Medical Device Daily Washington Editor

WASHINGTON – The 11 letters forming the word "outsourcing" have not deterred some from seeing it as a four-letter word in recent years, but that word will come to occupy a larger place in the lexicon of device makers in the coming years, even when the outsourced function is done in the U.S.

This was the message of a presentation offered during the third day of AdvaMed 2008, sponsored by the Advanced Medical Technology Association (AdvaMed; Washington), and while documentation snafus have peppered recent warning letters in connection with outsourcing – a.k.a., contract manufacturing in this context – the speakers at yesterday's session all said that this problem is easily overcome if an appropriate mechanism is put in place early in the contract manufacturing agreement.

According to the announcement for the meeting, research done by Covington Associates (Boston) indicates that a fifth of all manufacturing described as original equipment manufacturing "was outsourced to third-party vendors in 2005, resulting in annual market growth of 26%, to $4.4 billion." This is double the $2.2 billion spent on contract manufacturing three years earlier. Covington's report apparently also made the claim that the ratio of devices made by third parties will rise to about 40% by 2010, a scant year and a half from now.

Presenting a real-world scenario for outsourcing were Chris Oleksy, President, ATEK Medical (Grand Rapids, Michigan), an outsourcing firm, and Bryan Szweda, the director of OEM transfer for Boston Scientific (Natick, Massachusetts). The two teamed up on a presentation that described how to go about making such a collaboration function well.

Oleksy said that a contractor needs to clearly understand where the client company wants to go. "It doesn't start with me coming in telling him 'what ATEK can do for you,'" he said, but starts with asking the customer where they are trying to go.

"You'd be surprised at how many people fail" at the effort because of erroneously proposing a direction instead of getting the customer's input first and then suggesting a way to get there.

Szweda noted that he and his employer had at least one thing in common with many companies looking for outside manufacturing. "We don't want a partner for the next year or two," he said, noting that a longer-term perspective is mandated by the fact that many prospective customers have more than one product line in mind when they think of contract manufacturing.

One of the essential questions about a company, Oleksy said, is "where is it and what is it based on?" Firms can usually do pretty well on two out of the three of the measures of operational excellence, customer intimacy and product leadership, but doing all three well is quite a tall order. Most med-tech companies with a portfolio want to focus on the second and the last, in part because there is "quite an overlap between those spaces," Oleksy said.

Szweda made the case "that you cannot afford to be a leader in all three."

Describing a guidebook to the relationship, Szweda said "the owner's manual is more important than the contract" because the former provides a detailed map as to who will do what. Putting this into a contract makes the contract a rather huge document. Furthermore, a contract fixes some functions that may need more flexibility than a contractual definition would allow. "As you move into the relationship, there may be something that needs to be altered" in order to deal with the rapidly changing landscape of device manufacturing.

David Busch, a principal at the management consulting firm PRTM (Boston), confirmed the notion that device and diagnostics firms want to move to a variable supply chain. "They may be in China today, but when will they be in Viet Nam?" he asked. He also predicted that Africa will soon become a source of low-cost labor.

Busch said a device maker can trim its cost of goods sold by as much as 50% over five years by outsourcing "if you build a good model and are working with your partner appropriately." He reminded the audience that "the auto industry is transforming itself from an offshore model to an outsource model" in that it will buy parts from manufacturers rather than locate its own facilities in other nations.

The first step a firm might take is to "triage your [product] portfolio: what has to stay in house, what has to go out of house, what has to go offshore," Busch said, making the case that "huge cost savings are available." He said he is aware of one firm that shaved $60 million from a half-billion-dollar tab for cost of goods sold.

"Part of your rationalization is moving to where you have an attractive market," Busch said, saying that Shanghai, China, and Singapore are attractive as both markets and places to locate manufacturing plants. China "typically comes out on top" in such an analysis, he said, and while Brazil is an attractive market, it is not great place to locate. Romania, in contrast is an unattractive market, but potentially good for a sourcing location.

However, Busch advocated a long-term strategy. "If you don't have that in China and India, you're going to get slaughtered," he said.

When asked to comment on recent warning letters that address contract manufacturing, Oleksy said some customers "will throw the ball to the supplier and say 'it's yours.'" In such a case it is very easy for contractor and contractee to get out of sync in GMP terms.

This can be handled with matching compliance software, Busch said, but he said that contractors often operate with more sophisticated software than their OEM clients, so "data is not collected [by the client firm] as regularly as it should be." He said "IT is a huge part of" the transition, but routine updates to data files are often the last thing the client bothers to think about.