Costs continue to soar in the medical device industry. According to recent data, the Index (PPI) for medical equipment and supplies has reached its highest level in 20 years, with an increase of 3% in just the past 12 months, and nearly 6% over the last 24 months with no signs of abating. In this environment, medical device manufacturers are faced with a set of unfavorable options that include absorbing increased costs, passing cost increases along to customers, or taking more drastic measures such as downsizing staff, divesting divisions, or terminating customer relationships. Medical device manufacturers are faced with a set of unfavorable options that include absorbing increased costs, passing cost increases along to customers, or taking more drastic measures such as downsizing staff, divesting divisions, or terminating customer relationships.
But in the face of these challenges, there’s also opportunity. With the right information, you can get clear insights into your costs that can be used to streamline your operations, support your negotiations with customers and suppliers, and ultimately preserve or improve profitability. From this position, you can explore and pursue business opportunities that are aligned with your financial and operational objectives.
However, if your company faces competing priorities and data that lacks actionable insights, the first question you may need to answer is, “Where do I begin?” We’ve identified four strategies to help maintain (or improve) your margins, stay profitable, and utilize data to make better strategic decisions.
1. Understand and accurately assign your costs
How you assign labor and overhead costs to stock keeping units (SKUs) is critical. Too often, companies offshore, re-source, and exit business based on inaccurate costing. Ideally, your costs should be allocated based on drivers such as labor hours, machine hours, or machine-specific costs, not a broad-brush approach that groups these items together.
Have your managers assess the business objectively. Does labor really drive the amount of maintenance expense, utilities, and perishable tooling of your machinery? Are SKU proliferation-related costs such as the supply chain, inventory storage costs, setup time, and related costs of increasing your product catalog based on changes in customer, channel, or industry being “peanut butter spread” across the entire factory? One indicator of inaccurate costing is the use of a single overhead rate for a plant with multiple, heterogenous processes. It distorts your view of product profitability, leading to poor business decisions. If that describes your company, it’s time to get more granular and produce timely, accurate costing information at a product level.
In most cases, inaccurate costing can be attributed to a lack of good data. From bills of material (BOMs) and production routings to labor productivity and overhead rates, the source data that’s used to generate product cost information is often poorly maintained and improperly calculated. The data doesn’t need to be perfect, but it does need to reflect your actual operational practices and performance with reasonable accuracy. Discipline and accountability, as well as the pragmatic application of industry best practices in costing methodologies, will get you there.
2. Identify internal waste reduction actions
In the face of rising inflation and shrinking profit margins, you must prioritize identifying and eliminating internal waste to help maintain financial stability. One effective approach is to conduct a comprehensive assessment of all operational processes to pinpoint inefficiencies. This assessment should encompass every aspect of the production cycle, from raw material planning and procurement to finished goods delivery. By leveraging available data and process mapping, you can uncover bottlenecks, redundant steps, and areas where resources are underutilized. Implementing lean manufacturing principles, such as just-in-time inventory management and continuous improvement methodologies, can further streamline operations and reduce waste.
Additionally, fostering a culture of continuous improvement and employee engagement is crucial. Encourage staff at all levels to contribute ideas for waste reduction and efficiency improvements. This can lead to innovative solutions and a more agile organization. Regular training and development programs can equip your employees with the skills needed to identify and address waste in their daily tasks. By systematically addressing internal waste, you can offset the impact of rising costs on profit margins and enhance overall operational efficiency and competitiveness in the market.
3. Prepare to negotiate price increases with customers
When you first realize your cost increases are going to surpass your contractual agreements, your first instinct may be to pass them directly onto your customers. But without an understanding of which specific parts or customers are impacted, it’s extremely difficult to negotiate. You want to engage in fact-based discussions with solid supporting data. Having the right data at hand maintains transparency and shows customers that you’ve done your due diligence to pass on the lowest cost increase possible.
Before entering discussions about a cost increase, you should first determine:
- Which parts are impacted.
- The customer’s share of price change (if the part is made for multiple customers.)
- Whether your customer and supplier material recovery mechanisms are synchronized.
To help build a business case around the data, consider these actions.
- Monitor your purchase price variances. If you’re using standard costs, tracking purchase price variances upon receipt of goods is critical to understanding when and where changes occur. When passing costs on to the customer, detailed records of supporting invoices are key to making the business case for an increase.
- Review parts tied to material agreements. Understanding raw material indices and any triggers for increases will help you align on commodity cost increases with customers and suppliers. That said, in the current inflationary environment, the indices often haven’t kept up with specific purchased parts. Customer recovery agreements may not match up with supplier recovery agreements, or vice versa, so a deep understanding of those recovery mechanisms is essential to knowing what your true costs are.
- Review parts not tied to material agreements. Most customers and suppliers are open to tying raw material costs to indices that are balanced and fair. If the commodity price goes up, so does the finished product price to the customer, rather than evaluating this as a lump sum.
- Adjust pricing monthly or quarterly. The more efficient your data collection, the more frequently you can adjust your pricing. In today’s rapidly changing environment, semiannual and annual adjustments are the least desirable; when possible, make them more frequent to avoid lagging debits and credits on your balance sheet.
When preparing for pricing negotiations, keep in mind that customers will normally want to see, if not require, solid justification when reviewing cost increases that aren’t tied to a market index.
4. Rationalize/eliminate poor performing stock keeping units (SKUs)
SKU rationalization is a strategic approach to optimizing your product mix, improving operational efficiency, and better aligning your offerings with market demand. It involves a thorough analysis of your entire product portfolio to identify underperforming or redundant SKUs. By evaluating factors such as sales performance, profit margins, inventory turnover, and customer demand, you can determine which SKUs are contributing to financial success and which are draining resources. The goal is to eliminate low-performing SKUs to reduce inventory costs, minimize complexity in production and distribution, and then focus your resources on high-value products.
To effectively carry out a SKU rationalization exercise, you should leverage data analytics tools to gain the necessary insights into product performance and market trends. Involve teams from sales, marketing, finance, and operations to ensure a comprehensive, collaborative evaluation. It also wouldn’t hurt to engage with key customers to understand their needs and preferences and use this as input in your decision-making.
Moving forward
In an environment of high inflation and evolving trade and tariff concerns, a strategic approach to protecting margins is essential. Start by prioritizing one or two initiatives, and bring in experienced advisors for critical support in planning, data optimization, and augmenting your internal resources with specialized expertise. By adopting these measures in the face of rising costs, you can prevent margin erosion, maintain your competitive edge, and be ready to seize on strategic opportunities as they arise in today’s uncertain market.
