The Outlook on Outsourcing

Larry Strauss PRTM

Larry Strauss ([email protected]), a member of the Medical Product Outsourcing Editorial Advisory Board, is a principal in the Global Life Sciences Practice at management consulting firm PRTM (www.prtm.com). His expertise includes working with medical device and diagnostic companies on outsourcing strategy, contract manufacturing and partner selection and implementation. His other areas of expertise include operations, manufacturing and logistics, acquisition integration, site transition management and distribution operations improvements. Strauss has extensive experience with contract manufacturing operations and site transition management. Before joining PRTM, he worked as manager of logistics for Haemonetics Corporation.

During the past few years, medical device manufacturers and diagnostic companies have significantly increased their use of contract manufacturers to outsource production of disposable sterile products. We define contract manufacturing as the hiring of an external company to manufacture products or sub-assemblies (where some value-added assembly occurs) for your company. The product is manufactured to your specification (your company controls the design and bill of materials), bears your company’s brand name and is sold through your sales channels.

As the volume and complexity of companies’ outsourcing activities increase, developing and maintaining successful relationships with contract manufacturing partners become increasingly important. Medical device and diagnostics companies are leveraging their relationships with contract manufacturers to not only reduce costs but also gain access to new technologies and markets while focusing on their own operations. These relationships are becoming increasing critical to the medical device manufacturer’s strategy and success in the marketplace.

This article provides an overview of the strategic incentives for medical device manufacturers (OEMs) to consider when working with contract manufacturers. It also discusses key factors in building successful relationships with contract manufacturers and the challenges in maintaining those relationships. It will also discuss some OEMs’ future plans on how much additional outsourcing they intend to pursue and in which areas. The insights discussed here are based on a survey that PRTM conducted with more than 40 of the world’s top medical device companies as well as project work with numerous medical device and diagnostics companies.

Survey Background
The survey aimed to determine how extensively OEMs are using contract manufacturers today, identify key success factors and major challenges in outsourcing relationships, compare actual performance with expectations and analyze future outsourcing plans. We spoke with the “owners” of the outsourcing relationship within the procurement, manufacturing and external operations units of our survey companies. Of those, about half had revenues of $500 million or more. The overwhelming majority—about 90%—use contract manufacturers.

More than half the respondents said they have worked with contract manufacturers for more than five years (see Fig. 1).

Outsourcing to a contract manufacturer has become one component of most OEMs’ operations strategy, but for most companies it is not the only strategy. Of the respondents that outsource manufacturing, almost 80% outsource a quarter or less of their total cost of goods sold (see Fig. 2).

For most companies, the decision to use a contract manufacturer is based on strategic issues such as gaining access to new technologies, improving speed to market and/or increasing the focus on core competencies (see Fig. 3). While cost has certainly been a driver for OEMs to use contract manufacturers, it is not the only driver; it’s not even the primary driver. In instances where cost was a driver, the primary goal of total cost reduction—not just labor but also overhead —has been the key incentive.

Success Factors and Major Challenges

Nearly 80% of the respondents using contract manufacturers said their outsourcing relationships met or exceeded their expectations. Our survey and project experience has shown that a number of key factors contribute to successful partnerships (see Fig. 4). These are:

• A “partnership mentality”
• Good communications
• Trust
• Experience

We define a “partnership mentality” as one in which both sides realize that they cannot win at the expense of the partner’s loss, or more simply put, either both sides win or they both lose. As in any operation, good communication is critical to a successful relationship. In the case of contract manufacturing partnerships, it is even more important that lines of communication be formalized because it will not be possible to “walk down the hall” to answer a question or resolve a problem. This does not mean that communications need to be formal—just that it needs to be clear who contacts whom, how, under what situations, etc.

Ultimately, successful contract manufacturing relationships come down to trust on both sides.

Partnership Selection

The high degree of trust required in a successful relationship is a crucial reason why the partner selection and start-up process is so critical and needs to be done carefully and thoroughly. Having the right team and experience in this process can ultimately spell the difference between a good and bad choice for a partner.

The fourth key success factor—experience—is obviously something that you cannot make happen quickly. However, it can be promoted by keeping a stable management team in place on both sides. For a new relationship, that means documenting processes in a Joint Service Agreement (JSA). Having the start-up team work through the creation of a JSA is valuable because it forces the partnership team to think through in advance how they will work together and what potential problems may arise before they become critical issues in real time.

In our study, we found that there were a number of attributes that successful OEMs included in their contracts or JSAs with contract manufacturers. These included: cost reduction targets, performance measures and quality requirements. Clearly specifying these helped these companies form better partnerships and avoid miscommunication and misunderstandings.

OEMs, even those who are satisfied with their contract manufacturer partners, cited a number of challenges when working with contract manufacturers (see Fig. 5). The biggest was maintaining product quality. This statement needs to be put in perspective. It was made by OEMs who are satisfied with their contract manufacturers and have been working with them for many years. The key point is that successful OEMs cannot expect to simply ignore product quality issues once they have transferred production to a contract manufacturer. They need to be prepared to commit time and resources for the life of the relationship to this area.

Product quality was also cited as the greatest challenge by OEMs who were not satisfied with their contract manufacturer relationships. So the message here is that OEMs and contract manufacturers need to focus on this as a priority issue in any relationship.

The next two greatest challenges cited by OEMs were maintaining target costs and getting the right quantities of the right product on time. Interestingly, these top three challenges—maintaining adequate product quality, cost and production volumes—are the same challenges that most companies face with their internal manufacturing operations. In this respect, outsourcing production to a contract manufacturer does not eliminate those problems; however, it does change how much time senior management will need to spend managing them and possibly the performance achieved in each of these areas. (Consider that a contract manufacturer may be able to bring more focused resources to bear than the OEM in some situations.)

Future Outsourcing Practices

Future outsourcing plans for most OEMs focus more on organic growth than on major strategic shifts. Seventy-five percent of the OEMs interviewed stated that if they increase outsourcing, it would be through growth in volume of existing products already outsourced or products with similar manufacturing processes to those outsourced. Only 25% of the growth will come from new operations or new functions outsourced to contract manufacturers.

When asked specifically what capabilities they might be interested in outsourcing in the future, OEMs did not overwhelmingly identify any one area (see Fig. 6). The capabilities that drew the most interest were:

•	Design or co-design of new products (ranked first and fourth, respectively)
•	Distribution (ranked second)
•	Product or process design change recommendations for existing (outsourced) products (ranked third)
•	Sterilization management (ranked fifth)

Increased interest in outsourcing manufacturing engineering (for new or existing products) and sterilization and distribution management is consistent with a trend we have seen over the past few years in the medical device and diagnostic industry among OEMs. These companies want to focus their own operations on their core competencies (generally in product design, marketing and customer service) while outsourcing more of their non-core activities.

Key Survey Findings

Our survey of contract manufacturer use by OEMs highlighted a number of key messages:

•	Use of contract manufacturers has not only become common among OEMs but is becoming more of a key component in many OEMs’ operations strategy.
•	The decision to outsource production to a contract manufacturer is primarily a strategic decision, not a cost decision. (While cost may play a key role in that strategy, it is not just a low-cost play.)
•	There are numerous key factors in successful outsourcing, including having a partnership mentality, good communications, a high degree of trust and experience (or some proxy for experience such as a JSA).
•	Even in successful contract manufacturing partnerships, there are challenges, the biggest of which is maintaining product quality.
•	Growth of outsourcing will continue, but it will be primarily organic growth.
•	OEMs continue to be interested, albeit not overwhelmingly, in outsourcing non-core activities such as manufacturing engineering and post-production sterilization and distribution management.

Developing and maintaining a successful contract manufacturing partnership requires a significant amount of work and commitment on the part of an OEM as well as the contract manufacturer, but judging by the attitudes of the survey respondents and continued growth in this field, it would seem that the benefits are worth the costs and risks involved. OEMs who plan to use this strategy need to be prepared by doing their homework not only during the partner selection process but also after the partnership has begun to make sure that it is a successful, mutually rewarding experience.