International Product & Process Transfer Planning: Par for the Course Isn’t Good Enough
The increased emphasis on cost containment in healthcare has many ripple effects, including those being experienced in the medical device industry. Reduced reimbursement for medical
devices, change in the decision-making sources and increased competition in the field already are forcing companies to deal with the reality of margin erosion. Amid these market forces, the job of maintaining profitability in medtech has fallen squarely on the shoulders of operations, purchasing and supply chain management. Opportunities to seek cost reduction and generate increased contribution based on how and where products are made is receiving increased attention across the supply chain.
The traditional components of cost of goods sold include material, labor and overhead, of which labor typically is the most readily addressable. The lure of lower labor rates, tax incentives, and the attractiveness of a low-cost-country (LCC) sourcing appear to provide a strategic remedy to achieving cost reduction with significant impact to the gross margin equation. A full-time equivalent (FTE) labor differential of more than $30,000 is common among the United States, Mexico and Central America, and it marginally is better between the United States and Asian countries. Simplistically, this differential multiplied by the number of FTEs converted to the lower labor rate can more than justify the added cost of transferring production to low-cost country sources for many medical device manufacturers and contract manufacturers.
The business case for production transfers to low-cost countries can provide a very attractive return on investment on paper. However, the actual result of the transfer can be wrought with risk andunpleasant surprises.
First, the medical device industry can benefit from valuable lessons learned by other manufacturing sectors—many that have more than a decade of experience with low-cost-country sources. These sectors have learned a number of very costly and difficult lessons in their LCC production transfers and sourcing decisions. No longer is LCC the commonplace approach in these sectors. Rather you will hear these industries refer to best-cost countries (BCCs).
What is the difference? LCCs can provide the lowest cost quote, but they do not necessarily result in the overall lowest costs. Issues such as taxes, duties, logistics, energy, operating infrastructure, talent and workforce stability, natural disaster vulnerability, weather patterns, and political instability all are factors that have on a number of occasions cost companies unplanned dollars, customers, reputation damage and market share. These companies have learned some very expensive and important production transfer lessons as well. A low-cost option may not (and is not likely) the best-cost country. Selecting a BCC will require an experienced approach.Experience with the hidden traps and factors that can turn a low-cost sourcing and transfer decision into a costly move that negatively impacts service levels, quality and ultimately market share.
For example, while we were working recently with one medical device client on a production transfer, the topic of service levels and market share risk became a very intense topic. While a potential source in Asia provided a 6.25 percent price advantage compared with a Central America option, the combination of additional inventory carrying costs and logistics began to eat into that cost advantage. That, combined with the risk of service level performance and resulting market share loss ultimately caused the client to select a BCC option over a LCC option for a production transfer.
Don’t go through the painful learning curve. Instead, use the lessons learned from other industries and consider the BCC transfer strategy.
Too often, we see companies pursuing the LCC path based upon an accounting paper exercise, focused on a model that assumes all the variables are known and execution occurs flawlessly. Based on the paper analysis, companies begin reaching out to suppliers and receiving quotes. The quotes confirm the savings to be realized from executing the production transfer. The suppliers quoting the transfer reference experience and what appear to be reasonable one-time costs in these activities. Where we see companies getting into trouble is they do not have the experience to understand the scope of questions to ask nor do they understand the factors that need to be built into the quote or terms to negotiate into the contract. Once the business case is presented to the executives, there is no turning back.
Organizations that effectively implement production transfers to BCC suppliers invest the time and resources to build a robust and detailed production transfer plan. The transfer plan includes activities and task for all stakeholders in the transfer; internal functions, distribution, the sending site team and the receiving site team. The transfer plans should be built with input from an experienced team. Performing a domestic production transfer once or twice does not qualify as ample experience. Roles, responsibilities and scope need to be clearly documented and agreed to by all participating stakeholders … including the supplier’s receiving site team. Get an experienced team involved in negotiating the contract with the receiving site supplier. The contract negotiated needs to be comprehensive and clear.
In a recent example, a medical device client was negotiating with a potential supplier.The supplier resisted having warranty responsibility for product defects caused by manufacturing for more than 120 days after manufacture. The shelf life of the device was 48 months. Not only should the supplier assume responsibility for the lifetime of the product supplied, provisions also should be built into the contract enabling the customer to require increased auditing and inspection at the supplier’s expense if their qualityperformance falls below establishedperformance standards.
We recently were involved in helping a client construct its production transfer plans. After countless hours of grueling planning, which includes Gantt charts, open issues logs and a production transfer failure mode and effects analysis, the chore ofallocating resources began.
Repeatedly, members on the client team asked why a given activity would require the amount of resources suggested during the planning process. Each time this challenge came up within the client planning team, two sides formed—those that had been involved in production transfers previously and those that had not. Consistently, people who had not been involved in production transfers previously were on the low side of resourcing. Individuals who previously had been involved with production transfers consistently pushed to increase the amount of resourcing for activities.
I was recently in a meeting with a client who had been through multiple transfers before and he stated it this way to his production transfer team: “We don’t want to ‘underclub’ this one,” he said. “There is too much risk and too much at stake.” This executive had been through production transfers before and he had learned toexpect the unexpected.
(Editor’s note: For those of you who may not be familiar with the meaning of “underclub,” it is a term used in golf when the club selected to hit a shot does not provide adequate distance to reach the intended target and when a another club would have provided enough distance to make a successful shot. For example: “You don’t want to underclub your shot into the third green with the water along the front edge.”)
Internal production transfers are complex and challenging. Production transfers to domestic suppliers add complexity and risk. Production transfers to BCC suppliers exponentially expand both the risk and benefit if planned for and executed effectively.
To realize the benefits of a BCC transfer strategy, don’t “underclub” the planning or resources to execute effectively.
Jeff Jenkins is a partner at Plante & Moran, where he leads the Operations & Supply Chain Management practice. For the past 10 years, Jeff and his team have focused on helping medical device OEMs and suppliers in the areas of supply chain management including supplier development and low-cost country sourcing, product commercialization and launch, inventory management, manufacturing, lean, project management, problem solving, logistics and transportation, strategy, and quality systems.