President Donald J. Trump’s plan to reset the global economy’s competitive landscape through sweeping tariffs is causing significant market chaos. As of mid-April, medtech supply chain companies were still trying to decipher tariffs’ full effect, as the terms imposed by the United States and counter-imposed by its trading partners changed daily, sometimes hourly. Nevertheless, it is safe to believe the industry will face the repercussions of higher tariffs for quite some time. And while medtech suppliers plan for costlier imports they may be forced to grapple with other, larger challenges. These issues may not have made headlines yet but they most likely will be larger and more painful than just higher costs for direct imports. Some of these challenges will be apparent in the coming months and others may take years to develop, but all of them will be harmful to American manufacturers.

Labor Costs

The greatest problem medtech managers are likely to face in the next 12 months is the rising cost of U.S. labor. Tariffs, by their nature, are inflationary. It is an expense placed on the importer for the choice to use foreign materials or products. But if a company, or person, avoids purchasing a product being taxed upon import or finds an alternative from a low/no tariff country, there is no inflation. So what is the problem?

Answer: It’s not so easy to avoid purchasing tariff-linked products or find alternatives. Trump’s tariff regime (now on pause for 90 days) is broad-based and particularly targets Chinese products. America purchases all types of products from China but the mix largely skews toward inexpensive consumer goods—the kind of products found in Walmart, Home Depot, and on Amazon. These retail outlets sell products Americans buy every day, so a trip to the store is likely going to cost more. Given the average American lacks the resources or the willingness to fund the tariffs and has little or no ability to avoid them, they will turn to other methods to make ends meet.

Medtech managers will encounter this situation firsthand in the coming months. As they sit in their office desperately attempting to source materials, components, and assemblies from some combination of low tariff countries, they will likely be approached by employees asking for raises to cover the higher cost of living brought on by tariffs. Domestic labor cost increases will have as much or more of an impact to the cost of goods sold than buying more costly resin or tubing.

It is impossible to say how much wages will increase but double digit tariffs on consumer items are likely to raise household costs from 5% to 10% within six months. The average line worker will have to turn to their employer for relief or start looking for a better job. It is labor costs that will bite harder than tariffs on imported goods specific to the medtech industry.

Currently an American Export Industry But…

Medtech faces other threats from U.S. tariffs. Like energy and agriculture, a notable portion of American medtech products are exported, primarily to other developed nations. As our trade partners respond with counter-tariffs, U.S. medtech companies face a decision to raise prices or absorb the tariff fee in whole or part. Clearly the first approach strangles demand and the second reduces profitability. Avoiding these equally unpleasant choices is a third approach. U.S. medtech manufacturers may move production to markets large enough to justify the expense of the move. Likely beneficiaries are Ireland, lower cost EU countries, and Asian countries not in tariff battles with China. Some may expand Latin American manufacturing to serve the world market. Regardless of the combination of approaches OEMs and contract manufacturers choose, the result will likely be fewer U.S. made and exported medical devices.

Higher U.S. Interest Rates

As counter-tariffs spread through the American economy, inflation pressures will mount. A knock-on effect of inflation is higher interest rates. Equipment leases, construction loans, and bank lines of credit are going to become more expensive. Yet inflation will not be the only interest rate amplifier. Tariffs are barriers to trade and historically suppress economic activity. Not surprisingly, businesses and investors outside the United States may see less need for dollar-denominated assets, either for commerce or investment. As they find new homes for their money, American bond issuers—including the U.S. government—will have to raise interest rates to attract bond buyers. The result is higher American interest rates and additional pressure on an already overextended U.S. Treasury. Certainly, the U.S. Federal Reserve can help by lowering interest rates but doing so in an inflationary period is like putting out a fire with gasoline. Increased borrowing at lower rates will stoke more inflation.  

Won’t The Problems Solve Themselves?

Simply stated, yes, but the cure may be worse than the disease. Higher labor costs, imported product costs, and interest rates suppress demand. People won’t be able to afford to buy what they could in the past. Declining consumption reduces inflation and interest rates. People will also face layoffs, destroying demand. The U.S. will eventually reach equilibrium but poorer and with less capital for expansion. Medtech is more insulated from economic decline than most industries but will suffer in specific segments.

Economic downturns play out differently in different medtech markets. OEMs of critical technologies like cardiovascular and trauma will see only modest impacts to their order books. The “canary in the coal mine” for the medtech industry will be orthopedics. Most orthopedic procedures are both non-emergency and require recovery periods of weeks or months. With layoffs increasing, few people will want to be absent from the workplace for long. With their job on the line, a sufferer of knee or hip pain may decide fistfuls of ibuprofen preferable to surgery. Besides orthopedics, aesthetic procedures will also decline sharply because they are usually not covered by health insurance.

Short Term vs. Long Term

Inflation, higher interest rates, declining exports, and eventual economic contraction are the troubles likely to be stirred up by tariffs in a few months. The longer term threat of tariffs, however, is declining innovation in the protected country.

At first, this statement seems counter-intuitive. Tariff walls make it harder for foreign competitors to succeed, limiting their R&D budgets. As U.S. OEMs dominate medtech (roughly two thirds of the MPO Top 30 OEMs are American) this seems like a benefit. U.S.-developed products from established manufacturers should benefit from this protection but economic history says otherwise. Tariff protection has proven to be a crutch to protected industries, one in which they take full advantage. The suppression of competition leads to declines in innovation. Why spend to innovate if there are fewer threats to existing product lines? As innovation declines, business leadership becomes more reactive. Product leadership slips from the protected companies to risk-taking innovative firms often in other parts of the world. Anyone who doubts these statements might want to speak to the CEOs of American shipbuilding companies. This may prove a challenge, since very few are still in operation due to a lack of innovation in design and manufacturing brought on by tariffs and other trade barriers.

Recommended Steps for Medtech Suppliers 

For the next 12 months, medtech supply chain managers will have to play flexible defense as tariffs are announced, canceled, changed, and negotiated. Still, companies have a few modest opportunities to respond to the situation:

• Automation and process improvement. Often sidelined by day-to-day issues, efforts to improve labor productivity will pay dividends as wages increase.
• Renegotiate energy contracts. By summer, U.S. energy costs are likely to decline as tariffs make exports more challenging. Medtech supply chain companies that have contractual leeway to negotiate with or replace current suppliers may achieve notable savings.
• Close evaluation of capital expenditures. With the possibility of higher borrowing costs and demand dislocations, managers should carefully consider equipment acquisitions and sales.
• Examine credit risks. While most OEMs and contract manufacturers are both liquid and solvent, the coming months will put stress on over-leveraged companies. Credit reviews of major accounts and suppliers may help organizations avoid payment and/or supply problems. 
• Admit the obvious. No one in the world knows where the trade wars will end up. In speaking with customers, suppliers, employees, and investors, the best response is, “We don’t know but we will keep watching.” This is a time for defensive measures, not taking bold new risks.

Trump’s disjointed tariff tango has only just begun. It would befit medtech companies to learn the dance sooner rather than later.

MORE FROM THIS AUTHOR: The Future of the Medtech Supply Chain

Tony Freeman is the president of A.S. Freeman Advisors LLC, a merger and acquisition advisory firm in New York City. He can be reached at tfreeman@asfreeman.com.