Sustained depression in crude oil prices, from $100 per barrel in 2014 to the current level of $50 per barrel, has brought the prices of derived polymers such as Polypropylene (PP), Polyethylene (PE) and others down by an average of 20 to 30 percent. Due to these developments, medical devices manufacturers have realized annual savings close to $1 million $10 million spend on categories such as disposables which heavily utilizes the use of plastic polymers.
Medical devices industry utilizes a number of medical polymers to manufacture their products. Polyvinyl chloride (PVC), Polypropylene (PP), Polystyrene (PS) and Polyethylene (PE) are some of the most prominent polymers used in the medical devices industry. For certain products such as disposable syringes and tubes, the plastics constitute almost 40 to 50 percent of the total cost associated with the product. The prices of these polymers are heavily dependent on the prices of the source material i.e. crude oil. Any major fluctuation in the crude prices is mimicked in the resin and polymer prices.
During the period from 2012 to 2017, crude oil prices have rapidly declined from more than $100 per barrel to the current levels of $47 to $50 per barrel. This happened due to higher outputs, oversupply, declining demands and competition from U.S. Shale. This pattern has also been mimicked in the medical polymer market and prices of polymers have declined from 2014 levels. The price of PP has declined by almost 30 percent, PS by 24 percent, HDPE by 25 percent and PVC by 16 percent.
Savings Opportunity: Realized or Lost?
Let’s assume a scenario for Company X that spends around $10 million on their product category which heavily utilizes polymers like PP, PE and others. Assuming that plastics constitute 35 percent of the total cost of product, the total addressable spend due to plastics comes around $3.5 million. Company X has mid to long term (3-5 years) agreement with their current supplier or outsourcing partner and the contract was framed during the period of 2012-2014. Considering the decline in polymer prices, Company X had an opportunity to realize savings of $500 thousand to $1 million per year. When combined, this interprets into unrealized savings of an average $2.5 million in past 3 years. On top of this, factor-in the decrease in costs associated with manufacturing such as utility costs (due to decrease in coal costs), logistics and transportation costs (dependent on crude), the lost savings keeps on stacking.
Why are companies like X unable to capitalize in such markets?
Contracts will certainly have clauses for passing costs or benefits due to the fluctuations of underlying cost drivers, but, in the end it is totally depended on contract compliance. In an ideal case scenario, the supplier should automatically pass on the savings achieved due to raw material price decrease to the client which some suppliers certainly practice, the word of importance here is “some” as it is not the ideal world where businesses operate. Factors like poorly framed contracts, lack of strong contract compliance teams, absence of market tracking teams, inefficient SRM program and others leads to waste of such cost saving opportunity.
The key to extract the best out of the market fluctuations is to have a robust contract compliance team which is empowered with strong contracts containing performance and penalty clauses. The team should ideally have access to category databases or third party research platforms and should track market movements of the major categories of spend once every quarter. Any sustained fluctuation over a period of three quarters should be immediately addressed with relevant suppliers and stakeholders within the organization.