McKesson Corporation: Medline and US Rebate Pricing System

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I think we were discussing the whole contracting process with the IDNs and all that. But before we jump into that, I have a question. I was rereading our notes, and you mentioned it was a love-hate relationship with some of the brands. I'm curious to know if it was common for Medline to lose brands. Are there any relevant names that wouldn't work with you, and to what extent did that impact you, or was it not really significant?

Once we built up enough distribution volume and business through our contracting strategy and relationships, we started making inroads into larger health systems. By around 2016, Medline's market share had grown enough that companies could no longer claim Medline wasn't a real distributor. Now, nearly everyone distributes through Medline. The exception is still in the lab distribution space. In our first call, we discussed the different distribution sectors; here's med-surg distribution, there's pharmaceutical distribution and then there's yet another section, which is the laboratory and Cardinal and then Thermo Fisher are the market leaders in laboratory.

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Are there any brands that offer better terms to companies like Cardinal, McKesson, or other distributors? Since Medline is more aggressive with private label, does that affect your relationship with them, perhaps resulting in worse terms or less product availability?

Absolutely, it does. Those back-end funding and terms are never publicly disclosed, but from my experience, specialty reps from large companies often travel with their counterparts from Cardinal to make joint calls on customers. This doesn't happen as frequently with Medline. I'm confident, based on circumstantial evidence, that there are back-end funding and incentives going to Cardinal and Owens to compete against Medline. They're actively putting people on the ground to help with sales. Many companies, as Medline holds 60% market share, see it as a necessary evil. If you're distributing through Medline, they might eventually try to compete against your product. But with their significant market share, you don't have much choice. Most companies aren't putting much effort into working with Medline, and we see this more in other areas.

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What can be the difference in back-end funding agreements between what you have and what Cardinal might have? How significant is that for the account?

It's quite significant. While I don't know the specifics of what Cardinal negotiates with third parties, for companies that are Medline Platinum vendors, part of our preferred distribution program, the back-end funding can be as much as 5% to 7%. This is significant, especially with a decent volume. You might get cost plus one bulk distribution plus a 2.5% added fee, netting cost plus three and a half on the Medline side. If you can get seven points of funding below the line for selling that product, you have a 10.5% gross margin. You're profitable selling those products, and there are usually sales tracings and other fees on top. Medline could net 12% to 13% gross on distributing a preferred product, whereas a company offering only sales tracings and no back-end funding might result in Medline netting just 2% to 3%. It's a substantial difference. Medline's salesforce is highly incentivized through compensation. For preferred Platinum vendors, there are additional incentives, like a half-percent SPIFF or $500 SPIFF, to motivate collaboration.

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