Intermediaries Must Produce or Get Out

Intermediaries that don’t add value don’t belong in the supply chain

Published: Monday, April 18, 2022 - 12:03

Ryan Day¹ describes how the rise of independent auto dealers is a “gray swan” event for the automobile industry. This was not only bound to happen, as observed by the author, but also long overdue. The article states, “...current state laws prohibit OEMs from selling new vehicles directly to consumers (D2C). Selling directly would cut out the dealership franchise—the middleman—and all the associated price markup fees. This could theoretically save car buyers an alleged 30 percent of the cost of a car.”

This problem has been known for decades, and it is not something the supply chain’s value-adding stakeholders should continue to tolerate. Dealerships do not add value to the transaction, but if the 30 percent figure is correct, then $7,500 of the price tag of a $25,000 vehicle constitutes pure waste. My recommendation to consumers, as an immediate recourse in the absence of changes of the laws in question, is to game the system by waiting until the end of the model year to buy a new car. The car is still new but, as it is now last year’s model, the dealership must offer a substantial discount to get it off the lot to make room for more inventory.

The inability to move new cars should meanwhile encourage manufacturers to demand changes in the distribution system, and also might encourage one or more states to break ranks by allowing D2C sales. An incentive is that the state in which the sale takes place gets the first cut of the sales tax. If, for example, the car is sold in Pennsylvania, where I live, 6 percent of the $25,000 sale comes to $1,500. If the customer is from another state where the sales tax is 7 percent, he or she must pay another $250 to that state, which would have otherwise gotten $1,750 had it allowed D2C sales.

The bottom line is that any entity that needs laws to keep it in a supply chain does not belong in the supply chain. Henry Ford² made this clear more than 100 years ago: “If their money goes to complicating distribution—to raising barriers between the producer and the consumer—then they are evil capitalists, and they will pass away when money is better adjusted to work....”

Regarding unproductive jobs, Ford added, “This did not mean that six out of 15 men lost their jobs. They only ceased being unproductive. We made that cut by applying the rule that everything and everybody must produce or get out.” Ford did not fire the people in the unproductive jobs; he moved them into value-adding jobs. This rule must, however, apply to supply chain partners as well as employees. A supply chain can no more afford to carry a nonvalue-adding middleman than it can to carry employees whose jobs do not create value.

Do pharmacy benefit managers belong in the supply chain?

There is also a controversy about the role of pharmacy benefit managers (PBMs) in medication supply chains.³ “The companies act as middlemen between health insurance providers and pharmaceutical manufacturers, and the middlemen known [as] PBMs create the rules that can line their pockets with our money.” The editorial adds that the PBMs’ “formulary exclusion lists” can block access to specific medications that doctors prescribe.

The first question, then, is why PBMs are in the supply chain at all. They add costs for patients and manufacturers, but it is difficult to see where they add value. The second question is what patients can do to bypass them, noting that any licensed pharmacy can dispense any medication that is prescribed by a doctor. The fact that insurers work through PBMs looks like an obstacle, but the truth is that some medications cost less without insurance than with it.⁴ The reference adds, “Behind the seemingly simple act of buying a bottle of pills, a host of players—drug companies, pharmacies, insurers, and pharmacy benefit managers—are taking a cut of the profits, even as consumers are left to fend for themselves, critics say.” If PBMs’ sole contribution is to take a cut of the profits, then they should be bypassed if possible.

The same issue applied to the controversy over the high price of Mylan’s EpiPen, an epinephrine injector for emergency use against anaphylactic shock. “My frustration is there’s a list price of $608,” says Mylan CEO Heather Bresch,⁵ who complained that the price reflects a system where there are “four or five hands that the product touches and companies that it goes through before it ever gets to that patient at the counter.” She adds that Mylan got only $274, or 45 percent, of the $608, which leads to questions as to what the “four or five hands” did other than to take a cut of the sale price.

Although I am not familiar with Mylan’s business model, my own inclination would be to channel Henry Ford to see what could be done to get those hands out of the supply chain entirely. The consequences of tolerating nonvalue-adding intermediaries are meanwhile self-enforcing, especially noting that 1) synthetic epinephrine has been around for more than 100 years and therefore cannot be patented; 2) while the current EpiPen is still under patent, the original design (U.S. Patent No. 4,031,893) is now in the public domain. Therefore, anybody is free to build and market a generic injector that does not infringe on the design in the current EpiPen patent, and the $608 list price for the EpiPen in 2016 (changed since then) was an open invitation to act on this.

Generic injectors were in fact marketed, and a doctor published instructions on how to make your own emergency kit with 1) epinephrine prescribed by a doctor; and 2) a syringe and needle. The overall cost was roughly $10. The drawback is that the user must, in an emergency situation, draw the correct dose into the syringe and then self-inject, as opposed to just inserting the auto-injector’s needle. Users can, however, practice the drill repeatedly until they can perform it almost without thinking, and syringes can be selected to hold the correct dose without the need to look at the graduations. Prefilled syringes also are available. The bottom line is that when you sell something for $608 that allegedly costs less than $40 to make⁶—two injectors at $20—people can and should look for ways to avoid using your product.

The music industry

There was a time when musicians did not make much money even from million-album sales.⁷ The reference claims that bands made, on average, only 13 cents for every dollar in sales. The balance went to distributors and the record label. Now, however, most bands make their music available for free on YouTube, not because they want to give it away, but because they want listeners to buy the music from their own websites. This again cuts nonvalue-adding intermediaries out of the transaction to give buyers lower prices and more compensation to the value-adding musicians. Downloading the music directly, e.g., in MP3 form, also removes the cost of the manufacture and distribution of physical media such as CDs.

Another issue in the entertainment industry consists of “convenience fees” added onto the price of live entertainment tickets.⁸ I cannot identify any value the middleman adds that is worth $50; smart consumers should look for ways to buy the tickets directly. You can buy entertainment tickets from street vendors and booths in Las Vegas, for example, to skip the convenience fees.

The apparel industry

Another business model that consumers should reject is retailers buying cheaply made clothing from low-wage countries, applying a fancy brand nameor celebrity endorsement, and charging an enormous markup. One brand of ripped jeans—the kind you could probably not give to the Salvation Army—costs upward of $120, and the country of origin is cited only as “Imported.” If it was imported from a high-wage and high-quality country like Italy or France, it would say so, and items sold by the website in question do cite Italy when this is the country of origin. This tells me it is probably from a low-wage and low-quality venue instead, and similar items can be bought at Walmart for less than $20. This issue also ties in with that of inflation, and the need for consumers to demand value for their money. Remember that you wear clothing, not a brand name or a celebrity endorsement, so the mere presence of an upscale brand name or celebrity endorsement is prima-facie evidence of waste.

Summary

It is a basic lean principle that any operation in a process that does not add value, such as 1) setup and handling; 2) inspection; 3) transportation; and 4) waiting, is waste or muda by definition. Lean practitioners seek to reduce setup and handling with, for example, single-minute exchange of die (SMED), while defect prevention and automated inspection are preferred over traditional manual inspection. Work cells and single-unit flow reduce the need for transportation, and also waiting in the context of batch-and-queue operations.

If, however, goods that leave even the leanest factory must then pass through the hands of entities whose sole function appears to be to take a cut of the sale price, these lean benefits go away very quickly. Therefore, producers and customers must take a close look at what each intermediary does to add value; if they cannot find an answer, that intermediary does not belong in the supply chain. Meanwhile, intermediaries must ask themselves what they do to add value to a transaction; if they cannot identify this value, they need to look for ways to add it if they want to remain in the supply chain.

References
1. Day, Ryan. “Independent Auto Dealerships: An American Gray Swan?” Quality Digest, Jan. 31, 2022.
2. Ford, Henry, and Crowther, Samuel. My Life and Work. Doubleday, Page & Co., 1922.
3. The Dispatch Editorial Board. “Our view: ‘Middlemen’ tactics increase costs, reduce healthcare options.” The Columbus Dispatch, June 21, 2021.
4. Ornstein, Charles, and Thomas, Katie. “Prescription Drugs May Cost More With Insurance Than Without It.” The New York Times, Dec. 9, 2017.
5. Mangan, Dan, and Balakrishnan, Anita. “Mylan CEO Bresch: ‘No one’s more frustrated than me’ about EpiPen price furor.” CNBC, Aug. 25, 2016.
6. White, Martha C. “It’s Jaw-Dropping How Little It Costs to Make an EpiPen.” Money.com, Sept. 7, 2017.
7. Masnick, Mike. 2010. “RIAA Accounting: Why Even Major Label Musicians Rarely Make Money From Album Sales.” Techdirt, July 13, 2010.
8. Glum, Julia. “Why Ticket Service Fees Are So Annoyingly High—and How to Avoid Them.” Money, June 24, 2021. 

About The Author

William A. Levinson

William A. Levinson, P.E., FASQ, CQE, CMQOE, is the principal of Levinson Productivity Systems P.C. and the author of the book The Expanded and Annotated My Life and Work: Henry Ford’s Universal Code for World-Class Success (Productivity Press, 2013).