Maunfacturing Matters: Navigating Outsourcing in China

Navigating Outsourcing in China

Bob Barnhart

Most medical device companies that decide to use an outsourcing provider in China either are driven by the need for cost reduction or the desire to expand into new markets. These are valid (and common) rationales. Procurement from China can be an effective method to reduce material and manufacturing costs, as well as act as a gateway to one of the world’s fastest-growing markets. Experienced medical device OEMs will caution, however, that successful outsourcing ventures require diligent homework.

Fundamentals First

Selecting the right outsourcing provider, of course, is the first and most crucial consideration. As in any potential partnership, an OEM must conduct due diligence by asking several important questions. Does the contract manufacturer (CM) possess the required manufacturing capabilities, as well as process and quality controls to ensure consistent and compliant production? Has the CM been certified to the requisite standards (ISO 9000, 14000 and 13485, for example)?Environmental, health and safety considerations as well as compliance with both U.S. and Chinese laws and regulations are equally important, as noncompliance by association could have a detrimental effect on an OEM’s reputation. Conducting an onsite facility audit is a must in order to ensure that these elements are adequately addressed.

Another consideration is the CM’s engineering expertise. Some medical device OEMs take a narrow view of outsourcing, where manufacturing is done by the CM and all design and ancillary support efforts are retained in house. However, as CMs expand their capabilities and OEMs recognize the value of expert assistance with new product design and development, selecting a supplier with the requisite level of engineering competency is a good strategic move. Outsourcing engineering services can reduce non-recurring costs and accelerate time to market.

Assuming the potential service provider has the appropriate manufacturing facilities and capacity and the desired engineering capabilities, the next consideration should be materials. While the global economy has made the world much smaller in the past 15 to 20 years, material acquisition still can present availability and logistical challenges.Benefits from lower-cost manufacturing in China quickly can be eroded away by extra expenses incurred from using the existing supply chain to support distant operations. To optimize the cost benefits of outsourcing, OEMs should consider expanding their approved manufacturer vendor lists to include local or regional companies. However, changes in material and component suppliers carry risk. For example, while some alternatives may provide form, fit and function equivalency (for example, electronic components), others may require further investigation. In either case, OEMs should call on internal engineering teams to assess proposed changes. Also, they should ask key questions, such as:Are the potential suppliers well versed in international procurement? Do they possess adequate supply chain resources and/or the knowledge to maintain continuity of supply as required? In spite of efforts to find new suppliers, there may be materials that either are sole sourced or, for other reasons, require retention of certain parts of the current supply chain.

The transition of the supply chain often can be a major hurdle. As in any work transfer, good project management is essential to ensure that the changes in materials and other elements are addressed. If not managed properly, ramping up the new supplier while ramping down the existing source, whether internal or external, can tie up significant amounts of inventory and impact the potential savings from the transfer. Maintaining a level of buffer stock should be considered in order to facilitate the transition and ensure that the supply chain is uninterrupted.

A device company also should investigate how capable the supplier is in expediting local manufacturing. Something as simple as Society of Automotive Engineers metric conversions to more-detailed assessments of Chinese vs. U.S. or European standards to facilitate material or process alternatives can result in real savings.

A final, basic element in evaluating the candidate CM is an assessment of its overall financial stability. A company that is remiss in its financial obligations will, in all likelihood, impact its OEM partner through delayed shipments or a request for pricing renegotiations, for example, thus reducing the anticipated benefits of outsourcing to a significant extent.

Beyond the Basics

Once a medical device OEM has ascertained that the chosen CM has the wherewithal to meet its requirements, what else should be considered to ensure the overall success of the outsourcing project?
The main issue on most people’s minds when contemplating sourcing in China is the protection of intellectual property (IP). Because China has become quite masterful at duplicating goods, a device company should evaluate its IP risk with a CM partner. Risk assessment should start with understanding the potential exposure. Assuming that the device you plan to produce (qualified here to exclude military or other regulated goods) will be available on the open market to any buyer, it is feasible that any company, anywhere could buy your product and copy it. Granted, the counterfeit may take time to produce and lack the required firmware or software to function identically, but the potential exists to replicate a product that’s close enough. While this risk is by no means limited to China, there is a greater perceived risk in outsourcing there due to extensive manufacturing capabilities across all markets and a history of Chinese manufacturers engaging in such practices.

Two basic solutions to mitigate IP risk are:1.) outsourcing elements of the final product while retaining final assembly, software installation or other critical processes in house; or 2.) selecting a China-based provider that is part of a non-Chinese company (American, European, Japanese, etc.). This latter approach ensures that the CM’s parent understands, has experience with and honors the intent of IP agreements. Similarly, the choice of applicable contract law in the development of your manufacturing agreement (the governing law and jurisdiction) can help strengthen IP protection and increase confidence in the partnership.

Working with the China-based division of a global CM can offer the best of both worlds—not only for IP protection but also to gain a partner with a better understanding of international standards and experience in addressing multinational requirements, particularly sourcing and logistics. Additionally, the broader geographical footprint of these CMs can be beneficial in supporting domestic (U.S., European) new product development and subsequent internal transitioning to a Chinese or other international outsourcing partner. Internal process controls of large, global CMs tend to be standardized, facilitating any planned product moves to another manufacturing location to achieve either market penetration or cost reduction over time. Contractual agreements and related elements (e.g., choice of currency, payment terms, warranty provisions) often are easier to draw up due to the longstanding experience of these firms.

Logistics and Other Details

Other, more tactical issues also affect the risk/benefit ratio of outsourcing to China. A U.S. company faces an inconvenient 12- to 15-hour time difference, forcing real-time communications to be relegated to off hours. While the number of Chinese trained in English seems to be increasing rapidly, it is important to follow up discussions with written confirmation to be sure points are well understood. This is another area where a multinational firm can provide advantages. From a logistical perspective, transit times and customs processing may impact the lead time that must be factored into the ordering cycle. As with any international procurement, the OEM should determine up front what import duties, if any, may impact the cost equation.

Penetrating the China Market

The right CM not only can streamline the outsourcing process but also facilitate establishment of the device firm in the local market. With knowledge of local suppliers, a CM can help the medical device OEM find supply chain partners in advance of, or concurrent with, opening its own manufacturing entity in China. This assistance significantly can reduce time to market and help to position products competitively on price, giving the OEM a running start in the Chinese marketplace. The same local suppliers may provide assistance, references or recommendations to support efforts to establish a local presence. If the OEM’s longer-term objectives include transitioning to its own facility, an outsourcing partner (as opposed to a commodity supplier, for example) can play a crucial role.

Thorough due diligence in the CM selection process will result in the highest probability of success. A wide range of risks—from delays to poor quality and noncompliance to IP exposure—can be mitigated significantly up front by leveraging multinational service providers with the experience and knowledge to facilitate the project. It is essential to evaluate candidates based upon their total value proposition—not just the desired cost effectiveness but also expert assistance in all elements of the procurement proposition.

Whether the goal is cost reduction or market penetration, it can be achieved readily with the right partner.

Since 2007, Bob Barnhart has served as the business unit director for Jabil Healthcare & Life Sciences, where he is responsible for the business development and overall profit and loss for several strategic accounts. Barnhart joined Jabil in 2004 as a global business unit manager for the company’s global medical business. Prior to Jabil, he worked in sourcing for GE Healthcare. Barnhart earned a bachelor’s degree in business administration from Gannon University and a master’s degree in finance from Loyola College.