Dr. Richard Lee’s vision was clear from the very beginning. He envisaged a practical use of his doctorate-endorsed proficiency in experimental economics (i.e., the study of economic theory and markets through controlled laboratory experiments); he fancied switching careers; and perhaps most importantly, he imagined himself fulfilling his childhood dream of working in medicine.
Lee’s vision never once wavered. Neither did his resolve, though the Chinese native also recognized the formidable challenge he faced in turning his professional wish list into reality—he’d have to find a way to connect all the dots, so to speak. Hence, the birth of Amsino International Inc., the “dot connector” Lee founded in 1993 to integrate his longtime love of medicine and his remarkable acumen in experimental economics. The Pomona, Calif.-based firm develops and manufactures intravenous administration sets, urological products, enteral feeding devices, respiratory equipment and surgical tools such as suction yankauers, connectors and umbilical cord clamps.
Like most newborn businesses, Lee’s corporate baby required considerable focus and attention on such operational basics as location, talent, market, core competency, name, customers, intellectual property and costs. Some decisions were fairly simple while others took some careful thought. The firm’s name, for instance, wasn’t too difficult a choice—it’s a tribute to the two countries, America (“Am”) and China (“sino”) that provided Lee—the current chairman—with the academic fortitude and grit to start his own company (the former college professor earned his undergraduate degree in economics from Peking University in Beijing and his doctorate from the University of Arizona). Manufacturing site selection was relatively easy, too: “At that time, China was a very cost-effective location,” explained Stanley Lau, CEO of Amsino’s parent company, Amsino Medical Group. “After graduating from the University of Arizona, Lee set up two [manufacturing] facilities in China to produce high-quality products for OEMs in the U.S. market. It was his vision that led Lee to set up the manufacturing facilities in China.”
Sourcing decisions no longer are so simple or straightforward, however. The rise of globalization and breakneck pace of innovation since Amsino’s birth have made the world a flatter place, expanding sourcing options and generating a plethora of new revenue bases for cash-strapped device firms. Companies increasingly are offshoring manufacturing, design, R&D services and product development processes to take advantage of the lower overhead, cheaper labor and improved technical capabilities offered by foreign markets.
Some of these newfound medtech meccas are located in traditional vacationlands like Brazil, Mexico, and to some extent, Costa Rica, India, Malaysia and Singapore. But China has clearly become the top corporate haunt, having morphed from an industrial backwoods three decades ago into the world’s second-leading economy, commanding a gross domestic product of more than $12 trillion. The republic’s export-led growth over the last 30 years—nearly 10 percent annually—has helped lift 500 million Chinese out of poverty and created a burgeoning middle class that is projected to swell 50 percent by 2020, fueling 20 percent annual gains in the country’s $17 billion medical device industry. Much of that growth is likely to come from the orthopedic sector: Overall procedures are forecast to surge 18.2 percent per year through 2015, with joint replacements ballooning 17.4 percent and fracture management/repair treatments skyrocketing 25.2 percent, according to Elsevier Business Intelligence data. Disc/bone removals and spinal fusions also are expected to grow by double-digit rates.
Such promising demand has triggered an inundation of top medical device OEMs in recent years. Medtronic Inc. and Swiss engineering giant ABB have led the charge, each spending more than $1 billion to enhance their manufacturing, R&D and delivery systems in China’s $46.7 billion healthcare market (currently the world’s fourth-largest).
Zurich-based ABB divided its money among 38 sales offices (all in major Chinese cities), 23 joint venture/wholly owned foreign enterprise manufacturing facilities, and two R&D centers. The investments helped boost the company’s domestic Chinese revenues more than 16 percent annually between 2005 and 2010.
Medtronic, on the other hand, spent most of its greenbacks on the purchase of orthopedic implant maker China Kanghui Holdings last fall. Analysts claim the $816 million deal gave the Minneapolis, Minn.-based device behemoth access to a solid distribution network for all of its products, including pacemakers, implantable cardioverter defibrillators, insulin pumps and heart valves. The company shelled out an additional $66.2 million for a 19 percent equity stake in Shenzhen-based LifeTech Scientific Corporation, a manufacturer of cardiovascular and peripheral vascular disease treatment devices; $3.13 million to open a research and development center in Beijing; and an untold amount on an R&D facility in Shanghai, where Boston Scientific Corp., Covidien plc, GE, Smith & Nephew plc, and Stryker Corp. also have established bases of operation.
GE and Smith & Nephew have set up shop in Beijing as well (GE’s R&D center develops and markets “In China, for China and the world” products) while Becton Dickinson and Company, Johnson & Johnson, Smith & Nephew and Stryker have launched product development or manufacturing facilities in Suzhou, a city in the Yangtze River Delta near the world’s busiest port in Shanghai. Smith and Nephew transferred production of its advanced wound management portfolio to the Chinese metropolis from its Largo, Fla., plant four years ago to satisfy increasing global demand for its Allevyn Adhesive dressings, Cica-Care silicone gel sheet and other wound care products.
JNJ’s innovation center in Suzhou develops products for emerging countries across all seven of the company’s device franchises. The New Brunswick, N.J.-based healthcare conglomerate launched several mid-tier products including the linear cutter (Advant 55) with a reusable body and reloadable staple, Synsyl absorbable sutures manufactured in India and DePuy’s REACH knee design with fewer components to decrease cost and make it easier for surgeons to implant.
“[China] has become a sales market as well as a manufacturing market over the last five or 10 years,” noted Chris Tatten, supply chain director for Vernay Laboratories, a College Park, Ga.-based fluid control solutions provider with sales locations, engineering, testing and manufacturing operations in the Americas, Europe and Asia-Pacific. “If you look at the places where Western companies have spent a lot of time establishing a manufacturing presence, it’s usually in countries with a developing middle-class society. Countries like China, Korea and Vietnam now have certain expectations regarding their standard of living, healthcare, minimum wages, hours—things that in the past were not much of a factor. At the same time their costs are going up, which make it less desirable to export from those locations, these countries have developing middle classes that want to buy products being manufactured locally.”
Walking the Sourcing Tightrope
Indeed, China and other developing medtech markets offer better growth opportunities than their established counterparts in the United States, European Union and Japan (some estimates render the growth gap to range between two- and five-fold). But such promise is not without risk.
With healthcare spending slated to skyrocket from $357 billion in 2011 to $1 trillion in 2020, China is among the planet’s most attractive medical markets and offers by far the largest growth opportunity of all emerging economies. But the Sleeping Giant no longer is a slam-dunk for low-cost manufacturing. In fact, a study from global consulting firm AlixPartners claims the cost of outsourcing manufacturing to China by 2015 will be equivalent to the cost of manufacturing in the United States due to higher salaries, more expensive shipping rates and the rising value of China’s currency.
Chinese labor costs have risen about 15 percent annually since the onset of a 2008 labor contract law that prompted greater workforce awareness and led to sweeping strikes. Last year, minimum wages throughout the republic rose 22 percent, though they still were considerably lower than Western earnings.
“The cost of doing business especially related to labor is less expensive in emerging markets,” noted Joe McBeth, global supply chain vice president at Nypro, a division of electronic manufacturing services firm Jabil Circuit Inc. with offices/facilities throughout Europe and Asia. “Labor in the final assembly of the device can be significant but labor cost can also be significant in the stack up on all of the sub components. This is primarily in sourcing mechanical and electromechanical components as the supply base consists of smaller local suppliers producing custom or semi-custom components. We often think of international sourcing as simply Asia or India. Although China and Malaysia have been fast-growing medical sites for Jabil, we have seen recent acceleration in sourcing products in Mexico as well. It is clear that China’s rising labor costs are creating opportunities in other geographies but as the model is refined, China manufacturing for Chinese consumption will create great market penetration opportunities.”
To fully exploit those opportunities, medtech firms must be willing to plan, organize and act like the companies in their markets of choice. They must empower local decision-making and enable local experimentation while realizing the manufacturing, commercial and consumer insights required for success will vary by region.
Companies also must understand the proficiency of their foreign workforce. Asian workers, for instance, generally are well-educated, but they often lack the necessary skills for sophisticated assembly. The shortcoming has caused some multinationals to relocate their operations to areas with more highly-skilled employees, but others, like Siemens, have combined incentive, training and recruitment programs to improve local skill sets.
Siemens Medical Solutions USA Inc. has established on-campus recruiting partnerships at top Chinese universities and created an educational scholarship in medical physics with Beijing-based Tsinghua University. In a similar move, the company’s parent firm, Siemens AG, set up a management institute in Beijing which trained more than 16,000 employees through 2010 and is credited with helping the German engineering and electronics conglomerate avoid typically high attrition rates in the area.
Boston Scientific is combating low-level labor skills with a development/worker training center in China while Medtronic is boosting its ranks of employees with engineering and research backgrounds.
Successful training and recruitment programs, however, can be a double-edged sword. A better-educated, technically-trained workforce certainly can help companies manufacture complex products, but they also can trigger high turnover. “I moved some product to Slovakia about five years ago. The average salary over there was the equivalent of $2 an hour—fully burdened it was $12 an hour, so it was a great savings,” recalled Ed English, director of supply chain management at KMC Systems Inc., a Merrimack, N.H.-based medical device contract manufacturing and engineering services firm. “We were able to get materials there very reasonably priced as well. The problem in Slovakia was that once people were trained and learned the job, they became valuable to other countries that were moving in there and they were leaving for those other companies. We had to constantly retrain people.”
A “smart sourcing” strategy can help companies reduce high turnover rates and ensure both product quality and regulatory compliance, experts contend. Such a strategy examines the total cost and implications of sourcing decisions rather than the initial part per cost, taking into account variables like wages, energy costs, labor skills and expertise, shipping rates, regulatory proficiency, material expenses and the financial/legal ramifications of poor quality products and/or recalls. As one industry observer noted, “We are in the business of making medical devices, so lowest cost is not usually the best approach to evaluating suppliers.”
A more effective approach is based on local partners’ competency in intelligent property protection, regulatory compliance, international customs laws, U.S. Food and Drug Administration audits, and design for manufacturability as well as overall supply chain risk. Full-service EMS provider SigmaTron International Inc., for example, created a green compliance service center in China to ensure that supplier documentation meets its customers’ regulatory and/or export requirements. The company, which has a network of manufacturing facilities in China, Mexico, Vietnam and the United States, also put systems in place to provide customers with 24/7 project status.
“In short, providing robust project visibility and regulatory compliance support is an integral part of the contract manufacturing equation,” explained John Sheehan, vice president-director of materials and supply chain for the Elk Grove, Ill-based firm. “Customers used to assume that those were services they needed to provide by installing a source inspection team at offshore suppliers.”
Forefront Medical Technology has incorporated offshore technical and regulatory support system services as well, opening a facility in an area of Changzhou, China, that is subject to more stringent governmental regulations.
“In our business segment, customers aren’t simply selecting a supplier to build product,” explained Mark Samlal, CEO of the Singapore-headquartered medical device contract manufacturing firm. “They are selecting a supplier that ideally helps increase the overall competitiveness of their strategy through a combination of technical expertise and familiarity with the markets they plan to enter. Support needs are increasing as market opportunities increase and there is an expectation that responsiveness and flexibility will be on par with what is found in mature markets, such as the U.S. customers also recognizing that the supplier will be an extension of their reputation. We’ve recently opened a facility in Changzhou, China in what is known as a ‘green’ special economic zone. Companies in this zone are subject to more stringent regulation in terms of environmental regulations, and worker health and safety practices. We have developed a strong connection with the China FDA. Being knowledgeable in this area allows us to help our customers with product registrations and ultimately provide improved access to the China market. We felt putting our factory in this region was positive for our customers both in terms of the more robust set of checks and balances it represented and the marketing benefit of manufacturing in one of the most heavily-regulated regions in China.”
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The complexity, competitiveness and unpredictability of globalization has pressured manufacturers to provide more flexibility, speed and reduced cost to their customers. To meet these demands companies must draft strategies that incorporate smart sourcing decisions based on support services, partner expertise and workforce skill sets. Manufacturers also must choose the sourcing option that ensures the highest quality outcome and minimizes total product cost rather than the initial per-part pricing. Cheaper sourcing is not always the best sourcing.
“The reason most companies practiced international sourcing was the cost differential involved,” Vernay’s Tatten noted. “China has now established minimum wages and favorable exchange rates, which has driven up the cost of sourcing. It’s a much more level playing field now. The big question everyone is asking, at least in the sourcing world, is where’s the next location? Is it back to domestic sourcing or do we end up in Vietnam or South Korea or some other place? That’s really going to be the next driving focal point over the next 10 years.”
Farewell, almighty BRICS. The BILNS are in charge now. Brazil, Russia, India and China may still be the bastions of low-cost labor and manufacturing, but they nevertheless are being eclipsed in offshore earnings by the lesser-known quintet of Bermuda, Ireland, Luxembourg, the Netherlands and Switzerland (BILNS). Global companies, in fact, are so smitten with the BILNS brothers that they increasingly are setting up shop there—mostly to take advantage of the tax laws. A recent U.S. PIRG study found that American-based multinational firms generated 43 percent of their 2008 total foreign earnings in BILNS countries, yet the regions accounted for just 4 percent of the companies’ overseas workforce and 7 percent of their foreign investment. By contrast, Uncle Sam’s major trading partners (Canada, Australia, Germany, Mexico and the United Kingdom) contributed only 14 percent to total profits in 2008 but represented 40 percent of their international workforce and 34 percent of their foreign investment.
That same year, U.S. multinationals’ profit in Bermuda equaled 1,000 percent of the British territory’s economic output, nearly quadruple the companies’ reported earnings in 1999, according to Congressional Research Service Data. Proceeds in Luxembourg experienced a similar surge, going from 19 percent of the nation’s economy in 1999 to 208 percent nine years later.
“The practice of artificially shifting profits to tax havens has increased in recent years,” PIRG’s 35-page report contends. “Many large U.S.-based multinational corporations avoid paying U.S. taxes by using accounting tricks to make profits made in America appear to be generated in offshore tax havens—countries with minimal or no taxes. By booking profits to subsidiaries registered in tax havens, multinational corporations are able to avoid an estimated $90 billion in federal income taxes each year. These subsidiaries are often shell companies with few, if any employees, and which engage in little to no real business activity.”
Though they are spread throughout the globe, tax havens in Northern/Central Europe are the world’s most popular profit preserves: PIRG data show that 89 percent of the top 82 publicly traded U.S. companies stowed money last year in Irish, Swiss, Dutch or Luxembourgian subsidiaries, where corporate levies were roughly half of America’s 39.2 percent rate. Five in 10 U.S.-based multinationals booked profits in no-tax countries like Bermuda (53.6 percent), the Cayman Islands, Bahamas, Barbados and British Virgin Islands (collectively, 52.4 percent), and a few squirreled away cash in Cyprus, which boasts a 12.5 percent corporate tariff, and Mauritius, where companies pay a 15 percent duty (slightly better than the BILNS combined average rate of 16.9 percent).
Eighty-two U.S. companies held $1.17 trillion offshore last year, PIRG’s report concludes. General Electric and Apple led the pack, stockpiling $108 billion and $102 billion, respectively, in BILN jurisdictions, though GE also stashed some profits in the Bahamas and Singapore. Medical device firms stashed $177.2 billion overseas in 186 jurisdictions worldwide; each company kept money in BILNS-member countries but a few spread their wealth among other tax havens, including Hong Kong (China), Malta, Costa Rica, Gibraltar, Latvia, Lebanon and Panama. Abbott Laboratories was the most diversified with its offshore holdings, distributing $40 billion among 107 subsidiaries, PIRG statistics suggest. Johnson & Johnson was next, hoarding $49 billion in 55 subsidiaries, while 3M and Cardinal Health brought up the rear with $8.6 billion in 13 tax havens and $2.2 billion in 11 low- and no-tax countries, respectively.
Boston Scientific Corp. was not among PIRG’s roundup of offshore profiteers, though it easily could have been. Two years ago, an Irish holding company of the Natick, Mass.-based firm paid $60 million (40 million euros) in corporate taxes on 1.4 billion in profit—an effective rate of 4 percent, or a quarter of the republic’s standard 12.5 percent business levy, The Irish Times reports.
Similar arrangements were in place at other Irish-incorporated multinational subsidiaries as well. Abbott, for instance, paid no taxes on its 2011 profits of 2.9 billion euros ($3.75 billion), and BMC Software Europe doled out just $92,580 in taxes on 2010 profits of $144 million, the Times notes. Software giants Novell and Symantec, and French telecommunications equipment firm Alcatel Lucent dodged the taxman in recent years through some sleek accounting and perhaps a bit of Irish luck. Similarly, Microsoft cut its tax bill by 2.4 billion euros through its Irish subsidiaries and Apple paid a bargain-basement rate of 2 percent on $44 billion in global income held by its Irish companies.
Apple’s sourcing shell game infuriated U.S. lawmakers. In May, U.S. lawmakers accused Ireland of supporting a “tax avoidance strategy” that allows the consumer electronics behemoth and other companies to save billions in “otherwise taxable offshore income.” Irish lawmakers, naturally, denied the charges, insisting “there are no special deals in Ireland.”
Maybe not, but the Emerald Isle is hardly the first country to host subsidiaries for U.S.-headquartered firms. Tropical paradises like the Bahamas and Cayman Islands are as renowned for their tax breaks as they are for their beaches, having long provided multinationals with a safe and legal refuge for their foreign proceeds. Such breaks, however, could become more scarce as American legislators attempt to reform the nation’s tax code. “The right kind of tax reform could do a lot to bring corporate profits back to the United States for investment and job creation,” U.S. Sen. Charles Grassley (R-Iowa) told Bloomberg News in an email. “The current system provides an incentive for companies to keep money overseas indefinitely.” — M.B.