The Impact of Rate Hikes on Inelastic Medtech Supply Chains

Throughout the past year, the U.S. Federal Reserve has raised interest rates to “control” inflation, prompting business analysts to resurrect that mantra about healthcare being immune from economic volatility and recessions. In “normal times” I would agree, as that statement has some truth to it. But normal times have not yet returned to planet Earth, thanks to a lingering COVID-19 hangover that continues to vex most supply chains, particularly those in healthcare. One of the reasons these chains are still knotted is the incredible lead-lag effect from the medical device industry’s steep multi-leveled bills of materials (BOMS). With each interest rate hike, the clock resets and the BOMS lead-lag impact is felt anew. Complicating the supply strains are the Russia-Ukraine war, labor shortages, and escalating energy costs (which make logistics costs practically unbearable).

I’ve always believed the cup is half-full rather than half-empty and I always will, simply because of the industry in which I choose to work. This has been the hardest column I’ve ever had to write because of the headwinds that have, and are still working against the healthcare sector. The time has come for some candid discussion and early warning “alerts” so the industry can prepare for these headwinds. Therefore, this column will be split into two parts (the second arriving in the April issue).

The Federal Reserve raised interest rates seven times last year in an effort to control inflation. There are very few options available to manage skyrocketing consumer prices, so higher interest rates are the Fed’s “go to” solution when inflation spikes. This approach is designed to impact demand because theoretically—and sometimes historically—inflation slows with demand. Thus, the consumer price index (CPI) is a key bellwether to the Fed. This may sound logical on paper, but I’m concerned the solution designed to benefit 80% of America’s non-healthcare GDP could severely damage the 20% that funds life-saving treatments and technologies (healthcare).

Do interest rates always impact demand the way the Fed expects? And should that impact be so broadly brushed? Honestly, it depends. Many things looked good on paper in the early 1970s that ultimately turned sour (i.e., wage and price controls). Or, in 2006, when banks invested in derivatives—a major cause of the housing collapse that eventually led to the Great Recession. The Fed and Obama administration deployed tools I personally never knew existed, so there is an arsenal at the government’s discretion.

It’s important to understand that economics and supply chains are synonymous. I first became acquainted with economic principles as a key component of my Quantitative Business Analysis degree more than 40 years ago. Since a supply chain course of study did not exist at that time, economics were key building blocks of what I would later craft into some type of supply chain degree. After applying these principles and pioneering new ones for over 40 years, I’ve realized that supply chains are nothing more than advanced economic theory on steroids. And there are many “steroids” to choose from: the Supply Chain Operations Reference Model (SCOR) built more than 20 years ago and linear programming industrial engineering principles, to name two. But economics is the foundation; without it, there would be no supply chains.

It seems Merriam-Webster agrees with my economics + steroids = supply chain formula, as it defines economics as “a social science concerned chiefly with description and analysis of the production, distribution, and consumption of goods and services.” As good a definition of supply chain as any. Note the key phrase in Merriam-Webster’s definition: consumption of goods and services. What is consumption? Demand. In a module to be released at SCHAIN101, I explain why demand is the most important element of supply chain synchronization. Although demand in and of itself is column fodder, I want to concentrate on a concerning impact the Fed’s actions could be having on global healthcare supply chains.

A very important, but often overlooked economic element of demand is elasticity, which describes a price change’s impact on demand. For instance, if a 1% change in price creates more than a 1% change in demand, it is considered elastic. If it does not have this effect, it is considered inelastic. According to theory, an item is elastic when there is a direct correlation of demand to pricing. A common example of inelastic demand is salt, as salt prices don’t really affect consumption. The same can be said for many luxury goods like expensive jewelry or collector cars—their demand is generally insulated from price action, thus they are inelastic. Elastic examples would consist of discretionary goods that can be delayed or avoided due to high costs—i.e., vacation travel or a pair of tennis shoes that has enough tread for just a few more months. Take note, however, that no products are perfectly elastic or inelastic, and the degree of elasticity can change over time.

What about immaterial concepts like healthcare? Is it more a want or a need? Throughout my career and to this day, I contend that healthcare is predominantly inelastic (as price generally does not affect demand) and it should remain that way. There are discretionary portions of healthcare where demand side “actions” like rate hikes could possibly be effective but those are few and far between. Many of healthcare’s discretionary areas have become inelastic, such as clinic-based cosmetic procedures (injections, laser procedures, etc.), which are generating record sales. These procedures could be included in the same category as fine jewelry, as they target the same clientele. But those undergoing those procedures consider them needs, not wants. I experienced this in the breast implant world when I began my career at Dow Corning in the early 1980s. Many ladies back then were seeking breast augmentation purely for cosmetic reasons (more a want than a need) but there were also numerous women recovering from breast cancer who needed such surgeries to restore their quality of life. Hence, whether or not a healthcare product or service is discretionary, elastic, or inelastic depends on the recipient. Such subjectivity is what concerns me most now.

In my experience, healthcare leans heavily towards the inelastic side because increasing costs can hurt patients. Most people need professional healthcare services to save or sustain their lives, or restore abilities affected by disease. One economist differentiating healthcare stated it well: “if you need it…you need it.” Think about that for a minute. How many healthcare areas are wanted but not needed? A very small portion, certainly.

Why the concern, then, if healthcare is generally inelastic? Because there is no guarantee that demand will continue as it has in the past. Today’s world is like nothing humankind has ever experienced. I don’t think anyone would have thought that supply chains would still be struggling three years after COVID-19’s initial rampage.

I’m very concerned about the similarity of today’s world to the 1970s, with soaring energy prices; runaway inflation; rising interest rates; national division; political unrest; and wars on multiple continents. Only today, there is a COVID-19 hangover to contend with as well. I’ve often wondered how well the 1970s deployment of demand compression efforts helped when my parents had a double digit mortgage rate and were trying to raise a family. As bad as things were, there was still opportunity as there is today. But the world must be smart about its next steps.

Conclusion

I worked at Medtronic while Art Collins was president. I always admired Art because he was a wise person and supported my supply chain reconfiguration efforts, including being a keynote speaker at a supplier summit my division hosted to stress the importance of suppliers as partners to the Medtronic mission. I still have my notes from a Medtronic leadership program where he said, “everything we do in our roles must foster creativity, ingenuity, teamwork, openness, service to each other, our communities, and our shareholders, and very importantly, be relentless about finding ways that we can help foster access to healthcare to those that need it”. That could very well be the medtech industry’s motto. Therefore, anything that increases patient costs, like increasing borrowing rates in a multi-leveled BOMS industry, only prevents access to it.

Fortunately, there is a better approach. I strongly believe the economic system must foster supply-based capitalism, not demand-based restriction. Supply side capitalism fosters competition, and utilizes both natural resources and creative ingenuity to invent and improve patient care. Tweaking demand side economics, on the other hand, increases costs in an effort to slow demand. Is healthcare really the right place to slow demand? Surely not. Perhaps the Fed should slow portions of the GDP dealing with widget sales to help tame inflation. But applying the same logic to healthcare is only taking money out of patient’s hands and making it harder for them to get access to what they need.

The second part of this column will build upon the dangers of inelasticity in the medtech industry and detail the repercussions if demand side compression efforts continue. I’ll refer to another Medtronic leader who mentored me and had a good lesson to teach. I’ll also discuss the consequences of moving from inelastic to elastic for the wrong reasons, and the strategy medtech companies need to recover and move forward. Until then, let’s try to keep the cup more full than empty. 

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Chris Oleksy is founder and CEO of SCHAIN101. He can be reached at [email protected] or by visiting SCHAIN101.com.