Originally Published MDDI July 2004
Guide to Outsourcing
Contract manufacturers discuss the most common misconceptions about outsourcing and offer solutions to OEMs.
Christina Elston
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| “It is rare that a company uses activity-based costing and truly knows its manufacturing margin for each product line or lot.” —Joan Will |
As the medtech industry has become more innovative and more advanced, outsourcing has become increasingly indispensable. Although the industry relies heavily on outsourcing, some OEMs have difficulty forming mutually beneficial partnerships with contract manufacturers.
According to Marius Balger, vice president of business development at BIT Analytical Instruments (Menomonee Falls, WI), many medtech companies still harbor misconceptions about outsourcing. These misconceptions are based on four factors. Timing; money; partner evaluation issues; and a disconnect between R&D, industrialization, and manufacturing, get in the way of potential outsourcing successes.
Lack of information and unclear customer expectations abound, says Balger, adding that customers tend to underestimate factors such as cost and R&D workloads. They also fail to provide relevant market data and product specifications. Potential customers often ask for timelines that are too short to allow for quality work.
Many outsource service providers tell similar tales. Here are some common myths and misconceptions that abound in the industry.
Outsourcing Is More Expensive
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| “Many customers underestimate the startup and continuing costs of coating their own products.” —Lonny Wolgemuth |
The belief that it is always cheaper to do things in-house seems to persist for several different reasons. One of these, says Joan Will, director of new business development at Enova Medical Technologies (Saint Paul, MN), is that companies underestimate potential savings. “The company perceives it already has incurred a ‘sunk cost' of overhead, such as labor and building, and it does not consider the issues surrounding the profitability of manufacturing a low-volume or intricately assembled product,” says Will.
Capital equipment and facilities expenses are one of the largest areas of savings in most outsourcing opportunities, says Gene Long of Altron Inc. (Anoka, MN). Companies that try to keep everything in-house can spend “millions of dollars, with a need to update every 3 to 5 years to stay competitive,” he explains. “A good contract manufacturer can typically save an OEM 10–20% of the OEM's true burdened costs.” The savings add up to more than just minor per-unit cost decreases, Long says.
OEMs also mistakenly assume that their overhead rate is the same for all products, and then they underestimate what it will cost them to do work in-house. “It is rare that a company uses activity-based costing and truly knows its manufacturing margin for each product line or lot,” Will says, “so [most companies] don't have a true basis for comparison.”
Investing in outside core competencies (e.g., in medical coating) is often more expensive than OEMs realize, says Lonny Wolgemuth of Specialty Coating Systems (Indianapolis). “Many customers underestimate the startup and continuing costs of coating their own products,” Wolgemuth says. “In addition to floor space and the actual coating equipment, ancillary tools such as preparation equipment, cleaning and testing equipment, drying equipment, etc., may be necessary to complete the coating processes.” Additional expenses include training, development, routine maintenance, and raw-material costs, as well as “hidden opportunity” costs. “Companies that do not commit the resources to their in-house coating—including time, financial resources, and people—may find themselves either facing costly issues with their coating due to inexperience, or neglecting their core competencies when going outside their area of expertise,” Wolgemuth says.
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| “Most outsourcers are more concerned about customer satisfaction than about opportunities to increase their budget.” — Dirk Smith |
On development projects, companies with an internal development staff might perceive outsourcing as more costly because it is easier to spend budget dollars internally, where more money can be spent with less scrutiny, says William J. Allen, executive vice president of R&D
at Synectic Medical Product Development (Milford, CT). “A highly focused, nonbureaucratic contractor who understands the problem may very well finish the job in fewer man-hours, at a lower-than-internal hourly rate,” Allen counters.
Most outsourcers, in fact, are more concerned about customer satisfaction than about opportunities to increase their budget, says Dirk Smith, director of business development at Minnetronix Inc. (St. Paul, MN). “Overcharging, ‘nickel and diming,' or milking a customer for extra, unwarranted dollars is not a good—or even viable—long-term business approach,” Smith says.
“Outsourced project costs do often increase beyond initial budgets, and generally the cause can be attributed to both the outsource company and the customer. However, seldom, if ever, are cost increases or unexpectedly high budgets due to an outsource company's desire to make a bigger profit, particularly with well-established contract companies.”
If We Outsource, We'll Have to Manufacture in China
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| “Doing manufacturing and assembly in the same place is one way to keep costs down.” —Steve Santoro and Jim Jock |
Offshore production does sometimes save money, and it can offer other advantages, but this depends on many factors, says Steve Sundberg, director of sales and marketing at Technical Services for Electronics (Arlington, MN). These factors include local availability of parts, the complexity of the design, and the ability to plan orders.
Offshore production is also cost-effective if there is excellent demand for a product where production occurs, says Michael Flater, director of business development at Facet Technologies (Marietta, GA). “However, this is not true for many products [when considering] the hidden costs and fees of offshore production, as well as the costs of holding increased safety or buffer inventories, and currency valuation swings,” says Flater.
Luckily, offshore manufacturing isn't the only cost-saving tool at a contract manufacturer's disposal. Doing manufacturing and assembly in the same place is one way to keep costs down, say Steve Santoro and Jim Jock of Micro Medical Technologies (Somerset, NY), adding that “this way, everything can be modified in real time, and you get immediate feedback in the loop.” Designing products to minimize labor is another. This often means products can be built “as cost-effectively domestically as offshore or in Mexico, and with more flexibility,” says Long. “The OEM needs to work with the chosen contract manufacturer to minimize labor costs,” he suggests.
It Will Take More Time to Outsource
Many outsourcers also have strategies to accommodate even the most critical turnaround schedules. “A strong partnering relationship between customer and provider is an integral part of effectively communicating and meeting the needs of the customer and the logistics capabilities of the service provider,” Wolgemuth says.
Some expectations, however, are too high, admits Allen. “Clients sometimes simply have unreasonable expectations of what anyone can accomplish in a given time,” he says. “We usually no-bid these cases unless the client is really adamant and is willing to take development risks (e.g., skip a prototype stage) where necessary.”
Our Staff Won't Like It
There is a perception that learning opportunities for in-house talent—or even jobs—are inevitable casualties of medtech outsourcing. But a good outsource company can help manage staff concerns at the OEM by welcoming staff to oversee and collaborate on projects, says Allen. “A sensible contractor will welcome the interaction both for technical and political reasons. In our long experience, this has not been a problem, and I believe that our attitude has been and will continue to be instrumental in making it work.”
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| “We have had employees of the contracting company work full time at our facility to learn and keep current on the project.” —“Ace” Edwards |
“Proper coordination between the companies is imperative,” says Albert “Ace” Edwards, director of sales and marketing at Sector Electronics Inc. (Acworth, GA). “In many projects that we have worked on, we have had employees of the contracting company work full time at our facility to learn and keep current on the project as it is transitioned back to their facility.”
Sundberg also reminds medtech companies that freeing up resources through carefully planned outsourcing can mean an opportunity to create more and better jobs in-house.
No Outsource Company Could Possibly Match Our In-House Skill and Knowledge
Opportunities are lost, however, where a “we can do it better ourselves” mentality prevails. “Many companies don't want to believe that a vendor is in fact better equipped and more knowledgeable about certain processes and products,” says Mark Saab, president of Advanced Polymers Inc. (Salem, NH). “They often think they have to do it in-house when the better choice is to outsource.”
“We are often as well informed as the client,” insists Allen. “With our immediately accessible medical staff, we can often acquire expertise about a clinical issue more efficiently than the client. The key is in choosing the right contractor and communicating effectively.”
The right contractor, outsourcers say, doesn't always need experience with a product exactly like yours to do a good job. “For instance,” says Smith, “an outsourcing partner having significant experience with embedded microcontrollers, rechargeable batteries, dc and stepper motor control, and medical sensors would likely be well equipped to assist a company in the development of a next-generation insulin pump. Past experience with insulin-pump design would be advantageous, but not a required attribute for a successful development effort.” In fact, Smith contends that partners with broad rather than focused application experience often bring unique crossover ideas and complement the application-specific focus of the customer.
Proper research is the key to finding an outsource match that makes the OEM comfortable and the product trouble-free. “The biggest obstacle is when manufacturers (especially smaller companies who would be more interested in outsourcing) do not know what parameters to investigate to select a qualified medical device outsourcing partner,” says Will. “If proper due diligence is not done, they can experience problems when the product gets outsourced. But, since there is no checklist of things to follow when researching an outsourcing firm, it takes a lot of effort to research the firms.”
Outsource Companies Steal Customers' Technology
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| “Many companies often think they have to do it in-house when the better choice is to outsource.” —Mark Saab |
While some medtech companies worry about outsourcers not having enough experience, others are concerned about contract resources having too much experience and too many connections in their application area, Smith says. “While in some cases within extremely small markets this can be a valid concern, in general, contract design and manufacturing companies take confidentiality very, very seriously,” he insists. “It is in the nature of their business to be in contact with potential competitors and companies with related technologies or applications, and, as such, it is essential that outsourcing companies maintain strict confidentiality among customers.”
And, of course, sometimes experience with similar products or product applications is an advantage. Product development engineers with an understanding of the product application and product-use scenarios will have a running start on the project, Smith says.
Development firms are especially aware, says Allen, of the ethical issues they face. “Consulting firms like ours cannot survive in a small innovative business environment for very long without impeccable ethical behavior,” he says. “Carefully written nondisclosure agreements, prompt technical disclosures, categorical patent assignments, and an ethical refusal to solve the same problem for different clients all serve to provide the same level of protection as would be obtained from an internal development program.”
Of course, OEMs shouldn't expect outsourcers to forego protecting their own technology, says Steve Griffin, vice president of technology at Innova- Quartz Inc. (Phoenix, AZ). “Most of the customers coming to us for product development or manufacturing seek unilateral IP agreements to protect their technology and resist bilateral agreements that would protect our technology,” he says. “This arrangement severely limits our ability to serve the customers because we can't risk applying our more-advanced solutions to their problems.”
Quality Control Will Be Tighter In-House
Medtech companies may also distrust an outside firm's quality assurance systems. However, outsourcers say that they are not only as interested as OEMs in producing quality products, but are also as well equipped to do so. “Usually the facilities and equipment are replaced and upgraded more often at a contract manufacturer than an OEM,” Long says. “The level of experience and expertise is typically higher at a contract manufacturer due to the variety of projects and products supported. The state-of-the-art equipment and higher level of expertise will normally provide a higher level of quality.”
And because strict quality requirements aren't limited to the medical industry, the choice of outsource partners need not be either, say Santoro and Jock. “In fact, certain requirements in some industries (e.g., automotive electronics) are more stringent than the corresponding ones for [medical] devices,” they say. “In those cases, an amalgam of those systems and the medical systems can be stronger than each separately.”
A key factor is whether your potential outsource partner has resources dedicated to the medical device industry, including experienced medical market specialists who have a working knowledge of the latest trends, applications, and requirements of the industry, says Wolgemuth. He recommends asking about a contractor's FDA device or drug master files, dedicated resources for the industry, and regulatory experience with such medtech particulars as FDA audits and required documentation.
Checking a company's regulatory understanding and experience is essential when qualifying outsource partners, cautions Smith. “There has been significant interest in the last several years by historically nonmedical contract manufacturers to get into the medical device marketplace. Many of these companies bring solid manufacturing capabilities and technical experience,” Smith says. “However, some do not fully understand or appreciate the regulatory requirements involved in medical device manufacturing.”
You also shouldn't ignore the need for FDA registration and compliance with the CFRs for good manufacturing practices in contract manufacturing, says Griffin. Many OEMs take advantage of the fact that FDA allows production by nonregistered contractors as long as the product is designed by the OEM and as long as a contract exists to ensure compliance with the CFRs in manufacturing. “In practice, the execution of a written contract and supplier audits are forgotten in the haste to get the product to market and keep supplies moving,” says Griffin. “In each and every case that we have become aware of, materials traceability, design and process controls, CAPA, etc., have been neglected to the detriment of product performance and safety.”
All We Need to Know About an Outsourcer Is in the Price Quote
Some companies that decide to trust an outsourcer with their products focus their selection process on the RFQ, but this is a mistake. “Each contract development and manufacturing company is unique, with unique capabilities, experience, focus, and perspective,” Smith says. He advises that companies find out about the in-house expertise and capabilities, product and regulatory experience, and focus of each company it considers.
“Many contract manufacturers offer product design services, but are heavily biased toward manufacturing. Likewise, large outsourcing entities may focus primarily on mainstream, high-volume products, with little experience or real internal incentives to assist startup companies with prototypes and initial clinical trial devices,” Smith explains. A thorough investigation of prospective contract resources—visiting facilities, checking references, understanding past product experience, and reviewing and discussing proposals and quotes—can make a difference. “In the investigation process, face-to-face interactions with management and likely project leaders and team members are invaluable,” says Smith.
During those investigations, beware of the lowest-price bidder. “Typically the low-price bidder is not the one with the resources, process control, or experience to manufacture a high-quality product,” Long says. “An OEM should qualify those contract manufacturers that have the resources and experience to provide the level of service, flexibility, and quality necessary. Let only the qualified contract manufacturers quote your projects so you get the value you expect.”
Design and Manufacturing Can Be Kept Separate
No matter how qualified they may be, the people who are designing a product and the people who will manufacture it need to work together—even if they aren't all in-house—say outsourcers. Many cited problems with scale-up and manufacturing when designers go it alone.
“Product designers are usually only interested in functionality,” say Santoro and Jock. “They don't always think about how it can be manufactured in the real world. In many cases, they put unrealistic tolerances in there. Contract manufacturers can bring their core competencies in manufacturing to the table. The product designer and contract manufacturer can play off of each other's strengths to collaborate on a design that is both functional and manufacturable.”
In fact, contract manufacturers are often eager to help. “One of the best value-added services we can provide is to share our expertise in how to better design for manufacturability,” says Sundberg. “We have been doing it for a long time and can help our customers learn from others' (including our own) mistakes.”
The transfer to production is never a simple process, says Smith. “Often numerous minor discrepancies are discovered during the scale-up process, particularly when transferring design information from a customer's lab or from a contract design partner to a contract manufacturer,” he explains. “Also, often design issues relating to device tolerances and part variations not obvious during preproduction builds can become apparent when completing initial production builds. Building the first 10 devices can be difficult, because it's never been done before. Building the next 100 can be equally as challenging, often due to subtle, volume-related issues.”
If you are outsourcing design, it is worth considering contracting with the same company for manufacturing, suggests Griffin. “We've had many experiences where customers come to us to develop a product for them but, once developed, take the manufacturing to another company,” he says. “In each case, this has cost the customer a great deal more time and money than if they'd allowed us to scale the production here.”
You can also save time and money by addressing automation issues during design. “A key consideration in early phases of outsourcing is determining whether the product or production can or will be automated in the future,” explains Wendi Achey of Integrated
BioSciences Inc. (Harrisburg, PA). “The design for the product should then fit into the automation technology. It is typically more cost-effective to address this issue in the early design stages rather than later.
Automation can then lead to higher volumes at lower costs.”
Outsourcers Can Work with Inaccurate Information and Inadequate Funds
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| “A key consideration in early phases is determining whether the product or production can be automated in the future.” — Wendi Achey |
Some OEMs expect to receive designs, products, and top-flight service from outsourcers without themselves supplying anything up front, outsourcers say. “As a contract manufacturer, we do not stock a wide variety or a large volume of materials,” says Jay Murray, sales manager at Sealtech Inc. (Athens, TN). “Many do not understand that they may need to pay for a minimum run of material even though their order may only consume a small portion of it. Some folks also come to us with an idea and assume that we will do the R&D, make drawings, and produce prototypes at little or no charge.”
Some medtech companies even assume that outsourcers will produce short runs and samples of parts “without any commitment to actual business,” says Richard A. Sunderland, business development manager for Smiths Medical ASD Inc. (Gary, IN). They also expect that work begins when revenue begins. “Actually, investment begins when assessing projects and only reaps a reward when revenues start. This can be a long period of time,” Sunderland says.
Other off-the-mark expectations can also harm your outsourcing relationships. Don't assume, says Wayne Black of CP Medical (Portland, OR), that a contract manufacturer will always have a product in stock or will drop everything—including work for its other customers—to accommodate your needs. Many medtech companies also wrongly expect an outsourcer to absorb engineering and tooling cost changes needed to modify the design of a current production item. They assume that they will have access—free of charge—to products developed for another client at that client's expense. Once manufacturing is under way, keep in mind that product will only keep rolling off the line if you pay your bills on time, says Black.
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| “Investment begins when assessing projects and only reaps a reward when revenues start.” — Richard A. Sunderland |
The idea that your outsource partner can produce accurate price quotes and meet product demand with inaccurate information provided gets many OEMs in trouble. No outsource company can compensate for flaws in your own forecasting and planning, Sundberg says. “While we strive to anticipate the OEM's spoken and unspoken requirements, we still cannot deliver miracles,” he asserts.
And no company, no matter how experienced, can anticipate all the twists and turns of every single project—especially when it comes to development, says Smith. “Each project is different, and every customer is unique,” he explains. “And, of course, product requirements and other information provided at the RFQ stage often undergo significant change during a project.”
The medtech industry itself continues to evolve, and the role of the outsource provider may change along with it. And while it is impossible to predict outsourcing trends very far into the future, it is clear that in the short term, OEMs that can address in-house misconceptions will find
contracting out a better fit.
Copyright ©2004 Medical Device & Diagnostic Industry