Envisioning the Medical Device Company of the future

The U.S. market for medical devices is expected to reach $89 billion this year. But with this promising opportunity comes the added pressure for medical device companies to stay ahead of the competition through innovation at a reduced cost.

According to an online survey conducted by Knowledge@Wharton and HCL Technologies, industry respondents see outsourcing as a potential solution to this challenge, and yet they are aware that this new set of tools brings with it new risks.

Although the best ways to mitigate those risks may seem unclear, interviews with experts from Wharton, HCL and medical device firms indicate that a particular set of best practices may make success more likely.

Abstract

Weighing the Risks and Benefits of Outsourcing ..................................................................................3

From Cost Saving to Partnering ..................................................................................3

Survey : Outsourcing Risk & Realities ..................................................................................4

Structuring Alliances ..................................................................................4

Communicating Clearly - Inside and Out ..................................................................................5

Moving Forward: All Eyes on the Goal ..................................................................................6

Annexure ..................................................................................8

Table of Contents

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3

A n aging world. Fast-growing markets. New life-extending technology developing at an incredible pace. It sounds like the recipe for a booming industry, and in fact, medical device manufacturing is one of healthcare’s fastest growing segments.

But medical device manufacturers also face huge challenges in trying to manage that growth. Competition is tough. Infrastructure and clinical practice may differ considerably from market to market. Device development costs are high. Margins are shrinking. To complicate matters, the fastest-growing markets are going to be accessible only to companies that learn to make the same equipment for a fraction of the cost and at the same time launch new, cutting-edge products faster than their competition.

To learn how medical device manufacturers are reacting to these changes and how they are responding to new opportunities as they develop, Knowledge@Wharton and HCL Technologies conducted an online survey of medical equipment manufacturers, vendors and other industry experts in November 2007. The survey generated a total of 264 responses; of these, 39% indicated that they were involved in medical device manufacturing or sales, and 35% in consulting or research. A variety of company sizes were represented as well: 51% were from companies with less than $500 million in annual revenues, and 49% over $500 million, with a little more than half of that number (26% of the total) from companies of more than $5 billion. General managers of these companies had the highest representation among respondents (23%), along with roughly equal representation from finance (10%), marketing (13%), R&D (13%) and sales (12%).

The picture that emerges from the survey is of an industry struggling with profound change in every respect -- from the way it is organized, to the way it operates, to whom it serves. The respondents indicated that they see strong potential in outsourcing or collaborating with outside experts as part of the solution to these challenges, and yet they are well aware that this new set of tools brings with it new risks. Although the best ways to mitigate those risks may seem unclear -- not surprising, given the relative nascence of outsourcing in this market -- interviews with experts from Wharton, HCL and medical device firms indicate that following a particular set of best practices may make success more likely.

From Cost Savings to Partnering

Seven years ago, when HCL Technologies began offering outsourcing services to U.S. medical device manufacturers, most of the executives with whom Pradep Nair spoke viewed outsourcing as strictly a matter of cost savings.

In the beginning, clients turned to HCL for cheaper programmers, according to Nair, Head of HCL’s Global Lifesciences & Healthcare Practice. Today, he says, they are looking for solutions to more complex technical problems and business issues. “Four years ago, I was a vendor to a customer,” says the Florham Park, New Jersey-based executive. “Today, that relationship is changing to a partnership.”

One indication of this shift is that the financial structure of these relationships is changing, according to Nair, moving beyond cost-plus transactions for services on an hourly basis to agreements based on fixed-bids or even simple profit-sharing -- the kinds of structures that partners tend to share. “Today, it is moving towards: You pay me only once I am delivering your product, or you pay me once the product is launched and into the market,” he explains.

The rapid growth of outsourcing in this space may have to do with the range of potential benefits some companies have reportedly found:

=Reduced margin pressure - The Asian outsourcing boom began purely as a matter of labor-cost arbitrage, and that is still seen as an important benefit. A 2006 study by the Conference Board estimated the unit labor cost of manufacturing in India and China as roughly 20% lower than in the U.S., even after adjusting for higher productivity in the U.S. In engineering services, the differential can be as much as 50%, according to some estimates.

=Increased ROI on R&D - In some industries, outsourced relationships extend the reach of the company and accelerate the speed to market for new features. Outsourcing can also be a tremendous spur for innovation:

A 2006 survey of 1,000 CEOs by IBM found that nearly 40% get their best ideas from business partners. One study by NASSCOM, the Indian software alliance, and Booz Al l en Hami l ton , t he management consultancy, forecasts that 70% of global R&D will be conducted in emerging markets by 2010. “Given the amount of innovation that goes on in the world, it’s very hard to not take advantage of outsourcing,” says Saikat Chaudhuri, a professor of management at Wharton who studies outsourcing management.

=Faster speed to market - The medical device manufacturing sector is very innovation-driven. When a substantially better device enters the market, physicians and hospitals begin to prescribe it. Over time, such shifts can be quite painful for unprepared companies. For instance, drug-eluting cardiology stents came on the market in 1994, and by 2007, they had largely taken over the market: Between 2002 and 2007, demand for the traditional metal-only stents dwindled by nearly 90%. In that kind of situation, speed to market can be extremely important -- perhaps even more important than cost.

=Easier entry into emerging markets - Today, the market for medical devices is growing in the U.S. and Europe at a rate of roughly 7% to 8% a year, according to Nair. At the same time, the India and China market is growing at 25% a year. To reach that market, though, will require some substantial changes in product design, user interface and cost structure. The biggest one: learning to build medical equipment at the right price point. In the U.S., a dialysis machine might cost $1,400, Nair says, whereas in India, the market will only bear a machine priced below $600. In such a case, Nair argues that an offshore partner is really the only game in town. “Who else can help you?” he asks.

Deerfield, Illinois-based Baxter International Inc. reached a similar conclusion when it decided to develop a new product targeted for emerging markets. “To do that for an emerging market, we must understand their needs and realities intimately, and that is

“The biggest learning : to build medical equipment at the right price point.

– Pradep Nair, HCL

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1 “Innovators without Borders,” Booz Allen Hamilton presentation, July 2007 http://www.strategy-business.com/media/file/Innovators_Without_Borders-webinar.pdf

“[M]ost outsourcing partners are simply order takers -- no end-to-end creative thought processes [are] available,” one respondent wrote.

Nor were clients totally free from blame. “They lack initiative in innovation, especially in emerging markets,” one respondent complained. Others said that many of the problems were due to the client

company not being specific enough about what it wanted from a program.

Despite those cautionary tales, most of the individuals surveyed were optimistic about the capabilities of outsourcing partners or outside collaborators. In fact, 84% agreed with the statement that “an outsourcing partner can appreciate the complexity ofyour varied supply chain and support you through the consulting and execution piece alike” (Question 17), and 78% said they do not intend to restrict R&D to their home country (Question 20).

One reason for this positive attitude, pe rhaps , i s t ha t med ica l dev ice manufacturers’ fears of intellectual property loss seem to be relatively low. Ronnie Toddywala, vice president and leader of an internally funded Johnson & Johnson start-up based in Sommerville, New Jersey, believes those fears are often just an excuse to not move forward. The design of a product is only one of a number of steps between product conception and its introduction to the market, he says. “Yes, they may be able to steal a circuit, but the question is, what would they do with it? In most cases, the key IP is already filed, and it takes much more than a circuit to bring a

(Question 19).Time zones, said one. Communication was also difficult, said another, partly because of low English skills among vendor employees, and partly because of glitches in telecommunications. “People overestimate the value of global IT teleconferencing and communications. Often, these systems do not work nearly as well as advertised,” said one respondent. Occasionally, cultural idiosyncrasies can

also get in the way.

Other times, a vendor might misunderstand what a client company requires at a more

strategic level: One vendor “simply didn’t understand our needs,” a respondent noted. A general lack of communication between vendors and clients was also cited: “Most problems have to do with the ability to spec the problem correctly, get a realistic time schedule and meeting agreed-to cost and quality standards,” one participant said.

Failure by the vendor to produce a product that met critical performance specifications earned the ire of one respondent, while another complained that the vendor had used inferior materials. High staff turnover in the contractors’ firm causes problems, and a lack of expertise affects production, others

“Yes, they may be able to steal a circuit, but the question is, what would they do with it? In most cases, the key IP is already filed, and it takes much more than a circuit to bring a product to life. Device manufacturers own the surgeon relationships that are key to developing the rightproduct with the right clinical and economic evidence. That part of development is difficult to replicate.

– Ronnie Toddywala, Johnson & Johnson

“

difficult to do if all the thinking is centered in a developed market such as the U.S.,” says Rohit Vishnoi, the company’s vice president for technology resources. Similar to the $2,500 “Nano” automobile that Tata Motors just rolled out in India, which lacks air conditioning and other features common to most cars in the U.S., the device Baxter is working on now might not be conceived effectively in the context of a developed market.

A surprising number of the 264 industry respondents to the Knowledge@Wharton-HCL online survey were enthusiastic about outsourcing despite having relatively little experience with outsourcing relationships.

Although 72% indicated they have never outsourced any product development work (Question 12), their perception appears to be extremely positive. Many see relatively high potential benefits from outsourcing, particularly in manufacturing (51%) and IT (46%) (Question 6). Within manufacturing, test jigs and fixtures are believed to have the potential for the highest returns (41%), but other areas of high potential are seen as well in verification and validation (IQ, OQ and PQ) (38%) and manufacturing execution systems (also 38%) (Question 8). Many are also quite enthusiastic about the potential for better outsourcing ROI on R&D and the potential for designing and developing

products in emerging markets (74%) (Question 11).

Such gains, however, are not all easily harnessed .Unl ike the bes t -known outsourcing projects, such as contact centers or business-process outsourcing, medical device development is extremely complex. To begin with, the development of a highly complex product such as a medical device is often not easy to divide into distinct modules, Wharton’s Chaudhuri notes.

In the survey, over a third of the participants -- 106 -- offered comments on why a past outsourcing project had not worked out

Survey: Outsourcing Risks and Realities

“To begin with, the development of a highly complex product such as a medical device isoften not easy to divide into distinct modules.

– Saikat Chaudhuri, Wharton Business School

“

Structuring Alliances

4

device firms suggest that there are specific practices that can help companies make the most of outsourcing partnerships.

The most important of these seems to be making sure that the lines of communication are very strong. A number of survey respondents said their attempts to outsource f a i l ed in l a rge pa r t because o f miscommunications -- specifications that were not clear enough, or that were misunderstood by the vendor.

“The challenges always come down to communication,” says Jim Fidacaro, vice president of R&D and director of business development for Datascope Corp., a Mahwah, New Jersey, company that began outsourcing many years ago and now outsources an increasing amount of its work.

But what are the factors that get in the way? One problem companies that outsource face is the fact that the earth remains stubbornly round, in a geographic sense. This distance between partners can make timely communication difficult. In response, many clients and vendors seem to be evolving a set of practices to help mitigate the impact of the differences in time zones. Shifts at HCL, for example, are adjusted to ensure that there are typically three or four hours of overlap with Western clients every day, according to M. Venkatesan, associate vice president of embedded systems for HCL Technologies in Chennai. Clients also receive frequent reports on what progress has been made for particular milestones. In fact, the distance between companies can be seen as an opportunity rather than a hindrance. Venkatesan notes that outsourcing design, for example, can actually speed design production cycles because work can continue around the clock at a near 24/7 pace.

Cultural differences can also exacerbate communication problems. Although only 19% of respondents said that “cultural synchronization” was an extremely important factor in the decision to enter into an outsourcing relationship (Question 13), a number of respondents said that their outsourcing projects have foundered because of cultural differences. For example, one executive noted that a Chinese outsourcing relationship went wrong because the two companies were unable to

understand each other. “Chinese culture encourages them to say ‘yes’ even when they are not sure they can comply. They don't think it's fair to be bound to contracts because they often feel they are unfairly pushed to accept unrealistic terms,” explained another respondent.

To overcome those kinds of shortcomings, experts say it can be helpful for each side to learn about the other’s culture through classes or seminars that cover customs or b e h a v i o r s t h a t m i g h t b e e a s i l y misunderstood -- even simple things, like the South Indian practice of nodding from side to side to mean “no.” Along the way, executives working with offshore service providers might find that some cultural differences can be a boon. Apurva Chamar ia , Group Manager, HCL Lifesciences & Healthcare, argues that there are positive differences in working with an offshore engineering outsourcer that Western executives sometimes don’t sufficiently appreciate. For one thing, engineers often work in multiple verticals, giving them knowledge of a wider set of best practices that they might bring to a problem.

More generally, Chamaria argues that the particular experience of a country like India where many people have had to struggle

product to life. Device manufacturers own the surgeon relationships that are key to developing the right product with the right clinical and economic evidence. That part of development is difficult to replicate.”

This may be especially true, paradoxically, when the product in question is being designed for the outsourcing shop’s own home market. In that case, Vishnoi says that a potential pirate would face a variety of challenges before he could bring the product to market, including finding local suppliers and cont rac t manufac ture rs , and shepherding the product through local clinical trials. “We’re blazing a brand new trail in terms of how to do all this, including how to set up the service infrastructure,” he explains.

Whar ton’s Chaudhur i sha res the respondents’ underlying optimism that global outsourcing can work for medical devices. It’s already being done in other industries that produce complex products, he says, such as consumer electronics and automobiles. The challenge is no longer really keeping up quality levels or finding a vendor with sufficient expertise, he adds. “The question is more, how are you going to handle all the organizational issues?”

Perhaps the first step, in Chaudhuri’s view, is for the company to recognize that complex, high-technology design or manufacturing can’t be outsourced on a casual basis, the way it might be when outsourcing a less complex, less strategic function. “You have to treat it much more like an alliance,” he says.

The structure of such alliances seems to vary. At the organizational level, he says, several models are now popular. The first is putting groups of staff from the vendor onsite. This makes a close working relationship easier, but it also reduces the potential cost savings. The second is to outsource mostly offsite. The third is to use an offshore subsidiary that can work with the outsourcing vendor. No one is sure yet which model works best, or if one would be particularly suited to a certain kind of outsourcing. “It’s an ongoing experiment,” Chaudhuri says. “We see all three of these, and it’s not yet evident what is working or what is the optimal model.”

There may well prove to be no best structure, but experts at Wharton, HCL and medical

Communicating Clearly - Inside and Out

“The challenges always come down to communication.

“

– Jim Fidacaro, Datascope Corp

“Outsourcing design, for example, can actually speed design production cycles because work can continue around the clock at a near 24/7 pace.

“

– M.Venkatesan, HCL

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against adversity, has served to make its engineers more innovative. “People have had to innovate just to live,” he says. “Indians bring to the table what is called ‘jugaad’ in Hindi -- an ability to find their way to a solution, even when the straight path is blocked. The whole Indian psyche is geared toward innovation.”

Along with bridging any cultural divides, the medical device industry executives interviewed for this report emphasize the following practices to ensure productive communication in outsourcing partnerships:

=Be sure to schedule ‘face time.’ In-person meetings -- especially during the early stages of a relationship -- are important, advises Toddywala. For his last o u t s o u r c i n g p r o j e c t , h e s a y s , representatives from his company and their outsourcer met at a halfway point, in London, to discuss their project. “It’s very important, especially in the beginning, to set up these things. Otherwise, you’re just talking to a voice.”

“This is not just a distinct project that is handed off. To be effective, we need to leverage the expertise that exists on both sides,” echoes Vishnoi of Baxter. “We have a number of people from this side involved and we have a local presence in all the developing and emerging marketplaces.”

=Develop a clear and complete set of project specifications. “Clear upfront requirements are really the trick,” Fidacaro says. Clar i ty in these communications is important, in part, because the costs of indirection are more apparent with an outsourced project. “When a company develops something internally, it’s not always easy to see the impact that changing the scope of the project or its feature set has on costs. Internally, it’s a sunk cost … on the outside, you see the dollars,” he says.

J&J’s Toddywala came to a similar realization after a bad outsourcing

the arrangement. For medical device companies moving forward with plans to outsource, experts from Wharton and HCL recommend the following:

=Set specific goals for the outsourcing initiative. Chaudhuri and others note that it is helpful to look beyond labor-cost arbitrage toward more strategic reasons for outsourcing, such as access to a new market or the ability to ramp-up a research project quickly. “I think when you’re starting to outsource the higher end like this, it shouldn’t be done just for cost purposes,” he says.

Part of that evaluation also involves a careful consideration of the problems that can come into play in outsourcing arrangements. “It’s very important to analyze the risk and bring all the risks to the table,” Venkatesan says.

=Maintain realistic expectations. Understanding the capabilities of the outsourcing service firm is important. Often, for example, the experience level in the hiring organization is much higher than in the vendor -- say, engineers with 15 to 20 years of experience at one company compared to an outsourcing firm where even senior engineers will typically have only 6 to 7 years of experience, according to Venkatesan. These issues tend to sort themselves out over time, once the younger engineers have proven their mettle to the client.

=Align the goals of vendor and client. It’s important in these relationships for vendors and clients to share common goals, experts say, particularly while working on a project that is complex and may evolve over time. Part of that, says Chaudhuri, is choosing the right vendors and the right number of vendors. Outsource too little work, and it might not be worthwhile. On the other hand, work with more than a few vendors, and management could become unwieldy.

Beyond aligning goals on the project level, Venkatesan notes that in order for these

experience several years ago.

While communicating the details about a device it needed designed, Toddywala’s firm forgot to convey to the outsourcing team a critical specification: the device needed to fit into a human bladder. “We got a nice-looking square chip,” he recalls, “[only] there was absolutely no way I could fold that up and put it into a bladder.”

=Articulate team structures and roles. It’s often important for the manufacturer to understand exactly how the outsourcing provider plans to work, according to Fidacaro. Since most firms operate on a matrixed structure, many times the senior members of a team will be called away for another project. For best results, he suggests making sure that at least some members of the outsourcing firm work on the project 100%. “Have a core set that is committed to your work,” he suggests.

Having someone from the outsourcing firm who can stay in the company’s office can also be helpful, he adds - “somebody [to turn to] if things aren’t going right.”

=Plan beyond the project. Technical support after the project is completed is another important element to clarify in an agreement, according to Fidacaro. It’s useful to arrange to have all the designs transferred after a project is completed, he says, and in some cases even to arrange for ongoing support for the life of the product.

Outsourcing partnerships require careful, up f ron t t hough t abou t wha t t he manufacturer hopes to accomplish through

“Indians bring to the table what is called ‘jugaad’ in Hindi - an ability to find their way to a solution, even when the straight path is blocked. The wholeIndian psyche is geared toward innovation.

“

– Apurva Chamaria, HCL

“We have a number of people from this side involved and we have a local presence in all the developing and emerging marketplaces.

“

– Rohit Vishnoi, Baxter International Inc.

Moving Forward: All Eyes on the Goal

6

partnerships to truly succeed, outsourcing firms in the medical devices space need to share the same underlying value their customers place on the importance of the work they do. “More than the effort we put there, more than the costs of X dollars or whatever we are going to charge … if you are working on a life-critical development, if there is a problem in what we do, in the ultimate deliverables, it can cost human life,” he says.

“It’s very important to analyze the risk and bring all the risks to the table

“

– M.Venkatesan, HCL

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Under which category does your organization fall? What is your organization’s size in terms of revenues?

25%

24%

22%

17%

1%

11%

Medical Device OEMMedical Device Supplier/VendorEMS VendorResearch OrganizationConsulting FirmOther please specify

Less than USD$500 million$500 million - $1 billion$1 billion - $2 billion $2 billion - $5 billion$5 billion - $10 billionMore than $10 billion

18%

51%

9%

8%

6%

8%

What is your business function? What are the top challenges facing your business enterprise? (Select all the apply)

In which business areas do you think outsourcing can give your firmmaximum potential benefits? (Select all the apply)

General Management FinanceMarketingR&DSales & MarketingHRManufacturing/ProductionOther, please specify

23%

10%

13%

13%

12%

3%

6%

20%

Increase Costs & Time to Market

Long Product Life Cycle

Adopting Technology Innovation

Security & HR issues

Regulatory Compliance

Other please specify

35%

13%

4%9%

9%

30%

How much of your product development work does your firm outsource/offsource?

Less than 20%21% - 40%41% - 60%More than 60%

75%

8%4%

13%

Axi

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itle

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20

40

60

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140

28Response 75 132 46 44 120

R&D Manufacturing Regulatory Compliance

Sales & Marketing

IT Organization

Otherplease specify

Annexure - Survey Questions & Responses

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What are areas within the Manufacturing process that outsourcing can help? (Select all that apply)

What are the areas within the Sales and Marketing process that outsourcing can help? (Select all that apply)

What are the areas within the Regulatory process that outsourcing can help? (Select all that apply)

Full product development implies outsourcing work around hardware,software, mechanical, embedded and other systems. Have you tried outsourcing any of these functions to a partner?

Do you think you can use offshore product development for better ROI on R&D and potentially for designing and development productsmeant for emerging markets?

What are the areas within R&D process that outsourcing can help? (Select all that apply)

Axi

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20

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140

Response

Clinical Trials

Product Verification & Validation

Hardware Engineering

(Mechanical & Electrical)

Software Solution

Other please specify

99 101 94 133 22

Axi

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itle

0

10

20

30

40

50

60

100

7080

90

Response 69 2591 99 56 97

Manufacturing Informatics

Verification & Validation

(IQ, OQ & PQ)

Manufacturing Execution Systems

Enterprise Plant

Integration

Manufacturing Test – Jigs &

Fixtures

Other please specify

Response

Axi

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0

20

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104 10332 64 22

Sales Force Automation

CDI/MDMDownstream

Visibility Campaign

ManagementOther

please specify

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20

40

60

80

100

120

140

Response

Submission CAPA

Management Solutions

Vendor Qualification Third Party

audits

Design SOPs Protocols and

Reports

Other please specify

1973 40 129 91

74%

26%

Yes No

Yes No

28%

72%

10

Hello there. I am from HCL Technologies. We work behind the scenes, helping our customers to shift paradigms and start revolutions. We use digital engineering to build superhuman capabilities. We make sure that the rate of progress far exceeds the price. And right now, 51000 of us bright sparks are busy developing solutions for 500 customers in 18 countries across the world.

How can I help you?lifesciences@hcl.in

Please rate the following criteria for getting into an outsourcing/offsourcing relationship:

0

20

40

60

80

100

120

140

160

180

0

Not Important

Least Important

Important

Some what Important

Most Important

N/A

Cultural Synchronization

Technical Competency

& Quality Systems

Transition Plan & Governance

Structure

ClientReferrals

Time Zone Difference

Not Important

Least Important

Important

Some what Important

Most Important

N/A

Cultural Synchronization

Technical Competency

& Quality Systems

Transition Plan & Governance

Structure

ClientReferrals

Time Zone Difference

20

40

60

80

100

120

140

160

180

200

Please rate the following criteria for vendor selection:

Do you think an outsourcing partner can appreciate the complexity of your varied supply chain and support you through the consulting and executing piece alike?

Yes

If not why?

16.33%

83.67%