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Industry Analysis: Securing USA Made PPE Before the Next Health Crisis

September 14, 2020

By Kenneth Rapoza, CPA Industry Analyst

Summary: If we experience a global pandemic like this again, we know two things to be true: we can’t get critical medical supplies from China when China and the rest of the world need them too. We can’t rely on our allies to get it to us when they need it just as badly. We have to make masks and personal protection equipment (PPE) for hospitals ourselves.

It wasn't too long ago that we learned that without China, nurses were forced into wearing garbage bags as personal protection equipment because -- at the height of the pandemic in New York City -- we couldn't find any. 

California health care unions and the hospital chain Kaiser Permanente ordered 39 million masks from brokers representing China and demanding 40 percent of the price in cash upfront. No masks were ever delivered. According to the FBI, the hospitals and health care union were scammed. 

During the pandemic, brokers marked up the prices at factories that were not officially sanctioned by Beijing to sell. Many of the products were counterfeit knock-offs. Beijing shut them down. 3M started making emergency masks in the U.S., and was initially unable to deliver the masks it ordered from China in any timely manner. 3M was not in control of its own supply chain. They indicated as the pandemic was gearing up in the U.S. that they did not have the Chinese government’s authorization to export. Some 90% of all PPE comes from Asia, with China in the pole position.

We do not need to reshore all US production of all PPE. But we need to reshore a substantial amount of each critical product. Because of the pandemic, we are already moving in that direction. The question is whether this trend solidifies post-pandemic. There are a few ways to make sure that it does.

Potential Solutions

If you can’t count on the private sector to buy American PPE, then we must be able to rely on the state. We need to think of government PPE purchases as similar to a defense contract in the future.

From what we have gathered, it will require long term contracts from federal, state and local governments; as well as hospitals and medical centers opting for supply security over buying everything at the cheapest possible price. If price is what matters more than security of supply, American manufacturers will never be able to compete with manufacturers of face masks and PPE in China, let alone anywhere else in the developing world.

Pre-pandemic, the average safety mask for medical use was 35% cheaper to buy from China, according to industry sources.

There is currently only one bill in Congress that addresses critical supply chains for medical equipment. Their passing into law would get us moving in the right direction. Moreover, signing these into law might give major private sector hospitals the motivation to source locally if they see reshoring as the prevailing political winds in Washington. Right now, it is not.

The American PPE Supply Chain Integrity Act (HR 7841) was introduced on July 29 by House Representatives Patrick McHenry (R-NC) and Bill Pascrell (D-NJ) and would establish a standard that PPE procured by the Departments of Defense (DoD), Health and Human Services, Homeland Security, and Veterans Affairs must be “100 percent of a product that is grown, reprocessed, reused, or produced in the United States.” This is the same standard contained in the Berry Amendment which the DoD already follows when procuring American-made uniforms and other textile products for the military. The bill resets the contract level for the Berry Amendment from $250,000 to $150,000. We think it would ensure more US-manufactured PPE gets purchased by government agencies, namely the Defense Department and Health and Human Services. Recognizing that it will take time to build domestic capacity and ramp-up American PPE manufacturing, the bill contains standard waivers found in the Berry Amendment to provide the flexibility the government needs to meet the massive demand for PPE while American companies get production going.  

Time is of the essence. Once the pandemic is over, people will be celebratory rather than preparing for the next health crisis. The moment may be lost. In making sure it is not lost, we spoke to some companies making PPE today to see what it took to get them there, and what it will take to keep them in the business.

American Suppliers: Long Term Deals, Treat It As Health Security

We found that there are three types of companies involved in making PPE. They are the minority, core suppliers, whose primary business is making (and importing) medical equipment; the emergency suppliers, who tend to be in textiles and have used the PPE shortage as an opportunity to keep their workers employed and help the country; and finally, the entrepreneurs.

The typical entrepreneur is either sourcing from China and acting as a broker or has seized on the opportunity to create a side hustle business. Opportunistic entrepreneurs are fulfilling a need today but are not a long-term solution to our PPE dependency on foreign sources.

The emergency suppliers can be considered as potential long term suppliers. It will take long-term contracts to provide  them the incentive to become a core long term supplier. Without that, they will exit the business when the pandemic abates.

Without the right policies, most of them will manufacture abroad and import supplies into the US.

Once upon a time, the US made  around 95% of the masks used in dental and medical offices. In the late 1990s, Kimberly Clark went on an acquisition spree and bought up a number of companies to become a market leader. Kimberly also offshored its manufacturing. By 2004, the entire US mask making industry was in Mexico, China, Thailand and Vietnam.

The outstanding exception to the industry’s offshoring trend is Prestige Ameritech of North Richfield, Texas. Its co-founder, Mike Bowen, has been something of a one-man Chicken Little since the early 2000s, warning that the next health crisis would expose America’s desperate lack of mask production capability. Republican and Democratic administrations listened to his pleas but offered no solutions. Even the panic over the 2009 H1N1 flu pandemic that infected more than 60 million people in the U.S., did not move Washington to take our lack of productive capacity seriously.

Prestige Ameritech makes isolation gowns, face shields, eye protection and masks. They make a million products per day and employ around 250 people in a 220,000 square foot factory in Texas.

Prestige Ameritech says that despite all the demand from domestic buyers, they still cannot beat China on price. “Chinese prices are not real. Their prices are whatever they want them to be,” says Bowen. “We’ve recently been competing with Mexico. They are a little cheaper than we are, but we can compete with them better. I’m not saying you can save money with buying American,” Bowen says. “I’m saying you are gaining peace of mind.”

Prestige learned after the 2004 H1N1 scare that customers would leave and go back to buying Chinese if they could save pennies on a mask. To avoid that this time around, Bowen has convinced private sector customers to sign on to longer term contracts. Major hospital chains have learned that if they wait for the next pandemic to source materials, they will have to wait in a very long line to get it. Core suppliers like Prestige are more apt to serve those clients who stick with them, meaning hospitals that vacate and return to the cheaper supply chain will have a hard time jump starting their relationship with the domestic supplier in the middle of a crisis.

Core suppliers and emergency suppliers we have spoken with are working on two to five year deals. Some government deals with the Federal Emergency Management Agency and Health and Human Services have been shorter one-year deals, and at least one supplier we spoke to said their deal with their state was basically a “hand shake.”

US textile firms could only compete with China if they had the right manufacturing equipment. The equipment, mostly made in China and Taiwan, was not available. Instead, they retrofitted the apparel equipment they had to make PPE..

A  coalition of around 50 textile and apparel companies, including big brand names like Hanes, banded together to make masks. FEMA and HHS put in an order for around 600 million. One textile company we spoke to said they turned part of their own production line used for making T-shirts into making masks and testing swabs. Because of the government order, they were able to keep some of their employees working instead of laying them all off. They managed to keep around 20% of their 2,500 employees at work because of PPE.

Most of the people we spoke to said it took them a while to ramp up production and would take them even longer if they were to shift into core suppliers. Others ran into trouble selling to hospitals because their masks were not FDA approved. The general estimate was that companies making PPE needed around $100 million just to be competitive with China.

Companies that were involved in making masks and PPE as emergency suppliers utilized assets they already had, assets that were not being put to work because markets were largely closed. Some emergency producers found cost efficiencies they did not know they had. Pricing models were difficult because none of them made the product before, and they had to calculate for shipping.

Newport, RI based Safe Health competes with China by using a fabric and chemical product line that China has not yet mastered. The higher end model is another way to keep Asian competitors at bay. Texollini in California makes their masks and gaiters, called Safe Face. They are selling to the private sector.

They would like to stay in the business post-pandemic. But before they can sell to governments, they need FDA approval as a class 1,2 and 3 medical device. Their approval is still pending, based mainly on backlog. California Governor Gavin Newsom and his family use their masks. As does LA Dodger Mookie Betts and Vice President Mike Pence.

“We are wary about China of course, but long term we don’t see them as a problem because our products are a much higher quality than anything we’ve seen them produce,” says Tony Rey, one of the Safe Health investors. “If we tried to save a few dollars by moving production to China, we would be incurring higher shipping costs, unforeseen delays, and also incur constant worry over quality control,” he says. He would also risk the Chinese company copying their formulas and making their own company, selling it throughout Asia, and eventually just putting Safe Health out of business once that company started selling here for half the price. “We believe that we can keep our costs reasonable in the US, and that also gives us the benefit of working with the emerging market of customers who prefer US products from US manufacturers,” he says, which should signal to policy makers that the business community is on board. The trend is there for Made in the USA in this space.

It’s all good, if they have a market to sell to. To get a sense of whether or not this is a market worth protecting and pursuing, we got our hands on some proprietary data that lays it out for us.

Economic Benefits Include Manufacturing Jobs

If we are concerned about blue collar labor, and the job market in general, then reshoring some PPE is a job creator. We estimate that roughly 1,000 jobs were saved at just three companies we spoke to – including core producers, emergency producers, and the entrepreneurial opportunists. Safe Health is starting a new retail unit for consumer health protection, for instance.

In March, a CPA study by Steven Byers and Jeff Ferry that modeled the reshoring of a significant portion of the medical supplies industry estimated that such a move would lead to the creation of roughly 302,000 jobs nationwide. It would also create 109,780 high-paying manufacturing jobs in the medical supplies industry.

As far as market size, the US market for masks is around $4 billion, with a compound annual growth rate of anywhere from 10% to 20% to 2024. PPE is a smaller market, at $1.5 billion, with a smaller growth rate of 5% to 15% compounded annually to 2024.

States and government agencies will not be the biggest buyers. Government purchasing will be driven by stockpiling.  FEMA, HHS and state governments will likely account for around 20% to 30% of the market, with hospital systems being the main demand driver at 50% or 60% of the total. Still, government procurement contracts will play a key role in stimulating US production if legislation promotes it.

We suspect the pandemic will remain a demand driver for these products through 2021 before falling off a cliff once there is a vaccine or the virus goes away like the first SARS.

We are hearing that some private hospitals are already stockpiling, as are some private school systems. Based on the report we have, the market for PPE will be around $35.7 billion in 2021, dominated mainly by hospital gowns, gloves, disinfectants and masks.

Long-term growth is what matters here. Companies will not invest if there is no growth, and hospitals will not buy American if they are not worried about supply constraints.

Local producers will not be able to compete on price against China and other Asian players. Advanced materials, such as the type used by Safe Health, could be a differentiator and enable the U.S. to compete on product superiority. But this is a very tiny portion of the market, and demand.

Loopholes in Existing Laws

We are concerned that The American PPE Supply Chain Integrity Act, coupled with existing Buy American laws, are so riddled with loopholes that nothing but long term contracts and rules against government procurement buying foreign PPE will make this viable.

If the product does not exist in the US, then existing legislation and pending legislation does not give any incentive to build it here. It just allows importers to buy from elsewhere if it cannot be found domestically. Under the Supply Chain Integrity Act, companies cannot break up purchase orders into small groups of $150,000 or less, but small businesses with legitimately small purchasing orders are exempt and can buy from whomever.

Existing legislation has some capability to encourage and protect US PPE manufacturing through the HHS, Defense and FEMA orders. But we think a lot of this will be up to the states themselves.

State government contracts and some demand from the private sector will make this a viable industry post-pandemic. We are seeing this in some extent with Civica, a non-profit 501(c)(4) established by hospitals like the Mayo Clinic and philanthropies to reduce chronic drug shortages and ensure a safe and stable supply of essential medicines to US patients. We are not seeing it with masks, and hospital gear used for infectious disease patients.

“It’s a sustainable business if you realize it’s a security issue,” says Bowen. “If it’s just about price, China or Asia will beat you. We were never built to be an international business because China owns it. But since the pandemic, I am hearing from governments around the world, companies from everywhere. The best way to do this is for the government to be involved like it is in China because no one is going to make a million masks that nobody wants.”

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