Michael Barbella11.14.08
Playing in the Big League
In the second artlcle from our two-part series, large contract manufacturing firms outline the advantages they can offer medical device OEMs.
Michael Barbella
There is no mistaking the irony. Ronald B. Earle spent more than 30 years helping companies develop new medical devices, but he learned one of the more valuable lessons of his career from a toy engineer.
In the mid-1990s, Earle was working with a West Coast company to develop a syringe and pump delivery system for diabetics. At the start of the product development process, the company hired an engineer from Mattel to work on the project, a move that seemed unconventional at the time. As Earle’s team worked with the engineer, however, the reason for his hire quickly became apparent.
“The toy engineer understood tooling and undercuts and complex molding details in a small area much better than we did in the medical [device] industry,” Earle recalled. “So the collaboration between the two sides resulted in the development of an ambulatory insulin pump and a stackable IV therapy pump. Both were sophisticated devices—the IV pump could have been a multi-channel device but it was just ahead of its time. The company eventually sold the device off to Siemens.”
The insulin pump may have been ahead of its time, but the concept of outsourcing certain aspects of a product development project was slowly gaining popularity in the medical device industry. While the practice has thrived in both the automotive and telecom industries for years, outsourcing has only recently begun to take a more active role in the medical device industry.
Photo courtesy of Covidien. |
As the medical device market began to grow, however, OEMs were forced to find ways to reduce costs, increase their profit and get products to market faster. Outsourcing, they soon realized, could help them accomplish these tasks.
“Other industries have embraced the idea of outsourcing and not having manufacturing as a core competency. But in healthcare, everything takes longer,” said Ben Dunn, managing director at Covington Associates, an investment banking firm based in Boston, MA. “That idea has gradually been making its way over to medical device companies and a realization has taken place among these firms that they don’t have to get involved in manufacturing. There is an understanding now among medical device companies that outsourcing organizations can develop a product and get it to market faster.”
The medical device market in the United States is valued at $80 billion and is growing annually between 8% and 10%, with some sectors growing at a rate of 15%-20%, according to industry estimates. This enormous growth has put OEMs under an increasing amount of pressure to develop new products. Industry analysts expect OEMs to respond to this pressure by relying more on outsourcing partnerships over the next few years.
Initially, outsourcing was used by OEMs mostly in the manufacturing phase. But as the practice has evolved and the medical device industry has matured, OEMs have begun to realize that outsourcing across a wide range of services also can help them gain a competitive advantage. There are hundreds of contract manufacturers in the industry that provide specialized services such as stamping, assembling, sterilizing, molding, and packaging. But with OEMs continually searching for ways to reduce costs, many contract manufacturers have evolved into “one-stop shops,” offering a full range of services, from product development and design to production and packaging.
“From an OEM perspective, the ‘one-stop shops’ are places where everything is going to be handled. The project will get done faster and everybody associated with the project is under one roof,” Dunn explained. “I recently met with a company that is having a catheter produced but there are six different [contract manufacturing] firms making the catheter. From a logistical standpoint, it takes a lot of resources to manage six different companies.”
Is Bigger Always Better?
Boston Scientific is one of the world’s largest medical device companies. More than 25,000 people work at the 26 manufacturing, distribution and technology centers the company has scattered throughout the globe. Without question, Boston Scientific has the facilities, the capabilities, and the capital to make any product it wishes.
Yet the company—like most other OEMs in the industry—uses outsourcing to get its products to market quickly and more efficiently. Speed to market and improved quality controls are just two factors that make large contract manufacturers an attractive choice to OEMs lookin to outsource part of the manufacturing process.
Quality control regulations from the FDA have helped contract manufacturers reassure OEMs about the superiority of the products being manufactured. Requirements handed down by the FDA over the last five years have helped ensure that all medical manufacturers are on the same playing field: They all must adhere to strict manufacturing guidelines and ensure that products are made to exact specifications.
“One of the big problems OEMs had years ago and what deterred them from outsourcing their product manufacturing was their concern about the suppliers' ability to meet product quality specifications and reliability. As the new ISO and FDA device compliance regulations expanded and increased in their application, it became much easier for OEMs to audit contract manufacturing to determine their capabilities. This qualification or disqualification process gave OEMs a higher level of confidence to outsource," said George Blank, president of The MedTech Group, a medical device contract manufacturer in South Plainfield, NJ.
“These requirements gave OEMs a much higher level of assurance that when they establish a relationship with a contract manufacturer, they are entering into an environment that will support their specifications,” he continued. “And that has given OEMs a much better magnifying glass to look at these contract manufacturers and determine whether these companies have what they need.”
Making such a determination is not an easy task, considering the number of contract manufacturers vying for business (one estimate puts the number at more than 3,000). Small “mom and pop shops” dominate the medical device landscape, but large contract manufacturers such as Accellent Inc., Symmetry Medical, Greatbatch and Heraeus control about half of the market, according to industry estimates.
The sheer size of these larger firms make them an obvious choice among OEMs looking to outsource. Industry experts who spoke with Medical Product Outsourcing said large contract manufacturing firms make better outsourcing partners than their smaller counterparts for several reasons: They are capable of providing soup-to-nuts services and can handle large-scale production requests. Larger contract manufacturers also tend to communicate better with their partners and be more financially stable than smaller firms.
For some OEMs, financial stability plays a central role in determining whether to form an outsourcing partnership. Multi billion-dollar companies such as Boston Scientific risk their money and worldwide reputations by entering into outsourcing relationships, so they must naturally be more analytical of a vendor’s finances and quality controls than tiny medical device firms struggling to make a name for themselves.
“There are a variety of things we look for and it’s really dependent upon the opportunity. But one common thread is a company’s financial stability and whether or not it has a good track record regarding quality,” noted Bryan Szweda, director of operations for Natick, MA-based Boston Scientific. “We look to see if there have been any recalls, because recalls are the worst thing that can happen. That puts a scar in people’s minds. We also find out who the notified body is for ISO and the kinds of quality systems that are in place.”
Besides their financial stability and vast resources, large contract manufacturers can offer their customers “global capabilities” and services that have become necessary in today’s global economy, experts said. In addition, the broad array of services offered at larger firms can result in lower costs and faster results. Keeping the various product development processes under one roof often results in a more efficient product development process, which enables devices to be brought to market quicker. It also ensures consistency in quality—large contract manufacturers can guarantee customers that the quality of the product development process will be consistent throughout the duration of the project.
Providing a broad range of services also gives larger contract manufacturers the ability to better handle and solve unexpected problems that arise during the product development and manufacturing process.
Sandvik, for example, can tap the expertise of its research and development team (which currently tops 2,200) to address customers’ concerns early in the product development process. That team, according to an executive with the Swedish engineering group, is knowledgeable in metallurgy and coatings, and is driving key initiatives in surface technology, wear properties and powder technology.
Similarly, Covidien has experts in vendor-managed inventory, sterilization and biocompatibility testing on hand to address customer concerns. The $10 billion medical device and pharmaceutical manufacturer was a part of Tyco International (as Tyco Healthcare) until its spin-off and name change last summer. Having sold its products in more than 130 countries, Covidien also has experience working with a diverse clientele, ranging from global entities and virtual companies to emerging startups. Such a diversity, industry experts agreed, gives the Mansfield, MA-based firm a better understanding of customers’ needs and enables them to be more adept at preventing problems during the production process.
“Having been in the medical device business for more than 25 years, I’ve learned that issues and problems happen frequently,” noted Tony Mulone, vice president/general manager for Covidien’s OEM Division. “It is how you deal with those problems that show your true value to the customer. As a large company, we can call upon many disciplines to address a customer’s concern.”
One of the less obvious advantages of partnering with a large supplier as opposed to a smaller one is the manufacturing agreements that the bigger firms tend to negotiate. While such agreements can be both timely and costly (not to mention bothersome), they nevertheless serve an important purpose. “They represent a roadmap for the [outsourcing] relationship,” explained The MedTech Group’s Blank. “These agreements provide details on how each side is going to behave and what the responsibilities will be. It’s like an SOP (standard operating procedure) for the relationship. Typically, smaller contract manufacturers don’t do that. There are benefits for both sides but the greatest benefit that I find is that it gives both parties a very detailed, up-front description of how the relationship should work. And that’s a big advantage.”
Big Advantages Beget Big Challenges
Large contract manufacturers certainly have some big advantages over their smaller counterparts in the industry. But those big advantages can spawn some equally big challenges.
Naturally, large contract manufacturers must work harder to control costs. While the revenue they generate is significantly more than small or midsize companies, large contract manufacturers have more employees to pay and more overhead costs than other firms.
Large contract manufacturers also tend to conduct business with large customers. On the surface, this may not seem like such a difficult challenge. But large customers have large requirements; they have a big appetite for speedy service and they often have demands that extend beyond the borders of the United States. Simply interacting with a large customer (such as Boston Scientific, Abbott Laboratories or Medtronic) requires strong management skills, industry experts said. In addition, large customers often expect their outsourcing partners to conduct business in the same manner they do, only faster and for less money. As a result, large contract manufacturers are under enormous pressure to perform well, perform efficiently and at a lower cost.
Large contract manufacturing firms make excellent outsourcing partners for various reasons, including financial stability and the broad array of services they offer. Photo courtesy of Covidien. |
Perhaps the most difficult challenge facing large contract manufacturers, however, is the same one that affects their smaller cohorts: a lingering trepidation toward and general wariness about outsourcing. Overcoming this obstacle won't be easy, but industry experts believe it can be done - once companies gain a better understanding of the practice and realize the ways it can benefit their bottom lines.
Once medical device companies become more comfortable with outsourcing and gain a better understanding of its benefits, they will be better equipped to form successful relationships with vendors. Industry experts agree that successful outsourcing relationships are based not only on good communication, trust and honesty, but also on a mutual understanding of the ways in which outsourcing can benefit both parties.
Successful relationships also are ones that are clearly defined. The needs and objectives of both parties must be made clear, along with the expectations of both sides, contract manufacturers said. In addition, vendors must be honest with OEMs about their capabilities and be careful not to make unrealistic promises about deadlines or aspects of the production process.
(Editor’s note: For a complete list of mistakes to avoid when forming relationships, see “Top 10 Mistakes Made in Outsourcing Relationships” on page 48).
“There has to be good communication between the parties along with an understanding of what outsourcing can and cannot do,” Covington Associates’ Dunn noted. “Both sides should know who is going to handle what process, and what exactly is expected from each other, so there are no wrong assumptions going into the relationship.”
Avoiding a “divestiture mentality” adds to the chances of success, too. Once a project is outsourced, companies must make a concerted effort to manage and nurture it, said Chris Oleksy, president of ATEK Medical, a medical device contract manufacturing firm based in Grand Rapids, MI. “You can’t simply outsource and forget. A divest mentality usually creates strained relationships.”
Most importantly, however, outsourcing relationships that are most successful are those which are based on a partnership. As Boston Scientific’s Szweda explained: “A partnership is a plan for a long-term business relationship. With a partnership, both parties have key stakes into the business success of the project. In a partnership, you both tend to push for a higher level of success and you are both in it if things are good or if things go bad. The successful outsourcing strategies—the ones that work—are considered a partnership.”
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The concept of outsourcing is not new to the manufacturing industry. The automotive and telecommunications sectors have utilized the benefits of this practice for years to boost their profits and reduce expenses. As a relatively late arrival to the party, the medical device industry is just now beginning to embrace the idea of outsourcing and understand the ways in which companies can use it to their advantage. Large contract manufacturers make excellent outsourcing partners for obvious reasons such as financial stability and vast resources. Those vast resources also enable the large players to respond to potential problems better and more quickly then their smaller counterparts.
For OEMs, outsourcing is a way to gain a competitive advantage in an increasingly ruthless market. The practice enables them to save time and money by contracting out services they are not capable of performing and focus instead on core competencies such as research and development, technology, sales and marketing. Put more simply (thanks to Earle): “The cost of getting into business whether it’s injection molding that you need, or assembly, is very high. And it’s iffy whether your product is going to get to market, so why should you spend all that money to try and reinvent the wheel? Go outside, find a contract manufacturer and use their capabilities to make that product for you.”
Editor’s note: See Part 1 of our series on outsourcing strategies, “Succeeding in Outsourcing With a Small to Midsize Solutions Provider,” in the October 2008 issue of MPO.
SIDEBAR:
The Top 10 Mistakes Made in Outsourcing Relationships
Successful outsourcing relationships are based on honesty, trust and good communication. These traits, however, do not always exist between a contract manufacturer and an OEM. A number of stumbling blocks can trip up vendors and OEMs in their pursuit of perfect outsourcing relationships. The most common (according to industry analysts) are listed below:
1. Failing to communicate. As in any partnership, communication is key to a harmonious relationship. Failing to effectively communicate and be honest about the goals, opportunities and vision for the relationship will lead to certain doom.
2. Buying many companies and failing to spend the money and/or effort to integrate them properly. In most cases, customers prefer consistency in the product development/manufacturing process.
3. Having a short-term venture capital strategy. Customers typically favor long-term stability.
4. Failing to take the time to define the outsourcing relationship and its requirements and expectations. Undefined relationships ultimately lead to disappointment when expectations are not met.
5. Establishing specifications, expectations and testing that the partners’ business relationship or technical capabilities cannot support. Specifications and expectations should be based on the well-defined capabilities of both parties and a commitment to met precise specifications.
6. Assuming the outsourcer (contract manufacturer) will cost less than producing the product (or part) internally. Outsourcing does not always translate into dollar savings.
7. Expecting the outsourcer (contract manufacturer) to work on one project exclusively. A project from an OEM may not always be the vendor’s sole focus. OEMs must analyze the vendor to determine the value it can bring to a project.
8. Overpromising. Companies should never promise to meet deadlines or part tolerances that are unrealistic or not within their scope of capabilities.
9. Failing to understand exactly how the relationship will work. An outsourcing partnership is a long-term relationship; its success depends on sharing long-term goals for the project and ways of dealing with unexpected changes in the manufacturing process.
10. Working with too many outsourcing partners. OEMs that establish relationships with a wide range of suppliers are setting themselves up for failure. Working with numerous suppliers is complex and time-consuming; limiting the number of suppliers can ensure a more efficient project management process.
SIDEBAR:
Outsourcing: A Necessity or an Option?
Ronald B. Earle can still remember the comment that changed his outlook toward outsourcing.
“An executive at B. Braun once said to me at a meeting, ‘I’d rather walk past a new idea that I could pick up for a dollar and wait and see if the product is successful, then pay $1 million for that product three years from now,’” recalled Earle, retired group senior vice president of B. Braun Medical Inc.’s OEM/Industrial division. “And I never understood that. I said to him ‘if I could get something for a dollar and believe in it, that $999,999 is mine.’ And he said, ‘yes, but I didn’t waste time trying to make it work. I waited until somebody showed me it worked and I can count on it for profits.’”
That executive's philosophy toward outsourcing shows just how important the practice has become in the medical device industry. The benefits are obvious: higher profits (for both contract manufacturers and OEMs), a more efficient product development process and a speedier trip to market. And while most industry analysts agreed that outsourcing has become a necessary part of the product development process, there are some who argue that companies can be just as successful without it.
“It’s not necessary. It depends on the scale of the organization and the type of product that is being made,” noted Ben Dunn, managing director at Covington Associates, an investment banking firm based in Boston, MA. “A company can be more successful and more profitable by employing a successful outsourcing strategy, but it’s not a requirement. Just the fact that you use outsourcing doesn’t guarantee that you will be more profitable or more effective.”
Maybe not, but large companies that don’t outsource are predestined for mediocrity, most experts said.
“There’s no one I can think of in our industry who doesn’t outsource something,” said George Blank, president of The MedTech Group, a medical device contract manufacturer in South Plainfield, NJ. “It’s possible to survive without outsourcing but it reduces the growth rate of the OEM. It prevents them from taking advantage of all the opportunities they have on their plate. They certainly can survive but they will not be the best in class.”
Besides fostering growth rates, outsourcing enables companies to focus on their specialized skills or services. The practice is most successful when each partner in the value chain concentrates on what they do best. As one medical device executive put it: “divide and conquer the value chain.”
“Outsourcing has become recognized as a ‘must’ in the medical device industry,” said Chris Oleksy, president of ATEK Medical, a medical device contract manufacturing firm based in Grand Rapids, MI. “Trying to be a ‘jack-of-all-trades’ across the value chain is very difficult and proves sub-optimal. Aligning best in breed capabilities of multiple players possessing various skill sets has proven to be most beneficial.”
Despite its palpable advantages and its growing popularity among contract manufacturers and OEMs, outsourcing is still not as widespread a practice in the medical device industry compared to other sectors (automotive, for example). One analyst estimated that less than half of all production in the industry is outsourced, leading some experts to contend that companies can still be successful (and profitable) on their own.
“There are a significant number of small- and mid-cap OEMs who continue to cling to the vertically integrated business model. They believe it protects their IP and flexibility and gives them greater control over their destiny,” said Bill Ellerkamp, CEO of ExtruMed, a precision tubing manufacturer in Placentia, CA. “They can do this profitably as narrow platform companies, as they don’t require such large investment in R&D and sales channels as the more broadly focused major OEMs. Both models can be profitable based on the gross margins in the industry.”