Originally Published MX March 2001
Is healthcare too complicated for an Internet-based supply-chain solution? Here's what manufacturers should expect in 2001.
Flora Nguyen
To dot-com or not to dot-com, that is the question. With all that's happened in healthcare e-business in the past year, say the experts, medical device manufacturers should exercise extreme caution in forming alliances with e-commerce business-to-business (B2B) companies that promise to cut costs and drive out inefficiencies from the healthcare supply chain. The solutions that these companies offer aren't complete–at least not according to what was seen in 2000–and, as many device manufacturers have already realized, they're expensive. This article follows the rise and fall of the healthcare dot-com cavalry, using an e-healthcare B2B leader as an example, and examines what might be next on the horizon for medical device manufacturers seeking to make healthcare e-business work to their best advantage.
Dot-Com Devolution
The year 2000 was a manic period for healthcare e-business. It started out with a big bang. Wall Street had strong expectations for the e-healthcare supply-chain management business. After all, using the Internet to bring together buyers and sellers of medical equipment and supplies seemed to hold enormous long-term market opportunities. Not only did the Internet have the power to automate the existing paper-based process of the healthcare supply chain, but it could also reduce the extreme fragmentation among buyers and sellers of medical products and provide potential cost-savings benefits.
The first quarter of 2000 gave rise to more than 30 companies focused on developing Internet-based medical supply-chain solutions. The idea at work was to meet the different needs of all the constituencies in the healthcare sector. On-line marketplaces linking buyers and sellers directly in cyberspace would enable hospitals and physicians to save money on purchasing, not to mention afford manufacturers an opportunity to target a new, untapped customer base–all while simultaneously boosting stock prices with some Internet magic.
Projections for e-healthcare B2B sales skyrocketed and e-healthcare B2B stocks reacted accordingly. The combined market capitalization for three such companies–Neoforma (San Jose), SciQuest (Morrisville, NC), and Ventro Corp. (Mountain View, CA)–reached $15.1 billion in February 2000. At that price, these three stocks were valued at nearly 100 times the estimated $165 million in combined revenue they generated in 2000.
With on-line marketplaces being hailed as the next business boom, even the stodgy brick-and-mortar medical device companies were finally catching on. By early spring of 2000, some of the biggest names in medical devices were announcing plans to join forces with industry rivals to build marketplace after marketplace (see sidebar, page 76).
Since the second quarter of 2000, however, enthusiasm for the e-healthcare B2B arena has cooled for a number of reasons. First, there came a change in valuation models on Wall Street after first-quarter earnings reports. As Richard Wagner, research analyst at the Rainbow Fund (Los Angeles), explains, "Because tech-related valuations at that time were exorbitant by historical standards, the Federal Reserve cited inflationary signs in the economy and switched to a tightening bias. The prospect of a government-induced slowdown darkened investor sentiment, and nervous investors logically went from evaluating companies based on their positions in the market to evaluating their revenue growth and then to evaluating their bottom lines." Needless to say, this stock market "correction" toppled not just e-healthcare B2B stocks, but e-commerce stocks altogether.
A second reason behind the e-healthcare B2B decline was the realization that building and operating on-line marketplaces was much more difficult than anyone had imagined. As Carey L. Jennings, research analyst at Robertson Stephens (San Francisco) explains, "The expectation level was simply too high. E-healthcare companies quickly discovered that the relationship-driven system for sales and distribution of medical supplies and equipment was not easily replaced by nameless Internet connections, despite the cost savings." She adds, "The ability to build a critical mass of buyers and suppliers is dependent upon the adoption rate of e-commerce in healthcare, which is still slow in coming."
In addition, there are numerous requirements and regulations that medical device manufacturers must attend to before promoting or selling their products on the Internet, says Manoj Kenkare, research manager and senior analyst at Frost & Sullivan (Mountain View, CA). "Some companies have received warning letters for violating FDA and Federal Trade Commission requirements while promoting their medical devices," he notes.
Compounding the problem was the biggest hurdle of all, which no healthcare dot-com could overcome: medical device suppliers weren't too eager to watch their profit margins get hammered by the high transaction fees charged by e-commerce service providers. "Initial projections of transaction fees as high as 15% were unmet, as the actual contracts with suppliers were as low as 1%," says Wagner. "This simply did not generate sufficient revenue to meet the costs of operating an on-line marketplace."
And finally, there was the fact that it cost more to build and operate the marketplaces than initially expected. According to Jennings, "Getting things up and running on-line meant having to upload all the product information provided by the suppliers, which turned out to be very costly." Companies operating on-line marketplaces therefore found themselves in a squeeze, generating lower-than-expected revenues while facing costs that were higher than originally anticipated. Such a realization resulted in massive shutdowns of healthcare dot-coms and a good deal of downsizing across the board (see sidebar, above).
The Ventro Story
Ah, how the mighty have fallen. Let's look again at Ventro Corp., a one-time builder and operator of B2B e-commerce companies whose marquee marketplaces, Chemdex and Promedix, were rooted in healthcare. Chemdex brought buyers and suppliers together in the life sciences industry, while Promedix served the specialty medical equipment market. Back in March 2000, Ventro's share price soared to $243.50. Today, however, the company is experiencing its true value. Transaction volume from Chemdex and Promedix rose less than 1% to $29.3 million during the third quarter of 2000, compared with $29.1 million in the second quarter. In addition, Ventro's gross profits of $1.4 million for the third quarter were down 22% from $1.8 million in the second quarter. A year of poor quarterly performances, a questionable turnaround strategy, and the recent shutdown of both Chemdex and Promedix have investors and analysts scratching their heads. On December 22, 2000, Ventro's stock hit a new 52-week low of $0.59. As of press time, the stock was trading for less than $2 per share.
This turn of events resulted from the fact that continued disappointing revenues from the Chemdex and Promedix marketplaces had failed to live up to Ventro's expectations. However, instead of hunkering down and strengthening their relationships with medical equipment suppliers to bolster the e-commerce adoption rate, Ventro jumped ship. In October 2000, the company hired a strategic advisor to sell both Chemdex and Promedix, but was unable to find any buyers. Then in December 2000, the company's board of directors determined that "it was in the best interest of shareholders to shut down both Chemdex and Promedix in an orderly manner." While the company had previously positioned itself as an operator of wholly owned B2B marketplaces, Ventro CEO David Perry was confident that "transitioning the Ventro model toward the core of our capabilities as a marketplace service provider" would eventually lead the company down the path to profitability. In other words, if at first you don't succeed, rewrite that business plan–and fast!
The question, really, is, "What happened here?" According to Eric Upin, managing director and senior research analyst at Robertson Stephens, this intense devaluation stems directly from Ventro's "unclear strategy and business plan moving forward." To address the issue of what went wrong with Ventro, we first need to look at the company's constantly changing business model. (see figure 1)
In the Beginning, There Was Chemdex
Before Ventro ever entered the picture, there was Chemdex, an early-stage effort to transform the fragmented healthcare supply-chain management business through B2B e-commerce. Chemdex, launched in September 1997, was the first vertical marketplace ever to receive venture capital funding. The company quickly established itself as the B2B e-commerce leader for life sciences research. And that description doesn't even begin to cover it. Even now, after its shutdown, it's hard to talk about healthcare e-commerce without making some sort of reference to Chemdex. It was, after all, the first on-line exchange to offer evidence of how Internet-based solutions could be used to streamline the fragmented marketplace for the life sciences industry.
We'll Take Promedix, to Start. The ability to win the confidence of all your investors translates into big bucks. Chemdex's July 1999 initial public offering raised $112 million. It was time for the company to enhance its position in the life sciences industry by expanding into medical devices. The first public evidence of Chemdex's new direction came in September 1999, when the company announced its plans to acquire Promedix, an on-line marketplace trading in specialty medical equipment and supplies, in a stock-for-stock deal valued at $385 million. Following the announcement, Chemdex's stock jumped 21% to $27.63, raising the company's market value to $878 million.
"This acquisition is part of a broader effort to leverage the Chemdex technology platform and acquire a company with really deep industry-specific expertise and a complementary business model," said Robin Abrams, chief operating officer of Chemdex.
And, indeed, the Promedix acquisition gave Chemdex the edge it needed. At the time of acquisition, the Promedix Web site was up and running, offering 260,000 products from 500 suppliers.
More, More, More! It was at this point, however, that Chemdex started to get in over its head. The company burned through every last investor dollar in making its move to establish itself as the dominant player not just in life sciences research, but in the entire healthcare sector. In December 1999, Chemdex revealed plans to acquire SpecialtyMD.com, an Internet information search-and-retrieval service designed specifically for physicians. On the same day, Chemdex announced its intent to join forces with Tenet Healthcare Corp. (Santa Barbara, CA) in forming Broadlane, a company focused on developing B2B solutions spanning the healthcare sector as a whole. Tenet brought to the venture its group purchasing organization (GPO), which handled procurements for more than 1000 medical facilities and nearly 45,000 physicians.
Does it sound a bit like Chemdex thought it could corner the market for vertical on-line exchanges? Following establishment of its joint venture with Tenet, Perry stated, "Through the acquisition of Promedix, we first entered the specialty medical products market. Now, through the joint venture with Tenet, we're entering into the higher-volume-commodity healthcare products segment. Those two companies together will offer a complete purchasing solution for hospitals and other medical providers."
The Birth of Ventro
Certainly one of Chemdex's greatest assets was its impressive architecture in terms of infrastructure, software, services, and vertical layers. The Chemdex marketplace alone boasted more than 2.3 million life sciences products, and its system was able to process as many as 20,000 orders per day. With more than $50 million invested in both technology and intellectual capital, Perry saw the opportunity to leverage the company's assets in developing vertical on-line exchanges for other fragmented markets. And so Chemdex's drive to grow gave rise to Ventro, a powerhouse company created to capitalize on high-potential vertical markets within the broader B2B e-commerce industry. Ventro was to incorporate all of the existing operations of Chemdex, Promedix, and SpecialtyMD, each with its own industry-specific management team.
That's when things really sped up. From January to August 2000, Ventro launched three additional marketplaces–Industria Solutions, Amphire Solutions, and MarketMile–all of which, like Broadlane, were the results of joint ventures with industry partners. Some analysts have suggested that Ventro may have spread itself too thin by launching three marketplaces within such a short time period.
In October 2000, Eric Upin said that Ventro "has not yet provided details in terms of the strategy, business model, financial projections, or organizational structure." Beginning in July 1999, Upin downgraded the stock twice, citing "continued disappointing results, a major reorganization in process, and lack of visibility moving forward." In November 2000, he predicted losses through the end of 2001.
Beyond Chemdex and Promedix
Ventro's stakes in Industria Solutions, which offers e-procurement for the global fluid-processing industry, and Amphire Solutions, a B2B e-commerce company addressing the needs of the food service industry, are 49.7% each. The company's equities in Broadlane, its joint venture with Tenet, and MarketMile, an e-commerce sourcing solution for everyday business products and services, are 19% and 35%, respectively. Ventro's partners own the rest.
Decreasing its equity stake in its marketplaces over time has served Ventro well. According to Melissa Gisler, director of public relations at Ventro, "Our joint ventures with industry partners have proven to be very successful. Broadlane currently has more transactions flowing through its Web site than both Chemdex and Promedix combined."
What Gisler is alluding to is that in the New Economy, Old Economy players are still very much present and necessary. Nevertheless, you have to hand it to Ventro for recognizing that fact more than a year ago, while other e-commerce start-ups steamrolled their way into bankruptcy.
Ventro's first lesson, then, was the recognition that equity in its marketplaces–at least in the case of its four joint ventures–must benefit its industry partners, because in the end those partners remain integral to bringing in business. And yet it's difficult to overlook the fact that enlightenment on the subject of partnering arrived a bit late in the case of Chemdex and Promedix.
In October 2000, Ventro retained a financial advisor to explore alternatives for Chemdex and Promedix, including sale or strategic partnerships. Two months passed, and still there were no takers. Finally, on December 6, 2000, Ventro announced that it was shutting down both the Chemdex and Promedix marketplaces. Promedix officially shut down on January 5, 2001. Chemdex is scheduled to close on March 31.
What Went Wrong?
According to Eric Upin, Ventro faced the same dilemmas that triggered the healthcare dot-com devolution. In his report dated December 29, 2000, Upin stated, "Investors have realized that in order for healthcare e-business companies to automate business processes beyond the four walls of the enterprise, they must first build the infrastructure to enable communication among themselves, their buyers, and their suppliers."1 Ventro was never able to accomplish such a feat. Upin attributed this failure to "the company's struggle with slower-than-expected adoption by manufacturers, a transaction-dependent revenue model, and massive competition from traditional suppliers and distributors, industry players with their own purchasing solutions, and other on-line marketplaces."2
Slow Adoption. What does all this mean? First, Ventro overestimated its ability to promote adoption of e-commerce in the healthcare sector. "Middlemen are important in healthcare," says Jennings of Robertson Stephens. "E-healthcare B2B companies were expecting that manufacturers would throw entrenched relationships with their distributors out the window so they could join the dot-com revolution. We haven't seen it happen, and we're not likely to anytime soon."
It certainly didn't happen for Chemdex and Promedix. Ventro learned fast that breaking up existing relationships between medical device sales representatives and hospitals, physicians, and research scientists is hard to do. As Wagner of the Rainbow Fund explains, "Sales reps have committed years to developing their customer relationships. I can't imagine the Internet will be able to replace such an investment."
Low Profit Margins. In order to get suppliers to participate, Ventro lowered transaction fees to as little as 0.5% and suffered financially. "Ventro reported a disappointing third quarter, with revenues of $28.7 million, 9% below our estimate and up only 14% sequentially," said Mary Meeker, research analyst at Morgan Stanley Dean Witter (New York City) in her report dated October 30, 2000.3 "Most exchanges like Ventro that are planning to survive off trading volume are in for a rude awakening, and transaction prices get squeezed for simple order matching." She was right–Chemdex had gross margins of only 4% in the third quarter, which made for unhappy investors, and flat transaction volumes, which made for unhappy suppliers. Eileen Skaletsky, president of QED Bioscience Inc. (San Diego), notes, "I don't believe we ever received any sales leads as a result of being listed with Chemdex. We are listed with a few other Web-based exchanges, such as SciQuest, LabVelocity, and BioSpace, but these have also been underwhelming in terms of sales."
Difficulty of Integration. The biggest challenge that Ventro had to overcome was the problem of integrating the supply and the demand chains. "To get started quickly, Chemdex and Promedix simply loaded their supplier lists into a directory with no detailed product description, availability information, or fulfillment capabilities," said Meeker.4 "But buyers demand to know more about the supplier as the importance and amount of the purchase grows. This process will take longer than anyone thinks–someone has to provide the technical integration services." She continued to say that most catalogs provided by suppliers "contain numerous, inconsistent abbreviations and choppy descriptions. Additionally, the catalogs are full of errors that have mounted over the years–different units of measure or obsolete products. Before they can be moved on-line, they usually need major manual conversion work along with a technology upgrade."
Apparently, the process took longer than Ventro was willing to wait. The company branched out into other fragmented industries in hopes of generating revenues. "The technology investment was so high that we had to be able to leverage that cost across multiple markets in order to gain profitability," says Gisler of Ventro. When that failed, the company remodeled itself as a service provider instead of a marketplace operator.
Conclusion
Currently, many in industry are gloating at the failures of e-healthcare supply-chain solutions offered by industry outsiders such as Ventro. But the fact still stands that the Internet will continue to play an increasing role in the way medical device manufacturers do business. According to Manoj Kenkare of Frost & Sullivan, "In 1999, the U.S. medical device industry generated revenues of approximately $40 billion. The industry is expected to reach a market size of $57 billion by 2004, representing a compound annual growth rate of 7.5% for the forecast period from 1999 to 2004. Currently, a small percentage of transactions occur via the Internet. However, by 2004 approximately 23% of total manufacturer revenues are expected to come from Internet transactions. Total e-commerce revenues are expected to make up 52% of manufacturers' revenues in 2004."5
Even if Kenkare's projections are optimistic, the figures show that healthcare e-business is here to stay. Companies like Ventro are fine-tuning their business models as e-healthcare evolves and turning to industry partners to begin the next step in the ongoing search for solutions that provide meaningful return on investment, deepen customer relationships, expand distribution channels, reduce costs, and streamline complex processes.
But perhaps manufacturers will find a viable alternative to the services offered by companies like Ventro in the new crop of industry-led consortia (see sidebar, at end of article). According to Cheryl Flury, director of marketing for the Global Healthcare Exchange (GHX; Westminster, CO), "The most difficult parts of running an on-line exchange have to do with connectivity and standardization and of product information across the supply chain and the demand chain. We think we've solved both problems." GHX is currently working on a mapping system that will provide a common product code on both the supplier and the buyer side and will work to connect disparate systems without modifications to existing product codes. As for product breadth, Flury comments, "GHX is committed to offering our buyers the widest range of products possible. We currently have 75 suppliers and offer 80–85% of all healthcare products sold in the United States, and that number will continue to grow."
What seems most promising about GHX, however, is that the company doesn't charge transaction fees. Instead, suppliers sign on and pay a flat subscription fee, regardless of how many purchases are made. That should be a bit of a relief for device manufacturers.
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Trouble Brewing . . . Chemdex and Promedix aren't the only dot-coms that have been affected by massive corporate restructuring across the B2B sector. Many e-health companies are facing imminent shutdown due to dwindling revenues and lack of sequential quarterly sales growth, and others are adapting their business plans to suit market needs. Here is a short status report on how a few of the healthcare dot-coms have performed thus far.
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Industry Seizes the Reins Despite the steep losses reported by healthcare dot-coms throughout 2000, two consortia boasting some of the biggest names in medical devices and drug wholesalers have now jumped on the Internet bandwagon, vowing to build their own on-line supply-chain solutions. The first of these consortia, The Global Healthcare Exchange (GHX; Westminster, CO), was formed in spring 2000 by five of the largest global healthcare companies–Johnson & Johnson (New Brunswick, NJ), GE Medical Systems (San Ramon, CA), Baxter International Inc. (Deerfield, IL), Abbott Laboratories (Abbott Park, IL), and Medtronic Inc. (Minneapolis). GHX offers customer-directed distribution, inquiry of order status, order confirmation, product catalogs, and access to correct contract terms–all on-line. To date, 75 suppliers have joined the exchange, with the ongoing addition of other healthcare organizations, including manufacturers, group purchasing organizations, distributors, and hospital systems. The spring of 2000 also gave rise to the New Health Exchange (NHX, Minneapolis), created by major medical technology distributors to enhance healthcare supply-chain efficiency. Among the founders of NHX are McKesson HBOC (San Francisco), Cardinal Health Inc. (Dublin, OH), AmeriSource Health Corp. (Malvern, PA), and Fisher Scientific International (Hampton, NH)–four wholesalers with combined annual revenues of $65 billion. Expected to launch in spring 2001, NHX claims that it is a commercially neutral body that will serve as a point of convergence for healthcare product and contract information. |
REFERENCES
1.* Federal Register, Part VII, Department of Health
and Human Services, FDA, 21 CFR, Parts 808, 812 and 820 Medical Devices; Current
Good Manufacturing Practices (CGMP); Final Rule, Monday October 7, 1996, V.13
p. 52607. 1. E Upin, "B2B E-Commerce Update," in The Web Report [on-line]
(San Francisco: Robertson Stephens, 2000 [cited 29 December 2000]); available
from Internet: http://www.myresearch.com/prod/CGIBIN/result.exe/
Use=RSCO/5385743.pdf.
2. E Upin, B2B September Quarter Review [on-line] (San Francisco: Robertson
Stephens, 2000 [cited 13 November 2000]); available from Internet: http://www.myresearch.com/prod/CGIBIN/result.exe/
Use=RSCO/ 5193055.pdf.
3. M Meeker, "Strategy Evolving . . . Again . . ." [Ventro Corp., equity
research report] (New York: Morgan Stanley Dean Witter, October 30, 2000).
4. M Meeker and C Phillips, "The B2B Internet Report: Collaborative Commerce"
[on-line] (New York: Morgan Stanley Dean Witter, 2000 [cited April 2000]); available
from Internet: http://www.msdw.com/institutional/eInterpriseSoftware/
b2breport/b2b_internet_report.pdf.
5. M Kenkare, "Impact of Internet on Medical Devices" [report #5592-54]
(Mountain View, CA: Frost & Sullivan, June 19, 2000).
Flora Nguyen is assistant editor of MX.
Copyright ©2001 MX
