Fulfilling the Vision for Full-Service Outsourcing
Despite continued cost pressures and increasing government scrutiny, industry experts predict robust growth for the medical device outsourcing sector.
Michael Barbella, Managing Editor
Motivational speaker, author and speech coach Les Brown makes his living by inspiring others to achieve their dreams and reject mediocrity. He has shared his mission and motivational messages with audiences throughout the nation, urging people to take control of their destinies and conquer their fears. He also has encouraged his listeners to embrace change, telling them, “Change is difficult but often essential to survival.”
Nowhere is change more essential to survival than in the medical device industry. It virtually is everywhere: in the bombardment of regulations from the U.S. Food and Drug Administration (FDA), European Union and other foreign governments; in the advancement of new materials and technologies; in the pace of innovation from emerging companies; and in shifting demand from customers.
Tempering all that change, however, are some constants. Quality is still (and most likely always will be) a driving force in the industry, as are lower costs and faster lead times. And, despite the economic roller coaster ride of the last few years, the full-service outsourcing market still seems to be growing at a decent pace.
To gain some insight into the full-service outsourcing market and help identify the trends shaping the sector as well as the challenges currently facing companies, Medical Product Outsourcing spoke to nearly a dozen industry professionals over the last few weeks.
• Michael Anderson, manager, contract manufacturing and packaging, at Oratech, a private label manufacturer of dental and medical products based in Salt Lake City, Utah.
• Tom Burns, vice president of business development at Tegra Medical, a contract manufacturing and assembly firm based in Franklin, Mass.
• Dan Croteau, president of Flextronics Medical, a division of Singapore-based Flextronics, an electronics manufacturing services (EMS) company.
• 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.
• Robert Fesus, business development manager at R&D/Leverage, a supplier of tooling for the healthcare, food and beverage, and home and personal care industries. The company is headquartered in Lee’s Summit, Mo.
• John Mulvihill, vice president, sales and marketing, Cirtec Medical Systems, a contract manufacturing firm with facilities in Los Gatos, Calif., and East Longmeadow, Mass. The company was formed last year by the merger of Texcel Medical and Circle Medical Devices.
• Kathryn Olson, business development director, and Mike Schulzki, senior program manager, California MedTech LLC, a Rancho Bernardo, Calif.-based provider of medical device design, development and manufacturing services.
• Helen Ryan, CEO, Creganna-Tactx Medical, a supplier of products, technologies and services to medical device and lifescience companies. The firm is based in Galway, Ireland, but has U.S. facilities in California, Massachusetts and Minnesota.
• Carl F. Savage, vice president of sales and marketing, The Micro Stamping Group of Companies, a Somerset, N.J.-based firm that provides manufacturing services to the medical, automotive, aerospace and electronics industries.
• Brady R. Shirley, President and CEO of IMDS (Innovative Medical Device Solutions), a full-service medical device development and manufacturing company based in Logan, Utah. Shirley joined IMDS in August 2009. Before that, he was senior vice president of Stryker Endoscopy and president of Stryker Communications, a division of Stryker Corporation, where he spent 17 years in various general management, sales and marketing roles.
• C. Russell Small, executive vice president of sales and marketing at Theragenics Surgical Products, a division of Theragenics Corporation. The Buford, Ga.-based firm manufactures surgical products and prostate cancer treatment devices.
Are requests for full-service outsourcing, either for components or finished products, still on the rise? If not, what has contributed to the decline?
Helen Ryan: We continue to see an increase in outsourcing opportunities, in particular, since we increased our technology offering and geographic presences with the acquisition of Tactx Medical.
C. Russell Small: At NeedleTech, full-service outsourcing requests are still strong.
Michael Anderson: We are finding that more and more companies who believed that the best business plan was to do everything in house are reconsidering their methodology. The realization is that their strengths lie in research and development, maketing, and customer service and not in manufacturing, fulfillment, and pack-out.
Kathryn Olson: Full-service outsourcing is still in demand. The number of well-funded startups has declined due to the scarcity of VC [venture capital] money, which has shifted our client base toward larger medical device companies.
Carl F. Savage: Definitely on the rise. Capital dollars are now being allocated to a new series of next-generation products. Medical companies are looking for contract manufacturing companies that are vertically integrated and can handle components, subassemblies or full product (or any combination of these).
Robert Fesus: I’d have to say the market has been spotty.I’ve noticed that some firms [OEMs] are reinvesting in development, but I believe the economy has taken a lot of focus off of development and is emphasizing the maintaining of platform programs. Where it’s spotty is that there are signs that firms are starting to invest in R&D [research and development] because they realize they now have to invest in order to compete.
Benjamin Dunn: I do think full-service outsourcing requests are continuing to increase. One of the main drivers behind this is the large OEMs reducing their number of suppliers to rationalize the supply chain, so they are looking for more full-service solutions.
Dan Croteau: Definitely on the rise. It’s primarily driven by people needing lower costs, needing the same level of quality and reliability, and needing more innovation faster than ever before. All these things—the cost pressure, the drive for more innovative products, the need for a very high level of quality compliance—are driving a lot of products to be outsourced and tighter partnerships with suppliers.
Tom Burns: Historically, we were more of a component manufacturer. While we still are happy to make single-level components, more and more of our customers desire more comprehensive solutions to simplify their supply chain. We also have customers that have brought to us a process or testing methodology that they currently utilize in their own facility to facilitate inspection correlation and reduce the incoming burden on their end.
John Mulvihill: They’re definitely on the rise. I believe that the consolidation of companies will result in more outsourcing opportunities. The internal resources are limited and focused, and the opportunity to move projects along needs to be picked up by outsourcing companies. I see this trend continuing for the next three to five years.
Brady Shirley: Customers are asking for turnkey. Whether that’s OEM, or with a private label or dock and stock, they are looking for more opportunities to work with vendors that can do the entire piece not only from the manufacturing side, but from design through manufacturing. Why are these services so popular? Based on the significant focus on compliance and quality, companies simply have less resources available to apply to their outsourcing activities. It’s much easier for them if they’re working with one vendor that is handling all of those components versus having to deal with the multitude of suppliers that might be involved if they were handling that piece themselves and working with individual suppliers.
Mulvihill: The trend of design, development and proof of concept is probably going to be the most popular for the next few years because of new product introductions and some verification validations of products or projects that had been closeted for a number of years.
Burns: Reliability and risk management are paramount today given some of the quality and regulatory challenges in the past several years. Medical device manufacturers want suppliers that understand and are experienced with tools like real-time statistical process control, design of experiments and process validations. They want to know that outsourced components and assemblies will not pose any additional risk to their business and reputation.
Small: Design for manufacturing and product validation are very commonly requested. Every customer wants to receive a well designed and robust product.
Savage: They are looking for innovation solutions more than specific services. Customers have problems and objectives, and they are looking for companies to solve these through whatever services are needed to obtain the objectives. Areas where we have seen growth through this method have been:
• Laser cutting;
• Laser welding;
• Automation—a major area for cost reduction in higher labor products and services;
• MIM [Metal Injection Molding];
• Clean room assembly—automated and manual;
• Final packaging; and
• Project management—this is becoming a major selling point.
Fesus: We have experienced more than the usual amount of interest in design/preproduction/prototype work. This may coincide with the feeling that firms out there are starting to reinvest in their brands. We are also seeing where a few large firms are going back to grass roots manufacturing. In essence, if they have had a core competency in injection molding but elected to outsource in the past, some are now focused on bringing those projects back home so they can utilize their overhead and achieve a level-loaded operating cost. This may not be what contract manufacturers want to hear, but it’s somewhat inevitable in tough economic times.
Dunn: Companies are looking for a wide range of services. An area that I see a lot of growth in recently has been in design-related services. There is a greater appreciation these days working with an outsourcing partner earlier in the process as a way to help things move more efficiently and avoid issues down the road. I think what’s happened is that there’s more experience with outsourcing now. People realize that if you start the process earlier, it can be a better relationship. You can avoid a lot of problems by engineering at the design phase that will crop up later in the manufacturing, assembly or packaging phase. That lets you do things more efficiently, cut costs and ultimately be more productive. In terms of what has driven growth, I believe it’s just based on experience. As companies have gotten more experience with outsourcing, they’re in a better position to realize the benefits of design services.
An increasing number of contract manufacturing firms now offer a full service of capabilities to their customers. With such a multitude of options, how can OEMs and other firms choose the best full-service outsourcers to partner with? And, how can full-service outsourcing providers distinguish themselves to potential customers?
Croteau: Customers have to look beyond what the best solution is for the next 12 months to what the best solution is for the next five years. Customers also have to determine whether their partner has made investments in its quality systems, in Lean Six Sigma, in shop-floor control and traceability, and in engineering so they can bring innovation in addition to merely developing global supply chains. Customers should also look for an outsourcing partner with a global footprint that will help them get the appropriate costs in the appropriate regions in the world. All of these things are key elements of partnerships that as they evolve over the long term, will be important drivers of value. Generally, strong quality, the ability to deliver costs, the ability to get global, and the ability to help innovate are really four key themes that create value for customers and differentiate the suppliers in our field.
Ryan: The most important thing in selecting a supplier of any product or service is their expertise and track record in providing that service or product. It is very easy for a company to advertise themselves as a full- service provider; it is much harder to demonstrate a track record in all aspects of service along the full supply chain.
I think you can only really distinguish yourself if you have a depth of expertise in the required product or service area and you have a track record of delivering reliably within the time, quality and cost constraints.
Mulvihill: There’s a couple of different ways. I think the market is small enough that word of mouth and reputation and customer experience is significant. Once someone has had a good experience, I would say the team efficiency, the responsiveness delivering on time and below budget is absolutely paramount for outsourcing companies to continue to grow and bring additional services and additional innovation to customers or partners. I believe our customers will drive that distinguishing factor of who’s good and who’s not.
Shirley: There’s not that many companies that provide a full service of capabilities to the broad spectrum of customers. Certainly, there are some that provide more than others. But an OEM cannot really afford to have one vendor for a particular service. It needs somewhere between one and five, and most [OEMs] would say they want at least three. When you look into full-service capabilities and whether you need to acquire all of those capabilities or offer all of those capabilities, I think the market is segmented enough that if you’ve got a good supply base and you have the right quality system and compliance components in place, you can be that mediator towards full service capabilities for the OEM without providing them all in-house. That’s really what OEMs are looking for. As far as how a full-service outsource provider can distinguish themselves, in today’s environment, it’s about whether you can you do the first mile as well as the last mile. There’s a lot of companies that pile up the capabilities. The larger publicly traded players do a very good job with the first mile which is the design side, and on the last mile, all the way to sterile packaging. To me, if you’re in the middle and that’s your play, you’re providing better quality, lead times and synergistic systems with your customers.
Small: The OEM should pick a contract manufacturer based upon the risk associated with the product, the level of trust in the supplier, and the level of service the supplier offers. If the product risk is high, then the choice of supplier will be the one it trusts the most. The best partner is one who has all the capabilities required, communicates very well, and meets the flexibility of the customer’s needs.
Savage: Many firms market themselves as “contract manufactures” but this characterization isn’t always accurate. True contract manufactures not only offer a full array of services, but also offer the engineering expertise and depth to support the programs. Project management has become a major differential for companies.MICRO’s APQP (Advanced Product Quality Planning) separates us from others. We “look” for potential issues early in the process and engineer solutions to insure that they are addressed. While some may say that this is a time consuming and costly process, we counter that when this is incorporated the time to market is decreased, development time is shortened and the overall “all in cost” of the program is lower due to any required changed being identified in the early, less costly, phases of the program.
Fesus: The devil is in the details. Strong documentation and history, process, project management and Lean manufacturing will surely speak volumes. However, a lot of firms also taught this but I can’t say that all are the same or are as robust. It comes down to the details and the breadth the services. More than ever, customers do not want to worry about their projects placed with contract manufacturers. If a company wants to grow in the medical industry they must not have a history of missing due dates or show signs of financial instability. If a contract manufacturer has little or no experience in the medical supply chain, their growth horizon will be extended significantly. Further, if a supplier is financially weak, the customers will know it probably before you do. On the flip side, if you are a healthy company that is proactive, has reinvested and increased offerings, you will shine a lot better than one that has not and is offering desperation pricing.
Dunn: In selecting who is the best full service outsourcer to work with, you really have to look at the product or services being outsourced and whether the work is going to an outsource partner who has experience with a similar type device or service. The other thing you look for in selecting a partner is which other firms have worked with this outsourced manufacturer. Do they have a good reference base of top-tier OEMs that have worked with them? Another factor is the geographic end markets you are going to sell to. Do you need a full-service outsource provider who has operations or capabilities in the Far East or over in Europe? If your end market is based just in the United States, you might be able to get by with firms that don’t have operations in those areas. But if you are selling into foreign markets or have operations overseas, it may make sense for your outsourcer to have some relationships there as well. In terms of distinguishing themselves, from the outsource perspective, they can distinguish themselves by the types of products or medical device subsectors that they serve. They can differentiate themselves through their foreign expertise but from a service level I think there’s always room to differentiate yourself from the pure customer relationship-management function.
Burns: OEMs need to do their homework and verify that the contract manufacturing firm really can do what it claims in its promotional materials. What is the makeup and experience of the senior leadership team? Does the company have the necessary infrastructure and systems in place: project management, engineering resources, quality systems and capacity? For a contract manufacturer, it’s important to not try to be all things to all people. At Tegra, we screen every opportunity to ensure that it is a good fit. In the long run, it’s better to develop a strong following through consistent execution than it is to dilute your efforts by taking on projects that stray too far from one’s core competencies. The hardest part is conveying that expertise while respecting customer confidentiality. It’s often not possible to discuss past projects as it’s critical to respect customer mandates for secrecy.
Olson: The most important selection criteria are the company’s track record, depth of relevant technical expertise, and strong referrals from previous customers. Other considerations include available capacity either on the engineering side or production side, the number of years the vendor has been a full-service provider, and the number of successful products that have been designed and manufactured.
Outsourcing all aspects of the medical device process—from design to packaging—takes a great deal of trust. How do companies establish such trust with their outsourcing partners?
Dunn: A lot of times this trust begins with a small project that an OEM will give an outsourcing partner, and really it’s the first step in a relationship. Assuming it goes well, that smaller project then expands into a larger project or new assignments. Essentially, this is a relationship of service-oriented business with very high bars for quality and on-time production. Outsourcers need to demonstrate their ability to follow through on that. The trust is formed when there is a problem. How was that problem handled? How quickly was it resolved? And that is one of the reasons why in medical product outsourcing, relationships tend to be stickier than in other types of outsourcing. Due to quality and regulatory issues, these relationships are particularly critical in this sector.
Fesus: A customer will have interest if your company fits the products and services they are looking for. However, with a lot of companies showing poor stability, many customers are looking into other options. In the end, if a customer feels their source of supply is threatened, they will go elsewhere. Here is where competitors will jockey for positioning.RD Leverage recognizes this. We practice what we preach and confirm that we do what we say we will do with data.
Burns: OEMs are looking for suppliers that will do what they say they are going to do. Too many times, contract manufacturers, in their zeal to establish a new relationship or to win a new piece of business, over commit and then disappoint their customer. Trust is all about setting the proper expectations, communicating proactively, and executing effectively. It doesn’t mean that a contract manufacturer can’t ever make a mistake; we all do. It’s more about how a company conducts itself when a problematic situation develops. OEMs are looking for suppliers with integrity, adequate technical resources and a sense of urgency. Those attributes, combined with good communication, will earn
Ryan: Trust can only be built over time by being a reliable and responsive partner that can be totally depended on to deliver. If you are a reliable partner in one part of an OEM business, that can be used to demonstrate a track record to build trust for a larger project or a broader service provision. Being responsive is also extremely important. The OEM needs to know that you value their business and that your objectives are directly aligned with theirs.
Mike Schulzki: Set a budget and a timeline and stick to it.
Olson: Outsourcing partners also need to communicate frequently and efficiently with their clients. There are always challenges in product development and manufacturing, so it is important to maintain open communication with customers to address issues promptly and collaboratively.
What are your customers’ overall primary concerns and demands?
Croteau: Customers want uncompromised quality and compliance; they want the lowest possible cost; they want faster innovation; and they want global capabilities. When you look at the product development cycle, whether it’s 12 months, 24 months or 36 months, there’s an intense amount of pressure to try and shrink that and get a validated, verified product made even faster than it’s ever been before. And, there’s pressure to make that product at a lower cost, which is why you invest in China and in different parts of the world, and you invest in the NPI [new product introduction] process so you can get a product not only designed quickly but also get it into production with the same level of reliability of a product that’s been running for 10 years.
Shirley: Quality, and compliance, which go hand in hand. But they should be listed separately. It’s one thing to deliver a quality product; it’s another thing to be compliant and, largely, I do agree with the FDA that you can’t have quality product without compliance. I think that is true. In our marketplace over the last several years, I think there were a lot of companies that put out a quality product that was not compliant ... in the space. The second piece beyond quality and compliance is lead times. Certainly, in a challenging environment that is shrinking or consolidating, there are fewer players and there will continue to be, so it is incumbent upon larger players like us to expand our capabilities to handle the volumes that will come our way by providing appropriate lead times.
Savage: Quality of the product is always the primary concern. With that stated, every industry is under tremendous pressure to reduce costs, bring products to market more quickly and reduce the number of vendors. We don’t view their needs as demands, we view it as what the customer needs in order to make both of us profitable. We take this approach because that’s what we believe. Customers don’t have demands; they identify what they need to be successful and are looking for partners to help them achieve that objective. The word “demand” has the impression of a one-sided situation and a push back. We can’t take that type of approach. The amount of time and effort spent on trying to change what the customer wants is much better spent trying to achieve their desires.
Ryan: While the direct impacts of healthcare reform are yet to be determined, it is a primary concern for our customers. On that basis, I think many customers are taking a fresh look at their business models to determine what is really important to the future growth and profitability of their companies. There is a recognition by customers that activities which were deemed core to the organization in the past, such as a specialized manufacturing capability, are perhaps not as value-adding and can be conducted more efficiently by an external partner who has expertise and scale in that area. Therefore, we are seeing increased demands from our customers to provide such services and capabilities on an outsourced basis.
Burns: Reliable quality and the ability of their supply chain partners to ramp up their capacity quickly and with flexibility to shifts in demand and product mix. As products mature and volume grows for the OEM, it is imperative that supplier processes are made more efficient and costs are reduced to bring pricing down. OEMs want to see Lean/Six Sigma tools being deployed to manage the product life cycle successfully and maximize profitability.
Anderson: Knowledge to properly develop and fulfill their product. Then assistance in getting their product to market with proper documentation. Last but not least by any means, confidence that you’ll be around in a year or five. Today’s economy is depleting the contract manufacturing world.
Every business venture has some degree of risk associated with it. What are the risks involved in full-service outsourcing? How can companies overcome these risks?
Ryan: The main risk associated with full-service outsourcing is that you are only as good as the weakest link. You need to be expert at all aspects of the service and you will not be successful if you do parts of the process excellently and then fail to deliver other parts. As a supplier, I think it is very tempting to position yourself as being able to provide all the services even when you have limited expertise in some parts, as this appears to present bigger opportunities. But, in general, that lack of expertise will come through to your customer and may severely limit future opportunities. The best way to manage the risk is to play to your strengths and make sure you are an expert in the services you provide.
Burns: The biggest risk is when there are not clear expectations between the OEM and the contract manufacturer. At a high level, there must be clarity on each other’s role and project leaders should be clearly identified and empowered on both sides. In the event of a situation that goes beyond the project leader’s scope, a clear understanding of who/how to elevate the discussion is important. Peer-peer relationships at different levels and functions in the two companies can help mitigate risk efficiently.
Schulzki: Project scope creep is something that we deal with frequently. It is important to determine the implications of changes to product specifications early, discuss them and redefine the project if necessary. A detailed requirements document and clear definition of deliverables on the front end also reduce the risk associated with full-service outsourcing.
Olson: Consistent communication and client proximity significantly reduce the risk in outsourcing a project.
Small: From an OEM’s perspective, there are many tools to choose from to mitigate risk. If the OEM and its outsourcing partner are diligent with the design controls and the underlying market assumptions are regularly verified then the risk should be manageable. Good, regular communications with your customers is essential in mitigating risk.
Savage: Everything is a risk, however it’s the level of a calculated risk that we look at. To understand this, you need to fully understand the market and what the customer’s needs are. The best way Micro has overcome risks is to be totally open with customers and fully disclose details. While this approach is viewed by some as opening our books and disclosing confidential information, we view it as a way to allow us to have open communication. It also allows the customer to fully understand our risk and, therefore, have some affect upon it.
Anderson: Information dissemination is possibly the biggest risk in outsourcing. Whenever you start to work with someone new learning how they convey information, what they mean when they say certain things, and what their expectations are can create problems. To combat this, Oratech gets project managers and engineers involved early in the process; the more ears hearing information helps minimize the risk of filtering information through multiple channels.
Mulvihill: Especially in the market we’re involved in with startups, the financial piece is the highest risk that we see. We try to minimize that risk with a phased approach, a phased project where the finances are manageable for both the startup and for us. If something does go wrong with the startup company, we’re both covered. Other risks we would be concerned about is if the project was cancelled. Communication is critical—regular communication is mandatory.
Fesus: Because our customers are also victim to headcount reductions, there is a significant amount of risk with customers giving up full control of the project. Customers that do so either do not have strong internal skills (or available headcount) themselves or have to become reliant on others to fulfill this due to cost. This makes the supplier selection more critical and possibly more costly to them in the long run—if done poorly. If a customer truly wishes to have a fire-and-forget approach, the vendor must have talent available that can be a judge or referee when these risks emerge and be able to articulate them. To safeguard some of the risk factors with vendors, some customers have taken steps to include a financial incentive or penalty based on good and poor performance. This often filters suppliers who are not willing to take ownership of risk.
Dunn: There are a couple of risks in full-service outsourcing. As a general one, as with all outsourcing providers, they need to be careful about overpromising. It’s one thing to say that you can do everything in all phases, but it’s another thing to actually be able to do it. If you promise to do something and you can’t the relationship is going to fall into trouble. The biggest risk that I see in the actual operations of full-service outsourcers is the coordination between the steps. If you’ve got a design function, you’ve got a manufacturing function, you’ve got an assembly function, you’ve got a packaging function—how well integrated are all these steps? Who’s managing the operation? Is there a weak link in the chain? As a full-service provider you’ve got more areas where things can break down and where problems can occur. Companies can overcome these risks by being very honest about what they can and cannot do with a customer and being very careful to manage that relationship and identify any weak links in the chain for the services they’re providing.
Is it possible for companies that do not provide a full service of capabilities to be profitable in today’s market?
Small: If you are smart about what you provide and the market to which you sell, you can succeed.
Ryan: There is a continued trend of outsourcing at all levels in the industry. While I agree some of those require full-service offerings, many of the technologies in these products require partners who are technical experts. If your company has developed a deep technical expertise in any area, then you can have a profitable business and become a key partner. In most cases where that expertise is critical to the product, the OEM will direct that you retain the business if they outsource to a full-service provider, and this allows you to protect margins.
Croteau: Yes. I think there’s always possibilities, you’ve just got to have a good technology. It’s increasingly difficult, though. Because of consolidation in the supply chain and because of customers choosing a fewer number of more significant suppliers, there’s risk that component suppliers get disaggregated from their actual customer. Because of the premium on innovation, there will always be a place for highly innovative component companies.
Burns: Sure. Customers are willing to pay for value and many component suppliers are expert in their areas of expertise and offer a tremendous service that is hard to find. There will always be a place for innovative service providers that address unmet needs.
Savage: No. The days of doing a majority of your work through outsourcing is a thing of the past. With the cost constraints we are all dealing with and pressure to continually reduce costs, the thought that multiple companies can build profit into a program is not going to happen. Outsourcing also requires the movement of product and with shipping costs on the rise, this is another area that must be minimized. There are specific areas where outsourcing is still justified—for specific technologies that are very capital intensive and/or when programs have a unique requirement and the volumes are generally lower.
Fesus: Yes. But they must understand the competitive playing field and how they fit in it. Let me put it another way and industry. Back in the day when Taco Bell offered a full service dining experience, they were losing money to Pepe’s, McDonald’s, Burger King and others because they didn’t realize they were trying to compete in a fast food market. Once they figured that out, they changed their operations to fit the market requirements and needs and eventually came out of financial distress. Fit and focus are key to any company’s survival. If you try to be all things and are not, you will fail. It may mean that you have to think about change, but change is inevitable. Authors like Edgar Schein, Jim Collins and Michael Porter have written some great books about change, leadership and competition. The theories are still very relevant, even in this recession. Adapting the topics to today’s playing field is worthy of discussion.
Olson: Design houses and pure contract manufacturers that don’t offer the full range of services can certainly be profitable. However, it is important for them to distinguish themselves by having expertise in a particular engineering discipline or offering an ultra-low-cost option for manufacturing.
Shirley: I think that they will be suppliers of the larger outsourcing companies more so than they will be suppliers of the OEMs. That will be the shift. Currently, many of our suppliers are also DePuy’s or Stryker’s or any of the larger players’ as well. Over time, for someone to not offer full-service capabilities, they would be more our supplier instead of direct. There’s continued room for those players but even that portion of the market will consolidate.
Dunn: Absolutely. One of the ironies here is that I would argue that component manufacturers are perhaps more profitable than some full-service manufacturers. If you’ve got a very differentiated capability for a component that you can manufacture cheaply, the market will pay for that. There are lots of smaller niche providers who are highly profitable by doing one or two stents or one or two key components that nobody else can make or making things better than somebody else can. The issue they face is that there’s a limited market for their component, so they’re never going to be huge companies. But they can certainly carve out a nice niche.
The recession has prompted contract manufacturing firms and outsourcing providers in other industries to enter the medical device market, as they seek to capitalize on the sector’s solid growth potential and considerable profit margins. What are the chances of success for these companies? What can they do to compete with more established competitors in this market and convince OEMs that they are viable, adept contenders for their business?
Anderson: Converting from a retail contract manufacturing facility to a medical contract manufacturing facility is an extensive and expensive undertaking. If someone truly takes the time to properly convert their facilities they have only taken step one. The differences in proper documentation control between retail and medical are enormous. It would be hard for a converted contract manufacturer to truly know what their overhead costs are. They have to become certified and then they have to convince prospective customers that they are ready to take on work. Most medical companies are risk adverse and are not necessarily willing to bring crucial projects to inexperienced manufacturers.
Mulvihill: They have to build a reputation with specific customers, and do it consistently.
Fesus: As the auto suppliers adapt and learn the ways of the medical industry, they will increase overall macro- and microeconomic supply. Without an increase in demand, growth and pricing will not likely be as linear and will likely force prices in the industry to drop further. We can’t blame low-cost labor and globalization on this one. However, a customer will have to determine the level of risk and if the program warrants it. I see this level of adaptation as a slower penetration but these new entrants will likely bring value to some buyers as they adapt. For the firms escaping from the automotive sector, strong soft investments will need to be made in infrastructure and culture. For a medical customer, automotive has a perception to it and a different quality system. I have seen some customers shy away from vendors if they see a focus on the TS16949 attached to a vendor’s quality system. It makes the salesperson’s job more difficult to compete against a vendor advertising ISO 13485. The vendor will have to do a lot to prove that their focus is not on automotive and is on medical. I once worked for a supplier that competed in both. They had a two-thirds automotive and one-half medical split. When discussing with the president about strategic changes to move towards a greater proportion of medical, he said, “The money made from fast and high volume automotive is just short of narcotic and difficult to leave when the gestation period for a medical program can be years.”He wasn’t far off. Any automotive firm or other industry must decide to make the changes for the long haul and accept the change in culture that goes along with it.
Burns: There are lots of qualified and very capable manufacturers already serving medical device companies. A new entrant better have a unique value proposition if they hope to get the attention of an industry looking to rationalize its existing supplier base.
Ryan: The two greatest challenges facing contract manufacturers seeking to enter the medical device market is the need to invest in developing medical device quality standards and having sufficient funding to survive long product development cycles.
Olson: There is some crossover between the medical and defense industries as they both have stringent document control processes. However, there is always a learning curve when entering a new industry and implementing new processes. This is especially the case when one is as strictly regulated as the medical device industry and most customers are looking for manufacturers with years of experience manufacturing medical products.
Savage: There is absolutely a trend to market yourself as a “medical contract manufacturer.” Every medical show now has prior electronics and automotive suppliers attempting to sell into the medical market by showing non-medical products. They will not be successful. Companies in this situation don’t understand the medical requirements and the differences required for validation. Additionally, the probability of breaking into the medical market is slim. Medical device companies are not looking to increase their vendor base; they are looking to reduce it by consolidation to full-service and financially stable companies with the engineering capabilities to meet their needs. The only way to break into the medical market is to have a truly unique and needed service.
Croteau: It’s a long, hard road unless they acquire to get in that space. It takes a real long-term commitment of at least four or five years, based on product lifecycles, sales cycles, and product ramp cycles. It takes a long time and it requires both money and patience.
Dunn: There have been a number of outsource manufacturing companies eyeing this sector. The margins of the medical side are significantly higher than they are on the electronics or automotive or defense side. It’s an attractive business. A lot of larger suppliers from other sectors have most of the capabilities to address this market, particularly aerospace and defense—they are used to working within a highly regulated environment. Automotive suppliers are used to working with very demanding and cost-sensitive OEMs. The issue that they have is one on the regulatory and quality side, of not having a track record. This is a significant barrier to entry for all these firms which is why we haven’t seen a faster movement into the sector. The regulatory nature of the contracts, the trust factor needed takes a while to overcome. The ways they can overcome it is through acquiring a smaller outsource provider in the segment that already has the relationship with the OEMs and has the track record. Looking at businesses like that to get a foothold and credibility is one of the ways to do it. The other way is to just try and get a contract, but as most of the large OEMs are trying to shrink their number of suppliers, unless you are doing business with another division within that OEM, it will be very difficult to get in.
Many large OEMs are re-examining their supplier lists and reducing the number of approved vendors (to better manage the supply chain). What impact will this have on full-service contract manufacturing firms?
Shirley: It will have a great impact without a doubt. I have great relationships at many of the top OEMs in the orthopedic space, and almost without exception their intention is to reduce the number of suppliers to one third of their current suppliers. They’ve already started that process in 2009, and I think they will largely complete that process by the end of 2010 or the first half of 2011. If you look at any of the segments within that space, instead of having 15 to 20 vendors for a particular segment that may be broad, they’ll have three to five. There are a number of companies today—smaller companies—that are either closing their doors or they are setting themselves up for acquisition.
Mulvihill: It will have little impact on the full-service contract manufacturing companies. I believe that full-service manufacturing companies regularly have to approve multiple vendors or suppliers for each component. We may be better at finding some of the higher quality, more responsive and sometimes smaller, regional suppliers that deliver high-quality products or components.
Fesus: It could have both a negative and a positive impact. It could be negative for vendors that are suffering or have not reinvested in their companies, and positive for those that have. But it will depend on a lot of what-ifs. I’ve noticed that many of the large pharmaceutical [companies] are going through this evaluation process to determine who will be kept and who will be left behind. A lot of customers are sending questionnaires that get into the details of services provided, processes and quality controls and financial stability. In terms of consolidation, I think it will have an impact. Customers will reduce and control the amount of suppliers they work with and the suppliers will seek to add more services and value. Additional services may come in the form of acquisitions or purchasing the knowledge to compete.
Savage: This vendor reduction will cause either consolidation or closure of some of the contract manufacturers who cannot adapt to the changing requirements. The recent economic problems have already forced many closures, and those that survived by refocusing themselves are well positioned for the upcoming years.
Burns: Consolidation will continue and suppliers that are marginal performers will cease to exist over the next five to 10 years. It will be more difficult to stay viable and grow as a small, single-site supplier unless you offer a truly novel service or have intellectual property that is attractive to the industry. Full-service suppliers that offer very competitive capabilities will continue to have an advantage as the rationalization advances. Just offering a broad array of services won’t be sufficient; a supplier must do them all well.
Anderson: It probably will further consolidate the contract manufacturing pool. The quality contract manufacturers who offer the best services will stay on OEMs’ lists and the others will be dropped. The reduction may decrease the number of vendors, but the quality and competition will remain.
Dunn: I think there’s a clear movement trying to rationalize the supply chain, make it more efficient, make it easier to manage on behalf of the OEMs, so they’re constantly looking to reduce the number of suppliers. On one side of the coin, you can say it’s difficult for full-service manufacturing firms because now there are fewer opportunities out there since firms are reducing the number of groups they are working with. But I view it as an advantage for the full-service firms because now there’s an opportunity to do more business with each customer and grow. This will result in further consolidation in the market as some of the smaller players combine with other groups that remain on the approved supplier lists for the OEMs.
Olson: This will definitely lead to further consolidation in the industry, particularly to better serve the needs of larger established companies.However, there will always be a strong need for smaller boutique full-service firms that have unique expertise and are willing and able to assist early stage companies in developing and commercializing their innovations.
Croteau: One of the biggest things it will do is require that full-service contract manufacturing firms that are becoming more like Tier 1 suppliers to have very robust supplier management programs as part of their quality management system. Many of our customers are trying to have fewer suppliers that are more significant and can bring that broader spectrum of value versus just transactional value in terms of continuous improvement, globalization, investments in innovation and technology. It’s going to be important that companies have a certain breadth of capabilities that allow them to be full service and that they have a breadth of capabilities in different geographies of the world to help enable customers’ growth in innovation in other parts of the world albeit for market access or cost reasons. Some are going to win and some are going to lose.
Ryan: The large OEMs are reducing their number of approved vendors to better manage their supply chain but also to reduce risk. This trend should present opportunities for full-service providers who have a broad technology range. The main watch-out is that the large number of suppliers are not just moved from the OEM’s supply chain to the contract manufacturer’s supply chain. To make longer-term, sustainable improvement, the OEMs need to look for suppliers that have well-established supply chains, either by internal vertical integration or by using external partners.
Have any customers taken processes back in house recently? Will “insourcing” become more popular going forward?
Croteau: I have looked at our large business, and it’s extremely rare that a customer takes something back in house. It maybe happens once or twice a year. Unless there’s a service or quality issue or something like that, it doesn’t happen that often. To a certain extent it varies by customer but the majority of companies are thinking the other way—how do I go from 20 plants down to 13? I don’t need 20 plants; what I need are good outsourcing partners and fewer factories, and a more nimble supply chain. That is more the model of the future. I don’t see [insourcing] as a trend. There may be one or two examples of that but it’s the exception to the rule.
Ryan: While rare, we have seen a limited number of cases where customers are considering this mainly to allow them more flexibility internally. The decision to insource now by certain customers is very linked to the decision that drove outsourcing in the past. In some cases the OEM’s core competency has changed or they are trying to change their business model. As a contract manufacturer you also need to change your offering to stay relevant to all your customers as their businesses change. Overall, our interactions with customers indicate that outsourcing and not insourcing will become more popular moving forward.
Shirley: There’s not enough to trend that activity one way or another. When I talk to customers, there seems to be a focus on their part towards outsourcing more, but a very specific strategic approach to doing so. Without a doubt there continues to be a focus for low-cost manufacturing. Things like implants will stay in house and insourcing might potentially increase from that perspective, if there is a greater value add that can be brought and a desire to have the R&D team work very closely with operations. In things like instruments and packaging there seems to be a continued strong movement to outsourcing. And then there’s some low-hanging fruit like cases and trays that OEMs perceive they can insource to their own facilities in the United States at a better cost.
Dunn: I think it’s still happening but it’s a company specific decision. I don’t think it’s part of a general trend.
Burns: OEMs will be more careful about what manufacturing technology and processes they invest in. There is a greater sophistication around cost accounting and make versus buy decision-making is becoming more objective. Each OEM has its own strategy, some value vertical integration and low manufacturing costs, others would rather invest more in R&D and distribution. Contract manufacturers need to understand each company and not assume one solution works for all.
A Flextronics facility in Gushu, China. The company maintains a strong manufacturing base throughout Asia. It’s part of an overall international production strategy. Dan Croteau, president of Flextronics Medical, told MPO that in the next five years, the outsourcing market would evolve into “a much more globally competitive market with more supplier consolidation, tighter partnerships with fewer customers ... and more partnerships around innovation in different parts of the world.” Photo courtesy of Flextronics.
Olson: Some companies are choosing to insource if they have existing manufacturing infrastructure and appropriate quality systems. This is sometimes the case when companies originally outsourced due to lack of internal capacity and now have excess capacity due to a slowdown of other product lines.
Small: We have not seen any processes taken back recently. I would expect that any product or process with proprietary technology will be done inside when the risk is deemed too high to outsource or the technology is a trade secret.
Anderson: Insourcing was a big movement during the 1990s and the first part of this century. However, we are being asked to take on even more. Our customers are realizing that their strengths are [product] development and marketing, and our strengths are manufacturing and fulfillment.
Fesus: Yes. More customers are going back to what they used to do and looking at outsourcing less. We have seen this with some tooling, molding and assembly.
Savage: No, we have seen the trend to be the opposite. Many of our customers have put their engineering resources towards product improvements, next generation, new development and cost reductions—not setting up internal contract manufacturing. The majority of the customers we have been working with want or need to concentrate on what they do best—designing the next generation of instruments. Bringing processes in house dilutes the resources they have to generate growth.
How will the new healthcare reform law directly impact your business?
Olson: We see significant innovation occurring as a result of shifts in healthcare information systems and investments in cost-cutting technologies. This trend will likely help fuel new projects for our business in the next few years.
Savage: It’s too early to tell, but the obvious impact will be upon the cost of the products we produce and sell. Cost reductions will be the theme for the next couple of years. The most dramatic impact will be the ongoing pressure to reduce costs and the potential for expansion of the refurbishing of disposable instruments.
Small: It is yet to be determined, but more than likely it won’t be positive.
Dunn: It’s too early to tell the full effect here. But clearly the tax on medical devices is going to put pressure on margins for the device companies, and they are going to put pressure on their suppliers. An effect further down the road is going to be that the life cycle of medical products is going to be extended. There will be not as many new products coming on the market, and the older ones will remain for a longer period of time. From an outsourcer’s perspective, you need to be looking at how are you going to continue to manufacture this product for a longer period of time? Are you going to be able to continue to reduce your cost to maintain that relationship longer than you would have previously? With the focus on efficacy and reimbursement, there’s going to be a higher hurdle for new devices. To get approved for reimbursement, you’re going to have to prove that it’s a more cost-effective approach. A bunch of the devices that have been approved have only incremental benefits, and incremental devices are just not going to be reimbursed.
Croteau: Healthcare reform is putting a tremendous premium on cost. How are we going to help our customers make up the three percentage points in margins that they are going to be taxed with? There’s a lot of activity in the FDA right now. There’s a real premium on the innovation cycle, having strong design capabilities, having a real robust NPI process, and having a quality system that allows you to seamlessly get into production fast with the same level of compliance and reliability. That can’t be compromised. Customers who used to want a product developed and launched in 12 months now want it in nine or eight months. We have to be responsive to that without compromising quality. The cost, the innovation cycle and globalization are really the three key impacts that I see the healthcare reform having on our business. And the cost is manifesting itself into lots more outsourcing activity in different sizes and scales than we’ve considered before because our customers have never really had to make up three points of gross margin in a year.
Mulvihill: We don’t know enough about it yet to determine whether it will affect our business. We’re seeing new projects frequently so that’s an indication that people are pushing forward with innovation, launching new products, and launching new technology.
Ryan: It is too early to determine what the direct impacts may be, but we see opportunity in the larger numbers that will be insured and also the potential for price pressure as the healthcare providers look for more cost effective ways of delivering healthcare. Turning to an external partner that can assist to deliver efficiencies along the entire product value chain may be a solution for many OEMs in meeting these challenges.
Shirley: There could be cost pressures to us on the manufacturing side, there will also be pressure for speed to innovation. If there’s a $2.3 billion tax to our industry, the easier place to find cost savings would be in research and development, which would not be beneficial to innovation in healthcare. Therefore I think maintaining that level of innovation in a condensed period of time would be preferred.
Fesus: It’s too early to tell just yet but I think it could negatively affect contract manufacturing companies. As seen in other parts of the world, if the government now becomes a greater customer, they will likely dictate a lot of the pricing. This may cause OEMs to focus on cost reductions, so they may not have the resources for development as before. The act of government involvement in medical care will likely complicate matters and perhaps cause pharmaceutical companies to hold back on funding for other projects until the dust settles. Without development, all progress and long term momentum slows.
Where do you see the medical device outsourcing market five years from now? What will drive industry growth?
Mulvihill: There is still a tremendous amount of emerging technology, emerging businesses and emerging startup companies. In the next three to five years we’re going to see tremendous growth both internationally and in the United States with new materials, new components and new technologies. We are on the cusp of some tremendous growth in areas that cover all different markets and therapies. It’s an outstanding time to be in the full service outsourcing and contract manufacturing business. What will drive our business is being flexible, being nimble, being able to adapt and to bring innovation through different and complementary areas and delivering that to the customer cost effectively and on time.
Fesus: Outsourcing firms will have to take on greater responsibility within quality and regulatory, and offer more supply chain opportunities. I also predict that we will see further expansion towards globalization. With this I mean we may find less exporting opportunities—outside of critical care products—and see suppliers setting up more operations in different regions of the world to supply those regions. This will all be in the effort to reduce shipping time, cost, taxation, and better manage the regulatory requirements of that part of the world, such as Japan. Contract manufacturers that focus on globalization may have better staying power than those that do not. And the ones that do will have the financial resources to do so and thus withstand the recessionary survival test.
Shirley: Certainly five years from now there will be less companies in the space, the margins will without a doubt consolidate. That consolidation will force some innovation in the technologies of materials. When that transition happens, some of the leverage points will change. When you’re an outsourcing player and you’re manufacturing parts or machining, quality and lead times matter in your relationship. When you step over and provide a unique technology to the space the leverage point changes. To view the market going forward, I think it will be consolidated with larger players that will offer more full service offerings from napkin to launch. The drivers of the growth will be on the technology that will be brought to bear and on the clinical product development and intellectual property that actually comes out of the outsourcing space.
Croteau: Over the next five years, it’s going to evolve into a much more globally competitive market with more supplier consolidation, tighter partnerships with fewer customers, tighter links right from design through NPI and production, and more partnerships around innovation in different parts of the world. People have to have the investment in systems, whether it’s globally consistent quality systems, compliance systems, traceability systems, as well as the global footprint and strong manufacturing capabilities to continuously add value to customers in different parts of the world. We’re really starting to see lot of these dynamics take hold now as customers get much more serious about emerging markets, much more serious about how to improve their cost positions faster than they’ve had to do it in the past. I’m optimistic that we can have all the customers do that and the supply chain in general will respond to try to do that as well.
Ryan: I expect that the medical device outsourcing market will continue to grow, in particular, for those companies that can demonstrate a track record of being valuable partners to OEMs. I think the ability to partner with OEMs to reduce the overall time to market for new products and the ability to be a reliable partner across the full supply chain will be the critical success factors.
Burns: It will continue to grow faster than the medical device market segments with a smaller group of contract manufacturers capturing a larger share of the market. A much higher percentage of manufacturing will take place outside of the United States to service assembly operations and end-customer demand around the world.
Olson: There will likely be continued consolidation among the larger contract manufacturers, and a trend toward partnering with boutique firms in order to add a broader base of full-service capabilities. Growth will come from innovations in device technology and laboratory instrumentation that clearly reduce healthcare costs and improve patient outcomes.
Small: The strong companies will be stronger. Growth will be driven by service flexibility, innovation and automation.
Dunn: I see the outsourcing market continuing to consolidate, and OEMs and other companies will grow even more sophisticated in their use and approach towards outsourcing. What’s going to emerge is a more defined group of large full-service outsourcers. Right now we still have some emerging firms and platforms in the sector and those will mature and continue to consolidate. I also believe the medical device outsourcing market will be a bunch of truly global operations. Right now we’ve got a handful of companies who have global operations, but I think we’ll see more.