Mutual Benefits Drive EMS Outsourcing

Mutual Benefits Drive EMS Outsourcing

Device Manufacturers Look to Increase Focus on Research and Development

Frank Celia
Contributing Writer

Few things are certain in the business world. But we can usually count on the American automotive industry to provide a cautionary tale that allows other industries to learn from its bad example.

One of Minnetronix’s assemblers, Connie Lauterbach, building a subassembly for a clinical blood analyer. In the background, one can see the assembly procedure for the process on the computer monitor. As is the industry trend, the majority of the company’s device records, including assembly prodcedures and drawings, are stored electronically and viewed/used in electronic formats instead of paper. Photo courtesy of Minnetronix.

After years of relying on sales of SUVs to increase market share, US automakers in 2005 faced a huge spike in gasoline prices that caused the bottom to fall out of sport utility vehicle demand. General Motors lost $1.6 billion in the third quarter of 2005, lost about a quarter of the market by the year’s end, announced massive layoffs, saw plummeting stock prices and so on.  

The auto industry offers classic examples of vertically integrated companies. They own and operate nearly every aspect of their design and manufacturing systems. So when the market takes an unexpected downturn, they are stuck owning infrastructure and capital assets that generate no revenue.

For many years, medical device manufacturing companies have been organized along similar lines. They have owned and operated their manufacturing systems, usually as a means of ensuring the best possible quality in their products.

This process is now changing. As medical device makers face increased market pressures, many are embracing a more horizontal business structure, one that allows them to concentrate on core competencies while outsourcing aspects of their manufacturing in which their expertise is limited—without sacrificing quality.

Electronic manufacturing services (EMS) are often a natural first choice for outsourcing opportunities. Although electronic components are vitally important to the quality of the product, they tend to have high density and the technology is constantly changing and improving.

Over the past decade, medical OEMs have become increasingly comfortable with outsourcing EMS services.

“Ten years ago, OEMs tended to come to us for [circuit] board manufacture; five years ago, it was assemblies and subassemblies,” said Brad Goskowicz, vice president of the medical sector for Plexus Corp. in Neenah, WI. “What we do now gets into what we call HLA [high level assembly]—assembling the product, sometimes a complete finished product, and doing the shipping.”

For their part, the EMS providers are developing a keen interest in making inroads into the medical device industry. Having been burned fairly badly in the most recent economic recession, the EMS industry has come to view healthcare as a safer, less volatile business environment than its usual big-ticket clients: telecommunications and consumer products.

Penetration of overseas markets, increased research and development resources, discouragement of corporate takeovers and more well rounded client portfolios are some of the numerous mutual benefits of these outsourcing relationships. 

Positives for EMS

In the latter years of the previous decade, electronics manufacturers reaped huge growth and profits by serving the telecommunications and consumer industries. When the recession of 2000-2001 occurred, those markets took huge losses and the EMS industry suffered along with them. Now many of the companies that once viewed the medical device industry as too low volume and high density are having second thoughts.

“The last recession forced a lot of these companies to reassess their vision,” explained Keith Robinson, a consultant from Frost & Sullivan in San Antonio, TX who specializes in the EMS field. “The medical device industry has solid growth rates. It’s stable. They don’t have the huge ups, but they also don’t have the extreme downs either.”

Assembly operators in one of EPIC Technologies’ Juarez, Mexico manufacturing facilities. Photo courtesy of EPIC Technologies.

In fact, the EMS providers who serviced only medical device clients weathered the last recession rather well. “We were protected to a certain degree from the last recession by being exclusively in the medical field,” said Dirk Smith, vice president of business development for Minnetronix, Inc. in Saint Paul, MN. “Other industries experienced downturns in those years, but we sort of stayed even … flattened out rather than went down.”

Furthermore, the number of electronic components involved in medical devices is expected to continue to rise. Even devices such as thermometers, which were once simple mechanical apparatuses, now have digital readouts and components.

“Go into a hospital and count the electronics that are used on you in the first five minutes,” noted Susan Mucha of Powell-Mucha Consulting in El Paso, TX. “Even the hospital bed—the hospital bed is an absolute miracle of electronics.”

A number of factors will continue to drive this trend, according to Mucha. Wireless technology will play a greater role in medical devices as the current rush to develop at-home diagnostics becomes more prevalent. Medical records are increasingly being stored electronically. (In the summer of 2004, President George W. Bush called for all medical records and prescriptions to become paperless within the next several years.)

Hospitals are also exploring programs that use bar coding to deliver pharmaceuticals to patients. Finally, innovative technologies such as lab-on-chips and medical micro eletromechanical systems (MEMs) have the potential to drive whole new modalities based on electronics.

Mucha is unsure what percentage of medical OEMs outsource for EMS services, but she knows there is room for growth. Some experts estimate that only 30% of medical device manufacturers outsource any aspect of their EMS design or manufacture.

Cautions for EMS

Of course, the medical industry is not for everyone. “Some medical business models are not that attractive to mainstream contract manufacturers,” Mucha explained. “They tend to look for high volume with low mix, and most medical device companies are the opposite of that.”

In addition, outsourcing providers need to comprehend and navigate a much higher degree of government regulation and risk management than they may be accustomed to in fields outside healthcare.

Many EMS providers that service medical OEMs are “registered” with the FDA, which essentially means they are subject to FDA audits—although being registered is not a requirement to doing business. Those who are unregistered still must inform the FDA of any flaws or issues with a product; most other contract manufacturing fields are not held to this responsibility.

Tighter methodology for ensuring material integrity is also in place. Manufacturers cannot switch or substitute components once a bill of materials is approved. The traceability of products and parts is also of high importance, as everyone in the manufacturing chain must be prepared for potential recalls.

Finding the right match between an EMS provider and OEM can be a time consuming process. Both sides must conduct a great deal of preliminary research and share their knowledge.

“We are looking for OEMs that are going to be strong, long-term players and are going to dominate their market segment,” said John J. Sammut, CEO of EPIC Technologies, a mid-tier EMS provider headquartered in Rochester Hills, MI. “As contract manufacturers, we are only going to be as successful as they are in penetrating the market … so we are very cautious about who we bring on board. We want fewer customers but more of their work.”

These sentiments are reiterated by officials at larger EMS providers. David Busch, vice president of the medical business unit at Solectron Corp. headquartered in Milpitas, CA, said, “We tell customers that the best time to outsource is when the OEM is healthy, not when the OEM has financial problems, such as a missed earnings projection, or operational problems—this is a recipe for failure, and it doesn’t work well for either party.”

The knowledge transfer that must take place between a contract manufacturer and medical OEM is so rigorous, intense and time consuming that it should be accomplished before a company is in dire financial straights. Part of the reason for this, Busch explained, is that medical devices have a long life cycle, and “the longer a product is around, the more knowledge of that product becomes ‘tribal.’ By that I mean more of the knowledge is kept and captured in people, rather than in documentation … that is why you need a good road map for how to transfer this stuff, because it is not the same as a computer or a cell phone.”

Positives for OEMs

Medical device manufactures tend to have high profit margins, but from a publicly traded company’s point of view, a high gross profit margin is no longer the primary factor in determining stock price. More so than ever, Wall Street honors asset velocity and cost variablization; since most medical device manufacturers are highly vertically integrated, their stock prices are undervalued.

“[Medical OEMs] are sitting on fixed expenses with a high ratio of fixed to variable expenses,” Busch noted. “Any financial weakness can result in a drop in valuation that can put a company in play.” As an example, he cited the bidding war in December between Johnson & Johnson and Boston Scientific Corp. to acquire Guidant Corp.

Outsourcing can help medical device manufacturers reduce fixed costs and increase the speed at which they can bring their products to the market. Contract manufacturers are also a reliable resource for OEMs that are looking to implement lean manufacturing principles.

“[OEMs] come to us for that kind of help,” Busch explained. Solectron combined lean manufacturing and Six Sigma principles to develop its trademarked Solectron Production System.”

Another advantage EMS contractors can provide is to keep OEMs ahead of the electronics innovation curve.

According to Frost & Sullivan consultant Keith Robinson, it is easy for device makers to lose track of the latest trends in EMS technology, and a contracting partner can sometimes act as a safeguard against obsolescence.  

Solectron’s Timisoara, Romania demonstrates Lean manufacturing with a U-Cell assembly model. The company’s proprietary Lean Six Sigma methodology—the Solectron Production System—improves efficiency and quality while reducing waste and defects. Photo courtesy of Solectron.

Companies that opt to outsource EMS are striving to put more energy and resources into new product design and less into manufacturing. “We are not manufacturers,” said Plant Manager Eric Kulikowski of Murrysville, PA-based Respironics. “We do assembly, testing and packaging.” Much of the manufacturing that goes into Respironics’ products is outsourced, allowing the company to spend more time and money on research and development.

“These product companies grow their top lines not through manufacturing excellence, but through new product design and getting into new markets,” Busch said.

He also noted that the industry is seeing a “huge rush” to increase research and development spending.

According to Busch, device manufacturers spend an average of about 5% to 6% of their budgets on research and development, and many feel that figure needs to be around 12% to 15%.

To be sure, the electronic components of a medical device are vitally important to overall quality. As John J. Sammut of EPIC Technologies explained, electronics are “the heart and soul” of the product.

They are the “brains” of the device and usually the means by which diagnostic information is conveyed to human users via digital readouts. However, the electronics also “tend to be by far the most expensive part of building a product; it’s the most complex component, involves the most technical resources, engineering changes and so on,” Sammut said.

To be relieved of such manufacturing burdens—even if it involves considerable time, research and, possibly, trial and error—device manufacturers are increasingly turning to EMS experts, often to the great benefit of themselves, their clients in the healthcare field and the patients who rely on their products.