Medical Device Link.

Originally Published MX January/February 2004

BUSINESS PLANNING & TECHNOLOGY DEVELOPMENT

New-model outsourcing firms are improving their offerings for medtech manufacturers.

Moderated by Steve Halasey

As a business strategy, outsourcing has been around a long time. But today, something is different about the way that medtech companies are using outsourcing.

Faced with the needs to preserve investment capital, streamline operations, and advance multiple projects simultaneously, medtech executives are increasingly turning to outsourcing firms that offer a wide range of integrated services. The emergence of such full-service firms specializing in medical technologies is making it possible for medtech companies to outsource an even greater number of operations and to optimize their spending in those areas.

To find out more about how and why medtech outsourcing is changing, MX called on two experts in the field for this issue's roundtable conversation (see sidebar). And to flesh out the picture provided by the participants, MX challenged representatives of several major medtech outsourcing firms to give their best advice for addressing difficult scenarios in outsourcing. Their responses, presented here in sidebar format, demonstrate that today's full-service outsourcing firms provide excellent resources for helping to resolve such dilemmas.

MX: Is there something about the way the medtech supplier community has grown that makes the terms contract manufacturing and outsourcing mutually exclusive or different from one another?

Michael J. Burke: I think most people are still using those terms in the same sense. But certainly, my firm is looking for a relationship different from what we have had in the past with contract manufacturers.

The kinds of relationships that we are developing now are very different. We are working with our outsourcing partner all the way from initial product design through the whole manufacturing process, including validation and final distribution of the product to the customer. So, rather than maintaining the traditional arm's-length relationship between a device company and a contract manufacturer, we look at that relationship as a basis for integrating our outsourcing partner's activities into our supply chain so that we are virtually one company.

Corinne Z. Augustine: I have heard the terms used interchangeably as well. In one case, we worked very closely with a contract manufacturer from design through validation, and we pretty much compressed our in-house manufacturing to nothing. That firm was a very standard contract manufacturer, but the key was that there was a match between its business and the needs of the company I was with at the time.

At what stage does that kind of relationship start? Can early-stage companies establish dynamic outsourcing relationships that expand as their company grows?

Burke: Yes, I think very much so. The relationship we have with one of our outsourcing partners started back in 1996 with a very small $1 million-a-year business, which this year will eclipse $40 million. So we've seen tremendous growth in that business.

The relationship with that outsourcing provider started in the early stages of product development. We didn't have the internal design capabilities or manufacturing technology necessary for the project, and we were looking for a company that had them. The outsourcing firm was a relatively small company, but it had the capabilities we needed, so we married up with it. We have jointly grown the business over the past five or six years, and our partner has had to put in place a lot of brick and mortar as well as operational systems.

Augustine: I think Mike is right; that's the way it works best. The most forward-looking suppliers are those who understand that getting involved early is really in the long-term best interests of their company. In order to have a new product from its inception, such companies may need to be willing to undertake low-margin activities and sometimes even to charge them as nonrecurring expenses.

Pharma companies have a long tradition of outsourcing. What market forces are impelling medical device companies to adopt this strategy, and how has the outsourcing community responded?

Burke: A lot of the pressure comes from efforts to achieve economies of scale. In the case of an outsourcing firm that supplies one of our sterile disposable components, for instance, that product probably represents about 20% of that company's business. Consequently, the company has been able to invest in all of the processes and skills necessary to create a highly automated, high-efficiency process.

Augustine: Economies of scale are important, and the type of product is probably a big factor, too. If a product lends itself to automation or manufacturing processes that can be utilized by multiple companies, then a supplier knows that it will not be captive to a single customer. That knowledge can enable the supplier to invest some of the cost savings that it expects to achieve through economies of scale.

One of the things that has limited the use of outsourcing by medical device companies is that a very high proportion of those companies have revenues under $500 million. They are in the medium- to small-cap range, and their products are very differentiated. Consequently, the supplier doesn't have much advantage over the customer in setting up low-cost manufacturing.

As the supplier community has responded to the potential for outsourced business, how important has it been to have a method for certifying companies according to voluntary international quality standards?

Burke: I do not know if international standards have driven us to select better suppliers. ISO certification is certainly one of the criteria that we impose on our supplier base, but I do not know if that has driven us to different decisions than we would otherwise have made. We would do our own audits of our suppliers anyway.

Augustine: The suppliers have caught on to the value of such standards and have taken the initiative to become not only ISO certified but FDA registered. In part, they view such certifications as a marketing tool, and they market their services accordingly.

The Right Choice?

What sizes of medical device companies are most likely to outsource? Is the strategy workable at every stage of a company's growth? How willing are outsourcing providers to partner with very early-stage companies?

Burke: It covers the whole spectrum, beginning with small companies. For small companies, there are some advantages to using a contract manufacturer. It keeps them from incurring brick-and-mortar expenses, and also eliminates the need to internally develop all the competencies and capabilities that might be needed to manufacture the product.

The strategy has continued utility all the way through to very large companies. In some cases, for instance, a large company with a product that is in the waning years of its life cycle may simply be looking for a way to drive down its production costs. Some contract manufacturers can offer low-cost manufacturing for such products. So, I think outsourcing offers good potential for both small and very large companies.

When a medical device manufacturer partners with an outsourcing provider, what kinds of terms are negotiated into their business agreements?

Burke: Each situation drives the degree, depth, and differences in the contractual agreements between the medical device company and its outsourcing partner. But companies are coming up with some innovative approaches.

One thing that our company has done—and it was hard to do—is to establish a cost-savings–sharing program. In that program, our company and our outsourcing partner jointly review the entire supply chain, and we share any cost savings that we come up with. The intent is to create a working arrangement such that the outsourcing company is motivated—as we are—to continuously drive the improvement of cost, service, and quality in the supply chain, and to make the partners function as though we were a single company.

Augustine: I haven't really seen a lot of contractual commitment to cost sharing. But I have seen negotiated approaches with early-stage companies, in which the supplier offers a lower price and absorbs a lower margin because the manufacturer's product is not yet mature. The supplier is taking the upfront risk on the assumption that product costs will drop as the product is adopted and volumes increase. And then, as optimization occurs, the reduced costs and higher volumes are reflected in future years' negotiations.

Are there particular medtech sectors or types of products that are especially suited for outsourcing?

Burke: A medical device company may not have the technology required for plastics molding or manufacturing with stainless steel or exotic metals. Those would all be considered subcomponents, and companies often depend on a number of different outside sources to make them. And then the device company itself does the final assembly.

Capability Statements

How does a medtech company decide what capabilities it needs from an outsourcing firm? Is cost the single, overwhelming factor? To what extent are factors such as a company's own core competencies or production capacity considered?

Augustine: A company's manufacturing strategies should be driven by its business strategy. So, I think a company has to start by defining what the entity is trying to accomplish over the short and long term, and then identify how manufacturing can best serve those purposes.

Burke: I agree very strongly that a company's outsourcing strategy must be directly linked to its corporate strategy. A company's corporate strategy should define where it wants to go and what it wants to do. And those elements should then be translated into a supply-chain strategy for marrying effectively the capabilities of the company with those of outside contract manufacturers.

Augustine: Otherwise, the tail is wagging the dog. Another thing to consider as part of the capabilities analysis is whether it might provide a competitive advantage for a company to bring a particular processing technology in-house. In cases where that question applies, companies really need to make a conscious operational decision about whether to grow and develop that talent in-house or to outsource it.

How do you determine which projects are done in-house and which ones are outsourced?

Burke: I cannot say that, in the past, there has been any formal method. The decision has mostly been a matter of considering which firm has people with experience in projects like the one in hand. And if our outsourcing partner has someone who has done it before, they may be in a better position to take on the project than we would.

A lot of coordination issues can arise when a medtech firm is working with an outsourcing company—especially when the device firm itself has many divisions. How are those problems typically addressed, and what role do IT solutions play in dealing with such issues?

Burke: Coordination issues are very difficult, and we see them on a day-to-day basis because we have a number of different departments working with our supplier. We have R&D, manufacturing engineering, and logistics people all working with our supplier, and trying to coordinate everybody's activities can be very difficult.

There are some great solutions that we hope to implement in the next year or two. For instance, the I-Supplier and I-Procurement solutions enable manufacturers to monitor their suppliers' operations, including current inventory levels and even their supplier base. Implementing such a system will make it possible for us to confirm that raw materials and components are moving through the supply chain so that they come together in a timely manner to make the finished product.

Augustine: The tools are available. There is a plethora of solutions that companies can purchase, but sometimes they can be rather cumbersome to implement. Assuming the company has invested well in infrastructure, it is generally easier to implement interplant or intercompany solutions because the company is guaranteed of commonality once those solutions are rolled out.

Are the providers of IT solutions making them scalable enough so that a start-up company can buy in at low cost and scale up as the company grows? Or is there still some flexibility needed from the providers?

Augustine: Depending on a company's business model, there are essentially two different strategies it can adopt for implementing an IT solution. Each company usually decides pretty early on which strategy it is going to adopt.

The first strategy is to put in place a large enterprise resource planning (ERP) system that ends up growing with the company. In this case, the company usually implements new modules as it grows or as they become necessary.

The other strategy is to adopt a best-of-breed approach, buying and implementing the best IT solutions for any given application, even though they may come from a variety of different vendors. This model can work for small companies that do not intend to grow very large, because nowadays different providers' IT solutions can generally be made to work together when necessary. The strategy offers the additional advantage of permitting the company to decide where to invest its IT resources, and when. A company with a single facility, for instance, would typically invest first in developing its internal systems. But as it develops additional sites or connections with extramural entities, it can add modules designed to handle such communications.

Burke: The critical factor is being able to link up different systems. Without too much struggle, the small systems used by small companies should be able to link into the large systems used by large companies.

Viable Strategies

Overall, how would you rate outsourcing as a viable business strategy?

Augustine: Considering whether to outsource is a standard part of company operations. It is certainly a viable alternative for many situations, and it needs to be considered. The more suppliers there are that can meet the needs of companies of different sizes, and with different product specifications, the more likely it is that outsourcing will become a widely used strategy.

Are particular types of outsourcing likely to grow significantly in the next three to five years? Are there areas that you would caution manufacturers not to outsource?

Burke: If we continue to have pressure on the pricing of all the commodity products that one finds in a doctor's office—everything from Band-Aids to small instruments—outsourcing providers that can give a manufacturer access to low-cost labor will do a great business.

Augustine: I agree; the need for low-cost labor offers a real clear path for outsourcing. Another area of expansion might involve manufacturing for which there is an opportunity for automation, but where the costs of automating might be prohibitive for a single device company trying to go it alone. In some such cases, when a single company can't attain sufficient return to justify the investment in automation, aggregating the operations of a number of companies can provide a route for automation. And here, also, there is an opportunity for expanding the use of outsourcing.

Is all outsourcing going to increase?

Augustine: I think that will depend in part on the supply chain's expansion into automation and in part on the appearance of success stories that go beyond what we are seeing in outsourcing today.

Burke: Again, this decision is very company and product specific, but I believe that outsourcing will continue to grow as companies focus on their core competencies. It really comes down to the strategy of the company, and whether the company considers the development and delivery of product to be among its core competencies.

Copyright ©2004 MX