So You Think You Need to Outsource. Now What?

Originally Published MDDI March 2004Q&A

Erik Swain

March 1, 2004

12 Min Read
So You Think You Need to Outsource. Now What?

Originally Published MDDI March 2004


Deciding to outsource may be an easy judgment, but analyzing cost and quality implications, finding the right partners, and forging strong relationships are tough tasks.

Erik Swain

Robert Wyckoff, senior outsourcing consultant for Technology Partners Inc. (Alameda, CA).

Outsourcing of medical device manufacturing and even design is becoming a preferred industry tactic. Some might even call it a necessity. But not all firms have a systematic process for deciding what products and functions to outsource, selecting a contractor, and implementing an agreement. This is where consultants like Robert Wyckoff come in. As a senior outsourcing consultant for Technology Partners Inc. (Alameda, CA) and as a self-employed consultant, he has helped a number of device companies, especially those who work with electronics, make better outsourcing decisions. He spoke to MD&DI East Coast editor Erik Swain about some of the key considerations device companies must keep in mind during the outsourcing decision-making process.

Q: What does a device company need to consider when deciding whether to outsource?

A: The first thing to ask is, what is your core competency? Is it design? Is it marketing? Is it delivery? A lot of firms used to say that manufacturing was one of their core competencies. Nowadays, a lot of contract manufacturers specialize in medical, or they have a portion of their resources dedicated to the medical market, and that's helped convince some device firms that manufacturing all or part of their products is not a core competency. Ten years ago, there were only two or three good medical contract manufacturers. But due to the turndown in the industry, after everything bottomed out in 2000 and 2001, everybody has tried to diversify their product lines, and many have outsourced products in relation to their core competencies. The contractors that have emerged do a good job because they understand the risks involved.

In talking this through, you should ask why you feel your company is the only one who could make it. If there's a competitive, strategic, or cost advantage to making it yourself, or if it's a core competency, then you'll want to keep it in-house. But if, for example, a firm that makes defibrillators says, “nobody can put together a circuit board the way we can,” well, yes they can. The [device] company has to ask, what are they about? What do they want to be about? Where do they need to be in terms of quality and cost?

We take firms through a process called activity-based costing. You have to identify what the true cost of the product is. To make an outsourcing decision, you have to determine whether, at the end of the day, you are gaining money on this. That means taking them through the manufacturing process and accounting for all steps in terms of actual dollars expended. Yield is a factor that goes into cost. It may cost you $2 in materials and labor to make something while it costs a contractor $3, but if they make it five times faster, that could sway your decision. 

This is part of the first step of a four-phase approach, called the assessment phase. Once we are done with it, we can say we truly know the cost, and we know from a distribution standpoint where you are today and where you want to be. Once you understand what the costs are, you have to put that into a profitability model. One company we worked with wanted to reduce costs by 20% but keep a profitability expectation of 10–15%. But the way they manufactured the product, there was no way they could get there. So they saw that and made some adjustments. 

Q: Who should take responsibility for these decisions?

It is necessary to form an outsourcing team as soon as you possibly can. The more eyes and ears that can be involved in the process, the better it will be. Have someone on the supply chain side who knows who your suppliers are and what things cost. From the technology side, you need to have at least one engineer of sorts, whether it be quality, manufacturing, or design. It depends on what you think you're going to outsource. You should usually put in a financial advisor, and it may pay to include supporting functions like IT and HR. At the very least they need to be aware of things, even if they are not involved at all times. You need to have people who can tell an outside firm that's never seen this product before how it's made, and how the technology transfer would work so it could be made the same way. 

Who leads this team? Somebody has to step up. There needs to be a project manager who can divvy up the thousands of questions that will be asked. But the business issues will be the manager's responsibility. You have to put your best players on the team, because what goes in comes out. Of course, they are going to be involved in making the product right now, so a division of workload has to be thought through. 

Q: Once it's been decided that you should outsource, how do you get the process moving?

A: In the planning and development phase, you have to ask what's out there and who meets your needs. You should also assess how real your expectations are, and whether your strategy makes sense.

Then it's time to go out and find contractors. It's best to look to those who are familiar with your kind of technology, and, who, if your needs require it, are diverse geographically. Ask for informal quotes to see what ballpark they're in, but also let them know if you're serious or just tire kicking. Once those quotes come back, you'll get a feeling about whether you should revise the strategy. For example, you may find that putting all your eggs in one basket does not make sense. But if it's a low-volume product, it may make sense to single-source. 

You want to make decisions as they relate to quality, cost, and engineering capabilities. But you also need to make them with an eye to the future. Say you make a defibrillator out of plastic, and you go with a contractor that does $1 million of business with ABS plastic material. But what if you are thinking about making it out of titanium in the future? Do they have the ability to do it in titanium as well? 

Now you can go back and do a formal request for proposal or request for quote. Keep in mind that OEMs take an OEM-centric view of the process, whereas contract manufacturers take a contract manufacturer–centric view. That means that during uptimes, they qualify you as much as you do them, and the more that you put into your RFP about yourself, the better. For example, when you say low-volume, what does that mean? A hundred thousand or five? Make sure you're comparing apples to apples. Communicate your volume expectations, your cost-reduction expectations, and your quality concerns. Is it that you've had difficulty making the product yourself, or have you had trouble finding a manufacturer that can make it as well as you can?

Once the request for proposal is put together, they will typically send a team of people to see you, so they can interpret what you're asking. During this face-to-face process, a lot of the intangibles can be weeded out. Then it is helpful to put together a decision-process matrix. List all the suppliers and all your demands. You want to identify everything that you think is important, and rank everything by importance. Your industrial engineer will say design, your financial person will say cost, and your manufacturing guy will say ease of manufacture. But it's up to the team to agree on what's most important. At one company we worked with, upper management had to intervene because the team could not get a consensus about what was important. They finally decided it was cost, and the team went back and reranked everything with cost issues as the most important. 

Your team will need to have soul-searching conversations about the supplier responses. In some cases, it will be very black-and-white. But in some cases, all the responses may look good. That is why it's most important to decide what factors are your biggest priorities—cost, quality, or something else? Your decisions should be made based on your overall strategy. Make your strategies based on capability. You may find, for example, that one supplier is better for your low-volume products and another is better for your high-volume products. 

Now it is time to visit them, and to ask more refined questions. How do they deal with returns? How will they help with postmarketing surveillance? What is their ability to respond? Do they have a sophisticated tracking system or someone who sits in a corner and writes things on a pad of paper? 

Q: After you've chosen your contractors, what should be in the agreements?

A: For the implementation phase, a supply-agreement contract has to be written. You have to agree who is going to assume which risks and responsibilities, and who will supply what material. You have to specify how many months' worth of material they should have on hand, and who assumes the risk if the material is bad. There should be a big long checklist, and performance metrics should be specified. Reviews to make sure quality expectations are met need to be scheduled. A return policy must be specified. Procedural issues, such as a requirement to use six-sigma rules all the time, must be specified. The expectations around cost must be made clear. You might specify that each quarter, you all look at ways to make the product cheaper. You're also looking for a good, savvy business partner who can tell you, “this product is at the bottom of its manufacturing curve. Let's design a new product.” Metrics must get reviewed, and how that is done must be specified. Sometimes it is even done on-line in real time. Sometimes some of the information that must be shared in the transfer is what is commonly called tribal knowledge, so you have to get it written down, whether it's intellectual knowledge or physical things like tooling. You expect them to mimic the way you do business, or even improve upon it. 

You have to qualify their process as well. They are supposed to be making it correctly all the time. All procedures you have about how to do that have to be communicated as well. The two sides should be constantly communicating, and there has to be a good interface between the project manager and the team members. 

Q: How should a device company review and audit its contractors?

A: In the improvement phase, metrics must get looked at periodically, and feedback must be given. From there you can derive not only process improvements, but design improvements. Both companies should agree on what metrics should be measured and audited, the frequency at which they should be audited, and the methodology. Who do you assign the responsibility to? One of the biggest areas where an agreement can fall apart is that in the implementation phase, there is nothing in the written contract about what metrics are to be reviewed and how the transfer process is to be put together.

Instead of reviewing retroactively, try to review proactively and take care of problems as quickly as possible, so at the formal review you can say what has been done and what is still outstanding. 

Q: Are you seeing more outsourcing of medical device design?

A: It is happening more and more. Almost 30% of device companies are doing it in some form, up from 15% a few years ago. And more are thinking about it. The issue comes down to cost. If I am based in Silicon Valley and I design and build everything, I am paying top dollar for engineers, designers, documentation, even land. Healthcare is astronomically expensive, and there is a great desire for costs to go down. That means everyone is looking for ways to save costs. If a contractor can design noncore products or noncore parts for products that are just as good as anything I could design, and do it for 50 cents on the dollar, I will use him. 

Most device companies don't do design out-of-house because they view it as a core competency. But what if your contract manufacturer has a great R&D department? Why not leverage that? For example, that's why there's so much software development going on in India. They can do it as well as we can for a fraction of the cost. 

The assignment of responsibility is a major issue here. If your contractor is doing design for you, who will do the risk analysis? Who will keep the technical files? Certain kinds of individual part labeling will need to be done. Who takes care of that? 

Q: What kinds of medical products lend themselves best to outsourcing?

A: Noninvasive products are easier for an outsider to design and build than invasive ones. There's a world of difference between a heart valve and a hearing aid. Quality should be an equal consideration across all products, but it isn't. If a hearing aid doesn't work one day, it can get fixed and nobody dies. The same is not true for an implantable device.

Q: How should a device company communicate with a contractor about regulatory issues?

A: It should become a performance metric. A firm should send a team to the contract manufacturer on a periodic basis to review the areas where they need to be compliant, and to verify that they continue to be. And before the contractor is hired, you need to look at their records to see if they've been cited for anything, as that's an indicator of whether they know what they're doing. 

Q: What is upper management's role, if any?

A: The project managers of both companies have the overall responsibility to make sure the relationship stays healthy, but the buck stops at the president. So you need to keep a steering committee in place so that upper management is informed as needed, and issues can be escalated to the appropriate level to be dealt with in a timely fashion. If yields aren't what they should be, the project engineers need to talk to one another. If that leads to a dispute, the project managers need to talk to one another. If it's going to court, senior management must get involved. You want to keep them as uninvolved as possible, but you don't want to keep them in the dark. 

Copyright ©2004 Medical Device & Diagnostic Industry

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