Industry, page-4

@paradigmaus,

Your post presented such a well-crafted and cogent industry backdrop that it sort of contains many of the answers to your questions.

As it happens, some years ago I went through this same exercise in trying to understand the extent of the "customer hook" of SDI's product offering.

In summary, the propensity for dental practitioners to switch suppliers is very low and is largely not price-influenced (at least within pricing ranges that are practically possible).

Here's the logic:

Digging around in people's mouths for 8 hours a day is sure to be a challenging gig, so what is most important for dentist is that their tools work properly all the time. The last thing a dentist wants to have happen is for his or her drill to stop working or for the nozzle of dispenser of the filling material to become blocked at a critical point in the treatment when the patient is sitting with mouth open, with nerve exposed and the anaesthetic is about to start wearing off.

Which means that once the dentist is accustomed to a tool or product, which has proven to be safe and reliable, to dislodge that dentist into trialing another rather similar tool or product is very difficult.

And on that note, a decade ago, when I first became a shareholder in SDI I initially though that the product differentiation resided in the chemistry of the filling compound (be it amalgam, glass ionomer or composite).

But I soon learnt that the chemical and physical properties of the products are all reasonably similar across competitors (broadly speaking, amalgam is amalgam is amalgam [*] and glass ionomer is glass ionomer, but maybe with a few chemical tweaks), and that the real differentiation is to be found in the packaging, specifically the delivery mechanism by which the product gets applied (so, things like the shape and size of the capsule/receptacle/dispenser, the dispensing nozzle and the ease of product application, are what matter most.)

[*] Although there are sometimes product breakthroughs; for example, more effective cements and curing systems or the new natural colour amalgam product that SDI is about to launch. But my observation is that any competitive advantage to the developer of such new products is only temporary; the rest of the industry at some point plays catch-up.


Which segues into industry pricing dynamics:

This sticky nature of dentist customers, combined with the fact that the sorts of dental consumables SDI supplies makes up a very small proportion of a dental practice's operating costs, are the basis for good pricing outcomes for suppliers.

To which SDI's ~60% Gross Profit Margins over time bears full witness.

But that acts as a double edged sword for someone like SDI; because just as hard as it is for SDI's competitors to dislodge SDI from its customers, so too is it difficult for SDI to take business away from its competitors.

Discounting a few percent on price certainly won't do it, so my sense is no one really tries it.

Which all points to a nice, cosy, duopolistic-style industry structure in which real revenue outcomes are nice and stable, growing at more than twice the rate of CPI.

SDI have never had a revenue problem; it's revenue growth over extended periods of time is enviable:





What gets SDI's operating profits tripped up are the extraneous factors that impact its operating expenses - the sliver price soaring in 2007/08, the A$ going to parity with the U$ in 2011/12 and, currently, the global logistics problems which are creating a distinct geographical disadvantage for SDI, and which don't look like they are going to be going away any time soon.





And all that, in turn, leads to what I think is one of SDI's fundamental strategic weaknesses: its lack of distribution ownership.

The company garners great R&D margin, full manufacturing margin, but in relying overwhelmingly on distributors, it cedes all distribution margin.

This lack of distribution capability is not an outworking of negligence; for decades it has been a perfectly appropriate arrangement given the stable industry structure.

However, now - when outbound logistics are all clogged up - is one of those rare times when having control over distribution would have been crucial.

Because SDI is so geographically far from its markets, its outbound supply chain has become disproportionately longer than its competitors based in Europe and North America.

So, if it wants to avoid continuing to have the margin chew on the significantly elevated logistics expenses, it is going to have to re-price like crazy, certainly more than competitors will need to do.

And while the market might tolerate a modest degree of differential pricing, the scope to do so is not limitless.

So I suspect the next 12 months are probably going to be a bit of a grind, margin-wise (I certainly don't think we can expect to see Gross Margins ensconced happily above 60% again for some time.)


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