unintended consequence of reducing distributors' compensation under the buy-and-hold model. This change has implications for manufacturers and distributors, but, more important, for health-care providers and patients. Under the fee-for-service model, we can improve upon the old system without losing its fundamental benefits for providers and patients.

The benefits that distributors such as Cardinal Health provide are derived by aggregating volume to become very efficient. We deliver more than 90 percent of all pharmaceuticals at extremely high service levels and an incredibly low cost structure. By delivering all needed pharmaceuticals to a particular hospital or institution, we can dramatically improve service levels, while lowering costs throughout the pharmaceutical supply chain.

For example, providers need fewer resources to manage purchasing and accounting, because they deal with just one ÒprimeÓ vendor. And the system is more efficient for distributors, so we have been able to increase deliveries from two or three days per week to five or six days per week. With more frequent deliveries, providers carry significantly less inventory, which again lowers costs. These are just a few examples of how the healthcare system benefits from a prime vendor model.

JHC: Can you elaborate on the buy-and-hold model and on market conditions that made this shift necessary?

Walter: In the buy-and-hold model, manufacturers compensated distributors through product-price appreciation for the services we provide. Essentially, we bought excess inventory from manufacturers and earned a profit as prices rose. Manufacturers had policies that supported this method of compensation, and it served the industry well. Distributors such as Cardinal Health have removed more than $10 billion in cost from the U.S. pharmaceutical supply chain over the last 10 years and passed these savings to customers.

Recently, market forces have required manufacturers to decrease the amount of inventory in the channel. This will ultimately be a positive change and will help make the supply chain even more efficient. However, if ignored, it would have placed service levels at risk. To avoid this disruption, we must transition to the fee-for-service model, where manufacturers fairly pay for the distribution of products.

JHC: How did you decide that fee-for-service was the appropriate approach, rather than simply raising your prices to providers?

Walter: We first studied the reimbursement system in the United States, which reinforced the inelasticity of the market for providers. Providers of care can't easily absorb a price increase from distributors, because they are reimbursed based on the manufacturer's average wholesale price. An increase from the distributor would only serve to cut into the very small margin made by providers.

We also talked to customers and tested the importance of the services we provide through the prime vendor model. Our findings encouraged us to find solutions that would not compromise the value we provide through these prime vendor relationships.

We determined that a non-contingent, fee-for-service approach would work best. It would preserve the integrity of the pharmaceutical supply chain by simply replacing the former inflation-based compensation with non-contingent fees for distribution services. This is a model that works successfully in Europe, where global manufacturers are already accustomed to paying distribution fees.

JHC: How did you determine the appropriate fees for manufacturers?

Walter: We used a fair, fact-based methodology to establish the proper fees. We undertook a disciplined study of the costs to distribute each manufacturer's line, and we established fees at or below each manufacturer's next best alternative for distribution services. These fees are market based, meaning they are aligned with costs to distribute pharmaceuticals through a third-party logistics firm.

We then shared our analysis of the next best alternatives with manufacturers. Most wanted to test the methodology and make sure it was credible, which we found to be a healthy part of the process. It reinforced the quality of our analysis. Through this process, we've reached resolution and a common understanding with many manufacturers. Of course, we all share a common interest in patient safety and a dedication to serving our ultimate customers.

JHC: Can you explain the One Cardinal Health initiative?

Walter: Over the course of 30 years, Cardinal Health grew as a collection of independent, market-leading companies serving the needs of healthcare customers. What we learned over this period, and as we developed our diverse offerings, is that Cardinal Health can provide even greater value to customers, and can generate substantial savings internally, when we partner across our internal business-unit boundaries. With One Cardinal Health, we are making it easier for customers to do business with us by encouraging this type of collaboration among our team.

As you know, pharmaceutical distribution is just one of our businesses. We also offer providers a broad range of medical and surgical products, medication management systems, pharmacy management and franchise services and consulting. We offer drug and biotech manufacturers a broad range of services as well, from contract manufacturing and packaging to stability testing and marketing. These integrated services are designed to help customers improve the effectiveness of their therapies and get them to market faster and more efficiently.

Through these diverse offerings, we share a common goal: to make healthcare better. One Cardinal Health is our shorthand for how we work together and with our customers to improve the delivery of care.

JHC: What is the biggest challenge facing your hospital customers today?

Walter: While every hospital has a unique set of challenges, the big issues haven't changed a great deal in the last several years. Healthcare executives continue to cite financial challenges as the greatest concern. A lot of this has to do with declining reimbursement, the rising cost of caring for the uninsured, labor shortages, malpractice insurance and the price of new technology. Quality, patient safety and capacity also top the list of most of our customers. Our offerings are designed to solve many of these issues directly, and to free up our customers' resources so they can do more themselves.

Each day, Cardinal Health does the following:

Manufactures pharmaceuticals for nine of the top 10 pharmaceutical companies and most leading biotech firms
Develops, manufactures and packages more than 500 million doses of pharmaceuticals
Manufactures more than 4 million medical-surgical products, including surgical instruments, respiratory products, suction tubing, surgical drapes, gowns and gloves in 31 facilities worldwide
Employs more than 1,800 pharmacists and 1,000 scientists
Provides more than 1,000 hours of temporary staffing in retail pharmacy chains, hospitals, mail-order pharmacies, HMOs, home infusion companies and long-term facilities
Makes more than 50,000 deliveries of pharmaceutical and medical-surgical products
Picks and delivers more than 2 million pharmaceutical products for 35,000 customers nationwide
Holds more than 1,500 patents worldwide
Delivers unit doses of radiopharmaceuticals to 90 percent of U.S. hospitals within three hours.

Cardinal Health facilities include:

30 medical-surgical manufacturing plants and 46 medical-surgical distribution centers
25 U.S. pharmaceutical distribution centers
42 pharmaceutical manufacturing, laboratory and packaging facilities in 11 countries.