Can History Repeat Itself?
The Case for the “Virtual” Medical Device OEM
Dave Busch, Solectron Corporation
Although the modern high-tech industry is less than 50 years old, patterns already have emerged that present key inflection points to accelerate innovation and expand markets. These patterns offer a brief history lesson that can serve medical device OEMs well.
The evolution of semiconductor companies from in-house fabs to completely outsourced (fabless) manufacturing is indicative, and prescriptive, of the direction in which the medical device industry is heading.
A Powerful History Lesson
At the birth of the semiconductor industry in the 1970s, integrated design manufacturers vertically integrated the entire semiconductor process, including design tools, design expertise, manufacturing processes, manufacturing capacity, sales and services. By the late 1970s, more specialized entities emerged that could more efficiently address various aspects of the value chain, such as distribution for sales and support.2
During the industry’s early years, the manufacturing process was a complicated aspect to outsource. This was because the industry was in its infancy and heavily reliant on PCs for demand, customized tools and manufacturing processes, while also requiring the efficiencies achieved through a vertically integrated design and manufacturing process. But as the overall market for technology products grew, demand for semiconductors increased tremendously, driving up associated investment and overhead in the manufacturing area. Over the next decade, semiconductor producers faced one of two options: to remain focused on maintaining current production and demand, or to realign resources to focus on research, design and development.
In the late 1980s, the semiconductor foundry business was formed by innovative Asian companies that provided a shared semiconductor manufacturing resource to smaller semiconductor companies. For an IDM, the foundry model involved the use of either in-house design resources or external design services followed by a choice of foundry or other supporting services, such as packaging.2
The emergence of foundries also ushered in an entirely new class of smaller, highly innovative semiconductor design companies that outsourced their fabrication needs to the Asian fabs. The 1990s subsequently saw explosive industry growth as the “fabless” model essentially eliminated production-based barriers to entry, allowing innovation to be the key driver for success. Small, nimble companies, such as NVIDIA, launched as fabless providers—free of the enormous investment required to build fabrication facilities and associated operational and compliance responsibilities. NVIDIA quickly gained market share by leveraging third-party foundries to speed its products to market.
By the end of the 1990s and into the 21st century, outsourced manufacturing proved a successful strategy in accelerating product cycle times and innovation for the semiconductor industry. At the end of 2006, semiconductor foundries exclusively focused on manufacturing represented 23% of the semiconductor industry’s total manufacturing capacity.3 Today, fabless companies outnumber companies with standard (200 mm or 300 mm) fabs by more than 15 to 1.2
Applying the Virtual Model to the Medical Device Industry
Fabless semiconductor companies are an early example of what is known today as a virtual company: an organization in which selected business processes—such as manufacturing and aftermarket repair services—can be implemented and managed by a trusted partner. By outsourcing selected processes, top-line revenues and/or bottom-line profitability can be improved. The decision of which processes to outsource is firmly rooted in the business objectives of each company.
For medical device companies, business objectives can range from enhancing the stock price by lowering costs to gaining a foothold in highly competitive new and/or emerging markets. The virtual model can be applied to medtech firms of all sizes to help them meet the growing demand for innovation. It also enables increased efficiency by leveraging the capabilities of a trusted contract manufacturer (CM) partner. The CM can provide an end-to-end manufacturing and supply chain solution for the medical device company’s product, including supply chain management and manufacturing services for regulatory compliance.
The resulting realignment of company resources allows the medical OEM to redirect R&D and engineering resources on new products, accelerating innovation and future success. Ultimately, this can lead to a competitive advantage in a highly complex global market.
Immediate and Long-term Benefits
The medical device industry is following a path similar to that of its distant semiconductor cousins. Instead of virtual “fabless” organizations, many med-tech firms are becoming virtual “manufacturing-less” operations.
Both well-established medical manufacturers and start-ups can benefit from CM partnerships, just as semiconductor companies of all sizes now rely on outsourced fabrication. Medical technology firms gain market traction because of innovative ideas the company founders felt would address an unmet need, not because they were interested in becoming world-class manufacturers. Medical device firms tend to lack economies of scale and, thus, are severely challenged in attempts to create state-of-the-art manufacturing facilities. Moreover, medical OEMs lack significant component purchasing power for comparatively tiny production volumes.
Even though most medical device companies today outsource the manufacturing of certain product components, the full benefits of the virtual business model cannot be achieved without complete outsourcing—and eliminating the associated facilities, costs and management overhead.
Many established leaders of the medical industry have recognized the disproportionate amount of resources required to maintain in-house, integrated manufacturing—painting an even more unattainable picture for even less resource-rich, startup medical device firms. Innovation is surging in the medical device arena, as new companies quickly develop and validate new products. But the prospect of establishing physical manufacturing and service facilities, and managing a supply chain, can become daunting projects well outside a company’s core competencies. This ultimately delays product launches and revenue realization.
As a result, most medtech firms are acting on the reality that to remain competitive—and improve market position—they must adopt outsourcing as an essential business strategy. Like the benefits gained in the semiconductor industry, medical device OEMs are forging partnerships with trusted CMs to outsource manufacturing and supply chain management—the first step in becoming a virtual organization and in increasing innovation cycle velocity.
How Outsourced Manufacturing Accelerates Innovation
Adopting a virtual organization model, led by outsourced manufacturing, promises to benefit med-tech firms in two important ways.
First, large, established manufacturers can significantly reduce the level of resources currently used to maintain existing manufacturing facilities and supply chains, re-allocating these funds to increase R&D budgets. The resulting financial impact can be swift and significant. For example, by outsourcing manufacturing and associated supply chain management, large, publicly held medical device companies can reduce their costs of finished goods by 10%. This results in per-share increases in their stock price of several cents2 —a significant, and readily achievable, financial improvement.
Analogously, according to research performed in 2006 by Frost & Sullivan Market Insight, med-tech firms that employ outsourced manufacturing achieve higher profit margins more quickly and consistently. This points to the fact that product manufacturing does not define success in the medical device market; rather, it is speed to market with innovative new products, which are the result of faster product development cycles.
Second, smaller and new medical device companies can benefit from adopting a virtual organization model by making product innovation their competitive focal point and the key to growth. By avoiding the financial burden of building and managing a manufacturing operation, these firms can leverage contract manufacturers’ investments in advanced, global-reaching facilities to quickly ramp up production capabilities.
Regardless of size, medical firms that partner with a CM can reduce their production costs and speed their time to market. CMs have enormous purchasing power and manufacturing economies of scale, resulting in lower production costs. Even small medical device OEMs with low production volumes can gain significant cost savings by partnering with tier-one CMs, which, through their investments in Lean manufacturing, can effectively address low-volume, high-mix, complex manufacturing needs.
The impact of contract manufacturing already can be seen in the US market. Here, 20% of all medical manufacturing was outsourced to third-party vendors in 2005. This resulted in annual market growth of 26%, or $4.4 billion, up from $2.2 billion in 2002, according to research recently released by Covington Associates, a specialty investment banking firm in Boston that handles mergers and acquisitions in the healthcare sector. The firm also predicted that as much as 40% of all device sector manufacturing could be outsourced by 2010, leading to 15% annual growth.2
Environmental Issues Affect Medical Device Manufacturers
While outsourced manufacturing can provide immediate short-term impact, the future potential of the virtual organization model is even more powerful. For the past decade, environmental regulations have been increasing and limiting options for many current manufacturers. More extensive regulations undoubtedly will affect the medical manufacturing industry within the next decade.
One such environmental initiative is the European Union’s Restrictions of Hazardous Substances directive (RoHS), which is quickly gaining momentum worldwide. Europe’s RoHS has been in place for one year, and China, Korea and many other nations are adopting their own versions of RoHS legislation—some more stringent than Europe’s directive. RoHS is one of many “green” initiatives being adopted and/or expanded in countries around the world to address environmental impact of the materials and components found in medical devices.
Currently, medical devices are exempt from most RoHS statutes. However, there is far less certainty that medical devices will be so fortunate in the future and in other, similar directives. For example, the adoption of a RoHS initiative in China in March 2007 already has mandated labeling of non-RoHS compliant medical devices. Environmental regulations similar to RoHS are currently being considered in the United States by more than 20 states, and compliance with similar environmental legislation will require increasing amounts of resources.
The virtual organization model allows med-tech firms to outsource the responsibility for meeting international environmental guidelines, which poses a significant burden. Medical companies that continue to manufacture in-house will expend significant financial resources to comply with environmental directives—resources that are, directly or indirectly, taken away from research and development.
Going Virtual: Who’s Doing It Right, Right Now?
Today, the move to a virtual model is being tested by early adopters. One such leader is a global, top five medical device company, which is developing plans to completely transition its manufacturing to CMs within the next five years, including end-to-end services and supply chain management. The med-tech firm is projecting significant decreases in production costs, lead times and risks while enhancing its competitive position by accelerating the development of new medical devices.
On the other end of the spectrum, CSA Medical is a much smaller, newer medical device company that has catalyzed business growth by adopting the virtual organization model. Based in Baltimore, MD, CSA Medical recently partnered with a leading CM to manufacture its CryoSpray Ablation system. The device freezes and destroys unwanted tissues found in the esophagus, which, according to various reports, arise from chronic acid reflux. Peer-reviewed research estimates 65 million US citizens suffer from this condition. Delivered through the CryoSpray Ablation system, the 10- to 20-minute procedure uses a catheter to transport and spray liquid nitrogen under low pressure through an endoscope to freeze the tissue.
Following eight years of invention, testing, product development and clinical trials, the CryoSpray Ablation system is in production at Solectron’s Charlotte, NC facility. CSA Medical leveraged Solectron’s integrated supply chain services and medical manufacturing capabilities to accelerate time to market without making costly infrastructure investments. To ensure a successful launch, CSA Medical and Solectron have collaborated since August 2006 to establish an optimized Lean supply chain and manufacturing process. In addition to manufacturing the CryoSpray Ablation system, Solectron also manages orders and ships directly to CSA Medical customers.
Business history presents valuable and repeatable lessons. The semiconductor industry migrated to fabless manufacturing as the norm for all but the largest providers, allowing greater innovation as well as accelerated time to market. As a result, the semiconductor sector has prospered as a whole, propelled by innovation and supported by the increased efficiencies that outsourced manufacturing imparts.
As business forces converge—financial, competitive and regulatory—the question will be not whether, but how fast med-tech firms both large and small embrace a virtual, variabilized manufacturing/supply chain model. Early adopter medical device companies are making the shift toward becoming virtual organizations through manufacture-less operations, leveraging the global footprint and expertise of experienced medical device contract manufacturers, thus allowing the re-focusing of scarce resources from manufacturing and supply chain management to core research and development. This transition will improve their own financial position and competitive stance—and, in turn, accelerate overall industry growth and the world’s well-being.
1. “Fabless Semiconductor Model—Shaping the Semiconductor Industry’s Future!” Frost & Sullivan Market Insight, March 17, 2006.
2. “The Common Platform Technology: A New Model for Semiconductor Manufacturing,” Jim McGregor, In-Stat Research, Jan. 5, 2007.
3. “Chipmakers Take a Global Perspective,” Tom Abate, San Francisco Chronicle, May 15, 2007.