Originally Published MDDI October 2001

CONTRACT MANUFACTURING

While outsourcing design and manufacturing processes, OEMs should stay involved and maintain in-house expertise.

William Leventon

Medical device companies all over the country are disintegrating—but it's not a bad thing. In fact, it may be giving these companies an edge in today's competitive marketplace. "When companies look at their vertically integrated manufacturing operations, they see that they're not as efficient as they could be," says Tom Thompson, executive vice president of business development for Avail (Dallas), a contract manufacturing firm. "So one way to be more competitive is to outsource manufacturing."

Outsourcing is becoming increasingly popular among medical device companies, according to Thompson. "The trend is toward dis-integration, as we've seen before in the automobile and computer industries," he adds.

Manufacturing isn't the only job that companies like Avail are taking on. Many contracting firms now offer a comprehensive menu of services, including design, packaging, shipping, and repair. Outsourcing these tasks and others can save medical device companies time and money. But there are also pitfalls that companies must avoid if their outsourcing ventures are to be successful.

CONTRACTING ADVANTAGES

Why should a company outsource? "Manufacturing can really be a pain in the neck," says Al LaVezzi, president of contract manufacturer LaVezzi Precision Inc. (Glendale Heights, IL). It is not uncommon for companies to purchase a number of specialized machines to make a single product. They must then find and hire highly skilled machinists to operate the machines. And when new technology makes the machines obsolete, they have to purchase new ones.

"It's very expensive to maintain in-house manufacturing expertise," notes John Pfaff, vice president and general manager of The MedTech Group (South Plainfield, NJ). By using a contract manufacturer, he adds, "you're distributing the manufacturing cost across a broader base, which should result in a better return on investment than you would get if you did the manufacturing yourself."

This leaves medical device companies with more money to devote to areas such as R&D, marketing, and sales. "Companies are finding that it makes more sense for them to concentrate on their core competencies and outsource to companies the tasks that are our core competencies," says Sandra Schneider, marketing manager for Lake Region Manufacturing Inc. (Chaska, MN).

By outsourcing, companies eliminate the cost of manufacturing overhead. "We convert fixed manufacturing costs to variable costs," explains John Nussbaum, president of Plexus Corp. (Neenah, WI). "Customers are charged a variable rate, depending on how many units they need." When there is no need for production, there are no manufacturing costs to pay.

Both large and small medical companies are outsourcing their manufacturing operations. As they recognize the advantages of the practice, large firms are losing their attachment to proprietary manufacturing technology, according to Clark Briggs, vice president and general manager of Sparton Medical Solutions (DeLeon Springs, FL).

Sometimes, these companies decide that the switch to outsourcing is a good opportunity to "raise the bar" on product quality. A firm that has manufactured a product for a long time may not make changes even if some customers complain about the product. "But we've seen that if they decide to outsource it, that opens the door to tweaking the specification," says Thompson. "They say, 'Let's get six sigma, let's tweak the AQL levels to reduce field failures.' So they're driving us to be better than they were."

As for small medical firms, many simply don't have the money to manufacture their own products. So they use the "virtual company" model common in the networking and telecommunications industries.

"Most medical start-ups outsource everything. It's part of their business plan," notes Jack Fulton, sales manager for Specialized Medical Devices (Lancaster, PA). "For them, the cost of bringing all the necessary capital equipment in-house would be astronomical."

Without contract manufacturing facilities, "it would cost a tremendous amount of money just to get to the starting point, let alone build your product," says Gerald Sanders, managing director of California-based San Francisco Science. "Typically, a start-up company would never realize the economies of scale that would justify putting together that type of facility." Start-ups also benefit from the experience and expertise of their outsourcing partners, Sanders adds.

MORE TO OFFER

Both large and small customers have been attracted by capabilities that many contractors have added to their core manufacturing operations. "When people come in, a lot of times they'll look around and say, 'Wow!'" Nussbaum reports. "They're surprised and impressed by what we have to offer."

The evolutionary process that has resulted in today's full-service contractor can be attributed both to increased customer expectations and the contractors' desire to attract new customers. In addition, the expansion of services has followed a certain logic. "We've got the product in our possession, so while we've got it, why not attach this other thing, do this other task, etc., to add more value to the basic fabrication and assembly process?" Thompson says.

Typically, full-service contractors can take a medical company's concept, turn it into a product, and get the product into the hands of customers. Services usually include design, engineering, manufacturing, assembly, packaging, sterilization, and distribution. In recent years, contractors have also been taking on product validations and verifications, vendor audits, and even product repairs.

Contractors have also been expanding their manufacturing capabilities. For example, Specialized Medical Devices has recently added a finishing department, which can handle such tasks as vacuum heat treating, passivation, electropolishing, and laser marking.

Contractors have expanded in some cases by simply bringing in new personnel and equipment. In other cases, they have acquired or partnered with other companies that have capabilities they lack.

By consolidating a variety of services within one company, contractors gain more control over product quality, notes Don Sherratt, director of business and technology for medical devices at the ETL Semko division of Intertek Testing Services Ltd. (Boxborough, MA).

"When different parts of a job are contracted to different companies, you can lose sight of the quality trail," says Sherratt, whose firm works with contract manufacturers. "This makes it extremely difficult to pin down who's responsible for what."

But there can also be downsides to consolidation. "A company might buy a machining operation so they can say, 'Now we can do it all,'" says LaVezzi. "But if it's not a good machining operation, you're stuck with it if you use that contract manufacturer."

Despite such pitfalls, contractors are expected to continue to expand their services. "Our customers are expecting more," Thompson explains. "And I think their expectations will keep escalating."

DESIGN DUTIES

In response to customer demands, contractors are now deeply involved in product design. "To call us a contract manufacturer is really a misnomer, given the huge amount of design input we give our customers," Nussbaum says.

A contractor's design engineers can assist customers in developing their products. Or they can take a customer's concept and design the product themselves. More customers are asking contractors to handle all design and manufacturing tasks, Pfaff reports.

In developing products for customers, some contractors will add their own intellectual property to the design. "We have access to technology that can make their products work," says Tom Kleist, vice president of sales and marketing for Lake Region, which holds nearly 30 patents for cable and wire technology.

Nevertheless, Sanders warns medical device companies to be careful about using a contractor's designs and technology. "You could end up with a device that's three-quarters your intellectual property and one-quarter the contract manufacturer's intellectual property," he says. "And you don't necessarily have access to the contract manufacturer's intellectual property. So in effect, you're held hostage by the contract manufacturer. Or worse, you may have to pay them a royalty to use their intellectual property."

To prevent such problems, Sanders advises medical device companies to hire a lawyer who is knowledgeable about agreements between contractors and customers. When the agreement is drafted, lawyer and client should make sure that intellectual property developed for the product in question belongs to the medical device company, and that the medical device company gets an exclusive, paid-up, worldwide license to use any of the contractor's intellectual property used in the product—without being tied to that contractor.

If the proper precautions are taken, Sanders believes that medical device companies could find it economical, efficient, and timesaving to let contractors design and develop their products. At the very least, a company would probably be wise to give the contractor input on design manufacturability. "With their experience, contract manufacturers can often show you different ways to design your product that will make it easier and less expensive to manufacture," says Sherratt. He adds that such changes could reduce the cost of a part by up to 30%.

THE NEED FOR SPEED

One of the main reasons contractors have been adding design teams and other services is to get products to market more rapidly. "It's all about speed," Fulton says. "With all these capabilities in-house, we can control our lead times from start to finish. Once you reduce lead times, you're far more successful in attracting and retaining customers."

Why the need for speed? In the past, Nussbaum explains, many medical products had fairly long life cycles. Today, however, new designs and technologies are constantly replacing old ones, making speed to market crucial to the success of medical products.

In the race to turn out new products, contractors claim they have an edge over medical device companies. When it comes to manufacturing products, "we can be quicker because that's where we live," Schneider says. Contract manufacturing plants are filled with state-of-the-art equipment, such as machine tools that combine many operations into one.

Another tool that is speeding up production is the Internet. Contractors report that e-mail has greatly improved communication between people in different locations. Drawings, images, and other types of information can reach their destination in seconds rather than days. The Internet also allows virtual "meetings," where individuals at different points on the globe can review design drawings together and swap information.

Plexus uses the Internet to connect various printed circuit board (PCB) design sites in several different countries. "If we have a rush PCB design project, we can literally work around the clock," Nussbaum says.

Using the Internet, a medical device company fed CAD data on a part directly into a machine tool at LaVezzi Precision. The company "didn't even have a drawing," LaVezzi reports. "They just dumped their program into our system and it made the part for them."

In addition, the Internet can connect one of LaVezzi's coordinate measuring machines to similar equipment in a customer's plant. With the right software, the customer can see exactly what's being checked at the contractor's plant and how it's being done. The customer can also inspect a part in his own facility at the same time the contractor is checking it.

Sparton customers can also use the Internet to keep tabs on a project. From their own facilities, they can access Sparton's database to check the status of a project, make engineering changes, and submit approvals.

Briggs believes that, in time, contractors will offer customers Internet-based tools similar to those provided by major computer manufacturers. "Customers can go to their Web sites, build a custom computer by clicking different boxes, click the order button, check in daily to see the order status, see when it ships, and know the day it's going to show up on their doorstep. We're not quite there yet. But there have been experiments in that area."

Already, Briggs says, the Internet has made it possible for contractors and customers to merge into a "virtual company" in which everyone is connected despite distance. "Customers can come right into your company as though they were down the hall—even if they're in another country."

LONG-DISTANCE MANUFACTURING

By tearing down distance barriers, the Internet has made it easier to move manufacturing operations to Mexico and other locations outside the United States. Recently, a medical device company closed its Midwestern manufacturing plant in order to use an Avail-operated facility in Mexico. Avail has four offices in the United States; however, most of the company's employees work in plants in Tijuana.

Put simply, the reason for the move was cost. By manufacturing in Mexico, where wages are much lower than they are in the United States, "we can make our nickel and still save customers a lot of money," Thompson explains.

On the other hand, a medical device company's anxiety about outsourcing can increase with its distance from the manufacturing process. "Any time you outsource, there's a feeling that you're losing some visibility and control because you're not there," Briggs says. "There's a certain comfort in being able to see your product being made every day. And the farther away you are from the manufacturing process, the less comfortable you might be."

A contractor with distant facilities is probably not a "one-stop shop," which is supposed to be desirable because it implies a coordinated work effort. According to Schneider, "one-stop shop" has become a buzzword among contractors, who sometimes advertise themselves as such. She warns, however, that medical device companies ought to investigate such claims. "Is their shop really one stop? Or is it six stops across the country under one [company] name?"

SEVERE DILIGENCE

Investigating potential outsourcing partners can be a painstaking process. "It's important for the OEM to get into the contractor's [facility] and do some severe diligence," Thompson says. "Once, a large OEM told us almost apologetically, 'We hope you don't mind us wanting to look at your financials. But we do almost as much diligence in picking a contractor as we would if we were looking at a company for acquisition.' But it makes sense, because if we mess up, you're messed up. So you want to choose your partner very carefully."

During such investigations, contractors recommend checking the company's quality system, pricing structure, design and manufacturing technology, and especially its experience in medical device manufacturing.

Manufacturers should not be satisfied with impressive presentations or fancy certificates hanging on the walls. Sanders recommends conducting audits of the contract manufacturer before signing on the dotted line. "Ultimately, you are the party that's responsible for the product," he tells manufacturers. "So you have to make sure that [the contractor] will keep its commitments."

At Sparton, potential customers are conducting ever-more-detailed audits of the company's facilities. Sometimes, says Briggs, large companies will send teams of people who spend a week at his facility—just to see if Sparton is qualified to bid on their project.

Briggs believes that some of these companies are being extra careful because they have been burned by foreign facilities and small contractors that lacked an adequate manufacturing infrastructure. Whatever the reason, he's actually grateful for the increased scrutiny, because Sparton has upgraded its facility in response.

REACHING AN AGREEMENT

Once a contractor has been selected, the next step is hammering out an agreement. Fulton recommends that the agreement clearly identify who is responsible for which tasks, what the deadlines will be, and how communications between the contractor and customer will work. In Sanders' view, the agreement should also limit turnover of manufacturing personnel, which can cause production mistakes and delays.

Contracts should also assign responsibility for product quality. "Often, contracts leave the OEM with all the liability," Sherratt says. "You don't want that kind of contract, because then there's no pressure on contract manufacturers to produce a good product. If they make it and it's wrong, they must take responsibility for making things right."

After the contract is signed, the company's engineering, quality, and manufacturing departments can just be eliminated, right? Wrong, says Pfaff. "You can't outsource to the point where you have no in-house expertise," he warns. "Though you don't have to keep the whole department, you still need people in your organization who understand engineering, quality, and manufacturing. These people will interface with the contract manufacturer to make sure your requirements are met."

To make communications as simple and clear as possible, Sherratt suggests that medical device companies have a single point of contact within the contract manufacturing organization. Sanders recommends finding the people who are working on the contracted product and staying in close touch with them.

Although a company may not be doing the actual work, the firm can't just hand off large chunks of the project and move on to other things. "It's a mistake to think that you'll just give instructions to a [contract manufacturer] and a good product will come out of the pipeline," Sanders says. "You can't just turn your back on the process."

CONCLUSION

Today's full-service contract manufacturers can take on all of the tasks necessary for bringing a medical device to market. These companies save large medical device OEMs time and money, and they're essential to the existence of small medical start-ups. There is more to successful outsourcing, however, than just turning a project over to another company. To prevent problems and disappointments, contractors and customers alike recommend that potential outsourcing partners be carefully investigated and that manufacturers remain involved in the process after the contract has been signed.

Copyright ©2001 Medical Device & Diagnostic Industry