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Medical Device Distribution in an International Market

An MD&DI January 1997 Column

BOTTOM LINE

Distribution in foreign countries can pose special difficulties;
unless manufacturers take steps to avoid these problems, profits will suffer.

Foreign countries are a substantial part of the market for most U.S.
medical device companies. In fact, public medical device companies conduct
approximately 30­45% of their sales internationally. Realizing a reasonable
profit in this global environment requires handling many complex issues
successfully.

Distribution abroad is one issue that can cause profits for U.S.
manufacturers to suffer. Basically, there are only two foreign distribution
options: distribute products directly or use a foreign-based distributor.

Direct Distribution. Direct distribution may seem like the more
attractive option, providing greater control over pricing, sales policies,
inventories, and credit, and more complete information on customers and their
needs. It is used successfully by large companies.

However, recruitment, training, and understanding of foreign customs, work
ethics, laws, and languages can combine to derail even the most committed
international sales manager. Most smaller U.S. firms are not in a position to
sustain the trial-and-error process of developing sales through a direct force
in a foreign environment.

Third-Party Distribution. The alternative is to establish and
maintain a profitable relationship with a foreign-based distributor. Many of the
same criteria for choosing a distributor in the United States apply to the
selection of a foreign-based distributor. It is important to find a distributor
that has a proven track record and strong contacts in the medical community. The
distributor should demonstrate success in attracting and retaining a
high-energy sales force, and should have access to the decision makers in the
market: the physicians or administrators who are involved in purchasing
products.

SUCCESS FACTORS

Whether a manufacturer decides to hire a third-party distributor or to
distribute products directly, a successful distribution strategy will depend on
several important factors.

Having Adequate Capital. An adequate capital base is critical to
support the inventory investment that foreign sales require and to support the
company during the period before receivables are collected from customers.
Necessary inventory and collection times vary by product as well as by market;
for example, orthopedic products sold in Spain require an extensive inventory to
support surgery, and collection times average more than 10 months in certain
sections of the country.

Understanding the Process. The distribution process from the
manufacturer's dock to the ultimate consumer may vary considerably between
countries. Tracing the process with a flowchart that includes factors such as
the influence of decision makers and the profit margins at each point can
clarify many issues.

For example, in some countries, the government is the direct buyer of all
medical devices. In such cases, distribution is simple. In other countries,
however, distributors may sell to subdistributors who handle different regions
or market segments. In such complicated systems, the margins, collection risks,
and physical distribution constraints must be understood.

Understanding such factors also allows for open discussion of a prospective
distributor's business practices. In many countries, buying decisions are
influenced by factors other than price, service, and quality. Ignorance of the
business practices of a foreign distributor may provide a limited legal buffer
for a manufacturer, but cannot protect its reputation.

Limiting the Number of Middlemen. The number of middlemen in the
distribution chain can affect profits. In France and Spain, countries with broad
regional differences, subdistributors are often used. This extends coverage to
areas otherwise difficult to reach, but also adds middlemen and reduces profit.
The profit margins of the subdistributors and the amount of necessary inventory
at each point should be considered when setting product price.

Understanding Tax Structure. It is also necessary to know how and
when customs duties and taxes will be collected. In many countries, it is
possible to delay the imposition of taxes by establishing bonded warehouses
outside the customs wall. In cases in which substantial inventory is required to
support the market, warehousing products this way can frequently save up to 15%
of inventory carrying costs. Even if the title of the products is transferred
to the foreign buyer at the U.S. plant, understanding taxes and duties will
help manufacturers grasp a distributor's economic situation.

Collecting Receivables. Profits will obviously vanish when accounts
are not collected. Collecting receivables from foreign-based distributors or
customers is a continuing challenge in the world market. Although the safest
method of doing business is by letter of credit, this can be expensive and
difficult to arrange.

Financing costs in foreign countries are often high. The government often
controls the hospital system, either directly or indirectly, and payment delays
of up to a year are common. In fact, above-market interest rates and slow
payments cause many distributor bankruptcies.

Negotiating Financing. Even if distributor margins are excellent by
industry standards, difficulties with cash flow can erode profits. In such
cases, extended financing--negotiated at the outset of the relationship with the
distributor and factored into product pricing--is critical to long-term
success.

A number of proven techniques are available to foreign-based distributors
for financing inventories and receivables. Any one or a combination of these
methods paired with realistic margins may result in a successful relationship
between manufacturer and distributor.

For example, the U.S. manufacturer can retain a security interest in
distributor inventories. The same bonded warehouses that are used to defer taxes
can sometimes be used for inventory control.

In addition, the manufacturer may retain a security interest in distributor
receivables through jointly controlled bank accounts. Receivables from foreign
governments for medicines and devices delivered to hospitals are often excellent
collateral.

Manufacturers can sometimes arrange export accounts-receivable insurance.
The Export-Import Bank, an agency of the
U.S. government, has a program that insures export accounts receivable in
selected areas at a premium cost, approximately $0.80­$1.30 per $100 of
accounts receivable. Private insurers are available as well.

Manufacturers can often arrange or guarantee U.S. dollar loans to the
foreign distributor. In some countries, such loans can be obtained at lower
interest rates. For example, loans in Greek drachmas by Greek banks to Greek
companies frequently cost more than 20% per year in interest. Loans in U.S.
dollars to the same Greek borrower would be made at about half that rate.

Choosing the Currency. Many U.S. firms believe that the dollar is
still the best currency for doing business abroad. Although invoices dominated
by foreign money can present a significant challenge, the impulse to reject
foreign currencies should be tempered by a study of their changing values
relative to the dollar. Table I provides examples of some of these changes over
the last 10 years. According to this table, for example, using Japanese yen
would have been more profitable than using the dollar.

Country Foreign Currency
Units per U.S. Dollar
Foreign Currency
Gain or Loss (%)
1984 1994 Nov. 25, 1996
Japan 227.00 102.00 113.00 +100
Switzerland 1.68 1.37 1.29 +31
Austria 11.40 11.40 10.72 +6
Germany 1.81 1.62 1.52 +19
France 4.22 5.55 5.16 -18
Spain 73.00 133.00 129.00 -43
Canada 1.17 1.36 1.34 -13

Table I. Changes in exchange rates among selected currencies.

To further reduce the risks of using foreign money, forward hedging is an
option that is available for most foreign currencies in the developed world. In
this arrangement, U.S. commercial banks agree to purchase your foreign currency
collected from receivables at a future date at a fixed rate of exchange, thereby
eliminating your exchange risk. Although it is expensive, it can be good
insurance against currency fluctuations.

DISTRIBUTION STRATEGIES NEEDED

With increasing numbers of U.S. companies in the medical device industry
venturing into the world marketplace, the need for practical distribution
strategies is growing. Clearly, a better understanding of international
distribution processes and a wise policy guiding distributor selection will
overcome the most common pitfalls. In addition, the use of intelligent financing
mechanisms will provide further protection. Firms must do more than merely
analyze market conditions and project sales; they must understand all the risks
associated with distribution in order to maximize profits.

Lew Parker is a business consultant with the McShane Group, Inc.
(Timonium, MD).


Copyright © 1997 Medical Device & Diagnostic Industry

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