Volume 4, Number 2, April 2006
This newsletter is published in cooperation with the ISM Chemical Group.  


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In This Issue ...
  • Chemical Industry News
    • Drug Discovery Outsourcing: The swiftly growing market for outsourcing services, fueled in part by impressive advances in the Asian market, will increase at a rate of 15 percent from the current 2005 figure of $4.1 billion. Read more.
    • Recovery in the Gulf: Labor, services and equipment, and repair vessel availability in the region are expected to remain key constraints for operators in the near term as they complete repairs and work to return full production. Read more.
    • Record Natural Gas Prices: The average wholesale price for this winter's November-through-March heating season was $9.26 per MMBtu, 43.1 percent higher than the $6.47 per MMBtu average for the 2004-05 winter season. Read more.
    • Climate Change Strategies: A growing number of leading U.S. companies are confronting the business challenges from global warming, recognizing that greenhouse gas limits are inevitable and that they cannot risk falling behind their international competitors in developing climate-friendly technologies.Read more.
  • Feature Article
    • Differentiation in the Chemical Industry: As chemicals companies struggle with the onset of maturity, a differentiated approach will continue to widen the gap between industry leaders and those caught in the relentless squeeze of energy cost volatility and customer consolidation. Read more.
  • Commodity Report: Today's natural gas price levels make much of domestic production uncompetitive on a global basis, and U.S. producers have lost billions of dollars to overseas producers as a result. Read more.
  • Announcements: If you're a supply management professional, the Minneapolis Convention Center in Minneapolis is the place to be from May 7-10, 2006. Read more.
  • Additional Resources: Check out these links to additional resources on the ISM Web site. Read more.
  • Contact Us about ISM eDigest: Chemicals


Chemical Industry News

Drug Discovery Outsourcing

Drug Discovery Outsourcing Market Set to Exceed $7 Billion by 2009

Outsourcing is not just affecting information technology and telecommunications industries. For start-up and industry-leading pharmaceutical and biotech companies, outsourcing drug discovery services, including chemistry, biology, screening and lead optimization, is expected to reach nearly $7.2 billion by 2009, according to the study "Outsourcing in Drug Discovery, Second Edition," by Kalorama Information, a division of MarketResearch.com.

The study predicts that the swiftly growing market for outsourcing services, fueled in part by impressive advances in the Asian market, will increase at a rate of 15 percent from the current 2005 figure of $4.1 billion. In fact, upon discovering the benefits of outsourcing in Asia, many of the top pharmaceutical and U.S.-based contract research organizations (CROs) have opened their own operations there.

As the trend for outsourcing becomes more widely accepted by companies needing to supplement their own internal drug discovery efforts and/or utilize technologies they can't afford to do in-house, concerns of intellectual property protection, trust, honesty and transparency still remain obstacles in the global marketplace. However, Jack Gardner, author of the report, says that despite any of the risks, outsourcing has become a necessary means of doing business. "The upgraded quality of CROs and pharmas in India, China and Eastern Europe makes outsourcing a cost-effective and timely business decision which can translate into drugs coming to market faster and revenues increasing," he says.

For more information about the report "Outsourcing in Drug Discovery, Second Edition," visit the Kalorama Information Web site.

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Recovery in the Gulf

U.S. Oil and Gas Companies Still Recovering in the Gulf

While financially the Gulf's energy industry may be on stable ground, efforts to rebuild the supply lines continue. Standard & Poor's Ratings Services reports that despite the dramatic destruction and disruption Hurricanes Katrina and Rita brought on oil and gas operations in the Gulf of Mexico, energy companies in the region were largely able to weather these storms from a credit standpoint. However, the region's infrastructure recovery is ongoing, with full production unlikely in the near term.

According to the report "U.S. Oil and Gas in the Gulf: Still Recovering," labor, services and equipment, and repair vessel availability in the region are expected to remain key constraints for operators in the near term as they complete repairs and work to return full production.

Jeffrey Morrison, an analyst with Standard & Poor's, says strong commodity prices and robust financial results for oil and gas companies somewhat offset the serious damage done to production facilities, refineries and pipelines. "Even so, a significant amount of natural gas and oil production from the region remains shut-in as of early March, and extensive repair work to damaged infrastructure is still going on," he says.

For more information about the "U.S. Oil and Gas in the Gulf: Still Recovering" report, visit the Standard & Poor's Web site.

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Record Natural Gas Prices

Record-High Natural Gas Prices For 2005-06 Winter Season

If supply managers thought this past winter had to be a record for natural gas prices, they were right. Despite two consecutive monthly declines in the average U.S. natural gas spot prices, the winter of 2005-06 was the highest priced since natural gas markets were deregulated in the mid-1980s, according to data released by Platts.

The average U.S. monthly natural gas spot price for March dropped 11.8 percent from February, to $6.67 per MMBtu, following a 24-percent decline a month earlier. However, the average wholesale price for this winter's November-through-March heating season was $9.26 per MMBtu, 43.1 percent higher than the $6.47 per MMBtu average for the 2004-05 winter, and an amazing 81.9 percent above the $5.09 per MMBtu average for the five previous winters.

Kelley Doolan, natural gas market specialist for Platts, says despite record mild weather and relatively soft demand, natural gas prices went through the roof this winter due to the lingering effects of twin, late-summer hurricanes that caused widespread damage to the Gulf Coast-producing region, historically strong oil prices and growing linkage between North American natural gas markets and others around the globe. "Over the past two months, average spot prices have dropped by more than one-third as unusually mild weather across most of the United States has allowed natural gas inventories in storage to remain well above seasonal norms," she says. "But had this winter been colder than normal or even normally cold, we might not have seen much of a price decline at all."

For more information about natural gas prices, visit the Platts Web site.

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Climate Change Strategies

Ceres Releases Climate Change Report and Rankings

The Coalition for Environmentally Responsible Economies (Ceres), recently released the findings of its first-ever report that analyzes how 100 leading companies are addressing the growing financial risks and opportunities from climate change — whether from expanding greenhouse gas regulations, direct physical impacts or surging demand for climate-friendly technologies.

The report, "Corporate Governance and Climate Change: Making the Connection," found that after years of inaction, a growing number of leading U.S. companies are confronting the business challenges from global warming, recognizing that greenhouse gas limits are inevitable and that they cannot risk falling behind their international competitors in developing climate-friendly technologies. Altogether, 76 U.S. companies and 24 non-U.S. companies in 10 business sectors are profiled in the report.

Foreign companies such as BP, Toyota, Alcan, Unilever and Rio Tinto had the highest scores in five of the nine sectors that included both U.S. and non-U.S. firms. American companies DuPont, General Electric, International Paper and United Parcel Service led in the other four sectors. The report's overall results are encouraging. In 2003, Ceres released a report on 20 companies showing that major U.S. businesses were doing little to address climate change. By contrast, this report shows that leading companies in many key industries are now tackling the issue at the highest level, with boards conducting strategic assessments and management setting performance goals for reducing greenhouse gas emissions and developing new climate-friendly products.

Still, Douglas Cogan, principal author of the report, acknowledges that the challenge ahead for all companies is enormous, given that greenhouse gas emissions must be reduced substantially below current levels to stop rising global temperatures. Businesses that are most successful in implementing climate change strategies will be those that look beyond short-term thinking and the gridlock that currently grips Washington on this issue. "Typically, CEOs and boards look out only three to five years when making investment decisions — about as long as they serve in their leadership roles," says Cogan. "But the assets they put into place last much longer. Building a new conventional coal plant or a new engine factory for SUVs might make sense under 'business as usual' thinking, but what will happen to these facilities in five or 10 years, when they're still not fully depreciated but facing carbon emission constraints?"

To read the full report, visit the Ceres Web site.

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Feature Article

Driven to Differentiate

Chemical compounds are not exactly household names for most of us, but we literally wouldn't get far without them. Consider life without automobiles, which, to work properly, require antifreeze and brake fluids. Or imagine a world without plastics, which are derived from petrochemicals. From healthcare to housewares, the products of the chemicals industry provide essential building blocks for much of modern life. Yet because this huge, diverse and vital industry is facing many challenges, there are important lessons to be learned from those companies that have managed to become high performers.

Although large and far reaching, the chemicals industry is highly fragmented. The top 50 companies account for only a little more than a quarter of total sales. There has been a trend toward consolidation but there are still many players. What's more, margins have also suffered from increasing energy costs. What distinguishes the high-performing companies from the others and what calls for closer consideration, is differentiation.

The challenges facing the increasingly mature chemicals market seem almost insurmountable. However, the industry's most serious challenges are familiar ones — maturity, consolidation and prices.

Commoditization and consolidation. Product commoditization is exacerbating the problem, steadily eroding profitability across the industry. What's more, consolidation among chemicals customers, especially in the retail sector, has intensified the squeeze on margins.

Energy prices. There are external factors affecting the industry as well. Take the impact of soaring energy prices. The U.S. chemicals industry as a whole incurs $4.2 billion in additional operating costs for every $1 increase in the price of natural gas; the methanol, nitrogenous fertilizer and synthetic rubber subsectors, where energy expenditures exceed 25 percent of total material costs, have been especially hard hit.

Challenges Spawn Consolidation

The industry's response, predictably enough, has been to accelerate its own consolidation. The rate varies across subsectors. For example, concentration is high for a number of petrochemicals intermediates, such as acetic acid, but lower for many base petrochemicals. However, despite the mergers and acquisitions, there are probably as many chemicals companies in the world today as there were 10 years ago (and, counting the Chinese companies, probably more) — the net effect of spinning off businesses as these companies struggle to come to terms with multiple challenges. The number of players still in the game only serves to intensify price pressures.

Differentiation Critical for High-Performance Businesses

For most, it's been an uphill struggle. Accenture recently analyzed 105 chemical companies worldwide. Thirty companies emerged as value growth leaders from several phases of analysis such as performance longevity, positioning for the future, historical returns and future growth prospects. From those 30, Accenture identified 12 companies that have managed to consistently deliver superior returns to their shareholders over many years and are likely to continue to do so. The heterogeneity of the industry is mirrored in the diversity of the business models these companies have developed to achieve this status. Two are scale-driven operators, competing globally but in selected geographies; three are solutions providers, focusing on specific services that are uniquely tailored to selected customers.

Most of the companies, however, use a differentiated operator business model in which they set themselves apart through product innovation or customer relationship management, or through some special services combining an exceptionally acute understanding of their customers' needs with highly focused product innovation.

Differentiation, indeed, is the one quality common to all the high performers in this industry. Several high-performing companies differentiate themselves by combining two or more of the following success factors: scale, innovation, customer insight or service/solution. But what distinguishes all 12 as a group is the recognition that some form of differentiation is fundamental to their success. Their choice of business model always supports that drive to differentiate.

In addition, all the high performers identified share a number of attributes with high performers in other industries. They all demonstrate the sort of financial flexibility and acumen that resonates well with financial analysts and allows the companies to make countercyclical investments. Their portfolio management skills are also top-notch. And they are unsurpassed when it comes to operational management capabilities.

But it is their mastery of three key capabilities in particular that clearly distinguishes high-performing chemicals companies:

  1. Translating insight to action
  2. Customer orientation
  3. A performance culture

Translating Insight to Action

High performers in chemicals recognize shifts in the competitive landscape almost before they happen — and respond with alacrity. Their ability to quickly innovate and commercialize new customer ideas in response to these shifts hinges on having systems in place that can actually produce insight, rather than just process information.

One of the industry's high-performing scale operators, for example, effectively leverages its IT systems to develop crucial insights by gathering all its global customer data into one strategic network. Another aligns and connects front- and back-end operations exceptionally efficiently, ensuring that insight about customer demands is immediately communicated to its production and R&D divisions, whose functional excellence, in turn, ensures a swift response.

Customer Orientation

It might seem a truism to say that customer orientation is critical to high performance, but all of the high performers identified do, in fact, display an unusual degree of customer focus and understanding. This springs, apparently, from a clear initial decision, based on profitability and growth potential, to select just which customers they want to serve — another form, of course, of differentiation.

High performers are adept at deepening these customer relationships. Some have taken a collaborative approach, embedding themselves in the customer's supply chain or working closely to develop tailored products — as The Dow Chemical Company did with one major retailer by developing a plastic garbage bag specifically for that company.

And all high performers excel when it comes to understanding the particular value of their products to each customer, leveraging knowledge of a customer's unique needs to differentiate their own brands. Even a chemical as commoditized as salt can be differentiated depending on its use — say, in highway maintenance, for water softening or in the kitchen.

High performers also excel when it comes to expanding their customer base in pursuit of profitable business. Some do so thanks to the rigor of their systems for identifying customer segments and new potential within them, others by placing bets on key growth markets. For example, one high-performing company developed systems to track opportunities for substituting plastics (its product) for steel and other materials across a number of end markets, such as automobiles, appliances, electronics and construction, and has been remarkably successful in persuading manufacturers to make the switch.

A Performance Culture

All high performers in this industry exhibit special internal strengths. Their leadership teams are remarkably stable; although recent CEO turnover in the chemicals industry overall has been high, the average length of CEO service at high-performing chemicals companies is more than five years. In addition, these high-performing leaders don't shrink from taking measured risks.

High performers also benefit from robust organizational structures that allow their leaders to take a big-picture approach to both corporate objectives and employee performance in fulfilling them. Air Liquide, for example, expects high performance from its executives, but as one company executive puts it, "Accountability is based upon differences in culture, geography and causality." This demonstrates that effective leadership means taking into account whether something beyond the executive's control had an impact on business performance.

High-performing cultures are always open to change and always encourage new ideas about how to improve their operations. They ensure that the right people are in the right positions, decentralizing work that requires local knowledge. But they are also very good at centralizing, automating or outsourcing work that is easily standardized and shared. All these companies consistently follow through on business and individual executives' objectives, and have systems in place that can consistently measure the results.

Differentiation is plainly crucial to operating successfully in maturing chemicals markets. All high-performing companies have successfully differentiated their products and services to satisfy specific customer needs. What's more, the best blueprint for future success lies in the development of a differentiated operator business model; few companies will be able to make the transition to successful scale or solution business models.

As chemicals companies struggle with the onset of maturity, a differentiated approach will continue to widen the gap between industry leaders and those caught in the relentless squeeze of energy cost volatility and customer consolidation.

By R. John Aalbregtse, head of the chemical strategy practice for Accenture, Chicago. To contact the author, please send an e-mail to author@ism.ws.

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Commodity Report

One Wild Ride in Natural Gas

Over the past year, the U.S. natural gas market has been one of the most compelling stories in the energy complex, a "wild ride" that many would not like to see repeated any time soon. Natural gas prices started 2005 at what would historically be extremely high levels — the January 3, 2005, closing price for the New York Mercantile Exchange (NYMEX) natural gas contract was $5.79 per MMBtu. By December 13, however, the price rose to an astronomical level of $15.378 per MMBtu, a price that no one had ever thought possible. As of mid-March 2006, the price for the natural gas contract traded down to $6.66 per MMBtu, a reduction of nearly two-thirds of the peak price.

Recent Events and Outlook

Commencing in the late spring and summer of 2005, the market showed signs of extreme wariness over the prospect of a major hurricane impacting natural gas supply availability in the Gulf of Mexico. This nervousness was sparked by the serious damage done by Hurricane Ivan in the summer of 2004, which caused the shut-in of significant levels of production and the destruction of a sizeable number of producing platforms in the Gulf. Each time a tropical wave developed off the coast of Africa, natural gas prices on the NYMEX would climb. As the storms threatened to enter the Gulf, concern would grow and prices would escalate further.

Starting on July 26, 2005, prices began an unprecedented climb that lasted until October 25. Since the July 26 close, prices doubled to $14.338 per MMBtu. The fear that caused these dramatic rises in price was fueled by the concern that the destruction caused by hurricanes Katrina and Rita would potentially bring significant disruption to gas supplies destined to be placed into storage for the coming winter season. After the hurricane season, there was some short-lived relief, but the concern over the industry's capability to fill storage capacity for the coming winter drove prices to extraordinary highs.

Unusual weather patterns seem to be the order of the day, and the winter of 2005-06 fit the criteria. And, proving the adage that what goes up must come down, the natural gas price took a severe beating, falling rapidly from its lofty levels in mid-December to a closing price of $6.66 per MMBtu on March 7. If things continue as they are, prices will move even lower, leaving storage levels higher than normal at the end of winter.

There is evidence that prices will continue to erode for the near term. This can be seen in the variable known as "open interest" in the natural gas contract, which is increasing as prices fall. Open interest, the total number of open contracts on a security, applies primarily to the futures market. It is often used to confirm trends and trend reversals for futures and option contracts. Another interesting development in the market is indicated in the chart below. Prices in the summer months are far below those of the winter months. What this indicates is that the market is nervous about its ability to meet peak winter demand should a "normal" winter weather pattern return.

NATURAL GAS FUTURES SETTLEMENT PRICE
February 24, 2006
Natural Gas Futures Settlement Price - February 24, 2006
Source: NYMEX


Impact on the Chemical Industry

The events that occurred over the last year, and the prospect for even more of these types of events, have kept the natural gas market on high alert. Participants in the market are nervous and uncertain about the future, which is driving a market that is more volatile than any time in its history. Prospects for the chemical industry, which uses natural gas as both a source of raw material feedstock and as a fuel, are particularly uncertain.

Considering that petrochemical producers are accustomed to a historical price range of $2 to $3/MMBtu, it is perhaps an understatement to say that these companies are concerned about today's gas price levels. Moreover, it is not simply the magnitude of prices that has producers worried. The high degree of volatility in price levels makes it increasingly difficult to pass along price increases to customers, because there is always some degree of anticipation that prices will settle back to "normal" levels. This line of reasoning has effectively caused chemical producers to undertake the role of "price shock absorbers" historically, with negative financial implications.

Dow Chemical is among the chemical producers hard hit by rising natural gas prices. The price of gas contributed to Dow's decision last year to shut down its ethane-based, ethylene production plants in Texas City and Seadrift, Texas. Dow is now seeking opportunities in regions with abundant and lower-priced gas resources, such as in portions of the Middle East and South America. Other producers, including Lyondell and ChevronPhillips Chemical, have shut down ethane-based, ethylene capacity in the United States as well.

According to the American Chemistry Council, the U.S. chemical industry uses 2.5 trillion cubic feet of natural gas every year — more than 10 percent of the nation's total consumption. Today's price levels make much of domestic production uncompetitive on a global basis and U.S. producers have lost billions of dollars to overseas producers as a result.

Conclusion

The wild ride in natural gas pricing during 2005-06 yielded price levels that are permanently higher and much more volatile than desired. This makes planning and purchasing more difficult than at any time in recent memory, particularly for large users like petrochemical producers that are increasingly losing their competitive advantage to overseas producers with access to abundant and inexpensive natural gas resources.

By Ken Stern and Bob Broxson, managing directors for Lexecon Consulting, an FTI Company in New York and Houston respectively. To contact the author, please send an e-mail to author@ism.ws.

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Announcements

It's Not Too Late To Register for ISM's Annual Conference!

There's still time to register for ISM's 91st Annual International Supply Management Conference and Educational Exhibit. This is the place to be if you're a supply management professional — May 7-10, 2006, at the Minneapolis Convention Center in Minneapolis.

Dr. Stephen R. Covey, business guru and management expert, opens the Conference on Sunday, May 7, 2006, with "Leadership is a Choice! Not a Position."
Covey's presentation discusses principles to help you increase your ability and capacity to lead and exert influence regardless of your current position.

Lou Dobbs, CNN Anchor and political journalist, addresses the Conference, Monday, May 8, 2006.
Politics and policy affect investment and the international business environment. Dobbs' address will give his political perspective blended with fascinating anecdotes from a distinguished career in financial journalism. From his role as anchor of CNN's Lou Dobbs Tonight, he will provide a look at what's ahead for the economy — and how it will affect you.

For more information and to register for the Conference, visit ISM online.


Looking For a New Position?

Don't miss the ISM Conference Career Center at ISM's 91st Annual International Supply Management Conference and Educational Exhibit.

ISM's Conference Career Center is a great way to advance your career! As a Conference attendee, you are eligible for on-site job interviews. Employers review the submitted résumés and choose those who meet their requirements for an on-site interview on Monday and Tuesday of the Conference. Plus, you will also have onsite access to career opportunities from around the country. Once you register for the Conference, you will receive information on how to submit your resume to a special database developed for this event. Only Conference participants enjoy this opportunity! Begin your legacy in Minneapolis.

For more information about the ISM Conference Career Center, visit ISM online.


The Power of the Services Supply Chain: Strategies for Innovation

Become a strategic force within your organization by attending the Annual Services Group Program, June 8, 2006, at St. John's University's Manhattan campus in New York City. This one-day event is filled with back-to-back sessions, including dynamic negotiation strategies for service-related contracts and techniques that improve the bottomline. Leave with plenty to think about and begin building and implementing revolutionary processes that will make a significant difference within your organization.

Topics include:

  • Tools, Technology and Tips to Drive Services Forward
  • How Change Management Techniques and Best Practices in Sourcing Services Can Improve the Bottomline
  • How to Implement Dynamic Negotiation Strategies for Services-Related Contracts
  • Using Contemporary Sourcing Practices for HR

This program provides sessions that demonstrate how you can enhance your current process to realize considerable return on investment. Discover advanced strategies and tactics that when that will create a powerful influence within your organization.

Presented by the industry's leading experts, learn how to integrate real solutions that achieve significant results! Register online at www.ism.ws and save $25. Earn 6.25 Continuing Education Hours (CEHs) when you attend this one-day event. $495 ISM Members/$695 Nonmembers.

For more information or to register, visit ISM online.


2006 Fall Sourcing Summit

Together with the Drug, Chemical and Associated Technologies Association (DCAT), the ISM Chemical Group is pleased to announce the Annual Sourcing Summit, November 1-2, 2006 at the East Brunswick Hilton Hotel in New Brunswick, New Jersey. This event is a joint effort between DCAT, the ISM Chemical Group and the ISM Pharmaceutical Forum.

Program information, registration and more information will be coming soon.

Event details will be posted on the ISM Chemical Group Web site and on DCAT's Web site.

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Additional Resources

A Wealth of Information at www.ism.ws

Visit ISM's Web site, www.ism.ws, for more supply management resources. The site provides published articles, conference presentations and reference materials that pertain to supply managers in all industries. Here are some items that might be of interest:

  • The flagship publication of the world's largest supply management association, Institute for Supply Management™, unveiled a fresh editorial approach and complete redesign with its March 2006 issue. Readers will find shorter, easier-to-digest articles; more personal, insightful discussion on hot topics; a monthly column on leadership; detailed profiles and much more waiting each month in the pages of Inside Supply Management®. Take a look at our premier, all-access March 2006 issue to see for yourself why Inside Supply Management® is one of the leading supply management publications available today.

  • Are you leveraging the value in your chemical company's services spend? This was the topic at ISM's Sixth Annual Services Group Conference. Peruse conference presentations given by some of supply management's leading practitioners and academics, including Theresa Metty, C.P.M., 2006 chair of ISM's board of directors, and Lisa M. Ellram, Ph.D., Bebbling Professor of Business and professor of supply chain management at Arizona State University. Whether it's finding the hidden value in your company or learning the latest in program management and sourcing of non-traditional services, a plethora of information is available to view.

  • Logistics is a crucial component of a chemical company's supply chain. And with globalization and competition becoming more dynamic, logistical functions such as transportation, warehousing and distribution must evolve at nearly the same rate to meet the requirements of customers. Because those functions are rarely a core competency in companies, third-party logistics (3PLs) providers are called upon to manage these critical areas. However, the relationship between companies and their 3PLs is changing. In the article "Going Vertical and Getting Integrated With 3PLs," find out how the 3PL industry is taking a strategic approach with customers that calls upon long-term relationships, collaboration and supply chain integration.

  • If you missed the ISM Chemical Group's Mid-Winter Conference "Surviving High Prices and Hurricanes" in February, you can still view all the presentations held during the two-day event. Find out the latest on the following topics:

    • Chemical cycles and the outlook for 2006
    • Drivers behind raw materials impact
    • Managing commodity price and supply risk
    • Mergers and acquisitions
    • Strategic supplier relationships

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Contact Us

If you have editorial suggestions or would like to participate in upcoming editorial, contact RaeAnn Slaybaugh.

If you would like to sponsor this e-newsletter, contact Trish True or Kathy Braase, or call 800/888-6276.

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