The Pain Continues: Time for Controlled Paranoia About Rate Hikes

The theme of this column is going to sound familiar, and it should, since I wrote about the same thing in MPO’s March issue. Loyal readers will remember the column discussed demand elasticity and explained the ways prices changes can impact demand. To recap, demand affected by price is elastic (i.e., vacations, travel, apparel) but demand impervious to price fluctuations is inelastic (high end jewelry, collector cars).

I consider most healthcare items to be inelastic because they are needed rather than wanted, though there are some healthcare services that are not essential—elective surgeries, for example. Accordingly, the U.S. Federal Reserve’s aggressive increase in borrowing rates can have a crippling impact on the prices of healthcare products and services. Costs that go too high, too fast, could upset the balance of items deemed inelastic, potentially risking societal health.

A relative whose doctor recommended she undergo an invasive diagnostic procedure recently asked for my opinion on the matter. Having deferred the procedure due to COVID-19, this relative was now contemplating postponing the procedure yet again because the price had risen by 75%. “I think I’ll wait and see if the price comes down,” she told me. “Maybe the supply chain issues are driving the costs up and they’ll be fixed soon.” Maybe, but that might not happen. Then what? This example perfectly reflects my earlier point that fast-rising costs can turn inelastic demand elastic and endanger patient health.

Mother Nature has also proven this point very well of late. Utilities are generally inelastic—when it’s cold, people turn on the heat (and vice-versa in the summer). But over a 40-day period, California’s natural gas prices surged so high that consumers statewide turned off their furnaces and shivered through unusually cold nights. Some former Minnesota transplants claimed to have set their home thermostats lower in sunny California than in frigid Minnesota.

The bottom line is inelastic demand can sometimes tilt due to excessive price increases and become a horse of a different color. 

A former mentor, Bob Guezeraga (Medtronic), once wisely said, “…know when to be paranoid and when not to be paranoid.” Uncontrolled paranoia can destroy good businesses and their corresponding supply chains but controlled paranoia can have the opposite effect. Trust me, as I’ve witnessed both. The latter is in order now, since it appears the Federal Reserve is not changing its position on interest rates anytime soon. A good dose of controlled paranoia is necessary to help the healthcare industry successfully  navigate the increased costs currently spanking its supply chains.

It is important to look at interest rates and price increases from an OEM’s viewpoint because they drive the rest of the supply chain downstream. OEMs are, essentially, the head, not the tail of the healthcare value chain. Thus, they will have a different outlook on rate increases and may be asking themselves the following questions in drafting a long-term growth strategy.

Question 1: Will reimbursement levels (which predominantly drive OEM pricing) rise at the same rate as prices in order to cover increasing costs? Historically, they have not because a large portion is driven by tenuous Medicare/Medicaid funding. Now more than ever, companies must be aware of the margin squeeze between pricing and reimbursement levels and devise an approach to manage it. Some strategies could entail driving volume consolidation internally through site consolidations to achieve economies of scale or driving volume to suppliers through supplier consolidation so they can achieve economies of scale.

Question 2: Can suppliers offset the increasing costs impacting them from their downstream supply chains? Borrowing rate increases is making it more difficult now for suppliers to provide price breaks and cost concessions throughout the value chain. Many are doomed if the interest rate landscape does not improve and they cannot initiate volume-based savings or pass on cost hikes. Thus, suppliers should seriously consider consolidating to save money, gain economies of scale, and attract OEM business. Small suppliers generally have difficulty scaling but a collection of smaller players working together can achieve significant scale.

Question #3: Can a product line be moved off shore to reduce costs? My column last summer contains the answer. Geopolitical conflicts are making offshoring more difficult, though relocating manufacturing or production to lower labor costs and taxes and ease regulatory burdens is not necessarily a panacea, either. Offshoring is often warranted but it sometimes can exacerbate an already frustrating situation. Ideally, it should be evaluated on a case-by-case scenario using economic profit landed cost models. In doing so, companies should apply “The Wizard of Oz’s” classic lesson of “there’s no place like home.” The United States is a safe, reliable business locale, awash in resources, automation technology, and individual ingenuity. But not all U.S. sites are created equal. Case in point: I love California for many reasons, but if lawmakers there do not address rapidly rising costs (taxes, gas, food, etc.), the Golden State could quickly become as desolate as its deserts.

One helpful source for companies considering onshoring is the Tax Foundation’s State Business Tax Climate index, which ranks the most corporate tax-friendly states (Wyoming is tops, New Jersey placed last). Many analysts speculate the Federal Reserve is raising interest rates to finance the incredible debt incurred from COVID-19 spending. States may be, or soon could be following suit. Thus, state tax rates will play an increasingly important role in U.S.-based supply chain decisions. For proof, consider Florida’s ranking (fourth) with New York and California (48 and 49, respectively). The Sunshine State has the best individual tax rate, while New York and California have the worst. Is it any wonder then, that residents are fleeing the latter two states in droves?

Call to Action 

It’s time for the medtech industry to adopt a more heightened level of controlled paranoia. Escalating costs and interest rate hikes threaten to turn traditionally inelastic healthcare products/services into elastic items, jeopardizing elective procedures again. That would snarl the world’s already tangled supply chain even more, resulting in product shortages and manufacturing hiccups. Of course, different healthcare products and services would be affected in different ways: a pacemaker procedure, for example, is considerably more necessary (inelastic) and less likely to be delayed than a diagnostic test or bunion correction surgery, which are both somewhat dependent upon cost (elastic).

I’m going to conclude with an “open” letter to the Federal Reserve Board.

“Dear Federal Reserve members, Please bear in mind the ways in which your interest rate hikes are affecting healthcare—an industry built on need, not want. I understand why you need to take broad steps to tame inflation but in doing so, you risk throwing out the baby (healthcare) with the bathwater. Most  professionals working in the healthcare space since the early 1980s can attest to the exceptional supply chain functionality when supply-side actions (often referred to as “Reaganomics”) were embraced. There was an explosion of invention, creativity, affordability,  and quality of life, as well as the blossoming of organizations like Medtronic, J&J, Becton Dickinson, Boston Scientific, Zimmer, Intuitive Surgical, and St. Jude Medical, among others. These organizations not only created a better quality of life for industry employees but more importantly, for everyone needing healthcare worldwide. Supply-side economics proved a welcome successor to the failed demand-side economic policies of the late 1970s.

Please revisit what these hikes are doing to healthcare’s demand side and don’t risk jeopardizing the medical needs of millions of people around the world. We can wrestle inflation into submission but we must do so carefully and determine whether we are approaching it correctly by influencing consumption/demand the same way across all industries.

One more thing: Please don’t shoot the messenger.” 

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Chris Oleksy is founder and CEO of SCHAIN101 and can be reached at [email protected].