Even in a down economy, electronic manufacturing services firms remain positive about the bottom line.
No examination of an industry’s performance, trends and expectations for this year would be complete without at least partially framing the discussion in terms of the current state of the economy. While certainly not the whole story, the reality of financial bailouts, the current credit crunch and recession guide most corporate messages (and game plans). Some would argue that healthcare is insulated from such concerns. “Not so,” say medtech executives. Though the medical device sector is far from taking the pummeling that, for example, automakers have been, it is not entirely immune.
Companies that provide electronic manufacturing services (EMS) for medical device OEMs seem to be well positioned to ride out today’s financial storm. At one time, EMS firms focused primarily on the information processing and communications industries, providing printed circuit board fabrication. But in recent years, companies have branched out into new fields such as medical devices, allowing EMS firms to draw upon (and aid in) the device industry’s overall stability and long-term growth prospects.
The business model for the EMS industry has been to specialize in large economies of scale in manufacturing, raw materials procurement and pooling of resources, and industrial design expertise, in addition to creating added-value services such as warranty and repair work. Now, EMS companies are offering manufacturing solutions for high-mix, low-volume products, as well as substantial vertical capabilities—from design through system assembly, testing, delivery and logistics, warranty and repair, network services, software and silicon design, and customer service.
To examine market trends over the past year and explore predictions for 2009, Medical Product Outsourcing recently discussed the medical EMS segment with several sector executives and industry consultants. Despite the less-than-rosy economic picture at present, executives were unanimously bullish about the prospects for EMS and the larger device arena.
“Certainly from the OEM perspective, our customers are being impacted by the economy,” said Tony Allan, vice president of global business units for St. Petersburg, Fla.-based Jabil. “[The device industry] certainly isn’t recession proof, but it’s not suffering anywhere near the same effects as more highly volatile markets—such as consumer products.”
EMS firms are providing contract manufacturing capabilities to device manufacturers in multiple product categories. Patient monitoring and radio frequency technology are among the many technology areas in which firms predict solid growth potential.
“Given the circumstances, that is still a pretty good result given how the economy is,” he explained. “But from our perspective, we’re still looking at it as being a growth year. And what we’re seeing obviously is more customers coming to the outsourcing model. We’re seeing some vendor consolidation. We’re also seeing many customers not making any more investments in their own manufacturing footprint. Senior OEM management is saying, ‘Hey look, if we need to build more products, we’re going to outsource it.’”
Susan Mucha, president of El Paso, Texas-based Powell-Mucha Consulting, Inc., which advises EMS firms, agreed that the medical sector—and the EMS firms that serve it—won’t feel the effects as much as other industries, but noted that some of the impact was felt in the fourth quarter of fiscal 2008.
“From what I see—at least what I see in the EMS community—is that everyone is taking a cautious approach, especially those who have been in the industry and have seen upturns and downturns,” Mucha explained. “They recognize that they have to manage their resources carefully but aren’t cutting back in any areas that have a negative impact on their ability to take advantage of an upturn when it comes. I still see companies hiring new people if there’s a critical position they need to fill. I’m not seeing lots of layoffs. There is some caution in terms of making decisions to spend money. Across the board, payables are stretching out, which is always bad when 70 to 80 percent of your revenue is material cost.
Companies are “pushing back” or delaying decisions, according to Mucha, as executives wait to see how long the recession will last. “There haven’t been enough numbers to indicate we’ve seen the bottom,” she added. “When we get to that point, I think you’ll see a lot of hesitancy come off the table.”
Bhawnesh Mathur, CEO of EPIC Technologies, LLC, an EMS firm located in Norwalk, Ohio, said his firm was adopting the “wait-and-see” posture described by Mucha. “We’d have planned some capacity expansion this year that we’re now going to assess over the next six months to see how things shake out,” Mathur explained. “We’ll see if we need it come 2010. So that’s slowed us down a little bit. We have to keep a closer eye on our costs.” Like Jabil’s Allan, Mathur also predicted a relatively flat growth year across all sectors the company serves, bolstered by a “dynamic” medical technology business. Approximately 50 percent of EPIC’s business comes from medical, according to Mathur.
Joe Horvath, vice president and general manager for the Medical division of Sanbor, based in Allentown, Pa., said a freeze in available venture capital did impact some of his customers. He also noted that belt-tightening by hospitals also could “trickle down” to EMS firms and the broader device industry.
“Part of our business involves work with startup companies, which most often have some degree of venture capital backing. And that money is really getting more restrictive, so it’s becoming harder for some clients to maintain their venture funding,” Horvath said. “We had a couple of customers who lost [funding] last year and had to shut down projects.
“Looking at the general medical device community, hospitals are looking to cut costs. Hospitals are businesses, and they have to borrow money to operate, too. Virtually every business needs a line of credit for operating capital. And when money gets tight they cut back. So, in turn, there’s a lot of pressure on our customers to reduce their costs. And that has an impact. But it provides us with the opportunity to show our customers how we can help to reduce their costs and make them more efficient.”
A recent study released by the Noblis Center for Health Innovation in Falls Church, Va., seems to support Horvath’s assessment. As the economy worsens, hospitals are forced to cut capital spending dramatically, which takes a toll on the industries that supply and serve them. Many U.S. hospitals have introduced hiring freezes, cut capital spending and closed unprofitable locations.
At the time of the study, 31 percent of the hospitals surveyed already had reduced or were committed to reducing routine capital and other spending by more than 30 percent.
In the face of more cautious industry watchers, Greg Bannick, the new director of Medical Industry Solutions for Jasper, Ind.-based Kimball Electronics, is unapologetically bullish about prospects for EMS and the medical device industry.
“I still think the 6 to 8 percent growth in the medical device industry as a whole is not unrealistic. I’ve talked with many medical device leaders and they feel the same way,” Bannick said. “Demographics point to continued growth. There’s tremendous growth potential in home monitoring, sleep apnea and respiratory, urology, and advancement in optics and sensors, for example. There are some unknowns in the short-term though. The new administration is somewhat of an unknown. Will new products be more difficult to get through the FDA? There are a lot of things that are swirling that companies are waiting to settle. But I think the growth will still be there.”
The Outsourcing Answer
According to EMS experts, outsourcing—in addition to a robust portfolio of services offered by contract manufacturers—becomes increasingly attractive to medical device OEMs during lean times. The upside seems to be a steady stream of business for many contract manufacturers. The downside is, however, that OEMs are drastically reducing the number of suppliers in order to streamline business, rein in costs and simplify supply chains, EMS executives reported.
That, according to sources, could make competition more intense as firms develop tighter relationships with a few key partners. “The times we’re in right now make everything a bit more of an issue,” Mathur said. “OEMs’ balance sheet is an issue. Their desire to reduce costs is an issue. Their desire to focus on their core competency is an issue. This can be an opportunity for us. That’s the relationship and trust we have with our OEM customers. We understand how the product is manufactured in addition to how it performs in the field. With that capability, our customers are looking for even more than before—for us to help them manage with limited resources.”
According to Jabil’s Allan, this is an environment where larger EMS firms, perhaps, have an edge.
“This actually is a very busy time of year for us,” Allan said. “We’ve got a number of customers who want to discuss outsourcing—how to do it, what it would look like, etc. One of the trends that I’m seeing a lot is risk management and risk mitigation. A lot of smaller contract manufacturers are in difficult fiscal times and perhaps over-reliant on a single or a few customers.”
OEMs want to consolidate the business they have with smaller contract manufacturers and EMS firms into “a couple of larger players,” according to Allan, reducing the number of outsourcing firms they use. Some larger OEMs have contracts with more than 20 outsourcing firms.
“Companies are being very detailed about pouring over the financials [of outsourcing firms] when they evaluate selection and validation criteria. They want to know how much of their business makes up the contract manufacturer’s portfolio to ensure they’re not reliant on just one or two customers,” he added. “I think it’ll be more of a problem for the smaller contract manufacturers—the ‘mom-and-pop’ shops—that rely 70 to 80 percent on one OEM for their survival. You need to feel confident your partner is going to be around tomorrow.”
Though companies clearly want to consolidate their supply base, smaller EMS firms may actually be well-positioned to survive in this market, argued Mucha, because many provide a niche service or skill that some of the larger firms ignore.
“Even in some of the smallest EMS companies I talk with—low-volume houses—their customers still expect them to have engineering capability, to do box build as well as [printed circuit] board level, and have automated process controls,” she explained. “There’s not an assumption among OEMs that only the tier-one companies have these capabilities. If [OEMs] go to a smaller shop they expect that if the EMS firm doesn’t have a capability in house that they’ll find a way to get them through strategic alliances or through tapping vendors. There’s more synergy between smaller EMS firms and their suppliers. They’re working together to solve problems. Smaller houses are investing more in automation that allows them to do more with fewer people. One of the challenges for the smaller revenue producers, if you’re going to be full service, you have to make investments in people or equipment and you can afford the underutilized capacity. They invest in equipment and good software tools. There’s a lot of: ‘How can we work smarter and give our customers what they want?’”
Gelston Howell, senior vice president for the Medical Division of Sanmina-SCI, agreed that OEMs continue to seek a wider menu of services—and much earlier in the process—but noted that exactly what customers want can vary depending upon the size of the medical device firm.
“For smaller or startup companies, the needs may be somewhat different,” he said. “These companies are sometimes more interested in product design and a complete solution to get their product in production and to market. These services might include full product design, having Sanmina-SCI manage the design history file and other services such as developing the in-store packaging for a consumer medical product.”
Ultimately, cost is king and there is opportunity for companies in the coming years that take cost out of the process, experts said.
“When you outsource there are cost-reduction opportunities everywhere,” Mucha said. “There are costs in terms of overlap of processes between the customer and the contractor; there are costs in terms of how product moves around the world; there are costs in terms of poor quality of failing to anticipate product obsolescence. There are a lot of little pieces that go into that equation. The companies that really understand that and can reduce them will have a competitive edge over companies that are just really good at putting together product. And that will be of more interest than it has been.”
Where to Manufacture?
Part of improving an OEM’s bottom line, of course, is overseas manufacturing in low-cost countries. EMS executives caution, however, that offshoring is not a panacea and that any move to manufacture abroad must be carefully considered as part of a larger manufacturing strategy.
Allan said Jabil provides its clients with a full analysis and risk summary to help them achieve the lowest cost, but also reduced risk when it comes to changes in global economics.
“Customers appreciate that we’re putting the effort into bringing solutions to the table and not just the lowest-cost solution,” Allan added. “Some of the products just aren’t geared to some of the countries they’re talking about. You need the right volume to go overseas. Some of the approaches are very kneejerk reactions. So we walk customers through the logic. If there’s a small amount of touch time with a product, you’re not going to get much savings by going abroad. So it doesn’t really get you much benefit. So you have to understand how we help change the shape of the product to reduce the cost. How do we bring in an improved design benefit or value engineering analysis? How can we impact the cost of the products based on the makeup of the product itself? The makeup of some products may not suit an offshore option, particularly if you’re not selling into that market.”
Even with the current state of the global economy, major medical equipment companies are achieving year-over-year sales growth in emerging countries, according to Howell of Sanmina-SCI, which has 10 medical manufacturing facilities worldwide. In the past year, the company (headquartered in San Jose, Calif.) added a facility in India and expanded its footprint in China.
“This coupled with freight and VAT (value-added tax) associated with shipping products into some emerging countries, as well as our customers’ needs for on-going cost reduction has influenced our global manufacturing strategy and leverage of lower-cost countries,” Howell said.
Over the last few years, Sanmina-SCI has worked with its customers to replicate capabilities for complex systems manufacturing across all of its 10 ISO-certified facilities, Howell noted. He said a key factor in the company’s success has been in establishing a “strong, comprehensive” supply chain in close proximity to its manufacturing facilities.
“A well-developed supply chain for low-cost components and materials is as important as having regulated medical manufacturing facilities in low-cost countries,” he continued. “Right now other major medical OEMs are focusing a significant amount of their resources expanding their ROW (rest of the world) revenue streams. We are fortunate that we have a significant and well-established medical footprint already, and are well-positioned to sustain the changes in source of supply that are bound to occur as we support our customer initiatives.”
Kimball’s Bannick said having a global footprint is a “must.” “When products reach a certain volume, it’s important to have the option to move to a low-cost region,” he said. “Customers want local proximity with global reach. Our customers like to have that sense of comfort that we can take them there when the time comes. We need to understand what our customers’ short- and long-term goals are. Nobody is immune to the cost pressures.”
Kimball recently constructed a new manufacturing facility in Poland (where the company has been for nine years), adding to its current lineup of facilities in the United States, Mexico, China and Thailand.
The buzzword for many years has been China. But the desire for companies to manufacture in China solely to reduce costs may be fading, Allan suggested.
“A lot of OEMs are no longer chanting China, China, China,” he said. “They’re talking about offshore, but it’s not all about China anymore. And that is something that’s been a significant change over the last 12 months. It had been all about China a year ago. How were we going to help them get to China? And now it’s about how we get them to a low-cost location—a big change in mindset. Jabil has facilities in North America, Europe and Asia. The bulk of the firm’s manufacturing—50 percent—is still done in the U.S. and Mexico, though the company does have plants in China.
According to Allan, if examined in terms of percentages a company may realize a 20 percent benefit in moving to contract manufacturing and then another 10 percent benefit moving to a low-cost country. On top of that there’s an additional 4 percent benefit moving to China specifically. Companies need to decide if that 4 percent is “worth it,” he said.
China most definitely is worth it for Sanbor Medical, which does all of its manufacturing at two plants it owns in the country, one of which is FDA-registered. Horvath says he invites all his customers to audit the factories and most take him up on the offer, and that they put processes in place to mitigate quality concerns.
“Our VP of manufacturing was our original quality manager, so our factories have been built up from a quality perspective. We’re ISO 13485-certified and we get audited,” Horvath explained. “It’s no different than here in the states. We do internal audits. We maintain device master records and basically work to mitigate risk, because everyone knows the stories about materials in China and the “ol’ bait and switch.” So we control all of our materials. We make sure everything is lot-certified that comes in the door. If something has to be processed outside, we source the material and supply it to the subcontractor for processing. We have a strong ECO (engineering change order) system in place, so if something comes up and a material is no longer available, the plant will contact our engineers here. We talk to the customer and seek their approval and supply samples and technical specs. We won’t manufacture with an alternate material until the customer has approved the product.
Horvath said there’s always going to be product types that OEMs want close by. “There’s nothing wrong with that, and they won’t consider a company like ours,” he added. “But there are many products that easily lend themselves to production overseas, whether cost driven or for other reasons the customer wants a cost-effective assembled product or molded part, whatever it is, and there’s not a negative consideration with offshore outsourcing. We have a good history. We continue to grow, and we continue to find new clients who are looking for the cost savings opportunities we offer.”