Dominant Supply Chain Strategies—Integrated Contract Manufacturer and Specialist

Long-term business strategies in the medical device supply chain have been shaped by two overarching trends. The first trend is outsourcing manufacturing from OEMs to supply chain partners. Since 2000, the percentage of medical manufacturing handled by contract manufacturers (CMs) has increased from under 10 percent to more than one third of today’s production. The second trend has been supply chain consolidation. While there are various reasons underlying the acquisition boom, the deals have created numerous CMs with annual sales over $100 million and foundationally similar business models.

Two dominant business strategies have arisen from these trends. The first model and most prevalent among the largest CMs is the integrated contact manufacturer approach. Under this model a supplier attempts to profitably capture as much content as possible in a device. These companies offer a broad spectrum of manufacturing capabilities, often complimented with program management, assembly services, sterilization management, supply chain management, warehousing, and logistics management. Some companies go a step further by offering seminal design services in the specific medical fields they are best suited to support.

Since CMs cannot expertly design all medical devices, they often provide design services skewed to specific areas of medicine (i.e., interventional products, orthopedics, surgical devices, imaging, etc.). Integrated CMs that do not offer design services do not appear to suffer from those decisions. Rather, they identify and are identified according to the manufacturing disciplines for which they are noted such as plastic injection molding, extrusion, electromechanical devices, and precision machining.

The aspirational strategy for many of the largest CMs has involved building full-service device manufacturing capabilities under their own roofs. Through organic investment and aggressive acquisition, most of the top 25 medical device contract manufacturers have built facilities that match or surpass even the largest OEM flagship manufacturing sites. The effectiveness of this approach is evidenced in quarterly earnings and rich valuations of the contract manufacturers that select the integrated CM strategy.

Yet not all supply chain companies have the necessary expertise or deep pockets to become integrated CMs. Some have adopted a specialist strategy that entails marketing their expertise in a specific area. The goal is to capture a few high-value components in a device, rather than many components. Through expert knowledge and focused investments, specialists sell to both OEMs and integrated CMs with a price, quality, and delivery schedule better than those of generalists or integrated CMs. Examples of specialist firms are found in laser processing, micro manufacturing of both plastics and metals, grinding, metal injection molding, and surface treatments.

Like any strategy, specialization has its advantages and disadvantages. One of the key benefits is cost: Suppliers specializing in a given manufacturing discipline can often produce parts at an attractive price with a good profit margin. Two disadvantages stand out, however. Specialists concentrate in a market niche; as such, their growth is usually tied to the sector’s expansion rate or their ability to capture market share from competitors. This cap on opportunity may be a disincentive to companies swinging the fences in valuations but generally specialist managements operate with higher operating margins than some integrated CMs. Another drawback is specialization may lead to disintermediation between OEMs and specialists. As more device manufacturing is outsourced to integrated CMs, specialists may find they can no longer land business directly with their traditional OEM customers.

Are These Strategies for Everyone?

By definition, these strategies are not for every company. Organizations that are already successful in implementing either integrated contract manufacturing or dominating a specialist niche are hard to displace. Medical device supply chains are becoming more mature, meaning “me too” adopters will face entrenched competition. Even companies that have taken steps to become an integrated CM or specialist may find their lack of market share precludes notable growth at this point. While such firms may be lulled by the medtech industry’s steady growth, a shake out of competitors will ultimately favor larger companies with diverse customer bases.

So what can and should be done?

Certainly, owners can sell their companies. Others, with sufficient backing, may consider acquiring competitors to build scale and market position, though this is difficult given the limited number of available M&A targets and high valuations. Another alternative is a strategic pivot to evolving markets opportunities.

Areas of Opportunity for Strategic Expansion

A sailboat racing truism advises second place contenders to do something different in order to win. This often means changing course to take advantage of more favorable conditions. In the healthcare supply chain, it may mean redefining a medical device and rethinking the suppliers’ role. Four strategies to consider follow.

Pharmaceutical devices: One of the greatest challenges faced by pharmaceutical companies is commercializing a drug before its patent protection expires. Another big challenge is finding a way to extend patent protection by improving the drug’s efficacy. One of the newer ways of extending a drug’s life under patent protection is to combine it with a device that demonstrably improves patient outcomes. These products are favored by both physicians and insurance companies and generally either improve drug delivery or administer the medication in a more timely manner.

Current pharmaceutical products are generally developed by firms with medical device experience, but few device suppliers focus solely on pharmaceutical companies. Medicinal offerings are biased toward chronic disease treatment, causing patients to remain on a drug for years and creating more opportunity for pharmaceutical device suppliers.

Prefills: As industrial CMs entered the medical device space, there was often a hesitancy to make implants because management teams were concerned about liability. As these companies gained experience in healthcare and became more confident in their abilities, they tackled these more lucrative projects and now routinely produce implantable products.

A similar situation/opportunity currently exists with prefills. These products contain a device and a pre-measured amount of a biologic product. A simple example can be found in a doctor’s office. In the past, nurses filled a syringe by eye (visual estimation), but physicians today prefer to purchase syringes pre-filled with precise doses of medicine, eliminating the possibility of over or under dosing. Extensive medical literature supports the thesis that precisely delivered biologics are often better loaded in a factory than an office or an operating room. The biologic can be a drug but can also be bone cement, antiseptics, imaging dyes, and diagnostic reagents.

Most biologics manufacturers are focused on developing compounds rather than filling delivery mechanisms, so they are amenable to outsourcing filling technology. Companies that manufacture the delivery device should consider expanding their capabilities into pre-filling innovation. Sterile material handling and manufacture is essential but achievable by most medical device makers. Margins on pre-fills rival OEM margins on many devices.

Private labeling of non-flagship products: Many supply chain companies are fully capable of designing and manufacturing complete devices but choose not to compete with their customers. Most customers, however, have holes in their catalog for prosaic products that support their flagship offerings. Often, the customer’s R&D teams place a low priority on these necessary but second-line devices despite requests from field sales teams.

Carefully identifying these holes in a customer’s product line and offering a complete device branded under the customer’s logo can be a long-lasting and lucrative alternative to fighting for the next big OEM project.

Digital devices: Few suppliers focus on manufacturing connected medical devices or network-enabled products despite healthcare’s continued digitization. The opportunity to concentrate on digitally capable devices remains open for at least the next few years.

In a maturing industry like medical device manufacturing, looking outside traditional projects and market niches may reveal exceptional opportunities. 

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Tony Freeman is president of A.S. Freeman Advisor, LLC, a mergers, acquisitions, and corporate strategy firm focused on the specialty materials and precision manufacturing markets. The company is located in New York City. Tony can be reached at [email protected].