Optimal Outsourcing for Medical OEMs

Originally Published MDDI March 2003

GUIDE TO OUTSOURCING

The question for device makers is not whether to outsource—it's what to contract out, where to do it, and how to begin.

Stacey L. Bell

Ten years ago, medical device companies wondered if they should consider outsourcing particular projects and processes at all. Today, outsourcing is more a question of which projects will be produced out of house, and when.

"Almost everybody outsources something today—whether it's product development, manufacturing, payroll, or human resources," says Mary Poniktera, business manager of consulting firm Fallbrook Engineering (Valley Center, CA). "A decade ago, people talked about outsourcing. Now it's a given."

Data from Frost & Sullivan support that assertion. From 1999 to 2000, medical technology companies increased their number of outsourced projects by more than 18%. Further, Frost & Sullivan predicts that outsourcing of value-added products by medical device companies in the United States will grow at "17% per year through 2005... [and by 2005,] 42% of the cost of goods sold for value-added products will be outsourced."

Growth in this sector also is evidenced in the expansion and increased number of contract manufacturers. Jack Kincke, principal consultant of NewOps International Consulting (Weston, FL), says contract manufacturers' businesses are growing by 10–20% annually.

While outsourcing has proven a valuable option for many medical device makers, some have endured missed deadlines, poor-quality products, and other travails. Industry experts say companies can avoid common mistakes by mapping out a detailed approach to outsourcing in advance.

First Things First

"Ideally, companies should make outsourcing part of their overall business strategy," says Larry Strauss, a principal in the life sciences practice of global management consulting firm PRTM (Waltham, MA). "Every two to three years, a dedicated, knowledgeable task force, representative of all parts of the company, should look at the company's entire product line to see what can be outsourced."

Older, established products with well-defined manufacturing processes and low margins are strong candidates for outsourcing. On the other hand, newer products that are still strongly tied to R&D and marketing might not be good prospects. They often represent newer proprietary information and undergo continual refinements—although some companies do outsource product development with excellent results.

"Companies that don't go through this process of analysis are probably leaving money on the table and missing opportunities," Strauss says.

Certainly, product life cycle is a significant driver of outsourcing, but a number of other compelling reasons to outsource a project exist as well.

Gaining a Competitive Advantage. If competitors are consistently beating a medical technology company to market with new products or updates, the extra help and resources an outside firm offers can help level the playing field. From providing extra brainpower and expertise in specific technologies to simply offering additional manufacturing capacity, an outsourcing partner can improve an OEM's competitive position and help it meet critical project milestones.

"Firms need to look seriously at their competitive strengths and weaknesses," advises Don Caudy, vice president of operations for the contract research organization Battelle (Columbus, OH). "Those weaker areas are candidates for outsourcing."

In addition, an OEM may wish to hire a consulting company to perform developmental work so that the OEM's name won't be associated with the project—and competitors won't notice, says Richard Meyst, vice president of Fallbrook Engineering.

Improving Economics. OEMs often turn to outsourcing to streamline overextended budgets. Contract manufacturing saves the cost and hassle of hiring a large number of new employees who may not be needed after a particular project is complete. It also offers the advantage of shared overhead at the contract manufacturer's plant. "Right now, cash hoarding is hot," Meyst reports. "Projects often progress in fits and starts, and there may be times when there's little for people to do, particularly during clinical trials. For economic reasons, it makes sense to hire technical experts on an as-needed basis instead of hiring additional staff or overwhelming current staff."

A contract manufacturer's high-volume, automated processes can prove profitable for medical device companies. One diabetes glucose-monitor maker recently saved 40% in production costs when it turned over the manufacturing of its product to a contractor who slightly redesigned the product for better performance and streamlined production.

Neoprobe Corp. (Dublin, OH), which develops surgical and diagnostic products, has been outsourcing product development for years, primarily when the company needs help meeting a looming deadline. "We have a staff of about 30, and when we need 10 to 15 additional people working for 18 months—rather than staffing up, then staffing down—we outsource," says Carl Bosch, vice president of R&D. It costs about twice as much per employee-hour to outsource, he says, but if a company can't keep a staff loaded three-fourths of the time, it pays to outsource.

Focusing on the Company's Raison d'Être. Kincke points out that the medical device and diagnostics industry has been "squeezed for profits" for 15 years. "Companies are constantly searching for ways to cut costs and grow business. Outsourcing is one method firms can use to accomplish these goals," he says. Outsourcing low-margin and older products allows companies to concentrate their efforts on core competencies and higher-margin products and innovations. Rather than juggling all the components of 10 different product lines, managers can devote their time and energy to one or two potential blockbusters.

"One company I worked with outsourced different product components," Strauss recalls. "Only 10% of the product was a core component, so the company outsourced the rest of the product. It maintained its intellectual property while getting the benefits of contract manufacturing." He recommends that core competencies critical to a company's continued success and profit margins be kept in-house.

Expanding Capacity without Making a Capital Investment. A diagnostics company that is manufacturing its own PC boards not only has to be cost competitive, it also must keep investing in new capital equipment, like surface-mount technology, to stay competitive, says Don Fuller, a principal consultant for NewOps International Consulting. By outsourcing that project, the company could avoid huge capital expenditures and the pressure of continually upgrading equipment. Further, outsourcing allows access to key technologies and equipment that may not be available in-house.

In early 2000, Endonetics, a San Diego–based start-up company acquired by Medtronic in late 2001, hired a consulting firm to help it meet milestones that its venture capital backers had set. "We were very small at the time—about 10 to 12 people—and we needed to focus on our core strategy. But we needed help and expertise to develop a lot of the design and to start manufacturing several parts for our Bravo pH monitoring system," recalls Michael MacCollum, who served as senior project engineer at Endonetics and is now a consultant with Pro-PE Mechanical Design Services (Poway, CA). "In addition to allowing us to meet our very aggressive timelines, the consultants gave us access to a wide variety of experts whom we couldn't have afforded as individual hires. We could call on experts in conceptual design, prototyping, injection molding, packaging, and sterilization as we needed them."

Reducing Risk. Some products present safety or regulatory hazards—perhaps they use a volatile material or trigger special attention by OSHA or FDA. Products important for a company's portfolio but difficult to produce may best be handled by a company with expertise in such matters, Fuller says.

Drawing on Diversity. Some companies suffer from tunnel thinking. Bringing in consultants with fresh, different outlooks and new approaches can rejuvenate a project and the staff's enthusiasm, Meyst adds.

Once a company has decided which projects make the most sense to outsource, it should next clearly define its goals. What does it hope to achieve by outsourcing a project, and how will that success be measured?

"A clear definition is critical," Meyst says. "The company must know exactly what it wants to do, have a vision of the outcome, then find the right partner, communicate well with that partner, and achieve buy-in to have a successful outsourcing relationship."

Finding the Right Partner

Since most outsourcing relationships last at least two years and have a profound effect on a company's bottom line and product quality, great care must be taken to find an appropriate partner.

Strauss recommends using the so-called funnel approach. "I'd start with 10 to 15 companies and then winnow that down to four or six companies to [consider seriously]," Strauss says.

How does an outsourcing company make the cut to the final round? Ideally, by displaying the following qualities: expertise and experience in the medical device or diagnostics industry (especially in the segment of interest to the OEM), appropriate manufacturing capabilities and capacity (including growing room in case the OEM decides to add extra volumes or processes in the future), and flexibility. Other desirable characteristics include strong supply-chain capabilities and experience, excellent quality systems and certifications (i.e., no major warning letters from FDA or other agencies should be on record), acceptable information management capabilities, and solid financial statistics. (Dun & Bradstreet is a good source.) Finally, an outsourcing candidate must have integrity and a positive reputation, and it should maintain a culture compatible with that of the OEM.

Location can be a consideration as well. While some companies choose a contractor outside of the United States to take advantage of steeper cost savings or greater proximity to suppliers or a consumer end-market, others may want a more accessible site.

"It's nice if you can get to their site easily, especially at the beginning of the relationship," Strauss notes. "Can you get there in a few hours in case there's a problem? A location in Mexico might be better than one in the Far East, for that reason."

Once a company has narrowed its list to three or four finalists, a team from the OEM should visit each of the finalists' facilities to see exactly how products are manufactured and managed, and to meet with each facility's management team.

The OEM should also call at least three references. "References provided by the company offer a biased sample, so it's a good practice to ask those customers if they know of other companies that also use the contractor," Strauss says. The key is to talk with the references openly and honestly, he adds. "Ask if things are all rosy, or if there is room for improvement in some areas. Also, listen to as many voices at that company as possible. Talk to senior personnel in manufacturing and quality, and within the supply chain."

Fallbrook Engineering's Poniktera recommends asking references the following questions:

Building a Firm Foundation

After choosing an outsourcing partner, the real work begins. The same team that was assembled at the beginning of the outsourcing project must build and maintain a successful relationship between the companies.

According to Strauss, having a dedicated, knowledgeable, and experienced team conducting the planning and managing the actual transition is critical to accomplishing the transition on time and on budget, with no [negative] effects on customers.

"The difference between successful and unsuccessful outsourcing often relates to the design of a manufacturing organization," Fuller adds. There's a tendency to outsource a product and thereby eliminate all the manufacturing tasks, but the OEM must still provide project oversight and ensure contract compliance, he says. "A few individuals should be specifically assigned to conduct this oversight, to make sure the outsourcing partnership works."

Although the contract, joint-services agreement, and quality agreement help set the parameters of the relationship, it's essential that OEM team members visit the contractor's premises in person. They should also communicate by phone, fax, or e-mail often—which will likely be daily at the start of the project.

A key challenge in any outsourcing relationship can be maintaining product quality. "Managing quality can be difficult because the contractor may have an excellent quality system, but because that system manages quality for 10 companies, it won't match your quality system exactly," Strauss says. "If the contract manufacturer makes a mistake, FDA will come after the OEM. Outsourcing doesn't abdicate responsibility [on the OEM's part]." An OEM must communicate what constitutes quality from Day 1, and develop systems to work closely with its contract manufacturers on quality issues.

Communication and trust are perhaps the most important factors affecting the success of the partnership. "To get the partnership off to a good start, make sure there is a clear, mutual understanding of the scope and requirements of the project," says Neoprobe's Bosch. The more time you spend defining the requirements, the far better off you'll be in the relationship over time, he adds. "Also make sure you can trust your partner to be disciplined. If you give them a specification, you want them to read it, understand it, and work through it—not set it aside and do it their way."

"We find one common thread among the outsourcing relationships that work," says NewOps' Don Fuller. "It is adjusting the organization to reflect a shift from 'manufacturer' to 'supplier partner overseer.' This means that you do not eliminate the entire manufacturing organization. You certainly eliminate direct manufacturing jobs and many supervisory jobs. But success comes from carefully designing a new organization skilled in quality oversight and assistance, product development assistance, and more." Clearly, with outsourcing there is a degree of loss of control. But with proper organization and contracting, and a realistic approach with the right partner, you can maintain sufficient control and gain greater success, Fuller adds.Trust in the relationship can free up valuable time for the OEM. Endonetics' MacCollum spoke with his outsourcing partner's project manager by phone daily at peak times during one particular project. "If I had a specific problem, but I needed to focus on something else, I could present [the project manager] with the problem and let him solve it."

Conclusion

Outsourcing is a job that is truly never complete. But because the advantages are numerous, it is likely manufacturers will continue to make the effort. Certain trends also are solidifying the continued growth of outsourcing. Contract manufacturers are offering more development and process engineering capabilities, which should fuel growth. Also contributing to the expansion are rapid deployments of new technologies, increases in margin pressures and competition, and shorter product life cycles.

By investing some extra time and effort in clearly focusing their outsourcing projects, manufacturers should reap great rewards.

Stacey L. Bell is a freelance writer based in Tampa, FL. She writes frequently for MD&DI.

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