Episode 5: COVID-19: Changing Dynamics
Mellon’s Matt Jenkin and outside expert Peter Bolstorff examine the operational challenges facing the healthcare economy due to COVID-19.
Rafe Lewis: Welcome to a special pandemic edition of Double Take, the Mellon Podcast. I'm your cohost, Rafe Lewis, Mellon's director of investigative investment research.
Jack Encarnacao: And I'm Jack Encarnacao, your other cohost and investigative researcher here at Mellon. Today we take a hard look at how the novel coronavirus known as COVID-19 is wreaking havoc with the healthcare economy, with a particular focus on the industry supply chain and innovation pipeline. To do that, we'll interview two experts, Mellon's own Matthew Jenkin and Peter Bolstorff, Executive Vice President at the Association of Supply Chain Management and the author of Supply Chain Excellence.
Jack: Okay. First let's talk to Matt. He's a senior healthcare analyst and portfolio manager who's spent the last 20 years or seasons, as he likes to call it, being the big sports fan, investing in this sector that's responsible for roughly $1 in every $5 in the US economy. Prior to investing, Matt was a senior research scientist at SmithKline Beecham where he helped to develop numerous cardiovascular and general surgical techniques. He designed surgical models for MRI and stroke research and researched osteoporosis. Matt earned a bachelor's in biology from Tulane University in New Orleans and an MBA from NYU, both cities now at the epicenter of the pandemic here in the United States. Matt, welcome.
Matt Jenkin: Oh, thank you. Thanks for having me.
Jack: Matt, from what we can tell, hospitals are increasingly in full triage mode, either dealing with or preparing for treating COVID patients. So first off, how well prepared was the US healthcare system for a pandemic? In your view, do they have the staff they need? Do they have the equipment they need?
Matt: Good question. I guess for starters, a little bit more macro. I actually think that there's some good in that... I'm always amazed how quickly we were able to get quarantined so quickly. It's never really happened in my lifetime, neither of yours. And I thought that generally, that transition of the public to quarantine actually was a lot smoother than I thought it would. On the healthcare system side, you're absolutely right. Definitely, it certainly has been a challenge and there's things to learn from in the future. The first thing is PPE or personal protective equipment. These are the masks and gowns that healthcare workers wear. I don't think that they ever envisioned how many different wardrobe changes they would need to do as they go in to room to room, how many times they would have to change their masks.
Matt: I also don't think that given this internet age where you can order anything online, that the public would hoard PPE before the hospitals were able to. So clearly, I think in the future they definitely need to have a US stockpile, if you will, much like they have for other things. On the ventilator side, which I think has been widely publicized, I think they're certainly correct. By our count, there's about a hundred thousand ventilators circulating and there's only about 60,000 ICU beds, licensed ICU beds in the United States. So that cushion is not very large, if you will. And to the extent that in certain regions the ICUs get over run, clearly there's going to be a ventilator shortage. Now there's obviously a call out to private industry to start making ventilators quickly, but it remains to be seen how quickly they can be made.
Matt: On the staff side, it's mixed. On the one hand you've got staff members that are getting sick, that can't come to work and that are dangerous to patients or their staff mates. So that's a net negative. On the positive side, given that most hospital systems have either delayed or stopped their elective procedures, there's quite a few anesthesiologists and there's quite a few doctors that aren't very busy right now that are now part of the front lines, if you will. And so that's certainly a positive. We've also heard lots of stories of nurses coming out of retirement, which for a particular hospital system that's quite good because that person who is coming out of retirement knows that hospital real well and knows the workings of it. So we've heard that that's gone well. So definitely a lot of challenges and a lot of things to learn from.
Rafe: Matt, one of the immediate side effects of this pandemic has been the near cessation of elective procedures in the United States. We've been running a proprietary survey of hospital executives as you know, for the past couple of weeks here at Mellon. And it now appears that less than 25% of typical elective surgery volumes are actually taking place. So Matt, what percentage of healthcare in the United States is elective and what does it mean for public health and for the healthcare economy in general that all of these procedures are being put off?
Matt: It's a great question and it's definitely been highly disruptive for a lot of companies that I follow and many of them are elective procedure companies. The best number that we've come up with coming from the companies and industry sources is roughly 60% of all procedures that happen within the walls of a hospital or an ambulatory surgery center are what we call deemed elective, but it's important to split up elective into two buckets.
Matt: One is emergent elective, so you'd be surprised to know that actually implantation of a pacemaker or implantation of a longterm defibrillator or even implantation of a coronary stent is actually deemed elective. Most of these procedures are actually scheduled. The good news is that they're deemed emergent. So clearly if a patient is in an emergency situation and needs a stent, they're going to get it and don't think there's any problem with it. But there's a good number of those in the emergent elective bucket that are definitely being deferred.
Matt: On the other side, there's what we call the non-emergent elective procedures. These are anything that has to do with the spine, knee replacements, hip replacements, those certainly can be deferred, canceled, and put off into the future. Oftentimes patients have lasted quite a bit of time before they actually made the decision to go get that elective procedure. So they certainly can put that off, and obviously the trade off is just a little bit more pain and maybe they're going to take more ibuprofen. So that's the state of that. And you're absolutely right, depending on what part of the country, region you're in, some places have stopped elective, either emergent or non-emergent altogether. So 100% down. And in some places that maybe haven't been as hard hit, maybe they're down 50%, 40%, just sort of come out to your average of about 25%. The longterm implications as you asked is an interesting question.
Matt: I'm more of the optimist and I like to think that things that are delayed just a little bit maybe won't pose too much a problem. Obviously it's just more of an inconvenience. But I do think an elderly person that is normally supposed to visit their normal doctor whose office is closed because they're in one of these real high quarantine areas like Massachusetts, things like that could get missed and it could end up being something a little bit more serious down the road. I think what we all hope is that while this is a necessary pause in these kinds of procedures and doctor visits, we just hope it doesn't last very long.
Jack: So Matt, another of our survey's findings is that not a single hospital that responded to our surveys is allowing vendor salespeople on the hospital premises, be it to hawk pharmaceuticals or devices or equipment. What is the likely impact of that? How much of the industry sales come from feet on the street, meeting face-to-face with hospital doctors and executives?
Matt: Good question. You'd be very surprised even in this day and age, face-to-face meetings and real relationship building from human contact if you will, really does directly correlate probably 100% or an R squared of one to sales growth. Particularly if a company is in the midst of kind of a new exciting launch, those touch points are extremely important. And you're right, salespeople by and large are not allowed in any facility. They're not obviously not allowed in any doc office, much the same way that loved ones are not able to see any of their sick family members face-to-face. The hospitals just don't need any bodies that they can't keep track of running through the hospitals and frankly they don't have the space or the time to deal with them. The impact is definitely a negative.
Matt: I guess the good news for any particular company is that their competitors don't have the salespeople in there as well. I would say where it hurts the most is on, as I mentioned before, on new launches. So if a drug company has a new launch and they have this nice window where they're trying to get some traction and they just can't get any new patient starts because the new patients are just not going to the doctor to seek new therapies, I think that's probably where it hurts the most. Where on the other side when all this is over, they've lost a little bit of that competitive window that they were counting on, and I've got multiple companies that I look at and invest in that are running into this same problem. We've heard the anecdotes, they're all doing virtual meetings with their doctors and nurse liaisons.
Matt: But the reality is, is while they say that those things are effective, I can't but help not think that they're terribly effective given that I do think docs are busy trying to track their own patients either on the phone to find out how they're doing or at least the ones that they're most worried about. And I just think the last thing they want to do is to take a call from a drug rep talking about the latest data set that just came out. So definitely a pause. Definitely a negative. Many, many stocks within healthcare that are levered to that have corrected as much or if not more than the market. So definitely feeling the effects of that and hopefully, like I said, won't last that long.
Rafe: Your lips to God's ears, Matt. We have an entire country putting off regular medical checkups, elective procedures as you were saying. Hey, we're all putting off dental cleanings, orthodonture, can't go to the gym, at the same time millions of us are sheltering in place, maybe eating too much, not exercising. I swear I'm not speaking from personal experience but what do you think are the longer term ramifications of this pandemic and all this sheltering on the health of the populace and actually for the companies you cover?
Matt: For the health and the populace I guess I don't know. I think it's really hard. It's really hard to make a call like that. Like I said, I just assume that we'll be in this situation for a few months. But I find it hard that people's behavior, certainly with respect to healthcare, are going to have really longterm changes. If a year from now you've got a problem that you want to get taken care of, the hospitals are all open, the dentists are open. I just don't think that this horrible episode is going to change the thinking there. On the company side, I do think that they're going to be a little bit better disaster prep work. I think companies are going to perhaps build bigger inventories of products that could be on shortlist in the event that this happens again. And I think everybody's getting the good lesson in virtual connecting with colleagues, employees, and obviously in the case of sales rep stocks. But I don't think longterm it's going to be that huge of an impact.
Rafe: Well, this is kind of grim, but I guess what I'm getting at is here you've got a lot of people who potentially are going to have a negative series of health outcomes potentially from being cooped up, stressed out, maybe overeating, maybe not exercising. I mean, are there sectors that can benefit from, as grim as that sounds... I mean, is there a dividend to be paid to healthcare companies of a certain kind from the American public being cooped up?
Matt: As grim as it is, and I agree that there's a mental aspect to it. Look, the things that happen while we're quarantined, obviously you're going to be... things that are where a person might get ill, are going to have to be taken care of by the healthcare system and there'll be many healthcare companies willing and waiting to take care of that issue. In mental, there's plenty of mental health products and services that can be used, but there's plenty of bariatric surgery to be done in the case that we get a little bit extra large. But longterm winners, I've thought about this quite a bit. I mean I see, obviously, diagnostic companies I think will benefit. I think they're learning quite quickly how to use the system to get things approved and pivot very quickly to get the right RNA test or antibody test. I think those companies will prosper.
Matt: I also think the vaccine industry is getting a real lesson in learning how to get things done quite quickly. They had an opportunity many years ago when the SARS and the MERS epidemics hit last decade, there was some green shoots on trying to get vaccines done, but for whatever reason it kind of fell by the wayside. I think this episode is large enough where companies won't forget and clearly there'll be vaccines because everybody expects that this will be a recurring seasonal virus. I think that's the consensus and I do agree with that. Other longer term, I think longer term winners and this might go against the grain, particularly for an industry that's just been battered politically and public-wise over the last many decades due to drug pricing. I think the biopharma industry might get a bit of a halo or somewhat of a medium term reprieve from the government vis-à-vis drug price just because at the end of the day, in addition to quarantining and all the things that all these frontline workers are doing, the drug industry is going to be a real part of the solution and I think they're going to get recognized for it.
Matt: That's something I think will take time. But given how much pressure on the industry is to lower prices, which frankly they have, I do think there'll be a bit of a halo effect. The losers, the longterm losers, I don't really see a ton of losers. I think just the near term losers. Anybody who's got an elective procedure as a main part of their revenue stream, I mean, is seeing right now the worst nightmare in revenue projections that they've ever seen as a company. I mean, organic growth rates could be down as much as 50% on companies that normally grow organically mid to high single digits. This is something they are certainly not used to and they have to right size their P&L. They're going to have to adjust their expense trajectories in order to to make sure that they have enough liquidity to make it to the other side.
Matt: By and large, most of them will, but when you have no revenues so there's no cash flow coming in and all the cash is going out, you got to make sure that you have bank account cash. You can't necessarily always count on the credit market. So I think those will be some longterm losers, but there'll be a lot of lessons learned from the elective side that in the future it would be mitigated.
Jack: When you think, Matt, as you touched on about recurrence, right? The idea that we might hear about COVID on a depressingly regular clip in the years to come, I'd imagine that must be a very difficult thing to model because are you modeling for the level of quarantine and economic destruction that we've seen with our first brush here this year? Or do we expect things... Can you model solutions coming to market, coming to bear that might lessen the economic impact of how we deal with the next wave? Could you just get more into your thinking about that and how you even project if we can handle this in a different way next time or if we even will?
Matt: I mean ultimately I think it boils down to vaccines. If we're talking about the same virus, vaccines are always the answer. Vaccines and humans that have been exposed to the virus that built up antibodies, it's essentially the same thing as a vaccine. That's the answer to mitigate anything. And once you have a vaccine, then it just becomes the seasonal flu, and the numbers are such that you're not going to overwhelm the hospital system and you're not going to necessarily make parts of hospital systems close for electives. So I mean ultimately that's the answer.
Matt: The other answer for just to go a few derivatives further, and this was written in the Wall Street Journal over the weekend, was gene editing, could be such a wonderful tool to be ahead of vaccines. If you're able to manipulate somebody's genome during a crisis like this, where they're able to develop an immunity well before the traditional vaccines are approved one year hence, that could be a wonderful tool. I don't think that that's going to happen tomorrow, but we have the technology today to do certain things to alter people's genomes, and that is certainly one of the many applications that will come out of it over time. So I would look for that.
Jack: Yeah, that's fascinating to think about. A key focus for us, Matt, has been understanding how the pandemic has been the ability or the inability of healthcare providers to access necessary equipment. We see this all the time, the sirens being sounded on this. Why did this happen, this sudden shortage? I mean, is it your sense that the United States is somehow unique in suffering this fate around equipment availability?
Matt: Yes and no. It's hard to know how every country stockpiles things. As I mentioned before, I think the PPE issue is easy, could have been avoided. I mean, there's no reason why a company like 3M can't have during good times longstanding contracts with the government, just to make sure that our hospital system's well in excess of the licensed beds have enough PPE. I mean, to me that seems quite easy. On the ventilator front, which I think is the other thing that is obviously very critical, in certain pockets of the country, we don't have enough ventilators and frankly doctors are using one ventilator for two, three patients, even using nasal cannulas.
Matt: I do think that whoever makes ventilators today, will certainly have lots of orders for stockpiling once this is all over and they'll likely dedicate a facility or two to just making ventilators to make sure the government has it. Obviously that will be in their economic interest to do so because the government will pay for it. But ultimately we just have a hundred thousand ventilators. There's no reason why we can't have 300,000 ventilators, which would be multiples of the 60,000 ICU beds that we have and should provide a real good enough cushion. And given the stimulus bills that are being paid for now and the trillions of dollars, adding another 300,000 or so ventilators doesn't sound like a tall task. So I do think that that will happen as soon as this is over.
Rafe: You know, speaking of the future, Matt, how do you think this pandemic has impacted the innovation pipeline? And I'm talking about drug trials, approvals for new medical devices, that sort of thing.
Matt: Well, it remains to be seen how handicapped the FDA will be on the current timelines of drug approvals. So for instance, if, let's say in November my company put together an application for a drug approval, it remains to be seen whether or not the FDA has been delaying. So far, no, there have been on-time approvals and on-time communication from FDA as expected from companies. That could change, obviously. But you mentioned a real good point on clinical trials and that is definitely one of the things that we're watching that could be reasonably bad is, companies are constantly running clinical trials. They want to start new ones, they want to continue to enroll ones that are all already enrolling and those are delayed. If you're quarantined, you're certainly not going to join a new clinical trial, so it's impossible to recruit there. So all those have stopped.
Matt: But also ongoing clinical trials. Again, it's hard to recruit new patients, but also what about the patients that are in the midst of a clinical trial? They've already been dosed the drug, they're waiting to see the reaction, the safety, the efficacy, but all during the course of that time you need blood draws, you need vital sign reads, you need behavioral logs, all the things that in a lot of ways do require some face-to-face contact and do require medical providers to be available. And we send stuff, there's a lot of those that have been disrupted. As I mentioned before, if this lasts two, three months, I think the clinical trial business will survive and prosper. If it goes longer, I do think plans will have to change and innovation will have to take a rain check, if you will.
Rafe: And one one last one for you. We've been hearing a lot about tele-health in the midst of all this. Needless to say, I mean physical health, behavioral health, lots of providers are now conducting visits of all kinds over the web. And I guess what I wonder is A, is that an adequate substitute for the kind of care we used to get? Or maybe it's better, I don't want to prejudge. And the other thing I wonder is, is it possible that kind of primary care, as we've known it for all these years, is about to change for good because of what's happened here?
Matt: No question. Telehealth has been an extremely valuable tool during this crisis. Before this telehealth penetration was extremely low, even though about half of the health plans in the United States actually provide coverage for it and low copays. But you're right, people are uncomfortable using a computer or a phone to tell their doctor or show their doctor on a FaceTime visit what ails them. And because of this crisis, people's behavior really had to rapidly change in and now it's become an extremely efficient tool, one that the penetration, which was probably in the low single digits, probably will ramp up into the 20% range over time. And you're right, primary care is probably going to be the biggest user of that. But you're right, it is a trade off. Do you really get the same care that you build the same relationship with your doctors? Does a doc palpate the bump that you're complaining about? You're not really able to do that over the phone or over the computer.
Matt: But I guess I'm more of an optimist. I do assume that if a doc is concerned about a patient, that doesn't really believe that the right diagnosis is being made, they're going to call in the future. They'll call that patient in. But telehealth is here to stay. Telehealth is efficient. Telehealth can be scheduled easy. Doctors can do telehealth after hours, and telehealth also costs less for payers, which in the end, which we would hope, might mean lower premium and out of pocket costs for the consumer. So there are going to be drawbacks as you pointed out, but I think net longterm, it should be a big positive.
Rafe: And maybe we can ditch those robes with the open back.
Matt: That's right. That's right.
Jack: Yeah, no reason you can't wear those on a video conference as well. Don't prejudge, although I'm sure they're in short supply. So certainly a lot of changes afoot and many will be resilient through the other side of this crisis. We just hope the positives are the ones that sustain and the daunting challenges are the ones that start to subside. Matt Jenkin, really a pleasure to have you here on Double Take. Thanks for sharing all of your insight.
Matt: Appreciate it. Thanks so much for having me.
Rafe: Now let's dive deeper into the seemingly unprecedented impact on businesses being wrought by the insidious Coronavirus known as COVID-19. The focus, supply chain management, a once arcane and uninteresting corner of commerce that has now become an absolutely vital point for policy makers, for healthcare providers, and the general public. We're looking at hospitals seeking out ventilators, shoppers scrounging for toilet paper, investors are searching for clues as to which businesses can and cannot access key components, products, warehouses, and even their customers that they're seeking to supply.
Jack: Joining us by Skype, to enlighten us as to the dark magic of supply chain management in the time of pandemic is Peter Bolstorff, Executive Vice President at the Association of Supply Chain Management, and the author of, Supply Chain Excellence, now in its third edition. The Association of Supply Chain Management, or ASCM, is the global leader in supply chain organizational transformation, innovation and leadership as the largest non-profit association for supply chain, ASCM connects companies around the world to the newest thought leadership on all aspects of supply chain. It also acts as the primary certification and training body for supply chain professionals. Their members include most of the Fortune 1000. Peter, welcome.
Peter Bolstorff: Thanks guys, really a pleasure to be here.
Jack: Yeah, and again folks, just want to remind everyone that we are all speaking from our respective remote offices, so please forgive any sound issues. Peter, I think the first question on everyone's minds in the investment world is this, were the world's preeminent supply chain professionals ready for a global pandemic? I mean how do you prepare for this kind of cataclysm?
Peter: That's a great question, and I've been a supply chain geek most of my life, so I'm very excited about sharing some of the art and science behind this with your listeners.
Peter: To start with, I want to introduce a very simple model on how we define supply chain. We own the supply chain operations reference model, and that model graphically is represented from supplier, supplier to customers, customer. There are key processes, plan, source, make, deliver, return, and enable. I think it's really important to have that kind of a context, so when we say something about supply chain, we think about it end to end.
Peter: The second dimension I want to share with your listeners is the idea that there is a scale of supply chain excellence. From laggers, on the left, to leaders on the right, and we know from our benchmarks over many, many years that leaders perform better to their customers and they perform better financially for their key stakeholders, including the investment community.
Peter: What we know about leaders is, in readiness for a global pandemic, is that leaders have, for the last five years, again based on other risk events in the world, they've been investing on integrating risk management into their planning processes, and that's helped them develop what we call risk mitigation playbooks. For those of you who are football fans, football, American football, if you've ever watched a quarterback go to their wrist and they flip open that little, I'll call it risk playbook, it's the same concept.
Peter: As we see different dynamics within the economic landscape or risk events surface in the world, there is a playbook that leading companies can refer to that will help them optimize their network, change flow, optimize their processes, change their processes, and things like that.
Peter: The last key point on, and how do you prepare for something like this is to really focus on building out your risk metric. Within the score model, we have a whole performance scheme of metrics, of which one of those is what we call value at risk. The definition of that, again all of us like definitions, is if you think about a risk event, it could be a pandemic, it could be a fire at a supplier. It could be a weather related thing. It could be a tariff. All of these things that we've experienced here in the last three to five years, so you think about the probability of a risk event occurrence, and then there's the monetized impact of the risk, so revenue, cost, or assets.
Peter: As different leading companies have organized and categorized their risk events, they put different probabilities against those types of events. From my point of view, leaders were prepared to manage through a risk event. Now the probability of a pandemic happening right now, well again we can all guess that, so let me stop at that. That's what we know leaders are doing today.
Rafe: Now since they've never had occasion, particularly on this scale, to use these backup plans and risk event plans, or put them into action, how would you say they are working so far? What are you hearing from folks?
Peter: Boy, so as it relates just to the COVID-19, I'll call it preparedness and response, one of the things we know is at the federal, at the state level, in the public, private collaborative, they've been struggling trying to define the supply chains that people have to think about. It's not just one supply chain. Then there are various population groups that you have to think about and worry about. You've got the general population. You've got mild cases that have been diagnosed. You've got severe. You've got critical, so I think the most strategic thing that we're seeing change right now in the public, private collaborative is how do we really define the supply chains that we're talking about, so we can put some ownership and focus on those?
Peter: We see that biggest ones are the critical care products going to the public health system, and going to what we're going to call the severe and critical care. The second one is what we call the home health supply chain, really aimed at the general public, who may be infected but don't know it, and the mild cases that have been diagnosed.
Jack: Can you, maybe this is a good point at which we could expand a little and just talk about the ventilators, since everyone is so focused on this, right?
Peter: Yeah, sure. Perfect.
Jack: You've got the Governor of New York saying he needs tens of thousands more. You've got the hospitals, generally speaking, in the United States along talking about needing many tens of thousands, and as we're looking at this, our country isn't the only one suffering from this problem. Every country on earth virtually is out there scrounging for these ventilators, which are made of a lot of different technological parts.
Jack: I'm wondering if you could give us some insight into that supply chain, and how that's going right now.
Peter: Sure, great. Again, I'm going to go back to the picture. I know this is a podcast, but if you can imagine in your mind a graphic where you've got five segments. You've got the supplier, supplier on the left. You've got the supplier next to it, then you've got your organization, and let's call that the ventilator supply chain, or organization. Then you've got the customer and then you've got the customer's customer.
Peter: For right now, let's think about the customer's customer as those diagnosed with mild, or not mild, but severe and critical care.
Jack: The patients, and then the customer is the hospital.
Peter: The customer is the patient, let's think about it from that point of view, not the hospital. The hospital would be the, between the ventilator and the patient, let's put it that way.
Jack: Oh okay, so I was thinking customer's customer is the patient. Customer is the hospital. Your organization is the ventilator maker.
Peter: Exactly, it's perfect. You're getting a passing grade already, so nice job. If you think about it from that standpoint, and so let's start at the right. I want to talk a little about that one, because a lot of people talk about planning. One of the things in this pandemic, in this public, private collaborative, we have to understand what the demand signal is going to be. Again, let's just think about those folks that are in severe and critical care, as the WHO defines it. Those that need hospitalization and/or intensive care.
Peter: We've got to understand how many requirements are going to happen as you think about this, the arm of this exponential curve. Again, depending on how well you've done in preparedness, there's a doubling rate factor. Singapore, for example, is probably the model country. They double their cases, diagnosed cases every 10 days. Right now, the U.S., like China, like many others, are doubling their cases every two to three days, and so there's this idea of trying to, in a dynamic way, trying to understand what, how many patients would require a ventilator because we know it saves lives.
Peter: I think that has been very tricky. I think there's a lot of public sentiment around that one, but I think from a supply chain standpoint, how do we actually put some science around that set of requirements? I know in Minnesota, we actually have that number. The Governor had put together a supply chain task force, and we actually understand, based on where we project the curve to go, how many requirements, and it's time phases. At what point do I need those?
Peter: Once I understand the number of patients that we need to think about, and the time that we think we're going to need them, then you back it up into, do we segment the, where that treatment occurs? Again, you've got countries like Spain, who are thinking about opening up an entire football stadium to serve as some aspect of the diagnosed cases. Again, you have to understand, from a hospital standpoint, or from a clinic, or from some other temporary health facility how that's going to work. How do you integrate that plan?
Peter: Once you understand what the requirement is, and the capacity to be able to service that, now you get back to the ventilator itself. You've got software things and you've got hardware things. On the hardware piece alone, I mean you could Google this on the Internet, there is at least 80 items on that bill of materials that you have to source, and then manufacture, and then test, and then quality.
Peter: Even if you have, if you start adding capacity into the middle of that chain, where you've got all kinds of people who can manufacture the ventilator, and test it and qualify it, you still have issues on can the supplier and/or the supplier, supplier support all of that? I think electronic boards has been a discussion that you've seen of late, but I can assure you that of all 80 of those bill of materials, there's going to be more than just one constraint.
Peter: I think one of the things we see is this is really driving what I call digital innovation. You've got all kinds of people thinking about how do I 3D print constrained items. Again, you can see that in the news and in the media. It's not just a simple question, and that's just the ventilator.
Peter: If you think about critical care, you've got swabs, so how do I actually test? If I've got enough test kits, I don't have enough swabs. I'm still constrained at that particular part of the supply chain. Let me stop there.
Rafe: That's a great point. Go ahead Jack.
Jack: Peter, 80 components, at least, into a ventilator is what you said.
Peter: Yep, and again, if you think about a ventilator and you can graphically think about it, you've got some kind of a digital display that is the interface. You use an interface. You've got the main CPU unit, where the gases are coming in. You've got the gases going through a humidifier generally. They're going out to the patient and then the patient exhales, and then it goes back in through a filter, and then exits in the back, on wheels that can be portable. Again, not a ventilator expert, but ...
Jack: No, I understand, yeah.
Peter: Generally familiar.
Jack: Incredible, so if there's 80 component pieces in the bill of materials, do you have a rough idea of how many of those 80 can be realized in one location? Do you need to go to 80 different suppliers for 80 different parts, or is it perhaps, hopefully simpler than that?
Peter: Well yeah, again, yeah if you were inside a company's four walls, they would have, in a bill of materials, a description of the item, the supplier that is servicing at some kind of a quantity of it that's needed to put the thing together, and then there's some other kind of a part number and a coding. Within this, I could count them up, but I'm guessing, I'm looking at probably 30 different suppliers needed to support those 80.
Peter: Without naming names, and that's just the hardware piece. That doesn't contemplate the software piece, the interface that actually drives the hardware piece to it.
Rafe: Let's broaden out the conversation again to just supply chain generally, okay? A lot of us in the investment community have been wondering if recent trends like Just In Time inventory management, Lean Inventories, are these being re-thought as we see this recent chaos? I mean how do you think the Coronavirus pandemic will permanently alter how corporate supply chains are managed going forward?
Peter: That's a great, great question. Let me just share some insights based on our corporate leaders, in our corporate community, within our association space. There's probably five points I'd like to make on this one.
Peter: The first point is we know that leaders right now are going to leverage lessons learned from this pandemic to make their supply chains more resilient and sustainable going forward. They're going to get the opportunity to redo some things, and I can tell you, agility, which is the ability to respond to unplanned demand up or down, will continue to rise, or maybe will accelerate in it's rise as the top competitive advantage for any supply chain.
Peter: Lots of people would compete on cost. Lots of people would compete on cycle timing, how long does it take me to get stuff there. Lots of people would compete on delivery reliability. I think this agility, the ability to respond to unplanned demand, especially around significant risk events is going to be a competitive advantage.
Peter: We also know that the leaders are doubling down on digital capabilities. 3D printing, so how do I start to think about my smart operations and digital development? How do I start to think about investments there? How do I start to think about synchronized capabilities needed to truly synchronize planning and dynamic demand management, and all those other buzz words that you might hear in the supply chain trade sector. Really doubling down on digital investments. I can see right now, today and the last six weeks people were on the edge of, "Should I invest in the digital thing or not?" They're saying, "If I don't, I'm going to get left in the dust."
Peter: There's going to be a lot tighter weave of risk management and the sophistication of that risk management into the end to end supply chain. I can tell you one thing, nobody likes buying insurance, right? Why do you buy insurance? Again, you've got all kinds of mathematicians out there saying, "The probability of this, the probability of that," but the idea here is it's to help you manage through events like this. I think right now, the Coronavirus has really put an exclamation point on how do we really put a tighter weave of risk management into the end to end supply chain as I described?
Peter: The other one, I know people are doing right now today is they're rebalancing their supply chain network. Are we overly dependent on resources that China provides? It wasn't just the Coronavirus, but again when you think about the China U.S. trade war, other, I'll call it more minor, but significant risk events in Asia around weather, etc., have caused people to really rethink about single source, low cost manufacturing. Right now those leaders already have in their blueprint, I have maybe a couple of sources for critical items, maybe one's more expensive, but they're more agile because they're in North America.
Peter: Then the last thing, the last lesson is we were absolutely caught flat-footed on the degree of collaboration needed in the public, private sectors related to public health supply chains. As I said, the two that I said is in the critical care products. How do we plan, source, make, deliver, return and enable critical care products to severe and critical cases?
Peter: The other one that I want to mention out, and I really want to double down on this one is this whole idea around home health supply chain capabilities. I want you to think about this, we don't know what the infection rate is, in the general population. All we know is once somebody gets tested, are the positive or negative. Now people are starting to talk about infection rate of the general population, and all of these shelter in place, and all of those kind of things are an attempt to manage this general population and prevent spread, but imagine all the capabilities that we have right now today.
Peter: It wasn't until just two days ago that I got a note from Blue Cross Blue Shield, again our provider that said, "Hey look, we have virtual appointments available. We can do tele-medications. We can deliver X, Y, Z to your door," all of those kinds of things. We did not prepare our home health supply chain to take care of the general population in mild cases, which is where the bulk of the volume is at this point.
Peter: Okay, as you can see, I'm pretty excitable about this one, sorry for the, right?
Rafe: No Peter, that's fantastic. Can you just explain a little bit, going back to your comments about how these supply chain managers are now seeing if they haven't embraced digital that they have to, and you gave one example, which I think is very tangible, which is a 3D printer. I think people can understand that.
Rafe: What does that category really entail digital, because presumably they were already working with computers. They already had electronic correspondence. Presumably they're able to track their goods in some manner with you name it, RFID or bar codes, so can you talk about what is it that they hadn't embraced in the digital realm that they now have to?
Peter: Yes, great question. Let's think about the current supply chain as I just described, kind of a linear plan, source, make, deliver, return and enable. You work from supplier, supplier, to customer's customer. We did a collaborative project with Deloitte. We introduced a new model called the Digital Capabilities Model. There are some key digital capabilities that we know that leaders are investing in today. One of them would be synchronized planning. One of the tools that we know there is this whole idea around artificial intelligence. How can we use that to sense demand and respond to demand easier, better, wider? How do we leverage advanced analytics? There's this whole AI cognitive computing.
Peter: There is the connected customer. Again, how do we sense demand? How do we know that a bed is available, for example. There's the dynamic fulfillment, so how do we fulfill things in a more dynamic way as opposed to a weekly or a monthly schedule? Digital development, as I described to you, so dynamic fulfillment would be things like driverless vehicles. It would be GPS. It would be real time signaling on where your goods and services are. Digital development, again the feature one there is the 3D pinching. Smart ops, manufacturing, that's where you get the sensors. How can a machine tell you that it's going to be broken three days from now, so that you can fix it before it goes down?
Peter: Then there's the intelligence supply, and that's how do I, in a dynamic way, understand commodity, capacity, location and all of those kind of things. We put some science around digital capabilities. We put them in buckets. That's a whole different conversation, but what we do know is, and this is for the investment community. We know that there's two sets of metrics that would tell you whether a company's investing wisely or not, in my point of view.
Peter: One is if their inventory turns are improving at the same time as their reduction in cost of goods, or improvement in gross margin, one of those two, and the other pair is, I'm growing my revenue and I'm improving my return on invested capital, or return on assets. We know that supply chain leading organizations are able to manage those two pairs of metrics over time, and I would look for companies making digital investments now, actually being able to grow faster with better margins and better use of cash. Let me stop there.
Rafe: All right Peter, that's great stuff. One of the unique aspects of the COVID-19 crisis is we've had massive disruptions to main street businesses, and really the entire supply chain routes that they rely on, ships being stranded off shore, borders shut, the U.S. experienced an unprecedented 45% slump in imports from China during the first two weeks of March this year. The port in Shanghai, one of the busiest in the world saw a 20% year over year drop in container through put. It is a wide spread change of dynamics here, so what of that? What would you say about how companies are dealing with these new barriers?
Peter: Great question. Let me unpack that for just a second. Let me talk about my main street. I'm in Minnesota. I'm sure, and everybody could use their home state and their home municipality. I think our first area that we need to think hard about is small business. It's one thing for a large company, who's moving goods around the world in a retail fashion. Certainly this spike in demand, up or down, is going to impact them, but if consumers are still going to the grocery store and they're still buying things within that context, and they're still going to other larger stores and buying in that context, that supply chain will self-correct over time. I mean they're that mature.
Peter: My worry is about the small business, those folks that are truly down on your main street. They've done an amazing job with innovation. Let's just take food service. They have all kinds of consumer preferences that they need to deal with, GMO, non-GMO, organic, gluten free, you name it, and fresh. As their supply chains have matured to handle that kind of consumer, that consumer choice, they've been inflicted by policy. You can't be open. They've had a policy change that's impacting them, and it's not one spike for one week. It's not like toilet paper just went out and I have to replenish it. Policy has dictated, at least in my state, that they can't reopen for an extended period of time. My concern on the business front is this, what I'm going to call small business, especially for food service, non-essential services.
Peter: The second thing that we need to be concerned about is what I'm going to call the other things that have had prolonged spikes, downward spikes in demand, hospitality and airlines. Again, I was driving by a large hotel chain, and there were two cars in the parking lot. Something that you never would expect to see, and then you've got all of the events that are postponing or canceling, or shifting to a virtual dimension.
Peter: To me it's small business, food service, non-essential, then it's hospitality and airline, and now let's get back to what I'm going to call the logistics and transportation of goods between Asia, the U.S. and Europe. Again, I think right now, within the COVID-19 response, you've got incubation periods that have to be adhered to. You've got shelter in place things that you're going to have to adhere to. As some of those regulations kind of ease up, those supply chains will self-correct because it's supply related. To me it's the demand side that we have to pay attention to. I'll stop there.
Jack: Peter, back to the technology point for a moment. One of the pet hypotheses of a lot of investors, I think is that there's going to be increasing adoption of automation across virtually every aspect of the economy, and when you look at a supply chain, there's a lot of people packing, putting things onto ships, taking them off of ships. It's still a fairly human intensive process. I guess what I wonder is, do you think that the supply chain gets significantly more automated because of what we've seen here, and some of the, I guess, what's the word I'm looking for here, the vulnerability to human health, and viruses and that kind of thing?
Peter: Great question. You know, you can see who's hiring right now though. That's still more people, but I believe over time what we're going to see is, again, I go back down to people are doubling down on digital investments. I see that there's going to be first, there's going to be more man and machine interaction within a particular supply chain space. That could be in a retail store. That could be in a warehouse. It could be a planner interacting with an artificial intelligent agent on a computer, so I know within our constituents, and before COVID-19, we were looking at how do we progress capabilities and skills within the supply chain community to be able to interact with technology, and make things better that way. We knew that to be true before COVID-19. We're very excited about that. Again, lots of opportunities there.
Peter: I think with the automation within warehouses, and within manufacturing plants, I think to me the more important question there is, given COVID-19 and our absolute flat-footedness around responding to capacity and volumes on some of the supply chains, I'm interested to see how many are re-shoring opportunities where we bring manufacturing and distribution back to the U.S.
Peter: When those factories and warehouses go in, I assure you they're going to be using the necessary automation to be productive. That's still not person less. I think last but not least, I think, and actually it should be first, is we also see the rescaling of the folks in supply chain, so food service, retail, logistics and transportation. We see the opportunity to rescale because a lot of the supply chain skills are transferable across industry. Again, we're very bullish on that.
Rafe: When it comes to China, Peter, this pandemic comes to us as supply chain managers were already dealing with massive disruptions from the trade war, and the new tariffs those introduced, and we're wondering where are we in the re-alignment of supply chains out of China right now? Where were we, does this accelerate it? Are you seeing instances where folks are indeed taking those concrete steps, shifting manufacturing away from China? Will those moves, if we are seeing them be permanent, anything in U.S., North America you're seeing in that vein?
Peter: Yeah, so let me go back a few years. Again, when the China economy was just going gangbusters, what was happening is all of the capacity that we had invested in China, to service export to the world, actually got filled up with the Chinese domestic demand. There was a point in time, at that point where companies in a very proactive way started to think about, "Okay, where do I put my next bit of capacity?" There were some decisions back then, "Do I bring it back into North American someplace? Do I go to Southeast Asia? Where do I, Eastern Europe?"
Peter: There was a migration at that point when the capacity that was in China was for China. Then enter in some of the other risk events that happened in Japan. The weather issues, Hong Kong political system has been interesting. The trade war, I think what has happened is for leaders it's just what I would call, every prior risk event further informs and updates their playbook to enable more rapid response in the future. Leaders gain share. It's the lagers that are going to be problematic. If you didn't think about it before, and you're using COVID as the first time you're going to look at capacity, they're going to have some challenges. Does that make sense?
Rafe: It sure does, and are we seeing concrete steps to put manufacturing away from China, that you expect to be permanent?
Peter: I think it's rebalancing. Yeah, nothing's ever permanent. I think there's going to be a natural rebalancing of capacity, absolutely. Again, when you look at the sheer volume of workforce in China, and the investments they've made on infrastructure, it's still a good place to do business. The question is, from a risk standpoint, is it the only place that you're going to be doing business? I guess that's the big question. Again, I think every supply chain is going to be re-evaluating and thinking about rebalancing their network for sure, if they haven't already. Again, we know leaders have.
Jack: Peter, last question for you. It's something I think folks were thinking about before the pandemic, and it's probably fallen off the radar a little bit, but it's still probably important in the longer term, which is that we created a NAFTA 2.0 here, the USMCA, which changed the relationship between the U.S., Mexico, in particular, but also Canada. I guess I'm wondering what we've seen to date in terms of how that's affecting supply chains, and supply chain management.
Peter: Good, so I'm not an expert there, but I can tell you a couple of things. One is, if we were to do it, the good news is that we actually have something on paper, right, so there is this whole period of time where it was kind of through the media, that we were talking about it. At least we have something on paper. It's too early to tell from a my vantage point, and my view of the supply chain, especially with our corporate members. I do know that by industry, dairy made out on both sides. Metals did not make out. They're still tariffs in putted, and then the projection is that automobiles, again came out, from a trade standpoint, the worst.
Peter: What I would suggest is there's nothing that's showing up on my dashboard that says, NAFTA 2.0 is causing huge pains. I think you'd have to go into an industry vertical, in one of those three, and really get at what are they seeing right now from boots on the ground standpoint.
Rafe: Well, it's an excellent conversation and it's a great way to set the table on reading what's ahead, changes that are permanent, changes that might just be in response to this pandemic we're dealing with, maybe a little bit of both. Peter from the Association of Supply Chain Management, it was a privilege to have you on Double Take, and best of luck to you.
Peter: Cheers guys. Thank you so much for the opportunity.
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