Having Addressed Threats from Resellers, Channel Enjoys Renewed Tailwinds
(A Green Circle Capital White Paper)
by Bakley Smith, CFA, Director – VMS, Green Circle Capital Partners
October 2021 ©
Takeaways
- Leading companies in the practitioner channel have taken corrective actions against the threat of unauthorized online re-sellers, or what we call “channel bleed.”
- Coupled with strong tailwinds, including the behavior changes related to COVID-19, the sector may be poised for continued robust growth.
- The leaders in the channel must continue to iterate and strengthen their position against the threat of unauthorized online resellers. They must also work to broaden the definition of the channel to adapt and change with constantly evolving consumer behavior.
- The industry needs a way to track and report sales via medical practitioners. It is currently held back by the lack of an AC Nielsen or SPINS-like data service.
What Is the Practitioner Channel?
The practitioner channel, as traditionally defined, is a sales route for dietary supplements where the seller (or retailer) is a practicing doctor, nutritionist, or other accredited healthcare practitioner. These products, though sold through the practitioner channel, are still regulated by the FDA as dietary supplements and are not FDA-approved as pharmaceuticals. They do not require prescriptions or the involvement of pharmacists as required for prescription pharmaceutical products. Practitioners traditionally buy the products directly from manufacturers at wholesale prices, and then sell the products to their patients, either in their clinics or via dedicated online dispensaries. We should note that some leaders in the space see the frame more broadly – they include products sold on the recommendation of a practitioner, but not necessarily by the practitioner as part of practitioner brands’ opportunity set.
While we know that practitioner sales represent billions in annual revenue, it is difficult to quantify that amount with specificity. For instance, we understand that Nutrition Business Journal (NBJ) includes medical nutrition like Boost and Ensure, and supplements sold at gyms, in its practitioner channel definition. When including such product sales in an assessment of the size of the channel in 2020, the channel accounted for $4.8 billion in revenue. As was the case with many businesses, the practitioner channel was adversely impacted by the pandemic, and with gyms closed in many parts of the country all last year, it is likely this area was impacted more negatively than the products sold at doctors’ offices, which were allowed to open sooner.
Source: Nutrition Business Journal 2020 Annual Report ($mil, consumer sales)
Many practitioners who sell supplements maintain product inventory in their offices and sell to patients when they come in for examinations, testing, procedures, or ongoing treatments. This could be called the “traditional model,” where the practitioner functions like a retailer, maintaining inventory and selling in-person to a patient.
We are well aware that the COVID pandemic hastened changes to this model that were already taking place, and this will be a key topic of our paper: How can we move to an omni-channel, online-based sales methodology that frees the practitioners from having to maintain inventory and manage the associated logistics of physically selling products? The shift to online dispensing provides patients the convenience they have grown accustomed to when they purchase other types of products.
In early 2020, we interviewed several leading investors in the supplement space and asked them for their views on the practitioner channel. While they generally noted positive drivers for the channel, most were also cautious on the outlook, and a few we spoke to were actively investing in practitioner brands.
The Perceived Risk of Online Channel Leakage
For much of the last decade, practitioner channel brands have been forced to contend with pressure caused by “channel bleed,” which is defined as direct-to-consumer sale of practitioner-only products by unauthorized online resellers who sell outside the proper channels, often undercutting authorized practitioners on price. Unauthorized online retail sales undermine a long-standing and fundamental value proposition for practitioner-focused brands: These products are available only from medical professionals, and they are to be used only with medical guidance from trained practitioners.
Despite the benefits of in-office visits, online retail often is far more convenient for end users, many of whom buy a majority of their day-to-day consumables online. Unauthorized resellers of practitioner-only brands are simply responding to consumers’ natural preferences for easy access, rapid home delivery, and discount pricing. Vern Christensen, Managing Director at Partnership Capital Growth, Chairman at Designer Protein, and former VP Strategic Development at Nutraceutical Corporation for many years, highlighted the issue of distribution control, saying, “The control of distribution is a major issue that all brands will face… Distribution growth will become more direct-to-channel (DTC) focused – and hopefully, brands will be able to control where products are sold online and get a better ‘prescription’ model.”
These dynamics have created a profound challenge for the practitioner-only brands: How can we maintain the practitioner-only value proposition and enforce pricing that provides economic support for holistic/functional/integrative medical clinics (most of which are excluded from insurance coverage), while also enabling consumers to obtain practitioner-recommended products, in a convenient way and at affordable prices?
Investors recognize this conundrum. When we asked Rachel Sexton, Innovation & Strategy Director, Vitamins, Minerals and Supplements at Reckitt, about the biggest challenges to the practitioner channel, she said, “Leakage to online – need to consider omnichannel approach on how the recommendation can be made for a practitioner supplement and then repeated.”
Source: Nutrition Business Journal 2020 Annual Report ($mil, consumer sales)
Others were more explicit about their concerns that channel drift to online outlets, such as Amazon, diminished their desire to invest in the space. Jason Van Camp, Director at Glanbia, when asked about his outlook on the space, said, “Not favorable. As consumers learn more about the products they are purchasing, it will become more likely that those consumers will purchase those or similar products through channels with more favorable pricing.”
Concerns about the practitioner channel’s positioning relative to online options are well-founded, according to our colleague Erik Goldman, founding editor of Holistic Primary Care, a longtime industry observer. Mr. Goldman describes a lengthy game of “whack-a-mole,” where practitioner brands spar with unauthorized resellers of their products on Amazon and other e-commerce sites. Many brands spend considerable financial and human resources tracking the sources of the online leakage, which is often attributable to unscrupulous practitioners who agree to the company’s terms and guidelines. Then, they order large volumes of product, only to turn the product over to an unauthorized online reseller in exchange for a cut of the proceeds.
Once a point of leakage is identified, a company will typically terminate the purchasing contract with the offending practitioner. But market pressures are such that there is always another practitioner willing to work with the resellers.
This game actually began more than a decade ago, according to industry expert Edward Hauck, of Nutrition Business Advisers. Mr. Hauck is also the former CEO of Klaire Labs and the former President of Healthy Directions. Both Mr. Goldman and Mr. Hauck agree that the initial emergence of Ebay and then third-party sales on Amazon that led to unauthorized resellers providing healthcare practitioner brands. This loss of distribution control had a negative effect on practitioner brands.
Corrective Actions Making a Difference
Conversations with well-placed industry participants and observers suggest that leading practitioner brands may have turned the corner. Our research over the last 18 months has consistently indicated that the key reasons the unauthorized resellers made an impact were the product’s low price and its convenience. As the music industry circa 1999 showed, when consumers could buy something at a lower price with relatively the same (or greater) convenience, they did it, with little regard for the legitimacy of the selling outlet.
One of the key needs, in our view, has been for industry players to work on an ongoing basis to increase convenience and manage any price gaps that exist between legitimate sellers and off-price resellers.
Many top practitioner brands have worked to do just that. A leading executive in the space recently informed us that today there’s often just a small price gap between resellers on Amazon and legitimate practitioners. The industry has taken steps to narrow the gap. Mr. Hauck confirms that the threat of the “online Wild West” was much greater in 2011 than it is a decade later in 2021.
E-Commerce platform solutions, like Wellevate by Emerson Ecologics and Fullscript (formerly Natural Partners Fullscript), are putting practitioners on equal ground with questionable Amazon resellers and are leveling the playing field. This allows the practitioners to offer online ordering and at-home delivery services for those who want them, while maintaining the exclusivity of the clinical setting and the revenue streams that many holistic practitioners need for the fiscal viability of their practices.
It is important to view the challenges presented by channel bleed within a broader context which, overall, is favorable for the practitioner channel. Many people today are dissatisfied with conventional allopathic medicine and seek ways to take personal responsibility for their health and wellbeing. In record numbers, they are searching for alternatives to conventional care, and despite the setbacks caused by clinic closures during the early phases of the COVID pandemic, the practitioner channel still shows positive compound annual growth rate.
It is a challenge to obtain accurate sales data on the channel (which we discuss later in this paper), and we are often forced to rely on anecdotal comments from industry insiders and observers to get a sense of what is happening. That said, those sources consistently suggest that performance has improved considerably in recent years.
One well-placed executive said, “We’re about three innings into a nine-inning game, but we do not believe pricing is driving people to Amazon at this point.”
Roy Chin, Principal of North Castle Partners (a leading private equity investor in the supplement industry and other areas of the health and wellness economy), believes the new hybrid online/practitioner model represents the future of the industry, which he believes has a strong outlook. The “old school” model, wherein individual docs are selling product out of their offices like a store, is not where we are going, according to Mr. Chin. In fact, he thinks those brands investing to develop hybrid “omnichannel” capabilities, where the practitioner represents a key link in a bigger chain and functions as an ambassador for a brand, will have the most success over time.
This setup favors brands with perceived quality benefits and strong reputations. Not every manufacturer or brand has sufficient financial resources to create the specific structural changes to sales and marketing that are now needed in the industry. However, brands such as Designs for Health, Biotics Research, Metagenics, and Integrative Therapeutics, have quality attributes, brand development, and a demonstrated willingness to adapt. All of these factors should support continued growth as the industry evolves. On the other hand, one thing we noted in our conversations is that not all brand managers necessarily think they need to change. It is likely that some of those, many of which may be smaller brands, will not survive the competitive threat posed by brands with an omnichannel sales strategy, or the threat from unauthorized online resellers and changes in the practitioner-patient relationship dynamic.
We assert that channel bleed is here to stay, and that the best practitioner brands will continue to iterate and adjust their distribution models to accommodate the expectations of their customers.
Let us take a step back and take a look at what works and what does not work in the practitioner channel.
Drivers for Growth
The practitioner channel is a unique distribution channel for supplement products. It is growing at a healthy rate, outpacing the supplement space over the last five years (which itself is growing faster than other non-durables, such as food and beverage).
There’s no question the COVID pandemic hurt sales in 2020, according to NBJ. During the early months of 2020, many clinics were forced to close entirely or to strictly limit in-clinic patient visits. On the patient side, most people avoided any but the most urgent and necessary medical services.
By the 3rd quarter of 2020, many of the clinics that had suspended operations were reopened and serving patients at close to pre-pandemic volumes. A large number of medical practices (estimates vary) weathered the COVID storm by augmenting their in-person services with teleconsultations.
But some practices—particularly solo and small group practices run by older physicians—closed for good. They simply did not have the resources or resilience to survive the pandemic.
The COVID pandemic had profound impact across all fields of medicine, and it has reshaped the healthcare landscape in ways we are just beginning to understand.
For starters, the pandemic forced many people to recognize the fragility of their own health as well as the limitations of the nation’s healthcare system. “Immune system strength” became a major concern for a lot of people who had previously considered themselves invulnerable. The intense public interest in immunity and resilience was reflected in massive sales surges for “immune system” supplements in the DTC retail channels.
Many industry watchers expect these benefits to continue as consumers remain conscious of health and wellness, even with the end of the pandemic in sight. The industry’s margin profile is strong, and investors see value in the premium pricing associated with practitioner recommendations.
There are other important growth drivers to consider: The U.S., like most other industrialized nations, has an aging population, a large segment of which is highly health-conscious and eager to maintain vitality, well into the 8th and 9th decades of life. Dissatisfaction with mainstream care is driving some older people to seek the services of naturopaths, chiropractors, functional medicine physicians, nutritionists, health coaches, and practitioners of Ayurveda, Traditional Chinese Medicine (TCM), and other non-Western methods.
Further, the supplement industry itself—and especially the practitioner-focused brands—have become increasingly sophisticated. They have developed product lines customized to specific conditions and, in some cases, entire product protocols keyed to genomic and metabolomic tests. The supplement industry has become more effective in messaging product benefits in terms of “root causes” and whole-systems changes, rather than in terms of simple symptom relief. All of these trends favor the continued growth of the practitioner supplement space.
Before the global pandemic took hold in the first quarter of 2020, we interviewed some leading investors, but the intervening disruption to all business put our research on hold. With the rollout of effective vaccines and an improving outlook for 2021 and 2022, we went back to some of those same participants to see what had changed.
The experts we spoke to come from venture firms and private equity companies as well as larger supplement companies. All of them are highly experienced and have invested in or led supplement companies over the last 20 years.
While the original respondents noted outsized growth for the practitioner channel, only a few were enthused about putting new investments into the space. The reason most commonly given was the aforementioned channel bleed and the associated erosion of pricing power and margins. Some even raised an existential question about the long-term viability of the channel.
More recently, we followed up with our sources and found a different story, which suggests the possibility that industry participants have adapted to the new reality posed by widespread acceptance of online retail channels. Furthermore, the pandemic encouraged the extensive and accelerated use of telemedicine, a new technology that will surely have deep and long-lasting systemic repercussions for the industry. It is too early to try to quantify the scale of those challenges or opportunities. Despite the nature of the quickly evolving landscape, one important conclusion we have reached is this: Investors’ perceptions about the practitioner channel have fallen behind the reality of what is actually happening, which presents an opportunity for value creation over the coming years.
One investor, Alison Minter, Managing Director of North Castle, has added significant commitment to the space, leading her firm’s acquisition of Vital Nutrients and the addition of Bariatric Fusion over the last 18 months. [Author’s note and disclosure: Green Circle Capital acted as the sell side advisory agent for Bariatric Fusion in that transaction].
Ms. Minter notes that the practitioner space is the second fastest-growing channel of vitamins, minerals, and supplements (VMS)/nutraceuticals, but because the channel is unknown to many in the investor community, it is easier to find areas to invest in.
She notes, “We think the time to strike is now, particularly while the channel is still in the transformation stage of becoming truly omnichannel. The practitioner category is also fragmented and there are many brands out there with unique, targeted and health-based focus areas that we believe are complementary as part of a broader portfolio of practitioner-first brands.”
When we asked industry experts how the companies in the space could hope to achieve higher valuations over time, the answer was clear: Solve for online competition and “channel bleed.” This situation could present a compelling investment opportunity for those who are able to navigate the known risks from online competition. It is often the case that the highest returns come from investments in companies or industries that have begun to turn things around but still suffer reputationally from a prior issue, and we see evidence that this dynamic could apply here.
The Lack of Data
There is another concern that is frequently raised by investors. This concern is the lack of accurate data to track the sales transactions that occur within the practitioner channel. The channel currently lacks a broad system akin to the SPINs or AC Nielsen scanner data systems, both in wide use in the retail channel. Practitioners who dispense supplements in their clinics order products directly from the manufacturers and/or they use online dispensaries like Emerson Ecologics, Natural Partners, Doctors Supplement Store, and others. Estimates of sales in the channel are based on reports from these companies. But unlike the DTC retail space, there are no centralized and readily accessible sources of transaction data to fully quantify practitioner-to-patient product sales.
Investors we spoke to were not comfortable with company-specific claims about their practitioner sell-through. This concern was echoed by Brent Eck, CEO of Metagenics, one of the largest players in the space. A clear example of the issue: It took around six months for us to learn what the industry sales were for 2020, and we will not be able to assess 2021 until around June of 2022. Explicitly, there is no central data source from which we can collect detailed and timely information that can be used to form analyses on specific brands or products.
While we have always found the Nutrition Business Journal Supplement Business Report (the industry standard for information) to be an excellent and comprehensive overview, it does not generally include brand-specific sales data, and it is published only once a year. It is very difficult to get timely channel data, and this lack adds to the perception among some investors that the industry is not meeting the needs of modern consumers or institutional investors.
More timely and definitive sales data – and a more widely accepted definition for what constitutes the practitioner channel – could support valuation and investor confidence. It would also improve strategic planning within the companies themselves. That said, we live in an environment where institutional investors spend vast sums on software tools, executive roundtables, and other data sources, just to gain small trading advantages. Yet, it is inefficiencies in markets that often create the best investment returns. Might this lack of clarity on industry performance present an opportunity for some better-informed investors to gain an edge?
The Pros for the Practitioner Channel
The growth rate of the supplement industry remains well ahead of the economy and the food and beverage space more broadly. As we discussed in a previous Green Circle Capital whitepaper, “Enhancing Enterprise Value In VMS/Nutraceutical Businesses” (Nov 2017), the supplement space has numerous demographic tailwinds that support outsized growth. Updated through 2020, compounded annual growth of supplement sales has been 7.4% and 14.5% over the last five and ten years, respectively, according to NBJ which compares positively with GDP at 1.7% for each time period, according to the Bureau of Labor Statistics. It also compares favorably with Food At Home spending (groceries purchased for use at home as opposed to restaurants and foodservice purchases) at 4.1% and 3.7% over the last five and ten years through 2020, respectively, according to United States Department of Agriculture.
Supplement industry growth has been driven by a combination of an aging population concerned with longevity and vitality, increased health consciousness among young and old consumers alike, and increased specialization and sophistication of the supplements now available on the market. Consumer preferences have evolved from the simplistic one-a-day multivitamins toward more specialized, condition-targeted formulas.
The arrival of COVID-19 in the beginning of 2020 intensified some of the drivers in the space and accelerated the growth of supplements. Total supplement sales grew 14.5% in 2020, according to NBJ, more than double the growth rate of 2019. While one could naturally expect that growth will self-moderate again this year and next, we think that many consumers have also made lasting changes in their behavior. People may not be panic-buying toilet paper these days, but sales of hand sanitizer remain robust despite a public perception that the pandemic is waning. We think that many supplement products will fall closer to the hand sanitizer side of the changes.
Consumers also desire to bolster their wellness through products perceived as “clean” or non-pharmaceutical. According to Erik Goldman, founding editor of Holistic Primary Care, the impact of COVID-19 on people with pre-existing health conditions pushed many consumers to recognize the importance of staying healthy and minimizing risk factors for conditions like diabetes, obesity, heart disease, and asthma. In the past, people’s supplement choices were simple. But today, people are more motivated to choose products that can help them strengthen their immune systems, fend off infections, and minimize systemic inflammation.
Two 2020 surveys, sponsored by the Council for Responsible Nutrition (CRN) and cited by Nutritional Outlook, indicated that 37% of respondents had increased their intake of vitamin D during the pandemic. This was likely in response to research suggesting that vitamin D deficiency was correlated with acute reactions to the coronavirus. Indeed, SPINS data, cited in the same article, showed that for the 12 months ending on November 29, 2020, “In the overall mainstream channel, vitamin D sales grew 34.4% to $544 million. Meanwhile, in the natural channel overall, vitamin D sales grew 36.5% to $40 million.”
NBJ expects supplements as a whole to grow around 4% annually over the next 3-4 years. This is somewhat below the last five years but still above total food and beverage, which has projected averages in the 1-2% range. The combination of the aging population, the greater interest in wellness, and the growth of individualized medicine is expected to support the industry well beyond the present five-year horizon.
The outlook for the practitioner channel is also better than that of the entire supplement channel. There, NBJ expects growth to exceed 6% annually through 2024. This channel has performed second only to e-commerce over the last 15 years, and we suspect that most investors do not appreciate the growth and scale of the channel.
In terms of overall sales volume measured by dollars or units sold, both the e-commerce and the practitioner channels trail significantly behind the mass market and natural products retail channels. But e-commerce and practitioner channel growth has been sustained over the last five years while the natural/specialty channel, the mass market retail channel, and the multi-level channel have all slowed down.
With a 7.9% compounded annual growth in the five years between 2014 and 2019, the practitioner channel grew from approximately $2.2 billion to over $4.5 billion in total revenue at the beginning of the decade, according to NBJ. This data predates 2020 and the onset of the pandemic. In a recent Wall Street Journal article, Rajeev Misra, CEO of the Softbank Vision Fund, said, “We’ve had 10 years’ worth of change in 10 months,” and 2020 did see a big acceleration in overall supplement sales – at over 14.5%, according to Nutrition Business Journal. We predict that growth in 2021 will slow down to some degree, but some behavioral changes will probably stick.
The drivers of this growth lie in societal trends and have been documented extensively by Mr. Goldman. He sees two interrelated issues moving practitioners toward holistic/functional medicine, and toward the embrace of clinic-based supplement dispensing.
Goldman’s first societal trend is a general and widespread frustration with conventional medicine. The dissatisfaction reflects the physicians’ decreased income, increased bureaucratic hassle factors, constant oversight, conflicting incentives, diminished time with patients, increased patient volumes, and the limited efficacy of many conventional treatments. Many American physicians feel that the practice of medicine is deteriorating. As noted in a 2015 article in Holistic Primary Care:
“According to a 2012 survey of over 13,000 American physicians, conducted by the Physicians Foundation, 85% of all respondents feel medicine is in decline, 77% are pessimistic about the future, and 59% are negative about healthcare reform. Over half are considering major practice changes in the coming years.”
While the data is a few years old, we see no evidence that this trend has reversed or that morale is any better now than it was back then. This belief that conventional medicine is in decline and that legislative, regulatory, and economic changes are harming doctors and medical practices is a positive driver for alternative medicine, inclusive of the practitioner channel for supplements. Doctors and other practitioners have been feeling the fiscal squeeze for years. With higher overhead costs and fairly anaemic reimbursement rates, they need more patients to achieve steady profits. The sale of supplements is an attractive option for increasing practice revenue.
For holistic, functional, and naturopathic practitioners, supplement sales are often a necessity for the economic viability of their clinics. For the most part, these practitioners operate outside the insurance system because their services are generally not covered by mainstream insurers or federal payors (Medicare and Medicaid). Consequently, they must develop robust cash-pay practice models. For many, supplement sales represent a significant portion of their total practice revenue.
Data from Holistic Primary Care’s practitioner surveys indicate that 65% of the magazine’s practitioner-readers dispense supplements (based on 2019 survey), up from 34% in 2013. Nearly 80% of those who do dispense supplements do so via in-clinic formularies (a.k.a stores), 56% use online dispensaries (like Emerson Ecologics, Fullscript, etc.), and many use both. Eleven percent sell their own private-label “brands.”
In addition, 60% of selling practitioners marked up their supplements by 50-100% over the wholesale cost. That translates to a 30-50% gross margin for the practice, with a relatively small requirement for additional time or overhead costs to obtain this revenue.
According to HPC’s 2019 data, derived from 360 respondents including MDs, osteopaths, naturopaths, chiropractors, nurses, and nutrition professionals, 14% of dispensing practitioners rate the revenue obtained from supplements to be “essential” for economic survival. An additional 35% deem it a very important, though not essential, factor in the economic viability of their practices.
This confluence of needs is a key value driver in the industry. The practitioners need additional profits, and the patients are seeking holistic or natural (non-prescription) solutions to prevent or ameliorate their health conditions. With no signs of either of these beneficial trends changing, we expect an ongoing boost that will support the value of leading practitioner channel brands in the years ahead.
Goldman’s second societal trend is the growing adoption of “holistic” approaches to medicine. This is seen in the number of physicians that identify as “holistic” or “integrative” or “functional,” a niche that has grown steadily over the last ten years. Indeed, many practitioners who identify as “conventional” or “allopathic” now report including methods typically considered “alternative” in their practices. A few examples include recommending omega-3 fatty acids, using probiotics, and testing for gluten-sensitivity and other food allergies, all of which were considered “fringe” 25 years ago.
This underlying shift has influenced doctors’ and other practitioners’ willingness to discuss and recommend dietary approaches to health concerns. According to the HPC survey, all the respondents who self-identify as conventional/allopathic agreed with the statement that “diseases can sometimes be prevented or treated with dietary supplements.”
This shift away from prescription solutions for quelling symptoms and toward non-prescription, nutrition-based approaches that address root causes of disease supports the overall growth of supplements. It is a key driver in the expansion of the practitioner channel. Consumers have long been convinced that diet and nutrition can be effective in dealing with certain medical conditions, and they have also come to view pharmaceutical solutions with some suspicion, which at times may be well-founded.
Over the last decade, many more western physicians have come to share this view, bolstered in part by the ongoing work of pioneering researchers like Dean Ornish and Dale Bredesen, who have shown a substantial reduction of disease risk, and even disease reversal, through diet and lifestyle interventions alone.
One perceived strength of the practitioner channel is in patient compliance. Rachel Sexton, with Reckitt, said, “Consumers that are recommended a supplement by a doctor are more likely to buy, stay compliant and spend more over their life – this provides an opportunity to drive efficient reach expansion and consumer conversion.”
The investors we spoke to identify two key strengths that bode well for practitioner channel brands: One is the inherent “stickiness” and loyalty that emerges in the practitioner-patient relationship when it is based upon trust. A leading institutional investor said, “Practitioners are better able to make a claim beyond structure/function.” In other words, practitioners can discuss the use of supplements and nutritional interventions in the context of disease prevention and treatment in ways that product marketers simply cannot, owing to the restrictions imposed by the Dietary Supplements Health and Education Act (DSHEA) of 1994. DSHEA, which guides FDA and FTC oversight of all supplement products, explicitly prohibits supplement brands from making disease- or symptom-specific claims and using terms like “prevent,” “treat,” or “mitigate.”
This law does not affect practitioner-to-patient communications, and regulators have recognized licensed or license-eligible practitioners as “learned intermediaries.” In general, practitioners remain free to discuss the potential benefits of supplements, though there is a regulatory grey area around practitioner-to-patient communication in the context of clinics that sell supplements for profit.
For the most part, though, practitioners have greater leeway in discussing and explaining the mechanisms of how the ingredients actually work and the potential benefits of taking supplements. Investors recognize this as a key strength for practitioner-facing brands.
The other key strength is the large profit margin inherent in the business. Margins are high for the practitioners, but they are also high for the manufacturers. Without the need for slotting fees, at-the-register price reductions, in-store trade promotion spending, or pricing to be competitive in a vast online system, practitioner channel brands can retain pricing control and thus defend strong margins. This, of course, is viewed positively by investors in the supplement space, including Mr. Chin of North Castle, who noted margins as an area of strength.
Mr. Chin said, “One key area of practitioner brands that we like is that, in addition to insignificant trade spend, practitioner brands are able to command stronger pricing given their greater focus on premium (often branded) ingredients and science-based formulations – both of which speak to efficacy and quality. Customers are willing to pay higher prices for peace of mind about what they are ingesting.
As noted, there is strong fundamental support for the practitioner channel of the dietary supplements industry. So why aren’t we seeing a steady stream of well-funded new entrants or sustained merger and acquisition activity? Why isn’t every major consumer product and healthcare company beating down the doors of successful practitioner-focused businesses?
Conclusion: Channel Bleed – Perception Is Not Reality
Clearly channel bleed remains a problem for practitioner brands. However, the magnitude of that problem is shrinking, and the degree to which it is overstated in the minds of investors and other industry stakeholders seems to be inaccurate and the basis for opportunities.
Despite the many positives mentioned above, interest from investors in practitioner channel-focused brands has been somewhat muted. Concerns about channel bleed appear to be one of the main factors impacting investor interest, and, perhaps, valuation in the practitioner channel. A majority of investors with whom we had conversations about practitioner brands cited the impact of competition from other channels, particularly e-commerce, as their basis for not investing in the space. Jason Van Camp, of Glanbia, said, “Competition from channels with margins and convenience that are more attractive to the consumer… ” are the leading challenges the industry faces. His interest in investing in practitioner brands was subdued, at best.
Ed Hauck, longtime industry participant, said that the issue is an old one that first surfaced among leading companies sometime around 2010. The effects of online competition are similar to that in other industries. Practitioners watch their hard work and long-standing relationships walk out the door and provide revenue to an online re-seller, based on the practitioner’s recommendation. This is clearly discouraging to the practitioners, and it needs to be addressed in order to preserve the viability of the channel and business model, in the view of Mr. Hauck and others.
Price is not the only issue. Consumers are also motivated by convenience. Convenience stores still charge more for deodorant than Amazon. Why? Because of the word convenience. A person who wants that deodorant wants it now and is willing to pay more to obtain it immediately.
We assess the practitioner channel as mixed on this front. On one hand, it is convenient for patients to buy a supply of supplements if they are already in the clinic for a visit. On the other hand, having to make separate appointments to obtain refills periodically is a major inconvenience, which might drive some patients to seek products online that look like reasonably good stand-ins for the ones they get from their practitioners.
Many people are willing to purchase their initial supplies from their practitioners immediately on recommendation. But repeat in-clinic purchases do tend to diminish over time.
The emergence of online competition from unauthorized resellers who undercut practitioners on price was an indisputable negative for the practitioners in the eyes of investors, leading to lower valuations for such brand assets. Further investigation reveals industry dynamics that are changing and improvements that are perhaps not obvious at first glance. Conversations with industry insiders, including Mr. Hauck, reveal that the price gap between identical products for sale in practitioners’ offices and on Amazon has basically gone away. Further, most practitioner brands have embraced Amazon to some degree – or have at least stopped fighting it – by establishing their own Amazon sales accounts.
The development of Wellevate and Fullscript has provided practitioners with a viable, even preferred, vehicle with which to handle online competition. Many investors seem unaware of the changes the industry has made to remedy the issue of channel bleed, according to Metagenics CEO Brent Eck. The industry has spent a long time, according to Mr. Eck, helping doctors (and investors) think distribution control is the key to industry success. Doctors and investors have naturally been concerned as they see distribution control loosening, which it has since the arrival of Amazon-based resellers. However, according to Mr. Eck, the recommendation by a practitioner and product quality are also what drive the business, not only channel control.
A Channel of Opportunity
The supplement business has strong tailwinds that will support growth over the next five years and beyond. The practitioner channel, in particular, stands to benefit from increased personalization and perceived quality for its products. The channel is additionally supported by an ongoing shift to holistic approaches to health, with a focus on prevention. The perception that e-commerce and Amazon-based resellers are killing these brands is outdated, in our view, but it still holds back valuation of practitioner-focused companies. This may provide value-based opportunities for long-term investors.
Understanding the gap between value and perception could be solved by a better, more timely source for sell-through data. We heard this notion suggested many times from investors and industry executives, but the lack of data may be creating an opportunity for long-term investors to gain advantages and perhaps acquire or invest in high quality assets at compelling valuations. In most business segments, “relationship” is often the key factor; nowhere is that truer than in the relationship between a patient and his or her trusted doctor. As practitioner channel businesses work to overcome the threat of online resellers, substantial value creation may have gone unnoticed in recent years and, in turn, could now create significant value for investors.