Beyond Outsourcing: Product Stewardship

This Model Redefines Partnerships to Restructure Costs
and Fundamentally Improve Competitiveness

Dave Busch
Solectron Corp.

Dave Busch

More than 2000 years ago, the ancient Greek philosopher Plato observed that “Necessity is the mother of invention.”

In today’s rapidly evolving medical device market, necessity remains the mother of invention or, more specifically, the mother of reinvention. OEMs in the medical device field are reinventing their business models in innovative new ways, as a confluence of forces is quickly changing the way these companies must operate to remain competitive. 

Market Forces Are Catalyzing Change

Perhaps delivering the most acute impact, profitability is being compressed as price sensitivity intensifies on both the provider and payer sides of the healthcare industry. This driving force is coupled with pressure from investors to grow top-line revenue and curb operational expenses in excess of the market, to maintain market capitalization levels. Above average revenue growth usually is accomplished in two ways: inorganically through acquisitions, and/or organically, by releasing new products more often. Existing products also can be reformulated for entry into new markets.

Outsourcing, which can range from contract manufacturing to external management of the entire supply chain, is another trend that is gaining rapid momentum in the medical OEM arena. It dominates many industries such as network equipment, where an estimated 98% of manufacturing is outsourced. Outsourcing is extremely attractive to medical device OEMs because it delivers a significant strategic benefit: increased asset velocity.

The term “asset velocity” refers to the speed with which companies make a product, turn over inventory or deliver the product to customers. Wall Street consistently rewards high asset velocity companies such as Cisco and Wal-Mart.

Although top medical device OEMs operate with gross margins in the 50% range, their market caps tend to be less than companies that have moved to an outsourced business model. The reason for this discrepancy is that medical device companies have a low asset velocity. Outsourcing improves this metric based on the principle that asset velocity increases as fixed costs in the supply chain are transformed into variable costs. “Variable-izing” costs are a major financial benefit from supply chain outsourcing. 

More Pressure, But Less in the Budget

On the technology front, there are increased demands to create sophisticated solutions that converge technologies—such as enabling infusion pumps with wireless Bluetooth connectivity, and building advanced networking products for state-of-the-art operating theaters. These breakthrough types of products require medical device OEMs to team with partners that can not only manufacture products to a design specification, but can also “innovate and renovate” an OEM’s product portfolio, thereby greatly enhancing the partner’s potential value.

The marked increase in pressure on OEMs to provide innovative new products, while concurrently reducing costs and speeding time to market, is creating new challenges—and new opportunities to rethink the way business is done to increase nimbleness, efficiency and profitability.

R&D Evolves to Focus on the Future

Employees from Solectron’s Medical Center of Excellence in Singapore perform a level-5 systems integration on a medical OEM’s product.  The product stewardship model of product design, manufacturing and complete supply chain management is a new approach to delivering proven services offered by outsourcing providers that can reduce time to market, speed product development and achieve quality standards while maximizing potential of existing products.

Due to the sensitive nature of the intellectual property engineered into medical devices, OEMs historically have developed vertically focused supply chains and managed them with tight command-and-control processes. However, rapidly changing market forces and industry trends are reshaping the competitive landscape and causing leading medical device OEMs to reconsider this approach.

For example, change already is underway in medical device OEMs’ R&D, engineering and manufacturing organizations. The most forward-looking companies recognize that the majority of R&D and engineering resources must be focused on developing new products and new revenue streams—but pressing issues associated with current products today consume a disproportionately large amount of limited resources.

Although R&D resources continue to shrink, consumers continue to demand the most innovative products, expecting the latest technology faster and at a lower cost. This creates a void—the need for medical OEMs to focus on new product innovation while sustaining current and new versions of existing products under budget constrictions. As a result, many OEMs try to prioritize their new product development initiatives over sustaining engineering efforts for current products. However, with so much intellectual property and financial resources invested in existing products, companies often fail to achieve the desired focus.

Rethinking Outsourcing With Product Stewardship

Product stewardship is an innovative solution that addresses market pressures to innovate while maintaining proven revenue-generating products. It is a natural extension of the outsourcing model, entailing a partnership between a medical device OEM and a contract manufacturer (CM) that concentrates on the entire life of existing products. With the product stewardship model (PSM), medical device firms can turn to a trusted outsourcing provider to extend the life and profitability of existing products, helping to ensure near- and long-term competitiveness. Under this arrangement, the CM assumes responsibility for design enhancements in the portfolio of existing products. In doing so, the CM partner can significantly improve the OEM’s success with proven revenue-generating products by improving quality, speeding time to market and reducing lead time.

As a result of driving down costs on proven successful product families, medical device firms can redirect their precious engineering resources to new product initiatives. This, in turn, helps medical device OEMs take a strong step toward future revenue performance and improving their competitive stance.

How It Works

Under a PSM, the CM assumes an integral role in the entire life of existing products—design and engineering, manufacturing and aftermarket service and support. Services for an existing product line typically include:

• Product design/redesign

• New product introduction

• Volume production

• Sustaining engineering

• After-sales support

An effective PSM allows OEMs to focus limited engineering resources on new product development, while the outsourcing partner provides new product design execution, enhances design and manufacturing linkage, improves quality and speeds time to market while lowering costs on proven successful families of products.

Using the PSM, OEMs can exploit the advantage of a CM’s lower overhead rate. For example, working with a tier-one CM allows OEMs to capitalize on its partner’s global footprint. This greatly enhances the medical device firm’s ability to achieve the lowest total landed costs while also gaining access to collaborative engineering resources close to the OEM’s engineers. 

The PSM approach is gaining momentum with many companies. Over the years, the model has evolved to include several phases:
   
• Phase I: Collaborative Design—Depending on the customer, the PSM typically begins by engaging engineers in architecture and system definition phase. The CM’s engineering team works as an extension of the OEM’s engineering organization. This early engagement model allows CM engineers to fully understand and, therefore, fully own the design execution of any PSM program.

• Phase II: New Product Introduction (NPI)—During NPI, the CM works with end customers to test the function of the product and stabilize the design. The PSM offers OEMs the ability to take advantage of a CM’s experience in design for X, where X includes design for manufacturability, design for test, design for Six Sigma quality, design for compliance, etc.  

• Phase III: Lowering Costs—While the NPI phase stabilizes the design and achieves the target yield goal, the PSM also addresses the readiness criteria to transfer volume production to a low-cost region (LCR). Both the sending team in the NPI site and receiving team in the LCR work together to complete necessary training and equipment setup. The transfer is ready when all technical criteria are met, but the transfer implementation is controlled under customer demand. During the lifecycle of the products in the PSM program, sustaining engineering plays a key role in maintaining and expanding the product life, which satisfies the OEM’s installed base. Design for cost reduction and obsolescence management also are key value-added services for OEMs. 

• Phase IV: Product and Process Optimization—Once the product has been sold in the market, it may require periodic servicing. During product servicing, CM engineers can track recurring flaws. These field failure data can be fed directly to failure analysis labs established in worldwide locations to support OEM customers. By continuously improving product quality in future generations of the product, quality is improved and costs can be lowered.

Assessing When to Use the PSM

Solectron engineers examine a design model from a leading medical device firm. Under the product stewardship model, a contract manufacturer’s engineering team works as an extension of the OEM’s engineering organization.

When considering a CM partner, an OEM should first assess its needs and identify which product or department requires assistance. Once identified, the OEM should determine the specific outsourcing services needed, such as product design, prototyping or sustaining engineering.

Most OEMs that are interested in the PSM typically are focused on long-lifecycle product families. In market segments with long product lifecycles, such as medical, telecommunications and industrial, the PSM can be adopted readily and successfully. 

In some cases, OEMs may need outsourcing assistance in numerous areas. In other situations, medical device firms may find that they desire support for only one aspect of the manufacturing supply chain, such as sustaining engineering efforts. OEMs that implement sustaining engineering practices to extend the life of current products will maximize the return on investment of the legacy product.

Conclusion

Despite a tradition of enjoying high profit margins, medical device OEMs are under mounting pressure to grow their market capitalization by increasing revenue, decreasing costs and boosting asset velocity. While new, breakthrough products provide the most obvious path to increased revenues, the pressing need to maintain current product portfolios is a powerful distraction. The PSM is an extension of the relationship medical device OEMs can forge with contract manufacturers. 

The PSM allows R&D and engineering efforts to be focused on product innovation while the CM outsourcer assumes responsibility for maintaining existing products. This benefit, in turn, allows medical device OEMs to take a strong step toward future revenue performance, larger market capitalizations and a more powerful stance in a competitive global market.

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Practices: Medical Device OEM Snapshot

The benefits of the Product Stewardship Model (PSM) are not restricted only to large companies with a large installed base; the model also is ideal for small medical OEMs. The following example illustrates how a medical startup company approached a large contract manufacturer (CM) for support with product design, setting the foundation for a full-scale PSM program. 
   
In this example, the medical company had developed a new electronic device to address migraine pain. The device was built in a university lab with discrete components, delivering very promising initial results during testing. At this point, a partnership was formed between the medical OEM and the CM, which assumed responsibility to design the device into a full production-quality product. In establishing the terms of the relationship, the medical company maintained complete ownership of the technology and intellectual property, while the CM’s engineers transformed the concept and architecture design into a working product. 

After the design was completed, the CM took full responsibility to produce the prototype devices for the medical company’s clinical trials, as required by the FDA approval process. The CM also worked with the medical device OEM in preparation of full-volume production, including all aspects of supply chain and logistic management. 

This example shows the flexibility of the PSM concept—the PSM allows both small and large companies to tap the resources of a tier one global CM company: complete product design, manufacturing and supply chain strength.  Under the PSM, time to market can be significantly shorter and engineering/R&D resources can be conserved, allowing them to be focused on high-impact projects with maximum revenue potential.

Dave Busch is a vice president of medical at Solectron Corporation. Solectron is a provider of contract manufacturing and integrated supply chain services. Dave can be reached at (408) 957-8500 or [email protected].