Outsourcing Markets and Models Evolve

Assembly expertise is one reason for growth in outsourcing. Above, workers manufacture products at one of Avail Medical’s facilities. Photo courtesy of Avail.

Unquestionably, the role of contract manufacturers has evolved markedly in just the past five years. Contract manufacturers who spoke with Medical Product Outsourcing noted that many projects they are asked to handle today would have been the sole purview of customers just a few years before. Critical product lines, small and large runs and even new launches are being outsourced these days as OEMs look to reign in their costs and capital outlay.

Take design functions, for example. In the past, many OEMs viewed product design as a core competency. Now, companies are willing to seek input early in the design stage. In fact, they see leveraging outside help as a more expedient way of getting products into the hands of healthcare workers and patients. Similarly, the production of critical components and even finished products has been shifted to contract manufacturers.

“The opportunities we are seeing today far exceed what I would have imagined 10 years ago,” said Randy Keene, president of Fort Worth, TX-based Avail Medical Products, one of the largest medical device outsourcers in the world. “Everyone thought [back then] that no one would be willing to hand over some of the things they are now outsourcing.”

Growing Confidence

Why are OEMs entrusting many critical functions of their business to vendors? A multitude of drivers such as lower costs, access to technology, speed to market and freeing up management focus all help to put medical device manufacturers at ease, but one of the most important factors, often overlooked, is growing confidence in the marketplace. In part, increased confidence in contract manufacturers has been fueled by prior successful partnerships between the OEM and service provider, some industry veterans point out.

For instance, OEMs these days simply expect their suppliers to be FDA-compliant, operate effective quality programs and meet any other regulatory needs. “You have to have that to play the game,” the procurement manager said.

In effect, the performance bar for CMs is consistently being moved higher as more responsibilities are shifted onto their shoulders.

“Today, every level of complexity in the manufactured component is being demanded,” said Randy Bormann, general manager at contract manufacturer UTI in Collegeville, PA.

UTI, which earlier in the year acquired another large contract manufacturer, MedSource, is by some estimates the largest service provider in the medical device outsourcing sector. Bormann said this and other past UTI acquisitions reflect management’s response to the changing marketplace. As OEM customers demand more capabilities, contract manufacturers are responding by expanding their competencies.

In UTI’s case, it strengthened its technology in the orthopedic and cardiac rhythm management businesses. More importantly, by expanding its offerings, the company is helping its customers’ efforts in consolidating their vendor base. Bormann added that some companies turned to UTI after smaller service providers failed to keep up with those customers’ growth.

In some cases, though, expanding competencies isn’t achieved through acquisition of a competitor; it’s done by acquiring customers. Or at least their facilities. Take the example of Durham, NC-based TriVirix, which in July purchased the manufacturing and support functions of the gastroenterology and neurology diagnostic business of Minneapolis-based Medtronic, a customer. Under the transaction, TriVirix will provide product development and manufacturing services to Medtronic, which will continue to market and sell the products as well as define and fund their development. The acquisition included facilities in Salt Lake City and Copenhagen, Denmark.

Josh Rose, the director of marketing at TriVirix, declined to discuss the specifics of the deal but noted that these types of deals will likely occur more frequently in the future. “Moving forward, we’re going to see more and more of it,” he said, adding that this trend mirrors a similar movement that occurred in the computer and telecom industry years ago, when OEMs in those sectors sold their production facilities to contract manufacturers.

Trumping all other requirements, quality remains the No. 1 mandate in any outsourcing model. Above, a worker at B. Braun OEM/Industrial Division assembles products. Photo courtesy of B. Braun.

Supplier-Side Economics

Why sell assets to suppliers? As George Blank, president of the MedTech Group in South Plainfield, NJ, pointed out, medical device manufacturers aren’t always able to keep up with the latest advances in manufacturing technology because they are focused on patient treatment and not parts manufacturing. For instance, he predicted that medical OEMs who now run injection molding operations will eventually outsource those functions. He said it’s highly difficult for medical device companies to focus on injection molding and invest in its continually evolving technology.

Contract manufacturers, on the other hand, are focused on manufacturing and materials and process control. Because they often encounter the same issues on other clients projects, vendors have much more experience resolving those problems than their customers. Additionally, they can dedicate employees to specific disciplines such as Six Sigma or lean manufacturing that a resource-strapped OEM cannot.

“We are a technology-driven company. Our capital is a critical component to our success,” said Bormann. “Our goal is constantly ensuring that we are bringing the highest level of technology to the customer.”

Having had offers to acquire some of his customers’ assets, Blank added that OEMs would never hand over the the reigns on critical functions Others, however, will eventually be dispatched to vendors. “It won’t happen with core technologies, but it will with periphery,” he said.

Clearly, the acquisition of customer facilities speaks volumes about the growing confidence that OEMs have in their suppliers. It also indicates that medical device companies are continuing to reshape the outsourcing model.

Consolidation Expected

Acquisitions, some observers point out, will likely continue in the medical device contract manufacturing market. They point to the fact that the majority of outsourcing activities today is not to giants but to smaller shops that offer specialized services in metals, plastics, assembly or automation.

But as more emphasis is shifted to quality and more FDA requirements are imposed, some of those smaller contract operations won’t be able to meet their customers’ needs unless they invest in expanded capabilities or merge with those who have the know-how. Furthermore, as OEMs become more global, they will want their suppliers to have an international presence as well.

Tom Podesta, vice president of healthcare at The Tech Group in Scottsdale, AZ, said his company has built its medical device contract services business over the years through organic growth, but he believes the division will need to make small acquisitions in the future to shore up its capabilities.

“We’ll need to make some moves in that area,” he said, adding that any acquisition will be aimed at specific niches and not to gain broader production capabilities. In fact, The Tech Group already has facilities in Mexico, Puerto Rico, Ireland and Singapore, which help to cover just about every major global market.

Does consolidation, however, mean that eventually only a handful of CMs will be around to service medical device manufacturers? And will this trend eventually hurt the finished device business?

Keene said there will be smaller operations catering to OEMs but he said many will fall by the wayside, especially as vendor consolidation takes hold.

“I think you have to be a big company to provide all-encompassing service,” he said, noting that investments in quality will require scale. “That’s where the little guys will have the hardest time—to convince the big [OEMs] they have an adequate quality system.”

More likely, the industry will continue to support tiers of contract manufacturers, with smaller companies finding their own niche, said Tom Black, the vice president of OEM sales and marketing at Bethlehem, PA-based B. Braun OEM/Industrial Division, a contract manufacturer. Smaller companies that can react more quickly than larger ones or offer unique capabilities will likely have a place in the market, he said.

New Models Emerge

Small or large, service providers will need to adapt to the ever-changing outsourcing model. Although traditional customer-vendor relationships are more typical of today’s contract agreements, that model is evolving.

The most common partnerships are those in which the provider is contracted to produce a set number of components or finished products, but as OEMs look to cut costs, they are relying on their vendors to reduce inventory, lead times and other overhead. The shift requires some contract manufacturers to adopt lean manufacturing so they can quickly respond to changing market conditions. In some instances, they even make day-to-day decisions on output based on a customer’s sales projection and order history.

Because the service supplier is much more embedded in the OEM’s operations, it can better anticipate the customer’s needs. At the same time, it is shouldering more of the resource planning responsibility.

“One of the big things they want is just-in-time, kanban inventory,” said Black. “That’s hard. If there’s a hiccup, they’re not holding the inventory. Shifting the risk forces you to adjust more quickly.”

In addition, he pointed out, OEMs are now relying on their suppliers to help handle materials inspections, validation and design.

Back to Basics

 

In the end, of all of the services that contract manufacturers can offer to OEMs, the most important has remained a constant: the ability to deliver quality. And that, said Frank Maloit, the vice president of corporate procurement at Murray Hill, NJ-based C.R. Bard, will always be the No. 1 mandate voiced by OEM customers.

“I want people who are experts. Cost isn’t the only driving factor,” he said, adding that there is no savings from outsourcing if the vendor can’t ensure quality. “I can’t afford a recall or a bad product. I can’t afford processes that are not maintained or controlled.”

He also cautioned against companies becoming too broad in their offerings. Those who are unable to invest in core manufacturing technologies because they diverted capital to other businesses face the prospect of falling behind the times.

Small or large, service providers will need to adapt to the ever-changing outsourcing model.

Another fundamental requirement that service providers must provide is continuous process control improvements. Contract manufacturers say even as OEMs demand more support, they also want to see lower scrap rates, conformance to tighter tolerance and reduced turnaround time—all of which further drive investments in manufacturing technology.

UTI’s Bormann said monitoring and improving process control should be a cornerstone of any contract manufacturer’s operations. He said that the rewards benefit the supplier and customer, who share in cost savings.

Avail’s Keene said that these improvements also require customers to make investments, sometimes in capital and other times in incentives to the contract manufacturers.

“On most of our projects, we have an existing technology fit of 80-90%. The customer is more than happy to help us span the final 10%,” Keene added.

That OEMs today are more willing to make investments on behalf of their vendors is perhaps the strongest indicator that they view outsourcing as an integral part of their corporate strategy. As a gesture to ensure strong manufacturing capabilities in the future, they are offering to help outsourcing partners that ultimately benefit both sides.