Distribution Channel Considerations For Medical Products Manufacturers

• Preferred distribution model: Most distribution model decisions are driven by customers. Many providers want to buy products from a preferred prime vendor in order to minimize transactions or take advantage of low-unit-of-measure programs. On the other hand, some large health systems run their own distribution centers and prefer to buy directly from manufacturers.
• Service levels: Manufacturers must consider what model enables them to best meet customer needs. For example, many healthcare providers lack the space or financial resources to carry a lot of inventory, so frequent deliveries in small quantities are sometimes mandatory. Customers may also expect higher fill rates than the manufacturer can consistently provide.
• Resilience: Shortages experienced before, during, and after the COVID-19 pandemic have impacted customer demands. Manufacturers should consider what channel strategy will best help provide resilient solutions to customers, such as inventory buffers and alternative products.

• Products: A manufacturer’s product offerings greatly impact the channel value calculation. Products that sometimes fit well into a direct model (also referred to as manufacturer self-distribution) include ones that have high dollar value and less frequent sales.
• As a percentage of revenue, products that are small but valuable cost considerably less to distribute than large, inexpensive ones.
• Products bought infrequently are sometimes not a good fit for commercial distributors, who need to continually turn inventory.
• Target markets: Manufacturers selling to large hospitals and other high-volume customers may find it easier to self-distribute than those targeting fragmented non-acute and post-acute customers. The sheer number of non- hospital customers tends to make self-distribution a non-starter for most manufacturers.
• Number of transactions: Manufacturers who use distributors deal with a smaller number of partners – from a handful of national distributors to many independents – rather than directly with tens of thousands of healthcare facilities. Fewer transactions generally equates to smaller investments in areas like warehouse management and accounts receivable management.
• Scale: Insourcing any function is easier to justify for larger businesses than smaller ones.
• Focus: Manufacturers should consider whether distribution, transportation, and logistics are core competencies they will continue to invest in to provide value beyond their products. If instead the main differentiator is product innovation and quality, the company may be better off doubling down on that focus and outsourcing other functions.

• Warehouse overhead:
• Space: rent, mortgage, or opportunity cost (if building is owned and paid for)
• Utilities
• Real estate taxes and insurance
• Depreciation on building and improvements
• Building repairs, maintenance, security, HVAC/temperature controls
• Equipment and technology:
• Shelving and storage infrastructure
• Product moving equipment (forklifts, picking equipment, robotics)
• Warehouse management system
• Other equipment such as product scanners, labelers, etc.
• Inventory carrying costs:
• Inventory acquisition cost
• Taxes paid on inventory value
• Insurance to protect against fire, flood, theft, etc.
• Shrinkage: lost, stolen, or damaged inventory; obsolete or expired inventory
• Warehouse labor:
• Wages, including overtime
• Benefits
• Recruitment and training

• Risk: The entity holding the inventory assumes the financial burden and risk associated with that inventory, including product shrinkage, unsold products, decline in inventory value due to decreased demand or deflation, etc.
• Opportunity costs: Holding inventory ties up capital that could be invested elsewhere.
• Customer service levels:
• Delivery lead times – These are likely to be less if distribution site is closer to customer location.
• Fill rates – This metric is closely tied to inventory levels. Distributors typically carry more days of inventory, and often receive products from manufacturers at lower fill rates (for example, 80%) but use their inventory buffer to ensure higher fill rates (often 97-98%) to customers.
• Number of deliveries – Since healthcare providers are often short on both staff and space, receiving more products on a single delivery is generally preferred over many separate deliveries. (Because of the complexity of receiving shipments from multiple manufacturers, some providers simply require all or most vendors to work with their designated distributors.)

• Technology: ordering systems, automated handling and picking equipment, picking systems, etc.
• Equipment and supplies: packing and labeling materials, pallets, boxes, product scanners, etc.
• Warehouse and order processing staff:
• Wages, including overtime
• Benefits
• Recruitment and training

• Customer efficiency: As noted, healthcare providers generally prefer to receive complete orders with all items in a single shipment, and may push vendors to use their preferred distributor so that more items can be ordered and received with each delivery.
• Small-quantity delivery programs (LUM, JIT, stockless): Some healthcare providers want product pre-sorted by department and delivered in boxes or “eaches” vs. cases or pallets. Such customers generally want their suppliers – particularly those making consumable products – to use their preferred distributor.
• Investment: Selling directly to healthcare providers greatly increases the total number of transactions and therefore also increases staff and technology requirements.
• Order minimums: Because order minimums tend to drive away new customers and small facilities, manufacturers that want to avoid low-dollar deliveries generally opt to use commercial distributors.

Special Considerations For Products Used In Kits / Custom Packs

• Many products are sold to healthcare providers as part of kits. These kits may be customized and sterilized for specific procedures and even aligned to specific physicians’ preferences.
• Some distributors run kitting operations in addition to their distribution services as a part of their customer value propositions.
• Providers value these kits because they provide internal efficiency. Facility staff need not gather items required for a scheduled procedure; instead, they can just reach for the appropriate ready-made kit.
• Kitting ensures a manufacturer’s product will be used for a procedure as intended, thereby ensuring consistent business model.
• Kitting makes it less feasible for a manufacturer to sell certain products directly to customers.

• Shipping charges for common carriers
• Vehicle costs, including lease costs (if leased), depreciation (if owned), repairs and maintenance, operation expenses, licenses and insurance
• Driver/delivery personnel, including salaries, bonuses, benefits and payroll taxes, etc.
• Other personnel such as transportation and logistics specialists to coordinate shipping, plan routes, and optimize transportation efficiency and costs
• Supply chain logistics software and technology

• Manufacturer’s outbound transportation costs: These will generally be lower if products are moving to commercial distribution centers than directly to customers, because the manufacturer is making fewer, larger deliveries.
• Truckloads vs less-than-truckload (LTL) or common carrier: Larger shipments are generally less expensive and often timelier. (Most common carriers are known for timely service, but LTL shippers must wait to fill a truck and timeliness is a key concern.)
• Type of customers serviced: Distribution requirements are generally simpler when delivering to large customers with a single delivery point (for example, the hospital loading dock). Transportation activities are more costly when delivering to smaller facilities and/or provider organizations with multiple ship-to locations.
• Enhancing efficiency of customer operations: Healthcare providers usually prefer to receive ordered items in as few shipments as possible; multiple shipments increase receiving costs.
• Equipment set-up and installation: For equipment requiring installation, manufacturers must consider who will perform this function. Manufacturers that consider this a core part of their value package may choose not to outsource this function. However, some distributors have this expertise, and some specialize in it. This can be especially valuable for customers setting up a new facility, when many items must be installed concurrently and quickly, and integrated with each other.
• Management of commercial carriers: Some distributors will take responsibility for managing logistics through third-party carriers
• Environmental considerations: Using commercial distributors typically means fewer, larger shipments, which may reduce energy usage, emissions, and sometimes packaging.

• Cost of money (to carry receivables)
• Contract administration and chargeback management: Most manufacturers and distributors have sizeable teams for managing the complexities of GPO contracts and pricing tiers and ensuring that customers are correctly invoiced
• Labor: This may include the contract/chargeback administration teams, accounts receivable staff, collections, and related functions
• Technology: Billing software, contract management systems, and other IT
• Bad debt: Write-offs due to customer failure to pay

• A/R days outstanding: Healthcare providers are often slow to pay, given that their revenue comes mainly from third-party insurers which are also slow payers. Distributors tend to pay more quickly, and to take advantage of any prompt-pay discounts from manufacturers. Many manufacturers report much lower DSO for their distributed sales compared to direct sales to customers.
• Risk: Extending credit involves risk. Using a distributor allows a manufacturer to offload a large portion of that risk, along with significant credit management responsibility
• Cash flow: Many group purchasing contracts allow providers to buy products for less than the wholesale price. When distributors sell product at these low negotiated prices, they apply for a chargeback from the manufacturer to cover the difference between the price paid by the distributor to the manufacturer and the lower contract price paid by the provider to the distributor. Any time lag in this process benefits the manufacturer’s cash flow.
• Pricing accuracy: Quality in the billing function means timely, accurate invoices that satisfy the information needs of the customer. There is a significant cost and responsibility to performing this function, especially given the complexity of healthcare contracting. Many providers belong to multiple GPOs and expect vendors to bill them based on the correct contracts and pricing tiers.
• Using distribution partners can add a layer of pricing complexity, but also another level of pricing management expertise.
• Efficiency of customer operations: Customers generally prefer to reduce their total number of invoices, reducing the staff time necessary to manage payables.

• Customer service staff
• Technology and software
• Return shipping (since supply chains are generally designed to move forward rather than in reverse, returns are much more costly than deliveries)

• Staffing levels: Manufacturers selling direct will need more staff in order to manage more transactions and deal with smaller customers and low-dollar issues.
• Sales force effectiveness: In the absence of a strong customer service team, the manufacturer’s sales professionals can get mired in issues like returns and price disputes. One manufacturer that shifted from selling directly to using distributors found that the strategy change had a large impact on sales effectiveness. Distributors managed day-to-day service issues like inquiries about deliveries, product availability, and pricing, freeing up the manufacturer’s sales team to focus on growing sales.
• Training: Great customer service depends on knowledgeable staff. Manufacturers must invest in training their own team, and if they use distributors, will want to also invest in training for distributor sales and customer service personnel.

• IT infrastructure: computers and related equipment, enterprise software, and specialized software for specific functions
• IT/data science staff
• External consulting and support

• Data aggregation and insights for the manufacturer: Manufacturers that work through distribution may be able to access data and insights aggregated across hundreds of thousands of customers. On the other hand, some manufacturers prefer to sell direct in order to have a direct view of its customer’s purchase data.
• Data aggregation and insights for customers: Customers may prefer to buy through a distributor in order to gain access to aggregated information. Rather than having to examine reports from each manufacturer, the customer can see information about purchases from hundreds or thousands of different suppliers, and identify opportunities to improve utilization, increase contract compliance, and enhance outcomes.

• Sales staff
• Marketing staff
• Advertising and marketing
• Website development and maintenance
• Technology

• Customer control: Some manufacturers maintain a direct-sales model to maximize their connection with customers and their influence over providers’ buying decisions.
• Customer intelligence: Similarly, the direct model gives the manufacturer direct access to customer data and market intelligence. On the other hand, distributors typically have more frequent contact with a customer’s supply-chain staff, and work with a broader array of decision-makers and influencers within each account. As a result, a manufacturer that uses distribution may be able to gain more insight into buying patterns, competitive trends, and sales opportunities.
• Access to customer base: Distributors carry a variety of product lines. For the manufacturer using distribution, this can mean more competition, but it can also mean additional access and exposure to a broad range of customers.
• Lead and/or demand generation: The distributor’s sales force can complement the sales and marketing activity of manufacturers’ representatives and provide more frequent customer contact. Well-trained manufacturer sales representatives can sometimes achieve a “multiplier effect” by developing strong relationships with distributor sales reps, who can then help to generate sales leads for the manufacturer. The level of distributor sales support provided to a manufacturer is usually spelled out in the distribution agreement and may involve additional fees or incentives to the distributor.
• Sales force productivity: Sales reps for a direct-selling manufacturer often spend a significant portion of their time dealing with issues like pricing, delivery dates, product availability, and so on. In an indirect model, these activities are more often managed by the distributor, allowing the manufacturer’s salespeople to spend more time on demand creation.
• Target markets: The value of distributor sales support is often strongest for manufacturers serving non-hospital providers, because the markets are so fragmented.
• Number of points of contact: Some providers prefer to deal with as few vendors as possible, and may prefer to buy through a distributor for this reason.
• Types of relationships: Manufacturer salespeople typically have clinical expertise and strong relationships with clinical decision-makers within healthcare facilities. Distributor salespeople often have stronger relationships with supply chain leadership.