The Outsourcing Option: No Longer Optional?

Caren B. Les, News Editor, caren.les@photonics.com

The global medical equipment outsourcing market is forecast to reach $40 billion by 2016 with a compound annual growth rate of 16 percent, according to a report from GlobalData, based in London. Published in January 2010, the report is titled Outsourcing in the Global Medical Equipment Industry – The Market Expected to Register High Growth in the Future.

“The growth is mainly driven by major companies looking to cut down costs and decentralize manufacturing capabilities, and the availability of cheap and effective contract manufacturers in countries like India, China and Malaysia,” said Ashwin Moduga, author of the report. The outsourcing market in the medical device industry was valued at $14 billion globally in 2009, he added.

Circumstances that are propelling the overall medical equipment market forward include an increased number of aging people, their desires to lead active lifestyles, a rise in chronic health conditions, and increased private and public spending, according to the report.

The report defines outsourcing as subcontracting that involves the transfer of a service, such as product design, research and development, or manufacturing to a third party. It notes that contract research organizations undertake device discovery and preclinical or clinical research-related activities on behalf of companies, while contract manufacturing companies offer services ranging from low-volume production for preclinical R&D to higher-volume fabrication for clinical trials and commercialization, according to the report.

Photonic outsourcing

“Photonic devices that typically benefit from outsourcing arrangements include light- and energy-based models used in aesthetic surgery and treatments. A significant percentage of outsourcing in photonic medical devices occurs in this segment,” said Moduga, who regularly tracks the medical device pipeline landscape. Other photonic devices associated with outsourcing would include optical sensors and retinal scanners that need many electronic components and whose assembly is an important process in itself, he added.

“In 2009, the outsourcing market for photonics constituted a significant 35 percent of the overall medical device manufacturing outsourcing. Among the medical equipment markets, contract manufacturing is most significant in segments such as diagnostic imaging and ophthalmology devices. The use of electronics in CT scanners, coherence tomography systems, light- and energy-based devices for diagnosis and therapy of the retina, and other such instrumentation is the key driver for manufacturers to take up outsourcing,” Moduga said. Electronics has not been a traditional medical device core capability.

“Traditionally, outsourcing was a method that allowed manufacturers to devote valuable R&D time to core research in their area of expertise. Following the economic recession, however, outsourcing has become a major cost-cutting tool, especially in markets such as diagnostic imaging systems and ophthalmic devices. Medical device manufacturers are relying heavily on the availability of specialized contract manufacturing organizations that provide research, prototype testing and manufacturing, while adhering to FDA and CE guidelines,” Moduga said.

Cost and capability

“From our perspective, mature products where the manufacturing processes involved with the product are well-established typically benefit from outsourcing arrangements, said Alexandre Fong, senior vice president of life sciences and instrumentation at Gooch & Housego. He added that many components that evolved from the telecommunications sector into biophotonics are a reflection of this. “There are also some intermediate assembly processes where traditional labor-cost-driven outsourcing adds value. I think the typical cost-driven outsourcing trend, as one might expect, is more prevalent with mature biophotonics applications such as clinical lasers or analytical equipment used in medical labs,” Fong said. He added that even more of the outsourcing is present in the software, and the electronic and mechanical components and subsystems that are required to support the biophotonics platforms.

“For relatively new areas such as biophotonic imaging, however, outsourcing is typically driven by capability. This includes some growing clinical applications (i.e., OCT), which we are involved in at the components level, as well as spectral imaging, on which we work with end users at the systems level. The level of expertise required to address the complex and sophisticated needs associated with such technologies means that the work goes where it can be done best. This labor cost factors less than, say, product performance and scrap rate,” he added.

“Of course, reduction of per-unit cost is the fundamental basis for outsourcing, but it also has to do with strategy and risk mitigation. Vertically integrated supply chains can be costly, and products are evolving at a much faster rate than ever before. Investing in capability to meet every aspect of a product’s development and production is no longer feasible given the complexity of most biophotonics platforms,” Fong said.

Reducing cost

“Outsourcing is becoming a global phenomenon. Companies recognize it as an important step in their value chain. The primary reason they outsource is their desire to reduce operational costs,” Moduga explained. “To reduce investment, medical equipment companies are searching for alternative approaches or strategies to find innovative and successful ways to run their businesses. It is expected that the average cost saved by the companies by outsourcing to contract organizations can range between 10 to 15 percent, depending on the number of functions or tasks outsourced,” he added.

“Also, outsourcing allows medical equipment companies to take advantage of the process experience and expertise, as well as the supply chain management of the third party. It enables them to decrease their fixed costs and shift to a variable-cost model, which is beneficial in the long term. The elimination of infrastructure investments is another cost-saving benefit of outsourcing,” Moduga said.

Reducing time to market

“Developing a medical device is time-consuming – it takes, on average, six or seven years to move a device from invention to regulatory approval. In today’s competitive world, it is extremely important for companies to be the first to enter a market,” Moduga said. “Companies are constantly looking for ways to reduce the development phase. The complexity of the clinical trials process and the stringency of regulatory requirements make it difficult for them to reduce device development time. Outsourcing certain functions in the development cycle allows the OEMs to save precious time,” Moduga said.

Risk-sharing agreements

“Outsourcing services traditionally involved a fee for the service business models. However, outsourcing organizations are now entering into risk-sharing agreements with medical equipment companies that approach them for various development services,” Moduga explained. He added that such an agreement means that the risk for the services outsourced is shared between the two businesses. The agreements require the companies to provide milestone payments to the outsourcing organizations. The amount of the payments depends on the results achieved. For example, if a contract manufacturer achieves good results ahead of plan, it will receive higher payments.

Concern for quality

“Issues of safety and regulatory compliance are among the concerns involved with outsourcing. The costs of having good quality controls and monitoring in place often offset the savings involved. This is particularly true when it comes to medical devices. Intellectual property is always a concern when outsourcing means off-shoring, and that adds another dimension to the management challenge. Even so, the risk mitigation stands as an attractive basis for proceeding with outsourcing,” Fong explained.

“Although outsourcing brings economic advantages to the medical equipment manufacturer, the increasing focus on developing new, innovative equipment and the recent cases of clinical trial failures have led to a rise in concerns over quality. When medical equipment companies outsource clinical trials or other services to a contract organization, they are entrusting others with an important aspect of their business – device design,” Moduga said.

“The manufacturing industry is raising questions over the benefits gained by outsourcing to commercial service providers. The greater concerns for the quality of activities carried out by contract organizations, especially in the [economically] emerging countries, is likely to hinder the acceptance of these organizations as strategic partners of medical device companies,” he added.

Regions of interest

Outsourcing to Asia has been ongoing for the past quarter century. With the increased competition in the US and Europe, medical device OEMs there have turned to countries such as China and India, which offer lower-cost skilled labor. Apart from these countries, which are considered major outsourcing destinations for medical devices in the Asia-Pacific region, Malaysia, Singapore, Taiwan and Thailand are also expected to see significant growth, Moduga said.

There are a number of reasons for outsourcing manufacturing to Asia. Moduga noted that the salary of an Indian engineer is roughly one-tenth that of a similar worker employed in developed countries such as the US. Also, he said that many manufacturers in India and China are paying particular attention to manufacturing standards, such as Good Manufacturing Practice (GMP) and International Organization for Standardization (ISO) guidelines, thus increasing the quality of outsourcing.

“In order to provide a safe, yet low-cost, market for contract research and manufacturing, Indian companies are becoming increasingly US FDA-compliant. There are currently more than 100 FDA-approved medical device plants in India. These numbers are increasing as Indian companies strive to attract more medically oriented outsourcing contracts,” Moduga explained.

Fong noted that, for the well-established components that evolved from telecom, Western firms typically outsource to Asian manufacturers in low-cost labor markets like China. However, for many specialized materials and components, it’s the other way around – systems tend to be integrated in the US, Japan and Europe, he added.