The past six months haven’t been easy for medical device outsourcing companies. Consolidation among OEMs, lower healthcare spending growth, a drop in orders and fewer product launches have combined to create what S&P Ratings Service analyst David Kaplan recently described as a “turbulent” few quarters for the industry. Add to that a temporary reprieve of the medical device excise tax – one of a number of cost pressures encouraging US OEMs to outsource – and it’s worth wondering the extent to which OEMs will be using contract manufacturers in future.
Take a step back from the short-term problems, however, and things look far from gloomy. Not too long ago, concerns about cost, skill and intellectual property meant there was almost no impetus for outsourcing among medical device manufacturers. Today, CMOs aren’t just a vital part of the medical device community: most forecasters estimate the sector’s growth rate will outpace the wider industry in the coming years.
In the same report by S&P, the long-term picture for contract manufacturing couldn’t look any better: “We believe this turbulence is a period of digestion following a wave of OEM consolidation, and that inventory reduction initiatives are finite and likely to be completed soon,” it says.
“We expect [contract manufacturing] industry growth to resume the low to mid-single-digit growth rate we expect for the medical device industry.”
Cost of success
One of the main reasons for this is cost. The medical device excise tax is set to return on 1 January 2018; regulations like FDA’s requirements for unique device identifiers are having a major financial impact, and other changes to the healthcare industry – including how hospitals pay for their products – mean medical device manufacturers are continuing to feel the pinch.
“The costs are still there,” says Chris Ahlers, vice-president, integration and operations planning at Integer, a contract manufacturer that combines Greatbatch Medical, Lake Region Medical and Electrochem. “The device tax may be lifted for now, but it is coming back and other things may come along. If you compare healthcare to other industries, it has probably been somewhat immune to cost pressures over the decades, but we see that time as ending.
“We don’t think we are ever going to go back to a point where cost is not a significant issue. That means that a lot of the larger OEMs are looking to save money, and this is driving them to consider contract manufacturing and medical device outsourcers.”
Underlying changes in global healthcare are also spurring on the outsourcing market in 2016, according to Ahlers. “Certainly, we would agree with most of the expert opinions that there is tremendous growth opportunity in the market,” he says.
“There is growth overall in the need for surgical procedures and medical devices, and you have areas like Asia-Pacific, where the middle class continues to grow, increasing demand.”
Ahlers also points towards a rise in the number of small and medium-size companies that are less interested in manufacturing than the OEMs that have come before them.
“These companies are developing unique and innovative products and therapies, but the vast majority of them don’t have any manufacturing capability,” he says. “They are primarily design and development houses, and don’t have the scale to build their own manufacturing.
“So, again, there is an opportunity for MDOs to be the manufacturing and supply chain arm of those smaller suppliers. And we see those smaller-to-mid-size companies increasing with unique therapies that require someone in the MDO space to do part of the work for them.”
So what do OEMs in the medical device industry look for in a partnership? And what are the qualities a contract manufacturer working with them needs to have? Whatever the product or service happens to be, some things tend to remain the same. According to Ahlers, OEMs are always looking for partners with regulatory know-how that can deliver on time, in line with the agreed parameters of the contract.
“The key is that OEMs are looking for a partner that is going to work with them on a very open basis, particularly when they are in the design and development space,” he says. “From a manufacturing perspective, it’s about being able to deliver high-quality products on time, and at the agreed price and cost. The other thing is understanding the regulatory and quality implications of the market.
“I don’t think anyone expects regulation in the world to decline – it seems to be ever-increasing – and depth of knowledge and capability is required to help customers navigate regulatory filings and related quality expectations, particularly in the MDO space. This is heard over and over from customers: it’s probably number one in terms of the capabilities they are looking for.”
Broadly suitable
One thing OEMs of any size tend to look for when outsourcing is a partner with a broad range of manufacturing capabilities. For the past few years, this has meant considerable consolidation in the CMO space and that trend appears to be continuing. In October 2015, Greatbatch completed the acquisition of Lake Region Medical, forming Integer, making it one of the largest CMOs in the world.
“OEMs are looking for partners with broader ranges of capability and that was a big driver behind the reason for the merger,” says Ahlers, who is in charge of integrating the different companies. “Integer wanted to give itself a broader, more complementary portfolio of products and services, because customers often say that they are looking to consolidate, or simplify, their supply bases. Many of these large OEMs are dealing with thousands of suppliers.
“If they can get one provider and take out ten to 20 others, it can make their purchasing and supply chain relationship and network much simpler. That’s definitely a trend that Integer recognises among a number of its competitors across the industry.”
As contract manufacturers get larger, though, there is a risk of the relationship with OEMs becoming strained. “From the customer’s perspective, I think there is a danger that as MDOs get bigger they may start doing their own proprietary products in certain areas, meaning supplier partners could become competitors. That’s something Integer tries to be very mindful of, but it’s a risk of the market in that potential partnership for OEMs.”
While some things have remained broadly the same, the relationship between OEMs and CMO service providers is changing as the market grows and matures. From not wanting to outsource any of their competencies, OEMs are now far more open to using contract services for design and development earlier in the process.
“One of the things Integer focuses on is development capability and support,” Ahlers says. “The company offers support not just from a manufacturing and delivery perspective, but also in terms of design and development. In some cases, Integer will take a concept from a customer and fully design and develop a product or a product system.
It can also do co-development, working in concert with a customer’s design team. In some cases, Integer will have a proprietary product that can be sold as an individual item to multiple customers, who can then present it to their clients as one of their solution capabilities.”
Collaboration has become so central to the OEM-CMO relationship for two reasons, according to Ahlers.
“Firstly, everybody has limited resources and budgets, so it is a way of providing an additional service to augment what an OEM customer may be generally capable of. It allows them flexibility in how they apply resources, and gives them a broader view of potential innovations. We would expect to see continued evidence of collaboration like that.
“Secondly, it is a way to reduce the overall risk of a programme financially, and to bring new products and therapies to market a little bit faster than if you use traditional OEM designing, then hand it off to a contract manufacturer. That tends to mean that a lot of iterations get to the final result. By using collaboration and co-development, you can really speed up a lot of the process of getting therapies to market.”
Of course, there are still areas over which OEMs don’t like to relinquish control. High-risk Class 3 medical devices, like stents, which many companies feel are too big a risk to outsource, and disruptive technologies where contract manufacturing companies lack the competency to produce or manufacture, are examples.
Things do change over time, however, as Brian Higley, CEO of Cirtec Medical Systems, pointed out in the last edition of this magazine.“Early on, OEMs were looking for manufacturing partners,” he said. “Today, they are looking for full service: design, development, manufacturing, regulatory, sterilisation and supply chain management. Yes, it is a very slow process, but I think they are getting more and more comfortable with us taking different capabilities.”
Whether that shift happens sooner or later remains to be seen. In the short term, however, cost will be front and centre for OEMs, and contract manufacturers stand to benefit. “I think we’ll see a shift in philosophy in healthcare whereby individuals are much more conscious of the costs involved in the industry,” Ahlers says. “I don’t see that changing. If anything, I see it accelerating.”
