Evolving Players in the Medical Device Supply Chain

Today’s medical device supply chain was shaped by two far-reaching trends: A realization among OEMs over the last 20 years about outsourcing’s ability to reduce manufacturing costs while producing safe, reliable products; and OEMs’ tendency to outsource to larger contract manufacturing firms when possible. Reasons included financial stability, fewer vendors to coordinate in product manufacturing, and confidence in larger firms’ abilities to invest in new facilities, equipment, and quality systems.

Beginning in 2000, OEMs’ desire for outsource manufacturing partners of scale often took the form of roll-ups, with companies like Accellent/Lake Region Medical, Tecomet, Freudenberg Medical, and Medplast built through acquisitions of smaller, well-established medical device supply chain entities.

OEMs responded well to the rollups, winning customer trust despite occasional integration issues. OEMs regularly funneled new projects to their larger partners and left their smaller but still capable (former) cohorts to work on legacy projects. Suppliers most popular with OEMs were among the top revenue generators, offered a broad array of manufacturing services, boasted an outstanding quality system, and could easily manufacture a complete device.

In recent years, non-traditional device suppliers have challenged the rollup model, taking advantage of the same market requirements that propelled the OEM alliances to prominence. With limited fanfare, the sizable global contract manufacturers (CMs) have entered the device supply chain and are disintermediating large traditional players in much the same manner as rollups displaced smaller competitors.

Flex Ltd. (formerly Flextronics) is arguably the global contract manufacturer archetype. Founded in 1969 in California, Flex originally manufactured computer and telecommunications equipment for well-known Silicon Valley companies. Drawn by Flex’s relentless pursuit of manufacturing efficiency and low costs, some electronics companies abandoned in-house manufacturing altogether. Relocating to Singapore to take advantage of Asian suppliers and lower labor rates, Flex mastered supply chain management to fill gaps in its already extensive manufacturing portfolio. Mimicking Flex’s success, CMs such as Foxconn, Plexus, and Celestica arose to service the burgeoning need for electronic devices.

Global CMs looked for new markets as their core markets matured in the new millennium. The medtech space had never been appealing to these multi-billion-dollar mass manufacturers due to its relatively short product runs (compared to electronics, at least), stringent quality requirements, and limited prospects for inexperienced players. Nevertheless, the device world proved attractive to global CMs accustomed to operating on single-digit gross margins in their legacy markets. Beginning with the assembly of electronic devices like diagnostic equipment, several global CMs began moving into the device supply chain.

Device OEMs took note of the new suppliers and their unique capabilities. Unlike their traditional vendors, global CMs tended to have billions of dollars in revenue. They manufactured and successfully sourced key components around the world, including China and India, where medtech manufacturers experienced mixed results. Their process management, inventory control, and logistics systems were second to none. While their experience with medical quality systems was limited, their culture of quality was a bonus in a world of mass production runs, continual product obsolescence, and thin margins. Medical device OEMs increasingly outsourced to firms that had written the book on outsourced manufacturing at attractive prices.

In addition to checking boxes on vendor scorecards for manufacturing expertise and price, global CMs brought to the table strong electronics, software, and electromechanical assembly capabilities. With next-generation technologies increasingly incorporating digital capabilities, electronic device manufacturers looked attractive compared to the supply chain partners OEMs had relied on for decades.

Besides electronic box build projects, global CMs’ initial forays into the device market often took the form of services rather than manufacturing. They were the designated project managers for the OEMs, assigned to handle all the paperwork associated with device projects—bidding, scheduling, document management—while also interposing themselves between the OEM and traditional product vendor.

From these initial forays, the last five years have seen global CMs grow to dominate top positions in the device supply chain. In 2018, seven of the 10 largest medical device and healthcare CMs could trace their roots to electronics manufacturing. Notably, these 10 firms represented approximately 26 percent of the global market for outsourced devices. The top two companies on the list, Flex and Jabil, are telling examples of the penetration and capabilities of global CMs.

Flex’s $2.4 billion in healthcare revenue is spread across 17 medical specialties with specific focus on medical instruments, drug delivery systems, and digital health. Flex’s Tijuana (Mexico) medical facility is 540,000 square feet (50,168 square meters) and employs 2,400 people. By 2021, the company expects to generate over 50 percent of its revenue from its trademarked “Sketch to Scale” program, which offers customers a complete package of design, regulatory, manufacturing, and logistics services for finished devices. In support of the effort, Flex acquired Farm Design, a U.S.-based device design house in 2015. These investments and results indicate Flex has the capabilities to match even the largest medical device-focused rollups.

The St. Petersburg, Fla.-based Jabil supplies 85 percent of the top 30 medical OEMs, serves 144 total medical customers, and manufactures products as diverse as glucometers and orthopedic implants. Jabil’s commitment to device manufacturing took a dramatic turn last summer when Johnson & Johnson’s Medical Device business unit transferred 14 manufacturing plants in the United States, Germany, and Switzerland to the smaller company, a move projected to save J&J roughly $600 to $800 million annually by 2022. The facilities, supplying DePuy/Synthes and Ethicon Endo products, represent a significant portion of J&J’s device manufacturing capability for orthopedic implants, instruments, and minimally invasive surgical devices.

An open question is whether the global contract manufacturers will change the economics of the supply chain. Companies such as Flex and Jabil have run for decades on profit margins under 10 percent. Whether these firms and their peers will be able to operate successfully in the device market at such thin margins is questionable. Still, the medtech market’s mid-single or double-digit profit margins remain a powerful draw for these global CMs.

Ten Largest Healthcare/Device Contract Manufacturers Based on Relevant Estimated Revenues ($ in millions)

Revenue Rank	Company	2018 Estimated Healthcare/Device Revenues
1	Flex	$2,400
2	Jabil	1,600
3	Integer	1,400
4	Celestica	980
5	Plexus	830
6	Aptar Group	765
7	Samina	760
8	Molex	600
9	Tecomet	500
10	MedPlast	500

The large CMs, with exceptional financial strength, sourcing capability, and manufacturing resources do not really have an insurmountable advantage over traditional supply chain companies, especially if the smaller firms focus on two issues. The first is to accept that device OEMs have transitioned work to global CMs to reduce manufacturing costs and pass along risk to partners that can shoulder the financial risk of multiple large programs. Competing head-on is a strategy only the largest traditional players may contemplate, and is likely to be a costly battle. A more effective approach may be to take advantage of three capabilities global CMs have not yet developed.

The first capability, and likely the most critical, is for traditional suppliers to demonstrate their unique expertise in their specialized fields. Global firms still have limited expertise in a number of non-digital niches in medical manufacturing. By stating that expertise to OEMs and demonstrating how it reduces the risk of manufacturing a product, the established supply chain company can claim an advantage over a larger, but much more broadly spread, competitor.

The second capability is time to market. One the best ways to reduce the risk of a product launch is to have the product on the market and generating revenue. If established supply chain companies can show OEMs they can get a product to market more quickly (with acceptable quality), the OEM has a strong incentive to select a smaller, but still capable, organization.

The third capability is better thought of as a requirement. Quality is no longer a “sometimes” issue. To compete against global CMs, companies that have integrated quality into their processes to both win customers and survive on razor-thin margins,  must demonstrate “first-time right” quality regardless of any other advantages they bring.

2018 Fiscal Year Gross Margin and Operating Income Percentages

Company	Gross Margin %	Operating Income %
Flex, Ltd.	6.5%	2.2%
Jabil Inc.	7.7%	2.7%

Global CMs will continue to reshape the medical device supply chain. Approaches that proved lucrative in the past will likely not be as effective against such capable competitors. To succeed, traditional suppliers will be well-served to understand their customers’ motivations for working with firms that have recently come to prominence in device manufacturing and tailoring an approach that relies on the traditional player’s expertise, agility in getting product out the door, and on exceptional quality as a standard. 

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Tony Freeman is the president of A.S. Freeman Advisors LLC, an advisor on mergers and acquisitions in the specialty materials and precision manufacturing markets. Based in New York, N.Y., A.S. Freeman Advisors also provides corporate strategy, market planning, and valuation improvement consulting services. Freeman can be reached at [email protected].