Raw Possibilities

Stabilized prices and industry consolidation are creating a wealth of opportunities for raw materials suppliers and contract manufacturers.

Michael Barbella

The words “crisis” and “opportunity” are very often intertwined. President Barack Obama used both words last month in challenging the nation to lift itself out of its economic slump: “…with every test, each generation has found the capacity to not only endure, but to prosper—to discover great opportunity in the midst of great crisis.”

Last fall, Obama’s newly appointed chief of staff used the words to convey a similar message. “Rule one: Never allow a crisis to go to waste,” Rahm Emmanuel told a conference of top corporate chief executives. “They are opportunities to do big things.”

Quick Wire Inventory from Tegra Medical allows same-day shipments for various types of wires. The color-coded system can help product developers compress project time lines. Photo courtesy of Tegra Medical.

Obama and Emmanuel are not the only politicians to use the words “crisis” and “opportunity” interchangeably. Presidents John F. Kennedy and Richard M. Nixon, as well as former Vice President Al Gore and former Secretary of State Condoleezza Rice have drawn a parallel between both words in order to initiate change or trigger certain behaviors. This parallel, or link, came from an interpretation (or misinterpretation, as some scholars would argue) of the Chinese character for “crisis” (weiji).

“As many know, the Chinese expression for ‘crisis’ consists of two characters side by side,” Gore said in a 2007 Congressional hearing about climate change. “The first symbol means ‘danger.’ The second symbol means ‘opportunity.’ “

While this interpretation of weiji has created some truly inspiring rhetoric over the last half century, it is not entirely accurate. Linguists and Chinese language scholars argue that the second symbol (ji) really means “moment.” Weiji, therefore, when it is more accurately interpreted, means “dangerous moment,” which is a fairly accurate definition of “crisis.”

Despite the misinterpretation of Chinese symbols though, the message from these politicians has been clear: Great opportunities can often be found in the midst of a great crisis.

The economic crisis that has circled the globe has presented businesses—including medical device manufacturers and raw materials suppliers—with their fair share of challenges. But it also has created a wealth of opportunities for them.

Pricing Pressures

One of the most obvious opportunities spawned by the lingering and deepening economic crisis is price controls. Many raw materials suppliers and contract manufacturers who spoke to Medical Product Outsourcing said the price of raw materials has now stabilized after experiencing huge fluctuations in 2007 and 2008.

The precious metals market is one of several materials markets that was prone to price volatility over the last several years. Available in various alloy compositions, precious metals can be manufactured as tubing, foil, sheet, or wire to be incorporated into medical devices.

Precious metals, particularly platinum, have a number of qualities that make them an ideal material for medical devices: They are biocompatible and resistant to corrosion, they have high-temperature melting points, and they are excellent conductors of electricity. These metals are most often used to make atrial fibrillation catheters, coils, pacemaker tips, and defibrillators. These materials also are becoming more widely used in the cardiac rhythm management and neurostimulation sectors, industry research indicates.

Medical devices, depending on the kind of material used, can be costly to manufacture. Precious metals can be the most expensive single item of a medical device (up to 90 percent of the cost of medical wire, for example, is the precious metals value, according to an estimate from Johnson Matthey Medical, a contract manufacturer based in West Chester, Pa.). With such a high content value, even the slightest variation in the pricing of precious metals can significantly impact materials suppliers and contract manufacturers.

When the platinum market experienced a supply shortage in 2007, the price of the metal shot up 35 percent. Industry experts attributed the shortage to power cuts and accidents at mines and smelters in South Africa, where about 80 percent of the world’s supply of platinum is produced. Last year, the price went up even further, peaking at nearly $2,300 per troy ounce. That figure represented a 91.6 percent increase compared with the $1,200 per troy ounce that platinum was selling for in late March 2007. The price, however, has since stabilized: As of March 24, platinum was selling for $1,143.30 per troy ounce, according to market reports.

Stainless steel experienced similar volatility last year. The metal, which historically has been used to make tubular components for dental and surgical instruments, sold for an average of $843 per net ton in 2008. Since the second half of last year though, the price of stainless steel has dropped 41 percent—it was trading at $499 per net ton in February.

“We are seeing a downward trend in steel, our primary commodity,” said Bob Miller, vice president of operations for Tegra Medical, a wire and tubular products manufacturer based in Franklin, Mass. The company also is a supplier of precision grinding and specialty needles.

The downward trend that Miller has noticed in steel is reflected not only in prices, but production data as well. Preliminary figures recently released by the International Stainless Steel Forum (ISSF) show that global stainless steel production fell 6.7 percent in 2008, dropping to 25.5 million metric tons. Production was strong in the first half of the year, according to ISSF, but the global financial crisis and sharp drop in prices adversely affected production in the second half.
While the economic crisis has created an extraordinary opportunity for companies to lock in lower materials costs, it also has prompted an increase in raw materials surcharges. “Temporary surcharges appear to be increasing,” Miller noted. “This is an area we feel we can press for reduction in the current economy.”

New England Urethane was bombarded with surcharges and price increases for its key raw materials last spring and summer. Some of the surcharges came from a critical supplier, which imposed a fuel surcharge upon its North American customers in the spring.

“We saw a lot of increases fast and furious last spring and summer,” said Cynthia Edgar, sales and marketing manager at New England Urethane, a custom thermoplastics resin materials compounder based in North Haven, Conn. “We saw multiple increases in a few short months last year. Every time we quoted a product we needed to check our raw materials cost. One of our key raw materials increased by more than 16 percent. We saw things like fuel surcharges and general surcharges on resins and additives that became permanent. Then, once the fall came around and the cost of petroleum dropped, we saw only the price of olefins (PE and PP) decrease.”

Many of the fuel surcharges stuck around, even after the price of oil plummeted. Curtis P. Smith, principal and director of R&D for New England Urethane, said some fuel surcharges are still in effect today. “Some of the major materials we use for the medical [product] side of our business sustained big increases. And the surcharges—companies just finally said we’re going to keep it permanent. A lot of our customers were not happy because we couldn’t absorb all of the [price] increases. We had to pass on a portion of it.”

So did Foster Corporation, a full-service materials solutions company serving the medical, pharmaceutical delivery, and biotechnology industries. The Putnam, Conn.-based company acts as a raw materials supply chain partner that helps manufacturers find, procure and inventory non-compounded raw materials.

As the world’s financial crisis worsened last year, Foster and other raw materials supply chain partners faced a frustrating dilemma: The price hikes they encountered for some of the materials they used and obtained for customers were being driven by the needs of suppliers who service various other industries.

Arkema Inc., for instance, raised the price of its Rilsan, Pebax, Platamid, and Orgalloy high-performance polyamides granules by 10 percent last May to offset rising energy, raw material and transportation costs, as well as “unprecedented” foreign currency exchange rates. The amount of the increase, according to the worldwide chemical manufacturer, reached 15 percent for dollar invoices, 10 percent for British pounds invoices, and 5 percent for euro invoices.

“Even though we’re still a very healthy industry, we’re being impacted by raw matrial price increases that may be driven by economies outside of our industry,” said Dan Lazas, Foster Corporation’s vice president of sales and marketing. “We are focused on specific niches within the medical device industry while many of our materials suppliers serve broader markets, including those consuming much larger quantities of materials. These markets are being impacted differently by the changing economy which may precipitate price adjustments in raw materials. In turn, we are required to either absorb or pass on these adjustments to our customers. In this economy, it is increasingly challenging to both manage costs and preserve cash flow.”

A Change in Buying Habits

The desire to preserve cash flow (and reduce unnecessary costs) has led many OEMs and raw materials suppliers to change their buying habits. Tegra Medical has been taking advantage of “bulk buys” where possible, and is asking customers to commit to longer contracts so it can negotiate material usage in bulk, Miller said. “Larger buys mitigate upturns, but this just moves the challenge from the income sheet to the balance sheet,” he noted. “Longer-term supply agreements with key suppliers…can spread the risk by agreeing to take material over the next ‘X’ to ‘Y’ date range.”

While buying raw materials in bulk can help reduce costs, industry experts said the practice most often is utilized by large companies because they have the money to purchase large quantities of materials. New England Urethane has fielded requests about bulk buys from several of its larger customers, Edgar said. In addition, a customer recently approached the company with a request for a quotation forabout 75 percent of the raw material it would need this year to be shipped in a single order.

New England Urethane also has noticed an increase in the number of customers placing “blanket orders”—requests for larger volumes of material spread out over multiple deliveries. Smith said the company usually can negotiate a better price for blanket orders, as long as a customer commits to higher than normal volumes with shipments made in a finite period.

Besides helping to reduce the costs of raw materials and transportation, blanket orders allow firms such as New England Urethane to take advantage of economies of scale and plan better. “It’s easier and more cost effective for us to run 1,000 pounds at one time than it is to run 100 pounds 10 times. In addition, if we have slow time on a production line and we have blanket orders, it allows us to run materials we don’t need to ship for a month or so,” Edgar explained.

Clearly, placing blanket orders or buying raw materials in bulk enable companies to reduce costs and preserve cash. Both options, however, are not without risk.

Medical device firms that buy raw materials in bulk count on suppliers to give them a price break if they purchase a certain kind of material in large quantities. But suppliers are under no obligation to do that; indeed, they may be more unwilling to negotiate prices during an economic downturn for fear of losing revenue, industry experts said.

Buying in bulk also makes companies more susceptible to market volatility. Firms that buy large quantities of raw materials assume that demand will remain high for the substance being stockpiled. But demand can be fickle and fleeting (a lesson Wall Street traders learned the hard way last fall), and a wrong assumption about demand can force companies to pay for a material that is not immediately usable.

“Especially in this market, given where we were with raw materials surcharges, a lot of companies are looking at whether they lock in and buy larger quantities to get the price stability,” said Steven Tamasi, CEO of Boston Centerless, a supplier of precision ground bar materials and grinding services based in Woburn, Mass. “But because of the uncertainty in the economic situation, if a company commits to buying what it had traditionally forecast and business drops off, that company is on the hook to buy the material, whether it needs it or not. With prices low, a company may look at buying a few years’ worth of a certain material. Well, what if you don’t need that material after year one? Typically one doesn’t buy for that long, but what about 12 months? If six months go by and you find there was a design change that makes the raw material obsolete, you’re stuck holding the bag committed to buying a bunch of material you don’t need any longer. Companies are constantly trying to weigh the price stability with the actual needs of what’s going on and the flexibility of managing their raw materials.”

Weighing the price stability of raw materials with market needs is a challenging task, particularly for medical device firms. Many of the materials used in medical device applications are specialized, so there is not as great a demand for them as materials used in other industries, such as automotive. This can complicate companies’ efforts to determine the amount of raw material to purchase, and whether or not to buy materials in bulk, industry experts said.

Bankruptcies present a different set of complications. Recessions are notorious for forcing companies out of business, or at the very least, to file for bankruptcy protection. And companies that file for bankruptcy protection are generally considered to be financially unreliable as customers.

“There are more companies in bankruptcy now than in recent years, both suppliers and customers,” said John K. Moore, director of medical sales for Plitek LLC, a Des Plaines, Ill.-based manufacturer of precision die-cut components and converted materials. “We’re being asked by our customers to carry higher inventory levels—basically, to buy more material. At the same time, the risk that those customers won’t be there to pay also has gone up. So if you go out and buy twice as much material as you need because you are worried about one of your suppliers going into bankruptcy, you’re also increasing your risk that your customer is not going to be there.”

To minimize this risk, contract manufacturers can request payments sooner from customers. The exchange of credit information between contract manufacturers, suppliers, and customers also is critical, Moore said.

Strong relationships with suppliers, of course, can reduce the risk contract manufacturers face when purchasing raw materials for their customers. The strength of these relationships also can ensure the quality of the materials that are purchased for OEMs and eventually made into marketable products.

“Medical device manufacturers can ensure the quality of raw materials by maintaining an open line of communication with their vendor via formal specifications and audits of the vendor’s quality systems,” said Brian Reilly, product director of Healthcare Materials for NuSil Technology LLC, a manufacturer of silicone-based materials for the healthcare and pharmaceutical industries. The company is headquartered in Carpinteria, Calif.

Foster Corporation executives believe effective management of the value chain requires both a strong relationship with OEMs and in-depth knowledge of the supplier base. “The closer we are with our OEMs the more we can understand what they value, including material performance and quality,” Lazas noted. “With a strong understanding of our key suppliers and the materials the offer we can better align our solutions to the requirements of our customer applications. In many cases, improvements in quality can greatly impact the total cost of ownership and help manage material price adjustments.”
History has proven that great crises often beget great opportunities. The current financial crisis that is driving up unemployment rates and straining business budgets around the world is no different. Opportunities abound for those that look for them. The stabilization of prices for many raw materials has created an opportunity for contract manufacturers and materials suppliers to reduce costs and preserve cash flow—factors that are critical to remaining fiscally viable during financially challenging times. Reducing costs and preserving cash flow also can help companies gain a competitive edge when the world recovers from its long economic slumber. In the meantime, device firms would be wise to adopt those two key points as a motto. “Companies always have a need to reduce costs and increase cash flow,” Foster Corporation’s Lazas noted. “And that’s really the challenge for us—to identify opportunities to improve the cash flow and reduce the overall cost of ownership for our customers.”