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Outsourcing and Trade Policies: Navigating a Complex Issue.

The goals for medical contract manufacturing run the gamut from simply finding a lower cost source for building products to finding a partner capable of supporting entry into markets where a device manufacturer has no physical presence. To best determine the ultimate goal, manufacturers must ask several questions:

* What product line(s) make sense for us to outsource?

* What outsourcing level of complexity provides the lowest total cost of ownership (TCO) relative to our requirements long term?

* What geography makes the best sense for our requirements long term?

* Which supplier has capabilities and locations that best align with our preferred strategy?

Developing a viable outsourcing strategy for an electronic medical device is often simpler than developing one for more complex, single-use devices. This is due to the fact that electronics manufacturing predominately involves assembly of off-the-shelf components and shared resources of automated production. It is not uncommon for products to be divided among at least two electronics contract manufacturers (CMs) and moved during the life of the product, as requirements change. Conversely, more complex, single-use devices are often comprised almost entirely of components designed specifically for that product. While the primary components may be molded, extruded, or fabricated on shared resources of production, the tooling is normally proprietary to that product and may have design elements or contractual agreements that limit its ability to cost effectively be moved among CMs. Similarly, at higher volumes, assembly and packaging automation is typically proprietary to the product. Consequently, moving the product among CMs over time may drive the requirement for non-recurring engineering costs and construction of entirely new assembly line automation. As a result, more complex, single-use devices often stay with a single CM for the life of the product. When the outsourcing strategy's primary goal is to make maximum use of the selected CM's capabilities to achieve lowest TCO, it is important to evaluate a much broader set of considerations than simply manufacturing capabilities.

One area often overlooked in outsourcing strategy development and analysis of potential supply chain partners and regions is the evolving nature of trade policies. Building an outsourcing strategy around a specific trade policy is a formula for failure since trade policies are subject to the political whims of change. However, particularly with complex, single-use devices, there can be benefits in analyzing both the region and the ability of CMs within the region to provide options for structuring a product commercialization process that utilizes lower labor cost production resources while mitigating the impact of trade policy regulations or tariffs that otherwise could add cost to the equation.

A good example that illustrates the benefits of evaluating this aspect in an outsourcing strategy are requirements for selling medical devices within China that are built in China. In this scenario, the manufacturer must register the product and hold the product license. For companies without manufacturing capabilities in China, this requirement presents challenging scenarios. If a CM is building the product in China, that CM will hold the license to sell the product in China. This potentially increases the risk of theft of intellectual property (IP) for the device patent holder. On the CM's side, this requirement increases product liability risk, since the CM is the registered owner of the product license in China. The device manufacturer does have the option of establishing a factory in China, but that adds significantly to the cost of market entry. Importing the product can be a viable solution, but can add complexity and may trigger tariffs depending upon the product's country of origin.

From an outsourcing strategy standpoint, the question becomes, "Is there a way to leverage regional free trade agreements (FTA) to eliminate import tariff liability and the requirement to transfer product registration to the CM?" Forefront Medical Technology has been able to leverage the ASEAN-China Free Trade Agreement (ACFTA) to offer a hybrid manufacturing solution for several projects. While this capability is not unique to Forefront, it does require a CM capable of managing the import/export side of the equation and a strategy for keeping product manufacturing cost competitive.

For example, in one project, injection molding is accomplished in Forefront facilities located in China, while assembly and packaging are done in Forefront facilities in Singapore. From a customs standpoint, the product's HS (Harmonized System) code transforms during the final assembly and packaging process and the product's country of origin becomes Singapore.

The process has some complexity. For a device to qualify under ACFTA as a Singapore-origin product, its regional value content from Singapore cannot be less than 25 percent. Additionally, if imported components used in final assembly are classified as standalone medical devices (e.g., a syringe), they must be declared by the CM and licensed by Singapore's Health Sciences Authority. The end product can be imported into China under ACFTA with zero duties and the device patent holder is able to register the product.

All that said, in order for this type of strategy to be viable long-term, it should be analyzed from multiple perspectives, including FTA flexibility, logistics infrastructure in chosen build sites, multi-build site synergy, product cost impact, available supply chain, and ease of doing business.

FTA Flexibility

In evaluating regional manufacturing strategies, it is important to consider the benefits across all potential product end markets. In this example, the tariff mitigation benefits of a Singapore-origin strategy are not limited to China. Singapore has 20 implemented FTAs with 31 trading partners, including the U.S. and the EU. While the criteria for classifying a product as Singapore origin may vary slightly by FTA and will require a separate process for each agreement, most products will qualify as Singapore origin under multiple FTAs. Consequently, this method could also be used to abate the tariff currently being applied to many products exported from China to the U.S. The Singapore Free Trade Agreement with the U.S. (SGFTA) also qualifies it as a "designated country" under the Trade Agreements Act of 1979 (TAA). As a result, products qualifying as Singapore origin under SGFTA can be sold as TAA-compliant, which can be important for products sold to U.S. government entities such as the Veteran's Administration. Products made entirely in China are not TAA-compliant.

Logistics Infrastructure

The ease of moving product in and out of the country of origin, modes of transport, efficiency of customs personnel, and availability of services such as sterilization are all important elements to consider.

Comparatively, Singapore is a regional hub in Southeast Asia with high volume air and sea transportation options. IMD's 2018 World Competitiveness rankings rate it the third most competitive economy in the world. The facility locations in China were also chosen with logistics efficiency in mind.

Multi-Build Site Synergy

When an outsourcing strategy involves multiple build sites, it is important to analyze whether the strategy will lead to inefficiencies in terms of equipment incompatibility, communication breakdown among teams, or significant duplication of effort. In the example, design platforms, equipment, and processes are standardized among facilities so teams can work interchangeably and projects can be transferred seamlessly.

Product Cost Impact

Manufacturing in multiple locations will increase cost. That said, the tariff mitigation or other business advantages facilitated by this type of strategy may cancel out that cost. Variance in regional cost structure may also need to be considered. In the example, Singapore labor costs are substantially higher than those of China. While regional value content needs to drive the determination of what elements of the product are assembled or fabricated in Singapore, production automation needs to be part of the equation in keeping costs competitive. The benefits of automation go beyond labor cost reduction. Automated assembly minimizes variation, which contributes to superior quality. There can also be opportunities to lower non-value added costs via continuous improvement initiatives, supply chain realignment, and a strong focus on logistics efficiency. Consequently, a CM's focus on design for assembly, a track record in achieving competitive cost through automation, and supply chain/ logistics expertise should be evaluated carefully. Ultimately, the costs of a single-site build versus use of multiple sites to mitigate trade policy related disadvantages should be costed out.

Available Supply Chain

Often a medical device incorporates components purchased by the CM in addition to those built by the CM. Consequently, any strategy designed around country of origin needs to ensure a viable supply chain will be available. Singapore serves as a regional medtech R&D hub within Asia. According to the Singapore Economic Development Board, more than 30 global medical technical companies are carrying out research and development efforts related to technology and product development in Singapore. This strong focus on the medical sector helps ensure availability of suppliers with the appropriate regulatory registrations and product quality standards.

Additionally, Singapore has a track record of supporting its supply chain with public-private partnerships designed to increase overall supplier competitiveness in world markets. For example, this CM recently received a grant to create a technical center focused on identification and commercialization of advanced manufacturing technologies.

Ease of Doing Business

This final area deserves analysis because it is often the source of cost surprises. The more closely aligned the partnership with a CM, the more important ease of doing business in the CM's home country becomes. Legal framework, language of business, IP protection, and government efficiency can have a significant impact on the cost equation. The World Bank's "Doing Business" survey ranks Singapore number two for ease of doing business in a survey that measures a variety of activities including trading across borders, enforcing contracts, obtaining credit, and paying taxes. Singapore ranks fourth globally and first in the region for institutional protection of intellectual property in The World Economic Forum's Global Competitiveness Report. English is the official language of business and its legal system is based on English Common Law.

Conclusion

Developing an outsourcing strategy that achieves lowest TCO requires careful analysis of a wide range of factors, particularly in categories of medical device manufacturing where tooling and custom automation make single sourcing the norm. While this article has focused on the advantages associated with the use of a Singapore strategy, the principles applied and factors to analyze are applicable in developing any regional outsourcing strategy designed to leverage FTAs in market entry or tariff mitigation. The key is looking at track record, costs, and the full range of advantages associated with each region and CM.

Walter Tarca, President * Forefront Medical Technology

Walter Tarca has served as president of Forefront Medical Technology since January 2016. He was earlier associated with Swedish global radiation therapy leader Elekta as a regional vice president for Asia Pacific. Prior to Elekta, Tarca held a number of senior positions for Covidien (formerly Tyco Healthcare) between 1992 and 2008, culminating in the role of Asia Pacific vice president and president from 2003 to 2008.
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Title Annotation:OUTSOURCING EFFICIENCIES
Author:Tarca, Walter
Publication:Medical Product Outsourcing
Geographic Code:9SING
Date:Jun 1, 2019
Words:1797
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