An MD&DI January 1998 Column
To Outsource or Not to Outsource?As manufacturers face rising costs, shrinking staffs, and increasing time pressures, outsourcing may be the answer to their needs.
The buzzword in business used to be vertical integration, in which a single company carried out all its major operations internally. These days, as competition and the pressure to cut costs increase, companies have reversed that trend. Now the word is outsourcing, in which businesses contract with outside suppliers to carry out a variety of functions that used to be fulfilled from within. According to Colorado MedTech (Boulder, CO), sales of outsourced medical devices were estimated at $2 billion in 1996, growing at a rate of 20% a year, and are expected to reach $5 billion by the year 2000.
"The pendulum has swung," says Jonathan Kagan, president of Novel Biomedical, Inc. (Plymouth, MN), a division of Colorado MedTech specializing in disposable medical devices. "Companies realize that with downsizing they can't be all things to all people."
Manufacturers considering outsourcing services have a wide range from which to choose. Every function, from concept and feasibility study through manufacturing, warehousing and distribution, marketing, and even postsale service, can be outsourced. Outside companies can also help with regulatory issues and patent applications. Contract service providers may be asked to take on part of a project or all of it, to build one part of a device or the whole thing. Some providers specialize in a particular function; others offer everything from concept development to delivery of the finished product to the customer's distribution system.
Several factors contribute to the trend toward outsourcing. For Imagyn Medical, Inc. (Laguna Beach, CA), time is the critical issue. "By using outside design and engineering resources, we can respond rapidly to opportunities in the marketplace," says Guy Lowery, senior vice president of new technology and business development for Imagyn. In addition, many large buying groups want to minimize the number of vendors they deal with, according to Alan Hershey, a business developer for ACT Medical (Waltham, MA), which provides turnkey contract services from concept development through marketing of the finished product. A device company can gain a competitive advantage by offering a comprehensive range of products, including some that are outsourced because they are peripheral to its core competency.
Outsourcing also helps small, start-up companies save money. Like most new businesses, eMed Corp., a MinneapolisSt. Paulbased company that specializes in localized drug-delivery systems, needs to conserve cash. "We don't want to bring in a lot of costly expertise too early," says eMed's COO Ed Shapland, "especially in technical areas that may not ultimately be critical to the long-term success of the company." eMed outsourced some of its initial project prototyping and early-stage manufacturing, thus postponing or eliminating the need to set up a manufacturing facility. "As we grow, we'll have to weigh the benefits and costs of doing things ourselves against those of outsourcing," Shapland says.
For Royce Johnson, former manager of advanced development with Ohmeda Medical Devices Div. (Liberty Corner, NJ), outsourcing was the solution when the company closed down its prototyping labNovel Biomedical assembled and tested a batch of experimental electrode catheters for Ohmeda. Although Johnson would have preferred to handle the function in-house, he reaped unexpected benefits from the relationship. "We acquired some additional technical know-how," he says, "and a series of additional inventions that originated through their expertise. We got more than our 50 catheters."
REASONS TO OUTSOURCE
When does it make sense for a manufacturer to outsource?
- When a company lacks the resources to handle a project. Outsourcing is a good solution when a business can't spare staff time or lacks specific expertise in an area. "When we contract to provide one man-month of service, we might provide five different people with five different sets of skills," says Kagan. "That saves my customer from having to hire five different people." Some companies may not want to invest in physical space or equipment, particularly for an unproven product. Outsourcing, especially at the outset of a project, gives companies the capability to test a product before making long-term capital commitments.
- When the function is not a core competency. Outsourcing allows a company to focus its resources on its main lines of business. "It comes down to what a company has decided its business will be," says Pam Foshay, marketing manager at KMC Systems, Inc. (Merrimack, NH), which provides contract services for a wide range of medical device firms. Does a company that is developing leading-edge assays want to distract itself with designing electromechanical instrumentation? Is this the business direction it wants to take? Such services are often too expensive for a company to begin in-house.
- When a product must be developed quickly. Hiring staff and setting up an operation takes timeoutsourcing for product development produces much faster results.
- When the need is short-term. It doesn't make sense for a company to invest in staff and infrastructure for a time-limited project. By outsourcing such a project, the financial commitment is ended once the job is complete.
- When a company wants to explore a completely new business. "One of the best times to outsource is when you are experimenting," says Kagan. "If the experiment doesn't work, you don't end up overstaffed." Venture capitalists, for example, have contracted with Novel Biomedical to conduct feasibility studies before start-ups hire their first employee.
Although each situation must be weighed on its own merits, outsourcing is probably not a good idea when the function is a core competency, when staff and equipment are available, and when time is not an issue. Chuck Philipp, vice president for new business at RELA, Inc. (Boulder, CO; a div. of Colorado MedTech), also cautions against outsourcing an element that requires a high degree of integration with the company's in-house product. "If you need a component that must be closely integrated with the rest of an instrument being produced in-house, the necessary level of communication can be difficult to achieve. It's better to identify a module subassembly or a complete instrument for outsourcing."
Furthermore, says Shapland, it's a good idea to think ahead when choosing a contract provider. "When you're developing a product for early bench testing or animal testing, one company may be fine. But as you move ahead to manufacturing for clinical trials, will your provider have the necessary ISO standards and GMPs in place? You want to choose a supplier that can make the transition with you and your company as your needs change. Go in with your eyes open, and see how far the supplier can take you."
ENSURING A SUCCESSFUL OUTSOURCING RELATIONSHIP
When developing an outsource agreement, it's a good idea to make sure the following elements are addressed:
Confidentiality. The obligations of each party to maintain confidentiality need to be clearly delineated.
Project Definition. Defining the project in specific terms is extremely important. Chuck Philipp, vice president for new business at RELA, Inc., says, "Many companies, big and small, don't do a good job of defining what they want up front. A clearly defined specification will help ensure that customers get what they want, on time, and on budget." If there is a product specification or requirements document, provide it up front. Other issues include what materials should be used, whether the contract is just for product development or also for manufacturing, what (if any) sterilization processes will be used, packaging issues, whether sales and marketing will be handled, and distribution arrangements.
Intellectual Property Rights. A definition of intellectual property and ownership should be included in the contract. Who keeps drawings and designs? Do rights include manufacturing processes?
Working Relationship. Both companies should have a clear understanding of the working relationship. How rigid or flexible, formal or casual will it be? There is no right answerthe nature of the relationship depends on the parties involved and how comfortable they are with various working styles.
Schedule. Both parties should be clear on exactly what the contract firm is expected to deliver and when.
Project Team Background. When considering a contractor's proposal, the manufacturer should request a tentative list of the people who will be working on the project, along with information about their expertise and experience.
Communication. The contract should define the lines of communication and who is responsible for the project at each end. Will a single project manager on each side serve as the central points of contact? Quantify at least the minimum amount of contact anticipated over the life of the projecthow often is contact expected and at what points in the project is it required?
Payment Terms. The contract should define the terms of payment. Will payment be expected monthly? Is an advance retainer necessary? How much will the entire project cost and what provision is made for changes in that estimate as the project progresses? What is the duration of the contract? What are the provisions for renewal or termination? Manufacturers should work with an attorney to draw up a formal arrangement that covers all foreseeable legal points.
DEVELOPING THE CONTRACT
The formal arrangements for setting up an outsourcing relationship vary, depending on the companies and the assignment. Detailed contracts take time to negotiate, but time constraints often drive the decision to outsource in the first place. Service providers frequently prepare a proposal or a letter with relevant information, then the customer supplies a purchase order. All concerns should be addressed at the outset so everyone has similar expectations about what will be delivered, when, and at what expense.
Although most outsource agreements are simply fee-for-hire, an established provider may consider alternative arrangements, such as accepting a lower fee in exchange for a long-term manufacturing commitment, a share of the rights to the product's design, or a percentage of future profits. As with just about every other element of outsourcing, the nature of the agreement depends on the project and the players.
The issue of intellectual property rights is usually straightforward. When a client hires an outside provider to design or manufacture a product, all rights to that product, as well as related drawings and documentation, belong to the client. Novel Biomedical distinguishes between design and process, however, and sometimes retains the rights to its proprietary manufacturing technologies.
No matter what the contractual arrangement, every company involved in outsourcing agrees that two issues are paramount to the success of a project: confidentiality and communication. "Confidentiality is usually an issue long before you have a contract," says Kagan, and a good confidentiality agreement will protect both client and provider.
Most companies use standard mutual confidentiality agreements that cover technical information, drawings, and product descriptions and specifications. Such agreements should also address any inventions or new processes that may arise in the course of the development work.
The value of regular, frequent communication cannot be overestimated. Client and provider will often each identify a single point of contact, usually a project manager, who serves as a conduit for others in her or his organization. Kagan encourages Novel Biomedical's clients to assign someone with the appropriate technical knowledge as the central liaison or as a resource. "We see this as having the greatest correlation with the success of a program," he says. "If a problem occurs, the client needs to have someone on his team who can understand what's going on and reassure him that the contractor is not just asking for more money but attempting to deal with a genuine change."
RELA sets up many lines of communication, Philipp says, including a project manager and engineering director on each end. RELA also includes a sales and marketing representative who is responsible for customer satisfaction and contractual issues. "If there's a problem, this gives the client another person to discuss it with. Most of the time, they are minor issues, but it's better to resolve them up front," Philipp says. Although nearly all communication is channeled through the project managers, RELA has found these multiple lines of contact to be useful checks.
Daily contact between a company and its contract service provider, usually by telephone, is not uncommon. Lowery also relies on E-mail for project updates and queries. Face-to-face meetings are less frequent, occurring every few weeks or even months. Lowery expects teleconferencing to assume a larger role in outsource agreements as more companies acquire the technology.
An outsourcing relationship is a kind of marriage. Like that union, its success depends largely on the reliability of the parties involved. It's wise to spell out as much of the business arrangement as possible in advance, but the day-to-day sharing of information and problem solving must be based on trust. "You have to build a personal chemistry that is effective and dynamic," says Foshay. Hershey agrees: "Clear communication about the objectives and milestones of a project fosters a relationship that leads to successful outcomes and future projects."
Deborah Conn is a contributor to MD&DI, based in Falls Church, VA.
Illustration by Brad Hamann