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Private Branding - Difficult Decisions

Dr. Gurram Gopal

Summary
This case study is presented to demonstrate the difficulty a major medical distributor, McBride Medical Surgical, is faced with while trying to determine whether or not to create a private label. The options presented within this case are those McBride Medical

Surgicals management feels it must consider to stay competitive within their marketplace. The actual name of the company is disguised for confidentiality purposes.

Keywords:

private brand, strategic sourcing, marketing, acquisitions

The Problem
McBride Medical Surgical has reached a critical juncture in its evolution where it has to make strategic decisions impacting its position in the medical surgical market . McBride Medical Surgical, henceforth referred to as McBride, is a full-line distributor of medical products to the surgical market. Among the products it sells are syringes, surgical gloves, anesthetics and many others. McBride Corporation is an acknowledged market leader in the surgical products distribution business, offering an integrated portfolio of products and services to the major healthcare delivery markets. The current economic reality facing the surgical products business is that most procurement decisions are being driven solely by price. McBrides large competitors have begun introducing their own versions of the more commoditized surgical products under private brand labels. Prices customers pay for these private brands are often twenty to thirty percent lower than the branded products. McBrides management has so far resisted creating private brands, partly to maintain

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relationships with the major branded manufacturers of surgical products including Baxter Inc. and Johnson and Johnson, Inc. McBrides management team must determine how to compete with their large competitors private brand strategies in an already margincompressed medical distribution market. McBrides major competitors have either selfmanufacturing or private brand strategies with outsourced manufacturing, or combinations of the two with brand recognition. In certain competitive bidding situations, these competitors have been known to market products at cost just to protect their strategic customers from moving to competitive distributors. McBride can also distribute these private label products made by other distributors, but with an additional distribution mark-up. This puts them at a tactical disadvantage when it comes to pricing. McBrides senior management must decide what strategy to pursue to maximize shareholder value while minimizing investment and operations risk.

Medical Surgical Supply Market


The medical surgical supply market is approximately a forty billion dollar industry. About fifty percent of the market is served through traditional distribution channels. The remainder of the market is comprised of direct manufacturer sales to customers. Distributors can put together a package consisting or products from several manufacturers that could serve a hospitals surgical needs. The medical surgical market is divided into three distinct segments. Acute Care This segment is comprised of Hospitals and Surgery Centers. This segment provides for distribution margins in the six to fourteen percent range depending on the size and the specific Group Purchasing Organization (GPO) affiliation.

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Extended Care This is comprised of Nursing Homes, Assisted Living Facilities and Home Care Agencies. This segment typically provides distributors margins in the sixteen to twenty eight percent range. There are products within the Home Care Market that can sell with a margin as high as fifty percent. Margins often depend on the distributors involvement in the customers Part B billing. Primary care This is comprised of Primary Care Physicians, Specialty Physician Offices and Clinics. This segment enjoys distribution margins anywhere from fourteen percent for large Integrated Delivery Network (IDN) to forty percent for a single physician practice.

The Acute Care Segment is very mature and the distribution margins have experienced extreme downward pressure over the past five years. As the society gets older and needs greater care when the care is becoming more costly, the point of care is shifting away from the Acute Care setting towards the Extended Care and Primary Care environment. Approximately sixty hospitals per year close due to financial stress, mergers or obsolescence. The overall annual growth in the medical surgical distribution is in the six to seven percent range annually and the Acute Care market is growing annually at a rate between five and six percent. To combat the pricing pressure for branded products most national distributors have moved toward a private brand with self-manufacturing strategy to remain competitive and expand overall margins.

Distribution in the medical surgical supply market is highly consolidated. Four National Distributors account for approximately eighty-six percent of the national Acute Care market. There are also three regional distributors that have significant market share within

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their respective regional areas. There are four distributors in the Extended Care space that control fifty-nine percent of the market and five distributors in the Primary Care space that control fifty-two percent of the market. There is considerable opportunity in both the Extended Care and Primary Care space for consolidation since the market leader in each segment owns nineteen percent and seventeen percent of the market respectively. Further consolidation could occur in the Acute Care market because two of the four national players could still be acquired in addition to the regional players.

The self-manufactured products produced by a traditional distributor make up only sixteen percent of the total medical surgical distribution market. Distributors who are also manufacturing these products have traditionally focused on the acute care segment because of the larger volumes required to support a self-manufacturing infrastructure.

As a consequence of the annual reduction in the number of hospitals each year, the number of customers is shrinking. When the market presents opportunities for new business, decisions on who would get that business are being made based on the initial cost of acquiring the product more than anything else. Since most of the inefficiencies have already been driven out of the distribution networks there are far fewer opportunities to reduce costs. With shrinking margins in the traditional distribution space, an organization must create new ways to increase margins and to stay competitive,. There are a couple of strategic ways to accomplish this task. One is to offer value added programs and help customers manage information. Another is to distribute new products that give better overall margins and do not negatively affect the companys cost-to-serve model. McBride

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already provides significant value added services to its customers in consolidating purchases, efficient delivery and disposal services. In the area of Private Branded products McBrides major competitors already have a solid foothold in this market area. It is critical for McBride to meet them head-on and to ensure that its strategy and product/service offering is more robust and can be delivered efficiently and effectively to the marketplace. McBride would also have to pay close attention to how their private branded products would compete with their very important national brand partners. The top three suppliers make up over forty percent of McBrides total sales volume and over fifty-two percent of the sales volume in Acute Care. Any strategy adopted by McBride has to be perceived as a positive move by its customers from a cost standpoint for it to be successful.

Alternatives for McBride Medical Surgical

Create a Private Brand, with low cost contract manufacturing The first alternative would be to develop a Private Brand strategy to compete in the high margin commodity arena. The products to be included in the Private Brand program must be part of a clinical strategy that ties the breadth of private brand and major branded products together in such a way so as to migrate the customer toward the McBride name. Once they have decided on of McBrides private brand product, the customer should want to buy from the remainder of the line McBride private line. This is the key to profitable volume growth based on account penetration success. Design and manufacturing of the private brand products would be contracted to the lowest cost contract manufacturer, often located in Asia.

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Create a Private Brand with Strategic Sourcing from a Manufacturing Partner The second alternative would be to develop a Private Brand strategy combined with strategic sourcing from a manufacturing partner. This strategy, like the private brand strategy above, must be integrated into a clinical setting. The products to be included in the program must be part of a strategy that ties the breadth of products together, as this is key to account penetration success. The strategic sourcing would be accomplished by partnering with a manufacturer that is already involved in the global marketplace and has relationships in specific areas of the world for producing medical products. In this case, McBride would tap into the expertise of this organization to develop a private brand strategy and a strategic sourcing strategy. As part of this alternative, McBride would continue their search for strategic opportunities to acquire niche manufacturers that produce products that compliment the overall strategy. These manufacturers may typically have revenues less than two hundred million. This could produce a return on investment (ROI) that would meet McBrides financial objectives and support the long term strategic direction.

Acquiring a Private Brand Manufacturer The third alternative would be to pursue a full-scale acquisition of a selfmanufacturer/distributor organization to provide Private Brand products that would add to the current McBride product offering. McBride would need to ensure that this fits with its business objectives and that the product line met the same strategic criteria necessary to ensure that the acquisition would be successful.

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Status Quo The last option is to make no changes to McBrides current marketing strategy. However this is not a viable option if McBride wants to stay competitive in this critical marketplace. With its current pricing McBride would be shut out by many customers who believe they can get competitive products at a far lower price from other vendors.

Evaluation of Alternatives
Private Brand, with low cost contract manufacturing This strategy has the least amount of risk of the three possible options (figure 1). It provides McBride with the Private Brand product strategy required to be competitive in the market space. It can be rolled out relatively quickly and with less capital outlay than the other alternatives. This alternative is the least complex and would be the easiest to manage.

However, there are several issues with this alternative as it relates to the long-term strategic direction of McBride. First, there is not going to be the margin growth potential that would be available with the other two alternatives. There isnt necessarily the long-term strategic control or relationships built with the contracted manufacturer. McBride could lose some control over the sustained quality if the only way to increase profit on a go-forward basis is to lower its base acquisition cost. This could force the partnered manufacturer to continually cut costs or could force McBride to move from one manufacturer to another, which could sacrifice consistent quality. It is important for McBride to drive consistency

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in quality as they move to build recognition for their private brand. It would also be more difficult to differentiate the private brand offering if McBride is working with manufacturers that are potentially common to its competitors. Entering into partnerships that are based on acquisition cost instead of shared efficiency and risk can yield results in the short-term but does not ensure that the two companies share a common, collaborative vision for long-term financial success. McBride would also have to pay close attention to how the private branded products would compete with their very important national brand partners and must manage the relationships very closely.

Private Brand with Strategic Sourcing from a Manufacturing Partner This alternative has a greater degree of risk than the private brand strategy but has much less risk than the full acquisition strategy (figure 1). It provides McBride with the Private Brand products required to be competitive in the market. It can be rolled out relatively quickly and with less capital outlay than the acquisition strategy. McBride would need to develop brand awareness but would have more control over consistency and quality in this alternative. With this alternative, McBride would be able to deliver a broad line of private branded products at a low cost to supplement or complement their national brand offering and can provide leading edge and clinically valued products in selected product categories. It would also be able to provide a higher level of service and customized solutions to its customers.

However, there are other issues with this alternative. First, there is not going to be the margin growth potential that would be available with the self-manufacturer option.

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McBride would not as much control over the sustained quality relative to manufacturing inhouse. Business partnerships, even those oriented for longer term and which include collaborative vision for long-term financial success risk the eventual severance of the agreement. This poses some of the same issues faced by the first alternative. As with the first alternative, McBride would have to pay close attention to how the private branded products would compete with their very important national brand partners.

Acquiring a Private Brand Manufacturer The third alternative to pursue full-scale acquisition of an existing selfmanufacturer/distributor organization to wrap the Private Brand products around the current McBride product offering is strong strategically. This would give McBride the ability to compete with their largest competitor on pricing and it would also give them access to an additional six percent of the overall medical- surgical spend and eight percent of the acute care spend. This alternative would give McBride the continued ability to compete on price and thus the best alternative to differentiate their private brand. The competitor that fits this profile has a respected brand name in the marketplace. The acquisition would also give McBride the ability to penetrate deeper into their current customer base.

The downside to the acquisition strategy would be the capital outlay in an already depressed segment that might return an economic payback past McBrides current threeyear payback threshold. Another down side to this option is the significant amount of management resources and time spent on pre-acquisition due diligence of the target

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company and the resource commitment to get a new company and culture integrated into McBride. This could be a relatively long cycle to actually have a deliverable to bring to market It also could cause some additional brand confusion with another name added to the current mix.

Key Decision Criteria


Some of the key criteria considered by McBrides management included the following: Meeting McBrides multi-year financial objectives Compete effectively with the major competitors Acquire market share, price effectiveness and build brand equity Enhance the value proposition to the customers and GPOs Create value for the supply chain Offer a more complete package of products and services Provide better distribution value Maintain a complimentary relationship with major manufacturers Implement in a reasonable cycle Execution risk should be low and the likelihood of success high

Vertically integrating through an acquisition of a stand-alone manufacture/distributor does not work well with McBrides objectives- there are too many risks including economic feasibility, current competency limitations and execution risk. In order to become competitive against all of the major players, McBride cannot solely rely on a pure sourcing or private brand strategy. They would need to combine several strategies from the hybrid

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model. The alternative that makes the most sense is to develop a strategic relationship with a highly respected organization that is known for their quality manufacturing, strategic outsourcing and global relationships. Private Branding with Strategic Sourcing from a Manufacturing Partner gives McBride the ability to compete head to head with their major competitors in the high margin commodity areas and also gives them the capital to invest in strategically positioned product introductions that can differentiate them from the market. The hybrid model has all the benefits of the sourcing/private brand alternative but has the ability to build brand equity, clinical acceptability and create a differentiated value proposition.

Implementation Issues
McBride does not have the current infrastructure to support any of the options. Recruitment of talent to assess and develop the appropriate infrastructure to support the Private Brand efforts and to manage the program is of high priority.

Conclusion:
Although it would appear to be an easy decision to create a private label to market a product, the evidence indicates that this decision is not as easy as it sounds. McBrides management has done a significant amount of research into the options presented here and has realized that there is no perfect solution to their problem. Regardless of the option that McBride chooses they are going to have to carefully execute their solution so as to avoid seriously jeopardizing their relationships with their branded supplier base while not pricing themselves out of the market.

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Authors Biography:

Dr. Gurram Gopal is an Assistant Professor of Marketing in the Center for Business and Economics at Elmhurst College, 190 Prospect Ave., Elmhurst, IL 60126. Previously he served as the Senior Product Manager and Product Planner at Tellabs Inc., and also as a Manager at ZS Associates, Inc., where he devised marketing strategies for pharmaceutical companies. He can be reached at ggopal@elmhurst.edu Dr. Gurram Gopal Assistant Professor of Business Administration Center for Business and Economics 190 Prospect Avenue, Elmhurst, IL 60126 Email: ggopal@elmhurst.edu Ph: (630) 617 3108 Fax:(630) 617 3497

Acknowledgements
Details of this case were prepared by Tim Engstrom, Jim Smith, Michelle Fragoso and Beth Toth, four graduate students in Elmhurst Colleges Master of Science in Supply Chain Management Program.

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Potential Entry Strategies


High
Broad Acquisition

Business Risk
Low

Strategic Sourcing

Extent of Vertical Integration

Private Branding

Pure Distributor

Pure Manufacturer

Figure 1: McBrides Potential Private Brand Entry Strategies

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