Asias Continued Manufacturing Evolution

There are two main reasons to go to Asia: to manufacture products at lower cost and/or sell to the Asian market. You’ve probably heard of companies bringing their operations back because of quality issues, or that China doesn’t represent the cost savings it once did, or that Chinese companies are making products for their markets that compete favorably with the same products from the West—although this is all true to some extent, it is not a rampant trend. Opportunities still exist for most companies in Asia—where they locate depends on many factors, including type of product, operations, target markets and business goals.

The outlook for medical device consumption in Southeast Asia, for example, is very favorable. According to a February 2012 report by Espicom Business Intelligence, Asian markets are expanding more quickly compared to the more developed, mature medical device markets in Western Europe.
China, of course, is still the leader, but Malaysia, South Korea, Cambodia, Vietnam and Thailand are strong emerging markets—both as a places to manufacture and as potential consumer markets. For example, South Korea has a population approaching 50 million and an overall gross domestic product that places it among the top 15 economies in the world. The country also has the highest healthcare expenditure in Southeast Asia, with an estimated 60 percent funded by the public sector.

The report noted that the high growth rates for this region have been spearheaded by strong medical devices import growth and steadily rising health expenditure. Healthcare development and provision is an increasing political and social priority for nearly all these countries, even the poorer ones like Indonesia, Thailand and the Philippines, and the prospects for medical devices remain strong. Other factors driving the market’s growth rate include Vietnam’s expansion of health insurance to all citizens by 2014 and the opening of the “notoriously difficult but lucrative” South Korean market via free trade agreements with the United States and the European Union, according to study authors.

Ten years ago, the majority of medical devices made by U.S. companies in Asia were exported out of Asia. Today, however, many of these products increasingly are designed and manufactured for local market consumption—especially in China.

Many OEMs have invested in China for years due to the rapid growth of the medical equipment market, which according to the Global Data market research firm, will show a compound annual growth rate of about 11 percent from 2011 to 2018. The actual value of the medical device market in China is expected to be about $28 billion by 2014.

“It’s been predicted that by 2040 more than 20 percent of the Chinese population will be over 65,” said Sivabalan Munusamy, senior business unit manager for Jabil’s Healthcare & Life Sciences division, which has operated in China for many years serving medical OEM customers. “Government investments and reimbursement and grants in healthcare over the past five years, which aimed to provide better healthcare access for the entire population, have resulted in many new hospitals and clinics with an increase of spending for medical devices and equipment.”

China Still on Top
There are three fundamental reasons for manufacturing in Asia, and specifically China:

• Cost savings realized due to the significant reduction in burdened labor rates;
• Availability of established, second- and third-tier suppliers to support product manufacturing; and
• Access to the lucrative Chinese device market.

Everyone knows the big reason for lower manufacturing costs in China is inexpensive labor.

“Labor rates can be up to 60 to 80 percent lower in China compared to the U.S.,” said Joe Horvath, president of Allentown, Pa.-based Sanbor Medical, which has operated in China since 1993.
However, this cost advantage has shrunk since the passage of a 2008 labor law that gave more rights to blue-collar workers.

“Wages and benefits in China have increased by 25 percent over two years,” said Ames Gross, president of Pacific Bridge Medical, a Bethesda, Md.-based consulting firm that assists medical companies in Asia.

Although China continues to be a country of choice for offshoring it is not always the lowest-cost location anymore.

“Some companies that make low-cost commodity products like rubber gloves, gauze and drainage bags are moving to Vietnam, India, Indonesia and Cambodia,” said Gross. “Companies that make more complex products will stay in China for quality reasons.”

Even with increasing labor costs, the Chinese market continues to grow for other reasons—companies want to be there because of the relatively stable government, higher quality of production and the huge consumer market.

“We were attracted to the low labor costs, strong medical industry growth potential and the fact that China is the biggest new market in the world,” said Anura Welikala, executive vice president of technical business development for Carpinteria, Calif.-based Helix Medical, which started production at its Shenzhen, China, facility in 2007. “We also wanted to be closer to several key customers—having a strong existing or potential customer base is critical to success for any startup in China.”

Mike Badera, owner of Precision Extrusion in Glen Falls, N.Y., indicated that not only was the number of customers asking him to come to China a big factor, the incentives being offered by the economic development zones also were highly attractive.

“The policies in China, especially in central government-sponsored zones, are much more generous than the enterprise zones in the U.S. because they are so eager to grow their domestic manufacturing base,” he said.

Asian countries compete fiercely for U.S. investment, especially from the medical device industry.

“There are many governments that are providing schemes and incentives to help underwrite a company’s initial investment or decision to plant a flag,” said Evan J. Winston, a senior market development executive for International Enterprise Singapore, an economic development organization with offices in Singapore and New York, N.Y. “They want to win its attention early in the global supply chain decision-making process. For example, Singapore wants companies to know it is English-speaking, has a stable government with a familiar British system of law, maintains world-class multi-modal logistics, protects intellectual property and offers a highly trained, well-educated workforce—all key considerations for medical device companies.”

Risks Remain
Big risks for firms looking for Asian entry include communication and cultural differences, unstable governments and policies, susceptibility to natural disasters, quality assurance issues, intellectual property (IP) protection and dealing with myriad, often-changing laws and regulations.

Many companies find that communicating halfway around the world can be extremely frustrating, with a time delay that can seem like an eternity in a crisis.

“For us a big risk we saw was that everything was 10,000 miles and 12 time zones away,” said Badera.
“We had to rely on referrals to find accountants and lawyers and translators who knew what we wanted and needed and could make it happen for us. It was very difficult and time-consuming because rules and regulations vary a bit from province to province. If we made a mistake during the setup of the business the whole thing could have been a waste of time.”

If either you don’t own the manufacturing facility (i.e., your products are contract manufactured and you are the specifications developer) or are not intimately involved in the design and development of the device from the very beginning, the probability is extremely high that the design control activities have not been executed and documented in accordance with regulatory requirements, noted Jonathan M. Lewis, principal with Advanced Biomedical Consulting LLC in St. Petersburg, Fla.

“Design control documentation can be extremely difficult to obtain ‘post-development’ and is even more difficult to translate,” said Lewis. “Rarely does this documentation fully address current FDA regulatory expectations.”

One of the biggest risks is protecting intellectual property. As the device industry continues to evolve in Asia and more foreign entities choose to manufacture there, IP protection is getting more attention by government agencies.

“Because the region has been lax regarding IP protection rights, the availability of product forgeries continues to be problematic,” said Christopher Devine, Ph.D., president and founder of Devine Guidance International Inc., a Las Vegas, Nev.-based consulting firm with extensive experience in China. “Granted, the $19 Rolex has been around for years; however, device and drug forgeries present a significant regulatory and enforcement challenge.”

But time has brought change.

“It’s not as bad as it was 10-15 years ago, especially with low-volume products that wouldn’t be worth the upfront cost of reverse engineering,” added Horvath. “However, just like here in the U.S.; it’s still worth the effort to take protective measures.”

Part of the problem is that the Chinese simply don’t understand what IP means, experts said.

“The Chinese are taught by copying, by rote learning,” said Gross. “It must be explained very clearly what IP is—they don’t understand the concept and it must be continuously reinforced.”

A Rapidly Evolving Market
Asia is a place of constant change. In the late 1980s the biggest concern was quality and the inconsistency in product quality on a lot-by-lot basis; although product quality issues still exist, the overall commitment to product quality by Chinese manufacturers has improved significantly.

“Part of the sustained quality improvement can be directly linked to the application of recognized quality standards such as ISO 9001:2008 and ISO 13485:2003,” said Devine.

Class 1 and Class 2 devices have been locally made in China for many years. Five years ago, most Class 3 devices were imported. For example, drug-eluting stents were 80 percent imported and 20 percent made in China. According to Gross that trend has now reversed, with 80 percent being made locally.

“More local Chinese companies are making Class 3 devices,” he said. “They are lower quality, but still significantly cheaper than those made in the U.S. Furthermore, their quality continues to improve and at some point a crossover will occur where it won’t be cost-competitive for U.S. companies to just export these devices to China. In the near future local Chinese companies will make Class 3 devices from FDA-approved factories in China and sell them in some Western countries.”

Economic policies and banking policies change frequently, which can cause some financing and investment quandaries. There are more regulations and bureaucracies engaged in foreign direct investment, with new sets of rules. Shipping rates, taxes, customs services and duties all are increasing. The costs of labor and materials in China also are increasing much faster than in the U.S.

“Some providences in China require salary increases of 18 percent to the employees,” said Alan P. Schwartz, executive vice president of MDI Consultants Inc. in Great Neck, N.Y. “Clients have told me that it is harder to keep staff because employees are now changing jobs for more money. These jobs are being advertised in papers or by word of mouth. Some production areas in China are a little like the Wild Wild West.”

High worker turnover rates are increasing training costs and reducing quality, with some facilities experiencing between 40 percent and 60 percent turnover annually.

Helix Medical has seen a 20-30 percent pay increase in southern China, primarily for technical associates, within the past five years.

“On the positive side,” noted Welikala, “we have also observed major infrastructure and logistic improvements in China. There has also been an increase in customers willing to consider China once they have seen the quality products we produce and the benefits delivered by a global contract manufacturer.”

This is a key decision for medical device manufacturers that are considering Asia as a location for a facility. Do they go for low labor costs (that are increasing steadily) and perhaps lower-quality infrastructure, or locate in a higher-labor cost country that already is well-developed and supported, where quality won’t be as much of an issue?

“Countries like Singapore are great places to locate regionally for these very reasons,” said Winston.
“Singapore is often not initially considered as a manufacturing site because wages tend to be higher than the rest of Asia due to the highly skilled workforce and quality of life. Singapore has evolved industrially due primarily to its highly complex manufacturing and services. These services are typically less manpower heavy and more technology-dependant. As labor prices rise, the overall effect is not as pronounced because it is already a smaller part of the cost matrix for many Singapore firms.”

Moving Ahead
Before a company sets up operations in China it must determine the market demands for its products. Research on the size and growth potential of the market should be done using experienced, primary market research firms. This can cost anywhere from about $20,000 to $150,000.

“It’s expensive to get the right information you need make these critical decisions,” said Gross. “More Class 2 and Class 3 devices are being required to have local clinical studies performed before they will be approved in China. In the past, this could be addressed using U.S. data. For some companies and devices, the cost of doing these local clinical studies can be a game-changer. Over $500,000 for clinical studies will definitely make smaller companies think twice about entering the market.”

Any cost-benefit analysis must go beyond labor rates and dig deep to determine hidden costs and their impacts.

“For example, direct labor costs can result in a 75 percent reduction over similar costs in the U.S. However, when you add all of the other costs such as costs associated with logistics, travel, quality
issues, communications and other intangibles associated with doing business in China, the net cost savings drops significantly,” Devine said.

This is supported by a case study reported in the August 2011 edition of Manufacturing & Technology News that revealed only an 8 percent savings when a product is manufactured in China rather than the United States.

“There are substantial savings associated with purchased parts from China that include direct labor (79 percent savings versus U.S. labor rates), indirect labor and salaries (61 percent savings), benefits (75 percent savings), overhead (40 percent savings) and selling, general and administrative (11 percent savings),” according to the article’s authors. “When adding logistics to the China price, the cost advantage of producing in China shrinks to 8 percent: $13.85 for a case-study product made in China versus $14.99 in the United States.”

Most medical device OEMs use global partners for help analyzing the best method of manufacturing and shipping their products into the China market, whether they are imported from another country into China, manufactured in a free-trade zone or in a local China manufacturing facility.

Large global design and manufacturing companies such as Jabil typically rely on trusted networks of internal and external experts to develop mitigation strategies for tackling the risks and unknowns they might face in the Asian emerging market—assets that smaller companies may not have and not willing to invest.

When making decisions about importing versus in-country local manufacturing, Munusamy suggests asking for different scenarios and analyzing all the elements that impact the final decision, such as:

• Shifts in liability in accordance to how the manufacturing and supply chain is being set up and modeled;
• Regulatory approval lead time and schedule for workshops and type testing specific to your product;
• Time frames to apply and obtain good manufacturing practice and MDMP (medical device manufacturing permit) licenses from state regulatory authorities;
• Logistics, timeframes and costs for repair processes;
• Different customs timeframes, fees and tax issues with imports from different countries;
• Local design support for new product launches; and
• How your product is perceived by the healthcare and regulatory community (this also is dependent on the selected country).

“Also be aware that when setting up a manufacturing partner in China, due to certain State Food and Drug Administration (SFDA) rules, the regulatory liability can shift from the OEM to the manufacturing partner,” Munusamy told Medical Product Outsourcing. “Therefore, careful planning with your manufacturing partner is required, but the long-term benefits of speed and costs are worth the up-front planning.”

It always is beneficial to find local market and regulatory consultants who can assist with understanding the structure and workings of the SFDA, which has national, regional and district offices that set guidelines for different product types and issue different manufacturing and trading permits required for medical devices.

“Having someone (or several people) on the ground in China with relationships built already for interaction and management of the design and development efforts and management of the manufacturing facility is a huge benefit,” added Lewis. “Also be sure to have an independent U.S.-based firm involved in the due diligence audit the proposed manufacturing facility (whether to be owned or a contract manufacturer) for FDA (U.S. Food and Drug Administration) regulatory compliance before the deal is sealed.”

Patience Required
Be prepared for paperwork—and lots of it.

“It’s relatively easy to find a good location, but getting through the bureaucracy seemed like a never-ending battle,” said Badera. “The only way to speed it up is by having someone on the ground in China to chase the paperwork and the people to get it done. Of course you also need all your documents in Chinese, and there are many more documents required than in the U.S. There are also business license requirements, tax licenses, appraisal requirements, business plan approvals and CPA verifications of funds. If you are leasing there is one set of documents; there is a different set if you intend to build.”

How quickly a company can set up depends on the effectiveness of their partners and the assistance they receive from the government.

“This varies greatly by country,” said Winston. “In Singapore, it is fairly easy. Registration is inexpensive and can take less than an hour. Approval of the registration can be instantaneous, but may require two to eight weeks if additional approvals are needed by associated authorities for specialized businesses.”

That ease is not always the case, however.

“I’ve heard it can be done in six months or take as long as two years,” added Badera. “From my experience in China it took about nine months from making the decision to go forward to getting licensed. After that another six months was required before we had the space renovated and equipment in place.”

A frustrating startup problem can be the integrity of the quality management system. Although always a concern, elongated supply chain issues usually can be resolved with a proactive approach to planning and effective supply chain management.

“The biggest challenge is rooted in effective material requirements planning management and specifically inventory management,” said Devine. “Understanding the lead times, predicted manufacturing cycle time and on-time-delivery performance of suppliers located in China will determine the inventory levels required to support customers in the U.S.”

When it started in China, Precision Extrusion installed the same quality management system it uses for its U.S. operation. However, the company quickly learned that the quality of products and supplies from local suppliers varied greatly.

“It is very difficult to source everyday supplies like we do in the United States,” said Badera. “The quick way to deal with it was to import what we needed from the U.S. to get started—then over time we developed relationships with qualified suppliers and supply chains locally, but this still requires constant vigilance to maintain. For example, dealing with local machine shops, every order for a special design requires meticulous care in the drawing and specifying of what you want, then follow up during the production of the part or parts, and of course a very thorough inspection when it is completed.”

Although workers are plentiful and, in general, very loyal, dedicated and productive employees, it takes time to understand the nuances of language and culture.

“You especially need to be very careful with common-use words, slang or jargon. These can be very confusing to Chinese workers,” said Horvath.

To make communications as clear as possible, Sanbor Medical uses a “bullet point” strategy.

“Everything we write is in bullet-point fashion,” Horvath said. “If I write a paragraph about five things, I break it out into five bullets.”

Besides clear communication, extensive training of Chinese workers also is required.

“We routinely send our associates from China to our U.S. facilities for training and to provide a cross-functional experience,” said Welikala. “Helix also provides language study and invests in the personal growth and development of their associates to develop the skills needed to serve our global customer base.”

* * *
Despite years of experience, even “established” Asian markets such as China continue to change rapidly. With newer emerging markets nipping at China’s heels and offering different value propositions, medical device companies must conduct a lot of homework before deciding to make the leap. The benefits aren’t always clear-cut, but with the right research and investment of time, companies may just find the right fit.


Mark Crawford is a full-time freelance business and marketing/communications writer based in Madison, Wis. His clients range from startups to global manufacturing leaders. He also writes a variety of feature articles for regional and national publications and is the author of five books. Contact him at [email protected].