Abbott's About Face: What It Means for the Physician's Office Market

In supplementing its small group practice diagnostics marketing effort with Physician Sales & Service, an outside distributor, Abbott is responding to a tougher business environment. The breadth and exclusivity of the Abbott/PS&S deal is galvanizing competitors to re-think their distributor/manufacturer relationships.

• In shifting its small group practice diagnostics business from a direct sales force to an outside distributor, Abbott is responding to a tougher business environment, but it also sees opportunities for growth.

• As a result of marketplace changes, distributors and manufacturers are also rethinking their relationships with each other and appear to be galvanized by the breadth and exclusivity of the Abbott-PSS deal.

• The mid-range group practice remains a viable customer for manufacturers of flexible instruments that offer comparatively low costs per test. But companies need to revise their sales pitch from focusing on the profitability to physicians of doing in-office testing to the outcomes and total system cost of on-site testing.

When Abbott Laboratoriesannounced last month that it had signed an exclusive agreement for Physician Sales & Service Inc. to distribute its diagnostics products for smaller physicians’ offices, it jolted competitors. The deal was huge—it affects products that account for about $100 million in revenues. It also was a departure for Abbott, which traditionally has sold all of its products direct. Furthermore, the agreement was exclusive, highly unusual for distributor-vendor relationships in the diagnostics or any industry. Was Abbott losing interest in selling to smaller group practices? The business has been battered in recent years, first by the implementation of burdensome CLIA regulations, then by uncertainties surrounding health care reform and managed care. Perhaps, wondered competitors, Abbott was delegating a declining business to a lower-cost outside sales force in order to concentrate on the more vibrant larger group practice and hospital customers.

Abbott DiagnosticsDivision President Miles White couldn’t disagree more strongly. The company, he says, remains fully committed to the smaller group practices. It sought the PSS alliance because its business is changing internally and externally. Abbott, like many of its competitors, predicts flat growth for the foreseeable future in major segments of the physician’s office laboratory. It feels that in order to sell in a resistant environment, it needed more regular access to doctors than it has had in the past. Says White, “This is not a caretaking move. We expect to grow the business. We’ll continue to spend a fair amount of money on R&D. There is consolidation into larger group practices in this business, but there is a role for certain kinds of diagnostic tests for the physicians’ office laboratory.”

Indeed, White says, the deal is part of the diagnostic division’s ongoing response to a market place that is very different from the past. “The old predictable practices won’t succeed in the same way and you can expect to see a number of changes in the way we approach the market,” he says.

The exclusivity stipulation of the PSS alliance is also a departure from past practices. By agreeing to it, Abbott risks being left out of some major markets, since no distributor is strong in all regions of the US. It won’t have access to the nation’s largest distributor, General Medical Corp. Furthermore, it means that Abbott, as well as PSS, has to give up some control over the sales process. But the breadth and insularity of the exclusivity provision appears to be galvanizing competitors. Some manufacturers were dropped from the PSS line as a result of the deal and immediately began scrambling to protect their market share by reviewing their arrangements with their existing distributors. The distributors, for their part, may be shaken up into retaliating by pushing Abbott’s competitors more aggressively.

A Consolidating POL Marketplace

Once one of the most promising segments of the diagnostics industry, the physician’s office market has been under siege for several years, due largely to uncertainties surrounding the implementation of CLIA regulations and health care reform. In the past year, the turmoil arising from CLIA, which sets tough labor and technical standards for laboratory testing, has subsided, executives say. Doctors who were put off by the additional expense of compliance with it have already stopped testing in their offices. Others who decided to continue testing seem even more committed than before.

The major obstacle to the market place, therefore, remains health care reform, namely managed care. While managed care’s ultimate attitude towards physician’s office testing has yet to be sorted out, in parts of the country where it is strong its effect so far has been negative. In some regions, like the Northeast, doctors continue to have a large percentage of their patients in fee-for-service programs that reimburse on a per test basis and in-office testing remains highly profitable for them.

But in an increasing number of places, the bulk of the population belongs to managed care plans. Doctors who practice in small groups in these areas are giving up their in-office testing because they aren’t making money on it, executives say. Many plans require them to use reference labs for all but a few basic tests or include the cost of in-office testing in capitated rates. In California, for example, 74% of patients are enrolled in managed care programs and the laboratory market there is shrinking, says Elliot Werber, VP, primary care sales, for General Medical.

In addition, managed care’s efforts to force economies of scale is affecting the business on other fronts— it is leading to consolidation of smaller group practices into middle-sized and larger practices and it is also partly responsible for the rapid consolidation in the highly fragmented distribution industry.

As customers get fewer in number but larger, the kinds of instruments they use are changing. But it isn’t happening in ways that are clear-cut and predictable. Some small groups that appear to be independent are actually affiliated with or owned by large integrated networks, hospitals, or physician management companies. Their purchasing patterns vary. They may continue to behave like small group practices and make their own buying decisions, they may cede control of their buying decisions to their corporate parents, or they may engage in a combination of those options.

Likewise, distributors are also consolidating as they seek to achieve economies of scale and please larger buyers who want to pare down the number of vendors they work with. In the past year, General Medical acquired FD Titus & Sons, which itself had recently bought a Southern California distributor Bel-Air Surgical, and Foster Medical Supply Inc. , an East Coast-based supplier. PSS has also bought Taylor Medical Inc. a large regional distributor in Texas, as well as a series of smaller companies, including Lancet Medical Ltd. in St. Louis, Winchester Surgical Supply Co. in Charlotte, and Bay Medical Supply Co. in New York.

Gaining Greater Access to Physicians

These changes are affecting Abbott, as well as everyone else. Abbott’s line of products to physicians’ offices covers about 70% of their testing needs and includes hematology, clinical chemistry, and immunoassay instruments, as well as a series of rapid tests called Testpack. When the market was hot, Abbott was one of the few manufacturers to use a direct sales force to sell these products to smaller group practices. With more than 140 reps, it was larger than any single distributor’s sales force and more focused than the networks of dozens of distributors that competitors were used to working with. It was managed by the company’s pharmaceutical division based on the premise that pharmaceutical reps could generate leads for the diagnostics team through their long-standing relationships with physicians. In fact, the pharmaceutical reps actually sold the rapid tests. But in January 1994, the company transferred the responsibility for diagnostics sales from the pharmaceutical to the diagnostics division in order to allow the pharmaceutical division to focus its attention on the introduction of several drugs and to allow the diagnostics division to assume supervision of a sales effort in a difficult business environment.

Moreover, its diagnostics division executives initiated internal discussions about whether to shift sales of selected products to outside distribution. The physician’s office market, particularly at the low end, wasn’t growing, says White. But Abbott felt that its market share could be expanded, given its broad product line and leadership position. Perhaps even more importantly, Abbott wanted the increased presence in the lower end of the market to protect its franchise in the higher end hospital and large group practices businesses. As integrated systems begin to absorb small group practices, it didn’t want a hole in its distribution chain.

“It sounds somewhat illogical to say that a market declining in size can be attractive, but we felt it could be. We had a large franchise and important customer base—not only important to diagnostics but to other divisions of Abbott,” says White. “But we were at a disadvantage from the perspective of sales and distribution coverage. We had a broad product line in diagnostics, but the problem was that our reps only had a reason to be in physicians’ offices every couple of months, while distributor reps are in and out of the offices several times a week.” Since doctors aren’t seeking to expand testing, it’s particularly important to have frequent access to them to be aware of what they need, he adds.

The decision to look for an exclusive arrangement was made early on. Abbott wanted the distributor’s attention focused on its products in a way that it didn’t think would be possible through traditional non-exclusive relationships. Initially, it offered one hematology product, but when distributors balked, it expanded the selection to include the rest of its alternate site product line.

Exclusive vs. Non-Exclusive

Abbott’s approach highlights the positive and negative arguments for exclusive distributor-manufacturer relationships. Most manufacturers for this market utilize many distributors on an either semi-exclusive or non-exclusive basis. Since most distributors are only local or at most regional in scope, this non-selective strategy allows them to work with the organizations that are strongest in each part of the country. Semi-exclusive arrangements usually entail the use of no more than two or three distributors per region and aim to maintain pricing and motivation, while non-exclusive strategies, used most commonly for commodity items, succeed by saturating the market with a product.

The problem with exclusivity has been that no distributor, even the largest, is strong in all sections of the country. General Medical comes closest to being a national force, while PSS is particularly strong in the Southeast and parts of the Southwest, and Taylor has excellent market share in parts of the Northeast, Southwest, and West. The majority of distributors, as they currently exist, are by and large, order takers who aren’t equipped to plan sales and marketing strategy and aggressively promote any one product.

Thus, even when Abbott promised the whole product line, many distributors were reluctant to enter into an exclusive agreement. They were wary of Abbott’s long-term commitment to them, since they were notified only at the last minute of Abbott’s decision to discontinue using outside distributors for hematology products shortly after its acquisition of Sequoia-Turner Corp. in December 1991.

Talks with General Medical were particularly intense and indicative of the kinds of issues that permeate such deals. Abbott and General Medical seriously considered a partnership. But General Medical eventually rejected the opportunity because its executives were wary of ceding too much control to Abbott in the guise of exclusivity. They feared such an arrangement would anger their other large vendors, such as Johnson & Johnson , who are important sources of not only primary care diagnostics, but also medical supplies and hospital equipment. “We felt it would have put us in an awkward position,” says Bruce Glickstein, who recently retired as SVP, marketing and manufacturing at General Medical and remains a consultant to the company. “We were concerned about our existing customers and felt it [the deal] was heavy-handed with the customer base.” Also, he argued, it would have reduced General Medical’s access to new technologies made by other manufacturers.

Furthermore, both sides sell to hospitals and large group practices and worried that, even with a contract specifying the boundaries of their territories, the desire to fulfill customers’ needs might lead to conflicts between them. Abbott “said ‘Trust us, we will work it out’ but these kinds of situations come up daily with our sales force and can’t be answered every time they occur. In these cases, we felt it would probably go to Abbott, not our way,” Glickstein says.

Making a Long-Term Commitment

Abbott was left with few alternatives if it wanted a large distributor that had sophisticated selling strategies. Aside from General Medical, the only nearly nationwide contender was PSS, with a presence in 60,000 physicians’ offices. With its recently announced acquisition of Taylor, its reps cover 80% of the US market. Nationwide, its market share is about 10%, although in some locations the percentage is much higher, says John Sasen, PSS’ chief operating officer. The distribution business is so fragmented that even with a 10% share it is the second largest distributor in the US.

Also, PSS is known for its pioneering aggressive sales approach that includes a well-trained, regionalized sales force; unlike traditional distributor sales forces, its reps get extensive training and are proactive proponents of the products they sell. It is particularly strong in the very small doctor’s offices, and Abbott’s market research showed that customers have a high regard for it. Even competitors agree with this assessment. Says Don Grantham, US manager for Coulter Corp., whose systems PSS is dropping as a result of the Abbott deal (PSS will continue to sell Coulter reagents). “When PSS says it will do something, it will do it. It is a very aggressive organization, which goes after market share.”

The deal calls for PSS to be the sole distributor of Abbott diagnostic products for group practices of 24 or fewer. Abbott’s sales to these customers, which number about 15,000, garnered revenues of more than $100 million last year. The transfer is to take place over the next three years, with business totaling $65 million to be affected this year.

Abbott also agreed to acquire 4% of PSS common stock in order to reinforce its commitment and to provide the distributor with a capital infusion to help support the deal, White says. It has no plans to acquire the company and signed a standstill provision that prohibits it from buying additional shares in PSS, except with special permission of the PSS board of directors. Nor is it putting a representative on the PSS board, he notes.

White emphasizes that Abbott is continuing to invest money in R&D programs for the physician’s office market. Indeed, Sasen says that one major reason PSS was willing to go into the deal was because it was impressed by the quality of the manufacturer’s ongoing R&D efforts in this field.

A key indicator of Abbott’s commitment is the amount of support it is giving PSS. Abbott’s existing sales force of 140 reps dedicated to the smaller group practices will now provide specialist support to PSS, helping PSS to focus its efforts. Says White: “Distributors alone don’t have the focus and expertise to push one vendor’s products over a period of time on a continuous basis. By combining both sales forces we get extra access.” If the support team remains in place long-term at its current size (and many observers question whether it will), it will be far larger than any other competitors’ sales support team for this market and could generate sales in territories where PSS is weak. Roche Diagnostic Systems, Becton Dickinson & Co. and Johnson & Johnson each have support teams of about 30, 35, and less than 30, respectively.

Pockets Of Opportunity

But maintaining this kind of infrastructure is expensive. As it stands, it isn’t clear that the deal can help Abbott improve its margins in the business, given that it will also have to share profits with PSS, notes one industry executive. White insists that Abbott doesn’t plan lay-offs, although he doesn’t know whether all of the reps will be needed in the long term. Instead, the company will make up the margins by growing its share of the market at the expense of competitors. While in-office testing in small to mid-range practices faces limited prospects for growth, there are pockets of opportunity, White says. Of the 350,000 or more physician offices in the US, about two-thirds are small to mid-sized. Yes, say optimists, consolidation is occurring, but the customer base is still enormous.

Furthermore, mid-sized practices (5 to 10 doctors or more, the cutoff depends on who is making the definition) are eager to provide patients with convenience and to drive costs out of their practices. “Having real-time diagnostic information is one way to drive down costs or manage them, Sasen says; the theory is that quick test results can lead to quicker treatment decisions, reducing the number of visits necessary to the physician’s office and getting the patient on appropriate therapy sooner. The number of testers isn’t expanding, he observes, but there is an “explosion” of interest in converting existing systems to those that offer more information for less operating cost. There are also more opportunities for them to do testing as patients are driven out of hospitals into ambulatory care settings.

Other industry executives agree with this assessment. Roche and BD executives say that they are doing well, despite the dire forecasts. The QBC Instrument, a BD hematology analyzer whose primary customer base is group practices of less than five physicians, is selling “at a good clip,” says Walter Miller, sector president, infectious disease diagnostics, which is in the middle of a study aimed at sorting out the mixed signals it gets from the marketplace. “Some physicians have stopped testing and others are starting to do it, and I can’t explain it,” Miller says. “I’m not sure the market is disappearing at the low end of the scale as everyone speculates, and if it is shrinking, it is not shrinking as fast as people imagine.”

Roche’s Cobas-Mirachemistry analyzer, likewise, had a “terrific” year last year because of its capacity to do comparatively low-cost testing, says Thomas Crowley, VP and director of the company’s clinical diagnostics business unit. In recent focus groups with physicians, Roche found that they are willing to do testing as a service to patients even if they don’t make money on it, as long as they don’t lose money. With a new Congress that might scale back CLIA and signs of weakness among managed care organizations, he is more optimistic about the physician’s office market than in the past. Managed care organizations face increasing competition and greater scrutiny from employers, who are looking not only for lower costs but for customer satisfaction, he says. In-office testing has the potential to offer doctors and patients convenience and information necessary to make quicker decisions about treatment, leading to better medical care, he believes.

A key issue in any distributor-manufacturer relationship is who controls the marketplace. If one side gets too dependent, it becomes vulnerable, leaving it at the mercy of the other, whose long-term goals may or may not present a conflict. PSS, for example, as a requirement of the Abbott deal, dropped several vendors that compete directly with Abbott, and is de-emphasizing others. Most notably, it has stopped selling Coulter’s hematology systems, although it will still continue providing its existing Coulter customers with reagents. Johnson & Johnson is also no longer using PSS to distribute its Ektachemchemistry systems and SureCell rapid tests.

Implications For Other Vendors

From PSS’s perspective, the trade-off was worth it. The discontinued lines accounted for only about 2% of PSS revenues, says Sasen. But Coulter was left on the defensive, since PSS had been one of its leading US distributors. Nonetheless, because Coulter has relationships with all of the major dealers in the US, it doesn’t expect a major fall out, says Coulter’s Grantham.

Coulter and Johnson & Johnson are now re-evaluating their relationships with other distributors. Neither company plans to look for exclusive alliances of their own. But they are interested in forming new kinds of partnerships that involve working more closely with them. “Our response is to work more closely with other distributors,” says Grantham.

Roche and BD also have a lot at stake, since PSS is the US leader in sales of hematology products for BD and of hematology and chemistry products for Roche. The distributor is continuing to carry BD’s QBChematology analyzer because Abbott doesn’t make a competing low-end instrument. Likewise, Roche’s Cobas-Mira analyzer remains PSS’ preferred mid-range chemistry system, also because Abbott doesn’t have a product that competes in that category. Both companies plan to continue using PSS but are watching the situation cautiously.

The Changing Sales Pitch

From Abbott’s perspective, the deal is a gamble. The company is, in effect, trying to take advantage of an outside distribution network without incurring the disadvantages of having to compete with other suppliers for distributors’ attention. In doing so, it risks losing access available from working with a broad array of distributors. Of course, those distributors had never been part of its strategy, but now they may be more motivated than ever to push products made by Abbott’s competitors. On the other hand, Abbott hopes to use PSS’ access to small doctors to make sure that it represents all segments of the market, as integrated systems takeover not only hospitals and larger groups, but also the smaller buyers.

In the minds of many, the deal crystallizes important shifts already underway in manufacturer-distributor relationships. In an environment in which physicians grapple continually with how best to control their practice costs, the reasons for buying equipment are changing. While in the past, the roles of each party in the selling process were clearly defined—manufacturers were responsible for brand identification and distributors were order takers—now, roles are shifting as distributors also become more oriented towards consulting.

Under the fee-for-service system, it was relatively easy to sell equipment: there were highly attractive financial benefits to doctors for doing in-office testing, as well as medical benefits. But under managed care, such testing doesn’t always generate profits. Both distributors and manufacturers have a stake in getting doctors to understand the benefits of in-office testing. But to do this, they must go beyond promotional generalizations. Only through credible studies of the outcomes benefits and analysis of the total cost of testing to the health care system will their products gain widespread acceptance.

Manufacturers like Roche and BD are already undertaking work of this kind. Distributors, however, are just beginning to sort out their role in this new marketing strategy. General Medical, for example, is working with selected partners on outcomes and cost-effectiveness studies, as its reps see themselves more as cost management consultants than order takers, says Werber.

The challenge, as Werber sees it, is “how to go into a group practice in a heavy managed care environment and cost justify in office testing to it.” But that is only the beginning. Many doctors already believe that in-office testing is productive. The bigger issue is how to explain it to the insurance providers who pay for the services, “to reposition the diagnostics instrument so that insurance carriers say we want these tests done in the office.”

For its part, managed care organizations are still open minded about in-office testing. Their approach to the issue is so varied, that there is a lot of room for argument in how tests should be utilized and equipment should be sold. Having more bodies to make the pitch, as Abbott is doing, is one step in the process. —WD