Contracting Out: Outsourcing Strategies for Medical OEMs

Originally Published MDDI November 2003

Outsourcing

Medical device makers are outsourcing design, manufacturing, and assembly with increasing regularity. To do it right, however, they must make quality a priority and determine to what extent they are able to apply vendor-managed inventory strategies.

Maureen Kingsley

No doubt about it: medical device OEMs are outsourcing design and manufacturing more than ever before. Large companies are moving away from vertical integration toward strategically contracting out various operations, and both start-ups and the new “virtual companies” are following in their footsteps.

Uday Karmarkar, a professor at The Anderson School of Management at the University of California, Los Angeles (UCLA), confirms outsourcing's popularity. “Companies do it more and more,” he says. “They say, ‘Gee, you know, let's just do what we do best. We don't have time to do all this [manufacturing] stuff. So let them do it, and do it well.'” Karmarkar points out that an economy of scale always tilts in the OEM's favor when the company removes an operation from its business and contracts with another firm to do it more efficiently.

Randy Bormann, general manager of the Development Center at UTI (Collegeville, PA), believes the nature of the medical device industry in particular lends itself especially well to contracting out certain operations. “The medical industry has a very short product life cycle,” he says. “The technology changes on an almost daily basis. If OEMs aren't prepared at the R&D level, they find themselves playing catch-up all the time.” 

Bormann also notes that recently, companies in the device industry have been taking a close, critical look at how their resources are being allocated. “They're looking and saying, ‘We're putting too much of our resources into making the products, and not enough into developing them.'”

In addition to admitting that they lack a manufacturing or design competency, and using that admission as the basis for contracting out, OEMs also tend to be won over by something even less complicated: the years of experience contractors have collected in their niche industries. Contractors specialize in everything from metal-tube fabrication to ergonomic product design. Bill Gaffney, vice president of marketing and international sales at UTI, says of his contract manufacturing company, “We have the experience, the capital equipment, and the technology to do [a particular type of manufacturing] in a very short period of time, as opposed to an OEM trying to develop a manufacturing competency in-house from scratch, which would take a great deal of time.”

But while the benefits of outsourcing are clear and the reasons for it solid, how does a medical device company go about choosing an outsourcing partner? What should OEMs demand from their contract manufacturers and product designers, and what does the future of outsourcing look like?

Right now, the industry buzzword for OEMs and contractors alike is quality, followed closely by inventory management and comprehensive services. And the future of outsourcing points to more of the same as it relates to keeping costs down, viewing devices as consumer products, and accommodating virtual companies.

All Eyes on Quality

According to OEMs and contract manufacturers, the number one demand of contractors is that they implement and maintain nearly foolproof, transparent quality systems. Under pressure from FDA, savvy OEMs require rigorous quality systems of their contractors more than ever before. But the pressure on contractors comes from within, too. UTI's Gaffney explains: “Improved quality systems is at the top of the list when you're dealing with multiple products and multiple components and putting things together and so forth. You have to have centralized quality systems. You're working with good manufacturing practices, and in some cases you've got FDA-registered facilities. Improvement of the quality systems is pretty obvious, I think.”

Because contract manufacturers—especially those that perform comprehensive soup-to-nuts services—essentially represent their medical device company clients to FDA, they take their quality systems seriously. J. Randall Keene, president of Avail (Fort Worth, TX), feels very strongly about the responsibility of the outsourcing partner with regard to OEMs' standing with FDA. “The quality systems that are required now and the fact that we actually represent our customers to FDA is all new in the last several years,” he says. “It's not about having a cleanroom and doing a couple of things in the cleanroom and having a couple of technologies. [OEMs] want to be able to have a complete solution, and that requires a fully integrated large organization, which is really what we're seeing is happening to the [outsourcing] industry.” Today, Keene says, the quality systems that contract firms have in place must be as good as, or better than, their customers'. “It's absolutely a requirement,” he says. “And to me, it's one of the single reasons why a lot of small contract manufacturers are not going to be able to make it to the next level.”

UTI's Bormann adds that in order for OEMs to be able to demonstrate to FDA that they actually have control over their processes, the OEMs must demonstrate that their vendors have suitable quality systems. This idea, termed due diligence, is too important for OEMs to overlook. Andrew Jelen, managing director of Encompass International (Edmonds, WA), a firm specializing in quality engineering, regulatory affairs, and process improvement, stresses it repeatedly to his medical device clients. “For certain classes of devices, FDA requires that potential suppliers, contractors, and consultants be evaluated on and chosen by their ability to meet specified technical and quality requirements,” he says. FDA wants to know that medical device companies are adequately qualifying, managing, and controlling their subcontractors. “That typically falls under 21 CFR Part 820, Subpart E,” Jelen notes. He emphasizes the importance of OEMs' prequalifying potential outsourcing partners by performing in-depth assessments of their systems, processes, and facilities. Companies need to have their best quality engineers walk the floor to talk with the people doing the work and scrutinize the process, he advises. 

John Pfaff, vice president and general manager of The MedTech Group Inc., a Plainfield, NJ–based contract manufacturer, says his company “absolutely insists that the OEM come and visit, if not to do a formal audit, then certainly to see and touch the systems that are in place, and talk with management and the people involved.” UCLA's Karmarkar adds, “Ask, ‘Do these folks walk the talk?' They say they have these systems, but do they actually execute them?”

Mike Burke, vice president of manufacturing and quality at KCI Inc. (San Antonio, TX), recently entered into a partnership with Avail to manufacture wound-care products. When KCI was shopping around for an outsource partner, quality was key. “One of the big things for us was that if we were to have a problem with microbiological contamination of any of these sterile disposables, it could mean a huge downfall in sales and revenue.” Choosing a partner that was not going to falter in terms of product quality was paramount. Now that KCI has chosen a partner and made a commitment, the company isn't resting on its laurels. “We do very extensive audits,” Burke says. “We have our quality people who will go into Avail's facility and spend days going through all of its quality systems and making sure it's meeting all of the FDA regulations. We do that on a six-month basis. We go back and do an inspection of the operations and the facilities,” he says.

Managing Inventory

Quality reigns when it comes to choosing an adequate outsource partner, but the significance of inventory management capabilities is increasing. Some of UTI's and Avail's customers have come to demand it.

In terms of vendor-managed inventory, or VMI, “there are two dozen acronyms you can throw out,” says UTI's Bormann, “but JIT, meaning just in time, is a common one.” While few OEMs are at the level where they are prepared to work with vendors as thoroughly as they need to do to accomplish VMI, Bormann says, those that are at that level are “very much insistent” that they expect the vendor to play a significant role in controlling the costs associated with inventory. “They're looking for shorter lead times, and they're looking for inventory management,” Bormann says. His colleague, Gaffney, adds that in many cases, UTI is “on dock-to-stock programs, where effectively, our product is going right into [the OEMs'] inventory. We're shipping product according to their demands, and drastically minimizing the inventory that they are carrying.” For this to happen, of course, the OEM must be convinced that the contractor is reliably maintaining quality systems and churning out quality product. To that end, “we're doing a lot of statistical process control and working with very tight quality requirements,” Gaffney says.

KCI's Burke is very specific about turning inventory management and distribution over to a competent outsourcing partner. “[What] we're looking for, particularly as we try to sharpen up our supply chain, is integrating the outsourcing company right into the flow of our material. With Avail, the most efficient way of distributing our product was to distribute directly from the manufacturing facility, [without] moving the product around.” He reiterates, “We want to move the product as few times as possible.”

Soup to Nuts—-And Beyond

In an industry that increasingly values innovation and generates breakthrough-technology superstars, many OEMs want to be able to hand over the less-glamorous aspects of their business to contractors. The more extensive the services offered by contract manufacturers, the better. “What people really want,” says Karmarkar, “is a significant degree of design capability, contracting, and subcontracting capability.” Pfaff of The MedTech Group adds, “There should be enough engineering support provided by the contract manufacturer to make suggestions and improvements in the product—not just in the manufacturing process, but also in the basic design. We find that most manufacturing costs, maybe 70 or 80%, are really determined up front by design.”

Burke concurs. “A lot of the medical device companies are really trying to put their core competence on the development of new medical devices, and that's where the cutting edge of new products is. That's where the margins are; that's where the benefits are.” It behooves contractors to be able to do more than just produce one component, in other words. UTI's Gaffney refers to “integrated, expanded capabilities. It's our model for contract manufacturing,” he explains.

When KCI, primarily a maker of hospital beds, wanted to expand into the wound-care market, for example, the company needed to find an outsource partner that could provide comprehensive services. “We did not have a lot of the resources in-house to do all of the R&D of these application-specific dressings,” he says. “We were looking for somebody who could give us some support on that, and we were looking for somebody who could integrate well into what we call our new product commercialization process. We needed to have someone design, develop, [manufacture], and bring to market these new application-specific dressings as quickly and efficiently as possible.” KCI was therefore intent on finding a company with the expertise to support that process.

Looking Ahead

The very near future promises some interesting new challenges to both medical device makers and their outsource partners. One fact won't change, however: outsourcing is here to stay. “I think the primary change is going to be that the magnitude of the adoption of outsourcing as a strategy is going to increase,” says Avail's Keene. “People are going to be able to see that outsourcing improves speed. And the big guys need speed.” Perhaps even more astute is Keene's prediction that most of what's to come in outsourcing is already happening now. “It's just happening on a smaller scale [than it will be in the future],” he says.

Considering Cost. It's good news for OEMs that contract manufacturers are concerned with cost. “I think the trend is just going to continue to get stronger as far as price pressures are concerned,” says UTI's Bormann. “We as vendors have to be much more intimately aware of the cost restrictions that our customers are dealing with than we've ever been before. We have to be much more in tune with our own capabilities and what we can do to improve costs, so that we can continuously pass those improvements along.” 

OEMs shopping for an outsource provider should look for companies that share Bormann's perspective. Insurance companies are the ones that hold all the power in terms of reimbursement, he says. If reimbursement doesn't go through on a particular technology, or if the reimbursement status changes, then the purchasing organizations take that information back to the OEMs. “The purchasing groups tell the OEMs, ‘Look, we have got to get control of these costs.' And subsequently, that comes back down to us,” Bormann says.
Gaffney agrees. “There's certainly a lot of price pressure,” he says. “OEMs are being squeezed by hospitals, and hospitals are being squeezed by insurance companies. So there are gaps in everything. The price pressure goes all the way down the line, and certainly goes to the contract manufacturers.”

Addressing “Consumerization.” Certain types of medical devices—glucose monitors and insulin pumps for diabetic patients, for example—are beginning to be viewed by healthcare personnel and patients alike as consumer products. The trend has tremendous implications for the companies that make and market these types of devices. “The consumer is starting to treat these things as more of a consumer product and less as a medical instrument,” says Aaron Oppenheimer, principal at Design Continuum, a West Newton, MA–based company that performs design services. “The manufacturers are being forced to understand what consumer products are. Nowadays, when you have maybe a hundred different glucose monitors to choose from, people are a lot more picky, and they're applying what they know about consumer products.” Contract designers and manufacturers with consumer-product experience have much to offer medical device OEMs in this regard. More and more, medical devices are being marketed by form, ease of use, convenience, and the user interface. In the case of these types of devices, Oppenheimer says, a company that has one foot in the consumer-product industry and the other in the medical device industry has the advantage over other companies vying for a contract. The company that knows how to commercialize and miniaturize will come out the winner.

Gary Stacey of Haemonetics Corp. (Braintree, MA), knows this firsthand. His company outsourced the design of a product called CellSaver, a device that collects and processes blood normally lost in surgery, then transfuses it back into the patient. Haemonetics needed an outsource partner that could improve the device's design, packaging, and user interface. “There's definitely more effort put into the visualization of the product” these days, Stacey says. “The prime need is functionality, but one wants to design a machine that's intuitive, not complex. And the application to the user [should include] foolproof loading of a disposable, and it should be very cleanable. User-friendly equipment in the medical device arena is definitely a trend.”

Firms such as Design Continuum specialize in commercializing, miniaturizing, and “humanizing” a product to make it more appealing to consumers. To do these things, the firms will go out into the clinical setting and spend time with end-users and patients. “Big, old-school manufacturers that aren't used to doing this sort of testing or research, as well as start-ups that don't really know how to proceed, can outsource that type of design work to us,” Oppenheimer says.

Allan Cameron, principal at Design Continuum, adds, “As medical devices begin to take on a consumer product's life, they also take on the consumer product's life cycle.” That means a faster pace and shorter turnaround times are required.

Going Virtual. A relative novelty in the medical device industry is the advent of the “virtual company,” which is an entity quite limited in its capabilities. A virtual company needs all the help it can get from outsource partners. Cameron explains it this way: “What's happening now with a lot of venture capital funding of these smaller groups is they are . . . looking for very strong outsource partners to help them commercialize, generally, their technology.”

Encompass International's Jelen points to the aging worldwide population as causing this novel trend toward virtual-company creation. “The demand for medical products is increasing,” he says. “You're finding individuals who work in the field, such as doctors and nurses, who have great ideas for products that address patients' needs. But those individuals may lack design or manufacturing experience.” As a result, Jelen says, designers and manufacturers that can offer turnkey services are scoring contracts with these individuals or groups of individuals. “If someone comes to you with an idea that has been validated by market demand and has funding,” he says, “but that person doesn't know how to bring it to fruition—not only in terms of design and manufacture, but also insofar as meeting regulatory requirements—and you can address these issues and bring the product to reality, that saves time and money.” Avail's Keene adds, “These smaller companies, the last thing they want to do is spend three or four or ten million dollars building a plant. Why not just outsource?”

Bringing It All Together

Outsourcing is steadily becoming a way of life for large and small device companies alike. A firm considering forming an outsourcing partnership must proceed intelligently. It should send its best quality and process engineers to investigate a potential partner's quality systems and documentation. It should determine the extent to which it wants its partner managing inventory, then look for a manufacturer adept at JIT or whichever technique the OEM prefers. Finally, it should be honest about its own capabilities and competencies.

The future of outsourcing offers greater benefits for OEMs and creative challenges for contract designers and manufacturers. Vendors will be increasingly aware of and adaptable to price pressures, while traditional and virtual device companies will demand more miniaturization and humanization of their products from their contractors. 

Copyright ©2003 Medical Device & Diagnostic Industry