In vitro diagnostic (IVD) device original equipment manufacturers (OEMs), like any commercial organization, measure commercial success by the ability to increase operating margin and revenue year after year. Increasing margin is critical to maintaining business sustainability to provide funds for investment in research and development, core growth and/or mergers and acquisitions. Achieving healthy operating margins can also strengthen the company’s market valuation through a premium on its share price.
IVD OEMs, however, differ from other industry sectors in one important respect: the diagnostics industry has changed dramatically in recent years as healthcare reform in Western countries triggered, and then accelerated, a reduction in test reimbursement and the price paid for these products. As pressure on prices gradually intensified, IVD manufacturers faced the challenge of how to continue to maintain their margins. Many IVD OEMs have turned to their supply chain to maintain their profits. One such strategy focused on the potential for manufacturing in low-cost regions (LCRs) such as Singapore, Malaysia and China.
Since the mid-1990s, many industries have sourced their products from LCRs. The IVD industry was perhaps one of the most recent industries to embark on this route. This article looks at the roadblocks that are encountered, and how successful players have been able to navigate the risks and exploit the opportunities.
Challenges in LCR Sourcing for IVD Manufacturing
Over the last 15 to 20 years, the medical device industry has become more sophisticated in using LCR suppliers and manufacturers to reduce costs and, more recently, to accelerate moving into high-growth regions. But it is only relatively recently that IVD OEMs and contract manufacturers have gone down this path. The delay is due largely to the different mix of complexity and volume associated with the instrument side of the IVD business.
The industry is now making a significant push towards outsourcing the manufacture of entire IVD instruments or components to selected LCR countries. A few of the factors that slowed realization of LCR expected benefits by IVD OEMs include:
Volume and complexity mix
IVD instruments vary greatly in the level of design complexity and in the enabling technologies that are incorporated into each system. This complexity requires highly qualified and trained assembly operators to ensure system reliability and meeting rigorous IVD manufacturing standards. Requirements for compliance to ISO 13485, compared to ISO9001, include closer scrutiny, highly detailed documentation and more transparent traceability.
LCR suppliers and manufacturers have had to develop these skills and standard processes. Having achieved this more rigorous standard, a network of suppliers and manufacturers willing and able to produce goods for the IVD market is now emerging in several low-cost regions.
Volume and complexity mix
Traditionally, Chinese manufacturers have been well suited for high-volume manufacture in a less stringently regulated environment. IVD instrument sales rarely achieve more than mid-volume levels – even at their peak, only a few hundred to a few thousand units of most IVD instruments are needed each year to meet market demand. Because of these differences in market needs and regional manufacturing approaches, the traditional Chinese model of generating profit through high volume does not align with IVD instrument manufacturing requirements. However, some Chinese suppliers such as Tanaka and Incote have adopted new business models that enable supporting the IVD industry needs.
IVD instruments are complex, requiring significant investment in research and development. Intellectual property in the system design and enabling technologies are therefore a significant asset for IVD OEMs. These companies are extremely sensitive to the risk of losing control over their design and technology security. For this reason, intellectual property concerns can be a significant factor in the delay of sourcing more products from LCRs.
Think LCR from day one
Although one strategy is to manufacture the initial run of a new device in-house, or outsource it to a Western contract manufacturer to support the product launch, the successful LCR strategy anticipates moving to the LCR manufacturer from the very first phases of the product’s life cycle, including prototyping. Suppliers such as TNK Precision have considerably improved their processes recently and can provide prototype parts to their customers in low volumes and within reasonable timelines to support early stage testing.
The benefits of this approach can be substantial:
The OEM can achieve higher profit margins with lower material costs available in the LCR markets.
The potential transfer of the instrument manufacture to an LCR can be simplified by maintaining the supply chain, as the design will be within the capabilities of the end supplier.
Additional benefits of early selection of the LCR supplier include the ability of the contract manufacturer to conduct precise due diligence audits of the candidate vendors while considering all options available. Managing risks that may jeopardize the quality of provided parts and components and checking a supplier’s track record on intellectual property management and document traceability, take time. Too many OEMs and contract manufacturers rush these critical audits while under the pressure of last-minute cost-saving exercises, placing their organizations at significant risk.
As an example, to maintain confidentiality of intellectual property, TNK Precision strictly controls staff and visitor access to its offices and documents. Hongjun Wang, president and CEO, states, “we value the importance of IP to our customers and have implemented controls to protect IP, including restricted access to offices and customers’ drawings.”
Transfer at the right time, and for the right reasons
Transferring the manufacturing of your instrument to an LCR can look like a very attractive option. The nature of IVD technology, however, is that the manufacturing transfer process does not always end in an easy and smooth product launch.
As a new IVD product reaches the final steps along the road to being launched into the market, the process is at the mercy of last-minute configuration or design changes required by regulators or suggested by user feedback. The decisions on making such changes need to be based on deep knowledge of instrument design, something LCR manufacturers rarely possess. For this reason, it can be a lower risk to manufacture the initial instrument run close to the point of design and the OEM decision-makers, followed by a transfer to an LCR at a later stage.
Launches are also often accompanied by roller-coaster volume demand. An OEM may need an initial batch of a few dozen instruments to support its clinical trials, launching the product in selected markets, or sending initial units to contract manufacturer partners as samples. Demand might then fall to very low levels while the OEM faces the long battle of obtaining regulatory approvals, or while it seeks endorsement of the product from key opinion leaders in the field. In many cases, this early slowdown is dramatically interrupted by a one-off event: perhaps a scientific paper supporting the technology is published, or the World Health Organization makes a grant to use the instrument for a specific disease, such as HIV or Ebola. In such circumstances, the OEM will expect an extremely rapid response from the manufacturer to scale up production urgently, and to respond in time to realize what could be the springboard to market success for the lifetime of the product.
These large fluctuations in volume demand, combined with the required design or user changes discussed before, mean that in the early months (sometimes early years) of a product release, extreme logistical flexibility is required. LCR assembly facilities cannot always offer this flexibility and rapid respond to changing volume requirements. Manufacturers need a highly qualified and closely managed logistics and supply chain to respond to such demand variations.
Subsystem or complete system?
The last aspect of the timing of outsourcing to an LCR is choosing between outsourcing subsystems only vs outsourcing the complete instrument production. Most IVD instruments, in both the middle-throughput range and point-of-care range, have a high ratio of material cost over labor cost. This means the potential cost savings to be made from outsourcing a subsystem to an LCR can be small, especially after allowing for the quality-management overhead that such transfers can generate. For this reason, many OEMs and contract manufacturers have decided to outsource to LCR only the assembly of the subsystem, keeping final assembly of the instrument and final qualification tests in-house. Another benefit of this approach is that the OEM can be selective when deciding which subsystems to outsource, keeping in-house those that present higher risks, whether from a quality, intellectual property or cost point of view.
When asked what factor is common to all companies who successfully transfer IVD products to LCRs in China, Invetech’s Shanghai-based Product Manager Ryan Zhang’s definitive answer is a “win-win partnership” (see our interview with Ryan below). Such a partnership is more than a commercial relationship between the parties. It is also a transparent communication and collaboration between the design and manufacturing teams.
An LCR transfer can be long and challenging, but many companies have developed processes and approaches that reduce the risks and result in a smooth transition. The following conditions are necessary (but may not be sufficient) to ensure the smooth transfer of an IVD product.
The first prerequisite is maturity of product design against LCR manufacturing requirements. Last-minute changes and constant re-engineering already create complications during the launch of a product. Such problems can be even more dramatic if these changes happen after the product has been transferred to an LCR manufacturer. Stability of product design is the key to the quality of what comes off the production line, and this risk increases with lower-skilled assembly operators. A successful transfer must include educating the design team about the manufacturing requirements of LCR assembly in general and risks specific to the selected manufacture location in particular. Such requirements may include use of the metric system, choice of locally available materials, or the level of detail required on drawings. Plus, the standard operating procedure documenting how the instrument will be built should not only be translated into the LCR native language, but should also be precisely adapted to the skills of the operator who will be assembling the instrument.
Another aspect of a successful transfer is the teams’ ability to work together in a collaborative manner. Traditionally, the OEM and manufacturer would send a team from their headquarters to ‘teach’ the team in China how to build the instrument. This approach is not the best because the design team will have limited opportunity to adapt to any local technical problems that can arise. The training is also theoretical in nature, rather than practical, as the team does not yet have a fully running line for the training. For these reasons, OEMs more recently have moved to a different approach: the Chinese team is deployed on the initial production line or pilot line, before the product is transferred to China. Using this approach, the new team is trained on the actual jigs and fixtures. Also, the source production line can continue running until both teams are confident that the transfer can happen seamlessly. Even after this training using the initial production line, the design team will need to provide support during the early phase of manufacture in China. Communication methods for the support such as sharing videos and teleconferencing are useful for overcoming differences in time zones and geographical distance.
As soon as an OEM decides to transfer a subsystem or a complete instrument, it should conduct a risk assessment. This should assess both the technical and logistical aspects of the project. One critical decision is whether to construct a second production line in China while keeping the initial product line running. Although this is expensive, it reduces the risk of temporarily being unable to provide the market with products if a problem delays production schedules. It also lets the manufacturer compare the quality of the outputs of the two lines to ensure meeting the required performance for the system.
The strategy plan should encompass every aspect of the transfer, including registration of the product in the LCR.
Direct from Shanghai: An interview with Ryan Zhang
Ryan Zhang has been product manager at Invetech Shanghai since 2011. His role is to identify, establish and maintain suppliers in China and South-East Asia for Invetech, in collaboration with Leica Microsystems Shanghai. Ryan is also responsible for transferring complex subsystems and proof-of-concept instruments from Western contract manufacturers to Leica Shanghai. He has a Bachelor of Science in Automation from Shandong University of Technology and an MBA from Keiser University in Florida.
Q: Ryan, you have 10+ years’ experience in transferring IVD devices from Europe and the US to LCRs. What would you recommend to an OEM starting this process?
My first and perhaps strongest recommendation would be to think ‘win-win’ when you develop a partnership in an LCR. This is a rule that should be applied in any OEM–supplier relationship that one wants to sustain into the future. There is sometimes the temptation to save money in the LCR by pressing suppliers more than you would press a local vendor. Long-term partnerships will only result when each player can enjoy a margin in line with its own business targets. This is true anywhere, including LCRs.
My second recommendation would be to have a local presence – a team that will represent your interests locally. The benefits of LCR outsourcing come from lower-cost labor and competition, but these are synonymous with lower qualifications and lower overheads. LCR suppliers are less well trained and experienced in dealing with OEMs and engineering firms from the US and Europe. Your local team will also be instrumental in educating your design team to understand cultural issues and avoid common communication problems. They can be your perfect coach to help your design team ensure that your product is ready for LCR sourcing and manufacturing.
Q: What do you think are the most common pitfalls for American and European manufacturers sourcing products from China or South-East Asia?
We are all well aware of the many cases of intellectual property protection problems faced by Western organizations over the past two decades. Although many OEMs and contract manufacturers have IP concerns, only a few are well prepared to deal with them. A carefully considered outsourcing strategy is absolutely necessary if such security concerns exist. One should identify and select suppliers that have a strong track record in this domain. Risk management is also critical, as one should not outsource core IP technology without conducting the most thorough due diligence. Managing the flow of information to your suppliers is a difficult skill. While you would like transparency in order to help strengthen the partnership and understanding between the various teams, you should always include precautions to limit your technical exposure.
The second common pitfall is to manage by cost only, instead of by resource. Particularly in the IVD industry, success comes from getting the right balance between quality and cost. So, selecting the right resource – a supplier who is able to deliver quality at a competitive cost – is the key to success. A focus on cost only will most likely result in technical difficulties, delays and low quality. Just as when selecting a supply chain anywhere in the world, your due diligence should take a holistic view of your product’s lifecycle, rather than focus only on price.
Q: You have witnessed many European and American companies establishing operations and partnerships in China. What is a key leadership skill shared by successful IVD players there?
If I have observed any common themes among the many successful organizations dealing with Chinese and South East-Asian supply chains, there are two: a real spirit of entrepreneurship, and transparency in their dealings with their partners.
Conclusion – a balancing act
The IVD industry is under increasing price pressure, due to recent healthcare reforms in most Western countries. This pressure diminishes OEMs’ ability to maintain profit margins to support investment in research and development programs. This challenge has led the industry to review its supply chains. LCR sourcing is providing opportunities to reduce costs.
Transferring manufacturing to an LCR brings risks and challenges, ranging from intellectual property threats to quality and reliability problems. But successful organizations manage to balance these risks with the benefits by using a newly formed network of suppliers willing to meet the IVD industry’s demand for lower volumes and high quality. There are trade-offs when evaluating outsourcing and LCR options, in order to limit risk and make the most gains. But LCR sourcing is now well established in the IVD industry, and is freeing up precious cash, which can be reinvested in developing the next generation of innovative diagnostic instruments.