Novation Warns Members of ‘Fragile’ Distribution Market

GPO asks hospital members to develop a logistics strategy that considers the costs Ð and savings Ð of using distributors effectively.

Amid speculation that some big manufacturers are preparing to go direct, Irving, Texas-based Novation, the group purchasing organization for VHA and University HealthSystem Consortium, is educating its members about what it calls the “fragility” of the medical-surgical distribution business. The GPO is warning members about the impact on distributors and Novation’s hospital members if manufacturers of physician-preference items were to pull away from distributors.

“This goes back to late last year, when Novation introduced its wound closure/endomechanical agreements,” explains VP of Contract and Program Services Larry Dooley. (In December 2004, Novation awarded 17 separate contracts to six companies for endoscopic instruments, mechanical stapling and cutting, skin staplers, sutures, topical skin closure, trocars and ultrasonic cutting and coagulation. The agreements were signed with 3M, Aesculap, Applied Medical, Ethicon, Genicon and United States Surgical. Prior to that, the GPO had signed an agreement with Ethicon and Ethicon Endo-Surgery for both suture and endomechanicals.)

“During our exchanges [with Novation distributors], what became apparent was the strong impact of these products on traditional med/surg distribution,” says Dooley.

Most funding from few companies
Novation’s research told Dooley that hospitals fund about 65 percent of distributors’ margins and suppliers 35 percent. Roughly 20 product categories drive 80 percent of distributors’ business and 10 suppliers dominate those 20 categories, he says.

“The question for our members is this, ‘If you buy endomechanicals direct, what will happen to the med/surg distributors’ economics?'” says Dooley.

J&J denies direct strategy
Many in the industry have speculated that Johnson & Johnson’s (J&J) Ethicon and Ethicon Endo-Surgery companies are preparing to go direct. They point to the company’s 2-year-old, 440,000-square-foot logistics facility in Memphis as one factor pointing to J&J’s desire to do so.

J&J denies any such intention. “Our strategy is not to take the market direct,” says Larry Malloy, VP of channel management for Johnson & Johnson Health Care Systems. “We believe distributors add value, at least for certain product lines.

“But we do want to offer our customers choice,” says Malloy. “In the past, we have been in situations where customers have demanded that we go direct, and we didn’t want to be in a position to always have to say ‘no’ to that. But there’s no grand strategy to get out of distribution.”

At press time, Dooley was preparing a white paper for Novation’s members, which will contain tools to help them develop a logistics strategy, taking into account how they buy and receive products.

“Hospitals [choosing to buy direct] have to evaluate the added costs they will take on in increased purchase orders, increased time for problem resolution, increased freight, increased inventory and resources needed to manage this inventory,” says Dooley. What’s more, if some of the big manufacturers were to pull away from distributors, they would be forced to ask hospitals to make up the difference.

Novation members have responded to Dooley’s message with mixed emotions. “The first couple of times we talked about it, they struggled with, ‘Who are you helping Ð the distributors or me?'” says Dooley. “But you have to explain, ‘If distributors go south, so do you.'”

The recent KPMG study on hospital procurement commissioned by Health Industry Distributors Association (HIDA) shows that hospitals that use distributors effectively lower their acquisition costs, says Dooley.

“I’m not saying you shouldn’t buy certain things direct, just make sure you buy the right ones direct.”