Nowhere is customer service more important than in the medical equipment market. No hospital wants to wait around for days while an expensive X-ray machine is immobilized for lack of a spare part.

Philips Medical Systems knows that very well. Based in the Netherlands, it is one of the world's top three providers of diagnostic imaging systems, including radiography, fluoroscopy, magnetic resonance and ultrasound.

The company also provides a wide range of value-added services, including customer training, aid in translating diagnostic images, advice to hospitals on systems acquisitions and equipment maintenance. The company has 9,000 employees who sell and service customers in more than 60 countries.

	Most medical-supply companies are small, depending on large wholesalers to get their products to the end user.

With such widely dispersed installations, providing critical equipment parts presented Philips Medical with a major logistics challenge - one that it was not adequately meeting under its previous distribution system, according to Hans van den Eertwegh, who until recently was manager of service supply. Under the old system, hospitals complained that they couldn't get clear answers from Philips Medical about where needed service parts were, when they would arrive and how long systems would be down, van den Eertwegh said. Meanwhile, the company was struggling to stay competitive in a market where prices were falling and worldwide growth was flat.

Philips' solution was to create a separate business unit to manage the flow of service parts to customers around the world. The company's Service Supply Agency (SSA) was given sole responsibility for parts availability, inventory management and logistics infrastructure. Its charge was to boost customer-service levels, reduce inventories, and generally gain more control over the supply chain. Or, to put it more succinctly: to have parts available at the requested location, at the requested day and time.

Key supply-chain performance measures, instituted since formation of the SSA in February 1995, demonstrate the effectiveness of this approach. The company saw an improvement in parts dispatch performance from 78 percent to upwards of 97 percent, according to van den Eertwegh. During the same period, the SSA developed a model for efficient inventory allocation of more than 50,000 SKUs. And it set forth coherent, company-wide procedures for purchasing, procurement and repair.

Internal Resistance
In pursuit of these goals, the project had to overcome a number of obstacles. SSA faced a natural resistance to change from within, said van den Eertwegh. Suppliers continued to carry out their own repairs, making it difficult for Philips to predict and manage its production flows, let alone oversee quality control. (The company intends to solve that problem with creation of its own repair facilities, van den Eertwegh said.) Moreover, neither the company's information technology system nor its third-party integrators were fully prepared to cope with the new regime.

Philips saw the benefits of centralizing regional parts distribution - a model followed by many companies - but it also believed it needed to locate stocks as close as possible to its installed base. At the same time, it sought maximum flexibility and transparency of the parts supply chain.

Centralization and proximity turned out not to be opposing concepts. Splitting the world into three logistics areas - Europe, the Americas and Asia/Pacific - Philips created a central warehouse for each area that could feed a small number of strategic stocking locations (SSLs) within a four-hour reach of end users. Then it designated a series of stockless drop points, where field engineers could pick up parts for particular repair jobs.

Philips placed its European distribution center in Best, the Netherlands, to support equipment manufactured at the same location. The warehouse both replenishes the SSLs and ships directly to field engineers. A smaller distribution center is located at the company's second manufacturing plant in Hamburg.

The SSLs hold mostly essential and fast-moving parts, along with those that are specific to customers within a given region. In most cases, order lead time to the installed base is around two hours, with a low of less than one hour and a high of four.

Philips draws a careful distinction between the value and frequency of its parts inventory. The so-called "trivial many" - low-cost parts that account for 80 percent of volume and 20 percent of value - are stored in sufficient quantities at SSLs in order to reduce order lead times. The "vital few" - the 20 percent of parts that represent 80 percent of value - are held in the central warehouse to keep inventory costs down. Further savings come from tight coordination between SSLs, thereby reducing the number of new parts needed to satisfy the global customer base.

A single information system oversees parts stocks on a global basis. The program allows Philips to track customer orders all the way from request to final delivery, while matching inventory levels to the actual consumption of parts. "It makes the supply chain like a fishbowl," said van den Eertwegh.

Obstacles to Centralization
As the Philips example shows, the selling of medical devices is a complex affair that may or may not lend itself to centralized distribution. The precise configuration of a given medical supply chain depends on a host of factors, including location of customers, product value and government policies on cross-border transport.

Moreover, the European market is extremely fragmented, said Charles Findlay, a partner in the supply-chain practice of Andersen Consulting. Most medical-supply companies are small, depending on large wholesalers to get their products to the end user. Ireland alone boasts some 200 companies in that sector. In all, more than 5,500 manufacturers of medical technology are active in Europe, according to a new report by the Holland International Distribution Council (HIDC), whereas more than half the market worldwide is controlled by just 20 companies.

In line with its having grown up from a host of small companies in separate countries, Europe's medical-supply business also is controlled by widely varying governmental specifications on virtually every detail of a given product. The European Union may have eliminated borders for the purpose of transporting goods, but it hasn't uprooted the thicket of regulations that still frustrates uniformity.

Nor did creation of the EU erase the region's multiple languages and strict local labeling requirements, Findlay said. Those rules may even increase in the years ahead, as consumers become more aware of safety issues related to drugs, and perhaps medical supplies as well.

"I can't see it not applying to devices," said Findlay. "I think it might spread."

Old habits also tend to frustrate efforts at centralization. Hospitals, which make up the largest group of buyers, are accustomed to purchasing from nearby suppliers, Findlay said. So are the government-controlled health organizations of many European countries, which have long stressed "buy local" policies, said Richard Greene, senior manager in the International Location Advisory Service of Ernst & Young.

Further blocking harmonization is the large number of conflicting local rules on health care payment and insurance reimbursement. "The fact that these are organized on a national basis means that suppliers of med-tech products have to contend with complex and fragmented trading practices," HIDC said.

Albeit slowly, progress on harmonization is being made, said Greene. He sees hope in the EU's formation of a central regulatory arm for the region's healthcare industry, based in the United Kingdom. The new body will help guide the European Parliament toward the formation of uniform rules for medical products. Meanwhile, items entering the marketplace are automatically subject to EU regulatory control, not the vagaries of its 15 members.

Eventually, Europe could see development of a gray or parallel market where medical products made in low-cost countries are transported and sold in higher-cost locations, Findlay said. That already has begun to happen in the area of pharmaceuticals, with drugs from Spain being imported by distributors in other EU countries.

The Push to Centralize
Also driving change is European economic unification, which will create incentives for buyers and sellers alike to cross national borders.

At the same time, government health organizations are moving away from large purchases of standardized equipment, in favor of units customized for the individual user. For example, wheelchairs are now being made to order, much like mail-order computers. Manufacturers are establishing single assembly points that can build units according to a wide variety of technical specifications. And with centralized production comes centralized distribution, cutting logistics costs dramatically.

One U.S. maker of heart defibrillators, for example, has centralized warehousing, distribution and value-added services in the Netherlands, HIDC said. It has outsourced those functions to Kamino European Logistics, which stores some 7,000 SKUs of finished goods and spare parts in Beek, near the Maastricht-Aachen airport. In addition to shipping to hospitals throughout Europe, Kamino also performs software installation and testing, kitting, packaging and the inclusion of manuals.

According to the HIDC report, the trend toward centralization should accelerate as hospitals and other buyers work to reduce purchasing costs, while vendors slim down their supply chains and consolidate product with large distributors. Countries such as the Netherlands and Belgium, with their well-established networks of value-added logistics providers, are likely sites for large distribution centers serving much of Europe.

The Netherlands already plays host to 56 percent of the European distribution centers (EDCs) set up by U.S. and Asian companies, HIDC said. Of the 344 American EDCs located there, more than 40 trade in medical devices and instruments. Their number is exceeded only by U.S.-based sellers of office equipment and personal computers.

Belgium, with 13 percent of American-controlled EDCs, and the United Kingdom with 12 percent, also play a major role in centralized distribution strategies in Europe, according to HIDC. Companies are drawn by logistics infrastructure, relatively cheap land and buildings, favorable taxation policies, low-cost labor and, in some cases, outright cash incentives by local governments. In addition, they like being close to established centers of medical technology.

The real payoff from centralization, however, is cost control, a must for any company seeking a greater piece of the EU market for medical-technology products - a market projected by the HIDC to reach $42bn next year. U.S. suppliers, as well as European companies, are in the race. In 1996, HIDC said, European companies held a 49-percent share of the market, but U.S. suppliers were breathing down their necks with a 44 percent share. At the finish line, the winning edge may well depend on distribution efficiency.

Getting Unique 'Brain Pacemaker' to Market Challenges Young Company

Having a unique product doesn't mean you can afford to ignore the logistics of getting it to market. Cyberonics Inc. has virtually no rivals in its field - the production and distribution of a groundbreaking medical device that controls epilepsy. The critical nature and high value of this product, however, makes 100 percent delivery reliability a must. In many cases, the device is ordered to coincide with a scheduled surgery, and because of the value - $9,000 to $10,000 each - it is not an item hospitals care to keep in stock. On its face, the Cyberonics supply chain is relatively straightforward. The company's sole product is manufactured in one place, near corporate headquarters in Houston, Texas. Shipments weigh less than half a kilogram and always are handled by express carriers, primarily DHL. Orders are small, often for a single unit. Because of differences in national laws, however, the young company was not able to keep its small operations centered in Texas. In fact, its first sales occurred in 1994 in Europe, where government officials were quicker to approve the device than was the always cautious U.S. Food & Drug Administration. Developers of new medical technology often find this to be the case. The wait for U.S. certification takes an average of six years, versus three to four in Europe, according to the Holland International Distribution Council. As a result, new medical products often are launched there. It took Cyberonics 10 years and seven separate clinical trials to win the green light from American regulators for its patented product, the NeuroCybernetic Prosthesis (NCP) System. The first new treatment for epilepsy in more than a century, it is designed for the 20 percent of epileptics whose condition cannot be treated by drugs or brain surgery. (Some 50 million people suffer from epilepsy worldwide.) The NCP consists of a metallic generator that is roughly the size and shape of a pocket watch. Implanted in the patient's chest, it attaches to a wire that wraps around the vagus nerve in the neck. The system sends electrical impulses to the brain, in 30-second bursts every five minutes. The purpose is to block epileptic seizures - a sort of pacemaker for the brain. Patients may further stimulate the device from a wristband if they feel seizures coming on. Since winning U.S. approval for its device in July 1997, Cyberonics has seen demand for the NCP rise steadily. It has since shipped more than 3,000 units and expects that number to climb to 7,000 this year. Sales could jump from $16m in fiscal 1998 (ending June 30) to nearly $50m in fiscal 1999. While waiting for the U.S. nod of approval, however, Cyberonics' only income came from its fledgling European operation, according to Joel Heirman, an Ernst & Young manager who serves as the company's finance manager in Brussels. Global Exports A small suite of offices in Zaventem, Belgium, just outside Brussels, serves as Cyberonics' European headquarters. From there, the company ships to most of the world, except for the Americas, which are serviced out of Texas. Cyberonics sells directly to hospitals in the United Kingdom, France, Germany, Switzerland, Austria and Belgium. For other locations, it works through 25 to 30 medical distributors, whose ranks are growing each month. They provide the global sales force that a company of Cyberonics' size cannot field by itself, said Carine Vangenechten, administration and operations supervisor. Local distributors also help it to overcome differing business practices in various markets. DHL handles all shipments for the Belgian office, keeping parts in its bonded warehouse just minutes away at the Brussels airport. Cyberonics has considered storing the goods at its own facility and saving the cost of DHL's transfer services, said Ingrid Seymus, marketing communications manager. Such an option might prove especially attractive as sales grow. But it also would shoulder Cyberonics with a host of new concerns, including security and inventory control systems. The company likely will make a decision at the end of the current fiscal year, when it determines whether to move out of the Zaventem office into larger quarters. It won't be moving far. Belgium provides the ideal location for distribution of the NCP throughout Europe and beyond, Heirman said. Maximum transit time to anywhere in Europe is 24 hours, and to Asia, three days. Cyberonics likes the multilingual culture of Belgium, the productivity of its labor, and its proximity to the major population centers of Europe. The Netherlands offers similar inducements, but office space is cheaper in Belgium, and the Brussels airport is less congested than Amsterdam's Schiphol International, said Heirman. The European headquarters of Cyberonics actually started out in Switzerland, which was responsible for all sales in the continent except for those to Belgium. It moved to Brussels because that was the regional headquarters of St. Jude Medical Inc., the St. Louis-based maker of cardiovascular devices. St. Jude had come through with a big infusion of cash and marketing support at a critical moment in Cyberonics' early years, and for a time was considering buying the company outright. When it opted not to, restricting itself to a minority ownership share, Cyberonics stayed put in Brussels and closed the office in Switzerland. Belgium's Tax Advantages On the basis of local sales, Belgium ranks relatively low in importance. France is a far more important market for the NCP, said Heirman, but tax regulations there are less advantageous, especially for a company that has yet to break into the black. In Belgium, he said, losses can be carried forward on balance sheets indefinitely; in France the limit is five years. The European Union currently is discussing harmonization of this rule, but no action is likely in the immediate future. Belgium has the additional advantage of being a member of the EU, Heirman said. Shipments from Switzerland into EU countries are subject to import taxes, including nonrefundable duties. Moreover, the debut of the euro as the EU's common currency should greatly simplify Cyberonics' accounting. In any case, the company feels right at home in Brussels, which plays host to virtually all of the major cardiovascular companies in Europe. "It's a very small world," Seymus said. Cyberonics also is close to many leading authorities on epilepsy, whose support is crucial to wider acceptance of the NCP by hospitals and neurosurgeons. The education process on the NCP extends to customs officials, many of whom aren't familiar with the new technology. The NCP doesn't always fit neatly into the listings of general medical codes used by customs agencies in monitoring imports, Vangenechten said. The novelty of the NCP may actually have helped it to surmount bureaucratic restrictions against crossing European borders. Devices based on new technology are not subject to decades of local regulation and legislation, said Richard Greene, senior manager of Ernst & Young in Utrecht, the Netherlands. As a result, they are automatically eligible for uniform treatment by the 15 members of the EU. Older products - including highly regulated medical devices - must await the painstaking process of harmonization, which is far from complete. For Cyberonics, Europe remains a small operation, albeit one with substantial promise. Although the company first received government approval in Europe, it was held back from exploiting the event by a lack of cash and the need to focus on winning FDA approval in the United States. Once those hurdles were overcome, the company began turning its attention to marketing and winning endorsements from insurers. Implantations are on the rise, but the scale of European activities is dwarfed by those in the U.S., where the company has a 40-person sales and marketing organization. U.S. sales of the NCP should continue to blossom now that major health plans have agreed to reimburse costs. Currently they are running in excess of $1m a month, said Vangenechten, but the potential is for much more. In North America, Europe and Japan, there are an estimated 600,000 patients - a $5bn market - suitable for the NCP implant. The U.S. market alone is valued at $1.8bn. Sales to Asia are just getting off the ground. For now, said Seymus, Cyberonics can easily supply Asian hospitals from its European location. As the numbers increase, it will consider the establishment of additional distribution points closer to buyers. Still a one-product company, Cyberonics doesn't plan to branch out widely into other areas of medical research. It does hope to develop new therapies related to vagus nerve stimulation for sufferers of Parkinson's disease, trauma, pain and depression. The goal is to remain a highly specialized niche player - but one with global scope and the leanest possible distribution network.