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Supply Chain Development in Orthopaedics

The following is a transcript from the OMTEC 2012 Opening Panel Discussion, Supply Chain Development in Orthopaedics. Video available online

Moderator, David Floyd: Challenges for OEMs mean challenges for the suppliers. The tightening of regulatory scrutiny, more overseas manufacturing and recent unusual fluctuations in demand present complications. Panel members, what are the key overall concerns for suppliers to the OEMs?

Brian Moore: All of the obvious ones: price, low cost competition…but the supply base is reacting to the strategies of the OEMs. How OEMs deal with their inventory management and marketing launches are the major drivers for demand for suppliers like Symmetry and others. I’ve worked in the automotive and aerospace supply chains as well as medical devices, and there’s been this wave of what I call the “5% down” guys who started off in automotive, went to aerospace and are starting to appear in the orthopaedic area. Looking at the aerospace experience, they’re finding that the supply chain, under this pressure, has been largely damaged. If you talk to the large aerospace suppliers, they are very concerned about the supply chain being weakened because of, if you like, a lack of respect from the large OEMs that use this great buying power to save 5% for three or four years. Any company that can give you that is not well-managed in the first place.

I would say that the biggest competitive factor for most suppliers is the in-house buy or make for the OEMs. They have a lot of manufacturing capacity, and until they change—if they change, to a more outsourcing model, I think the supply chain is just going to react to those comings and goings. And it’s a very volatile industry. Particularly if you link to instrumentation and product launches.

David Floyd: It’s no secret that the OEMs have a lot of inventory scattered all over the earth. Do you think that has an effect…as they have said that they are seeking to get more efficient in managing that inventory, and reducing those overall inventory levels; does that inventory have a direct effect on the supply base?

Brian Moore: Yes, it could be dramatic. One of the large OEMs did an exercise a few years back, going around to all of the hospitals and pulling in all of the instruments that they deemed not usable. They ended up with billions of dollars-worth in a warehouse. They said to two or three suppliers, including Symmetry, “We don’t want any more product for about six months.” Which to them is a minor adjustment. To a small supply chain, that’s six months of no demand. That’s traumatic. These decisions are far more important to the supply chain in orthopaedics than, say, procedure growth.

David Floyd: What should suppliers focus upon in terms of opportunities to grow in this environment?

Brian Moore: They need to stay close to the OEMs, move into more generic services other than just cutting metal, offering integration packages, total solutions if you will. If they have the ability, they need to offer more than just the made-to-print service. Give them some innovative ideas, give them some developments. A lot of the engineering resources in the OEMs, from what I see, are being deployed on regulatory affairs rather than what I call pure product development. The supply chain has an opportunity to bolster that.

David Floyd:
Bill Kolter, Biomet is among many companies that have established manufacturing facilities in China. Does that or do other factors change the traditional make vs. buy decision that you go through?

Bill Kolter: We continue to make those decisions in the same fashion we always have. Certainly we try to leverage our in-house capacity, but we consider three factors: Is it new technology that we have the expertise, in-house, to make? And if we do, then we make it. If we don’t, then out of necessity we have to outsource it. Second, we also consider whether it’s wise from a business standpoint to insource a product that might defocus our capacity. In other words, if we have competing priorities and insourcing would interrupt another critical priority, then we’d outsource. Third consideration is cost.

The other thing we keep in mind is that we understand there’s a risk to having an imbalance to insourcing and outsourcing, so we pay attention to that.

David Floyd: So before cost comes into play, you’re looking at capacity, capability, focus and cost. Bill Plovanic, does the investment community pay attention to the supply segment of orthopaedics? Are they so focused on the OEMs that they’ve ignored this space?

Bill Plovanic: The focus for investors is definitely on the OEMs. From our standpoint, if you look at the supply chain, it’s a challenging business. I think Brian said it best—you can have 5% pricing decreases dictated to you four years in a row. With investors, what we like to see is linear growth and a lot of visibility in the numbers. With suppliers in general—in orthopaedics or any other industry—that visibility is not there, because you’re at the mercy of an OEM. Typically, suppliers are not highly valued; they have lower multiples, and typically we stay away from them.

Brian Moore: I think Symmetry educated the whole of Wall Street about the volatility issue. But when we went public, we were the dream ticket, because they perceived us to be a tracking stock for the main OEMs, and then when they saw a fairly major drop in the instrument sales due to marketing activity, it had nothing to do with the performance of Symmetry—we hadn’t lost any customers or business. If some marketing guy at an OEM decides to move a launch a year, you lose $X million dollars’ worth of sales. The analysts of this world can’t handle that. They (Wall Street) ask, What’s going on?

David Floyd: Is there a future for smaller suppliers in orthopaedics?

Brian Moore: Of course! People ask that in any industry, any walk of life. Anyone who comes up with a good idea that is well-managed and innovative has got a future. The growing pains are the things to be careful of. If we were doing this all again, I think a lot of small companies with very good niche products and very focused markets, without having to go for volume, have probably the best model to service the orthopaedic industry, because as Bill said, they have tremendous capacity.

What they do as their major machining capacity for the major joints gets run down, because of procedures, they swing that in with instrumentation and other things, so you get this double-whammy when the thing slows up. You not only get the outsourcing decisions, you get the fact that they’re using their internal capacity, which gives two hits to the supply chain. Smaller companies, I’d be encouraged with a good, quality, innovative model—particularly if it’s got a very strong regulatory approach to life and starts off, straight out of the box, with a need to meet the high standards of the OEM, of quality and regulatory.

David Floyd: Gentlemen, you’ve given us a fairly—I won’t say rosy, but a positive view of the future for orthopaedics. There’s growth there, demographically-driven demand, some of the things that put pressure on the industry now will resolve themselves. Device tax or no device tax, we’ll absorb it and move on. There are opportunities for small companies, big companies; innovation is still there. And that’s good.