During the pandemic, OEMs and large suppliers of technology components required to launch new medical devices and sustain the lifecycles of existing products raised their prices to historic levels, largely in response to supply chain challenges. Although the Covid-19 crisis has abated, the economic consequences of the pandemic continue to have a significant economic impact on medical device companies.
Inflation in the U.S. and many other countries has resulted in: higher interest rates; increased costs related to capital, manufacturing, shipping, and labor; scarcity of some raw materials; and weakened exchanges rates against the U.S. dollar. Pricing pressure on MedTech companies has also been driven by consolidation of healthcare providers, growth of governments as the primary payers of health care, and reductions in reimbursements and medical procedure volume levels.
This all means that it continues to be a seller’s market for suppliers and distributors of electronic components, including monitors, on-board PCs, servers, and scores of other peripherals.
Standard Price Risk Management Tactics
Lacking leverage to negotiate lower prices for necessary components, many medical device companies are pursuing alternative ways to ensure availability of supply, extend product End-of-Life, and avoid an adverse impact on profitability and share price. Some of those price risk management strategies include longstanding procurement and inventory control tactics, such as negotiating Last Time Buys (LTBs) and increasing safety stock.
Under pre-pandemic economic conditions, OEMs were typically obliged to provide components for 10 years or longer for medical devices, and suppliers often had agreements with OEMs to make components available for a fixed timeframe. When that term was near completion and the supplier decided to end production, they issued an LTB, which served as a “last call” for a specific part or component. A manufacturer’s supply chain team was then required to develop a strategy to address their customer commitments, with little insight into future demand.
To address the current market’s pricing dynamics, and lacking any specific OEM announcements, some medical devices companies are using traditional LTB tactics to mitigate anticipated additional price increases for key components. This can be a risky move, as the immediate impact of LTBs is to tie up working capital. In addition to the large initial investment in the components, there are storing, shipping, and handling costs. LTBs can also result in excess stock which may have to be written off as an accounting loss and scrapped after some time.
Similar to LTB strategies, some medical device companies have increased their volume of product safety stock inventory to mitigate the risk of stockouts; allowing their supply chain to continue without interruption, regardless of technology component pricing. But excess safety stock is also a considerable business expense, in terms of increased production and storage costs. It also can mean less capacity for current cycle stock or new products.
Alternative Product R&D Approaches
Given the inherent financial risks related to inventory-based strategies involving LTBs and safety stock, a growing number of medical device companies have focused on product redesign to address component pricing challenges. Specifically, they are:
- Examining their hardware’s original and current requirements to identify any over-specification that might have occurred with next generation product versions, and then “right-sizing” product specifications
- Conducting parametric analyses, not only to address how well alternative components or subcomponents might meet specifications, but also to assess supply chain risks including life cycles, country of origin, sub-component material constraints, OEMs that may have better security of supply, as well as safety and security requirements in countries where their products are sold
- Selecting alternative electronic or hardware components that address design and specification requirements, as well as supply chain and pricing considerations.
For example, a medical diagnostic device manufacturer that required customer transformers as part of its solution was facing availability issues and increased pricing related to production-related problems experienced by the custom transformer manufacturer. Based on a comprehensive supply chain risk assessment, combined with exploration of alternative sourcing strategies, the medical device company coordinated with the sub assembly parts manufacturers, negotiated priority production processing, purchased supply ahead of time, and expedited production. This reliable, innovative solution mitigated future risk, and optimized cost savings and inventory availability.
Innovative Third-Party Procurement Partnerships
Prior to the pandemic, some medical device companies had partnered with third parties as an alternative to direct LTB purchases. Those procurement arrangements typically required the third-party to purchase and warehouse necessary components, and to sell them back to the OEM partner as needed over time.
Post pandemic, a more robust version of these third-party procurement partnerships has emerged that are custom designed to:
- Guarantee long-term fixed pricing of technology components
- Mitigate supply chain risk
- Extend product lifecycles
- Maintain Just-in-Time inventory management
- Minimize product validation cycles
- Avoid stock outs and End-of-Life issues
- Generate invoice when products are shipped
- Ship in predetermined intervals and quantities
Notably, these arrangements are also designed to keep the inventory on the books of the third-party, rather than the medical device company, which can have significant balance sheet-related benefits.
Recently, a leading medical device manufacturer structured a partnership with a third party to extend product lifecycle, maintain pricing stability and keep up with Just-in-Time order flow for one of its leading products. Complicating the challenge was a bill of materials that included 23 parts from 12 different OEMs—some commercial, some off-the-shelf, and some customized—all with different lead times and countries of origin.
By committing to fixed, all-inclusive material pricing, the third party guaranteed the availability and secured the supply of all necessary components, and shipped according to the company’s schedule without requiring an upfront purchase. In return, the company agreed to a “commitment to buy” over a three-year period, with options for additional demand and extensions. The third party assumed the risk of future product and service price increases.
This flexibility allows for adjustments to scheduled shipping volume and timing, adjustments to hardware specifications, and a proactive transition plan designed to extend lifecycles and minimize validation cycles.
Proving that “necessity is the mother of invention,” the medical device industry continues to explore ways to address the long-term economic impact of the pandemic, while addressing the current and future needs of its customers.