Abbott Spins Off its Hospital Products Group--and Then There Were None

Abbott's announced spin-off of its hospital supply business suggests once and for all that a key medical device model of the 1980s is now dead. At the same time, it creates an enormous company with significant resources.

Twenty years ago, the medical device industry was largely a hospital supply business and that hospital supply business was dominated by a pantheon of large companies—American Hospital Supply Corp., Johnson & Johnson , and Abbott Laboratories Inc. —all of whom sold a broad array of hospital-based products through advanced marketing and distribution networks. Other suppliers, including Becton, Dickinson & Co., CR Bard Inc. , Kendall, and Sherwood Medical, the last two now part of Tyco International Ltd. , endorsed the model, if they didn't copy it outright, by making distribution and channel management a critical priority. More importantly, virtually all saw a broad-based approach to hospital supply as crucial.

The announcement that Abbott is spinning off its hospital products group (HPG) represents the final bell tolling for such a strategy, if anyone needed a reminder that this once all-embracing vision is dead. Over the past 15 years or so, virtually all of the companies that ruled hospital supply have either disappeared or gone in other directions. The problem: after a decade and a half of giving customers what they were asking for—more products at lower prices—businesses like Abbott HPG found themselves in financially precarious positions.

Indeed, if anything, Abbott HPG played the game too well. The relentless price and margin pressures that came with national contracting ultimately proved nearly as damaging to those companies that won in hospital supply—those who used contracting to gain substantial market share positions—as those who were shut out of the market because of their inability to win such contracts. The fact that, over the same time period, a new generation of high tech devices came to dominate and define the medical device business only underscored how unfortunate, in retrospect, the hospital supply strategy was. American Hospital Supply was taken over by Baxter International Inc. in the mid-1980s; unable to digest it, Baxter spun it off as Allegiance Corp. , which was later acquired by Cardinal Health Inc. [See Deal]

The key to success in medical devices today is to sell to doctors, not hospitals. Abbott thus isn't abandoning medical devices—it's keeping and apparently building on its initiatives in interventional cardiology and spine/orthopedics, as its recent deals to acquire Spinal Concepts Inc. [See Deal] and parts of Jomed NV [See Deal] suggest.

Baxter is re-positioning itself as a biotech company, while Abbott is looking more like a drug company everyday. Even J&J, the most diversified of the former hospital supply giants, has eschewed the low margin commodity items that once played a central role in its strategy in favor of high tech device plays such as interventional cardiology, orthopedics, and some surgical specialties.

Indeed, the spin-off aims precisely at divesting all of Abbott's remaining low-margin product lines—segments like the Ross nutritionals and its dialysis businesses, the most profitable lines in the former HPG, will remain with Abbott.

That's not to say that the spin-off doesn't have promise as a stand-alone company. The new company will have HPG's IV solutions and sets business, a co-leader with Baxter, as well as a robust small volume parenteral and injectable generics operation. (Abbott is a worldwide leader in pre-mixed solutions and drug-filled syringes.) Abbott is also a major OEM supplier for the pharmaceutical industry, and there's a miscellany of other critical-care and related product lines, featuring suction catheters, thermo-dilution catheters, and needleless safety products. In total, the new company accounted for around $2.5 billion of Abbott's sales this year, generating $300 million in profits and employing 14,000 people. That's a major company by any reckoning.

It's possible that all or some of the spun-off businesses could eventually find an acquirer—one logical candidate is B. Braun Medical Inc. , a division of B. Braun Melsungen AG , which would benefit considerably from the acquisition of a major market-share position in IV solutions and sets. But there are those who believe that the new company will do fine on its own, notwithstanding its low-margin, commodity line profile. The injectable generics business, for example, generates significant revenues, particularly in the first couple of years after a new generic product's launch. Says one industry executive, "If you have a strong market position, you can get tremendous economies of scale." There's also the company's leading IV solutions and sets line. "That may be a commodity business by now," this executive goes on, "but it's not going away. Those products have great staying power; it's a nice annuity."

As a standalone company, the move positions the spin-off to be one of the few companies--Tyco is the best example--trying to build a business in low margin commodity lines. Other players in a similar space, including Braun and Becton Dickinson, have artfully tried to get around the inherent and unspoken limitations of a commodity-based business by redefining themselves as, for example, fluid management companies. Still, one question that surrounds the spun-off HPG is whether the new firm

represents a cohesive company rather than a group of products unrelated save for their low-tech, low-margin profile.

That's why some industry observers believe that rather than being an acquisition target, the new company could be an acquirer. Noting the $300 million in revenue HPG spins off today, one executive notes, "They'll be able to do more on their own because they'll have the dollars to buy some additional pieces that fit. Under Abbott, investing in HPG was never a high priority."

Indeed, enthusiasts for the deal discount criticism that the spin-off is merely a kind of addition by subtraction for Abbott—enhancing the parent company's stock by getting rid of all of its low-margin business. They believe a spin-off will allow HPG to compete more effectively and aggressively against other hospital suppliers, without having to live up to the profitability demands or expectations of its parent organization. "I think, if anything, the businesses are better positioned to survive as a spin-off than as part of Abbott," says another industry executive.

Executives who know Abbott say one major unresolved issue will be how much the spin-off will affect the company's strong Abbott International business. Reports are that Abbott will be keeping its AI unit, though the business sells a lot of the to-be-spun-off product lines through its various country units. How the two companies will divide or split off those products that will be part of the HPG spin-off remains to be decided.

Another major issue: as part of its 1980s hospital supply strategy, Abbott had built a large, internal distribution infrastructure through which to bring its products to market. Even today, HPG owns five large regional distribution centers and a large number of public warehouses. Early indications are that the spin-off intends to keep at least one large distribution center. But with prices and margins on commodity supplies beaten low and with hospital customers increasingly wanting to concentrate distribution through a single channel, HPG's independent and redundant distribution capability may be simply too expensive to sustain, forcing the company to begin to sell through national hospital distributors such as Owens & Minor Inc. or McKesson Corp. Says this industry executive, "Will commodity-oriented companies want to do distribution the way Abbott set up their system? Probably not."