A key question leaders in any company must face is how vertically integrated to be. This means deciding which links in the value chain they should operate, versus outsource to others. There are plenty of pros and cons to vertical integration. Often, the largest pros center around reducing the transaction costs in negotiations with suppliers or customers, as well as capturing the profits currently enjoyed by others along the value chain.
The medtech industry is not immune to these questions. Traditionally, there has been a clear distinction between manufacturers, distributors and users. Recently, though, a trend has started to blur those lines. As an example, some distributors have started to go upstream and produce private-label products or even to acquire manufacturers. In all fairness, the concept is not entirely new. Some distributors have manufactured “supplies-oriented” products such as hospital gloves, gowns and gauze for quite some time.
But the definitions and thresholds for “supplies” are evolving. In particular, some traditional “specialized” products, such as interventional surgical products, have been off-limits to the low-cost, low-service model most distributors offer. The March 2015 announcement that Cardinal Health will acquire Cordis is one example of this threshold evolution. The Cordis portfolio includes a variety of guidewires, catheters and certain stents. Cordis itself is quite a case study, and has risen and fallen spectacularly over the past 10 to 15 years. For now, suffice it to say that at one time, Cordis manufactured the pinnacle of high-margin, high-touch products, very different from what a traditional distribution partner would handle.
The fact that Cardinal believes that the Cordis portfolio can fit well within its capabilities is quite a statement to the other players in the interventional market. It may also be an indicator of the further slide toward commoditization within many medtech categories.
By the way, several alternatives can be considered as options other than outright vertical integration. Cardinal could have entered into a joint venture, a long-term licensing agreement or even a franchise. But it chose to take the full plunge into acquisition. That could be a good move if it has high confidence that it wants to become more of a manufacturing player, and that the skill sets required to run a manufacturing business are complementary with Cardinal’s strategy. Hopefully, for the company’s sake, the reasons for the acquisition are not simply a kingdom-building mentality or a misplaced belief that it can capture significant margins currently captured (if they exist) by Cordis itself. Typically those reasons lead to failed economic outcomes.
As a loose personal analogy, the situation is reminiscent of families considering whether to purchase a vacation home. Those who do have a vacation property probably obtain some degree of happiness from it, and also have an easier decision about where to go next year. Presumably, it also reduces some transaction costs, since they now can make decisions related to that property that are different than a purely rental property owner would make (maintenance, upgrades, marketing, increased insurance, etc.). But at the same time, these vacation home owners now tend to reduce their future vacation options. The likely guilt (and costs) of going somewhere else rather than their purchased home inevitably steers decisions on a regular basis. Also, they are more subject to the pitfalls of putting all their eggs in one basket.
Similarly, Cardinal will now potentially have fewer options to carry in terms of its interventional portfolio. Additionally, it will need to master manufacturing in a more robust way than it has to this point (although, to be fair, this is not Cardinal’s first foray into manufacturing).
In any case, this blurred line will likely get even blurrier as companies at all levels look to expand their revenue in an era of tightening budgets and a slide toward commoditization. This is not likely to be the last of the companies stretching beyond their traditional areas of expertise to go further upstream or downstream.
The acquirers need to believe they can do it more efficiently and/or more effectively than the current arms-length approach. They also tend to have a significant scale that will provide them with sufficient reach into the market, allowing an acceptable service level for customers. By vertically integrating, they may also be able to create some degree of a competitive barrier for others in that space.
One potential outcome from these sorts of mergers is to lead to more standardization of tools (such as procedure trays) for each type of surgical procedure. Rather than a physician having a unique preference set (traditionally captured on a written “procedure card”), he or she will likely be able to choose from a small number of standardized options for each procedure.
The execution of the strategy will be the next test of its effectiveness.