Industry Q&A: Outsourcing vs. Offshoring
A group of industry insiders shares thoughts on the definition of outsourcing, where the overlaps are, misperceptions and ways medical device companies distinguish between the two.
It may seem odd to have to define the word “outsourcing” to this magazine’s audience, but perhaps a quick back-to-basics is in order. Added to the Merriam-Webster dictionary in 1979, the term outsource is defined as: to procure (as some goods or services needed by a business or organization) under contract with an outside supplier.
The understanding of outsourcing isn’t as straightforward as this simple definition would lead you to believe. Very often—even within the medical device industry—the practice of outsourcing is
To seek some clarity and gain perspective, Medical Product Outsourcing recently spoke to industry experts from various points along the medical device outsourcing spectrum. Excerpts of those conversations follow.
• Tim Bowe, co-CEO and co-founder of Foliage in Burlington, Mass. Foliage provides custom software development services and product strategy consulting for the aerospace, financial services, medical and industrial equipment industries.
• Chris Coghlin, president and CEO of Cogmedix in West Boylston, Mass. Cogmedix focuses on the production of Class I and Class II medical and clinical devices.
• Walter Gilde is business development manager for Merrimack, N.H.-based-KMC Systems, a supplier of contract design, manufacture and maintenance for medical devices and instrumentation
• Edward J. Goldman is senior vice president with Waltham, Mass.-based Foster Miller, a product design and development firm founded in 1956.
• Andrew Kinross, an associate director in the Burlington, Mass., office of Chicago, Ill.-based Navigant Consulting. Navigant provides business services in a variety of industries, including healthcare and life sciences.
• Falguni Sen, PhD, professor of management, Graduate School of Business at Fordham University in New York, N.Y. Dr. Sen is an internationally recognized expert on medtech and pharmaceutical outsourcing issues.
• Bryan Szweda, director of OEM and Transfer for Boston Scientific Corp. Mr. Szweda is based in the Minneapolis, Minn., area.
• Marc Tanowitz, principal, with Pace Harmon, an outsourcing advisory, strategic sourcing and technology consulting firm based in Tysons Corner, Va. Tanowitz was named among “Provider Pros to Know” in 2008 by Supply & Demand Chain Executive magazine.
MPO: Though it may seem like a basic question, how do you define outsourcing? And why does it seem that people often fail to differentiate outsourcing and offshoring?
Marc Tanowitz:Outsourcing is a higher-level strategic relationship that is managed through a series of service level agreements, which are designed to align the interests of the buyer and vendor.
If you’re talking to the head of manufacturing for a medical device manufacturer, they may look at all of their third-party providers of finished goods and subassemblies that they resell as direct-material vendors rather than outsourcing providers. And they may be right, because they’re issuing a purchase order and they’re buying some goods. There’s no extended commitment, and they’re really just paying for that finished good and service to be completed by a certain day.
But there are other vendors that have said, “let me take this whole component or device and give someone the specs and they will own all of the raw material procurement and they’re going to be registered by the manufacturers and approved by the FDA.” That’s when you start moving into outsourcing relationships where the outsourced vendor is able to add value through capabilities such as an understanding of the regulatory environment in the country of manufacture as well as the country of sale, to the extent that the product will be sold in multiple countries.
Outsourcing is like a joint venture. If you want to make it successful, it’s incumbent upon you as the buyer to really invest in that relationship from a tactical and strategic executive level to collaborate to optimize that relationship.
A couple of different offshore concepts come to mind. A domestic company here in the United States could decide that they want to manufacture in Asia, for example, to take advantage of low-cost labor, or to be closer to their customers or to leverage a specific manufacturing capability. They may decide they have enough of a presence there, they understand the regulatory environment and they understand the labor force, so they’re able to set up a facility to handle all the start-up activities required, such as designing and engineering the facility, obtaining all of the zoning, permitting, and regulatory approvals, etc. They have the scale to make the business case work so they decide it makes sense to build and own that facility. They’ve created their own division, in essence, off shore, to take advantage of labor arbitrage and potentially some supply chain efficiencies on the logistics side resulting from a closer proximity to their end customers.
Then there’s the scenario where you have a company that perhaps may not have the skill or expertise to do this or the ability to dedicate resources halfway around the world. Therefore, offshoring becomes a potential option. Because they’re not just buying the capability to perform the manufacturing, they’re also buying the expertise to set up the facility or leverage someone’s facility that’s already set up to offset some of that capital investment.
Edward Goldman: It’s simple. If I am not manufacturing it in my shop and I am having it manufactured somewhere else, it’s outsourced. Offshoring is a subset of outsourcing. I always assumed that people knew what the difference was, and I never got the impression that they didn’t. Once you decide to [outsource], you have to decide what the best way to do it is. For some—though it wouldn’t be my first choice—it means going to China or India. There are too many quality concerns, in my opinion. Outsourcing is about choosing someone who has the skills to do the job better than we can. It doesn’t have to be about going overseas. We’re in Massachusetts and outsource to companies in Connecticut, New York and New Hampshire.
Andrew Kinross: Outsourcing is a catchall term for not only contract manufacturing, but outsourced design engineering and supply chain management. Contract manufacturing is narrower. It refers to manufacturing to specifications from your customer. Outsourcing is more general. Offshore manufacturing can fall under the outsourcing umbrella, but they’re certainly not interchangeable, though some people use them that way. I’ve had people tell me “we’re ‘outsourcing’ to China”—as in J&J has a facility of its own in China. That’s not outsourcing as we normally define it in the medical device industry. In the political realm, however, politicians define it differently—they use the term outsourcing to discuss loss of U.S. jobs to India or China or elsewhere. It depends on how people label things. But you’d think people in the device industry would understand the difference. Companies often have their own taxonomy. While most people in the medical device industry seem to understand that outsourcing purely means contracting with a third party (where ever that happens to be in the world), there’s some companies where it means “going overseas.”
Falguni Sen: It’s a very interesting question. I have wondered the same thing myself. If you look at total outsourcing in the United States, over 60 percent is done in the U.S.—and this is not just in medical devices, but overall. These figures are about three years old, but I believe still accurate. About 30-40 percent is done offshore. And even in offshore, there’s this notion of nearshore versus farshore, so there are really three varieties.What has happened, in my view, is that there is a perception that outsourcing meant China. And organized labor found that they were losing jobs—this is going back 15 years—and I think that has somehow stuck in people’s minds. It means loss of jobs and loss of jobs because of cost issues and therefore people see outsourcing and offshoring as one in the same thing. Many companies started outsourcing within the U.S., but as they got their processes under control found that they could look at cost-based options. Initially, they were reducing their risk levels by keeping the outsource groups nearby and also looking at value propositions. But, as product deigns became more standard companies began looking for cost improvement. And that’s what has slowly started to happen in the medical device space as well. People who are outsourcing locally are looking at Mexico and Ireland, for example, to find new cost propositions—China definitely, India as well. So even if a company starts out locally, perhaps people feel that a switch to offshore is inevitable.
Chris Coghlin: I don’t run into it too frequently with people within the industry. I do run into it, however, when I try to explain what we do to people not familiar with medical devices. When I explain that we’re an outsource resource for medical device OEMs that bring new medical technologies to market, they say: “I didn’t realize you had any offshore facilities.” Well, we don’t. So, clearly, there may be a general misperception, but I think the industry probably understands.
Walter Gilde: It gets complicated because companies may be looking to outsource offshore all in the same breath. And it’s understandable why, perhaps, there is some confusion even within the industry. The majority of people I talk to in the IVD (in-vitro diagnostic) industry have a clear understanding that outsourcing isn’t necessarily an international proposition. It depends on the nature of the company—an established OEM versus a startup or an emerging company, for example. They’ll have different perspectives on it. Established OEMs will look at what their core competencies are and what their platforms are for their success and they’ll want to maintain a high level of control over those elements of their business. Products that are peripheral to those core competencies or platforms, they’re probably willing to consider outsourcing those things. The next step is if we’re going to outsource, do we go domestic or international? So it’s a progressive leap that companies take.
Tim Bowe: Contract manufacturing, offshoring, etc. It’s really all outsourcing. The problem is that a distinction has arisen over the past four or five years and the connotations of each are fundamentally different. Outsourcing is almost always considered to be nearshore or all domestic, as opposed to the offshore model. And, obviously, the drivers for each are fundamentally different, too. If you’re outsourcing domestically or nearshoring, you’re focusing on hiring expertise. If you’re outsourcing offshore, you’re looking for cost. As a general rule, that’s how I see most people making the distinction.
MPO: Manufacturing offshore—and outsourcing, indirectly, lumped together—often carries a negative connotation. Where does that come from?
Goldman: I think it’s a quality issue. Sometimes it’s justified and sometimes it isn’t. The question becomes how you ensure that your quality is what it needs to be. Respect of your proprietary rights is another huge factor. You don’t want to put your device into a Chinese plant and then see it coming at you from six different competitors. I think customers are very cautious when it comes to considering an offshore option, and getting more cautions given some of the catastrophic quality problems we’ve seen coming out of China recently. The last thing you need as a medical device company is a recall. They’re giving away their crown jewels. It’s like sending your kids to day care. You just don’t pull up to the first place you see and drop them off. You do your homework.
Kinross: Medical devices have bucked the trend in terms of most manufacturing is still done in the United States. International manufacturing is still an unknown. Every other manufacturing industry has gone outside the U.S., but [medical] devices have been slow to follow. And politicians have picked up the word outsourcing to mean job losses, companies leaving the U.S., etc. I think that’s the problem. Though the medical device industry still does the majority of its manufacturing here, so many other industries have gone offshore. And medtech gets painted with the same brush.
Sen: Why does it get a bad reputation? Because it’s linked to a loss of domestic jobs—it just seems like people are making those associations. People also perceive that it isn’t a level playing field. In China’s case for example, the working conditions, the environmental conditions … the perception now is that you’re not getting good quality and that you have all these things going wrong from lead paint in toys to tainted heparin. These certainly don’t help.
Bryan Szweda: Well, as you consider taking a project offshore it’s natural to worry about the unknowns. But if you manage the process, it can work. People really start to focus in on logistics, culture, that type of stuff. It’s a harder sell for offshoring than for outsourcing. There are more logistical complexities—but the key is to set the business process between the two companies. If that’s set up right, it’s just the same as doing business in the United States. If you don’t spend the time and set up the right infrastructure to begin with then it becomes a very complex business to run, and that could be what scares people. Asia has a little bit of a stigma. There are many unknowns for device companies, and it hasn’t been a real focus of many medical device manufacturers, but it will be. We’ll be learning more and more. And knowledge is power.Once a few companies have been over there and learn the tricks of the trade, it will grow—and relatively fast. Cost reduction will be a big driver, as well as markets opening up. Right now, the process is easier closer to home, domestically or someplace like Mexico or Costa Rica.
Tanowitz: I think, to some extent, the challenge is that some of it is a cultural difference, and many people aren’t familiar with how business is conducted from a cultural perspective.It’s far away. It’s a different culture. When you hear people say that offshoring is dangerous or risky, they typically can’t get past those differences to take advantage of the available efficiencies. I also think that there are some infrastructure concerns as well. If your sales market is the United States, when you look at the working capital involved to move some of these products, the number of days of inventory required to support production in Asia given the lead-time between Asia and the U.S., it becomes a difficult business case to justify. Unless your products are small, light and cheap to transport, you end up with longer lead times, which has an immediate working capital impact. The difficult logistics often aren’t worth it. Specifically in the medical products field, the added regulatory challenges also play a huge role and can present more risk that some companies can or are willing to absorb.
MPO: Whether domestic or international, do you find that medical device OEMs truly understand the outsourcing process?
Szweda: I think understanding differs at different levels of the organization. I’d say people who are responsible for using outsourcing or using suppliers, partners and vendors to supply materials have a really good understanding. But I think if you get to levels that don’t work with the outside vendors and are purely focused internally, I believe they do assume that outsourcing means offshoring or a loss of jobs of some sort. No I don’t think they see vendors and suppliers as outsourcing. They focus pretty quickly once you explain the intricacies of the process. There’s a lot of education that needs to happen. Some people believe that if they have someone outside making it, it’s just “throw it over the fence” and that’s it. But you really have to have solid systems and support structures to make sure that you’re continually evolving and supporting the products and the process. There is a future for outsourcing and it will continue to grow. Outsourcing firms will need to continue to demonstrate their value. A medical device manufacturer cannot afford to be good at everything. There are the three buckets: sales and marketing, R&D and operations. You can’t afford to spend money to be great at all three of those. Good partnerships make all the difference.
Coghlin: The medical device industry has been slower to adopt outsourcing than other industries, and I think it’s because there really haven’t been that many partners to choose from. But now that has changed. Companies were very concerned with the possible risks of contract manufacturing and turning over a lot of what they do—but outsource providers like us and others have proven that we offer a safe, high-quality solution. In many cases, for example, we have more knowledge of compliance requirements than many of our customers. Many venture-backed, burgeoning companies have great intellectual property or great ideas that will solve medical challenges in the market; investors are not investing in these companies so that the company can build infrastructure. We provide the infrastructure they need, the opportunity to grow, save lives and cut costs in healthcare and drive more innovation. That means good things for outsourcing partnerships.
Goldman: I believe so. We almost never have to explain it. We don’t go through a lot of explanation. Companies know they need help and they know they need to outsource. Of course, we define the particulars in a business discussion, but I find companies understand what they’re getting into. The idea that they don’t have the capabilities we do—that’s no mystery. Clearly, this makes the most sense with startups. But, in general, people understand. Differences in the size of firms can be huge. A startup for example may not have any understanding of what things are going to cost—they don’t have an idea of what the real challenges are. We sort of have to “father” them through. You have to explain what the manufacturing steps are and what the regulatory steps are. You need a lot of stuff at the beginning to do the job right. We don’t just build a part or a device. We bring more to the table than that. A big company knows most of this, so the education is a lot less. A midsize company can be anywhere in between.
Kinross: I think a medical device company executive knows what his or her options are in terms of manufacturing in China or not, or manufacturing with a third party here at home or not. I really don’t think the use of different terms handicaps the industry. Because, at the end of the day, the medtech executive is making a business decision that’s best for his company, shareholders and product.
Sen: I don’t feel that they understand what it means. How many of them fully work out their manufacturing processes to see whether there are core activities that they can keep in house while outsourcing non-core activities? The whole idea of core and non-core activities I don’t think has reached that level of understanding in the medical devices area as it is beginning to reach in pharma. It has been changing slowly and has room to grow. I think there is a lack of familiarity. Many companies haven’t visited outsource providers in the United States or abroad to see how things are done and see how privacy and IP (intellectual property) can be preserved. There is a strong belief in the individual skills and craftsmanship needed for devices, particularly with more detailed products. First-time outsourcing is a very difficult task, unless you have a champion within the firm who really believes in outsourcing. Very often, it starts at conferences or meetings where professionals come together, and someone will extend an invitation to visit a plant. Companies that have outsourced a small component are an easier sell usually when it comes to outsourcing more pieces of the puzzle. Companies that have operated in little niches or in small batches don’t really feel the need.
Bowe: No, I don’t. Part of the reason is that other industries have been dealing with the offshore model for many years—the financial world started in the late 1970s. Some of the capital equipment manufacturers started in the ’90s. Only over the last four or five years has it been something that’s been talked about in the medical space with any sort of consistency.
First and foremost, it’s a very profitable industry so it hasn't been driven to reduce costs. Additionally, it’s an industry with a high degree of regulatory and technical complexities. So, it is often felt that it is easier to hold your IP internally, even though you may not be as efficient in developing new products as you could be if you were working with partners that focus on the various elements of the product lifecycle. Now that the industry is driven to reduce cost, there is the desire at the executive level to talk about doing things differently, which isn’t how it’s been for the last four or five years.
Working with any kind of partner is an incremental process. It is important to remember, however, that to work with an outside company, your internal processes have to be very good.Even though the medical device space is highly regulated, many companies don’t have very effective development processes. This can also contribute to initially making it difficult for them to work with outside organizations. However, improving your product development efforts in conjunction with an outside partner will result in a faster and more effective product development effort.