What decision would you make here and how would you implement your choice?

Northwell Inc.

When Northwell’s Senior Management and Board first gave Claudia the leadership role in the development of a virtual medical product and service mall with Medichek, a year and a half ago, she was delighted. She and Nathan Daniels (V-P Marketing) had uncovered the opportunity, Medichek was an excellent organization, and it had been clear that this was a venture well worth embracing. Claudia Leung, CFO of Northwell, had an excellent working relationship with senior management at Medichek. Since Northwell’s major contribution in the shorter term would be cash ($7.5 million as of now), she was the ideal candidate for the assignment. The development of this initiative would increase her entrepreneurial skill set and profile and looked to be a manageable addition to her portfolio of responsibilities. Claudia was beginning to wonder if this dream assignment was about to become a nightmare. The project had run into technical problems, was 4 to 5 months behind schedule, and the Board and Senior Management at Northwell were frustrated and putting pressure on Claudia to get things moving. Executives at Medichek were pushing back, in response to their own frustration, stating that Claudia’s interventions were hindering progress. In addition, she’d been hearing growing rumblings of concern and unhappiness in the sales and marketing areas, evidenced in the recent resignation of three staff members and the loss of a good distributor from the mid- west U.S. Northwell’s Senior Management and Board Chair had asked Claudia to recommend a course of action that would rectify problems with this undertaking. They were expecting this advice to be tabled within the next two weeks. History of the Firm Northwell Medical was founded 25 years ago, as the result of a merger between a Canadian and US firm. Northern Medical, the Canadian partner, had specialized in durable hospital/medical products, while Wellness Medical had focused on consumable hospital products. Both had distributed their products in Canada and the U.S. for a decade prior to the merger, and had shared marketing and distribution services for five years. The actual merger announcement was anticipated and welcomed by most shareholders and managers. There were some initial difficulties as structures, systems, processes, roles, and reporting relationships were sorted out during the first year. By year three the merger was viewed by both insiders and outsiders as a success. Market penetration and sales accelerated while average costs declined (after accounting for one-time restructuring costs). Growth rates averaged 20% (discounting for inflation) throughout the next fifteen years in what was a fairly mature market. Northwell made aggressive investments in technology and product development during this period. Profitability grew at rates 10% above industry norms, with the return on equity averaging 18% during this period. This growth was partially stimulated by the addition of new and/or improved products, but it was largely due to Northwell’s spreading reputation for value, service and support. They won market share from competitors, even though their price structure was typically 2% to 10% higher. As consolidation occurred in the hospital and nursing care delivery systems, it was clear that Northwell was well positioned to solidify its position as a preferred supplier amongst purchasing † This case was prepared by Professor Anthony Atkinson of the University of Waterloo and Professor Gene Deszca of Wilfrid Laurier University. Copyright © G. Deszca and A. Atkinson

agents, administrators and hospital user groups. In U.S. industry surveys of hospital suppliers, Northwell regularly placed in the top 5 for quality, service, support, and overall customer satisfaction during the two decades that followed. Northwell Medical produced a wide range of medical products for institutional usage. Products ranged from consumable patient supplies such as wound dressings, bandages, and disposable surgical supplies to more durable products (e.g., IV units, walkers, canes). In addition to the products it produced, Northwell used its sales network to distribute high quality, higher margin products, sourced largely from European and smaller North American specialty manufacturers. Ten years ago these accounted for 10% of the products listed, 15% of sales and 6% of the profits, and by the most recent year end they represented 10% of products listed, 15% of sales and 25% of profits. These products included hospital beds, wheel chairs, and orthopedic supports (braces for limbs and neck). The intent was to provide purchasing agents and their therapeutic committees with one stop shopping for their medical product needs in particular product categories. Northwell’s production facilities were located in the US, Canada, and Mexico. The Canadian plant specialized in products that involve metal fabrication (approximately 20% of total manufactured products, 25% of sales and 30% of profits in the most recent year end), while the two US plants manufactured both plastic and fabric related product (40% of manufactured products, 30% of sales, and 15% of profits). The Mexican plant also produced plastic and fabric related products (20% of manufactured products listed, 15% of sales, and 10% of profits). In addition, Northwell sourced manufacturing services for some of its products in the Asia-Pacific area (10% of manufactured products listed, 10% of sales, 15% of profits). In North America, Northwell marketed and sold its products primarily through its own sales force. In addition, a number of medical product distribution companies carried some or all of the Northwell line. They were prequalified by Northwell and tended to service smaller hospitals and nursing homes, medical and dental offices, and regional medical product retail supply outlets. The prequalification checks included financial stability, reputation, and service quality. Those selected, committed to agreed-to minimum sales volumes. Distributors were not given exclusive territories, but over the years they had sorted themselves out in ways that meant that most American markets were well serviced. These independent distributors accounted for 25% of sales and approximately 30% of the profits. Wholesale prices allowed for dealer margins that varied from 15% to 30%, depending upon the type of product and the complexity involved in selling and servicing the product (e.g., in-service hospital staff training in product use). Over the years certain managers and board members had expressed interest in extending their activities into foreign markets (Europe and Japan were the ones most frequently mentioned). However, Northwell had shied away from these opportunities, due to concerns over their ability to compete and the belief that there were more profitable growth opportunities available in North America. Throughout the years, at the request of specific European firms they trusted, Northwell had engaged in the export of a limited range of relatively unique products. For the most recent year end, these accounted for approximately 5% of sales and 5% of the profits. Growth and profitability slowed at Northwell nine years ago and flattened thereafter. A year ago, sales growth was 4%, profitability had fallen to 6% of sales and the return on equity was 6.5%. Their reputation as a benchmark to be emulated in the medical products sector was now a memory. Two notable new product failures about a decade ago had resulted in staff changes and a new Director of New Product Development. Since Sales and Marketing were seen as the primary clients of New Product Development, funding responsibility for R&D shifted to Sales and

Marketing eight years ago. The changes succeeded in reducing costs in this area by 33% through more careful screening and approval processes and tighter budget controls. However, within two years of the change, most of the output from New Product Development was in the form of incremental product improvements, and there was limited work underway in the area of significant product innovations. In an effort to increase their productivity, new product development personnel restricted their direct field involvement with sales personnel and clients. The problem/opportunity finding role was delegated to marketing and sales personnel, who were expected to forwarded project and product suggestions to the Product Development Approval Team. The Director of New Product Development chaired this committee, with representation from Sales, Marketing, and Finance/Accounting. The percentage of sales coming from products introduced in the previous four years declined from 25% a decade ago to 8% a year ago. Finger pointing had become the order of the day, as frustration surfaced over the slow pace of innovation. New Product Development staff complained about a lack of resources, equipment, and bureaucracy, while Sales and Marketing personnel grumbled that Northwell’s reputation as a problem solver and innovator was being eroded due to the inability of R&D to deliver the right products at the right time and price. Profitability was negatively affected during the past eight years by competitive pressures on price and customer servicing costs. Northwell was still a preferred supplier, but the emergence of health care cost containment pressures and powerful buying groups had reduced Northwell’s capacity to command a price premium. More importantly, key competitors caught up with Northwell in the areas of sales, support, and solutions, but were able to do so in innovative ways that reduced their sales costs (e.g., call centers, logistical streamlining, and electronically distributed training support). Sales and servicing costs at Northwell were now approximately 15% higher than their key competitors. However, customers did not perceive significant differences in the levels of support and responsiveness. Exhibit 1 summarizes the financial results and performance over the last 4 years.

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200

400

600

800

1,000

1,200

1,400

1,600

1,800

Dollars

Year

Northwell Medical

Revenue 1,680 1,500 1,440 1,382

Cost of goods sold 941 840 778 719

Gross margin 739 660 662 664

Selling and administrative costs 569 570 561 553

Profit 170 90 101 111

Most Recent Year End (YE)

Previous Year (YE-1) YE-2 YE-3

The Medichek Opportunity Two years ago Northwell’s Senior Management Team received clear feedback that stockholders were very dissatisfied with cost containment and market expansion activities. At that time, the Board replaced the Vice Presidents of Sales and Manufacturing (the President was replaced in a year earlier). All 3 appointments were from outside the organization – something unheard of in the past. In addition, the Board instituted performance contracts with members of the Senior Management Team. These performance contracts required the following improvements to be achieved within a four year period: sales growth of 30% over levels in the most recent year; a return on equity of 18%; a return to gross profitability levels that exceeded industry averages by 10%; 15% of sales coming from products introduced in the previous 4 years; and a return of customer satisfaction levels to those achieved a decade earlier. Nathan Daniels, the V-P Marketing and Claudia Leung, the CFO, had grown up in the Northwell and both had the trust and respect of the new CEO and the Board Chair. Both were appointed to their senior roles three years ago, following the early retirement of their predecessors. Approximately 2 year ago the CEO gave them joint responsibility for identifying growth opportunities. Nathan and Claudia had bumped heads in the past over the value of marketing expenditures, but they recognized the assignment’s importance and decided to set aside past difficulties. Both possessed a strong interest in emerging information technologies and this quickly led them to investigate Web-based marketing, distribution, and E-commerce opportunities for Northwell. Research conducted three years ago, told Northwell that their primary customers were either currently able to order and receive information over the Internet or soon would be Internet- enabled. Sales personnel reported that an increasing amount of their customer communications was being conducted over the Internet and that Northwell’s capacities in this area were lagging behind their key competitors, as they were in other areas of technologically enabled customer support. Further, many of these primary customers seemed quite interested in exploiting this technology to enhance efficiency, speed, communications, and the efficacy of training and development. These interests seemed to fit well with the ideas that Nathan and Claudia were pursuing. Shortly after being assigned responsibility for identifying growth opportunities, Nathan and Claudia decided to meet with the senior management of Medichek. Medichek was an emerging net-based U.S. firm, specializing in health care. They had been founded eight years ago, were located in Dallas, were growing very quickly (200+% per year) and had 275 employees. Medichek’s primary business was the design and management of Web sites for a number of leading health care organizations (hospitals, nursing homes, pharmaceutical manufacturers and distributors, medical product manufacturers), including Northwell’s (as of approximately 2 years ago). In addition, three years ago, Medichek launched a subscription service that provided on- line access to medical information to health care professionals and researchers. This was an expensive service to develop and maintain, but subscriber growth over the first 18 months exceeded Medichek’s expectations by a factor of 2. Medichek had a reputation for innovation, honesty, responsiveness, quality, candidness, and trustworthiness. They were very selective in terms of whom they chose to do business with. It was said that Medichek picked its clients and those who were selected were the lucky ones. Medichek was 75% owned by the five individuals who had founded the company (all were in their 30’s and directly involved in the business). They had resisted take-over and IPO opportunities, preferring to develop and control their own organization. Nathan first met the Medichek’s owners 3 years ago, when he was looking for a Web-site designer for Northwell. True to form, it was Medichek who, after careful deliberation, selected Northwell as a client.

While initially “put off” by Medichek’s approach, Nathan and Claudia quickly became fans, and this enthusiasm extended to other members of senior management. Their work was fairly priced by industry standards, but more importantly, their strategic approach to site design and management resulted in customer accolades and industry awards in recent years. Sales and marketing personnel responded favorably to Northwell’s new website, when it went live, reporting positive customer reactions to its layout, content, and functionality. Though they still felt that technology enabled customer support was lagging (e.g., electronic access to technical training support materials), they viewed this as an important step in the right direction. Medichek’s owners and employees often commented about how comfortable they felt working with Northwell. They particularly appreciated Northwell’s commitment to dealing with its clients in ways that emphasized customer knowledge, value, and informed decision-making. Medichek officials complained that Northwell’s decision-making sometimes took too long, that Northwell over-attended to cost rather than value, and that Northwell had difficulty keeping its “fingers out of the pot” once decisions were made. However, they discounted these frustrations, chalking them up to Northwell’s concern for quality and competitiveness. During the development of Nothwell’s website, it became apparent to Claudia and Nathan that there might be good reason to get closer to Medichek concerning another venture they were pursuing. Medichek had been exploring the development of a virtual health service mall, for use by the health care industry. The idea was that professional end users (hospitals, nursing homes, physicians, pharmacists) could access this site in order to electronically shop for the products they needed. Products and services supplying firms would be carefully screened to ensure that they met quality, value and customer service standards. Quotes could be solicited, orders placed, and payments received electronically. Further, the mall would serve as a primary source of product information, product warnings and recalls, educational on-line health care forums, health care news, and distributed web-based training in health care matters (e.g., product use education). From the initial meeting on the virtual mall approximately two years ago, Medichek was clear that it wanted to partner with Northwell in the development of this undertaking. They proposed that the mall be established as an independent business unit and that Northwell and Medichek own it equally. Northwell would commit to becoming a prime occupant in the mall and would supply the needed development funds (estimated at $5 to $10 million). Medichek would develop the necessary technology platforms, structure the services and pricing arrangements with mall occupants, structure the entry criteria, and market the mall service. Medichek’s reputation would prove very helpful here. They estimated that it would take a year to make this project a reality. Nathan and Claudia were excited by this opportunity. It had the potential to significantly reduce costs for both customers and suppliers and provide Northwell with opportunity to dramatically extend its reach into foreign markets. Though quality competitor products would also be listed at the mall, these were already readily available in the marketplace. More importantly, the mall would be selective concerning who was allowed to be listed and exhibit. When combined with the quality of the information, news and other services available, it was anticipated that there would be a very positive halo cast on firms allowed to market their goods and services at the site. When Nathan and Claudia talked to Northwell’s IT group and the CEO about this opportunity, interest and excitement spread. Sales and marketing personnel also expressed interested, but were concerned with the implications on existing channels of distribution and customer contact. This was a company that had built its reputation on its personal relationships with its distributors and customer (i.e., responsiveness and support), and they were concerned with how things would be affected by this new venture. Nathan and Claudia asked them to relax and give the

new venture time to develop. They told staff that the new venture would increase the exposure and reach of Northwell, thereby opening up new opportunities. Channels would not change overnight, and staff was advised that Northwell would monitor things closely and help employees adapt and transition into new roles, as needed. They were told that this was new territory for everyone, so the keys were to be patient and open-minded, communicating information, questions, and concerns in a timely fashion. Claudia worked with the Medichek’s CFO to develop the business plan, projections and a Letter of Understanding during April a year ago. Northwell’s Board was first informed of the possible opportunity in January a year ago. In May, Northwell’s senior management team recommended the partnership (as set out in the Letter of Understanding), to its Board. Medichek and Northwell jointly signed the Letter of Understanding in June a year ago, with the first $2 million installment of development support issued in June. Northwell’s managers were shocked (pleasantly) by the speed of the approval process. Primary responsibility for managing the relationship with Medichek was assigned to Claudia. During the latter half of the previous year Medichek hired additional staff and proceeded with the development work. By February of the current year Northwell had advanced $4.5 million in development support. During this period Northwell had focused on shoring up it internal operations and improving its profitability. By December of the previous year, products introduced within the past 4 years had grown to 9% of sales, and growth had increased 12% over previous year. Profitability had improved to 10% of sales and an 8% return on equity, and customer satisfaction results had improved marginally. Both the Board and the Senior Management Team were pleased to see progress, but felt there was still a long way to go. Discussion amongst these groups clearly indicated that they saw the virtual mall as the initiative with the greatest potential, as well as the greatest risks. Personnel in sales and marketing expressed increasing concern over how their functions and roles would be affected by the new venture and what would be the impact on their customers. Nathan continued to tell them to relax while they were waiting to see how roles and functions would need to adapt in the wake of the virtual mall. Though he couldn’t guarantee there would be no job losses, he truly believed this new venture would open up significant new opportunities and more meaningful customer relationships for many. In spite of these words of reassurance, the number of voluntary resignations in these areas rose by 15% and there were rumours that others were looking as well. Many of these resignations involved individuals viewed as high performers. In addition, some distributors were also expressing concern and looking for alternative lines of business to represent, in the event that they became redundant to Northwell. Human resources advised the executive to slow its recruiting initiatives for departing personnel until the effects of the new venture were better understood. Nathan and other senior managers in sales and marketing saw the wisdom in this advice, but they were also concerned about sending the wrong message to staff, customers and distributors. As a result, recruitment was slowed, positions were left unfilled for longer than in the past (150 days on average vs 60), and contract employees were brought in to help, where needed. The consideration of a new call center was also put on the back burner until the ramifications for Nothwell of the virtual mall were better understood. By April the Senior Management Team was placing increasing pressure on Claudia to get the mall up and running. Marketing of the mall was going extremely well. Product and service suppliers had been solicited and screened and a critical mass of these organizations was signed and ready to go (i.e., their initial product information, visual material, and related systems and supports were developed). The news and related information services and site features had been developed, staffed and beta tested by those who would be using the mall. Primary customers

were anxiously awaiting access to the new service. However, Medichek reported that the development of the technological platform and related supports (in particular, the E-commerce and security components) were proving more difficult than originally anticipated and that the complete Mall’s formal launch was about 4 months behind schedule. Claudia began to spend more time monitoring the pace of developments at Medichek. Monthly visits became weekly. In May she requested bi-weekly reports on progress achieved, funds expended, and the time allocations of the various project teams. These were very similar to the reporting Northwell required from its own operations. Relations with Medichek chilled in response to the increased frequency of site visits and the request for more detailed reporting. At first they resisted complying with the reporting request, but after a month of mounting pressure they acquiesced. Medichek’s senior management wrote that such information would be furnished under duress, because it would serve no useful purpose, be expensive and time consuming to develop, and divert attention from where it was most needed. The resignation of three more capable staff members from the sales and marketing area and the loss of a valued distributor from the mid-west U.S. in the late spring elevated Nathan’s anxiety over progress and he wanted to know just how much longer it would be before “Virtual Northwell” would be fully operational. Nathan continued to believe that it would be unwise to make major changes in sales and marketing until they really knew how customers would react to the new channel. He felt that it was difficult to predict, with any degree of certainty, what the ideal approach to sales and marketing should be, and he preferred to adopt an approach that reacted to what evolved as a result of the new channel. However, he was also aware of the need to address employee and distributor uncertainty as quickly as possible, recognizing that the “be patient until we have a better understanding” strategy was not working well. Since Claudia was in change of the new venture and since there would be organizational design, budget and control implications, he wanted Claudia’s advice on how best to handle the matter. When Medichek reported continuing development problems in July, Senior Management at Northwell voiced increasing dissatisfaction with the progress to date and asked Claudia to recommend a course of action that would rectify matters. Questions for Class Discussion

1. What are the management and strategic issues that Northwell face? 2. What are the opportunities, costs, benefits, and strategic implications of developing the

Internet site?

3. What decision would you make here and how would you implement your choice?