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 ahigh-energy sales force, and should have access to the decision makers in themarket: the physicians or administrators who are involved in purchasingproducts.

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 transferredto the foreign buyer at the U.S. plant, understanding taxes and duties willhelp 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-termsuccess.

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.

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