Pain Point – Escalating costs of raw goods hits the healthcare supply chain hard.

Editor’s note: In their dual role as contracting executives and consumers, JHC readers are feeling the heat from rising prices. Their suppliers are too. In this issue of JHC, we look at some of the reasons behind rising prices. In our next issue, we’ll look at some of the solutions.

What is your pain tolerance level? Suppliers are asking that of themselves – and of you.

Few suppliers or providers dispute the fact that the prices of many raw materials, including oil, resin (petroleum-based material from which many plastic products are made), latex and paper/pulp, are rising. Where they part ways, however, is in how severe those price hikes are, and how the burden should be divvied up.

Suppliers – manufacturers and distributors – tell JHC that they are experiencing unprecedented hikes in the price of many raw materials, finished goods and transportation. They say they are taking steps to improve their internal processes to offset some of those cost increases. But they add that these measures aren’t enough, and that customers must begin to bear some of the burden, in the form of surcharges, pricing flexibility or plain old price hikes.

GPOs and contracting executives, on the other hand, are crying “time out.” They’re aware that raw-goods prices and economic conditions abroad, particularly in China, are putting upward pressure on costs. But they’re not ready to accept price hikes without some frank, face-to-face discussions with their suppliers. They want to make sure that suppliers are not using economic and political conditions as a license to increase pricing.

Bleak predictions
In its July 2008 Budget Impact Projections Report, Novation corroborated its members’ worst fears by predicting that raw material costs will probably continue to increase in the year ahead. Using a variety of sources, the Irving, Texas-based GPO predicted price increases in paper, natural rubber, steel, cotton and food. Among its chief predictions:

  • The price of a barrel of oil in 2009 will be $133, and retail diesel fuel prices will average $4.48 per gallon.
  • Paper and pulp will see upward price pressure due to lower supply and high energy prices.
  • Prices for natural rubber-centrifuged latex and plastic resins will remain high because of their link to the price of crude oil. (That said, Novation predicted that a weak demand for resins could keep prices steady and maybe even bring prices down in late 2008 and 2009.)
  • Steel prices will continue to rise at a rapid rate due to a weak U.S. dollar, higher energy costs and the global consolidation of the steel industry.
  • Aluminum prices could climb 33 percent over the next two years, but copper prices may stabilize, thanks to new copper production and good supply levels.
  • Cotton – the primary raw material in the manufacture of healthcare textiles – will probably continue to rise in price, due to the shifting of U.S. acreage from cotton to corn, crop failures in Brazil, and political instability in Pakistan. (Between July 2007 and July 2008, cotton prices rose 33 percent.)
  • Food prices will rise, due to increased global demand for food and biofuels, and the higher cost of energy and fertilizers. That said, wheat supply levels are expected to rise, bringing some downward pressure on the price of wheat.

Perfect storm
Shortly after Novation released its report, the Health Industry Distributors Association released its own report, with the ominous title, “Navigating the Perfect Storm: Understanding the Steep Rise in Supply Chain Commodity Costs.”

“A couple of things make today’s situation unique,” says Andrew E. Van Ostrand, HIDA vice president of policy and research. “The first is the coming together of several forces. It’s not just a rise in commodity or fuel prices. It’s everything, from macroeconomic forces, such as globalization and the move to overseas manufacturing; to exchange rates; to the change of overseas tax policies; and, on top of all that, peaking oil and petroleum prices. That’s why we named the piece, in somewhat dramatic fashion, the way we did. Historically, we have never seen this.”

In mentioning the change of overseas tax policies, Van Ostrand was referring to the Chinese government’s decision in June 2007 to reduce or cancel the rebates on value-added-tax (VAT) to Chinese manufacturers of almost 3,000 products and product categories. The move was designed to force Chinese suppliers to raise the prices of products they export to the United States and other countries, and thus allay Americans’ fears of a runaway trade imbalance between the two countries.

The HIDA report shows that fuel replaced labor as the leading cost of medical products in 2008. In fact, the cost to ship a 40-foot cargo container from China to the United States jumped from $2,250 in 2005 to $5,500 in 2008, according to HIDA. Nor have fuel costs stung just importers. Domestically, common carriers such as FedEx and UPS have instituted fuel charges to recoup some of their rising fuel costs.

According to HIDA, rising petroleum costs affect not only the cost of transportation, but the cost of petroleum-based materials, such as plastics and resins, as well as the cost of natural latex (rubber), which in turn is affected by the demand for man-made rubber (another petroleum-based product). Since 2000, the price of petroleum more than tripled, and since 2005, the price of natural rubber doubled. Prices for plastics and resins grew by nearly 39 percent between 2004 and 2008, and the cost of producing propylene – a plastic used in many healthcare products – more than doubled between June 2005 and May 2008.

The decline of the value of the U.S. dollar has contributed to rising costs for products made overseas, according to HIDA. That’s because when the value of the dollar decreases, goods purchased in international markets with dollars become more expensive. A product that cost $1 in May 2007 cost $1.15 (in euros) in June 2008, $1.11 (in Chinese yuan), $1.09 (in Thai baht) and $1.08 (in Malaysian ringitt).

All-consuming issue
“This has been an all-consuming issue and strategic question for us for the last year,” says Scott Clausen, vice president of sales, Ansell Healthcare, Red Bank, N.J. “Without exaggeration, every one of our input costs is being impacted.

“It’s primarily raw materials, and in our business, you’re talking about latex and synthetic latex products,” he says. “Oil, of course, affects latex and all the costs related to the movement of products. We can only get [latex] from one part of the world, and energy there is skyrocketing.

“As a result, we’re looking at every element of our business to try to understand how we can still deliver value to our shareholders and to our customers in a world we like to refer to as very turbulent.”

Meanwhile, between 60 and 70 percent of the raw materials used by B. Braun Medical Inc. in its medical products are related to resins and oil and associated materials, says Willem deGoede, COO and executive vice president of the Bethlehem, Pa.-based firm. “In all categories, especially if they are oil-related, we are getting pushed for price increases almost on a monthly basis.”

Hauppauge, N.Y.-based Medical Action Industries is facing similar pressures. “You can’t go through a day without hearing about the price of gas and the impact of the price of a barrel of oil,” says Vice President Manny Losada. “It all trickles down to one of our base raw materials, which is resin. When 50, 60 or 70 percent of the base raw material in your products is resin, or plastic, and you have that type of impact, that’s where the rubber meets the road.”

Two years ago, the company acquired Medegen Medical Products LLC, a market share leader in plastic-based patient utensil products, such as wash basins and urinals. “With a 300 percent increase from resin brokers over six months, it’s hard to support an infrastructure – packaging, logistics, freight, sales – and provide the same level of service and quality that’s expected by your customers,” says Losada.

China connection
As manufacturers face challenges with the prices of raw materials, they also face a variety of economic and social changes in one of their main supplier countries – China. Labor in that country remains relatively cheap, making China an ideal place for the manufacture of labor-intensive materials, including many textiles. But the situation there is changing.

For one, the value of the Chinese Yuan is strengthening against that of the U.S. dollar. “That means we have less available cash flow for the products we’re trying to purchase,” says Losada. Second, the Chinese government has taken certain actions, such as revoking the rebate on the VAT, that have eaten into the profits of Chinese manufacturers. “Now they’re asking for cost recovery, because they can no longer operate with the profits they have historically had.”

Third, China is undergoing a series of huge technological and sociological changes. “The Industrial Revolution is taking place in China,” says Losada. “If you missed it here, China’s a good place to watch it.” Chinese workers are demanding benefits and better working conditions. That could lead to higher costs for Chinese manufacturers, who will no doubt pass them on to U.S. customers. In addition, the Chinese work force is becoming more sophisticated. They’re less enthusiastic about operating a sewing machine than working in the higher-paying computer or automotive industries, says Losada.

Yet despite all these changes, “[w]e still believe that for companies that are well-capitalized, and that have a management structure and quality assurance program in the country and longevity in their relationships, China is a viable option,” he says. Even so, Medical Action Industries has moved the production of certain products out of China. For example, its cotton-based patient slippers are now also in India.

Distributors hard-hit
Distributors are feeling the pinch as well. Dublin, Ohio-based Cardinal Health is actually getting hit several ways. First, as a manufacturer, it is facing similar increases in fuel and manufacturing costs. Second, as a distributor, it is looking at price hikes from the manufacturers whose products it carries. (The company is anticipating cost increases from its suppliers of medical and laboratory supplies of between 5 and 20 percent.) And third, as a distributor shipping products around the United States, it is incurring higher transportation costs of its own.

Fuel costs have increased 30 percent in the past year, says David Anderson, president, Hospital Supply. What’s more, the company is anticipating price hikes of between 5 and 20 percent from the suppliers whose products it distributes. Product packaging expenses are also up, due to a 7 percent increase in the cost of corrugate.

Adds Chuck Miller, vice president of vendor relations and operations for Nashville, Tenn.-based NDC, a co-op of independent med/surg distributors, “Typically, the majority of price increases take place at the end of the year. But we’re seeing far more mid-year price corrections now. In some categories, we’ve seen multiple increases. Manufacturers have tried as best they could to minimize the impact on the market, but at some point, they have been forced to raise prices.”

While the price of gasoline had, at press time, leveled off somewhat, the price of diesel fuel had not, according to Miller. Fuel surcharges on diesel had leveled off by August, but they were still double what they were in January 2008. Since diesel is a huge component of transportation, the impact on distributors is profound.

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