You’re Doing It Wrong: Innovative Outsourcing

The increasing shift to outsourced production and assets in the medical device industry is following paths of other industries such as automotive, consumer electronics, pharmaceuticals and personal computers, to name a few. In many ways, the road the industry is on has been traveled before and will be traveled again, creating certain opportunities for comparing and contrasting with other models.

Peter Harris

June 29, 2012

9 Min Read
You’re Doing It Wrong: Innovative Outsourcing

Two primary drivers of the increase in outsourcing are cost reduction and the speed of product innovation. In theory, because medical device companies do not have manufacturing in their set of core competences, divesting these activities allows them to refocus on their core activities of clinical education, R&D, and product marketing bringing better products to market faster at lower costs.1 The movement to outsource has also been shown to be higher in industries where the rate of change of technology in products and processes is high, like the medical device industry.2

In practice, realizing this increased speed and quality of product innovation is full of pitfalls requiring both device OEMs and their contracting partners to aggressively challenge historic thinking. Failure to do so will certainly cause the reality to miss the theoretical mark. The interdependencies between the boundaries of the firm (e.g. how much work is done internally versus outsourced) and product architecture and design have been studied in other industries and the result is a fairly tight linkage.3 If product innovation is to remain strong in the medical device industry, it is important to understand how these linkages will change as outsourcing increases.

Specifically, the process of marrying product innovation with process innovation represents a major area of opportunity for device companies and their partners, which unless specifically considered, could in fact slow rather than accelerate innovation. Outsourced manufacturers must deliver manufacturing process innovation in support of product innovation rather than trying to make products conform to existing assets.

One interesting 2007 study on the effects of outsourcing on product performance in the automotive industry reviewed major model decisions in the luxury car market in which the manufacturing of some were outsourced and the manufacturing of others were done by vertically integrated automotive companies.4 The outsourced models tended to score better in initial product ratings than those developed and made internally, but as compared over the next five years, the models made by vertically integrated companies caught up. Initial innovation was higher in the outsourced model, but subsequent improvements were higher in the vertically integrated model. To understand the cause of this difference, particularly as it relates to medical product outsourcing, consider the major differences between each potential path in the beginning.
In a vertically integrated model, the sourcing company owns and knows a certain set of manufacturing technologies and assets. This limited starting point creates certain constraints on their ability to stretch to new limits. Desired product attributes get measured against manufacturing capabilities in what is often referred to as design for manufacturability. Product features that push the limits of manufacturability are cut back to reflect the realities of the existing assets, and innovation suffers as a result.

By contrast if the OEM chooses outsourcing, they now have access not just to their assets, but also to a much larger set of assets across many companies. These companies are likely to have capabilities beyond their own such that choosing to outsource can significantly aid in stretching product feature delivery. Initially this path affords more product innovation through fewer asset constraints. It is easy to see how the choice of outsourcing can accelerate product feature enhancement when compared to using existing vertically integrated assets. However, this benefit of outsourcing is only one small step of what can be realized in the right form of partnership, expectation and relationship model.

Pushing Boundaries

As medical device OEMs seek to push the boundaries of device performance to improve patient outcomes and clinical economics, process boundaries must also be pushed. In the ideal state, manufacturing technologies would have innovation at or above the pace of product development, so that product feature enhancements are only rarely governed by manufacturing limitations. Although outsourcing affords a broader range of technology from which to pick, more initial choices is not the same as core process innovation to support products. Over a long enough time frame, manufacturing process innovation must be robust for product development to be significant.

One study of the global dynamic random access memory (DRAM) industry actually led researchers to conclude that vertically integrated firms were able to achieve time-to-market advantages over their non-integrated competitors.5 However, the main mitigating factor for nonintegrated competitors was how much the OEM understood about the various required component technologies. Maintaining the knowledge link between process and product is critical.

The typical engagement strategy between a medical device OEM and an outsourcing manufacturer involves a regular repeating loop of dialogue. The device company submits to the outsource partner a series of product requirements detailed in manufacturing prints. The outsourced manufacturer assesses the requirements against their installed asset base (and occasionally known assets they do not own but could procure), marks up the prints, and wins business when the designers at the device company are willing to adjust their product desires to match the installed asset base. Almost by definition, the order of events in the development process starts with the manufacturing method and tries to conform the product to the asset limitations.

Reversing the Flow

For most traditional outsourcers, the steps in the traditional cycle can be distilled down as follows:

  • Our company specializes in certain manufacturing processes

  • We support this specialization with known assets that have manufacturing limits

  • We review new product designs against our asset limitations

  • We win the opportunities where the OEM design teams can live with our process limits


By contrast, consider an exchange that reverses this flow and selects the manufacturing assets last. To maximize product innovation, the selection of the manufacturing process should be the last step, not the first step. Both the OEM and their outsource partner should consider first aligning around the patient outcome and associated testing methods, move through consideration of the key product specifications that deliver this outcome, and only then consider how the product should be made.

We refer to the reversal of the process as outcome-based manufacturing. It can be summarized as follows:

  • What is the improved outcome we are seeking for the patient, caregiver, or both?

  • What functional attributes of the device drive this outcome and how can they be tested?

  • What mechanical properties of the device and its components drive the functional attributes?

  • What manufacturing processes are best suited for achieving the required specifications?


The latter methodology has a much higher likelihood of driving process technology innovation to support product innovation. It greatly increases the chances of boundary pushing manufacturing methods, driving product innovation by making process innovation part of a concurrent cycle. Companies that take this approach will have many more “new to the world” process breakthroughs and ultimately deliver more value to their medical device OEM base through unlocking product features conventional manufacturing assets cannot.

As outsourcing increases, it will be easy for all parties to slip more into the first method of interaction than the second. A likely potential driver of Novak and Stern’s finding about vertical integration having subsequent product enhancement advantage comes from the distance and arm’s length between the product designers and the manufacturing technology. Unless both OEMs and contract manufacturers focus on outcome based process selection, outsourcing will likely only speed innovation through initial choices in vendors rather than in true process innovation. In fact, there is reasonable research that suggests if improperly managed, outsourcing can actually retard innovation.6

Medical device OEMs can review their supplier relationships against both paradigms through a simple series of questions.

Does my outsourcing partner have a patient- oriented mission, or do they define their business around a certain manufacturing capability (e.g. we are a precision stamping company)? The more your partner aligns with your mission, the more likely they will focus on the outcome for the patient. A review of mission statements of the top outsourcing players show less than 25% mention either patients, healthcare or clinicians. This percentage drops among smaller suppliers.

Can I point to new technologies my partner has delivered in support of my device goals? If your partner understands an outcome orientation, they should have a demonstrated track record of process technology innovation in support of your device development goals.

Will my partner take equipment and process development risks, or do they only deploy capacity after I deliver a purchase order? The best in class manufacturing innovators have confidence in their ability to push the technology envelope and will not wait on air tight contracts to advance the state of the art.

How often does my outsourced partner participate in or lead functional testing development for my devices? The best partners understand that they should be heavily involved in device testing development rather than seeing the boundary of their involvement at the dimensions on the prints.

Does my partner create visibility for me to lower tier suppliers with high technology contributions? As noted in recent work by Thomas Choi and Tom Linton, maintaining visibility to key technologies across the value chain is a best practice of leading outsourcers.7

Conclusion

As the distance between product designers and process innovators increases through outsourcing versus insourcing, it is critical for all parties in the value chain to stay oriented toward maximum total innovation in both product and process. Erica Plambeck and Terry Taylor’s work on outsourcing’s effect of innovation in other industries shows that unless properly managed, outsourcing can positively enhance costs objectives through improving capacity utilization, but weaken the overall incentives for innovation in the industry.8

The medical device industry need not realize this result if both device OEMs and their partners adopt business models that maximize both product and process innovation rather than forcing products to adapt to existing assets. Through actively pursuing a philosophy of outcome-based manufacturing, outsourcing partners can align themselves with their device OEM customers to drive improved patient outcomes and make a measurable difference in clinical economics.

References

  1. B Dunn and J Finn, “A Strategic Review of Outsourced Manufacturing for Medical Devices,” (Boston, Covington Associates, 2007).

  2. A Bartel, S Lach and N Sinkerman, “Outsourcing and Technological Change,” (National Bureau of Economic Research(NBER)/Columbia University, 2010).

  3. S Fixson, Y Ro and J Liker, “Modularisation and outsourcing: who drives whom? A study of generational sequences in the US automotive cockpit industry” International Journal of Automotive Technology and Management 5, no. 2 ( 2005): 166–183.

  4. S Novak and S Stern,“How Does Outsourcing Affect Performance Dynamics? Evidence from the Automobile Industry,” NBER, 2007.

  5. R Adner and R Kapoor, “What Firms Make vs. What They Know: How Firms’ Production and Knowledge Boundaries Affect Competitive Advantage in the Face of Technological Change,” Atlanta Competitive Advantage Conference Working Paper, 2009.

  6. RA Bettis, SP Bradley, G Hamel “Outsourcing and Industrial Decline,” Academy of Management Executive 6 (1992): 7–22.

  7. T Choi and T Linton, “Don’t Let Your Supply Chain Control Your Business,” Harvard Business Review, December, 2011.

  8. Plambeck and Taylor, “Sell the Plant? The Impact of Contact Manufacturing on Innovation, Capacity, and Profitability,” Management Science, January, 2005.

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Peter Harris is chairman and CEO of Cadence, Inc. Areas of expertise include strategy development, change management, transaction development, corporate governance, corporate finance, and values-based leadership. Harris is a public speaker who also teaches leadership and change management at the University of Virginia’s Darden School of Business. He has an undergraduate focus in mathematics and Mandarin, as well as an MBA from the University of Virginia. He is dangerously rusty in Mandarin, but can do rudimentary arithmetic with a calculator.

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