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Orthopedic Outsourcing Dynamics
Firms are taking advantage of an increasingly full-service and global model.
Christopher Delporte
Group Editor
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All joking aside, the largest drivers of orthopedic industry growth are well known. The rapid growth of aging US and global populations (here come active baby boomers who are living longer), along with what some have called an obesity epidemic, is keeping orthopedic companies and their outsourcing partners very busy. In addition, trends and innovation in areas such as minimally invasive surgery also fuel market expansion as they make previously traumatic implant surgeries much more patient friendly.
While some of the impressive expansion the orthopedic sector experienced in the recent past may be flattening a bit, continued growth still is expected. In 2006, the orthopedic market (including dental implants) was valued at $26.9 billion globally, according to research conducted by New York, NY-based Healthpoint Capital, LLC, a private-equity firm focused on orthopedics.
“We’ll see less dramatic price increases going forward, but the growth is largely volume driven,” said John McCormick, a Healthpoint Capital managing director. “That’s still very healthy growth.”
McCormick went on to say that growth is expected at the rate of 11%-12% per year through 2010. Prior to 2006, growth rates had been closer to 15%. Revenues are expected to hit $29.9 billion this year, reaching $41.2 billion by the beginning of the next decade, based on data collected from firms including Healthpoint Capital, Millennium Research Group, MedTech Insight, Merrill Lynch, Cowen, Wachovia and Sanford Bernstein.
To maintain their competitive advantage, orthopedic OEMs are continually challenged to innovate and get products to market as quickly as possible. Though there still may be significant opportunity in the orthopedic market—particularly in the growing spine and trauma sectors—competition is keen.
The industry has watched as wave of consolidation has altered the playing field. Outsourcing companies—either as acquisition targets themselves or adjusting to a smaller roster of industry players—haven’t been immune to the effect.
Though the number of players may be shrinking, Michael Matson, senior analyst with Wachovia Capital Markets in New York, NY, predicted that the orthopedic outsourcing market for just implants and cases and trays to be valued at more than $700 million currently. Through 2009, he expects the overall orthopedic outsourcing market to grow at an average rate of 13%, with outsourced implant manufacturing, instrument manufacturing and delivery systems manufacturing growing at an average of 14%, 12% and 9%, respectively, per year. Some unconfirmed estimates have put the total value of the current orthopedic outsourcing market even higher, but analysts seem to agree on future growth prospects.
The Value Proposition
“Innovation and differentiation are the order of the day,” Toby Buck, CEO and founder of Paragon Medical, told Orthopedic Design & Technology, explaining that fewer major device manufacturers and price pressures have made innovation even more imperative. Companies must ensure product differentiation and value (for clinicians and patients), as well as protect sales and profits, he said.
“It sounds obvious, but that trend is only going to accelerate,” he added.
Pierceton, IN-based Paragon Medical is a contract manufacturer of custom and standard surgical instrumentation, implantable components, as well as cases and trays for orthopedic OEM customers.
“Quality is always understood. You need to manufacture a good product,” Buck said, adding that the cost equation is playing more of a role “It used to be that he who owns lead time owns the game. Price was relevant but subordinate. Today, you’d better ship the right product, you’d better ship it on time and—oh, by the way—price is very relevant. The pressure to reduce costs has always certainly been there, but it is much more present today.”
What do these pressures mean for an OEM’s relationship with its outsourcing partners?
Most of the outsourcing providers who shared their insight with ODT said that they now have more opportunities to demonstrate their value and that their businesses have improved as a result. It also means, however, that to help OEMs with their innovation conundrums, outsourcing companies must—perhaps more often than before—reinvent the wheel, offering a greater number of service options, including taking advantage of resources that are more international in scope.
In the past, orthopedic outsourcing relationships were based mostly on individual specialty component manufacturing agreements. Much like the industry they serve, outsourcing companies also have consolidated. While smaller, more specialized component manufactures still play a role, the trend is toward a one-stop-shop approach. Where there had once been a group of many small players providing services such as engineering, forging, molding and machining, much of that can be obtained (both literally and figuratively) under one roof.
For OEMs, managing multiple suppliers required a large staff and could be taxing on resources and logistics, according to Jeffrey Zajac, director of product development for Wilmington, MA-based Accellent, which manufactures and assembles implants and instruments for the reconstructive, spinal, trauma and sports medicine sectors for its OEM clients.
“I am seeing where a company may once have had a broad base of suppliers and they’re going to a more strategic stable of suppliers,” Zajac said. “They are trying to consolidate their work from 20 into three, four or five strategic partners. It’s something that’s overdue in the marketplace, and it’s beginning to gain ground.”
Brian Moore, president and CEO of Warsaw, IN-based Symmetry Medical, agreed. “We have our own design engineers, procurement people and our own quality people,” he said. “It costs less for our customers to deal with our business than a whole myriad of smaller other companies. It’s all part of our Total Solutions service.”
Victor Rocha, spokesperson for orthopedic giant Smith & Nephew, said that soup-to-nuts philosophy is appealing for OEMs and that outsourcing certainly is part of his company’s strategy.
“There are different types of technology we don’t have, so we have to go outside to get that particular technology and expertise,” he said. “We’ve seen a lot of consolidation in outsourcing manufacturing. Larger companies offer full services, contract manufacturing, development and design. It really helps reduce design time, and the one-stop-shop model is efficient.”
Rocha said Smith & Nephew currently uses more outsourcing services for its line of hips than for any other product category, including knees (although use varies depending on need). He added that the company uses contract manufacturing for metal forming and some coatings but rarely with other surface modifications. He also noted that finished-goods outsourcing is used after a newer generation of product replaces an older implant that remains clinically popular. Smith & Nephew will focus on the production of its newer product in house while outsourcing the legacy product.
“It’s more cost effective to outsource,” said Jonathan Tillman, vice president of sales for Fall River, MA-based Millstone Medical Outsourcing. “The OEMs and start-ups are focused on getting products to market and selling them. Our focus is in a niche that isn’t really a core competency for a lot of companies, and they see that as a benefit to have an outside partner to run the post-manufacturing processes.”
Millstone Medical provides clean room, inspection and packaging services, along with aftermarket services such as instrument recycling and implant repackaging. The company also warehouses and distributes products for some clients.
Tillman said the idea of outsourcing is becoming more acceptable to companies. “We used to have a very hard time getting companies to outsource packaging because they felt it was such a critical piece of the puzzle that they didn’t want to have an outside vendor doing it,” he explained. “Over time, we’ve seen that open up quite a bit, and we’re now getting a lot more products from the big orthopedic manufacturers. OEMs began outsourcing packaging cautiously, but now they’re beginning to see that there are vendors out here that can maintain the same level of quality—or even better—than they may have been able to achieve in house.”
Tillman added that OEM customers strive for “simplicity of process” in addition to reduced cost and time managing the supply chain.
“We’re seeing that more and more as a big driver,” he added. “They’re putting the onus on us to manage the supply chain, and that’s something we’ve embraced.”
Jack Fulton, vice president of sales and marketing for Specialized Medical Devices Inc., in Lancaster, PA, said his customers are looking for a variety of engineering services to complement the manufacturing component. Specialized Medical (which recently was acquired by Teleflex Medical in Limerick, PA) focuses on the small-bone and spine markets, specifically on serving companies that don’t manufacture in house and embrace more of the outsourcing model.
“Customers are looking for more engineering services in addition to manufacturing,” he said. “Everything has become faster to market and the time-management aspect is probably more acute. Windows keep shrinking, and that has become the standard rather than the exception.”
Accellent’s Zajac mentioned that his company is seeing more opportunities for sterile packaging, components and subassemblies that support the orthopedic marketplace, along with more design-related services.
“Many OEMs have limited resources and they’re realizing the value of the outsource design partner,” he said. “During the past 18 to 24 months, we’ve seen orthopedic companies tighten their belts a little, and they didn’t have the same resources or were reluctant to bring on resources, so we’re seeing them turn to outsource partners such as Accellent to take on design activities for them.”
According to Zajac, while large OEMs remain the company’s “bread and butter,” the firm is seeing more start-up ventures looking for both design and manufacturing services.
“We’re seeing mostly spine-based business from the venture-funded small start-ups. And we’re watching them grow by orders of magnitude,” Zajac explained. “These small players with no internal manufacturing are good customers. Many of them have no intention of putting that infrastructure in place, and they’re up front with that information.”
George Weaver, vice president of marketing for Denver, PA-based Precision Medical Products, said his company only is interested in long-term relationships with OEMs.
“When they come to us with an idea, we get involved early on for manufacturability and we help them to evolve their idea,” he said. “We offer a host of services. When I team up with a company, I want to know as much as possible about their product and where they want to go so I can design a product that will make sense to them economic wise in the marketplace. It is a team effort. We are their manufacturing arm. We put their name on the product, so it’s a team effort.”
Going Global
For the most part, while there is an obvious and undeniable trend toward outsourcing overseas to seek low-cost manufacturing alternatives (aka, offshoring), most outsourcing companies interviewed by ODT claimed that the nature of the orthopedic business keeps US-based companies outsourcing closer to home. Some of the larger companies have facilities abroad, but they serve local markets and aren’t always a low-cost manufacturing option for cutting-edge orthopedic equipment repatriated to North America.
The buying network in Asia is “pretty weak” and offers little as far as services are concerned, according to Smith & Nephew’s Rocha. While Europe has more orthopedic outsourcing options than Asia, Rocha described the European supplier base as “a little more contractual,” noting, “You ask a European company to make a widget, and they’re going to make that widget and nothing else. In the US, they don’t just make the widget—they’ll help you design it, too.”
Accellent’s Zajac agreed with Rocha’s assessment of US orthopedic talent, adding that Accellent has many European orthopedic clients that have work done in the United States.
“I think the reason the US market stays close to home is the strong base of technology in the orthopedic marketplace,” he said. “Companies around the world do come to the US for expertise. We’ve seen development projects and component projects from Eastern and Western Europe—nothing yet from Asia.” Accellent has international manufacturing facilities in the United Kingdom, Germany and Mexico that primarily support the company’s cardiovascular and endoscopy businesses.
Paragon Medical’s Buck said the benefit of overseas manufacturing comes with high-volume products (bone screws, cervical plates, etc.) but that manufacturing in a low-cost location such as China is not an answer in and of itself.
“I think you’ll see a significant trend moving toward offshore manufacturing, but it depends on the categories of products,” he said. “What you’re really going to see more so is legacy products that have been out for awhile can go offshore to an low-cost economy. In high-mix, low-volume applications, China doesn’t work economically. Orthopedic applications, generally speaking, are high-mix, low-volume. Heck, there are some things being done in Eastern Europe that beat what’s being done in China cost-wise.”
Paragon Medical does some manufacturing in China, but Buck said the primary reason is to be in the position to respond to the client penetration in indigenous markets.
Symmetry’s Moore agreed that proximity to foreign customers has been key. He said most of his company’s manufacturing is done domestically, with 20%-30% done in overseas markets, also primarily to serve foreign-based orthopedic manufacturers.
“We have a strong European presence for our customers—with facilities in France, Switzerland, the UK and Ireland—and a strong Japanese presence for dealing with our customers in Japan,” Moore said. “We see ourselves as a worldwide company with a global presence. Part of our philosophy is that if our customers need support around the world, we’ll be there to help them.”
The company also has begun a move into Malaysia, with a facility in Penang. Moore said Symmetry has been working with the Malaysian government to establish a facility for manufacturing cases and trays.
“We hope to follow that up with other manufacturing and other sourcing, and we expect to grow that quite aggressively,” he said. “We chose Malaysia initially as a host for our Japanese market—Japan and Malaysia have a very good trading relationship.”
Moore also cited good business standards on intellectual property issues, along with a good infrastructure and a talented pool of middle management and technical workers, as reasons for the expansion there.
No matter how far-reaching the facilities a company may have at its disposal to offer clients, Moore said the ultimate decision-maker is the customer.
“Distributions channels, logistics and outsourcing are very much the success criteria of tomorrow, but, of course, the customer would have the major say on where they want their product manufactured, obviously for quality reasons and time,” Moore explained. “In orthopedics we have to constantly remind ourselves of speed to market. Can you get a product to market quicker by several months by outsourcing it by several months with the right margins for our OEM customers? That’s a major win for them.”
Looking Ahead
Outsourcing companies have had to respond quickly to meet the rapidly changing demands of their OEM customers and are aware that the ability to change as needs vary will keep them competitive for much longer.
“Strategically you have to keep an eye on what trends are in the industry,” Tillman said. “In 15 years, will metal go away? Will everything be regenerative bone? Companies need to be looking ahead to prepare for those changes.”
Paragon Medical’s Buck agreed, noting that keeping up with the day-to-day grind is always a challenge, but that companies have to keep “an eye peeled” for what’s coming—and outsourcing companies must respond to technological advances as quickly as their customers do.
“Today is so much different than just five or 10 years ago. It changes fast,” Buck concluded.
