The Narrowing Distribution Funnel: How to Get Your Medical Device to Market

Medical Device & Diagnostic Industry
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An MD&DI February 1999 Column

BOTTOM LINE

Especially for smaller companies, creating a compelling product line and getting it to the buyers requires resourcefulness and considerable strategic planning.

Virtually every day there is news that the distribution network from medical device manufacturer to healthcare provider is becoming more and more concentrated. Hospitals and alternate-site care centers continue to consolidate, and physician practices are becoming more interconnected as publicly owned physician providers organize to confront the health maintenance organization phenomenon.

Cost containment and the need to be more competitive have spawned larger and more-sophisticated buying entities seeking lower procurement costs and value-added inventory management services. Prominent examples are group purchasing organizations (GPOs)—independent entities that represent groups of hospitals and other healthcare providers in obtaining volume-based pricing and other benefits. In reaction to the GPOs, and to gain more control over product purchasing, healthcare providers are themselves forming centralized purchasing groups, further reducing the population of medical device buyers. These groups are called integrated delivery networks (IDNs).

To make matters worse for many device manufacturers, buying groups and large distributors are joining forces with one another. Although the McKesson– Amerisource and Cardinal–Bergen Brunswig mergers failed in 1998 to pass antitrust muster, McKesson's acquisition of Red Line and Cardinal's pending combination with Allegiance signal that the "urge to merge" is far from satisfied.

Not only are distribution channels narrowing, but the choice of products offered by many participants in the chain is shrinking. We are in the age of "sole-source" and "preferred-provider" contracts, accompanied by measures to encourage compliance. The distribution funnel can be compared to the cable TV industry: device manufacturers are like television program producers, and distributors and buying groups are akin to monopolistic cable systems. Producers may have terrific television programs, but if they can't get a cable system to carry them, no one will see them.

With all this concentration in the distribution network, the spotlight is on those medical device manufacturers whose products are already included in the system. Yet, behind the scenes, hundreds of smaller manufacturers struggle to get their products to market through conventional and alternative means. Larger companies too face similar issues with lower-volume product lines that are unrelated to their core businesses.

It used to be that having an effective product itself provided enough impetus for a company to reach its ultimate customer. Now, expensive marketing campaigns and extensive distribution channels are vital. And after getting through the supply chain, continued product improvement, R&D, and marketing are required to remain competitive.

The implications of this change in distribution affect not only the companies involved but also society at large, as the public is denied exposure to a vast array of products. Perhaps survival of the fittest dictates that scaling-up leads to efficiency and lower costs throughout healthcare markets, and that smaller firms cannot provide products cheaply enough. However, opportunity is the engine that breeds innovation and entrepreneurship. Smaller device firms have often been the source of critical new technologies or otherwise valuable products. In today's market, how does a small company deal with the narrowing distribution funnel? This article proposes a few strategies.

CREATE A DISCRETE, SPECIALIZED PRODUCT LINE

First and foremost, device manufacturers need to review their product lines and marketing efforts to determine how they can be improved. To gain recognition, smaller manufacturers need to create a specialized product line that can be promoted to elicit strong trade name identification from the marketplace—an awareness that "the specialist in this area is company X."

Not only must the product line be specialized, it must also include a critical mass of related products so that a product grouping can be marketed and distributed as a complete line. Too often, small companies create a singular product or group of products that fails to cover the targeted niche in its entirety, making the limited line difficult and expensive to market. Other times, small companies expand beyond their area of specialization, becoming miniconglomerates and spreading themselves too thin.

If a manufacturer lacks the resources to produce a certain item that would complete its line, it should consider commissioning a subcontractor to make it. If the outsourced product sells well, the device manufacturer may be able to internalize production later on.

MARKET TO BOTH HEALTHCARE PROVIDERS AND DISTRIBUTORS

Once a specialized product line is created (or redefined), small manufacturers need to follow a two-pronged approach. The objective is to "sow the seeds" within different parts of the supply chain, so that a groundswell of support for the product builds up. Certainly, manufacturers must appeal to networks of independent dealers to distribute their products. But demand must also be created at the grassroots level—with the medical providers or, depending upon the product, even with the end-users or patients.

Because dealers have their own competitive issues, they often cannot be relied on to promote a manufacturer's products, particularly those of a small company. It is worthwhile for the manufacturer to identify key physicians in the relevant field and concentrate efforts on converting them to its product line. Influential physicians can often serve as "champions" or informal endorsers of a product line, leveraging the marketing effort.

Of course, an effective marketing program should include targeted advertising, publicity, and exhibitions at professional association meetings. But efforts should be focused on developing demand in defined segments of the market, such as in selected geographical areas or with certain hospitals or physicians groups. In developing this demand, the device manufacturer may gain important insight into marketing to broader segments. Once demand is established in the defined areas, it is easier to expand by citing the earlier customer relationships as success stories.

STAY CURRENT WITH THE PURCHASING ORGANIZATIONS

Device manufacturers—whatever their size—should stay in contact with group purchasing organizations and apply periodically for inclusion within their networks. Manufacturers should track competitive products that are included and respectfully convey the advantages of their product line to the key decision makers of the organizations. Often, a buying group considering a contract with one medical device manufacturer will entertain competitive products that are presented in a timely manner. With persistence, a device manufacturer may, over time, gain access to these large-scale networks.

If a manufacturer is losing out on buying-group relationships because its product line is not diverse enough, it should consider teaming up with other manufacturers selling complementary (noncompetitive) products that fill out the line. Together, manufacturers with this kind of relationship can often present a compelling package to organized buying groups.

PRIVATE-LABEL YOUR PRODUCTS

Private-label programs can also provide a channel to market for medical devices. Provided the device company has the necessary manufacturing capacity to produce sufficient quantities, private labeling—especially for a large customer—can dramatically increase sales by taking advantage of the customer's marketing, advertising, and distribution resources. Obviously, private-label marketing carries risks. For example, a small company may be able to ramp-up production to meet the requirements of its larger customers, but a loss of such customers could be devastating to the manufacturer. However, once a broader market has been created for the product, the device manufacturer may be in a position to market the product under its own name.

ENTER INTERNATIONAL MARKETS

A critical distribution strategy lies in finding supply niches—either domestically or abroad. Many foreign markets are less mature and concentrated than the domestic market, and their still-developing status creates distribution opportunities. Often, ambitious foreign distributors can build a strong, regular following for a small company's products, serving as another base to support subsequent increases in domestic distribution. Foreign markets can also serve as incubators and testing grounds for new devices before such products are exposed to the harsher scrutiny of the domestic markets.

CREATE DISTRIBUTION, MARKETING, OR TECHNOLOGY RELATIONSHIPS

It is not only the smaller, internally funded device manufacturers that face distribution roadblocks; well-financed companies can also encounter problems. Frequently, companies funded from venture capital firms, initial public offerings, or other financial sources have been set up with the expectation that if their products are compelling enough, distribution will naturally follow. Although this formula sometimes succeeds, it often fails. There are innumerable competitive and unpredictable forces that make establishing proper distribution difficult.

To provide a measure of security, manufacturers regularly enter into distribution and marketing arrangements with large, well-established companies. These manufacturers have decided to concentrate on their strengths—product conception, research and development, and production. They leave it to proven professionals, with appropriate distribution networks in place, to sell their products.

Although device manufacturers theoretically may earn less by entering into these arrangements compared with distributing their products themselves, it is often better to guarantee distribution with the "big guys" than to risk failure on one's own. In a global economy, such marketing and distribution agreements are becoming more commonplace, especially to address territories that are underserviced. These agreements can be structured to cover some regional markets or customer categories and not others.

Another form of partnering with larger companies involves technology transfers. These transactions often include a conveyance of technology in return for a royalty keyed to the sales volume of the product incorporating the transferred technology.

CONSIDER SELLING OR DIVESTING THE PRODUCT LINE

In light of the narrowing distribution opportunities, the corporate sale or divestiture of a business or product line may be the appropriate answer. In fact, both large and small companies are generally in the market as sellers and buyers of businesses. (Increasingly, large companies actively consider divesting discrete parts of their overall business that no longer fit their core competencies or offer compelling synergies with other parts of their operations.) Obviously, the decision of whether to sell can involve a variety of complex factors and should not be taken lightly. If a company's growth prospects are reasonably predictable given internal resources, then it may be worthwhile to continue operating the business independently. There are many benefits—both tangible and intangible—to retaining ownership of a business.

However, an honest assessment should be made as to the value of the business under the existing ownership and resources over time. A device manufacturer may have its greatest value when it is expanding but may lose value when larger competitors—with better distribution and deeper pockets—enter the fray. Sometimes, the anticipation of positive developments may be worth more than the reality.

In assessing a business or product line, it is worthwhile to prepare a 3–5-year projection, carefully analyze the steps required to realize its objectives, and then frankly assess the likelihood of meeting those goals.

Transactions can be structured as an outright sale or, in many cases, the original owners can retain a meaningful equity stake and management role and participate in the future growth of the company.

CONCLUSION

Consolidation of distribution sources has severely limited the channels by which medical device manufacturers—particularly smaller firms—get their products to market. To optimize distribution opportunities, device manufacturers first need to create a specialized and compelling product line. They should continue trying to break into organized buying groups and conventional distributor networks. At the same time, they should create demand at the provider level and pursue alternative outlets, including international markets. Consideration should also be given to forming a commercial relationship with a larger, well-established company to market or distribute the products in question. Under certain circumstances, a properly structured sale-type transaction may be the prudent course to follow.

Richard S. Cohen is president of The Walden Group Inc. (Franklin Lakes, NJ), a merger and acquisitions and corporate finance firm specializing in the healthcare industry.

Illustration by Ken Corral


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