But those uncomfortable side effects are simply a byproduct of industry evolution, whether consolidation, acquisition or changes in the way products get from Point A to Point B.
R. David Yost, CEO of AmerisourceBergen Corp., knows that short-term pain is generally a prerequisite for long-term success. As head of one of the “big three” pharmaceutical distributors, Yost’s responsibilities in steering a $50 billion corporation extend beyond his own balance sheet. Many times, this means working through operational cramps for the sake of the industry’s future health.
“When you have a consolidated industry with three players that heavily influence what goes on and you are one of those three, you really do have to take an industry perspective,” Yost says.
Consider the fee-for-service distribution model, a supply chain shift from traditional buy-and-hold to a system in which manufacturers pay distributors for their logistics services. For Yost, the model means more data-sharing between the two players, more cooperation and inventory reduction. These efficiencies, he says, add up in a “pennies business” such as pharmaceuticals, where even the top players scrape less than 2 percent from every dollar in sales.
“But if we had been focused on the short term and worried about quarter-to-quarter results, the fee-for-service model would not be attractive,” says Yost.
While converting manufacturer contracts to fee-for-service, distributors often provide the services (logistics, for example) before collecting the fees. And, as with any change, the shift to a new supply model meant buffering services, personnel and distribution centers. Indeed, admits Yost, the short-term can bruise a business.
But it’s the long term that Yost has set his sights on. And already, fee-for-service has produced the strongest balance sheet in AmerisourceBergen’s history, with a record operating cash flow of $1.25 billion through the third quarter of 2005.
Yost, a 30-year industry veteran, has watched the pharmaceutical industry roll up into a three-player arena where the profit stakes are high, cost pressures are tense and today’s magic pill is not any one product. In the cut-throat, constantly consolidating pharmaceutical industry, Yost maintains that sustainability is attained only through offering service.
“Clearly, the market has progressed past having the right product and the right place and the right time,” he says. “Our customers are looking for far more than that. They want us to help them run their businesses better.”
Change in the chain
“Ten years ago, the manufacturers looked at us as a distributor, not a business partner,” Yost says, highlighting what he believes has been the greatest change in the pharmaceutical supply chain since his first job in the industry in 1974 at Kauffman-Lattimer, an AmeriSource Health predecessor company. “Today, that relationship changed dramatically.”
Even one year ago, distributors didn’t share data with suppliers to offer perspective on how products diffuse into the marketplace. Manufacturers didn’t openly discuss how much product was available to distributors. Neither collaborated or traded notes on the best way to expedite drugs to the right place at the right time at the right price, Yost says.
The system was one of buy and hold. Distributors stockpiled inventory and contained large volumes in their distribution centers.
“You bought as much product as you could afford, with the understanding that it would eventually go up in price,” Yost says. “That environment was a trade mentality a commodity issue. The key to success in the buy-and-hold model was capital.”
This traditional distribution model wasn’t lucrative for AmerisourceBergen, which was “capital constrained,” Yost says. “In that situation, the person with the biggest balance sheet wins, and that was not so good for us.”
What is better is the fee-for-service model, which focuses on streamlining inventory. It also defines a more meaningful partnership between suppliers and distributors, encouraging sharing of information so both can work more efficiently.
“Fee-for-service is a lot more collaborative with our manufacturer partners and really highlights our working relationship,” Yost says.
But the move to that model hasn’t come without a cost. In the last year, Yost re-evaluated AmerisourceBergen’s human capital. While the number of employees about 14,000 didn’t change much, its composition did.
“Job skills have changed dramatically,” Yost says, pointing to a handful of key managers who spent years working for large pharmaceutical suppliers.
“Traditionally, the interface and procurement tasks were handled by people who came up through the ranks in distribution,” he says, noting that employees with supplier side experience let AmerisourceBergen strengthen its partnership with manufacturers by understanding and catering to their needs.
A combination of training existing employees and bringing in new talent has helped Yost build that solid platform for growth.
“When you go through change, you need people who are wiling to be creative,” he says. “We’ve been blessed by that.”
Meanwhile, Yost is buffering the company’s bricks-and-mortar foundation 32 distribution centers strong with an investment to construct six new $40 million distribution centers that are capable of at least $5 billion in product throughput per year.
“The fee-for-service model requires us to be more sophisticated in how we run our business because we are frequently encouraged by manufacturers to have high service levels and still maintain modest inventory compared to what we had before,” Yost says.
That modest inventory is where Yost is earning big returns for AmerisourceBergen. Reduced inventory frees up cash flow, and Yost’s moves have trimmed 22 days out of the company’s inventory in the last two years.
“One day is a big deal for us,” Yost says.
In fact, one day is $170 million.
For a company that does $50 billion per year, cutting out five days of inventory produces nearly another billion dollars in cash, Yost says. But reducing inventory allows for less wiggle room for inaccurate product predictions.
“Two years ago, we were running with 55 days of inventory, and today we run with 35 days,” he says. “When you run with 55 days and you make a mistake in terms of demand, you have a real cushion to make sure you don’t run out of product. When you have 35 days of inventory rather than 55, if you miss that demand curve, you can end up with service-level problems.”
An efficient distribution center requires quick response and sophisticated prediction measures to ensure that distributors don’t miss a beat. Estimating product demand is no easy task, Yost says. “It’s difficult to figure out when people will get the flu,” he says. “Our customers expect us to have that vaccine, and if you miss that need by a couple of weeks, you will be hustling.”
To balance the risk, AmerisourceBergen carries a large inventory of generic drugs, which, because they cost less, put less stress on the balance sheet.
The trick now is to work through the 12- to 18-month adoption period while AmerisourceBergen transitions manufacturer agreements. Yost expects the process to be complete by year-end. “It’s been painful,” Yost says, “because in some respects, we had to adapt to fee-for-service before we got the fees. But once we get through the transition, the industry will be a stronger place and so will AmerisourceBergen.”
Prescribing service solutions
Fee-for-service translates into lower fees and more services. Customers don’t just want products that fill prescriptions; more valuable are business-builders such as marketing tools, automation and continuing education, Yost says.
“The real key for us going forward is not necessarily the physical product but the services that surround that product,” he says. “If you look at us versus our two competitors, we are heavily involved in the specialty pharmaceuticals industry, which includes oncology, nephrology and plasma. But more importantly, we offer a lot of services to back those products.”
Generic products fulfill hospitals’ demands for lower-cost alternatives. Automation for prescription dispensing improves pharmacies’ efficiency and allows them to manage a higher demand with a small staff.
Consulting services educate physicians on new products, therapies and market trends. Smart packaging and barcode systems reduce medication errors.
Continuing education courses provide opportunities for professionals to earn certification credits. Marketing programs help pharmacies display and promote products.
“You have to listen to your customers, find out what their needs are and respond to them,” Yost says.
The Brand Advantage packaging program is one example of how the company works to improve chain pharmacy businesses. Designed to increase inventory control and reduce labor costs, customers can save up to 13 percent on branded pharmaceuticals. Through a color-coded labeling system, pharmacists can distinguish labels that look alike and products that sound alike. The system includes the Manufacturers National Drug Code for use by third-party billing and offers a returns policy that reduces the risk of being stuck with outdated product.
In other words, by partnering with a packaging company, AmerisourceBergen can pass more sophisticated technology to its customers and help their businesses run more efficiently. And of course, price always enters the picture.
“Our customers continue to have a lot of pressure in their businesses,” Yost says. “As a result, they look for us to continue to help them save money.”
With headlines highlighting rising prescription costs, end-users might suspect that pharmacies make a tidy profit on the drugs they sell.
Not so, Yost says.
“It’s important to note that people who dispense those pharmaceuticals hospitals, retail drug stores and physicians have seen their gross margins go down,” he says. “They get a small piece of [the profit].”
Accordingly, Yost figures scant profit margins and customers’ demand for cost-effective solutions into the company’s service package. By slimming down distribution and removing fat in operations and inventory, the company will deliver to customers a best-possible package buffered with add-on services, Yost says.
“We are looking to take additional basis points out, tenths and hundredths of a percent,” Yost says, pushing for more efficiency, more cost reduction. “It’s a pennies business,” he says.
Good medicine for growth
Regardless of economic pressures and fast-forward evolution in the pharmaceutical supply chain, Yost can’t imagine a better business.
“It has an excellent ‘ABC’ Circle of Life,” he says, referring to a company slug for the industry’s innate supply-demand cycle. “The older people get, the more drugs they take. The more drugs they take, the older they get. It’s hard to find an industry with those growth characteristics.
“Father Time is our friend, and the biggest product we will sell five years from now is not on the market yet. I don’t know what it will be. But that’s what makes this business exciting.”
The business is even more exciting when the balance sheet works in your favor. Last year, Yost retired $800 million of debt, bought back $900 million in stock and finished with more than $1 billion in cash flow, primarily from inventory reduction, compliments of fee-for-service.
He reflects on the days following the 2001 merger between AmeriSource Health Corp. (of which he was CEO) and Bergen Brunswig Corp. that created AmerisourceBergen, describing it as a “huge homerun for everyone involved,” although he admits that business arrangement posed the greatest challenge of his pharmaceutical career.
“Many people didn’t think that big consolidation would work,” Yost says.
Different cultures, East and West Coast, collided with two distribution businesses that shared space as industry giants but differed in their strengths. For example, AmeriSource Health didn’t dip into specialty pharmaceuticals before it connected with Bergen Brunswig. Today, AmerisourceBergen is the largest player in that sector, doing about $6.5 billion per year in what Yost believes will be an entry point for breakthrough drugs.
Even in the beginning, Yost thought big and broad.
“Four years later, I would give us significant marks for how we pulled off [the consolidation],” he says, adding that the sum of two large industry parts pulled him away from day-to-day duties into a more visionary management role.
“I spend time making sure I have the right people in the right spots and that we have people getting ready to go into those spots. You need the right people. That was true when I started in the business, and it is true today.”
Also true is Yost’s industry spirit, tireless and optimistic proud and always anxious to discover what innovative formula will change the way doctors treat patients and the way people will live, and live longer. Signs above doors in every distribution center read, “Thank you for what you do. People’s lives depend on it.”
“We are in an exciting channel where we do make a difference in the health, safety and longevity of people,” Yost says. “We supply products and services that literally make the difference in people’s lives for the better.”
HOW TO REACH: AmerisourceBergen Corp. (800) 829-3132 or http://www.amerisourcebergen.com