Consolidation of x-ray distributors continues as large purchasers demand wider attention

February 4, 1998

PSS hopes to build a distribution arm to compete with Picker HCPMedical equipment OEMs aren't the only imaging companies being affected by increased group purchasing and the transition toward filmless x-ray. These two trends are also having an

PSS hopes to build a distribution arm to compete with Picker HCP

Medical equipment OEMs aren't the only imaging companies being affected by increased group purchasing and the transition toward filmless x-ray. These two trends are also having an impact on the dealer/distributor industry, which for years has consisted of small regional players selling consumables like film, contrast media, and chemistry to local hospitals.

Small mom-and-pop dealers are finding that their prospects are limited when faced with large GPOs and hospital chains that prefer national or regional distribution contracts. In addition, the future of film sales is questionable due to the arrival of digital technologies like PACS. Small x-ray dealers focused primarily on consumables must either cash out of the business or increase their equipment sales and service, finding shelter in relatively low-volume, high-margin products and a comfortable local-service niche.

The pace of consolidation in medical imaging distribution has picked up over the past two to three years and should continue briskly in 1998, according to industry participants. Over the long run, however, consolidation may slow as weaker players fall by the wayside and a core group of independents sticks it out. The technical and service requirements of medical imaging, compared with more commodity-based healthcare markets like medical-surgical (medsurg) supplies for private-office physicians, should leave room for some smaller players.

"I don't think this (consolidation) is going to go on forever," said Jerry Cirino, vice president and general manager for Picker International's Health Care Products division in Cleveland. "While we may not see two dealers (remaining) as in medsurg, over the next 12 months I think a significant number of independent (imaging) dealers will either sell their businesses, simply walk away, or narrow their scope substantially."

A fragmented industry. The historical trend in x-ray distribution has not always been toward consolidation, according to Edward Mullin, president of Centura X-ray of Cleveland and chairman of the imaging market group of the Health Industry Distributors Association. Twenty-five years ago, most major multimodality imaging equipment vendors also sold film supplies and accessories, dominating the field. Eastman Kodak and Du Pont were the two companies that dominated x-ray film manufacturing in the U.S.

After the major equipment vendors decided that profit margins for film and accessories were too low, however, most left the field. Of the major multimodality OEMs, Picker has been the most active medical imaging, film, and accessories distributor, although GE and Siemens have reentered the industry by launching accessories businesses in recent years.

Independent distributors filled in the gap left by the departure of the OEMs. For some years, they made a comfortable living despite tight margins, Mullin said. But this changed when competition in film supply heated up. Foreign suppliers, such as Fuji, Agfa, and Konica, began to take market share from Kodak and Du Pont. Film discounting intensified and unit profit margins shrank even further. Multiple dealerships sprung up in the same markets to carry the different brands.

Imaging distribution was thus a fragmented and intensely competitive industry when it was hit earlier this decade by a surge in consolidation among its hospital customers, which led to even more price competition. Hospital chains and managed- healthcare providers were buying in volume and demanding reduced prices from their suppliers. Purchasing decisions for x-ray film and other imaging suppliers were pushed up from the individual hospital to regional network offices, and, ultimately, national accounts.

"Now there is not a hospital of any size that isn't affiliated with somebody on a national accounts basis," Mullin said. "The majority of film is now controlled by national accounts."

Volume purchasing of film has driven market prices down further. Net profit margins for x-ray film are now around 1.3% to 1.75% of sales, he said. If a dealer has some equipment and service income, overall profit margins might rise to 4% or 5%.

Kodak reacted to the healthcare consolidation trend by initiating a reduction and rationalization of its dealer network two years ago (SCAN 2/14/96). The idea was to rely on dealers large and sophisticated enough to meet the needs of higher level purchasers, said John Bosek, channel marketing manager for the U.S. for Kodak's Health Imaging division. The number of Kodak dealers in the U.S. was reduced from several hundred to less than 100.

"Those customers who consolidate into national or regional organizations look for a supplier who can cover their geography," Bosek said.

In addition to geographical reach, large multihospital customers are looking for distributors who can provide a high level of technical support, in terms of both well-trained service technicians and business systems such as just-in-time inventory techniques, he said. Some independent distributors who decide to join larger organizations are seeking a way to gain a level of sophistication and infrastructure that they feel hard-pressed to provide on their own.

In addition to its national reach, Picker is also a pioneer in the provision of electronic data interchange (EDI) services for accepting and processing orders. This type of electronic commerce provides efficiencies and savings to those hospitals that chose to use the system, Cirino said.

Picker's Health Care Products division anticipates breaking the $500 million level in revenue for fiscal 1998, according to Cirino. Despite a sluggish overall market, the company has grown to record levels in each of the last three years.

"We can't change the market trend of less film or less chemistry, but we can pursue strategies designed to increase the share we get," Cirino said. "We have been able to do that."

But Picker is not the only force behind industry consolidation. Several new players are entering the scene. As weak dealers and distributors are winnowed out, the ones that can compete for a larger share of the market pie are prospering.

The rise of PSS. The most aggressive new competitor in the medical imaging distribution field is Physician Sales and Service (PSS) of Jacksonville, FL, through its subsidiary Diagnostic Imaging. PSS was an aggressive consolidator in the medsurg market, and hopes to repeat that performance in medical imaging, said Patrick Kelly, chairman and CEO.

"PSS was able to sustain a growth rate of over 40% a year for over 14 years," he said. "Then we got this national scope in the physician market and we saw our internal growth (drop to) around 20%, so we started seeking another opportunity. We felt we had some core competencies in our business model that could move over to other segments of healthcare distribution. We want to sustain a growth rate of 30% a year and must develop one or more other channels of distribution to be able to do that."

PSS made a dramatic jump into leadership of the supply business for long-term healthcare by agreeing in December to purchase Gulf South Medical Supply of Jackson, MS, through a stock-swap deal valued at $685 million (SCAN 12/17/97).

The company's road to a larger role in medical imaging distribution, on the other hand, started smaller and must still grow to a national presence. The first step came with its acquisition of Diagnostic Imaging in May of 1996. Diagnostic Imaging had been formed less than a year before by the merger of King X-ray of Jacksonville and three other independent distributors. Since then, the parent has been financing acquisitions to add to its imaging subsidiary. Last September, PSS acquired S&W X-ray of Rochester, NY, a well-established distributor. In November, it purchased a smaller distributor, A&W of Tallahassee, FL. Diagnostic Imaging is operating at an estimated annual revenue run rate of $360 million to $380 million, according to chief executive officer Gene Dell.

PSS has found the medical imaging field to have narrower profit margins than the medsurg physician distribution business, Dell said. But the company expects to repeat a successful strategy to boost profitability. Central to that strategy is achieving national status. Diagnostic Imaging functions in 12 states.

In the medsurg market, PSS was able to develop exclusive contracts with manufacturers, particularly in the physician laboratory testing segment, transferring these suppliers over from direct sales to use of its national distribution network.

"In the imaging industry, the same can happen once you have national channel coverage," Dell said. "This enables you to bring more value to vendors and customers and hopefully more profit for us."

Another PSS strategy is to move the distribution businesses it acquires from a heavy reliance on film and contrast sales to a focus on high-technology equipment, Kelly said. The average imaging distribution company acquired by PSS has had only 6% of its sales in equipment. That figure has been raised to 13%, and the company's goal is to reach 20% equipment sales.

The impact of digital technology. Over the long run, equipment will become an increasingly important part of the diagnostic imaging business as digital technology begins to take hold, Kelly said. While the shift from film may not be immediate, distributors positioned to supply national service for digital x-ray technology will be best placed to survive and thrive. This new orientation could also dovetail with the plans of some OEMs. For example, one digital x-ray developer, Swissray International, plans to rely on dealers for product distribution in more remote areas of the U.S. (SCAN 1/21/98).

Film isn't going to go away any time soon, however, said Lawrence Pegram, general manager of the X-ray Marketing Association (XMA) of Romeoville, IL. When a new generation of radiologists preferring the technology comes on the scene, the shift will begin to take hold, he predicted, but there will still be small hospitals who can't afford the new digital systems and will stick with film, unless the evolution of technology drastically reduces the price of these new digital systems.

XMA is a for-profit purchasing organization with about 80 independent x-ray distributor members. The group focuses on volume purchases of advanced technology products for its members, according to Mullin, whose company is a member.

Another grouping of larger imaging distributors is National Healthcare Distributors (NHD) of Cleveland, which has about 18 members. This group was formed to solicit some of the emerging national accounts business from large healthcare customers, according to Mullin. It can be considered a competitor with Picker and Diagnostic Imaging in its creation of a widespread distribution network.

Another distributor growing through acquisition is Merry X-ray of San Diego. In addition, two medium-sized distributors in the Northeast, E.M. Parker of Wilmington, MA, and Standard Medical Imaging of Columbia, MD, are nearing completion of a merger that should result in a distribution company with annual revenue of between $150 million and $175 million, according to Roger Norden, Standard president. Norden is also a member of the board of directors of NHD.

The combined company will likely focus its growth on the Northeast at first, since it seems that the trend to large national purchasing groups may be slowing somewhat, he said.

There seems to be a high level of interest among the owners of small x-ray companies in selling their businesses. Standard gets about one call a week from companies having no more than $2 million in annual sales who are looking for a buyer, Norden said. The problem is that the value of these small independents is decreasing as market conditions tighten. A second concern is that their value is usually dependent on the principal owner. If the principal leaves, the value of the acquisition can plummet.

Not all independents are eager to sell out. Mullin has seen two competing distributors in his Cleveland area, Marmer X-ray and Metzger, bought out by Picker. He is not eager to surrender his control and risk the future of employees at Centura
X-ray by selling out to a larger concern, Mullin said.

"It is not so much that I wouldn't mind being a multimillionaire, but I would have trouble if I was made a multimillionaire at everybody else's expense," he said.