Pain point

Edition: November 2008 - Vol 16 Number 11
Article#: 3062
Author: Repertoire

What is your pain tolerance level? How about that of your customers? If you haven't found out already, you probably will soon.

Manufacturers and distributors are experiencing unprecedented hikes in the price of many raw materials, finished goods and transportation. And even though they are trying to improve their internal processes to offset some of those cost increases, they're finding that these measures may not be enough. At some point, their customers will probably have to bear some of the burden, in the form of surcharges or plain old price hikes.

Bleak predictions

In its July 2008 Budget Impact Projections Report, released in early August, 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 that:

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.

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 (though copper prices may stabilize, thanks to new copper production and good supply levels).

Cotton - the primary raw material in 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."

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. 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.

All-consuming issue

"Without exaggeration, every one of our input costs is being impacted," says Scott Clausen, vice president of sales, Ansell Healthcare, Red Bank, N.J. "It's primarily raw materials, and in our business, you're talking about latex and synthetic latex products. 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 percent 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. "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 Vice President Manny Losada. "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."

China connection

In addition to raw-materials prices, manufacturers 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 it an ideal place for the manufacture of labor-intensive materials, including many textiles. But the situation 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.

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 percent 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 percent 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, "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.