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CHARGEBACK DELAYS ARE FORCING WHOLESALERS TO ABSORB FULL "COST BURDEN" OF HOSPITAL DISTRIBUTION, CONTRIBUTING TO DANGEROUSLY LOW GROSS MARGINS

Executive Summary

The 30-day industry average for wholesaler reimbursement on hospital chargeback claims is a situation requiring "immediate attention," NWDA 1988-1989 Chairman Barry Krelitz (Krelitz Industries) told the Orlando annual meeting on Oct. 15. The time it takes to resolve payment on the chargebacks, Krelitz observed, "represents a large financial drain on wholesalers that EDI [electronic data interchange] can reduce or eliminate." Wholesalers "should not be financially disadvantaged," Krelitz declared, "for providing a highly cost effective service." Departing from his prepared remarks, Krelitz reiterated the "critical importance" of the chargeback issue several times. He characterized the issue as a key factor contributing to the slow erosion of gross profit margins in the wholesale drug industry. "Many manufacturers believe wholesalers brought the chargeback system on themselves, and we may have in our desire to be prime vendors to hospitals," Krelitz acknowledged. "However, today we are carrying the total cost burden for the system," he maintained, "and we need relief." The carrying costs of "increased inventory and heavy receivables" lead to "very low margins," Krelitz maintained. Wholesalers are left "totally financing the system," he claimed, suggesting that "EDI and other efficiencies are needed to relieve the pressure." As head of one of the more aggressive mid-size independent wholesalers pursuing the hospital drug business, Krelitz is particularly sensitive to the chargeback topic. His Twin City Wholesale company does almost half of its sales in the hospital sector with a customer base of more than 200 hospitals. With the large hospital business, Twin City has a below average gross margin compared to the industry average. For the fiscal year ended April 29, the gross margin for Krelitz Industries (the parent company for Twin City) was 6.17% compared to the NWDA Operating Survey average of 7.34%. Krelitz defined profit improvement as one of the themes for NWDA in 1990 and the upcoming decade. He urged NWDA members to set an industry objective of matching the margins of current "upper quartile performance." The "challenge," Krelitz said, "then is to earn adequate profits on sales. Upper quartile performance should be a minimum goal." Noting that the median net profit to sales ratio for NWDA members in 1988 was 1.78%, Krelitz said the target should be the 3.08% ratio achieved by the high profitability group. NWDA President Charlie Trefrey picked up the theme of gross margin improvement in his Oct. 18 presentation to the annual meeting. Declaring the period of fast volume growth and declining margins nearing an end in the industry, Trefrey warned that drug wholesalers may be "about to starve on our own success." Trefrey noted that the big sales gains by wholesalers in the prescription business during the past fifteen years will be continuingly more difficult to duplicate. Wholesalers "already have about 70% share of market in terms of pharmaceutical distribution," Trefrey pointed out. "As we near the upper limit of the trendline of sales growth, the additional sales become harder to get -- and at lower gross margins." If wholesaler sales gains become tougher to achieve, the continuing improvement in operating costs is likely also to change, Trefrey pointed out. The two changes together would combine to bring "us to the end of the era -- the end of an era that is technology driven," Trefrey declared. "I maintain," the NWDA president said, "that our era, the way we are doing things today in the wholesale drug business, has ended as we sit here." He committed the association to "talking with you about breakthroughs, about gross margin enhancement, about new ways of doing business." Those types of discussion, Trefrey said, are "absolutely what NWDA ought to be doing." "I want to engage you in a process by which we invent a future which would not otherwise exist," the NWDA president said. Trefrey expressed a "formula" for the future as EDC (electronic data collection) + EDI (electronic data interchange) + EDI (data integration) + POS (point of sale) = JIT (just in time). The question for the future, he quipped, is "where you will be when the JIT hits the fan." Krelitz predicted that electronic data collection will "eventually cover the entire health care system -- reducing physician tendencies to overprescribe drugs, diagnostics, surgeries and rehabilitation." Indirectly supporting increased drug utilization review, Krelitz said: "I believe it is time for us to broaden our review and analysis of the effectiveness of treatment." However, he urged caution to prevent technology from outstripping "our ability to establish protocols." The next step in electronic breakthroughs, Krelitz said, is "to integrate electronic data interchange with bar coding and point-of-sale scanning at retail." Noting that the primary focus of EDI has been the manufacturer-wholesaler communication, Krelitz said that "EDI is coming to pharmacists as well." The extension of the electronic link "through point-of-sale scanning will complete the [electronic] loop," Krelitz said, "and will create a virtually paperless environment through manufacturer to retailer and back again." NWDA plans to issue an applications manual for electronic data interchange during the spring of 1990.

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