PSS Redux--The Fall and Rise of a Physician Supply Company, Part II

After a meteoric rise through the late 1980s and early 1990s, PSS began to stumble badly, beginning with a difficult IPO in 1994 and culminating in a terminated acquisition offer in 2000. Having seen even its last hope--a face-saving merger--evaporate, PSS' senior managers had no choice but to try to turn the company around on their own. That's what they've done for the past eighteen months, with a strategy focusing on better financial controls, on the one hand, and a rededication to customer service, on the other.

After a meteoric climb through the mid 1990s, PSS's fall was almost as precipitous. Now, the company is trying to put things right again. The second of a two-part series.

by David Cassak

• After a series of mis-steps and a withdrawn offer to be acquired, physician supply leader PSS had nowhere to go but up.

• A new management team, led by some of the executives who were there when PSS stumbled, but reinforced by a number of seasoned outsiders, has put the company's financial house in order and restored discipline to its logistical systems and operations.

• In addition, the company has returned to the philosophy that made it a leader in the first place: a strong customer focus, particularly in its SRx and Answers programs.

• Questions still remain about whether PSS's Diagnostic Imaging business truly fits strategically with its physician supply and long-term care businesses.

• With employee morale up and the stock price on the rise, PSS officials appear to have the company back on track, a feat they've accomplished not by fundamentally changing PSS, but rather by bringing back the approach and spirit that made it successful in the first place.

Last month, we looked at PSS's dramatic rise: from brash start-up challenging the distribution establishment to a national presence doing more than $1 billion a year in sales. PSS strategy—targeting solo practitioners and small physician groups—confounded critics, who thought the independent physician was a thing of the past, while its no-holds-barred approach alienated its competitors.

But with the distribution industry undergoing significant change itself, PSS executives grew skeptical that their model was sustainable. Following a rocky IPO, the company embarked on a series of strategies and experienced a number of crises that shook it to its roots. With its stock price dropping, PSS tried a last-ditch merger with Fisher Scientific, only to have Fisher withdraw from the deal. If PSS had any future, it would have to be as an independent company.

PSS World Medical Inc. officials might not have felt so bad about their terminated acquisition offer if no acquirers at all had stepped forward. The company could have masked the fact that no decent offers arose and gone on its way. But to have gone down the road with Fisher Scientific International Inc. , only to be rebuffed, was "demoralizing," says John Sasen, EVP, chief marketing officer [See Deal]. "We went into the campaign trying to create value for shareholders by finding a strategic buyer and settled for a price that I, as a major shareholder, wasn't crazy about." And still the deal didn't happen.

PSS officials had no place to go but up. The first order of business: a shake-up at the top. Whether former chairman and CEO Pat Kelly was convinced to leave or had simply grown tired is a matter of some debate, but four weeks after Fisher withdrew its offer, in October of 2000, Kelly returned to the company's Jacksonville headquarters after two weeks at the Sydney Olympics and offered his resignation. Dave Smith took over.

Today PSS's CEO, Smith wasn't given the title at first, a move he calls "smart." Smith dismisses the notion that the board's decision to make him president rather than CEO showed a lack of confidence. "I don't know if they didn't have confidence or not—and I didn't care," he says. "Here was a board under attack and the guy brought in to turn it around was part of the team that messed the company up. Would it have been the right thing to make him CEO right away? Or to leave some doubt and let him prove himself, especially from the perspective of the public markets?" In fact, arguably the last thing PSS wanted at that moment was a young, aggressive CEO with unlimited power—precisely the kind of leader it had just replaced. "If the idea was to make it a team effort, that was fine with me," says Smith. "I didn't care if I was chief bottle washer. I just wanted my money back."

Turning Things Around

Indeed, asked why PSS executives didn't simply give up, Smith's eyes grow steely. "Well, I personally had lost $10 million and wanted that back. Worse, my shareholders had lost $1 billion and I wanted that back," he says. "I rub shoulders with a lot of those shareholders everyday in this building [i.e., PSS headquarters] and when I drop my son off at school. My own secretary has stock in this company. So my personal motivation was pretty clear."

PSS's turnaround actually began before Fisher entered the picture. While other executives were preparing the company for a sale, Smith led a team of executives in a strategic review of what it would take to fix PSS. "The feeling was that if we were going to have a new owner, we'd still have to run it," he says.

And despite PSS's travails—perhaps because of them—Smith hadn't lost the fire or passion that had driven PSS in its early days. "I still believed we could outrun, outpace, outsell, outmaneuver, out-operate everyone," he says. "We knew this company better than anyone, and we knew what it would take to fix the company."

Smith's first rule: there are no rules. No sacred cows, no untouchable people or properties. If PSS were going to turn around, its senior managers would look at and re-assess everything. "We started with a clean sheet of paper," he says.

When Fisher emerged as the most likely acquirer, Smith and his team shelved their turnaround plan. But by the time of the October 2000 board meeting, Smith had dusted off his business plan and presented to PSS's board a program to turn the company around within 18 months. Smith's first order of business: regain credibility, for both himself and other senior managers, within the company. "Forget Wall Street," he says. "That's what got us in trouble in the first place." Plus, Smith knew that investors would come back only if PSS could fix its problems. If it couldn't, no amount of wooing or fancy presentations could paper over the problems PSS faced. "We had to get people here to believe in the leadership again," he says.

Thus, despite the fact that things like the Abbott Laboratories Inc. product recall and the Trex Medical Corp. debacle had been unforeseen and unforeseeable, Smith adopted that attitude that PSS's managers would take responsibility for everything. "I'm the CEO of the company and until I fix it, it's my fault," he says. Smith's effort to regain confidence was made more difficult by the fact that he was, by his own admission, "part of the old regime," at the same time that he was trying to lead PSS forward.

Moreover, turning PSS around meant saying goodbye to a lot of people that Smith and the other managers who stayed on, including Gary Corless, president, Gulf South Medical Supply Inc. , PSS's long-term care business, and John Sasen, had worked with for years, including their mentor Pat Kelly. Smith ultimately fired 18 PSS officers—including some that he had gone to school with or played basketball with as a kid—"people who were in roles they shouldn't have been in or didn't want to make the changes that needed to be made or didn't want to follow the plan," he says.

Just as importantly, Smith replaced those executives with outsiders, a group of seasoned executives like SVP, CFO David Bronson and Diagnostic Imaging Inc. president Joseph Pepper, who brought credibility and strong management credentials earned at other companies. Says one former employee, "They started to add more mature, experienced executives who balanced the old corporate culture."

Getting a Grip

Not everyone is convinced that PSS found the right formula. Cautions one industry observer: "Don't drink the Kool-Aid. A lot of the guys who got the company in trouble are still there, running it." But others argue that it is precisely those that stayed that give PSS hope for the future. "The executives who are there now are really the best qualified to run this business," says one executive who knows the company. "They're the ones who weren't scared off by what had happened or run off because of what they did."

One of the most wrenching departures for PSS was Pat Kelly's. Today, Kelly's exit is less a sore point for PSS managers than a cause for sadness. Smith insists that his plan never mentioned having Kelly leave. "I'd never be part of any plan to shoot my boss," he says. "That's just not me—I'm very loyal. I'd rather leave myself."

Still, virtually everyone recognized that what PSS needed most was a new approach at the top. John Sasen notes that in the early days, "There was an imbalance between leadership and management. It was all leadership; nobody used the word management here." But when times turned hard and, in particular, PSS's stock price began to slide, change becomes essential. "In many ways, it was difficult to say goodbye to Pat, but everyone agreed that when things aren't working you have to see change," he goes on. Gary Corless agrees. "It was very sad—Pat was the person who gave me my start," he says. "And there were a lot of people who worried that if Pat left, others would leave, too. But it was, in some ways, what the company needed. I mean this more as a tribute to Pat, but it's one thing to build a company to $1.7 billion and another to run it at $1.7 billion."

One major goal of PSS's management: stabilizing a work force that was demoralized because of the company's poor performance. "People were confused by the rapid stock slide," says John Sasen. "It's very difficult to manage in an organization when stock options are under water and where, on paper, employees had seen great wealth for themselves, only to see it all evaporate." Indeed, PSS faced wide-scale defections, precisely among those sales reps it had worked so hard to train. "We had 30% of our sales reps ready to walk out the door," says Dave Smith. "We had to settle them down, and the way you do that is to go out and talk to them, face to face, and admit what was wrong with the company, which no one had done for five years."

PSS's next order of business was a return to a vision of the company driven by customers' needs and wishes. Gone were small but annoying policies such as charging freight on orders; gone, too, were tactics that put earnings goals above customer service. "We were going to find out what the customer wants and do it," says Smith. "We were going to make a profit, but we were also going to recreate the reasons why people came to work at PSS in the first place."

Finally, PSS would have to pay more attention to its balance sheet. It promised Wall Street that it would pay off its bank debt in 24 to 36 months, and did so in 15 months, in the process accumulating $40 million in cash. It reduced DSO (days sales outstanding), a critical measure of financial strength for distributors, from the mid-50s to the low-40s and set goals of at least 20% return on capital in each of its three business, a goal it has already achieved in both its physician supply and long-term care operations. And it set a target of 7% profitability in its core physician supply business, which would match its high in the mid 1990s, with slightly lower targets in long-term care because of the financial pressures in the nursing home industry and in diagnostic imaging. With physician supply profits currently at around 3%, Dave Smith notes, "I see no reason why we can't do that."

CFO David Bronson had begun his career at American Hospital Supply's Scientific Products and moved on to lab supplier VWR Scientific Products Corp. (which is now owned by Merck KGAA ) when it bought Scientific Products from Baxter International Inc. , rising to CFO of VWR. "This was a business that had grown entrepreneurially and was very sales-and-marketing oriented," he notes. "There wasn't a lot of attention paid to processes and policies and controls." But, he goes on, "I've been in businesses that were very good at processes and couldn't sell a thing, and I'd much rather be in a business that can sell but just needs help keeping everything under control."

For PSS, specifically, says Bronson, that means channeling the company's growing sales as efficiently as possible through its distribution infrastructure. "Instead of having 100 branches, perhaps we can rationalize that number and make [any reduction] invisible to the customer," he says. Bronson also focused on product mix and marketing in an effort to improve selling margins. "With the base of business that we have, small changes there result in big changes at the bottom line, because distribution is such a thin-margin business."

Now 18 months since the company hit bottom, much of PSS's time has been spent, says Bronson, "on stabilizing and fixing the balance sheet—building a strong financial function, instilling into the [corporate] culture that we're about returns, not just sales. If we make a sale, let's make certain we collect it, and let's not buy more inventory than we need and work with our manufacturers to share in the ownership of that inventory."

PSS has also made investments in things like IT, where it spent $50 million, to shore up its supply-chain management and enhance its ERP system. Technology is critical, notes Bronson, particularly as PSS focuses on new growth goals. "The use of technology can keep us close to the customer and the market. That's what our manufacturers depend on, because the real value proposition in distribution is that we're not so much moving boxes as moving information. We've got manufacturers on one side who don't really know what's going on at the customer level and customers who need to know what the products are and their availability, and they don't really talk to each other efficiently except through their distribution channel."

"We're doing the things that we should have done ten years ago," says Dave Smith of the new financial controls. More importantly, PSS's improved performance, supported by verifiable metrics, not only restored fiscal stability, but, he says, "gave people confidence in management that we knew what we were doing. Now people are starting to believe in us because they can see it in our growth."

Building on Customer Focus

A new, culturally more mature management team, better communications throughout the company, and a new focus on the fundamentals of the business, including closer scrutiny of the balance sheet and operational controls—all were part of PSS's turnaround. Bronson arrived at PSS after the worst days were over, but even he sees the difference. "We're much more balanced," he says. "We'll always be growth- and sales and marketing-oriented. But now the company also values the infrastructure behind that and the controls that are in place."

At the same time that it was focusing on internal metrics, however, PSS, particularly in its core physician supply business, began to look outwards, launching new programs addressed at customer needs. PSS officials note that even during the company's worst days, there were never wholesale customer defections. "We had a few knee-jerk reactions or flinches when we started to add freight charges," says John Sasen. "But the customer perception didn't change because our service levels never deteriorated."

Still, some PSS reps did have a hard time maintaining a hold on their customers, and PSS began to lose share within its accounts. Customers, says Dave Smith, "were becoming less dependent on us and more dependent on someone else." As a result, sales rep instability became a vicious circle: as reps grew more anxious, customers pulled back and bought less, causing reps' commissions to decline, leading to more anxiety.

Even the new financial controls, often anathema in sales-oriented cultures, were implemented with customers in mind. Asked how PSS kept its reps from rebelling, David Bronson notes that PSS senior managers drew the connection between better profitability and better customer service by "talking to our customers about what they really do and don't need. In some markets, especially in the physician space, we were over-servicing our customers, and I think our reps understood that. But our message to them was, ‘We're not touching your customers—this should be transparent to them.'"

PSS officials argue that its reps are among the most influential in the industry in getting the attention of physicians, and they like to compare PSS reps to another physician-focused group, pharmaceutical detail reps. "Let me put it this way," says Dave Smith. "When the drug rep gets to the doctor's office, he sits in the lobby and waits. When our rep gets there, he goes in the back door, yanks on the doctor's sleeve and talks to him." Smith says he can't say for sure that PSS reps are always successful in getting the doctor to buy a new piece of equipment or a new program. "But," he notes, "I can tell you that we see the doctor anytime we want."

Solution Selling

Indeed, PSS remains committed to a physician business driven by aggressive sales reps attuned to customer needs. While PSS has rationalized and reduced the number of reps it has in its long-term care and diagnostic imaging businesses, Dave Smith argues that PSS's physician supply business could, if anything, use more reps—10-20% more if it could get them. "We have a lot of customers who aren't being taken care of because we don't have anybody to call on them" he says. "And in this business, you don't get customers through the Internet."

Typical of PSS's new, more customer-focused approach is its SRx program, which was launched a year ago. Designed to get PSS reps to understand and tailor their selling message to different types of physicians and specialties, SRx is, says John Sasen, " a solutions-based program" that looks at physician supply much the way physicians look at treating patients. "We look at disease states and disease management and at the application of product knowledge specific to that disease," he notes.

Thus, the program formulates different modules: Cardiology, Diabetes, Respiratory Therapy, Women's Health, and Surgical Instruments, among others. "For instance," says Sasen, explaining the Surgical Instruments module, "out of the thousands and thousands of hand-held surgical instruments, we selected a group based on what family practitioners have told us they want and created an inventory just for them. It has the look and feel of being a program just for family practitioners."

More to the point, SRx focuses not on a group of expensive, rarely used products, but on most of the products physicians can and do use in their day-to-day practice. "We're not picking esoteric tests on analyzers or highly profitable but seldom-used equipment—these are all mainstream products," notes Sasen. "What we're trying to do is move away from demonstration to application, and I don't think you can be a consultant if you only have a couple of products; you can only be a consultant when you handle 50,000 products and you understand the customers' needs."

The Right Product at the Right Time

But SRx is more than just a bundled offering program because it tries to engage the physician by helping him or her understand optimal product use as part of clinical decision making. "If you're going to sell a blood chemistry system to a family practitioner, it helps to know that the five disease states they treat most often all have some need for routine chemistries," Sasen goes on. Much of the information that reps bring to physicians has to do with reimbursement, which still drives a lot of buying decisions. But SRx goes beyond simply optimizing reimbursement. "If a patient is on Lipitor, we want our sales rep to know that Lipitor is a statin and that there are other chemistry tests the physician should be doing," he goes on. "When you engage the physician on that level, it's a much different conversation from, ‘How much does that equipment cost?'"

That's not to say that economics aren't critical. Sasen notes that the goal of SRx is to help physicians lower operating expenses and improve revenues and profits. But most physicians don't really care what brand of analyzer they buy "or how many knobs it has on it," he goes on. "What they're interested in is information," specifically, how better clinical care turns into revenue-producing opportunities. "This isn't about leveraging internal resources like supply chain and IT at the point of the customer," says Sasen. "There's only so much you can do there. SRx is about creating opportunities to select the right product at the right time for the right reasons."

Though only a year into its launch, the program seems to be working. It has produced four times the growth that PSS is seeing in non-program sales: last year, PSS's regular family practice business grew at 3%; this year, under SRx, it's growing 12%. More importantly, that growth is coming not just by selling more products to existing customers, but also by attracting new physicians to PSS. "I was very happily surprised, to see that in almost every trimester last year, we grew our business, on average, 3,000 new customers," says Sasen. "For the first time, we've found a program that can reach and penetrate at the same time; when we started I didn't think we get much reach."

For PSS, SRx brings back "the balance between selling and order-taking," Sasen goes on. As distributors went through financial pressures and felt directly the impact of the economic squeeze their customers felt in the 1990s, they spent more time focused on rationalization and standardization and less on new product introductions. "It was clear that if we didn't take a new tack by teaching our people how to sell again and get them the right selling tools, we'd be just another distribution channel," he argues. "And I don't know if we'd be able to survive."

A Manufacturer's Ally

Indeed, SRx began as part of a fundamental overhaul of PSS's marketing effort. "We wanted to stop thinking simply in terms of taking manufacturers' products, putting our name on the brochure, and offering them to the customer," says Sasen. "We wanted to focus more on what the customer needs." Using focus groups and connecting back to select PSS's suppliers, "we started taking a fairly broad-based perspective, from a product point of view, and then wrapped that all up in a strong marketing campaign and took it to the market in major launch meetings," says Sasen.

And Sasen argues that PSS's stronger customer focus can translate into powerful relationships with key manufacturers. PSS's relationship with Abbott, in particular, "has created a skill level with our reps over the last seven years that makes us a good access point for other expensive products that don't compete [i.e., with Abbott.]" But, he goes on, the Abbott deal, though formally drawn as an exclusive distribution arrangement, is only one of a number of close relationships with manufacturers. In the mid 1990s, PSS was a major supplier of Roche 's Mira chemistry analyzer, selling 300 to 400 of the $60,000 systems several years in a row. "We created a new category for mid-range chemistry," he says.

Another indication of PSS's efforts on behalf of manufacturers: its PSS Select private label program, which generates around $60 million a year in sales from products such as drapes, table paper, exam gloves, urinalysis strips, and orthopedic soft goods, to name a few. Says Doug Harper, president, Physician Sales & Service, the physician supply business, "We have very, very aggressive pricing on it, but we also have service guarantees that the product won't ever be backordered."

Here, too, private label programs, under which a distributor sources a product from a manufacturer and puts its own name or brand on the package, are not unique in distribution generally—there's a growing private label program in hospital supply. But in hospital supply, private label brands often threaten and conflict with the best interests of manufacturers, who dedicate a lot of sales rep time and effort to promoting their own brands. In the physician-office market, usually too small for large manufacturers to target with their own selling efforts, private label programs help by greasing the marketing channel. "A Kendall rep isn't going to call on a two-person physician group in Palatka, Florida," notes Harper. "But there's a PSS rep there every week."

If physicians benefit from these customer-oriented programs, so does PSS. For most distributors, high service levels are a drain on profits. For PSS, they provide a market segmentation that keeps PSS focused on more lucrative accounts. Asked about the price sensitivity of the traditional physician supply market, John Sasen concedes that there is a segment of the market that will make product selection decisions based on their ability to save a nickel. "And we have to compete for that business to some degree," he says. "But we've taken a different road with our ‘solutions selling,' and we've found people are willing to pay us a higher price if they see value in the end. It's when there's no value that the customer asks, ‘What's the price?' "

Finding Life in Long-Term Care

Sasen argues that, for PSS, SRx was "the right program at the right time," helping the company connect not just with customers, but with its own sales reps at a time when those reps badly needed something concrete to provide a jolt of confidence in PSS's turnaround. "It allowed us to develop a major campaign to go back on the offensive at a time when we had just come off a very difficult six- or seven-month period," he argues. "The company had been for sale and we were starting to rebuild, and we needed a very focused approach for the sales organization to get their minds off the internal problems and back on the customer."

Three years ago, as PSS hit bottom, the company's strategic forays outside its core physician business looked like serious mistakes, misguided efforts to build businesses in areas where the company had a sense of what they'd like to accomplish but no real business plan. But as PSS's turnaround continues, those businesses are becoming important contributors to the company's success.

Take Gulf South, for example. Founded in 1983 in Jackson, MS, the company grew aggressively, serving the long-term care market through 26 distribution outlets with the goal of creating a national presence. Though its growth came mainly through acquisition, the parallels were clear: fast-moving Southern-based alternate-site suppliers with dramatic growth and a national vision. "We used to get compared to them a lot," says Gary Corless, a long-time PSS executive who now runs Gulf South. And because Gulf South served a complementary, not competitive market, it was long believed, says Corless, "that this could be a pretty good marriage at some point." [See Deal]

At least part of the nursing home, or skilled nursing facility, market looks like the physician office market: small customers with low-volume orders and, compared at least to hospitals, a limited line of products. (Today, about 80% of Gulf South's business is in nursing homes; the rest is in home health care.) But where PSS's physician office business focuses mainly on smaller physician customers, Gulf South's nursing home clients cut across a wide spectrum of customers, including national and regional chains as well as independent facilities, each representing a different kind of customer.

National nursing home chains, like Beverly Enterprises Inc. and Kindred Healthcare Inc., usually have hundreds of facilities, each of which looks like a typical skilled facility of 60 to 100 beds. "If you passed by two nursing homes, you wouldn't necessarily know a chain from a mom-and-pop," notes Corless. Thus, from a purely logistical point of view, homes owned by national chains have to be served just like independent facilities. But national chains buy through a centralized headquarters in a more economically driven sale that features exclusive national contracts with their distribution partners.

They also have clinical teams that select products across the chain and stress the distribution efficiencies available through e-commerce. "Relationships are important," Corless notes. "But you also have to be able to explain to a CFO why this [contract] is a good business decision. And you better have the technology to support that. It's very sophisticated procurement."

On the other hand, as other Gulf South customers get smaller, in regional and independent companies, the company plays a much different, in some ways more active role. "It's much more of a relationship sale," he goes on. "And we're probably helping them select products."

Committing Heresy

Its growth-through-acquisition strategy would, ultimately, become an issue for Gulf South managers, leading to internal integration problems and other challenges that would manifest themselves in the accounting irregularities that were uncovered soon after PSS announced the acquisition. But even more than the accounting issues, what plagued Gulf South in the mid-1990s was a general softening of the nursing home market, driven largely by changes in reimbursement that put a tremendous squeeze on the facilities.

"At first, we all thought prospective payment would be a good thing," Corless recalls. "But when it was actually implemented, Congress took a lot more [reimbursement] money out of the system than we thought it would." Overnight, Gulf South lost 500 basis points of profit and faced a string of bankruptcies among important customers, particularly some of the national nursing home chains. "We were caught off guard," Corless concedes. It wasn't just a matter of calling up an account to remind them they were 10 days late paying their bills—suddenly Gulf South was negotiating a bankruptcy settlement with the CFO of a $2 billion company. "We didn't have the expertise in credit that we needed," he goes on. "We weren't ready for that."

PSS felt the squeeze everywhere, as the other divisions were asked to do more to make up for Gulf South's problems. More to the point, unlike PSS's core physician business, which needed to regain its footing to effect a turnaround, Gulf South's new managers had to come up with an entirely new strategy—this in PSS, a company that had long held that there was only one right way to run a business, i.e., intense customer focus, and that the strategy could be universally applied. PSS's corporate philosophy was based on the notion that, as Corless puts it "There are certain fundamentals of business that always work; you just have to work hard enough at them."

More by coincidence than by design, PSS officials discovered, Gulf South's distribution model looked a lot like the PSS model—highly decentralized, with a lot of distribution centers and high service levels. And for a while, that felt right. But PSS soon realized that that business model "comes with a high cost," Corless goes on. "It's like 7-Eleven; we'd sell them aspirin and have it there when they needed it, but it would be $5 a bottle. And we soon realized that didn't match what our long-term care customers could pay."

In fact, when Gulf South customers saw the company increasing its service levels, just as federal reimbursement was cutting back, they grew concerned. "Their attitude was, ‘Do you really have to do that, because we know that eventually we're going to pay for this,'" Corless recalls. "It became clear we needed to re-tool our business model." Over the past couple of years, Gulf South has cut the number of distribution centers in half (to 13) and centralized many functions, including customer service and accounts payable and receivable.

Not at the expense of customer service, however. Indeed, to enhance customer service, Gulf South has launched Answers—a bundled products program similar to SRx in physician supply. Such moves, backed by tighter financial controls, have helped to turn Gulf South's economics around. "Anything that didn't have value by bringing us closer to the customer, we centralized," says Corless. Thus, in sourcing products, Gulf South can now often get a better deal from manufacturers because it buys in bigger quantities and has fewer sites to ship to. "We can now buy gloves by the container-load, rather than the palette-load," he notes. Indeed, long-term care's product mix lends itself to efficient rationalization since 65% of a typical nursing home's purchases fall into three product categories: gloves, incontinence products, and nutritionals. Throw in wound care and that's very much of what Gulf South's customers buy.

Gulf South even reduced its sales force from 170 to 100, mainly by dropping less-experienced reps who didn't have strong customer relationships yet. But such centralizing and rationalizing moves weren't always easy. "In many cases, what we were doing was considered heresy at PSS," Corless goes on. "When I came up [through the ranks of PSS], the thought was the more branches the better, because more branches meant closer to the customer. And who could argue with being closer to the customer?"

Fixing Diagnostic Imaging

PSS's Diagnostic Imaging (DI) business posed yet a different sort of challenge: while long-term care nicely complements the company's core physician-office business because of its alternate-site focus, the largely hospitals-based imaging supply business has few obvious synergies. But finding long-term synergies wasn't the most pressing issue. Like its sister businesses, DI had internal problems to overcome.

PSS's most immediate concern for DI, which had been cobbled together from 51 acquisitions between November of 1996 and January of 2001, some as large as $80 million in sales, others doing less than $1 million: integrating and creating a single, well-run company. To do that, PSS hired Joseph Pepper, a seasoned executive who had served in senior positions at Ohmeda, now part of Instrumentarium Corp. [See Deal], and was CEO of c-arm leader OEC (now GE OEC Equipment Inc.) before it was acquired by General Electric Co. 's GE Medical Systems in 1999 [See Deal]. Having left soon after the acquisition, Pepper took a year off before joining PSS.

Pepper's only previous brush with PSS came soon after he joined OEC, when he began a program to take all of the company's sales direct. One of the distributors OEC terminated was Texas-based Gilbert X-Ray. Two months later Gilbert was acquired by PSS [See Deal], and the irony isn't lost on Pepper: after severing ties with all of OEC's distributors, Pepper would, just a few years later, find himself running one of the country's largest imaging equipment distributors. He says it isn't hard to reconcile the seemingly inconsistent stances on the value of distribution. At OEC, a specialty equipment manufacturer, direct selling made sense because distributors didn't always give the company the kind of selling attention and focus it needed. That's not to say distributors couldn't be effective, he says, just that they didn't work for OEC.

More to the point, he argues, consolidation in the diagnostic imaging business has opened doors for distributors over the past several years. "There's now a significant part of the customer base that, for lot of different reasons, doesn't want to deal directly with Philips or GE or Siemens," he says. "Maybe they feel that if they're only buying a $40,000 RAD room, they're not going to get the attention of a big manufacturer, whereas we're happy to give them our attention."

Diagnostic imaging suppliers tend to fall into one of two camps: those who sell mostly film and consumables and those who make most of their money from equipment sales and the service follow-up. The 51 companies PSS acquired ranged across the spectrum and over a large geographic area. Today, about two-thirds of DI's business is in film and consumables, though the mix varies from region to region, depending on historic focus. Like any distributor, it represents a wide range of companies, particularly in film, where it carries all of the leading brands. On items such as film and accessories, DI also has a private label program, selling its own brand.

On the equipment side, now that the Trex relationship had ended, its strongest relationship is with Philips Medical Systems Inc. , a division of Philips NV ; in all but two of its geographic regions it sells Philips' RAD/RF; on high-end equipment, such as a CT unit or cardiac cath lab, DI serves more as an independent sales agent rather than a distributor, getting a finder's fee for each sale rather than taking title to the equipment. It also represents R2 Technology Inc. and its ImageChecker mammography system, has a limited agreement with Japanese supplier Shimadzu Corp. , and represents Hologic Inc. mammography products.

Balancing National and Local

DI's primary customer base is, as noted, hospitals and large physician clinics, especially in orthopedics, though Pepper notes that it is difficult for DI to serve very large hospitals consistently and so the company concentrates on smaller hospitals (under 250 beds) and a range of orthopedic, oncology, radiology, and outpatient surgery centers and clinics.

PSS had begun to integrate some of its acquisitions prior to his arrival—for example, they were all on the same ERP system. But the 51 distributorships represented around 100 locations, and that number had to be reduced. Opportunistic tinkering at the local level had lowered that number to around 75 as of a year ago. But Pepper says more rationalization is underway. "We're going to have an organizational structure with a headquarters staff and seven regional managers beneath that, each running an $80-120 million business," he says. "And we expect that over the next two years, those 75 locations will go down to the mid-40s." The number of full-service locations, as opposed to distribution centers and break-freight locations, will go from 26 to7.

In fact, Pepper hopes to bring all of the true benefits of a centralized national capability to DI, benefits that accrue to both hospitals and manufacturers. "We're investing in our supply chain capabilities—on-line ordering and EDI [electronic data interchange]—now demanded by more and more customers," he says. At the same time, DI has centralized purchasing, which should benefit manufacturers as well as customers. "We can now give 30-, 60-, and 90-day demand forecasting," he says. "We can report data to them on what our customers are doing that allows them to do market share calculations." Those are the kinds of things, he notes, that really can be more meaningfully done from a large base than a small base. "The profit in film is so small today that shaving a quarter of a point is important," he goes on. "We can give them opportunities to pick up points that you just can't when working with a single, local distributor."

Moreover, because its customer base is institutional, DI, unlike PSS's core physician business, is much more likely to fall under national group purchasing agreements. While the physician office market tends to be less price sensitive, DI, says Pepper, speaking illustratively, "is bound on one end by Kodak and the other by Premier." (PSS, too, contracts with most of the large groups, but the physician office market remains elusive for most national alliances and GPOs.)

For Pepper, national capabilities translate into things like GPO opportunities and distribution efficiencies. As a result, DI is "trying to get as quickly as possible to one national identity for a lot of reasons," he says. "You really can't have service people dispatched ten different ways around the country," he explains. And he's not concerned about the loss of local identity. "In most customers' minds, the transition [i.e., from the former company to DI] has already taken place."

But DI has to be careful, in striving for national efficiencies, not to lose that local touch that is so important both to the customer and to PSS's corporate culture. As it begins to analyze where it can shut or scale back individual locations, says Pepper, "We're going to do calculations, on a regionalized basis, to determine the best way to serve our customers." DI will, of course, figure costs in its calculations. But, he goes on, "We're not going to stop serving customers. We could have gone further in our consolidation. We could have just shut facilities right away or backed out of some areas. But we won't. I need to get as close to that line as possible to get cost effectiveness without giving up more than I need in terms of the local touch."

A Marriage That Never Happened

For all of DI's progress, it's not clear that PSS will be a long-term player in diagnostic imaging. As noted, DI's customers are mostly hospitals and large specialty clinics; PSS's, small physician offices. "I think there is a strategic fit," says Pepper when asked about possible links. "It may not be at the customer level, however, but more in the back office, where all of us have national capabilities." Thus, in those markets where DI doesn't need a full-service branch, it can scale back to a distribution center or, perhaps, come to some arrangement with Gulf South or PSS, sharing warehouse and back office space, he says. And as noted, last December PSS launched a program to sell film and chemistry to doctors' offices in coordination with DI.

But Dave Smith ducks the question of DI's long-term role within PSS. Asked where DI fits strategically with PSS's other businesses, he says simply, "I've told Wall Street that I would decide that question strategically after we made more progress and could see the end results of our efforts." In fact, how closely PSS mixes or integrates all of its businesses is still up in the air. At the customer level, PSS officials are inclined to let each of its businesses play off the strong identity it has built. Thus, Smith argues that PSS will never try to replace the Gulf South brand name with a PSS label. "It's brand marketing 101," he says. "You don't change your brand once you've built it and it has value."

Nor is it entirely clear customers would benefit from a closer coordination. Doug Harper can walk through a detailed discussion of all of the ways that his physician supply customers can benefit from its sister long-term care and imaging supply offerings. But asked how much customers are actually asking for such links, he says "It's minimal."

Even behind the scenes, PSS officials concede the possible connections may look better on paper than in real life. Gulf South and PSS don't often sell the same products; where chemistry instruments and tongue depressors are a staple of doctors' offices, nursing homes are more likely to focus on nutritionals and incontinence supplies. "In some cases, we're not buying a common line, but we're buying from a common manufacturer," says Gary Corless, of sourcing opportunities with the physician office business. "We'll buy two different things from J&J or Kendall." In selected product lines, PSS is beginning to talk to manufacturers about taking advantage of its centralized purchasing volumes, even though the manufacturer will have to break up the order to ship it to individual PSS outlets. But how real or valuable such arrangements are remains to be seen.

As it embarks on its turnaround, PSS can't help looking backward as well as forward. Through the 1980s and early 1990s, the premier physician supply distributor in the US, without question, was California-based FD Titus & Son Inc., serving much of the Western US with an approach unparalleled for its sophisticated and efficient approach to distributors. And for much of that time, no supplier seemed a greater contrast with PSS than FD Titus. Dave Smith disputes such a view. When FD Titus was eventually bought by General Medical (now McKesson General Medical Inc. , a division of McKesson Corp. ) [See Deal], Smith notes, "It was a sad day at PSS," in large measure because it ended a dream by some at PSS that the two companies would eventually come together. Though there would likely have been clashes at the top-most levels of management in any merger of the two companies, Dave Smith concludes, "No two companies had a better cultural fit together. It would have been a wonderful marriage."

The sale of FD Titus to GM raised eyebrows not just at PSS but throughout the medical supply industry. The Titus acquisition was neither the first nor last of the major physician supply deals, nor was it the largest. But it did symbolize the end of an era, the end of a certain kind of distributor: a generations-old family run business that dominated its local market through a close customer contact and operational efficiency that even national giants aspired to match. "Customer-centric, very energetic, focused on the business, but with discipline and operational efficiency," says Dave Smith, summing up what he believes were the common characteristics FD Titus and PSS shared.

Getting Back to What Worked

Not everyone, particularly those who witnessed the distribution industry evolve through the 1980s, will agree on the similarities between the two companies. But it is one of the most interesting things about PSS's saga that, for all of its trials and tribulations, the company emerged from the 1990s—one of the most difficult decades in the history of physician supply—as the last major independent company. "We're also the largest," says Dave Smith. "The largest, period, independent or not." (PSS calculates its national market share at 14-15%, slightly ahead of General Medical.)

After bottoming out at around two-and-a-half dollars, PSS's stock has climbed past $9, and David Bronson argues that PSS's tighter financial controls are a big part of that. "Just [putting in controls] doubled the stock price from $3 to $6 and then returning to growth and some predictability in our numbers got us a bit further," he says. And Bronson believes PSS's value can go much higher. While he was CFO at VWR, the company's market cap went from $200 million to $1.2 billion, a six-fold increase, while sales increased just 50%, from $1 billion to $1.5 billion. "When I first sat and talked to Dave Smith about PSS, I saw a very similar opportunity and trajectory," he notes.

Smith, too, believes PSS is just at the beginning of its turnaround. "We've just started our three-year plan," he notes. "We needed 18 months to get it rolling because there were a lot of things we had to fix."

Internally, PSS is well on its way to regaining confidence with sales reps and other employees. "For a while, the only thing this organization focused on was, What's going to happen to us? Are we going to be acquired?," says Doug Harper. "We needed to focus on what we do best, which is selling—taking care of our people and our customers." Overall, sales rep turnover is down, from 30% two years ago to 17% in PSS's core business; in DI, turnover has gone from 25% to 15.5%. "I think the momentum clearly started to shift six months ago," says John Sasen. "Employees feel better about what they're doing; turnover has slowed dramatically; suppliers are giving us rave reviews." In fact, he notes, a small group of suppliers are helping to fund the research on SRx: "That's how deeply they believe in it."

At the same time, Dave Smith knows that for PSS's external constituents, particularly investors, the company has more to prove, notwithstanding the recent stock climb. "There are people in the market who lost a lot of money, and I think there's always going to be a level of skepticism when someone loses a lot of money," he says. "When we get that money back, we'll erase a lot of the sins."

One key to PSS's turnaround lies in a focus on the physician's office business that the company was built on. Asked if the disappearance of many of the large, independent distributors PSS grew up competing against ever made PSS officials question their long-term strategy, Smith says No. "Just the opposite," he argues. "We were winning every day on the street against companies like General Medical and Allegiance. The core business is still a very good business." Gary Corless agrees, "Maybe we were naïve, but we were never bothered by that. The larger companies that came in were outside our market. It was like supermarkets buying Seven-11s."

In fact, for all of the consolidation that has come to physician supply, the strength of solo practitioners and small groups, and of the suppliers that serve them, remains surprisingly strong. Taking the top four national suppliers together, their combined market share is barely over 50%, meaning that around half the market is still in the hands of small, local distributors. "And a lot of them are very healthy," says Doug Harper, precisely because the dramatic changes that came to hospitals didn't trickle down to physicians.

Restoring growth will be critical. But wasn't unmanaged, undisciplined growth what got PSS in trouble in the first place? "That's the challenge for us," says David Bronson. "Right now, I think this is a very flexible, responsive, results-driven organization. If we double in size, the challenge is to do so in a way that doesn't compromise that."

Indeed, PSS officials argue that PSS's future success rests precisely on re-instilling that original PSS spirit, its aggressive, growth-oriented, take-no-prisoners approach to success. The arrival of more seasoned managers like Bronson and Pepper notwithstanding, there remains a brash confidence, a kind of élan that is a strong undercurrent at the company.

Given all of the problems that PSS ran into, it's easy to forget how successful its original vision and spirit was in creating one of the leading physician supply companies of its day—doing so against tremendous odds and at a time when the rest of medical-products distribution was dramatically retrenching and consolidating. "Some of the people who have given PSS a hard time over the last year or so forget how successful a run they had from 1983 until several years ago," says Joe Pepper, who missed much of PSS's worst days. During that time, "The PSS model was unbelievably successful." Yes, he goes on, "the company got to a size where it needed more processes and some people stumbled." But, he adds, "For a company to get to $1.7 billion, it can't all have been bad here."

In turn, PSS officials disagree that in order to turn itself around, PSS has had to become a significantly different company than it was ten years ago. If anything, says Gary Corless, despite the strong internal controls, "It feels more today like it did" before all of the problems arose. "We're getting back to what made us so good." Dave Smith agrees. "Our old culture became bastardized in the late 1990s," he says. "What we're doing now is bringing discipline to that culture."