Charting the Course of Full-Service Outsourcing
Industry experts remain bullish about market growth for medical device outsourcing, though current economic realities create a new set of challenges.
Christopher Delporte, Group Editor
Uncertainty is a common emotion in today’s business world—and medical device manufacturing is not immune from this cautious corporate climate. Wall Street continues to have its ups and downs, as do markets across the globe.
A little more than 100 days into a new presidential administration in the United States, and anyone who works in the medical industry is waiting to see how possible—and imminent—changes to healthcare policy in this country will take shape.
At the risk of adding to the flurry of questions
To explore these issues in greater depth, the following industry professionals contributed their time and expertise to this discussion:
• Dan Adlon, director of contract product development at Lewisberry, Pa.-based Unilife Medical Solutions , which recently changed its name from Integrated BioSciences Inc. Unilife designs, develops, manufactures and supplies innovative safety medical devices.
• Tom Black, vice president of OEM sales and marketing for B. Braun Medical Inc., a medical device manufacturer and contract service provider based in Bethlehem, Pa.
• Dave Busch, principal, PRTM, a worldwide management consulting firm. Busch, former vice president of medical for Milpitas, CA-based Solectron, is based in Mountain View, Calif.
• Michael Cusack, director of business development, for MRI Medical, a start-to-finish development and manufacturing company focused solely on the medical industry. The company is based in Tucson, Ariz.
• Benjamin Dunn, managing director of Boston, Mass.-based Covington Associates, a specialty investment banking firm with a focus on the healthcare industry—medical technology and outsourcing companies, in particular.
• Richard J. Malo, vice president of contract sales for Ethox International Inc., in Buffalo, N.Y. Ethox provides design and manufacturing, sterilization, toxicology, analytical chemistry and microbiology services for the medical device industry.
• Thom Murphy, director of business development for Seattle, Wash.-based Vaupell Holdings, a full-service molding company. The company’s Northeast Molding and Tooling division in Agawam, Mass., where Murphy is based, focuses on the medical device industry.
• Vytas Pazemenas, president and founder of Aubrey Group, an Irvine, Calif.-based engineering and manufacturing firm specializing in the design and manufacturing of electronic and electromechanical devices for medical use.
• Gil Peterson, vice president of business development for the Aubrey Group.
• David C. Robson, vice president of development for Ximedica LLC, a medical device designer, developer and contract manufacturer based in Providence, R.I.
• Dana Schramm, vice president of engineering for New Brighton, Minn-based Donatelle, a full-service supplier of molded, machined and assembled products.
• Jeff Shepherd, director of engineering for Sandvik Medical Solutions in Memphis, Tenn. Sandvik is a manufacturer of instruments and implants used in orthopedic procedures.
Though the rate of outsourcing has grown in the recent past, the realities of today’s economy are impacting most industries. How are outsourcing providers being affected by the economic downturn?
Ben Dunn: I think that the economic pressures affect everyone. In particular, there are increased pricing pressures. Everyone is looking at how to cut costs and looking for suppliers and service providers to reduce their costs. In a lot of ways, the medical device market hasn’t been impacted as much as other areas of the economy. One of the trends that we’re seeing, particularly for outsourced manufacturers, is businesses that traditionally haven’t done medical [device manufacturing] or have had a small amount of medical business are actively looking to grow that. One of the effects of the downturn is increased competition for outsourced suppliers. For example, outsourcers that traditionally focused on automotive are turning to medical as their other business has dried up.
Thom Murphy: Companies don’t seem to be leaving any stone unturned as far as cost savings go—whether you manufacture medical devices or anything else. They’re looking for cost savings at every possible juncture. It’s the same with us. Internally, we’re looking at how we can do things more efficiently—related to overhead, for example. And we’re also getting the obvious requests from customers. Customers are looking for the ways to remove costs from products. So, that’s probably the majority of where we’ve been affected. We haven’t seen major drop-offs in volume related to existing products. And we haven’t seen major changes in the demand for new products.
Jeff Shepherd: The biggest impact has been cash flow, especially for the smaller shops. From a contract manufacturing standpoint it goes two ways. People look at the economy from a contract manufacturing standpoint and the first thing they think of is work might decrease to contract manufacturers. There’s some truth in that as OEMs try to manage their inventories. When times get tight, they tighten their belts a little bit. It’s a temporary interruption. I’ve been in orthopedics 20 years, so I’ve been through a couple of these. From a contract manufacturing standpoint, when the volume starts dropping you have to manage your cash much tighter. Smaller shops are getting hammered by that. They don’t have the cash reserves. We all feel the crunch, but it’s harder on smaller companies.
Tom Black: Overall, cost reductions are being pushed all the way down to the component manufacturers. At the same time, lean inventory and strong cash positions are critical for cash flow at healthcare providers, so there has been a slowdown in volume. There is a worry about whether suppliers are going to be around in a year or even months, so being a private firm that has been around since 1839 gives our customers a sense of security. They are looking for strong suppliers that will be there for the long term. Quality is still assumed, though there is concern that companies that are not healthy might not be able to keep up with the quality level that’s expected.
Michael Cusack: In general, I think medical devices are still protected by a fair amount of recession resistance. Medical device manufacturing is still plugging forward. We just had our best quarter out of the last six. On the other side, the design and development piece is being affected, and many companies are gearing back on their research and development projects. This affects the other side of our business, which is the development of the devices. There, I see two things: The first is that for smaller companies that are VC backed, tighter lines of credit are keeping them from moving ahead with development projects. Larger companies are still moving ahead, but they’re becoming much more rigorous about how they’re spending their development dollars. They’re not as free spending as they were.
Dave Robson: We’re finding just as many opportunities as we have in the past. I wouldn’t say that we’re finding more, but we are certainly finding just as many. It does seem that companies are taking longer to make decisions. It’s not necessarily because they don’t want to hire us, I think. But it’s because they’re doing more competitive analysis of our quotes versus somebody else’s. Once they have all these quotes in hand, they’re taking a hard look and being more conservative—understandably—about how they’re authorizing these programs. That said, we have had companies come back to us who need to find cost savings in previously approved projects. So there definitely are some pressures that the OEMs are feeling. We’re trying to help with that. There seems to be more risk for OEMs that manufacture elective devices. Some of the plastic—aesthetic—surgery companies we’ve worked with—skin resurfacing lasers, for example—are really feeling it. But as an entire industry, there’s still plenty of opportunity for outsourcing. In some cases, OEMs are laying off engineers and product developers but have just as much work to do. In those cases, outsourcing is actually a better alternative.
Gil Peterson: Demand for outsourced engineering services and development work has slowed from where it was over the last few years. We’ve worked mostly with early stage companies. We have a few clients among the big six device makers, but most of our work comes from early stage [companies]. Venture funding isn’t as robust as it has been. In addition, venture capital companies are spending their dollars on late-stage rounds of financing rather than early rounds. As a result, the aggregate amount of business available is less that it has been for startups.
Vytas Pazemenas: Things will slow down a little bit. Last year we grew about 30 percent. We’re planning for little or no growth this year.
Dave Busch: This is a multifaceted question. The first facet considers which industries the CM (contract manufacturer) is providing services to. The traditional CM (or electronics manufacturing services) industries of computer, storage, telecommunications, networking and consumer electronics have all been very hard hit by the recession, which in turn impacts the orders they place on their CMs. Industries newer to outsourcing such as medical, military/aerospace and industrial have been less impacted by the recession. Their forecasts are relatively unchanged. However, they typically account for a small proportion of a CM’s business.
The second facet is the value proposition that OEMs are looking for. While cost has always been a key factor—along with other elements of the value proposition such as design services, tax benefit transfers, supply-base localization and post-manufacturing services—the recession has brought cost to the top of the list, eclipsing all other elements. Ask a CM business development person what their OEMs are all asking for, and they’ll reply: “deeper and faster cost reductions.”
The third facet is the financial structure of the industry. Firms with strong cash positions obviously have greater flexibility in how they manage through the recession, including acquiring attractively priced distressed assets. Those with weaker cash positions and higher levels of debt will likely have to reduce head count and footprint.. The fourth facet is political. Companies that haven’t before outsourced may postpone the decision if they are financially able to, especially if it entails plant closures and significant headcount reductions. This helps them avoid recriminations from politicians and the press while the recession continues.
Dan Adlon: We are experiencing steady demand from healthcare and pharmaceutical companies to design complex injection devices that can enhance product differentiation and develop high-precision automated assembly systems that will improve overall cost efficiencies. Because we are expanding rapidly, we have been able to recruit world-class people that would not normally be available.
Dana Schramm: The medical industry has been impacted, although not as significantly as other industries such as automotive and consumer products. Those that do not currently supply to the medical industry are looking at this industry as an opportunity; however, they are learning that there is a significant learning curve to compete effectively.
Richard Malo: It’s good and bad. One of our customers had finished developing a new piece of equipment and anticipated great sales to the hospitals. With the economy being as poor as it is has been, the company realized only 15 percent of its forecasted sales for last year. Hospitals just aren’t making the capital expenditures on new or replacement equipment. They’re making do. That loss of business affects us. But we’re still getting the disposables part of the business for existing equipment. Right now, OEMs aren’t investing in brick and mortar. So, in many cases, they come to us to supplement their manufacturing and help with both mature and new products. That’s a positive. But we have been affected by it. Medical products aren’t recession-free, but they are recession-resistant.
Are requests for full-service outsourcing—whether components or finished products—still robust?
Murphy: Requests are still robust, but they’re changing a little bit. They’re coming across as potential cost-reduction opportunities, potential vendor-reduction opportunities. Existing customers are looking for ways to get the cost out of a product. Customers also are looking to consolidate their supplier base. For example, in injection molding, where you’ve got a company that’s significantly in the automotive sector and then dedicates some of its business to the medical sector, that company may no longer be financially stable. So customers are looking for streamlined suppliers and stability. It remains to be seen if there will be any fundamental shifts in companies growing or people leaving this sector. At this stage of the game, it is impossible to predict. But there’s still a lot of request for new projects.
Robson: We’re finding more and more people recognizing the value of a full-service, vertically integrated outsource provider. We can drive efficiencies. We have the capability of taking on more responsibility, of course with the OEM’s oversight, but without using their internal resources to do the work. It’s a pretty compelling offering.
Malo: Absolutely. I’m seeing more opportunities now than I have in the past. And I’m not sure what to attribute it to, but we’re busy. My engineering department is busy with RFQs [request for quotations] from existing and new companies.
Dunn: I think it is still very robust, and the economic downturn provides an opportunity for outsourcers. When you look at outsourcing, historically, it thrives across industries in times of market changes when OEMs are not sure whether to add or subtract capacity. This is an opportunity to get new business from OEMs that are trying to be more efficient with their capital. They don’t want to build capacity and make an investment in infrastructure. Smart outsourcers will act on that.
Cusack: One of the competitive advantages we have is that we’re a full-service outsourcer. When people come to us we provide them with design and development all the way through the design history file documentation and a finished product manufactured with their label on it. That’s still going strong. Some of that could be the result of projects from the past that are coming to fruition now, but we had a strong first quarter and we’re in line to have an equally strong second quarter. I wouldn’t say it’s robust—not booming like it was 18 months ago—but it’s still quite healthy and one of the rosy spots in the economy.
Peterson: I have a sense from listening to others that the contract manufacturing sector is lagging in the impact. It is continuing along its recent trajectory a little better than the engineering sector. At a recent conference, I heard a representative from one of the largest medical device contract manufacturers say they expected things to slow down in the third and fourth quarter of this year.
Pazemenas: When the economic bust became clear in mid-September, the rate of proposals for new business dropped. It remained low, but the shock seems to have worn off. On the positive side, companies have started looking for new product development help. Life has returned back to our business sector.
Busch: The greatest benefit of full-service outsourcing is when transferring several products from a product portfolio that have at least level, and preferably increasing volume projections. This allows the CM to localize a larger portion of the bill of materials and provides time to lean the manufacturing process. Full-service outsourcing has less impact on short-lived products (unless the CM is involved with the design up front) or products with declining volumes. For medical devices there is a demand for full-service outsourcing, but the capabilities of the CMs have not matured to the level of the OEM. This creates a capabilities gap that needs to be remediated. This usually requires investment on the CMs’ part, which they may or may not be able to execute based on their cash position in the current economic conditions. One of the things I advise clients to do is create a capabilities gap analysis. CMs need to have at least the same capabilities as an OEM does—regulatory systems, quality capabilities, adequate supply base, manufacturing capabilities. The OEM should do a site audit at the CM to identify the gaps. In electronics manufacturing, for example, CMs often have the upper hand on OEMs. You have to define the gap and then have a remediation meeting. It all needs to be spelled out. During this downturn, some CMs are unlikely to make that investment in front of revenue—meaning before receiving an order or payment. CMs would prefer to go through a selection process, become the finalist and then work out the agreement once they know there is a committed revenue stream coming and they can start spending money slightly in advance of that. But I think what’s going to happen is that an OEM may whittle it down to two or three and then see who has the best remediation plan.
Shepherd: The demand for full-service outsourcing is still strong. The economy is driving this. Customers who outsource are looking for ways to free up cash, and using a full-service provider does that. Taking possession of products with as much value-added service as possible reduces work in process inventory levels for customers. People who are thinking strategically realize that full-service outsourcing is still an opportunity because companies are looking to free their own cash and not devoting resources internally. It’s still pretty robust, even in this economy.
Adlon: The need to optimize business efficiency continues to drive manufacturers toward the outsourcing of non-core activities. What our customers want most from an outsourcing partner is the flexibility and in-house expertise to coordinate complex projects from start to finish. Our strategic alliances, ability to move quickly and rapid internal growth mean we are well positioned to secure new business.
Schramm: Certain medical products, such as those tied to non-elective procedures, are seeing stability or even growth. Those markets that are tied to elective procedures are seeing similar downtrends to the rest of the economy.
Black: They are still robust. I don’t see any changes in that right now. A lot of OEMs are cutting back on employee count, so they’re relying more on outsourcing partners as a resource to get things done. That is an opportunity now and will be even more significant during economic recovery.
What are the biggest challenges in being a contractmanufacturing firm that offers a full service of capabilities to its customers?
Murphy: As much as we all want to be one-stop shops, there are certain things that we do well and others we don’t. I think trying to solve a customer’s entire problem is always a challenge. Because there’s always going to be a niche application, for example, that you don’t have expertise in, that could be the decision as to whether you get that business. We’ve approached it by using a network of suppliers that can help us solve problems we can’t in house. And we disclose to our client exactly who we’re using. In the competitive landscape, there are many companies that are trying to be the primary vendor to the OEMs. And sometimes you just have to take a realistic approach and decide whether you’re the primary or the secondary. If you’re the secondary, do you know who the right primary would be so you can bring the whole package to the table to solve their entire problem? You’ll get the business primarily because you brought your network to the table.
Dunn: One of the challenges is in selecting the capabilities you want to offer. For a full-service firm, you’re asked to do everything—there are so many services and capabilities out there. So you have to pick carefully so that you can deliver quality across the board. One of the criticisms I’ve heard of some outsource providers is that they do a couple of processes very well, but don’t necessarily do the others as well. The challenge is maintaining quality throughout multiple processes. In a number of ways, it’s easier for component manufacturers because they’re only doing one thing and that’s it.
Cusack: Particularly in this economic climate, everyone is looking to save money. So what we see a lot of people doing is trying to break apart a project so that they can get the design and development done in one spot and the manufacturing done in another spot. In our experience so far, this year, most of the manufacturing is being done outside the U.S., in China, India or Brazil. So that’s a challenge for us because we won’t take on a design and development project unless we have manufacturing at the back end. Design and development is there as an added service for customers, but it’s not how we pay the bills. We have a good reputation for design and development, but we are resisting the call to break apart the project into two separate pieces.
Pazemenas: We get some difficult projects. Most of what we develop is brand new and hasn’t been developed before. We need the technical capability to execute that. We need to have competence in the areas of technology in all the different areas that medical products and instruments cover. It’s a diverse field. Getting the best engineers is a challenge. The other is timing. Most of our clients are startup companies, so time is of the essence. They’re burning cash. The last challenge is controlling costs. It is very hard to estimate what something will cost if it’s never been developed before.
Robson: It helps to have a flexible work force. While we all have a specialty in the organization, being able to wear a couple of different hats always helps. We’re focused on being vertically integrated, so we don’t use a large pool of third-party consultants and contractors. That’s not in our business model. An organization like ours is fairly large, and we have lots of different projects going through the building at any one time. We play the resource management game as best as we can. We also intentionally operate under 100 percent resource loading. Having a bit of a resource cushion is important. It allows us to put people on a new project that came up unexpectedly and absorb it. That has proven to be a valuable feature to a lot of our customers. Another challenge is that nobody asks us to go slow. They’re always in a rush.
Busch: For medical devices in particular, it’s two things. One is the staff and systems that meet and exceed the OEM’s regulatory requirements. The second is the ability to localize complex assemblies that include precision machining, castings, electro-mechanical and fluidic components. Both challenges require investment on the CMs’ part ahead of revenue.
Shepherd: Historically, contract manufacturers in the orthopedic industry have specialized by process and product. However, to be a full-service provider, you need far broader expertise. You need to understand the function of the part to provide intelligent design for manufacturability and have a broad understanding of processes such as forging and casting, machining, complex assembly, finishing, cleaning and kitting. Overall, this means you have to have the combination of leading materials technology and cutting-edge production expertise.
Adlon: The ability to focus on your core competitive strengths is critical. Another business imperative is to help customers develop up front a detailed project plan that fills in all the gaps. Finally, you need the integrity to come up with solutions for a customer even if they don’t directly benefit your own business.
Malo: We need to be competitive with an OEM’s internal capabilities. In many cases they want to see if we can bring prices down. Sometimes they don’t understand that we’re in a business to make a profit too. So they can’t always compare apples to apples. If they don’t have low-cost manufacturing options, then they can’t be more competitive than we are. We do lab testing, manufacturing, molding, assembly, packaging, and even have our own sterilization capabilities, which most contract manufacturers don’t. As a result, an OEM can add us to their supplier list and only have to audit one company—and still get a variety of services. It helps to streamline their processes. But staying on top of it all is complicated, but it is an advantage. OEMs want fewer suppliers.
Schramm: Being a full-service provider requires a significant investment in systems and processes to be able to manage full contract manufacturing projects. This also requires professional project managers to see that all pieces of a complex project come together to meet all pertinent customer and regulatory requirements. Donatelle’s 40 years in the medical industry has allowed us to capitalize on past successes and failures to develop robust systems capable of meeting these requirements.
In the past few years, there’s been a lot of consolidation in the marketplace. Is there still room for niche firms that offer specialized services?
Cusack: There’s always room for niche specialized service providers. Engineers at large companies lots of times are constrained either by processes, procedures or the inability to interact with people across divisions. Whereas in a small company, when you’re walking down the hall, you can meet three or four different subject-matter experts, and it sparks different ideas. The environment produces spontaneous creativity that you just don’t have in a big company.
Robson: Absolutely. Our primary development role is typically as systems engineers, which implies that we are sourcing specialty components constantly. We use niche organizations all the time. Of course, we do a lot of original research and design, but we use outsourced specialists in very specific areas—such as a company that handles nitinol forming or machining. We wouldn’t do that in house. Third-party subassemblies in niche areas are still very important. High-precision machining is another example. We’re not doing metal injection molding or anything like that. We’re constantly using niche players for those specialties.
Dunn: There’s always going to be room for niche players. There’s always going to be certain processes or specialized components that the large full-service providers won’t be able to do as well, and there will be a market for those. I think that niche players also play well for companies that employ mixed outsourcing programs, meaning they do some of the steps themselves and like to acquire other pieces. I’ve looked at a number of startups that get one component from one provider and the next part from another provider because they can’t find anyone that they feel confident in providing all the steps for a new device.
Pazemenas: I think so. Technology moves so quickly. There will always be specialized technology that only a few can handle.
Peterson: Technical expertise will trump size any time when it comes to implementing a successful project. That’s not going to change. We’ll continue to see smaller organizations, particularly in the product development, still having a very attractive opportunity.
Busch: If you agree that the primary value proposition of the contract manufacturing industry is its ability to work assets harder than the OEM, then aggregation is a critical advantage. Will there be room for niche players to handle outliers in an OEM’s product portfolio that a full-service, global-scale CM can’t address adequately? Sure. But realize that the full-service CMs’ capabilities will continually increase, and the capabilities will increase along product lines. It wouldn’t be surprising to see full-service CMs specialized in imaging or IVD (in-vitro diagnostic) devices in the not-too-distant future.
Shepherd: Absolutely. I believe there will always be a need for specialized services especially in rapid prototyping and process development. Niche players drive competition and innovation. There’s always a role for them. Just when you think you’ve got your arms wrapped around something, someone comes along with a new mousetrap or a new process. The center of the market is innovation. I’m not saying that larger companies can’t be innovative, but often the smaller companies are quicker with innovation. In theory, there’s a place. Economically, it’s probably tough to be a small, niche player at the moment. It depends on the money someone’s got. A good idea and a lot of money can go a long way. But a good idea with no money doesn’t get very far.
Adlon: It is more important than ever to focus on niche markets. Being a niche player gives you the flexibility, specific expertise and quick response times that customers increasingly demand. We are fortunate that our strengths in building customized automated assembly systems for high-precision devices complements the increasing market need for quality and reliability.
Schramm: We learn of special needs from our customers every day. Customers continually look for their partners to offer unique solutions that allow them to increase the value of their product, eliminate an operation within their facility, or make a design that wasn’t possible in the past become a reality. Being able to develop and offer specialized services allows an OEM’s outsource partner to stand out from their competitors.
Black: Selectively, niche players can provide advantages, but they’re going to be limited in their ability to provide a full suite of services. In addition, they’re in a more precarious position because they are typically focused on one market area rather than spreading risk across different product categories. Having too many niche providers can be risky for OEMs.
Murphy: The bigger question to be asked—when you’re talking about contract manufacturers—is if there are niches in the marketplace that will support two or three really good contract manufacturers. If the entire global market in the medical device space for your product is $5 million, you probably can’t get two or three companies that can compete in that space and make a go of it. I also think that OEMs have enough people within their organizations that understand the technology behind the manufacturing and often do things in house because the feel nobody else could pull it off. They look at the technology and their savvy about the contract manufacturing marketplace. There’s also the question about whether the niche part or process is intellectual property. And then you definitely don’t want to give it out to a CM.
Robson: There are two big service areas we’ve been focusing on in the last year that really have been catching traction and momentum. One is regulatory services. We’re helping to establish what the regulatory approval process should be—the right way to position the device to authorities at the FDA and in Europe. By having regulatory affairs services in house, we are able to ensure there is no gap between the development effort and the compliance effort. The other is advanced research. What should the product be? What is the voice of the end user? What are the inputs that should go into the product requirement specifications? We have more than 10 research analysts who are collecting information from hospitals, doctors and patients and other relevant key stakeholders to form what the device should be. That is information that little companies often skip. Even the big companies often skip it. This approach is born out of the traditional development process for the consumer market, where market research is a given. In the medical device field, it’s not always done as a disciplined research process. We’re finding more organizations understand that and how critical it is yet don’t have the resources in house to conduct the work. Like the regulatory affairs services, having the research efforts intimately located with the other development disciplines helps to ensure a successful outcome.
Schramm: More and more emphasis is put on demonstrating how the development and manufacturing processes are capable of meeting the regulatory requirements. Being able to offer assistance to the customer in helping navigate the regulatory requirements is fast becoming an expectation.
Black: Regulatory support indeed has generated more interest of late. Faced with stricter regulations, our customers want assurance that their products are going to meet not just FDA requirements but non-domestic demands such as ISO and Japanese QMS 169. Not all OEMs have the experience to handle these registrations.
Pazemenas: We’re seeing more requests for a combination of engineering development services and then manufacturing. The combination is generally very important. A close coupling of the two is important for the development of a brand new product. The engineers need work very closely with manufacturing to build the prototypes and the pilot run.
Busch: Customers are asking for increased cost reductions on existing work. New business for components will be much more aggressively “sold” such as GE Healthcare’s recent reverse auction of their remaining in-house [printed circuit] board manufacturing. There has been an increase in the number of instrument outsourcing initiatives that are looking for a long-term strategic partner that can not only source and build complete instruments, but which also can acquire and repurpose assets.
Shepherd: Rapid prototyping continues to be the most highly requested service. Tough competition drives the need to get products to market quickly, which makes this service critical for most OEMs. It’s always top of the list. As a result, over recent years, OEMs have become more open to design for manufacturability, which has reduced the number of design iterations and increases the speed to market.
Adlon: We are receiving an increasing number of inquiries to coordinate the development of new pipeline products rather than take on those that are commercial ready. The desire to balance cost, quality and speed also has made it a much more attractive proposition to only take labor-intensive elements of a project offshore.
Malo: We’re seeing a lot of packaging and sterilization demands. There’s still a lot of entrepreneurs developing products. In most cases they may be able to develop and manufacture, but they don’t have the other expertise that’s required.
Traditionally, components have been the largest sector of outsourced manufacturing—though finished-goods production has closed the gap some. Is this still the case?
Black: Customers are increasingly looking for someone who can provide them with a finished product and all of the support that goes with it. Component manufacturing is still vital, but the gradual shift to assembly and even custom products has been accelerating.
Busch: The trend in medical/analytical instruments is clearly toward increased box builds. There are several reasons for this trend. Most instruments are low-volume/high-mix, so the economics of outsourcing is not in the labor arbitrage of moving final assembly and testing from a higher-cost country to a low-cost country, nor is it in material purchase price variance—the two traditional advantages a CM offers on high-volume, low-mix products. The value proposition is in rationalizing PPE through facility repurposing/disposal, which is possible when the entire instrument build is outsourced and through re-sourcing complex sub-assemblies from high-cost countries to low-cost country supply-bases to arbitrage the labor in the subassemblies. Also, many OEMs are developing sourcing capabilities in low-cost countries allowing them to source commodity components almost as inexpensively as the CMs.
Shepherd: There is a steady growth in the demand for finished products, which is primarily being driven by the smaller, newer OEMs that do not want to tie up their cash in manufacturing capital. They prefer their capital to be applied to R&D or sellable products. Larger OEMs, which have internal cleaning and packaging capabilities, are generally less motivated to outsource those processes. They are, however, increasingly taking advantage of a whole range of value-added services spanning everything from raw material procurement to the delivery of product ready to go into the final cleaning and packaging operations.
Adlon: Adding value to the entire production process remains the number-one goal of our customers. In particular, they are becoming more focused on the high-volume assembly, printing, sterilization and packaging of finished goods.
Schramm: Several OEMs continue to retain many of the unique finishing processes for their products. Some of these are necessary because the final processes may be proprietary, while others have a tremendous infrastructure in place to support the final processes that make it more difficult to justify outsourcing. Many, if not all, processes that move from an OEM to an outsource partner would require costly requalification costs, which makes this move even more difficult to justify.
Malo: Without a doubt. The finished goods assembly is still strong. That’s most of what we’re seeing.
Have you had any customers take processes back in house recently? Do you foresee more “in-sourcing” going forward?
Murphy: We have not experienced it specifically. But we do have a couple of customers that are closely looking at their core competencies and what they should be doing in-house and what they shouldn’t. Some of that actually has resulted in new business for us. I’m aware of one company that has begun pulling some things back in house, but they haven’t pulled the business we currently have with them. The recurring theme still comes back to cost. Especially in injection molding, it’s very obvious to start looking at in-house molding capacity. If you’re not fully utilized, brining some molds in house may make sense.
Cusack: Not at all.
Robson: We had a few put projects on hold, but I’m not aware of anyone pulling anything in house that we were supposed to work on. If one of our clients were to pull a project in house, they’d have to find the people to do it, and their resources often don’t allow for that. I could see how it could happen, but it hasn’t happened yet.
Busch: I’ve seen it happen in cases where the CM never remediated the capabilities gaps I mentioned before. I don’t foresee a trend to in-source, but that could change if CMs don’t rapidly come up the capabilities maturity curve.
Shepherd: There was a downturn in the U.S. orthopedic market in the early 1990s that did hit contract manufacturers as the OEMs took work in house to take up their internal slack. The current economic downturn is different. There has been a little in-sourcing, but today’s customers are more focused on ensuring efficiency throughout the supply chain to reduce costs. Given my past experience, I thought there’d be more work being taken in by OEMs, but I just haven’t seen it this time around.
Malo: Unfortunately, we have. One customer recently needed to keep people working and fill vacant space they originally had anticipated being filled. Because of the slumping economy, however, they weren’t able to get they business they needed to keep certain projects going, so they went in house.
Schramm: No. In fact, we are seeing the opposite trend with customers seeking to further lower their overheads and drive costs down by outsourcing even more of their manufacturing activities.
Black: We are not seeing it on a widespread basis that would indicate a trend. It tends to be isolated based on specific company situations.
What are the primary overall considerations, concerns or demands from customers? Price? Quality? Speed to market?
Murphy: Customers still are focused on cost. From a service perspective, that’s what we’re trying to help with. Is there a way for us to bang on our suppliers and our vendor base to get better pricing? The spike in commodities drove prices up last year. Now prices are back down, so customers are looking for every opportunity. Price is overwhelming, but with the increased scrutiny of OEMs by the FDA, the flight to quality is the second-biggest drumbeat. And as FDA reviews get more detailed and stringent, we’ll need to help customers with that.
Robson: Price certainly is a huge consideration now. I think the big OEMs—the top 30 or 50—are just beginning to discover that the full-service model is valuable to them. They’re still getting comfortable with the idea that the product development process and the design control and compliance requirements can be adequately controlled by an outside firm. Many organizations are realizing that their manufacturing operations are not terribly well suited for new product rollouts because they’re geared up for volume. They are recognizing they can use us, or someone like us, in the early stages of the manufacturing process where you’re getting the lines organized. The first year of manufacturing often is inefficient. There are lots of bugs to work out. And as careful as you might have been in the development process, there’s nothing like that repetitive do-it-all-day process to work all the kinks out. And they seem to realize that an organization like ours may not be as inexpensive as if they did it themselves in a low-cost country, but the benefit is that they can get all the bugs worked out more quickly and efficiently—particularly if we’ve done the development work. And then we can bring our people in to train the OEM’s staff to bring the operation in house.
Busch: Right now, and likely through the trough of the recession, management is entirely focused on self-generated cash flow and capital preservation. Thus the primary demand of OEMs from CMs is for year-over-year cost reductions with less concern for product design. This of course assumes that the table stakes of quality and regulatory compliance are already met.
Dunn: Outsourcers need to have impeccable quality. It can be more important than price. It’s a real factor here. That said, there are significant price pressures as OEMs get more comfortable and gain more experience with outsourcing. They understand the process and are able to demand more.
Peterson: Quality and capability are why companies come to us. Quality is paramount. You have to be spotless as far as regulatory considerations are concerned. OEMs inspect our quality systems and our facilities. It’s important for the product and the patient, but, financially, if a startup is going to be acquired by Johnson & Johnson, quality must be pristine and they hold you to it.
Schramm: Quality in the medical industry is of the utmost importance. Secondly, delivery and value go hand-in-hand. OEMs can lose significant market share if they miss a launch date, but by the same token, they must hit the market with a cost-competitive product. This cost competitiveness goes well beyond purchase order price and needs to consider OEM internal costs such as missed deliveries, costs of managing their outsource suppliers, cost associated with incoming inspection, recallcosts, etc.
Shepherd: Price is always important, but it is not as critical as speed to market. For most customers the cost of goods sold is low in relation to the revenue generated. So while everyone always wants a good price, hitting launch dates is essential for driving income, which means speed to market is critical. It’s important to remember though that speed to market is more than just lead time; it also includes quality. A product may be delivered quickly, but if it is non-conforming it simply drives up costs due to the additional logistics involved in its return. Getting it wrong also runs the risk of damaging the relationship with the customer.
Malo: Speed to market is the dominant one. It’s such an advantage to being first in the market—becoming the vendor of choice. It is as important as price is—I think speed is primary when it comes to customers’ needs.
Adlon: The old rule of medical device manufacturing still applies. Customers want the best price at the highest quality in the quickest possible time. They can have two out of three. We’ve found that quality remains the consistent priority for our customers, with the choice between price and speed typically dictated by the project and its target market.
Black: Quality, price and speed to market are still the top three. We’re seeing a slight re-emphasis on quality during these uncertain times.
Is having an offshore (i.e., low-cost country) option critical for domestic outsourcing services providers today to compete?
Murphy: Going forward, it’s critical. I think that we’re seeing a lot more requests, especially when it comes to capital investment, particularly with injection molds. We’re getting a lot of requests to quote projects domestically and offshore. We’ve also gotten plenty of requests for manufacturing offshore. An important consideration for OEMs, of course, is if they are building a product offshore in order to serve the offshore market or to bring it back to sell it. Increasingly, we’re running across more companies that want to build it in China because they want to sell it in China.
Cusack: It hasn’t been critical for us. When customers show up at our doorstep, chances are they know something about us, and we don’t have that ability. That’s more of a commodity-type business. We like to get at least a three-year deal for manufacturing at the end of one of our development projects.
Robson: We have an office in Hong Kong and regularly source subassemblies and components from overseas. But we still bring them through our quality systems here in Rhode Island. People are absolutely asking for the low-cost solutions. But they are only appropriate at the right place in time. So, in the case of an existing product where a client is looking to cut cost of goods and it’s an older product, it would be a good candidate for being moved to a low-cost option. We advise, however, that an initial production run is done at our facility in Rhode Island. If we know long-term that we’re doing it in a facility overseas, we’ll still source parts from over there and do the initial builds here and then transfer production back overseas with the appropriate suppliers. We think that’s a pretty efficient way to do it. If labor isn’t a critical contributor of the product cost, it often doesn’t make much sense to go overseas.
Malo: Absolutely. It’s a necessity. Because if you look at all the outsourcing companies that are out there, most already have an operation in China or Mexico, or South or Central America. If you don’t, you’ll be hurting in some respects. The advantage is that you can develop a product for a customer, and when the numbers get to a point where they’re large enough—you can either automate, or you can go to a low-cost country. We’ve had an operation in China, and it’s helped us in our efforts to be competitive.We recently were acquired by Moog, and they’re building a facility in Costa Rica. It’s a great place to manufacture, and we’re looking forward to it.
Dunn: If you’re a component provider doing special applications, service or R&D, you don’t necessarily need the offshore component. But if you’re doing finished goods in any sort of meaningful volume or a contract that covers the lifecycle of a product, you really need to have that offshore option because you’re going to need the ability to show you can reduce costs over the lifecycle of the product. Offshoring allows you to do that. Certain processes are highly labor intensive, and that’s cheaper offshore. If you’re doing a large product for a global firm, having an offshore component in your value chain is important.
Pazemenas: We’ve used offshore suppliers for tooling or plastic parts. But it’s not a panacea. There are different challenges—quality, communications, etc.
Busch: There are two aspects of why to build in a low-cost country like China. The first is cost, which we’ve discussed at length. Lower labor and, potentially, material costs are why most medical device companies initially set up in a low-cost country. This impacts the bottom line through reduced cost of goods sold. However, the advantage lasts only as long as you’re there and a competitor is not. What many OEMs are finding is that you outsource also where you can grow your top line. So, building in China not only affords the cost savings but provides access to what will soon be the third-largest market for medical devices. This growth will only be accelerated by the $126 billion in China’s stimulus package earmarked for medical.
Shepherd: Lower-cost countries have a role in the industry. Certainly, some of the emerging markets, such as China, may be best served by product produced in that part of the world. There is also potential to take advantage of the lower production costs for some of the mature orthopedic products. Outsourcing to lower-cost markets is not, however, the right way forward for new, higher technology products. Given the relatively low-volume, high-mix and short product lifecycles of orthopedic products, the labor cost savings are erased by logistics and learning curve expenses.
Adlon: Unilife has the ability to place low-volume and labor-intensive assemblies with our strategic partner in China, and at the right time introduce U.S. production on customized high-volume automated assembly systems. The key to this two-phase approach is having a trusted offshoring partner that can comply with stringent quality control standards.
Black: It’s not critical to compete, but nice to have a less-costly option. OEMs need to look at overall costs—transportation, time and risks—when considering an offshore supplier. Often the supposed cost-savings are not as pronounced.
Schramm: There continues to be many products where the risk of defect outweighs the cost advantages of offshore manufacturing. In addition, many OEMs want the ability to work closely with their outsource partners during the development and launch of new products. This becomes much more challenging when working with offshore manufacturing locations.
Do you see more requests for outsourced R&D and product design services? Are you prepared for these requests?
Cusack: Definitely. And most of it has to do with flexibility of speed. Because we’re a small organization, we can move more quickly than a big company like a Johnson & Johnson, Medtronic or Boston Scientific to get a product development project up and running. They’re big and successful, but they’re also highly structured. And that structure can impede speed and nimbleness. We can bring that nimbleness to the process, and I think that will continue to be an attraction for big and smaller companies. Moreover, larger companies’ R&D budgets are intact for crucial projects; they haven’t cut back like smaller companies have.
Schramm: Although this isn’t commonplace, it is becoming more apparent that OEMs have more ideas than they have R&D resources. They are looking to increase the volume of new products introduced in the market, and as such, are looking for suppliers to provide additional R&D resources to bring these products to market. We’ve had to increase our in-house design and engineering resources to support these requests.
Robson: Yes to both questions. Regarding requests, we are definitely seeing increased inquiries for R&D and design services. However, much of the increase seems to be in context with a primary interest in turnkey, full-service solutions not just R&D or design services. Regarding our preparation for growth, I believe we are fully prepared. We have been building our infrastructure and staff capabilities over the last several years with the goal of being a major industry leader in outsourced medical solutions. We fully expect and have planned to controllably grow on a substantial level. Our current work capacity, both development and production, has plenty of room to absorb new programs. We’re positioning Ximedica’s capabilities and resources to stay in front our clients’ needs.
Busch: OEMs are looking to variablize their design costs as they have been variablizing their manufacturing and supply-chain costs. This is an area where a significant capabilities gap exists, and none of the major CMs has filled it adequately. CM design capabilities are still mostly electronics focused—sufficient for blood glucose meters and patient monitoring systems but not for imaging or IVD devices.
Shepherd: R&D and product design services are a niche market, with demand being both minimal and erratic. At Sandvik, our consulting services focus solely on optimizing manufacturing specifications, an area where we really are at the cutting edge of development. We do not recommend or otherwise advise on, in any manner, the design, suitability, appropriateness or effectiveness, from a medical/biological/safety perspective of any medical instrument and/or implantable device.
Adlon: Our key focus for new product opportunities is to help a customer de-risk the pathway from concept to commercial readiness by developing final design specifications that are market-driven and robust enough for high-volume production. This approach can make all the difference when it comes time for clinical trials and regulatory approval.
Black: We see the trend continuing and have positioned ourselves as an experienced resource. Many OEMs have cut back on internal resources, so they are looking for experienced companies for their R&D efforts.
Murphy: We’ve experienced it, but we don’t have product development in house. We work with a couple of partners that are established medical device design firms. They tell us that their business is increasing and doing well. We’ve even seen some contract manufacturers acquire design and development firms. Sometimes a customer doesn’t even really know they need design services. To help, we’ll bring a partner to the table as part of a pitch to solve their overall problem.
Any predictions about the outsourcing market over the next few years? About the medical device market overall?
Murphy: I think the fundamentals of a growing healthcare marketplace are still there. We still have an aging population. We still have an obesity problem in this country. We still have some chronic disease problems. Until some of those fundamental problems are solved, you’re going to have a growing healthcare marketplace.
Schramm: The market should continue to see stability in the amount of manufacturing outsourced. With the aging population and focus on less-invasive surgeries and more cost-effective treatments, there is a continual stream of new products being developed and introduced in the market. OEMs are finding that the best return on their investment is in the design and marketing of devices and not investing in the infrastructure for manufacturing.
Cusack: I think it’s a sweet spot for the United States, because the medical device market is primarily driven by this country. I also think that the medical device market provides the intersection of a variety of different technologies, and the ones I think of are nanotechnology, molecular biology and materials sciences. It’s cool stuff. Biomaterials hold a lot of promise. Medical devices will bring many of those together. That’s good for this country. The U.S. is leading the field, and I can see us continuing to maintain that edge. This combats some offshore challenges. The rate of technology acceleration has really picked up in the last ten years, and I think it will continue.
Robson: We’re pretty bullish. Big opportunities remain in the United States. OEMs of all sizes continue to realize the benefits of the efficiency and management capability component to using an outsource partner that aren’t available in house, particularly with some of the layoffs that have gone on.
Dunn: We expect the medical device industry to continue to grow. We expect that as companies get more comfortable with outsourcing that the outsourcing market will continue to grow as well. We’ll continue to see new entrants trying to participate, and there will be continued sophistication of the users of outsourcing, which will continue to drive down price, drive up quality and force outsourcers to continue to improve.
Malo: I feel bullish about the market. Last year wasn’t a good year for a lot of companies, and this year isn’t going to change much. This is a global recession. But medical device companies are still looking to reduce costs. They may not want to invest in brick and mortar or invest in regulatory personnel if there’s an outsourcing company with the expertise they need. Over the next few years, this will continue to grow.
Pazemenas: The reason we exist is primarily because medical devices are getting more and more sophisticated. For a startup company to succeed, they need access to lots of technology. And this won’t change. It will only become more important. They don’t want to build a large technical infrastructure. As a result, the demand for outside engineering and manufacturing services will continue to increase. And large companies often lackneeded skills and technology outside their areas of specialization, so they’ll also look for outside engineering options. Also, in the process of constant new product development, we have learned to develop products more efficiently. So we are cost effective.
Peterson: Another important consideration is that there will be significant and very robust opportunities internationally as medical technology and diagnostics continue to evolve. There are enormous market opportunities overseas. And if there’s any dampening effect from healthcare reform in the United States, then it could be more than compensated for by growth in overseas markets.
Busch: Medical device OEMs have realized that manufacturing and supply-chain management are not key differentiators. They are looking to variablize their manufacturing base as mentioned above to reduce costs allowing them to sell into emerging markets and to compete with low-cost country medical device companies with ever-increasing capabilities. The medical market is under-penetrated by outsourcing, and it is growing double digits in all but North America and Western Europe, so the opportunity is there for substantial growth by contract manufacturers, assuming they mature their capabilities.
Shepherd: The outsourcing market will remain stable in the short term and will see increased demand in the long term. With the aging population in the U.S., growth of the worldwide population and the development of a middle class in China, I expect the medical device market to remain strong, especially when considering growing problems associated with obesity, diabetes and heart disease. There will also be an important role for biologics. So if you’re a robust supplier, I think there’s a good future.
Adlon: We believe that the outsourcing market will continue to grow. In the current economic climate, it is even more important that companies focus on their core competencies.
Black: We’re going to see the stronger companies survive and be healthier coming out of the recession. Everyone will be forced to be leaner. Three to four years ago, a lot of smaller companies came into the market, but many are struggling in the current downtown, making it harder for them to compete long-term. We think OEMs will seek safety in established manufacturers who offer reliable resources and expertise.
The new administration and Congress continue to push for healthcare reform, and medical devices are being subjected to more legislative scrutiny. How do you think the proposed restructuring will impact medical device manufacturers?
Murphy: The flurry of activity relative to healthcare reform in the past four months has been almost impossible to keep up with. But contract manufacturers absolutely will be impacted, but the question comes down to how and when. But I believe that the outsourcing market will continue to grow. The OEMs that are providing value with their products will continue to grow. I think the screws are about to get tightened by the FDA. We have to stay price competitive to be able to compete in the market. However, some companies that had been in automotive and now in medical, for example, may be willing to undercut the rest of the market just to keep their doors open.
Dunn: All signs point to some kind of reform. And the issue here is we have growing demand, but we’ll have to reduce costs. So the way it most likely is going to play out for devices is that payment for devices will be based on efficacy for their cost. I think some newer products that are unable to show greater efficacy over existing products are not going to be reimbursed. The lifecycle of current devices may be extended. And from an outsourcer’s perspective, you need to look at the products you’re doing and expect them to last longer than they ordinarily would. You need a strategy for how you will manage the product and continue to reduce its cost, which, to some extent, goes back to the offshore argument. For new devices, one of the effects may be fewer of them.
Pazemenas: It’s an important question and one that is difficult to answer. The quest to keep people healthy may be blunted by the fact that you have to keep costs so low that patients don’t benefit from new technology—I say that as a patient and as someone who makes his living from the latest medical technology development. I think we may see some effect on reorienting investment from the next great thing to more incremental breakthroughs that improve cost effectiveness.
Cusack: This may not be a popular opinion, but I welcome a little more oversight and regulation. It will shake out the people that cut corners and don’t do things right. If you look to China and India, the companies in those countries that meet the ISO standards and comply with what is generally considered to be global quality standards will be competitive. At the same time, those companies that choose not to will be shaken out. And if FDA scrutiny expands it would be good for U.S. manufacturers who can toe the line and meet those standards.
Busch: How much time do we have for this very large question? The short answer is that there will be a significant impact. Consider just a few issues. Comparative effectiveness will put downward cost pressures on the device manufacturers as a new device’s price/performance will be compared to existing technology. Home healthcare is a key to reducing healthcare costs. This requires product designs that can be used by patients and caregivers at home with real-time data transfers to health information systems. This is a very different product design paradigm compared to the current, centralized and complex, laboratory or hospital instrument. The device/instrument will undergo the same metamorphosis that the computer industry went through going from mainframes to PCs. Changing from pay-for-procedure to pay-for-outcome will likely change the way medical devices are sold and, thus, change revenue recognition from a product sale to a pay-per-use model. As CMs build more complete instruments and manufacturing by the OEM is reduced or eliminated costs will come down. One of the reasons that contract manufacturers got into medical was because it had a higher margin than telecom or networking or computing. Those margins already have come under a lot of pressure. We’re just not going to be able to pay as much for healthcare in this country, so everyone is going to be fighting over fewer dollars and the device companies will have to lower their costs. On the regulatory side, CMs will have to have complete quality and regulatory systems in place just like the OEM. They will become the system of record for that device. This is important, particularly as we fully implement unique device identifiers—also called UDIs—specified by the FDA.
Shepherd: My biggest concern is the potential impact on R&D and new product development. Government tends to focus on historical data and the performance of existing, proven products. I am concerned that this focus could stifle innovation. In addition, reform associated with the way new products are brought to market—510(k)s versus premarket approval applications and investigational device exemptions—could have an impact on a customer’s decision to develop and launch a new product. If the FDA becomes more conservative in its approach regarding new product development, this could slow the stream of new product launches and increase the costs of launching a new product. Both of these results would stifle innovation.
Black: They will drive the cost reductions down to the manufacturers and even raw material providers. But at the same time, we’re likely going to see an increase in the regulatory side of the business. OEMs and contract manufacturers are going to have to find ways to reduce costs, which could be through strategic purchasing, design, and Lean manufacturing. OEMs will look for partners that provide a balance of initiatives to reduce cost rather than simply looking at one or two areas.
Adlon: The cost of medical devices is already a bargain in general. “Smart designs” can reduce total healthcare cost even further. Therefore, a major part of the solution that Congress should be looking for is medical devices that give direct user benefits, simplify the supply chain or help reduce overall healthcare treatment costs.
Schramm: Mature markets will continue to see cost pressure on existing devices. This encourages medical device OEMs to develop new products that reduce in-patient time, reduce recovery time, are more effective, and lower overall healthcare costs.