To Your Health

To Your Health

Experts Discuss the Positives and Possible Pitfalls for the Medical Device Industry and Outsourcing in 2006

By Stacey L. Bell – Editor at Large

Today’s global business climate presents medical device and contract manufacturers with some challenges they realy never had to consider in the past. During the past year, unprecedented natural disasters, combined with soaring energy and raw material prices, a resurgence of inflation and continued terrorist threats, prompted companies to change the ways in which they conduct business.

Unquestionably, expansion in the medical sector remains strong. Many companies report organic growth of 10% to 30% for 2005 and project similar, or slightly lower, figures for 2006. However, experts noted that they do have a number of business concerns for the coming year.

One area in which there are few concerns is demand for medical products. The aging worldwide population, coupled with increased buying power outside the U.S., promises to sustain continued double-digit annual growth for the foreseeable future.

Demand to Stay Strong

Kinross

The U.S. Census Bureau noted in its “Global Population at a Glance: 2002 and Beyond” report that 6.2 billion people inhabited the globe in 2002, with an annual growth rate of 1.2% (about 200,000 people per day). However, the growth rate is slowing significantly. Children comprised nearly 30% of the world’s population in 2002; by 2050, that percentage is expected to drop to 20%. On the other hand, the number of people 65 years of age and older is projected to triple during the same time frame. By 2050, seniors will comprise about 17% of the population.

Accompanying that population shift is an increased need for products in sectors such as cardiovascular, orthopedics, ophthalmics and interventional medicine. In addition, technological advances are allowing the integration of electronics and coatings into new products to provide more thorough medical care.

“Ten years ago, companies didn’t think about putting coatings on some types of products. Now it’s like a light bulb has gone on, and they’re realizing that if they use a coating on this product and it works, they may be able to incorporate it into 10 other devices as well,” noted Andrew Kinross, managing consultant for Navigant Consulting in Burlington, MA.

The Outsourcing Picture

The demand for outsourcing also is expected to rise as medical device manufacturers—like their counterparts in other industries who have long embraced the value of outsourcing non-core functions—turn to contract manufacturers for help in meeting their goals.

Frank Maloit, vice president of corporate procurement for CR Bard in Murray Hill, NJ, sees two primary trends in outsourcing. “More OEMs are outsourcing top-end projects that are in development—these are projects that may represent some opportunity for the company, but not enough to devote its own resources toward,” Maloit said. “There’s also a trend to outsource a project based on its earnings per square foot. OEMs are moving some projects out of their facilities so that they can concentrate on those projects that best meet their technical capabilities and earnings targets.”

Often, an outside partner can provide a new technology or other capability at a lower cost than the OEM would invest if it were to devote its own people, equipment and floor space to the task. Further, outside best-in-class partners have developed highly efficient procedures over time, allowing for faster product launches.

“If you can outsource the manufacturing, and the manufacturer can get the product to market two months earlier than you could, that’s two months’ more revenue and profit, which can mean hundreds of millions of dollars,” noted Kinross. Finally, product demand increases have translated into manufacturers upping their product runs nearly across the board; as a result, more companies are maxing out of their own manufacturing capacity. Outside partners, particularly those with facilities in portions of the world OEMs are interested in, can pick up that overflow easily and cost effectively.

Within the outsourcing arena, several trends have come to the forefront during the past year:

Goskowicz

• OEMs now prefer finished devices. “Medical device companies aren’t buying just a component anymore. They want an entire system that also includes expertise in the various disciplines—regulatory, packaging, sterilization, etc.—that a full-service provider has available. They want more value added to the product. A few years ago, they ordered molded components. Today, they want your years of experience to support a sterile ‘system,’” said Tom Black, vice president of OEM sales and marketing for B. Braun in Bethlehem, PA.

• OEMs want their outsourcing partner to manage it all, but not necessarily do it all. “I expect our suppliers to be able to manage secondary operations to bring a finished product to me,” said Maloit. “The ‘I can do everything’ approach isn’t always an advantage. I want the lowest cost possible, and one company generally can’t provide internally the best innovations at the best price across all capabilities.”

• Design and development represent the largest growth areas in outsourcing. More OEMs are seeking outside help from the beginning of a project to take advantage of complementary technical capabilities and design for manufacturability, noted John Lamb, a director at Pittiglio Rabin Todd & McGrath Management Consultants in Waltham, MA.  

• More OEMs want a global solution. Today’s customers are seeking global solutions—having boards built in Asia and then shipped to the U.S. or to the UK for assembly, reported Brad Goskowicz, medical sector vice president for Plexus in Neenah, WI. “On the other hand, we’re backfilling in the U.S., too. After all, 50% of healthcare dollars are spent in North America,” he said.

Outsourcing Challenges

While more companies are outsourcing more projects and more processes, there are some challenges that must be addressed.

Lamb

The first is quality control. Lamb noted that some OEMs are still cautious about outsourcing projects because they’re uncertain that all contract manufacturers fully understand quality and design control and, in some cases, whether they will protect IP. In short, “they want to be reassured that the supplier can be a reliable partner,” Lamb said.

“There’s a lot of demand on the supply chain to grow the quality systems to support the growing FDA requirements, which adds another layer of costs and challenges to the process,” added J. Randall Keene, president and CEO of Avail Medical Products, Inc., Fort Worth, TX. “A lot of companies aren’t experienced in the medical industry, so they don’t know how to do it, nor can they afford to do it. They don’t have the critical mass necessary to develop such systems. These holes in the supply chain create both problems and opportunities.”

Another large problem area is a lack of communication. “There are many capabilities that outsourcing partners create that never get fully leveraged within the OEM because of a failure to become synchronized within that OEM,” said Chris Oleksy, executive vice president and general manager of ATEK Cos. in Minneapolis. For example, an OEM might not realize that magnesium metal injection molding, a very recognized concept in other industries, may work much better for one of its projects than another process it has relied upon for the past few decades.

“OEMs should look at the capabilities their suppliers have and see how they can be used within their products. There is a hesitancy to take a risk with a new technology that’s not been used in the medical industry before, but these technologies have been vetted in other industries and could provide a significant competitive advantage,” Oleksy added. He also noted that too often OEMs don’t specify exactly how or when a material will be used. For instance, perhaps an OEM coats a metal before assembling a device. Sometimes the metal rusts before it’s used. If the OEM told the supplier the metal will be coated and that there has been a problem with rust in the past, the supplier could recommend another metal that is more rust resistant. It’s important to have the supply base deeply incorporated into the product development process.

Lack of communication can hurt the outsourcing function in other ways. According to Lamb too often companies do not have a coherent outsourcing strategy. “Too often, there is a strategic intention to outsource more, but the task is delegated to the operations department,” he explained. “Those folks don’t have the same vision. In fact, they want to protect the manufacturing that is no longer part of the corporate strategy. Therefore, there is no coordination of execution.”

To solve this problem, Lamb recommended that OEMs that wish to outsource “close the loop.” They must articulate a clear strategy around core competencies and the role of outsourcing. Then they must seek understanding and buy-in from groups throughout the organization, particularly in R&D, so that outsourcing opportunities will be thought of in the product design stage, before projects even get to manufacturing. In addition, the implementation should specify performance metrics for each position so each staff member is motivated to best meet the company’s goals.

Both the OEM and the contract manufacturer must develop data integration and effective governance from the highest levels on down to manage these high-value relationships and ensure that a true partnership mentality prevails, Lamb said.

The Business Climate

Sky-high energy prices have been the shot heard ’round the world in 2005. From affecting the costs of heating facilities and running equipment, to the use of oil and natural gas in making plastics and essential compounds used in processing, higher energy prices are affecting everyone. “I’m concerned about the stability of the worldwide supply network, particularly since energy plays into that and affects costs,” said Maloit. “There is not a plastic made that doesn’t come from oil or natural gas. Plastic prices have gone up 20% to 100% over the past year and a half. Higher prices affect us big time.

“Natural gas and crude oil touch almost everything,” he added. “From transportation to processes, the overhead of every company in the world is affected. Wal-Mart has reported its shipping costs are up $30 million this year. If Wal-Mart can’t negotiate out of these higher prices, how can any of the smaller guys?”

Higher energy prices are further curtailing a raw materials market that has been stretched lately due to high demand for metals and plastics from the aerospace and other industries. Consider: Titanium prices have more than tripled during the past 18 months, and lead times have expanded to 40 to 60 weeks; stainless steel prices have jumped by about 35 percent and lead times have nearly doubled to about four weeks.  

Craig Lozak, global strategic commodity manager for Johnson & Johnson in New Brunswick, NJ, reported that there also is an increased sensitivity in the availability of supply, particularly from those companies in the Gulf region, which is expected to continue through the first quarter of 2006.

Lozak noted that Johnson & Johnson continues to work with suppliers daily to monitor the prices and availability of materials and to ensure adequate supplies will be on-hand as needed.

Keene

“Far and away the biggest challenge in 2006 will be raw material availability and cost,” Keene said. “We’re so used to limited or no inflation that it’s shocking to see these price increases.”

Also surprising has been the number of changes occurring in resins. “Vendors are either walking away from or harmonizing resins—making fewer flavors, if you will—to focus on their top sellers,” Black said. Manufacturers typically are receiving about six to 12 months’ notice before changes are implemented. Manufacturers also are looking to reduce costs, or avoid increases, by converting to less costly materials. “In either case, our job is to find an alternate raw material and obtain all of the supporting data, biocompatibility, etc. in order to make the transfer seamless for the customer,” Black added.

In 2006, companies also may reconsider how much raw material and finished goods to keep in stock, as well as their business continuity plans.

“Certainly, the impact of high oil prices has had an impact on raw materials. Fuel surcharges and an overall transportation cost increase have been felt across our supply base. In addition, most supply chains around the world do not build into their inventory levels a buffer for rare events/storms like Katrina or Rita,” Oleksy said. “There has been such a move to reduce inventories across the supply chains of the world—and the medical device industry is no different.  When an atypical event such as these storms occurs, it creates havoc within the supply lines. We have seen vendors that manufacture in these areas, or import goods in these areas, struggle to meet ongoing operational requirements.”

In the wake of the widespread devastation wrought by the hurricanes, companies have been revisiting their business continuity plans. In some cases, they’ve increased the minimum level of supply they maintain. Others have put alternative suppliers in place.

Olesky

“ATEK is looking at the locations of its suppliers and asking to see their disaster recovery plans and sources of supply,” Oleksy said. “This level of business planning is new—we’re not used to seeing an entire city or region destroyed. Our customers, and our customers’ customers, rely on us to make sure we don’t have supply interruptions. Therefore, supply chain risk mitigation is key.”

Johnson & Johnson established a comprehensive business continuity plan after 9/11, which it continues to refine. The company expects its suppliers to have adequate continuity of supply and security programs in place for operations. “For our critical materials suppliers, we want to know that they have a back-up facility or supplier certified and available,” Lozak said.

Reimbursement Concerns

Some years ago, the FDA topped OEMs’ list of concerns in the business environment. Today, while the FDA’s commanding role remains the same, it’s reimbursement that is in the spotlight.

“FDA is an ongoing issue, but the process has been fairly constant over the past 10 years, and OEMs have a pretty good idea about what kind of data they need to produce to get a product to market,” Goskowicz said. “What’s changed is that reimbursement, particularly Medicare reimbursement controlled by CMS, has become a much more important concern. Our customers are sometimes spending more time and money on reimbursement approval than on FDA approval, or even marketing, these days. FDA approval is still a critical milestone—don’t get me wrong. But if hospitals or physicians can’t get paid for a product, it’s back to square one.”

Nevertheless, the regulatory environment is still of concern to OEMs. “When Mark McClellan was there, there was a vision and commitment to speeding advanced technology with patient and/or cost benefits to market. With the leadership crisis at FDA lately, that vision has apparently been lost,” Lamb said.

The European Union’s Restriction of Hazardous Substances (RoHS) and the Waste Electrical and Electronic Equipment (WEEE) directives also will impact U.S. manufacturing and products in 2006. Although medical devices are exempt from the directives, their supply chains aren’t. Therefore, by July 1, 2006, OEMs and suppliers must ensure that no lead is used in any process or product that enters the EU.

Other Challenges

Resources beyond raw materials also are in higher demand, most notably manufacturing capacity and labor.

“The biggest concern I’ve seen is capacity—getting the product to the customer,” Kinross said. “Particularly in the orthopedics and some cardiovascular markets, it’s all the contract manufacturers can do to meet delivery schedules. There’s such a huge demand. A lot of companies have announced expansions to their manufacturing footprints in the past 12 to 24 months to keep up with demand.”

Indeed, most of the suppliers and OEMs that spoke with Medical Product Outsourcing have either added more manufacturing space in the past 18 months or plan to do so in 2006.  Avail has added five plants in the past two years: three in Mexico, one in California and one in China, which opened in September. The company plans to open two additional plants in Mexico and perhaps a third facility in the U.S. in 2006.

“We have to stay ahead of demand, probably even more so than OEMs do because we don’t know what’s coming down the road,” Keene reported.

He noted that hiring has been a challenge in California, where highly skilled workers are in demand from IT, aerospace and other industries.

“Quality assurance people are the hardest to find. But for engineering and some other disciplines, we’ve found that the technology is much more advanced in some other fields, so by hiring an engineer from another sector, we can leverage that higher knowledge. The same is true in manufacturing—the medical industry can learn a lot from other industries. If we hire outside, advanced talent, then overlay our quality system, we’ve got a powerful combination.”

Keene added that some suppliers may need to add more design, engineering, quality assurance, regulatory and other experts within the next few years to continue to meet demand.

“One of our companies, a billion-dollar division of a large medical company, expects to grow 30% next year,” Keene said. “That translates into $300 million in sales, $75 million in manufacturing to be done. Will they hire 30% more staff or build another plant to handle the increased manufacturing capacity? No, the economic model favors outsourcing, and so we are preparing to meet this company’s increased needs ourselves.”

Kinross noted that OEMs have been hiring more engineers during the past year or so as they’ve worked to move more projects from concept to creation.

“The R&D budget as a percentage of sales has grown tremendously,” Kinross said. “Ten years ago, it was 5% of sales; today, the average is 12%.”

This increased focus on R&D should further increase the quality of medical products available and is expected to contribute to continued healthy growth in the medical device manufacturing for 2006. In the end, OEMs and their outsourcing partners must work together to ensure high-quality products get to market as quickly as possible—raw material and other challenges notwithstanding.

After all, “we’re all going to be patients, if we aren’t already,” Oleksy said. “We all need the industry to work in our favor. Therefore, we must bond together as an industry to serve that patient well.”

Stacey L. Bell is a freelance writer who specializes in business and marketing issues. She is based in Tampa, FL.