COVID-19’s Impact on the Medical Device Supply Chain

On March 11, the World Health Organization declared COVID-19 a global pandemic, prompting the shutdown of much of civilized life. Conventional wisdom holds that medtech companies are largely insulated from economic disruption due to the steady demand for medical products and procedures. This notion, however, could be turned on its head as hospitals delay elective procedures in order to free up space for critically ill virus patients. A careful review of all the issues associated with the pandemic shows that COVID-19 will have numerous short-, mid-, and long-term impacts on the medical device industry. Companies that operate regularly in the supply chain should expect to see the emergence of stronger, more conservatively financed, multi-site suppliers as a long-term outcome of the pandemic.

Where to Find Guidance
The fast-moving, evolving coronavirus pandemic guarantees challenges for businesses worldwide. As managers plan to ride out the disruption, many are finding they have no point of reference around which to organize their efforts. While supply chain executives have lived through banking crises, slowdowns, staff shortages, and even weather emergencies, few alive today have lived through a rapidly spreading health disaster. Where should a manager look to understand how the disruption is unfolding and how it will hit their company’s segment of the medical device industry? Traditionally, the supply chain has looked to OEM sales as the best indicator of industry outlook. In this situation, it is more useful to look beyond the OEMs to their customers—the hospitals, clinics, and physicians that comprise the provider segment—as the first movers that will set in motion the chain of events to which suppliers must react.

As the coronavirus crisis expands, providers are rapidly shifting their practice and purchasing priorities to meet the demands of a pandemic. Two changes in the coming months seem certain: The first is that medical staff and equipment will be shifted to fight the virus and its complications. Doctors, nurses, hospital rooms, diagnostic labs, and capital equipment will be shifted from traditional uses to screening and treating coronavirus patients. The second is that critical procedures will still take place, though with some minor delays for the less time-sensitive treatments. Non-critical procedures will be delayed or cancelled for the foreseeable future. These are only two of the changes likely to occur in the coming weeks. Still, we can project their short-term, mid-term, and long-term impact on the supply chain.

Short-Term Impacts: Commercial
Over the next six months, there will be a series of demand shocks, both positive and negative, as medical device OEMs and their suppliers respond to providers’ changing needs. Beneficiaries of the epidemic will be vendors of basic hospital supplies, as healthcare facilities fill to capacity with coronavirus victims. Many of these products will be low-margin disposables including masks, wipes, disposable hospital room products, and standard examination supplies. Demand for these products should increase markedly for a few weeks but a robust supplier base will be able to rapidly ramp to meet demand. Also benefiting from demand but more constrained in capacity will be manufacturers of diagnostic consumables and imaging suppliers as more patients are tested for coronavirus and those diagnosed are tracked for respiratory issues.

Beyond these “front and center” products, an area likely to be tested by the pandemic will be telehealth devices and services. For the next few months, this product class—largely considered a novelty or luxury up until now—has the opportunity to demonstrate real value as traditional healthcare services become overwhelmed by patient load demands.

Will the financial impact of these increases in demand be significant? With the exception of the diagnostics companies selling coronavirus tests, the uptick in device demand will be modest when compared against the broadly diversified product portfolios of the OEM suppliers. A few companies will garner higher sales in a few product lines, many of which are low-margin commodity products. The overall impact will not be exceptional, however.

In the short-term, demand will decline across the rest of the device industry. Manufacturers of critical devices and components will experience a modest slowdown in orders for two reasons. Device management executives at OEMs responsible for established products will be uncertain as to demand, given the rapidly evolving news about the numbers of infected and disruptions affecting medicines and devices. Thus, they will tightly manage inventories. Reorders will take place, though at a slower pace as OEMs strive to understand the full impact of the virus on their businesses. Managers overseeing new product launches will also act more slowly, hesitant to make bold moves in uncertain times. The impact of both these trends will prove operationally disruptive to suppliers but should have only a modest revenue impact in 2020 for OEMs.

OEMs of non-critical devices and their suppliers will face greater challenges in the coming months. No area of medicine will be impacted by demand shock as much as orthopedics. Orthopedic procedures are rarely considered critical and often have long recovery periods, requiring several trips to healthcare facilities. The possibility of multiple interactions with providers at institutions handling coronavirus cases will cause potential patients to choose ibuprofen over surgery. The orthopedic problem is compounded by the economic disruption certain to be caused by the virus. As stated, orthopedic procedures often have long recovery times; with the possibility of a recession looming, workers fearful of possible layoffs will be hesitant to take extended time off for joint replacement procedures or spinal fusions. Amplifying these delays in surgeries is the fact that orthopedic OEMs, by the very nature of their product lines, have significantly more inventory than a comparably sized non-orthopedic OEM. As was the case in the 2008 recession, orthopedic companies are quick to manage inventory in down times. The orthopedic supply chain should brace itself for a sharp drop in orders over several months. OEMs specializing in “quality of life” areas of medicine including aesthetic surgery and ophthalmology will also experience a decline in orders.

Mid-Term Impacts: Financial
As demand shocks make their way to OEMs and through the supply chain, financial strains will emerge. Over the next 12 months, deferred and diminished orders will show up as cash flow issues, particularly at smaller suppliers and heavily leveraged companies. Bankruptcies are unlikely but constrained cash will limit the operational freedom many OEMs and supply chain companies have enjoyed in recent years. Some companies will slow down hiring and/or defer capital projects.

Specific financial impacts will vary by area of medicine and by company. As with orthopedics, inventory management will become an increasingly important area of focus to manage cash and resources. Firms with exceptional debt loads may find themselves in discussions with their lenders regarding challenges in meeting bank covenants. Still, the cash flow effects brought on by the epidemic are likely to be limited to three to nine months as companies make difficult cuts to ensure profitable operation.

Long-Term Impacts: Strategic
The 2020 coronavirus pandemic will cause OEMs to reevaluate their supplier lists. The most well-known afflictions of the latter 20th century—polio, HIV, malaria, Ebola—were either limited to specific areas or concentrated in populations that device companies rarely served. Not surprisingly, the criterion “supplier is able to provide product reliably despite irregular orders and local sick outs” has not been on the checklist for selecting preferred vendors. In the coming years, OEM procurement teams will consider which suppliers are best suited to survive and supply products in the face of global health issues. Other reactions to the pandemic experience will include an increase in dual sourcing of key components and a preference for larger, more financially stable suppliers with multiple manufacturing sites. These biases will present new challenges for smaller and more leveraged companies, regardless of their expertise. Which firms will be affected? Assume supply chain managers at OEMs will draw their lessons from the worst cases of disruption or perceived instability.

The Best Approach: Demonstrate Stability in Unstable Times
As the device industry navigates unchartered and choppy waters, supply chain managers might want to consider how best to present their firms to customers. Suppliers should recognize that OEMs may be dealing with market disruptions. They may not be able to provide accurate information or lead the relationship in the ways they have in more stable times. Rather than ignore or complain about uncertainty, suppliers will be well-served if they can demonstrate plans that show customers they can reliably manufacture regardless of societal disruptions. One action should include calls with customers on how the supplier intends to operate over the next several months. Will production be handled in the traditional way? Will it be shifted to other facilities if needed? Are additional quality steps being considered? Will the supplier’s workforce be screened and offered care if required? Will hours change to accommodate closed schools and daycare? It is essential to show a plan, not “We are trying our best.”

Suppliers should manage the perception of their readiness to adapt to changing situations. Those that demonstrate competence will be rewarded as their customers look back in the coming years. 

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Tony Freeman is the president of the A.S. Freeman Advisors LLC in New York City. He advises on mergers and acquisition in the specialty materials and precision manufacturing industries. A.S. Freeman Advisors provides a corporate strategy, market planning, and valuation improvement consulting services. Freeman can be contacted at [email protected]