SPECIAL REPORT
Outsourcing in the Device Industry
As medical device OEMs redefine their core technologies, many are finding it advantageous to subcontract an increasing number of functions.
Norbert Sparrow
Remember when vertical integration was the wave of the future? The tide has most certainly turned. In fact, the question many device manufacturers are asking today isn't even whether to outsource, but which part of the product's life cycle to contract out. That is the prevailing opinion among industry experts, and it is borne out by a poll conducted among EMDM readers.
Eighty percent of device manufacturers who responded to our poll indicated that they outsourced part of their business. Of those companies, 71% said that their use of contract services had grown between 6 and 15% in the past two years. Apparently the formula is working, since many of those companies plan to increase their use of contract services. In fact, 35% of them expect outsourcing to increase by more than 10% within their company in the next two years. Their predictions for the device industry in general are equally bullish: 45% think it will grow by more than 10%.
There are a number of reasons that companies outsource processes, but in most cases it can be summarized as follows: Why do it yourself when someone else can do it better, faster, or at less expense than you can?, says Lynda Hunn, a senior consultant with Excel Partnership Inc. (Sandy Hook, CT, USA). "Whatever it is," she adds.
The Virtual Company
Outsourcing covers a range of activities, from the more traditional contract services such as sterilization and testing to distribution and marketing. The subcontractor may simply be assembling a component or he may be building the entire device, perhaps even shipping it to the final user. At that end of the spectrum, one increasingly hears talk of the virtual company.
A phenomenon that has emerged largely as a corollary to the US biotechnology industry, a virtual company is a firm that has outsourced all of its functions except for the strategic management of the business and the management of suppliers, notes Hunn. While this is an extreme business model that may not find a niche within the device industry, the concept of the virtual factory is indicative of a growing awareness that the physical act of making a product is rarely a company's core technology. Clinging to this vestige of vertical integration, according to many experts, only dilutes the company's resources and distracts it from focusing on its real strengths.
"Outsourcing gives a company the ability to concentrate more of its time and resources on its core technology," says W. Thompson Lawrence, vice president of new business development and product planning at Nova Biomedical (Waltham, MA, USA). "It makes sense for small companies because they can put all their resources into marketing and developing their product, not into bricks and mortar," he says. Larger companies gain a flexibility that may not be available to them within their own corporate structure, he adds. "Contract manufacturers generally are smaller, so they can be more responsive to the needs of their customers. Decision making is not bogged down by layers of management," says Lawrence.
Contract manufacturing is an unusually good fit for the device industry, says Martin Biggs of the healthcare consultancy Martin Biggs Associates (Godalming, Surrey, UK), because of its specialized nature. "You're getting many devices these days that require many different specialist activities," says Biggs. "Drug delivery devices are a good example. If a company is not only to survive but to increase its market share, its only option to produce this component quickly and cost-effectively may be to outsource it," says Biggs.
The trend in self-diagnostic products is another case where companies are better served by involving outside partners. "These products have to sell themselves at the point of sale to people with no technical background . . . and they should be as easy to operate as a kettle," says Stephen Williams, of Maddison Product Design (Fittleworth, W Sussex, UK), a consultancy that works extensively with the healthcare sector. "All the things that routinely apply to consumer products are now being used to develop diagnostic devices, and medical companies often don't have those skills in-house, because their staffs have traditionally been narrowly focused on their particular sector of industry," says Williams.
For Richard West, CEO of CMA Inc. (Chapel Hill, NC, USA), which recently opened a full-service manufacturing facility in Belfast to produce medical devices for OEMs, the expertise in a small to midsized device company involves an understanding of clinical needs and developing a technology to meet those needs. "Manufacturing in a regulated environment, especially if you intend to sell into the United States and need to meet US FDA and CGMP requirements, often is not a core competency among these companies," says West. Contract manufacturers, on the other hand, are able to invest in processes and information technology to successfully execute quality system requirements, supply management, and all the other requirements for highly regulated low-volume manufacturing, West adds.
Contract manufacturers also provide an edge when time to market is critical, adds Brian R. McKenzie, director of sales and marketing, medical, at McKechnie Plastic Components (Minneapolis, MN, USA), a full-service contract manufacturer of medical and surgical devices and implantable components. "The established timeline from development to manufacture can be as little as six to eight weeks," he says. "So it really makes sense to outsource to a full-service contract manufacturer who already has the machinery and knows the processes. That's his business after all," says McKenzie.
Tapping into a contract firm's flexibility is one of the key reasons to outsource, according to Simon J. W. Coe, managing director at Wesley Coe (Cambridge) Ltd. (Cambridge, UK), which specializes in the manufacture, assembly, and packaging of devices. "Our ability to cope with fairly irregular batch sizes has been one of our strengths," says Coe. "A subcontractor can deal with that sort of stop-and-start work, which would entail considerable cost and logistics if it were done in-house."
Establishing a Successful Relationship
Manufacturers need to carefully consider an array of issues before entering into an agreement with a service provider. "The success of large-scale relationships is determined up front by the amount of preparation in supplier selection, the planning of the customer-supplier relationship, and the organization, structure, and resources provided by both sides," stresses Hunn. Here are some of the key elements that she and other industry experts highlight.
Maintain open lines of communication. "So many problems between companies and suppliers that I have witnessed really boil down to poor communication," says Anthony Saunders, who founded the technical consultancy Minerva Technology (Horsell, Surrey, UK) five years ago following an extensive career in medical plastics. He cites the example of specialized moulders and biotechnology companies. "People in the plastics industry often do not understand the very peculiar needs of the biotech industry," says Saunders. "Likewise, biotech people look on plastics technology as a very low-tech operation, and of course nothing could be further from the truth."
A commitment to unfettered communication should include open-book accounting methods, adds Andrew Diston, group leader for electronic engineering at Cambridge Consultants (Cambridge, UK). "If the subcontractor provides this cost saving here or adds a feature there, everyone should know that an economy is being made or that value is being added on," says Diston. "There is a huge benefit to the company to state up front that the contract manufacturer is entitled to make a certain amount of profit on this business," he adds. "You're telling them this will be good business for you and good business for me."
Open costing data is one of the touchstones of CMA's operation, says West. "Our customers know what everything is costing us. That's one of the ways that we build trust." To effectively communicate this and other information, the company has gone to great lengths to design its processes and information systems to achieve a transparent operation, West explains. "From an information technology point of view, for example, we plan to put real-time production data on the desktops of our customers," he adds.
Seek flexibility. One of the biggest problems customers face is signing up with a company that lacks the capacity to deal with a change in demand, says Nova Biomedical's Lawrence. "At the outset, there's often a high order rate while inventory is being built up," he says. "After that, demand may drop off for a while until the sales ramp up again." In this sort of situation, notes Lawrence, it's critical that the supplier have the flexibility to deal with substantial and sometimes sudden capacity changes. "A contract manufacturer needs to be continually thinking about production volumes and how to accommodate the ups and downs," says Lawrence.
European companies outsourcing products intended for the North American market may seek the flexibility of working with a locally based subcontractor. That has been an important customer base for Horizon Medical Inc. (Santa Ana, CA, USA), a contract manufacturer specializing in the fabrication of single-use sterile devices. "Sure, you can ship the product across the pond, but that adds eight weeks to your lead time," says national sales manager Greg Olson. Why bother, when you can have it made in the United States and shipped to a warehouse?, he asks.
Practice effective project management. It's counterproductive to outsource processes—ostensibly to take advantage of a smaller, more responsive company—while leaving in place corporate hurdles. As Biggs succinctly puts it, "Large organizations can really screw things up."
He cites one project that was delayed simply because the subcontractor was not using the proper forms for assigning cleaning schedules. "I was involved in another project where all the main contractor had to do was to package and label the finished product," says Biggs. "That became a battle within the company, and what could have been turned around in a month took a year!"
The best way to avoid costly and aggravating delays, according to Biggs, is to put someone with authority in charge of managing the project, preferably a third party. "The problem with big companies is that they rarely consider finding someone with the experience and authority to do this job. More often than not, they will simply give someone the responsibility to oversee certain aspects, but they won't give him any [meaningful] authority." Hiring a third party, particularly when several subcontractors are involved in a project, may be the best way to bypass the internal politics and overcome inertia, according to Biggs.
Agree to the project definition. The supply contract is critical to a clear understanding by the parties involved of the responsibilities for all aspects of the business arrangement, including quality, delivery, cost, and regulatory requirements, according to Hunn. Items that should be addressed, she says, include comprehensive product specifications, the process and frequency for amending the specifications, minimum quality system requirements and the ability to conduct third-party audits, change control procedures, and the length of notice required by both parties to cease doing business together. "Depending on the product, a manufacturer may need a year or longer, particularly when regulatory approvals are needed, to replace the supplier," says Hunn. "The minimum notice time needs to be formally agreed upon."
Regarding the project definition, Lawrence strongly advocates establishing a change order mechanism in which both companies sign off on anything that happens. "You need to make sure it's clear who originates a design change and who is responsible if it doesn't work or if materials need to be scrapped because of it," Lawrence adds.
Make quality systems a priority. It should come as no surprise that quality systems was cited as the principal criteria for selecting a subcontractor among device manufacturers that participated in the EMDM poll. The fact that contract manufacturers are able to invest more time and resources in quality system requirements than many companies making end-use equipment is one of the chief reasons that outsourcing continues to grow in the device industry, according to West. That, after all, is one of subcontractors' core technologies, he adds. But OEMs should remember that there is a trade-off, cautions Hunn.
"The manufacturer exchanges the control and overhead costs that come with vertical integration for the variable expenses of a customer-supplier relationship. The manufacturer has to control subcontractors almost as if they were an extension of his own design or manufacturing unit . . . and they need to be part of the [customer] company's quality system," says Hunn. Adds Lawrence, "You need to put into place an effective system that integrates all the data and keeps track of everything that's going on with an eye toward improving the quality of the product."
Carefully evaluate timelines. When time to market is a critical factor for your product, pay particular attention to forecasting, suggests McKenzie. Under such circumstances, it may make more sense to engage a full-service contract manufacturer, he adds. Carefully evaluate the supplier's menu of services, says Lawrence. "Production is a given, but what about product inventory, distribution, even field service," he says. And don't neglect possible time constraints involved in shipping, labelling, and so forth, McKenzie adds. "That's especially true if you're shipping internationally, where customs clearance and regulatory issues may play a role," he says.
Use your subcontractor as a consultant. A contract manufacturer worth its salt brings a fair amount of expertise to the table, and companies should tap into that knowledge, says Olson. "Get the contract manufacturer involved as soon as possible and remain open-minded," he suggests. The supplier may be able to suggest more cost-effective packaging, specify a resin that will withstand gamma radiation better than what is being used, or add value to a project in some other manner. "Treat the supplier as if it were part of your own manufacturing department," says Olson.
Build trust. Trust is the bedrock upon which a successful agreement rests. "The whole notion of letting a supplier deliver your product to an end-user without your ever touching it demands that there be a relationship of trust," says West.
A rapport of trust must be established and both parties must think along the same lines if the relationship is to prosper, adds Lawrence. "Things can begin to fall apart when there is a lack of shared values," he says. "You need to have the same focus." Lawrence mentions that when Nova has run into problems with a customer, it wasn't because the product was not manufactured satisfactorily. "The cause has often been a result of differing expectations that stem largely from corporate-culture kinds of issues. Our partner's cultural background may be on the R&D side, and he didn't understand what would be reasonable for us, as manufacturers, to do."
Involve the right people. In some companies, lawyers are primarily responsible for drafting the supply agreement while the critical stakeholders in the project are overlooked, says Hunn. It is crucial, she says, that the appropriate cross-functional group of people be involved in drafting the document. "These should be the same folks (or at least representatives of the same stakeholder groups) that are selecting the supplier," says Hunn.
Following the lead of many other sectors of industry, medical device OEMs will continue to outsource more and more functions that will cease to be viewed as core technologies. "A company that wants to keep expanding in the marketplace often will have to consider marketing products or combinations of products where it may not have any specific manufacturing or R&D expertise," says Biggs. It's simply a matter of common sense, he adds, to "outsource those aspects of product development, manufacturing, distribution, or marketing that are not a core part of your business."
Photo courtesy Horizon Medical Inc.
