There has been a significant move among medical device companies towards the use of outsourced manufacturing services. Contract manufacturing organisations (CMOs) are increasingly finding that their services are in demand by the industry, which has not experienced the same urgent focus on cost reduction as other industries.
“The medical device industry has some of the highest margins of any industry,” says Andrew Kinross of Navigant Consulting. “So companies have focused on revenue growth rather than internal cost structures; they have found ways to improve revenue streams. They have also grown through mergers and acquisitions. A lot has been done already, so now the focus is on cost structure.”
Kinross’ career in management consulting has seen him work on strategic planning for large CMOs in the USA. He has seen at first hand the opportunities that CMOs can now exploit as medical device companies consider their costs. He has also seen the kind of efficiency improvements that a CMO can deliver.
“You can save money by outsourcing,” he says, “as has been seen in the automotive and electronics markets, for example. No particular event has catalysed the medical device industry to outsource. Companies have gradually outsourced more, realising that their core competencies are product development and marketing.”
For some firms, manufacturing might still be considered a core competency, but increasingly it is seen as a prime candidate for outsourcing, as product innovation and marketing become the key strategic functions.
“Strategically, you can outsource manufacturing,” says Kinross. “Other people can generally do it more efficiently than you can.”
One of the main reasons that manufacturing is often considered appropriate for outsourcing is the dramatic changes in the market that have led to the emergence of large, high-quality CMOs that can service even the largest clients.
“So much has happened in the last five years, it’s amazing,” says Kinross. “There used to be thousands of "mom and pop" shops, so companies would outsource to a great many, each handling one service. These suppliers could only serve one company well and there were concerns over their capitalisation. Now, we are seeing the market consolidate.”
The large, highly capitalised contract manufacturers that are coming to the fore have impressed many medical device companies with their quality systems and their scale, as well as with the level of cost savings they can offer.
“There are now a lot of credible CMOs that have risen to the point where they have a large footprint that mirrors the operations of their large clients,” observes Kinross. “I expect that kind of consolidation to continue for some time. For many medical device companies, it is not a question of if they outsource, but when.”
POISED FOR GROWTH
Kinross likens the medical device industry today to the electronics industry 20 years ago. Back then, around 20% of the cost of manufacturing was outsourced. Today, it is around 90%. In the medial device industry, the level of outsourcing of manufacturing costs is currently around 30%, so there is a lot of room for growth.
“I don’t think we will see 90% being outsourced – the medical device industry is too conservative. But we might see around 50% of manufacturing outsourced. For some devices, such as those that are implanted in the body, there are very strict regulations, and medical device companies may want to keep closer control over their manufacture.”
However, this may change as the level of sophistication and the capacity of CMOs continues to grow. “There are already some large CMOs that have quality systems in place to rival those of their clients,” says Kinross, “In some cases, we see medical device companies selling plants to a CMO, which will then invest in it and update it. However, the level of outsourcing that we see will depend on the mental attitude of the medical device companies.”
A QUESTION OF CHOICE
The concern that often accompanies consolidation in any market is the potential limitation of choice of service provider, particularly for large clients. In the medical device industry, however, this should not be a problem.
“This is not really an issue,” says Kinross. “In 1999, there were 4000 CMOs worldwide. Even with consolidation, there are still thousands. For large clients, there may be a limited number of service providers that can match their needs, but that is the same situation as five years ago. The limit of the supplier base is nothing like as tight as other industries.”
Medical device companies currently have a wide choice of service providers for many manufacturing processes, and this is likely to remain the case for the foreseeable future. Instances may arise, however, when the choice of outsourcing partner is limited, but this is largely due to the nature of the process rather than market restriction.
“There are instances where medical device companies auction off product lines, and usually they can get at least four or five approved vendors,” says Kinross. “If you have a unique product line, then maybe there will be a very limited number of suppliers, but this is rare.”
OFFSHORING AND PARTNERING
A wide choice of potential partners puts greater pressure on CMOs to offer better cost savings, and this is often achieved through the location of manufacturing facilities in countries where wage costs are significantly lower. A supply base that was once in the USA, for example, can move to Mexico or Ireland, where many medical device manufacturers and CMOs have a presence.
It is expected that the pursuit of labour cost differentials is likely to lead to CMOs reaching out further across the world. But cost differentials between different countries tend to erode over time, as new locations open their doors to CMOs.
“The trend now is towards countries like China, Puerto Rico or the Dominican Republic,” says Kinross. “For the foreseeable future, it is likely that cost reduction will remain possible, and it is hard to say whether there will eventually come a point in the future when it is exhausted. Many CMOs with well-run operations in Mexico can save a company millions of dollars each year, and that won’t end in five years.”
It is highly likely that China will emerge as a key location for manufacturing facilities in the medical device industry – as it has for many other industries – and the first operations are under way. Nypro, based in Massachusetts, USA, is one company leading the way in what is expected to be a steadily growing flow of business to China.
The dominant trend in the industry is the increasing importance of cost as a factor in determining the level of outsourcing. But, the location of manufacturing facilities is also a hot issue. And consolidation is also a factor in outsourcing decisions, as it changes the options that are available to medical device companies.
The nature of the relationship between a medical device company and its CMOs is changing. With CMOs becoming more sophisticated in their capabilities and with the increasing willingness among their clients to outsource, there is now an opportunity for CMOs to become closer to their key customers.
In future, it is likely that CMOs and their larger clients will work as partners, particularly given the current long-term growth R&D budgets.
In 1990, R&D spend was typically equivalent to around 5% of sales. By 2002, this figure had risen significantly to the region of 12%. Over this short time, this represents a huge leap in spending, and this trend has continued to play out since 2002. As R&D – a remaining core competency of medical device companies – becomes more important, firms increasingly want to involve partners in the process.
“Many medical device companies want their vendors to do more R&D,” says Kinross. “This is an opportunity for outsourcing companies to get involved early and play a part in a joint design process. At the end of this process they would typically get the contract for manufacturing.”
This new kind of relationship is set to flourish in the industry, no doubt helping to shape it in a way that encourages more outsourcing in the future.