J&J Decision Raises Questions

Edition: April 2003 - Vol 11 Number 04
Article#: 1498
Author: Repertoire

Johnson & Johnson’s recent decision to shave half a percent off its prompt-payment discounts to distributors effective May 1 brings to the surface uncomfortable questions for all players in the supply chain. Is it a sign that J&J doesn’t value distributors, or is it a move that reflects the simple economic realities of the times, such as low interest rates? Will other manufacturers follow suit or will they wait to see how distributors react before making any decisions? Will distributors recoup some of their losses by charging their customers higher prices? And just what will be the impact of the reduction of the prompt pay discount on distributors?

In its letter to distributors dated Jan. 7 (and signed, simply, “Johnson & Johnson,”), J&J recounts how it has improved its efficiencies and reduced supply costs through such things as consolidation of J&J franchises and reduction of overhead through plant and sales onsolidations. “Through these and other efforts, we have been able to double the purchase volume through distributors since 1995.”

Then, the company continues, “Our payment terms policy is being changed to better reflect the actual incentive required to foster prompt payment of the invoice.”

Effective May 1, payment terms will be 1 percent 30 days, net 31 days, for Ethicon, Ethicon Endo-Surgery, Johnson & Johnson Wound Manage-ment, Advanced Sterilization, Vascular Access and DePuy casting products.

Commenting through a spokesman, J&J downplayed the significance of its decision, calling it part of the company’s regular review of payment terms and policies. “If we make changes, we try to base them on economic market conditions, as well as our company policy in maintaining fairness with our suppliers,” says the J&J spokesperson.

Not surprisingly, not all distributors view J&J’s decision as fair.

‘Price Increase – Period’

“A reduction in prompt payment discount is a price increase – period,” wrote Alan Grogan of Lexington, Ky.-based Grogan’s Healthcare Supply in a letter to J&J. “It is, sadly, a discriminatory price increase, where those that pay promptly subsidize those that don’t, where those that are supporting your efforts subsidize end-users to whom J&J has already committed ‘firm’ contract distributor costs (GPOs). If you want to increase prices, fine, go ahead, just do it openly and equitably and quit messing with our prompt payment discount.”

For distributors, the overriding danger of the reduction is that “prompt payment discounts still represent a dangerously high share of the industry’s dangerously low net profits,” says Grogan. He calls J&J’s decision a “bad move for distributor profitability and a bad move for distributor partnerships. It removes some of the incentives for efficiencies in the supply chain.”

Small distributors in particular will feel the impact of the reduction, predicts Grogan. “Differences exist between today and 1995 [when J&J cut the discount from 2 percent to 1.5 percent] that should concern smaller distributors. Expansion of ‘channel fees’ and other essentially under-the-table (unpublished and unpublicized) payoffs to big distributors may make the prompt payment issue somewhat less of an impact to the big guys, though I suspect they will still scream,” he says.

At least one “big guy” – Owens & Minor – opted not to comment on J&J’s decision for this article.

Wake-Up Call

“With distribution margins as tight as they are,” says Al Borchardt, president, Midland Medical Supply in Lincoln, Neb., “losing either a point or the number of days in which you can take the discount is a detriment to the distributor.”

Still, Borchardt is trying to seize opportunity from a potentially bad situation. Decisions such as J&J’s “force you as a distributor to look and see where you can become more efficient,” he says. “It’s an opportunity to look at your own business and do something about it, which is exactly what we’re doing.”

Borchardt also sees the reduction in the discount as a wake-up call. “As distributors, we have to inform our manufacturing partners and our customers about the value of distribution,” he says.

And distributors can recoup some of their losses, says Borchardt. “Today, differentiating oneself with value-added services and then charging for them is where we are.” And those value-added services go two ways – to the customer and to the manufacturer, he says.

HIDA President Matt Rowan blames shortcomings in the nation’s healthcare system for J&J’s actions.

“These types of issues aren’t unique to the supply community; they’re happening throughout the healthcare delivery system,” says Rowan. “It’s a symptom of a larger problem. Reimbursement rates to every sector of healthcare have been cut as the government and other payers use across-the-board reductions as a way to ‘manage’ healthcare costs. Legislators need to realize that the system is broken and that we cannot cut our way to success in healthcare.”

How Big an Impact?

Just how big an impact J&J’s decision will have on distributors is hard to tell. Some observers predict that distributors serving hospitals will feel the pinch more than those in the non-hospital market for two reasons. First, hospital suppliers’ margins are generally lower than their non-hospital counterparts. Second, hospitals demand more J&J products than providers in non-hospital settings, who are more open to alternatives.

But putting numbers to the industrywide impact isn’t easy. “Average [distributor] profitability is somewhere between 1.5 percent and 2 percent of sales,” says Bill Cron, professor of marketing at Texas Christian University in Fort Worth, who manages the annual HIDA Financial Survey. “A significant part of those profits can be attributed to early payment credits. I hesitate to say it will be a quarter of that, but it could be.

“The real fear is if [reductions in prompt pay discounts] go across the board,” continues Cron. In other words, if other manufacturers follow J&J’s lead, distributors could get hit hard. “I suspect that if J&J is doing it, others will at least look at it.”

If others do indeed follow J&J’s lead, the industry could see a replay of what happened the last time J&J lowered its discount, in 1995, predicts Grogan.

“It brought quite a bit of gnashing of teeth, initiating HIDA communiqués, white papers and angry responses from big distributors that formally explained customer price increases with J&J’s change of policy,” recalls Grogan.